Q1 2022 F5 Inc Earnings Call

Good afternoon, and welcome to the F. Five incorporated first quarter fiscal 2022 financial results conference call. At this time, all participants and then listen only mode. After the speaker's presentation. There will be a question and answer session to ask a question during this session.

You will need to press star one on your telephone.

Today's conference is being recorded if anyone has an objection. 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, <unk> Vice President.

<unk> of Investor Relations.

That's why we will go to new Vice President and CEO , and Frank Pelzer Executive Vice President and CFO will be making prepared remarks on today's call.

Other members of <unk> 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 at <unk> Com, where an archived version of today's call will be available through April 26 2022.

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To access the replay of todays call by phone dial 805, 858367, or 4166214642 and used meeting I D 680 79935.

A telephonic replay will be available through midnight Pacific time January 26, 2022.

For additional information or follow up questions. Please reach out to me directly and as talked too long.

<unk> com.

Our discussion today will contain forward looking statements, which include words, such as belief 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.

Factors 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 <unk> has no duty to update any information presented in this call.

With that I will turn the call over to Faisel.

Thank you Suzanne and Hello, everyone. Thank you for joining us today.

Our strong fourth quarter results demonstrate our customers' needs to grow and evolve the application.

Art and drive their businesses.

Customer demand and our portfolio driving 10% revenue growth in Q1, and our first consecutive quarter of double digit revenue growth.

Underpinning our top line growth is 47% software growth, 1% systems and to put the global services growth in the quarter.

In fact, both software and systems demand exceeded our expectations in Q1 contributing to our outperformance.

Epicenter of digital transformation and application security.

We are differentiated by our focus.

Expertise and the <unk>.

Vision and technology assets to secure and deliver in the application.

Sure.

As a result, we have seen strengthening demand across our software portfolio and persistent strong demand for our system Niccolo.

My colleagues in the industry.

Late 2020.

I've been Turkey progressively more aggressive steps to manage supply chain.

These include preordering components investing to secure supply qualifying and sourcing alternate competence and purchasing on the open market to fill gaps that arise over the last year stronger than expected demand for system, coupled with ongoing supply chain constraints.

Our systems revenue growth.

As a result.

Strong system demand our systems backlog continued to grow in Q1.

Over the last 30 days suppliers of critical components that span a number of our platform have informed us of significant increases in decommission. These came in the form of order delivery delays and southern and pronounced production and shipment quantities.

That function decline in component availability.

MS Lee will strengthen our ability to meet our customers' continued strong demand processes.

Challenge is acute in Q2, and we expect Q2 revenue in the range of $610 million to $650 million. As a result, this revenue range reflects a $60 million to $80 million shortfall in our ability to ship in our.

Second quarter versus what we would've expected upset these recent supply chain constraints.

Based on the information we have today, we estimate that increased supply chain limitation a lie.

We saw a net $30 million to $90 million impact to our prior revenue guidance for fiscal year 2022.

We are aggressively working to mitigate the impact of two primary getting supply challenges near term.

Like others in the industry.

We are seeing worsening availability specialized networking chipset.

Within the last 30 days, we have learned that deliveries for 52 week lead time components ordered a year ago have been pushed out and our expected quantities have been reduced.

Second we also have experienced significant spend.

Our standard somebody conductor components, we are working to design and qualifying replacement components to resolve these standard component challenges.

While we are unlikely to be able to do so in time to mitigate production shortfalls in Q2, we expect that we can mitigate the impact on the second half of our fiscal year.

In addition to continuing to work with our suppliers. Our sales teams also will be working with customers to fulfill their demand with alternative offerings.

Some cases customers may be able to qualify and ship demand for recently introduced platforms that are less affected by supply chain issues, because they use more readily available components.

Now, let me be very clear.

The main drivers across our business are stronger than they have ever been while near term supply chain challenges may disrupt our revenue growth trajectory short term fundamentally they do not change the significant opportunity we have to solve our customers' most critical application security and delivery challenges.

Nor does it change our longer term growth potential.

Our software transition continues to gain momentum in fact, we now expect to be closer to the top end of our 35% to 40% software revenue growth range for the year. In addition system demand exceeded our plan in Q1 and remained strong headed into Q2 because of the strong demand.

Signals, we see and our confidence in our longer term trajectory, we will continue to invest responsibly in our business and will not make any dramatic changes to our operating model short term.

While this will mean near term pressure on our operating margin.

Best positions us to continue to capture our growth opportunities and long term earnings perpetual we expect to return to our previously forecasted operating margin profile as we return to full manufacturing capacity.

Our Q1 customer wins offer great insights to both our momentum and the opportunity ahead for instance for Bayesian application security threats like log forging literally demonstrated why every application needs web application firewall protection as a result, we are seeing heightened interest in <unk>.

Wap solution for both traditional and modern applications.

And just one example, during Q1, a customer selected nginx with Alphatec.

Whilst protection closer to the container is deployed by <unk>. This is in addition to the advanced WAF operated by traditional Chekhov seats.

