Q2 2021 F5 Networks Inc Earnings Call
Good afternoon, and welcome to the F. Five networks second quarter fiscal 2021 financial results Conference call.
At this time all participants are in a listen only mode. After the speaker's presentation, there will be a question and answer session.
Ask the question during the session you will need to press star one on your telephone also today's conference is being recorded if anyone has any objections. Please disconnect at this time.
I'll now turn the call over to MS. Suzanne Dulong, Ma'am you may begin.
Hello and welcome.
I'm Suzanne Dulong F EIS.
Vice President of Investor Relations.
So a lot of the new F Vice President and CEO and Frank Pelzer.
The executive Vice President and CFO will be making prepared remarks on today's call.
Other members of the F. On the executive team are also on hand to answer questions. During the Q&A session.
A copy of today's press release is available on our website on dot Com, where an archived version of today's call will be available through July of 'twenty 2021.
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<unk> of today's discussion.
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The telephonic replay will be available through midnight Pacific time April 28, four.
For additional information or follow up questions. Please reach out to me directly at S stopped due long F <unk> dot com.
Our discussion today will contain forward looking statements, which include words, such as believe anticipate expect and target.
These forward looking statements involve uncertainties and risks that may cause our actual results to differ materially from those expressed or implied by these statements.
Or is that may affect our results are summarized in the press release announcing our financial results and described in detail in our SEC filings.
Please note that F. Five has no duty to update any information presented in this call.
With that I'll turn the call over to Francois.
Thank you Suzanne and good afternoon, everyone. Thank you for joining us today I am pleased to be with you and to share with you our strong Q2 results.
For the second consecutive quarter of 10% revenue growth and double digit non-GAAP earnings growth in Q2.
We are outperforming both our revenue and EPS goals. It is important to note that we achieved Q2 strong results with a different revenue mix than we expected early in the quarter, we delivered exceptional systems growth of 17%.
The software growth was more muted than our expectation of 20%.
During this call we will discuss the market dynamics behind our product revenue mix in the quarter.
The transformation, we have worked persistently to achieve has put us at the center of applications, both traditional and modern with a truly multi cloud approach.
As a result, we are benefiting from strong and sustainable macro growth drivers of.
Ultimately powered by application growth.
The business and consumers increasing reliance on applications has accelerated all part of your expectations about the pace of digital transformation our customers across the globe are scaling the digital assets faster.
Salting and growing demand for F fives application security and delivery solutions.
With our strong overall results our conviction in our opportunity both short and long term is stronger than ever driven fundamentally by accelerating application growth we.
We feel very good about our future given robust the main drivers and our strong and differentiated market position.
I will turn the call over the fall to walk you through our Q2 results and our Q3 outlook.
Frank.
Thank you Francois and good afternoon, everyone as Francois just outlined our team delivered another very strong quarter.
Second quarter revenue of $645 million was up 10% year over year and at the top end of our guidance range.
Please note as I review, our revenue mix I will be referring to non-GAAP revenue measures for the year ago period.
Q2 product revenue of 309 million is up 18% year over year, representing a significant acceleration from 10% and the <unk>.
Same period last year, and even more so from flat growth in the second quarter of fiscal 2019.
Product revenue accounted for approximately 48% of total revenue up from 45% in the year ago period the <unk>.
Progress, we are making driving double digit product revenue growth and the increasing mix of product revenue as a percentage of our total revenue are both strong indicators of our transformation momentum and the long term health of our business model.
As Francois noted, we are seeing stronger than anticipated demand across the board.
Short term more of that demand is coming from systems, leading to the quarters product revenue mix.
Systems revenue of $201 million is up 17% compared to last year when systems were down 11%.
Systems demand was higher than anticipated in the quarter largely from broad based increase in application usage and the corresponding increase in application traffic.
<unk> growth of system space security use cases, as well as the emergence of five G driven service provider demand.
Against a particularly tough 96% growth comparison in the prior year period Q2 software revenue of $108 million is up 20% year over year, representing 35% of product revenue.
We continue to drive our transition to a subscription based model delivering record subscription volume in Q2 with subscriptions, representing 79% of software revenue in the quarter.
This is up from 73% in the year ago period.
Finally, our global services revenue of $336 million is up 4% compared to last year, representing 52% of revenue.
Revenue from recurring sources, which includes term subscriptions.
As the service and utility based revenue as well as the maintenance portion of our services revenue totaled 64% of revenue in the quarter.
On a regional basis in Q2, Americas delivered 6% revenue growth year over year, representing 54% of total revenue.
Our EMEA and APAC teams drove strong growth in their regions with EMEA, delivering 16% growth representing 27% of revenue in APAC, delivering 15% growth accounting for 20 percentage of revenue.
The quarter's strength spanned customer verticals, with especially strong demand from enterprise and telco.
Enterprise customers represented 68% of product bookings surface providers and government customers each represented 16% of product bookings, including 6% from U S federal from within the government vertical.
Let me now share of our Q2 operating results.
GAAP gross margin in Q2 was 81%.
Non-GAAP gross margin was 83, 4%, reflecting higher systems revenue as well as higher levels of managed service solutions and our usual Q2 seasonal decline in global services margins.
GAAP operating expenses were 463 million net.
Non-GAAP operating expenses were $342 million, reflecting our usual Q2 operating expense seasonality and the addition of two months of Voltaire related operating expenses.
Our GAAP operating margin in Q2 was eight 3% and our non-GAAP operating margin was 33%.