We also see growing demand for fraud, and Bot defense as an example in Q1 one of central America's most prominent banks, we're still struggling with data security despite deploying multiple security solutions.

<unk> selected our ships solution to defend the game persistence automated attacks shape dramatically reduce the customers' automotive traffic successfully reducing consumer friction across their digital channels. She is also providing broad based analytics for improved application security and visibility finally.

Customers modern applications are moving into production and experiencing significant and constant swings and user demand as a result, they need infrastructure that scales up automatically to meet user demand are down to <unk> cloud costs for instance, during Q1, an American multinational.

Investment Bank and financial services customer selected and generics to help modernize the kubernetes based applications.

The customers existing solution was unable to provide multi site resiliency for a service running within kubernetes clusters, the customer selected nginx plus to provide multi cluster multi site fail over.

Customers are increasingly looking to <unk> to help them solve an escalating volume of application security and delivery challenges and multi cloud challenges and more enough challenges like scaling kubernetes based apps into production.

These challenges and the complexity the NPL are only mounting for our customers.

<unk> as an innovator uniquely equipped to help them build and scale, both traditional and modern application environments.

And the cloud ready capabilities, we are building with our whole Tara and Westpac integrations, only enhance our positioning and appeal.

I'll now turn the call to Frank to review, our Q1 results and our outlook.

Frank.

Thank you Francois and good afternoon, everyone I'll review, our Q1 results before providing our Q2 outlook and updated fiscal year 2022 guidance.

As Francois outlined our team delivered another very strong Q1.

First quarter revenue of $687 million is up 10% year over year and above 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.

Q1 product revenue of 343 million is up 19% year over year, representing 50% of total revenue.

Q1 software revenue grew 47% to $163 million, representing 47% of product revenue up from 38% in the year ago period.

Systems revenue of $180 million is up 1% compared to Q1 last year.

<unk> a revenue picture, we see continued strength from our global services with $344 million in Q1 revenue.

This is up 2% compared to last year and represents 50% of revenue in Q1.

Taking a closer look at our software revenue subscription based revenue represented 81% of total software revenue up from 77% in the year ago period.

Subscription based revenue includes a ratably recognized as a service offerings and our solutions sold as term based licenses.

Revenue from recurring sources, which includes term subscriptions as a service and utility base revenue as well as the maintenance portion of our services revenue totaled 68% of revenue in the quarter.

On a regional basis in Q1, Americas delivered 17% revenue growth year over year, representing 59% of total revenue EMEA was flat year over year, representing 24% of revenue in APAC delivered 2% growth accounting for 18% of revenue.

The strength in Q1 spend customer verticals as well.

Enterprise customers represented 71% of product bookings in the quarter service providers represented 15% and government customers represented 14%, including 4% from U S. Federal.

I will now share our Q1 operating results.

GAAP gross margin was 83% non-GAAP gross margin was 83% along with our increased component prices. We anticipate continued pressures related to our supply chain in the next several quarters.

We expect these pressures will result in some increased cost related to expedite fees and sourcing of long lead time components.

GAAP operating expenses were $438 million.

non-GAAP operating expenses were $345 million.

Our GAAP operating margin in Q1 was 16, 6% non-GAAP operating margin was 32, 7%.

Our GAAP effective tax rate for the quarter was 16, 3% our non-GAAP effective tax rate was 19, 5%.

GAAP net income for the quarter was $93 6 million or $1 51 per share.

non-GAAP net income was $179 million or $2 89 per share.

I will now turn to the balance sheet.

We generated $90 million in cash flow from operations in Q1, we.

We tend to see cash flow dip in Q1, as a result of the timing of cash receipts and billings amongst other factors.

Q1 cash flow is below our recent range because of two primary factors.

First we had strong multiyear subscription sales in the quarter as a reminder, our multiyear subscriptions are generally sold on three year terms.

We built only one third of the contracted signing with the remainder going to Unbilled assets.

During the quarter. We also had some significant prepayments with our contract manufacturer associated with the components for future builds DSO for the quarter remained strong at 55 days.

Cash and investments totaled approximately 936 million at quarter end.

During the quarter, we repurchased approximately $125 million worth of five shares or approximately 539000 shares at an average price of $232 cap.

Capital expenditures for the quarter were 11 million deferred revenue increased 16% year over year to 1.5 dollars 76 billion up from 135 9 billion.

Growth in total deferred was largely driven by subscription and SaaS bookings and to a lesser extent deferred service maintenance.

Finally, we ended the quarter with approximately 6550 employees up approximately 90 from Q4.

This includes employees added with the threat stack acquisition, which closed in the quarter.

Francois shared our Q2 revenue outlook and our updated fiscal year 2022 outlook in his remarks, a recap our full Q2 guidance in fiscal year 2022 updates with you know.

Unless otherwise stated please note that my guidance comments reference non-GAAP metrics.

Let me start with Q2, we expect Q2 revenue in the range of $610 million to $650 million as a result of supply chain related systems production constraints.