Our GAAP effective tax rate for the quarter was 17% our non-GAAP effective tax rate was 22%.
GAAP net income for the quarter was $43 million or <unk> 70 per share non.
Non-GAAP net income was $155 million or $2 50 per share.
I will now turn to the balance sheet we.
We generated $128 5 million in cash flow from operations in Q2 cash.
Cash and investments totaled approximately $662 million at quarter end, reflecting both the cash used for the altera acquisition and the initiation of a 500 million accelerated share repurchase program.
As a result of the ASR, we retired approximately $400 million of shares in Q2, reflecting 2.1 million shares purchased at an average price of $194 91 per share.
We expect the remaining $100 million of ASR related shares to be retired early in Q3.
DSO was 52 days and capital expenditures for the quarter were $9 million.
Deferred revenue increased 7% year over year to $1 4 billion.
We ended the quarter with approximately 6360 employees up approximately 200 from Q1 in part as a result of the Bolthouse acquisition.
Now, let me share our guidance for our fiscal third quarter.
Unless otherwise stated please note that my guidance comments reference non-GAAP metrics.
Near term, we expect customers will continue to invest to support application growth and the modernization of their application infrastructures.
We also anticipate continued focus on and investment in application security.
It will come as no surprise that like others in the industry, we are seeing some tightening in our supply chain. Thus.
Thus far our team has navigated it well, particularly given the stronger than anticipated systems men of.
Obviously this is an industry wide challenge and like others, we have mitigation efforts in place and we'll be watching it closely.
With that as context, we are targeting Q3 fiscal year 2021 revenue in the range of $620 million to $650 million.
We have accounted for the reduced supply chain visibility with the wider revenue range for our Q3 outlook lowering the bottom end of our range by $10 million.
While we do not expect you routinely provide product revenue mix guidance, we expect software growth for fiscal year, 2021 will be at or around 35%, implying software growth in the back half of 'twenty, one exceeding what we delivered in Q2.
Near term, we expect continued system strength with a slower growth rate likely in the fourth quarter.
We expect Q3 21 gross margins of 84 to 84, 5% and we estimate operating expenses of $338 million to $352 million.
We also expect to achieve our fiscal year 2021, non-GAAP operating margin target of 31% to 32%.
We anticipate our effective tax rate for the year will be approximately 21%.
Our Q3 earnings target is $2 36 to $2 from 54 cents per share.
We expect Q3 share based compensation expense of approximately $63 million to $65 million.
With that I will turn the call back over the Francois Francois.
Thank you Frank.
The big takeaway from our Q2 results is that across the globe. Our customers are experiencing a pronounced growth in application traffic, which in turn is driving increased opportunity for of five.
Customers across geographies and verticals are experiencing application demand well ahead of initial expectations on timelines.
The escalating demand is coming on the heels of a prolonged period of sweating assets in anticipation of cloud modernization efforts and more recently pandemic induced investment re prioritization.
With no signs that application usage will slow customers are urgently working to ensure they are able to support application traffic growth.
The results were of five is strong and sustainable overall demand for application security and delivery as well as a temporary change in customer buying behavior evident in our Q2 product revenue mix.
I will stress that while we believe the opportunity around the application demand is a long term one for a five.
We expect the current trend favoring hardware based delivery models is short term the.
There remains a durable preference for software and SaaS based application security and delivery that will once again the evident in our results over the next several quarters.
So let us dig into the quarters the main drivers.
I will frame my discussion with the three growth drivers we discussed at our November 2020 analyst day.
One ongoing software and subscription momentum.
Two systems based on demand and three growing demand for application security in both software and systems form factors.
We continue to see rising demand for application security and increasingly F. Five as seen by customers as an application security leader.
In fact, Q2 was our highest security quarter, yet with the strength spanning both systems and software form factors across both traditional and modern applications.
We're application security is threaded through virtually all of our customer interactions both software and systems for the purposes of discussion today I'll highlight the security use cases through our both the software and systems form factor of discussions.
I will start our discussion with our software and subscription momentum anchored on trends, we are seeing with application driven demand.
Our growth in modern applications continues to accelerate driven by nginx container on cloud native deployments we.
We are seeing several top use cases emerge for nginx, including API Gateway Kubernetes, Ingress controller and software based load balancing.
Customers modernization efforts and the availability of Nginx controller and enterprise level of security with Nginx on protect are also driving larger nginx deal sizes as we anticipated.
In one example, our sales team successfully layer the nginx controller with nginx of protect to enable one of the largest digital product companies in APAC to modernize more than 40 digital properties, replacing multiple competitors with nginx, plus with our protect and controller.
As a result, the customer got a much better ROI in the long term subscription framework.
Customers are also increasingly aware and appreciative of nginx is extreme volatility.
For instance.
During the quarter, we secured an nginx win with the regulatory body in APAC.
The customer was facing two distinct challenges.
First they needed to refresh their electronic payment systems and the <unk>.
They needed to deploy micro services in a vmware tons of kubernetes environment.
And your next proved the ideal solution for both.
In the first instance, the customer of move from Nginx open source to nginx plus for the additional functionality and the added benefit of World Class Global service and support.
In the second the opted for a flexible subscription agreement, which gives them the ability to scale nginx, both as a software ADC.
And as the Kubernetes ingress controller as they grow their micro services.
And they are using controller for visibility and manageability across both use cases.
Of note Nginx was the only true multi cloud solution. They found the able to work in both the Vmware environment and the cloud.
With pronounced application growth and an ever expanding threat landscape. We also see continued demand for application security in cloud environments, and rising demand for fraud and bought the fence.
With our shape anti fraud on anti Bot solutions, we are learning our win rate is best when there is significant automated traffic that can often circumvent traditional WAF protection.
This is shapes sweet spot.
As an example during Q2 of large credit Union faced a massive credential stuffing attack, which their existing WAF could not defend.
<unk> could and did.
While momentum in Nginx, and modern application security software and use cases increased in Q2, we experienced a notable shift in customers delivery preferences for application security and delivery for traditional workloads served by big IP.
We continue to see growing demand from big IP software of multi cloud environments and expect the resumption of large scale modernization efforts will remain a powerful growth driver for big IP overtime.
Short term however, we saw a mitigating factor to big IP software demand.
Which paradoxically was driven by continued application growth.
Facing escalating application traffic several customers opted to refresh and augment their existing infrastructure instead of transitioning to software or of cloud environment.
While cloud modernization and expansion of most certainly part of their future plans they chose to deploy systems now.
We expect this pattern with big IP software is temporary and will moderate in the fourth quarter of rest customers resume big IP software purchases in support of longer term strategic projects and modernization efforts the COVID-19 working conditions of made challenging.
Stepping back we continue to drive very positive software trends in the business.
Our software subscription momentum continues with 79% of Q2 software revenue coming from subscription based sales up from 73% in the year ago quarter.
In terms of volume the number of multiyear subscription agreements were up 32% quarter to quarter and more than 200% compared to last year.
In addition.
While it is early still we are beginning to hit some multiyear subscription renewals and we are also seeing positive signs there.
During Q2, we achieved a 100% renewal rates on the long term subscription agreements that expired in the quarter.
In addition, 75% of those renewals grew over prior levels.
While we've yet to hit the inflection point for renewables. We are very encouraged by these early data points.
In addition, we continue to see utilization improvements.
Our Q2 customer success metrics show long term subscription customers are achieving 100% utilization sooner than ever before.
Turning to the systems.
Part of us price value proposition is our ability to offer our customers enterprise grade application security and delivery solutions in multiple form factors systems software and increasingly going forward Sam.
Yes.
As I, just discussed southern and rapidly accelerating growth in application usage led to accelerated customer demand for systems in Q2.
Last quarter, we articulated several systems the main drivers.
Another quarter and we believe we have additional clarity around the drivers of our systems growth and we can break them into two broad categories.
One accelerating application traffic.
And two security, including emerging five G driven demand.
So a large extent I have already spoken to the accelerating application traffic.
With the <unk> application consumption customers have urgent capacity demands to fulfill.
As a result, several customers are opting to refresh and augment the infrastructure at a faster rate than we anticipated.
Of note they are doing so without a new systems platform from us.
In some cases the deployments coincide with the end of software development day, we discussed last quarter.
But broadly speaking the underlying driver is the need for application security and delivery capabilities to deal with escalating application usage.
We are seeing demand spanned geographies and customer verticals from financial services, the technology to global SaaS providers.
The case in 0.1 of our biggest systems deployment. This quarter was with one of the planets largest cloud based software companies looking to build of scale model for organic growth and the scaled within their existing systems architecture.
Similarly last quarter, we had a sizable system deployment with one of the largest tech Giants in support of the global web based collaboration platform and the scale with their existing systems architecture.
These are cutting edge players.
And in all likelihood they will be among the first to move the software and cloud based infrastructure in the future.
However, today because of the confluence of demand the complexities of deploying and scaling in the cloud and the challenges of taking on transformative projects and of COVID-19 influenced environment. They are solving their application of deliver challenges with systems from F. Five.
Wrapping up our growth drivers discussion, let's talk about system space application security, including a new driver emerging five G demand.
As we have said for several quarters now our systems business is benefiting from increasing demand for security use cases.
The cross sell of application security is driving systems growth of more customers look to consolidate vendors and combine ADC in application security functionality.
Among enterprise and government customers. We also are seeing strong demand from web application firewall and continued strength in identity and SSL orchestration.
The new driver the develop this quarter is emerging service provider <unk> demand.
We expected that as five day traffic began to flow from the video edge into service providers for the core networks.
We would benefit from increased demand given our strong position in <unk> Gi Lan infrastructures.
We initially and conservatively estimated five G related demand would begin to materialize in late 2021 of early 2022.
In Q2, we secured several Gi Atlanta expansion projects, including a large Gi Lan firewall expansion with the North American carrier.
These wins and other active opportunities suggest that we are in fact, beginning to see the emergence of forging core expansion driven by five G demand.
So what does all of this mean for our business and growth going forward.
Fundamentally we expect customers to transition to more software and SaaS based solutions overtime.
We are confident that the investments we have made both organic and inorganic and forward momentum our teams of driving position F. Five as of significant beneficiary of that transition.
This is true in the short term as Frank said, we expect our software growth in fiscal year 2021 to be at or about 35%.
And it is also true in the long term of software and SaaS based revenue accounts for a more sizable portion of our total revenue.
We expect demand for application security will continue to grow as application demand growth and customer scale and modernize their applications.
We believe that we are exceptionally well placed with the right perspective, and toolset to solve our customers' most pressing application security challenges.
Our opportunity in application security is even more exciting with the ongoing integration of F. By the bolt era, which will bring enterprise grade F. Five application security to the edge and an easily deployable SaaS model.