Taking into account continued component cost increases and the cost related to actions. We are taking to mitigate supply chain pressures. We expect Q2 gross margins of approximately 82 to 82, 5%.

As Francois discussed because we believe the current supply chain challenges are transitory and do not reflect the underlying growth trajectory of the business, we do not intend to adjust our operating model we.

We believe doing so would risk compromising our ability to deliver future revenue growth.

As a result, we are likely to see operating margin pressure in Q2 and for the next several quarters I'll remind you that historically Q2 is our seasonal low for operating margins as a result of the annual payroll tax and retirement benefit resets.

That said, we estimate Q2 operating expenses of 357% to $371 million.

We anticipate our full fiscal year effective tax rate will be in the range of 20% to 21%, including the impact of our 19, 5% Q1 tax rate with some fluctuations quarter to quarter. Our Q2 earnings target is $1 75 to $2 15 per share we expect Q2 share based compensation.

<unk> of approximately 65% to $67 million.

Let me now review our updated fiscal year 2022 outlook, we expect fiscal year 2022 revenue growth in the range of four 5% to 8%, reflecting a reduction of $30 million to $90 million to our prior fiscal year 2022 revenue guidance.

The higher end of this range provides for the potential of some additional supplier documents. It does not however, assume another step function deterioration from the level of Decommit, we have seen recently.

We continue to be very confident in our software revenue growth range of 35% to 40% and expect to be closer to the top end of the range for the year.

We also anticipate global services revenue growth of 1% to 2% for the year.

Like other vendors, we have seen component cost next diet piece escalate over the last year.

As a result in December we announced we would be implementing a price increase of approximately 8% sure I series appliance platform effective February one.

We expect this pricing change will begin to positively impact gross margins in the second half of our fiscal year.

We expect non-GAAP operating margin in the range of 29% to 31% for fiscal 'twenty, two with Q2, representing the low point for the year and operating margins improving in Q3 and Q4, we remain committed to regaining our target rule of 40 operating benchmark where the combination.

Of our revenue growth and non-GAAP operating margins totaled 40.

We also remain committed to repurchasing $500 million in shares during the fiscal year.

With that I will turn the call back over to Francois Francois.

Thank you Brock.

In closing I'll note that we are making very good progress with novel Piran threat back integration and you will be hearing more about our resulting SaaS based solution offering very soon.

Our laser focused on doing everything in our power to mitigate supply chain impacts for our customers.

Our future growth and a long term opportunity will be driven by our software and are imminently launching software as a service app security and delivery solutions.

While we are solely disappointed that supply chain challenges up get it our ability to fulfill customer demand consistent in the near term.

More confident than ever in our production our strategy and our long term opportunity.

Our Q2 pipeline is strong and we have good visibility into demand for the back half of our fiscal year.

Our customers are faced with ever increasing performance expectations for their application while at the same time scaling to meet unprecedented demand and evolving their architectures to enable production scale container based infrastructures.

With our adaptive application vision and our ability to serve any app anywhere.

<unk> brings cloud ready solution that close the gap between customers traditional and modern application environments.

Finally, I extend my heartfelt thanks to the entire <unk> team for their steadfast focus and execution.

Thanks to our customers and our partners for being on our journey with us and providing guidance and support along the way.

With that operator, we will open the call to Q&A.

And as a reminder to ask a question you will need to press star one on your telephone to read your question press the pound key.

For our first question, we have changed the fish from Piper Sandler James Your line is open.

Hey, guys.

After hours getting a lot of the supply chain stuff.

A number of your networking system peers took careful measures to ensure supplies and mitigate the commenced.

Why is this now impacting our five or why wasn't it done last quarter and what are you guys. Specifically are seeing regarding your backlog that can really give us confidence that the demand side is still there.

Hey.

Jim It's Francois I'll take your.

First question.

So let me just start from there.

The last point of your question and then I'll come back to the.

Supply issue.

On the demand side.

Jim you know that.

Last year our backlogs.

Continued to grow I think we exited.

Last year with a backlog that was at the highest level it's ever been.

In Q1, if you're referring specifically to hardware.

You saw that our hardware revenue was pretty much flat.

But our backlog continued to grow.

First fiscal quarter in fact, it grew by more than 10%.

So based upon the demand we saw in Q1.

And the pipeline we see in Q2, we feel very very good about our demand in the health of the demand and so the issue that we're facing to be very clear, it's not a demand issue. It absolutely is a supply issue and the revision we've just done to our annual guidance is 100%.

The link to the supply issue now.

Now to the first part of your question about <unk>.

What we've been doing to mitigate the issues and why why are we facing this issue now.

So we've been talking about for several quarters that are the issue with our supply chain.

As deteriorating steadily and last year, we were not able to ship to demand, which is why our backlog grew so much during the year.

Things have been getting worse.

At the beginning of our.

Fiscal year, when we were doing the planning for this year, we actually took into account.

The number of <unk> that we were getting from various suppliers.

And.

A situation that was already very tight on number of components.