We expect the recent high growth rates, we have seen from big IP systems will begin to moderate in the second half of this year.
And we expect service providers five G related the men will likely begin to migrate from systems to software in 2022 of their five G cores start to hit production.
In the meantime, we see demand for systems based application security persisting over multiple quarters.
Before I close our prepared remarks, I will say a few brief words about both terra and our integration process.
We launched our integration and value creation efforts immediately following the acquisition closed on January 22nd.
We are thrilled to have anchor of singular and the Voltaire team as part of our security organization led by high end song.
While we have work ahead, we are very pleased with the initial positive customer response.
Early indicators show our vision of F EIS edge to the auto is resonating with customers.
We have started a pilot program concentrating on specific use cases and focused on bringing F. Five security to the edge with the goal of leveraging both terrorists organic momentum and early customer interest.
Through the pilot, we will develop new business as well as the right customer behavior insights.
As the first step in our long term integration of F. Five solutions on both tariffs platform.
We have begun the process of strategically and methodically combining our best in web application and API protection security offerings and.
And Volterra innovative platform.
We are also formulating our go to market approach and exploring ways to maximize the benefits with our channel partners.
Only a few months into this integration we are even more excited about the potential of this combination as we move into FY 'twenty two.
We will continue to share our progress with you in the coming quarters.
I will wrap up today's prepared remarks by thanking the entire F team of gain as well as our customers and partners.
In particular on AR.
I'll start with the F. Five team in India, the families and loved ones of the insurer of the extreme health risk and loss of life occurring there as a result of the current COVID-19 outbreak.
With that operator, we will now open the call to Q&A.
As a reminder to ask a question press star one on your telephone.
You withdraw your question press the pound key.
We will pause for a moment to compile the Q&A roster.
Our first question comes from James Fish from Piper Sandler.
Hey, guys. Thanks for the question here on I appreciate all the details from.
First of all of you really talked a lot about the near term benefits on the systems and the expectation for it to get software bookings later on in the year are there deals already engaged for that cross sell opportunity of say nginx in other parts of software that you can point to that's already happening and maybe Frank is there any way to quantify you know last quarter, we heard about.
Roughly $10 million impact from the end of development was there another kind of $10 million this quarter of kind of pulling in of demand or no.
Hey, Jim Thanks for the question.
The short answer is yes. The reason we have.
The strong pipeline of software.
Software deals both for Nginx and <unk>.
For Big IP.
That will materialize in the second half of the year.
What we did see this quarter. So if you look of the software growth drivers, Jim we've talked about three growth drivers on software.
And in the.
In that order one of modern applications second one of security and the third one is big IP deployments and multi cloud.
The first of all of driver around modern applications is going very well largely driven by nginx.
On exceeding our expectations and driven by.
The addition of the controller and security on Nginx and more and more.
Customers deploying modern applications in these cloud native and container native environments. The second driver of security also going to plan.
With more and more customers.
Deploying stocks of security either of these modern application environments or on top of the traditional applications. Both in systems, but also in software form factors the third driver of software.
Software growth is really the deployments of big IP into multi cloud environments, and specifically some customers migrating from systems to software first or cloud first environments and whilst we see continued growth on those big IP deployments.
But we did see this quarter.
It's a bit of of moderation as on that specific driver of customers that really need to increase the capacity to support application usage on application growth a lot of them chose the most expedient way to deploy that capacity.
Which is in hardware, whether operationalized and don't have the either the time or the mechanism right now because of the COVID-19 environment too.
To go and think about re architected things and moving to software, we do things of that will resume.
In fairly short order. So we're very confident about the software growth both for the second half of the year and for 2022.
Jim specific to your second question I think the end of that software.
The the end of software development cycle that we saw in the beginning of April that was one trigger but it's really hard to split out exactly the dollar wise what was the drivers from everything I think the others that we have to include in there all of the capacity expansion that transfer I'll spend a lot of time talking about in the prepared remarks.
The customer's depreciation schedules and then just there and the ability to continue to sweat the assets that they have probably for a couple of years now some.
Some re prioritize budgets on a few other factors if I had the quantify it I think it's probably about the same as it was last quarter, but there are a lot of other factors that went into the strength of of hardware.
Yes, totally understand and appreciate that and just one more follow up from me if that's all right.
Obviously, a lot of major breaches occurred before you reported.
Last time, and really that pipeline haven't had a chance to necessarily build too much.
I guess what are you guys seeing obviously youre talking from some really good security results on including the carrier side not just the enterprise side.
Yes.
Anything to call out regarding that security pipeline for WAF, given what happened with those breaches on are there areas of security you guys might look to expand into to kind of bolster the portfolio overall.
Hi, Jim.
Is your question specific to <unk>.
Yes.
Okay. So.
On <unk> and specifically on the web application firewalls on.
Jim we continue to see good traction there.
It's one of them.
Most in demand use cases from our customers we have seen that traction this quarter happened both in hardware form factors.
Either of Standalone form factor or with customers.
Sometimes of bundling that with ADC.
We also see.
Demand for web application firewalls in these modern application environments.
We really pleased to see the traction with nginx of protect.
Which as you know is the.
In fact, we're seeing of having made the decision to port our security capabilities onto nginx shortly.
Shortly after the acquisition that's getting a lot of momentum now so we're getting embedded for security in the modern apps environment.
And we.
We also see that with the big IP in terms of the portfolio.
Jim we really.
Our focus on the.
The web application firewalls application security in General API protection.
On a dos protection and Bot management and mitigation those of really the the areas of application security where.
We are we are placing focused on significant investment for the near future.
Thanks.
Your next question comes from meta Marshall from Morgan Stanley.
Great. Thanks.
Maybe a couple from me just on the first is there an organic software growth number that we have for year over year, I guess, excluding kind of of that two months of altera.
That would've been included and then.
And just maybe on kind of extrapolate on the last question, but just.
Now as you're deepening question deepening of conversations on sales.
The encompass kind of more than one product or what are you kind of seen as far as sales cycle for cross sell opportunity versus maybe a point product. Thanks.
Yeah. So.
Let me take the first one and then I'll, let kind of I'll take the second.
I think we talked about we were not going to split out of altera, because it is rather immaterial and I mean super of material, especially this quarter with the only only two months so.
It's not enough to move the growth point.
So I would just say.
Rather immaterial to the to the results of the operations it becomes a critical asset for us, particularly on the out years and we're really really excited by the excitement that we've seen within the customer base and our sales force already but in terms of the actual revenue results really nothing to speak of from Alterra, but I'll, let francois draws together.
Yes, I mean in terms of cross sell opportunities.
A couple of things, where we are really pleased is we are seeing more and more customers of the five adopt multiple elements of our portfolio.
And so more and more of the multiyear term subscription agreements that we are.
We are selling.
Hum multiple.
Products from the five.
And it's allowing us to elevate the conversation with our customers.
Really.
The elevate the the position of about five and a lot of these large accounts.
And we're really pleased with the traction of these agreements.
In fact as of as a data point.
On the software multi year subscription agreements.
We're up 200% year on year in terms of the volume of transactions that we completed the.
This quarter relative to Q2 of 2020 and this points to the number of our customers.
But I'm moving to the ton subscription agreements, where they can easily consume multiple of our products.
In terms of specifically of.
Our progress on the new point solutions, I think Voltaire ice too, it's really too early for us to speak to that because we are.
Basically fill through the integration porting our capabilities on.
On to the Volta platform, including our security. So it's more over the next few quarters that we'll be able to speak to deals that are coming through on Volta and then on shaped specifically.
Where we are we are pleased with the value proposition the customers that.
Shape are extremely pleased with the efficacy of the solution is best in class a lot of times, we see customers who are.
You know actually already have solutions, perhaps from.
Another vendor like of CDN vendors, but they are still under attack.
And we come in with shape and have a higher efficacy solution can solve those those attacks as a point solution.
Where we are seeing things take longer than we would've liked is in the COVID-19 environment.
When you have to go through of proof of concept.
The mechanically it's actually difficult to go through it.
And we're finding that in this environment big incumbent and operationalize, the big advantage, but when you're trying to introduce.
New solution that requires the proof of concept the sales cycles of bit elongated and it takes a little bit of time.
And I would say that overall as the the picture on cross selling the various elements of the portfolio.
Got it that's helpful. Thanks.
Thank you, Matt our next growth.
Your next question comes from Sami Badri from Credit Suisse.
Hi, Thank you for the question and congrats on the solid results.
The Francois in your prepared remarks, you talked about escalating demand you talked about some of these other tailwind, including five of G security and just service providers going forward.
I guess I think the big question that we have is as you see the incremental big drivers starting to come in and how that actually impacts. Your full year Guide is the reason why you guys aren't.
Of the position yet to increase the hurt.
Rising to guide points.
At this point or is there.
The reason why you're being a little bit more conservative about the growth outlook and why not to increase of the outlook.
Yes.
Yes, Tommy I think there are a couple of things.
We are horizon two is as you know in each quarter.
Our net quota period, we are two quarters into into that so generally we feel it would be really early too.
Make any change to our horizon two guidance.
On.
But I think the.
What we can say is a couple of things I think.
We are definitely seeing those trends of application usage.
Go up significantly.
As a result of.
Most of most of US frankly consuming more things on line and so more and more of our customers.
See more usage on the application whether they are traditional enterprises or even cloud providers. As you know we are we are embedded in them.
SaaS provider of stock or even cloud providers I think you've heard me say before that.
Somebody's clouded somebody else's data center and we are in those stacks and the number of our cloud provider customers of seeing escalating demand for their solutions and they have to go.
The capacity as a result, and we're benefiting from that directly so we're definitely seeing that.
As a result of that we can definitely say that.
Our hardware for 2021 will be in positive growth territory for sure given what we've seen and even for horizon two.
The performance of our systems will be materially better than what we thought it would be at the beginning of the horizon.
I think those are the things we can say, there's a little bit of uncertainty, we're dealing with the supply chain challenges that all vendors.
I think are seeing at the moment and so we're a little cautious about that and we share in the in the prepared remarks I think from shared that we took that into account the little bit in our in our guidance range, but.
But in terms of the underlying demand.
It is very strong.
Got it thank you for that.
And then I just wanted to visit U S federal demand.
On the presidential administration has been very active to raise the secure funds and modernize a lot of infrastructure.
Are you on you guys came in I think relatively in line on your number for U S. Federal fiscal two Q, but when we think about the rest of the year and how things are going with the U S. Federal could you just give us a bit of an update in terms of how that is looking.
Just if you can get an idea.
You know I think Sami on that.
We don't see a fundamental change in the demand trends the fed business has been pretty strong and we expect the to follow kind of normal normal patterns.