Over the last 30 days, though.

We have seen a step function decline in the.

The state of component availability from a number of suppliers.

And that's what's caused us to.

A real look at the view for the year.

And see that we wouldn't be able to even ship the systems that we are planning to ship for the full year.

To just give you a sense Jim the number of Decommit. So we're now.

Seeing over 400 Decommit.

<unk>.

Per quarter, and we were running about 30% less than that.

Even just a month ago. So we are.

The situation is quite unprecedented we are doing a number of things to mitigate.

These supply issues working with.

Our.

Our suppliers of course on Escalations and allocations of supply to two five.

We will be working on shifting some of our demand two we've introduced new hardware platforms that are just starting to ship recently.

<unk> utilized more readily available components. So we'll be working to shift some of the demand we have to these newer hardware platforms.

And we have a number of mitigation elements in place too.

Improve the situation.

But the supply chain is absolutely tied to the other thing that has changed in the last.

30 days relative to where we were before is that.

We had been going to not just our suppliers, but also when we couldnt get the supply we had been going to secondary markets. So on the open market through brokers forget part of our supply.

That Avenue has dried up.

Really in the in the last several weeks.

Because I think everybody's in the same situation in going through that so those are some of the.

Changes that have happened in the supply recently.

That's amazing colored Francois.

Keeping on the supply chain stuff as a follow up I mean, how much of the supply capacity are we now at given that the commitments, but also it sounds like new arrangement.

New arrangements with suppliers and then in addition, you guys talked about a mitigation timeframe for the fiscal second half. So does this mean, we should expect upside to kind of a fiscal 'twenty three for we're rat or your risk to these orders getting cancelled thanks guys.

Ah Thanks, Jim Let me just make sure. So we don't see any risk to orders being canceled.

And we have this very real.

Our lead times. Unfortunately, you have.

Gotten progressively worse over the last.

Five six quarters.

But we haven't seen any change in.

Any increase in order cancellation, and we don't expect to see that.

Going forward.

In terms of.

The timing of improvements.

Jim I wanted to clarify because there are two issues really at play here and I want to make sure I give you visibility into both issues. So let me talk first about our fiscal year.

So that $30 million to $90 million.

Reduction to our revenue for the full fiscal year.

That is linked to a.

Struggle to get specialized networking chipset that come from the big chip manufacturers.

And our specialized chipset that the lack of supply of those is really what's driving that 30% to $90 million reduction and we don't expect to see part of why we're pointing to that reduction is that given the level of the 10 minutes we have.

In deliveries and the visibility.

We have now from our suppliers, we don't expect.

This situation with specialized networking chipset to get better until the very end of calendar 2022.

Which is when the new fab capacity will start flowing into.

Part two of five and we would start to be able to ramp up.

Levels of <unk>.

Shipments. So that's the situation that is affecting the full year as it relates specifically to our second quarter. In Q2, we have an additional challenge which is more standard electronic components.

Where we have had a significant did commit in the last few weeks that is affecting only Q2, because we expect to be able to qualify alternative parts relatively quickly and make those shipments in Q3 and Q4. So the second issue has a much shorter timeframe to be to be resolved.

First issue is the bigger issue around the specialized networking chipset.

That will take several quarters before we see meaningful improvement there.

For our next question, we have Sami Badri from credit Suisse semi your line's open.

Alright, thank you.

Horst Francois and maybe Frank you could also help us as well can you just kind of unpack the growth algorithm of software and just how we got to this point because you essentially exceeded expectations on a very strong comp prior year could you just unpack what exactly it was that.

Got you to this result, so that's the first question. The second question is as I hear you described the degree and the magnitude of the supply chain constraints.

It almost sounds so strong that it would almost compiled a customer to change architecture because of the degree of the effect about the whats happening right that could service for example, what they had in mind, so how come what what's going on what you guys are saying the delays and essentially what sounds like a systemic problem is not <unk>.

Selling customers to say adopt more software type architectures, our solutions and sticking to specifically hardware.

And then.

That would be great.

Thank you Sandy I'll start with the second part of the question then we'll go to software.

And so and then <unk> may add to it.

So as it relates to.

The supply chain issue.

Just wanted to put it in the perspective of what our customers are seeing and what lead times they are seeing.

Historically, our lead times were two weeks or less they are absolutely world class.

And I mean that sort of.

Three.

2021.

As our lead times got worse in 2021 be extended to four to five weeks.

And I would say for the last several quarters, we've been in that kind of five five weeks ago.

For orders that are placed to date by customers. The lead times are extended but they are they're going to be in the range of six to 18 weeks, depending on the platform and the specific product that our customers all the way so.

So while these lead times are of course worse than than we've ever had them.

They are still in the zone of.

Kind of four to four five months at the high end, which you.

Checked with other vendors around the industry in our space and Youll find that those lead times don't don't stand out as being worse than anybody else.

And I think our customers have adjusted to have a longer planning cycles.

For the environment that they're building. So we are not seeing customers as a result of extended lead times start to.