Given given what we've seen the pipeline today.
Got it got it thank you.
Thank you Sandy.
Your next question comes from Tim long from Barclays.
Two two questions if I could first.
Could you talk a little bit about the cloud vertical which you broke out last fiscal year I think is on $100 million can you.
Just give us an update how growth has has trended in that.
And that vertical that piece of the business.
And then second.
On the software ramp for the second half of the year it.
It sounds like visibility is pretty good could you just give us a little more color. It's after a few quarters of kind of flat it looks like a pretty big dollar growth.
Are we to expect some elas or anything like that in the numbers to help.
The sequential revenue increases given that most of its kind of be on subscription I would assume if not you would need.
Kind of a big scale of of subscription deals. So any color you could provide there would be helpful. Thank you.
Thank you.
Thank you Tim.
So let me just start with the second part of your question on software growth in the second half and then I'll.
I'll come back to the first part.
On.
So in terms of the second half of the year in software.
There are a number of catalysts and drivers that have continued to gain strength I talked about nginx, a little earlier, but these modern apps environment, we see them continue to.
To grow.
We have in fact, a number of.
Subscription agreements in the pipeline, but I would say the.
The predominant factor is that the volume of <unk>.
Software multi year subscription agreements that we are signing is just growing extremely rapidly.
They grew sequentially from Q1 to Q2 of the grew roughly 30%, but if you look at it on a year on year basis, the volume of subscription agreements was up 200%.
It just continues in that in that direction. So we're getting visibility to this.
Well at some point, we're going to hit also of the inflection point on renewals of the subscription agreements. We're not quite there we think that's more of of 2022.
The effect, but even what we're seeing today from the renewal rates.
Of the ones that are coming to the term and the true forward.
On the ones that have more than a year of maturity.
Those metrics are just excellent.
At the moment so the catalysts are.
Important security continues to be a growth driver and the catalyst for growth.
In software and then the cloud and I want to come back to the first part of your question. The cloud continues to be of growth driver for our software. However, this quarter it was a little less.
In terms of the the growth rate and the reason for that is because we think that there was a moderation in the number of customers migrating.
Applications to the public cloud the and specifically migrating more of these traditional applications the sort of cloud.
And we think this is back to the the effect were seeing on our hardware business where.
Customers really sweating their assets.
The long period of time.
Hey, we don't want to deploy any more hardware because we are going to migrate to the cloud and what we're finding is a lot of them after having sweated their assets for a long time are caught with increased in the capacity needs that they have to serve very quickly.
And the operationally the the best on the easiest way to do that is to actually.
On <unk>.
With the go with hardware and so we think.
When you factor on top of that the fact that word of COVID-19 environment that moving from hardware to software of moving from hardware to cloud requires either we architecture or working in collaboration across multiple teams, which is much more difficult to effect in this environment.
And then we're seeing that most customers are able to do that at the moment, we think overtime.
But the trend will continue towards these cloud migration, but this this quarter it was a little more muted.
Okay. Thank you very much.
Thanks, Tim.
Okay great.
Just wanted to full start of with the implications of the reprivatization of spending that you're talking about towards the bit more systems.
You also talked about the five G. Spain, no as you put both of those together.
Think about the longer term is the outlook still for the systems to decline in the mid single digit range on it.
It does some of the three privatization of the increase in five of Chi does that change of one on how you think longer term of what systems and have followed.
I used to make.
It depends on what.
By longer term, so I'm going to speak with the within horizon to some inc.
You know as I said before I think 2021, we will see for the full year, our systems business will grow.
And for 'twenty for the combination of 2021 of 22 I think performance.
Performance the systems will be better than what we had anticipated at the beginning of the horizon, which was.
Which was high to mid single digit decline I think it will be materially better than that.
In terms of what this means.
Longer term frankly, it's too early to predict beyond the horizon to I would say in terms of the hardware ADC space.
Space, we think hardware adcs per se.
Those are in secular decline and should decline and continue to decline over time beyond the on horizon two.
We're not seeing that in hardware security today.
We continue to see growth in hardware security and that represents more of a mix for us so well to too early to make a.
The termination in terms of what.
What's happening beyond 2022.
Specifically when it comes to service providers, what we are seeing some make is.
Right now a lot of carriers have.
Put in place there five G radio as you know of the first smartphones with <unk> have come out in the fourth quarter of 2020 of lot of the spectrum auctions have happened and so we're now starting to see utilization of five G from the devices into the radio and that is coming into the carrier core.
Works now most of these carrier core networks are still <unk>.
And we have a.
Very strong presence in a lot of the infrastructure and so the capacity requirements of fulfilled by forging capacity upgrades and that's that's providing tailwind to our hardware business and I expect that to continue for the next couple of quarters, probably a little longer now actually go into 2022 a lot of these.
Carriers will start to put in production there five G core.
The goals of Virtualized, and so of that opportunity will turn into a software opportunity four of five.
And we have already alright.
<unk> already won significant design wins for the five G cores and we're in the process of doing.
The first office applications and pilots and things like that before going into production.
In the next six to 12 months. So it's a it's of hardware expansion opportunity today and over the next 12 months. He will it will move to be a software opportunity.
In <unk> Courseware F five.
Got it.
Just as a follow up looking at the growth trends across the different geographies I'm just trying to.
Get a better sense of the the beauty of would it be we are seeing like Americas was the strong growth.
Strongest growth geography for you last quarter on it.