<unk>, we think the architecture I think if our lead times were to become 12 months or more.

We would see a much different behavior, but we don't see that and we don't expect that.

Even with the.

The challenges that we're having at the moment shipping to customers. So that's on the first part of your question Sandy.

The software question.

We did indeed have a very strong software quarter.

And it's because the three drivers of growth in software.

As part of our strategy.

Are essentially.

Are all going to plan. So let me start with the first part so the three drivers of what it is.

Driving growth in traditional applications to software for us in multi cloud environments.

Scaling our modern applications franchise and third security.

So let me unpack. These three drivers are for your semi so the first one.

We have seen.

But broad based strength in enterprise for software for Big IP spin.

Specifically I would say financial services and service providers were strong this quarter. We also saw kind.

It kind of more resumption of customers, who have said they wanted to move to software and had put that a little bit on pause in the first quarters of the pandemic, we're seeing more of those customers moving wood there.

The migration to software first architectures.

Even for traditional applications and so that is.

That is helping seem very strong second terms renewal than true forwards for a multiyear subscription agreement. So all of that is contributing to our strength in.

Traditional applications growth in software.

The second aspect is auto applications.

Which we largely support with nginx.

We did over 500 deals with nginx this quarter, which is a record we're continuing to see the size the average size of deals increase.

Because of the additional products, we have released as part of Nginx.

And we are also seeing a lot of applications that are in kubernetes environment go in production and scale.

And what.

Customers are really seeing with kubernetes is that.

The networking and security issues that are associated with kubernetes are pretty challenging.

In kubernetes really ups trucks. This complexity for developers, but net ops teams still have this complexity to deal with in the networking and security challenges for kubernetes are very different than what they've done in the more traditional environment and nginx is really the ideal complement to kubernetes to address these challenges and so we're seeing a lot of.

Traction with its deployment.

And the third the third driver of security.

And security continues to grow faster than our overall product revenue and this quarter, we saw strength in security across the entire portfolio.

Strength in Big IP, we're seeing.

More customers.

Adopt our web application firewall that has accelerated.

And frankly, the log for Jabil mobility broad awareness to a number of customers that either didn't have a wax or.

Didn't have it activated to really.

Use that to protect the perimeter for customers that had a WAF in place we're able to protect.

The perimeter and then have a lot more time to touch on the parts of their infrastructure.

We're also seeing customers move beyond.

Web application firewall.

<unk>.

Anti bot and API security as a bundle.

We continue to see growth in engine X security and then shape.

Shape, how the store order, we had probably our best quarter in terms of new logo acquisition.

We started to see broad based adoption in new segments like service provider.

And also internationally with shape in part because of the continuing product maturity in part because of the go to market maturity that we now have.

And we're also seeing traction with cloud marketplaces, we completed the integration of shape into Salesforce Dot Com E Commerce platform.

So that our technology is visible to all of the all of the players in this marketplace.

And have other integrations with cloud providers that are.

So starting to contribute so you look at across all three drivers of software we really had.

Strong momentum and strong execution.

We're really pleased with where we are on software.

Got it thank you.

Forever in any kind of question we have.

Meet their biyani from Evercore Your line is open.

Thank you for taking my question off to as well.

First off I'm, hoping.

Can you just help me reconcile the March quarter and fiscal year guide in France, I thought I heard you talk about the two different component challenge that you have but your March quarter Guide I think in particular midpoint imply in the first half year grew three 7% or so.

And for you to hit your full year guide it almost implies that you have to grow high single digits in the back half of the year June and September So am I doing this correctly and I guess why the confidence that global snapback. So quickly in the June September quarter for you folks.

Sure why don't I start with that one and then Sia francoise anything to add so I think.

So I tried to articulate.

The difference of the near term challenges, we're having in Q2 and some of those.

<unk> standard components.

Components that are just taking a bit of time to redesign into the.

The solution, but we are able to make up for some of that loss in the back half of the year and so it's more acute because of just the timing of when we realized that this part that we expected to get this quarter is not now not coming until next quarter and it's going to come in much less than what we have.

Initially had ordered.

And so this redesign that we are doing for this part.

Is not going to be in place in time with our manufacturers to affect Q2 revenue.

But it will impact.

We will have the ability to quote unquote catch up on that in.

In Q3, and Q4 and so that's what gives us confidence that Q2 is the low mark when.

When you take the combination of the two quarters that you've just said yet for the first half that way, but we do make up for some of that Q2 demand in the back half on top of the ordinary demand that we would normally see.

Got it.

Perfect.

The second one on this almost seem silly to ask given all the hardware should be up but on the software side.

In front of you talked a fair bit about it but you did 47% growth on probably one of the more difficult compares I think it was 70% last year.

So right now the full year would imply that your software growth will decelerate as it compares start to get easier.

That seems a little counterintuitive and I guess theres, a need to because <unk> given the supply issues.

I guess I'd love to understand why do you think software diesel rates after everything you talked about that business.

Hey.