Moderated significantly in terms of the growth rate was still growing with EMEA and APAC line.
Driving the growth this quarter or is it like something on the ground thats impacting it in terms of late sales force et cetera on like what's really driving that amount of <unk>.
The performance by geography.
The there is the really.
Anything of note I would say the the service provider.
Vertical we had some important expansions in the EMEA and APAC.
That helped drive the the growth there.
But I wouldn't put too much into the quarter to quarter variability into the geographies overall some of the strength in demand that we're seeing.
Both in hardware and in the software.
Subscriptions that I've talked about that is across the board and across geographies.
Okay. Thank you thanks for taking the questions.
Your next question comes from Alex Henderson from Needham.
Thank you very much.
So.
I was hoping you could talk a little bit about.
The.
Transitioning to hardware in the context of the launch of the integration of the Beacon technology and the platform last year in the spring.
Which does tie in the.
The Cooper netting and.
Ingenix oriented products back to the.
The big IP.
To what extent.
You may be seeing some refresh of their in those systems because the.
Admin administrator of the CIO.
<unk> is able to bring some controlled back into the Dev ops process and use that integration between the big IP to the.
Two the <unk> product to put guardrails in front of the Dev ops people is that part of what's going on here as well or is it just simply the last year you couldn't do installs because things were.
So we'd locked down but.
The installed base engaged in the airport and even the upgrade.
Could you give us a little bit more clarity around that and then the other piece that is with kubernetes the adoption in the according to a recent <unk> the numbers the two.
<unk>, what it was a year ago.
And 96% of the.
Companies, saying, they're going to go with multi cloud can you talk a little bit about the what kind of integration you're doing with hashi in the partnering how your partnership the Patchy Corp is true.
Studying up thanks.
I like the Cara.
On the.
Good to talk to you on on the transition of hardware I mean, we talked through a number of factors that are driving the strength and the robust demand that we're seeing on hardware today.
One of those factors I do believe is around the strength of the portfolio.
Is coming together and customers are seeing of fives relevance and modern applications on strong relevance and security use cases, and certainly that's playing into some of what we're seeing.
I'd have to.
I really do you think on if you go back to the sort of scrap than what Francois has already addressed in the questions. The the robust demand that we're seeing is really more of of the latter of that latter factor that you described.
So that's at least the answer to your first question on the second question in terms of what we're doing with hashi.
We have a partnership with hashish, we have several integrations and the big IP space.
Around various elements, including we make strong use of terraform integrations to enable automation for our customers and.
And to simplify the deployments into into public clouds and in addition, we're also looking at how we have to have the integrations in the place to tie more into some of their their orchestration tools like console.
Automate the appointment and provisioning of big IP offerings.
Great. Thank you very much.
Thank you Alex.
Your next question comes from Jeff <unk> from Wolfe Research.
Thank you very much Frank can we start with you with the question on the guidance. Please could you help us parse kind of what you're thinking at the high end and the low end.
What the impact of the systems mix would be in there we typically when companies widen the range. The offered widened on both ends you why is it on the lower end of them.
Wondering what kind of expectations and variables are built into that range.
Sure absolutely Jeff so.
We were looking at all the factors coming into setting the guidance expectations and then in the normal cycle, if there werent any.
On the supply chain concerns, we would have said $630 to $6 50 was 640 as the midpoint and taken into account.
What I talked about in regards to just some less visibility than we would normally like on some of the supply chain components.
We wanted to make sure that we gave the additional room of the $10 million on the low end and so that's that's the result of the range.
On a perfect world it would still be that $20 million range, but we just wanted to be cautious with our outlook.
Are you more concerned that you might not get what would have been at the midpoint of six.
40 number.
Or are you more concerned that the mix might shift more heavily the systems than you thought.
No I think.
When we take a look out at the mix that we expect in the way that we talked about.
Being at or about that 35% for software for the year.
We're very comfortable with that with that outlook on on the software side of the services, we didn't give the exact numbers for that and what the remaining is the system size itself.
But when we take a look at the 10 million of risk, we see that $10 million of risk really in on the supply side certainly not on the demand side.
We've talked about the.
The multiple factors the day.
Demand is quite strong.
And then I guess lastly.
I think we would all look forward to a little bit more.
Their trajectory in the software side of business I think you had suggested that this march quarter was the last because usually really tough comp period.
How how close are we there having a more volatile or less volatile software of number from quarter to quarter.
Yes again.
I can't say with 100% clarity, Jeff, but I think to think two factors that I that I say on the back half of ryzen too and so when we're taking a look at.
The fullness of FY 'twenty, one and FY 'twenty two we knew this was a 96% comp quarter for us going in and that there was going to be some variability obviously in the last quarter we had.
70% with a 35% without and so the.
The the that range was right there, where we thought it was going to be and we think it's gonna be a bit smoother from here. They will continue to be variability when we start to see a lot more clarity on when we start to lap some of the multi year subscription agreements and the bulk of that is going to happen in the back half of it.
Slide 22, and so we do have.
Four more quarters of what I would say no variability I don't think the Choppiness will be what you saw between Q1 and Q2 of this year that we will continue to have some variability on that.
But.
Starting in that lapping period, and then frankly the denominator just got so much bigger. So you don't have things that swing right. We will we will start to see see that as well with the SaaS piece of the subscription continuing to grow as well. This is more when we take a look even beyond horizon to.
That will become a lot more ratable in that in that factor in sort of things out and so we do have some more choppiness ahead of us, but I think things really do start to smooth out when you take a look of the back half of 'twenty two and beyond.
Thank you. Thank you both very much.
Due to time constraints, we will take on our last question from Paul Silverstein from Cowen.
Awesome.
The five questions from them.
Great.
No I do appreciate you from me.
The first off first of all apologize.
I know you've addressed the.
This and other responses and if you fully address I do apologize, but I've got to ask you first off.
That is probably not of both student so youre not going to get credit from the investment community of the hardware strength slide.
So I just want to make sure that I heard you correctly, you're asserting that the software of weakness relative to your original expectations is entirely a function of.
The number of customers unexpectedly opting for traditional hardware systems.
Virgins June addressing the strong application growth and security needs is that what you're saying or is there something else in particular is there any underlying weakness in salt and software demand.
So the.
The.
The wheat. So if you look back there are two factors for if youre, specifically, Paul referring to the software growth rate of 20%.
Versus the 35% to 40% for horizon two.
The two factors one of course is that as Franco just alluded to it was the high comp relative to last year, but yet the the other primary factor is customers that of that pause the moderated on migrations to software due to operational constraints.
And that is reflected in the higher higher hardware number and a lower software growth number and that is very specific to the big IP. It's not specific so in the other aspects of our software portfolio around nginx and security.
We had very strong growth in fact, nginx grew faster than overall product revenue again.
But specifically with big IP.
The softness if you will in software there.
Is directly correlated to customers choosing unexpectedly to us that it was a little bit of a surprise to us choosing to go to.
The hardware form factor of instead of a software form factor and the number of cases I would also add Paul.
When you step back and you look of that the.
The overall demand for F. <unk> technology is very strong and as these customers.
We continue to deploy big IP.
It increases our footprint and when they do migrate to software they won't migrate what else we've already proven that for the.
The last three years, they won't migrate on our big IP software form factor.
So for those customers that did that it is the temporary delay the moving to software.
But there's absolutely there a substitute to the effect of customers pausing on software going more on hardware.
Because they were a little caught by surprise by the surge in application demand and given the COVID-19 environment and the inability to.
We architect and work across teams to go to the software they chose to continue on deploy hardware form factors.
Understood that's it for factory choice on what you're indicating.
Those customers choosing true men on the hardware will eventually migrate to software.
Not indicative of weakness on software per se, it's a form factor of choice, let me move on.
I appreciate you mentioning rather than the next grew faster than overall growth.
Any metrics you can say with respect to shape on.
Or anything above what you just said about the generics in terms of quantifying.
What youre seeing from those two acquisitions I recognize the butcher still at a very nascent stage of which it sounds like it is but anything you could add in terms of revenues of order book of all the metrics that you could offer providing more color of some progress on certain genetics.
No I mean, we shouldn't we shared the.
Paul as you probably remember at the same sort of important metrics about the growth in the or for four shape since the acquisition.
And the growth in the number of customers. We have continued to see growth in the number of customers I would say the growth specifically the growth.
In the are with the shape this quarter wasn't as strong as we wanted.
And that's largely because we.
I was saying earlier of that.
The customers for which we need to do a proof of concept in the current environment.
For the same reasons.
Some ways are keeping customers on hardware on the big IP.
Affecting the proof of concept when people are not in the office and have to work across teams and collaborate on connect different systems together for proof of concepts the happen, it's operationally a little more complicated.
It takes more time and.
And it takes more motivation for customers to go and do that.
And so when customers are insignificant pain and they are under attack it moves extremely quickly.
When they're not it doesn't move as fast as we want to.
And that's part of what we saw this quarter with the wood chip, but overall when you look at the efficacy of the solution and the the.
The satisfaction of customers and the way in which it's blocking an increasingly high number of automated attacks were very very happy and.
We think this the thing about the difficulty of Operationalize, Inc. Proof of concept on getting to our sales cycle is really a temporary thing with the.
With the COVID-19 that will go away down the road.
Finally, the first of all of its just a clarification.
Spots from a previous question that you had.
With respect of macroeconomic recovery and what Youre seeing on a regional basis I recognize it's still early but given that the U S and UK in particular, the appear to be well ahead of Europe.
Perhaps the other countries in terms of vaccination rates any data points in terms of order book in the U S and U K road the metrics that would suggest.
What you should expect from other countries and regions as we mentioned the return of the 21st century.
I would say generally Paul no I don't I don't think you know what.
When I look at the patterns of spend for us.
This quarter it was one of the system.
Last quarter.
So you remember Paul I want to say three years ago, we felt in Europe in particular, we had a situation where the.
The uncertainty of Brexit was weighing down on the on a.
Numbers and we could feel we could feel the spending pattern there of being really different.
This quarter in the last quarter I wouldn't say, we don't we don't feel that kind of difference what we are feeling across the board is this everybody's gone digital the using the digital channels more and more and it's causing the the applications traffic through the continued to grow steadily.
And that's we're seeing the same in Latin America.
Europe.
North America Asia, we don't see the difference related to COVID-19 and where people are are at and vaccination rates or coming back to the office, it's not really up for sort of affecting our business at the moment.
I appreciate the responses. Thank you Russell.
Thank you Paul.
I'll now turn the call back over to the presenters.
Thank you all for joining us today, we appreciate it.
As we said the costs recorded in the replay will be available on our website have a great day.
This concludes today's conference call. Thank you for participating you may now disconnect.
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Okay.
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