It's a good question, we don't we don't necessarily think it decelerates.

We are early in the year.

And we gave a range for the full year of 35% to 40%. We had a very strong first quarter, we feel very confident about our software growth. In fact, we said hey, we think it's going to be more at the top end of the range.

But.

Yes.

Too early to be.

Changing that view for now.

<unk>.

What you should take away from from our sense is that we really like what we're around software and we think it's going to be very good software year.

Fair enough and now best of luck. Thanks for that thanks for your time.

Thank you Amit.

For next question, we have Alex Henderson from Needham Alex Your line is open.

Thanks, Tim.

I wanted to ask a broad general question about the behavior of enterprises purchasing approach given the intense.

Pricing pressure and supply constraints around hardware.

As you've talked to CIO CTO.

C suite type people.

Has it resulted in a change in behavior, where we're seeing an acceleration in commitment to digital transformation. So I mean switching prices.

Just could kick their price up again.

This month.

Switching prices are up double digit and you know that.

Forcing people into these are subscription.

Around those hardware a lot of people I would think increasingly wanting to get away from that.

Would play into your strength I would think to the extent that you're such a strong player in the kubernetes workspace.

Workload space.

So can you address what youre hearing from.

The C suite on those.

Thoughts about changing their behavior.

Even more cloudy fashion.

Hi, Alex.

So I would first I would say I like our we know we are going through an extraordinary situation as it relates to supply everybody along the value chain is feeling that.

And youre seeing different type of behaviors in some cases, you are seeing some suppliers in the semiconductor space.

<unk>.

<unk> taken advantage of that too.

Yes.

To some extent gouge on prices.

And that we believe is a.

Short term approach that may have some benefits, but in the long term.

Detrimental to relationships and so.

The way we look at it is.

Our our customers and our shareholders are going to be happy. If we continue to have great long term relationships with our customers and continue to be with them as they evolve their architectures and so as we think about.

How do we balance the cost pressures with price increases we are looking at it through the lens of also maintaining strong relationships with our customers for the longer term.

From our perspective, we're always going to have that balance in how we approach things.

In terms of the way our customers are seeing things.

Conversations.

Of course, they want to get their products.

Fast as possible in the case of a five we are not seeing them as I said before we're not seeing order cancellations were not seeing them double ordering solutions because.

<unk> solutions is unique and you can't replace them like for like for something else and frankly also because so far we have managed to keep our lead times.

Much better than what they're getting from from other vendors.

So we are getting increasing pressure of course from customers to try and <unk>.

Supply to them faster.

But.

We're not seeing a dramatic change in their behavior.

Towards that five from what we saw through last year.

If I could follow up on a separate question.

The service provider business historically has been in the 20% to 23% of revenues range, it's been coming down.

Distantly every quarter I think you're talking about 15% this quarter.

<unk>.

It seems quite clear that with yours.

Pauses shift to software and security that you've shifted away resources away from them can you talk about.

To what extent, you're shifting away from intentionally shifting away from that space.

In favor of your higher growth alternative areas.

Alex I would not say that we are essentially shifting away from the service provider space, We had a very strong.

Through the last five six quarters, we have very strong demand in the enterprise that has been broad based and so when you look at the mix overall service provider as a mix.

Come down however.

However, our service provider business itself.

Has has actually been growing very healthily over the last several quarters, including this last quarter.

And so and also with what we're seeing coming in the <unk>.

Transition.

We see strong opportunities both in hardware and software.

This providers.

Some potentially important deals.

To come over the next few quarters and so no we are actually investing.

Into the service provider space, both for our existing platforms and Voltaire or that is also potentially a platform a very strong interest for service providers, we are starting to see more and more deals in the Iot space with service providers oftentimes requiring scaled to tens of millions of devices.

Which.

So thats currently served through hardware.

So we continue to invest in our service provider segment.

Understand how you drew that perspective from the from the mix. So that's why it has been only a 15% for the last few quarters, but it is growing in line with the rest of the business with very strong prospects to come and Alex just as a reminder, that 15% is a bookings.

Revenue and certainly not a total revenue so.

As a proxy you can forget about it and in relation to product revenue, but that's what it's in relation to.

Thanks.

Thank you Alex.

Our next question, we have Rod Hall from Goldman Sachs Rod Your line is open.

Yeah, Hey, guys. Thanks for the question I wanted to start by clarifying the backlog number.

Think francois you'd said it grew just over 10% and I think you guys had called out $125 million backlog last quarter. So is it right to think that that backlog. It's in the ballpark of $140 million this quarter.

Rod.

It's in the ballpark for the system side, what Francois was referencing was the systems piece of the backlog, which as we said in our K was the vast majority of that 125, but I just wanted to make sure you understand that.

He's just shave a little something off the 125 and up by 10, plus and that puts us in a ballpark. Okay. Thanks, Ron that's helpful.

And then I wanted to just kind of ask a bigger picture question you guys last year, we're talking about.

Systems being stronger because people were locked down and they couldnt test software in this kind of comes back to.

What people might be thinking here. So now you're in a situation where you can't supply systems people want I don't get why because it looks to me like you've raised your software guide by maybe 12 or $13 million from your midpoint of your 35 to 40 to 40, but then youre cutting your systems guide by <unk>.

30 to 90, so quite a bit more than that so youre not really getting that it.

It just seems like you should getting accelerating trade towards software.

If that dynamic last year, starting to unwind in your favor this year right.

I still don't fully understand why the why the software is not going up more to compensate for the hardware weakness.

Ryan Great question.

So I first want to remind remind you.

All of that.

Where there is an opportunity to substitute if you will.

Hardware for software is really in our big IP platform.

But the drivers of software growth are across the entire portfolio. So that's the that's the first.

The first thing you got to you got to remember second.

When you say why is there not more substitution in big IP of hardware for software.

The first reason is because hardware demand is not weak.

So the hardware the behavior of our customers as it relates to hardware.

Hasnt changed the hardware demand continues to be strong we saw broad based demand.

In India Enterprise on systems.

Security use cases continue to drive systems demand and we see we see security existing security customers, even extend <unk> security footprint in hardware.

And generally application growth traditional application growth continues and therefore, our hardware demand to support those applications continues to be very strong. So there hasn't been a change from a demand perspective. The issue. We have is the supply.

Apply issue.

So that's the second reason youre not seeing a.

Big substitution effect now you could ask well, okay, but if the if I lead times get.

Get much worse, we'll that encourage more customers to change their demand.

From from hardware to software.

And on the margins, we think there may be.

A slight element of that which is part of what's causing us to say hey, we're closer to the top of the range but.

So the top of the range on software.

We think that's a marginal effect because when customers look to say, hey, I'm going to go to a software first environment first of all it is not the only consideration that they have their other vendors that are part of the environment that drive that architectural decision and second.

I think our lead times would have to really extend well beyond six months for just the lead time factor to cause our customers to really change and look at software now.

With all of that being said with the supply challenges that we're having our teams when working with customers. If a customer is on the margin and really could go one way or the other I think of course, we will encourage them to move to software because they can get there much faster.

But we don't we don't look to that as a as a.

The thing that's going to shift multiple tens of millions of dollars from from one consumption factor to the other.

Great. Okay first of all I really appreciate all that color. Thank you.

Thank you Rod.

For next question, we have meta Marshall from Morgan Stanley . Your line is open.

Great. Thank you.

Just wanted to get a sense I know you noted.

This shortage is you're seeing our two pronged both on the specialized chips and the more standardized components.

Wanted to get a sense of it.

Deterioration is more severe than kind of one or the other in the quarter end.

What guidance kind of implies a top bottom of the range. This one after him for more than the other two.

<unk> achieved those and then maybe just a second question for me you know we've seen a lot of the networking peers kind of build inventory pretty significantly our attempt to build inventories pretty significantly over the course of the last year.

Going forward gain out of this.

Does this change your thoughts on on inventory stocking going forward. Thanks.

Yes.

Just a couple of let me start with the last part of your question.

So we have been.

Buying components with extraordinarily long lead times.

Some of the components that were committed at the beginning of this.

Calendar year for us where components that we had ordered more than 52 weeks ago.

We have several hundred components today that has more than two years lead time. So we have been getting ahead of this for the last 18 months and making very strong advanced buys in anticipation of issues getting commitments from suppliers that in some cases after 52 weeks of waiting but coming back when the deliveries are doing.

Saying, it's not going to happen in the quantities you expected or the timing you expect it.

And so.

And we've been able to manage that through the last time.

Several quarters, but but.

We've seen it even a step function deterioration on that.

Just in the last 30 days now to your question around.

One issue more severe than the other in terms of the two issues we are seeing.

I think there are really two dynamics.

The first issue, which is the specialized networking chipset.

From the large kind of.

Specialized chip manufacturers.

<unk>.

That issue is going to take a while to get better at is about it is about wafer capacity in.

More capacity coming online.

For us to get the parts.

We need to have ultimately and that's going to take several quarters.

And in our.

The range of 30% to 90, but we have assumed.

To be very clear.

We have assumed that in there the potential for more to commence than what we have seen to date, but we have not assumed yet another step function deterioration from the levels at which we're at today.

So thats kind of the 30% to 90 range.

And to get closer to the $30 million.

It would have to be successful in shifting some of the demand towards our newer platforms.

And we're already working actively on those programs.

As it relates to the in quarter issue of Q2, the specifically the standard components.

This really is.

It has to do with the timing of the.

Specific to commit for a couple of parts.

That is really unfortunate for parts that we had an order for a very long time.

And.

The timing of that Decommit makes it such that we can't we qualified the other parts and design around it and be able to ship in quarter.

We will re qualified there are alternatives available.

In the in the market. So we will be able to get our parts and we won't be able to recover that starting in our Q3, So thats more of a shorter term issue.

Got it thanks.

Thank you meta.

For our next question, we have to meet tried guarantee from JP Morgan your.

Your line is open.

Hi, Thanks for taking my question I guess.

Just start with the non supply question Hugh.

You mentioned that.

There is no change in how you think about the business longer term, you're not changing your operating margin.

Given some of the temporary issue Youre seeing.

You reiterated buying back about 500 million on stock whats the inclination.

The appetite to maybe aggressively a little bit more on the buyback given the outlook for the business longer term hasnt changed but this temporary sip.

Stepping back obviously is going to drive some weakness on the share price.

Sure. So let me, let me start with that one.

We.

We talked.

<unk> talked about the $500 million of share repurchase maybe more ratably throughout the course of the year.

We've established automatic share repurchase programs associated with that and so.

I'm not going to get into the ins and outs of the execution of that program, but it is.

Yes.

We haven't changed the level of commitment that we intend to make its still $500 million when exactly that triggers.

TBD as we as we see how the stock plays out, but we do not anticipate moving that program up from $500 million, because we want to stay balanced on.

The strategic reasons, why we entered into that kind of balance in the first place.

Oh, just a follow up on the software you've talked particularly last year about that.

<unk> Awards.

You will.

Got a benefit from it will be a tailwind in terms of the field.

How should we think about the trajectory of those that there was more weighted towards the back half I think in general as we look at the risks in terms of your software guide I think Glenn on your question. It does imply some moderation in growth, which I think is more you would just waiting for execution, but is there an impact there on the truthful awards being motivated.

One certain half of the yield.

So the true forwards.

There is some seasonality.

<unk> to them, what we talked about is really the second term of multi year subscription.

Absorption agreements coming into play which resets.

Whole cycle of revenue recognition with a new with a second term and those were more weighted in the back half.

Okay. Okay. Thank you.

Thank you.

Due to time constraint, we will take our last question from policy risk team from Cowen Your line is open.

I appreciate you squeezing me in I appreciate all your questions and responses from supply chains, So I'll apologize I've got yet another.

Perhaps just to be clear already but I just want to make sure I understand what you're saying.

If the $30 million to $90 million, if I understand you correctly 90 million shortfall relative to your original 90 day ago expectation for fiscal 'twenty two.

Is all related to the specialized chipsets.

I Trust your view your understanding of when the new supply when those new Fabs come online Hasnt changed over that 90 day period.

You didn't expect to benefit from those coming online earlier.

And what you now expect for what changed was the day commits from your current suppliers most specialists or current available chipsets is that correct.

Yeah, both assumptions are correct Paul.

Alright, France is at a given that if you're not losing.

If your customers arent shifting to your software and your customers are purchasing the hardware.

If they're not shifting to your competitors.

Given that your backlog will increase by.

$30 million to $90 million, whatever the ultimate shortfall relative to your 90 day ago expectation.

That's just basic math isn't it.

Pretty much I mean, it's <unk>.

Forecasting backlog exactly as we're probably not going to do that but yes, our backlog will increase by multiple tens of millions of dollars.

Starting this quarter of course in Q2, but even for the full year.

Yes, we expect our backlog to increase because we cannot ship the demand.

If I could squeeze one more in I'm going to apologize again, if it's surely be clearer but.

Given that you're almost a full month into the quarter.

Hmm.

Why the significant.

The range and the guidance for the quarter is just the visibility and confidence as to additional to commence.

Just months.

Sparse.

I consider we appointed what accounts for that dramatic a range in the near term.

Got two months left in the quarter and I assume you had to build up supply previously as everybody else has been doing in terms of advanced ordering in order to ship against whenever you would expect it once again why such a dramatic range.

Paul That's a great question and look absent the the significant supply chain challenges that we have you would have probably have seen sort of a range that would be closer to the two sort of $20 million.

And the range is twice that for two reasons.

And they're both related.

The first reason Paul is that this.

Decommit with handle the standard component.

Our teams are working 20.

24 by seven to requalify find alternative parts and be able to solve.

Some of that in quarter.

And so.

But we don't know yet if we're going to be able to do all of that kind of design work and get that to manufacturing and be able to ship. These parks.

Before before the end of March sorry, these products before the end of March to customers. So there isn't a net added uncertainty that comes from that and then the second part of that uncertainty is also in quarter.

We are looking to shift some of the demand to the newer platforms that are more readily available and.

And how fast we can ramp those platforms. There's also some uncertainty associated with that so those are the two elements of supply that could go one way or the other that add a little more uncertain too.

And this is why you see the range, but I want to be very clear both are related to supply.

They are not related to.

Some some worries we would have about demand.

And the reason.

We're of course are working 24 by seven to do this.

Because ultimately.

Our north star is getting products to our customers.

We understand that the lead times are extended.

For them and we want to be able to satisfy the demand as fast as possible for customers that are waiting on this too for the applications that are growing so.

That's our north star, but that explains the range Paul.

I appreciate the responses. Thank you.

Thank you Paul and Lady.

And ladies and gentlemen. This concludes today's call you may now disconnect.

Okay.

Okay.

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