Q2 2022 F5 Inc Earnings Call
[music].
Yeah.
Good afternoon, and welcome to the F. Five incorporated second quarter fiscal 2022 financial results conference call.
At this time all participants are in a listen only mode.
After the speaker's presentation, there will be question and answer session to ask a question. During the session you will need to press star one on your telephone keypad.
Also today's conference is being recorded if anyone has any objection. Please disconnect at this time.
I'll now turn the call over to Miss This Ain't Geelong Ma'am you may begin.
Hello, and welcome I'm, Suzanne Dulong, Vice President of Investor Relations.
So I'll look over to new <unk>, President and CEO and Frank Pelzer <unk> executive.
Vice President and CFO will be making prepared remarks on today's call.
Other members of 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 at <unk> Dot Com, where an archived version of today's call will be available through July 24th 2022.
Today's live discussion is supported by slides, which are viewable on the webcast and will be posted to our IR site at the conclusion of today's discussion.
To access a replay of todays call by phone. Please dial 805, 85836744166214642 and use meeting I D 7769889.
Telephonic replay will be available through midnight Pacific time April 27, 2022.
For additional information or follow up questions. Please reach out to me directly at S. Dot do long S. Five 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.
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.
Please note that <unk> five has no duty to update any information presented in this call.
With that I will turn the call over to Francois.
Thank you Suzanne and Hello, everyone. Thank.
Thank you for joining us today.
As you all know we entered our second quarter with some significant challenges that limited our ability to fulfill demand from our systems business.
We are pleased to have delivered above the midpoint of our revenue guidance and at the upper end of our non-GAAP EPS guidance. Despite those challenges.
Importantly, we continued to deliver strong results from our software business.
With 40% year over year growth in the quarter.
Software represented the majority of our product revenue for the first time.
Systems revenue declined 27% as a result of supply chain constraints and our global services revenue was flat year over year.
Our second quarter reflected another in an ongoing trend where customers continued to rapidly grow and scale, both the traditional and modern applications, while placing increased importance and focus on application security.
This benefits of five and translates to continued strong demand across our portfolio.
While our view towards strong demand drivers remains clear our visibility into resolution of hardware supply chain challenges is murky.
Going into Q2, we discussed two primary supply chain challenges.
I am happy to report that we successfully resolved the first which was related to standard electronic components and required us to design in and qualify an alternative source.
The second challenge, we discussed is related to global shortages of specialty semiconductor components.
While we have made some incremental progress on this issue. We continue to expect supply constraints will limit our ability to fulfill systems demand through the end of this fiscal year.
Part of our efforts to fulfill system demand included shifting customers from our IC res appliances to a next generation R series appliances, which launched in February .
We are seeing solid traction in our series sales and we are ramping manufacturing.
However, semiconductor constraints, primarily from a handful of suppliers continue to limit our ability to ship I series and are now also impacting our ability to accelerate the ramp of our series.
As a result, our system's revenue recovery has been delayed beyond the expectations, we had last quarter.
Frank will review our outlook in detail later in our prepared remarks, but as a result of the delayed systems revenue recovery, we now expect to deliver our fiscal year 2022 revenue growth in a range of 1.5% to 4%.
This compares to our prior expectations for four 5% to 8% growth.
Our underlying demand remains strong however, and we continue to expect to deliver software revenue growth near the top end of our 35% to 40% target for the year.
In light of the sustained strength of our demand and our view that the supply chain constraints are temporary we are not making changes to our operating structure and therefore, our margins will be impacted correspondingly near term.
We obviously feel a strong sense of frustration with this change and an equally strong sense of urgency toward resolution. So we can get back to reflecting the true health of the business in our reported results were.
We are taking every available path to resolve the issues as quickly as possible.
Our suppliers expect additional capacity beginning in the last calendar quarter of 2022, which should translate into improvements during our second quarter fiscal 2023.
While the supply chain challenges are more severe than we estimated last quarter. They are temporary.
In addition to seeing continued demand for hardware, we are seeing good traction across our software portfolio, including from security use cases, and our ability to bring a broader solutions portfolio to customers.
I'll speak to our business momentum and demand drivers before Frank reviews, the quarter's results and our outlook in detail.
Our customers are increasingly operating both traditional and modern architectures and looking to F. Five for solutions that simplify and unite their strategies for both.
As an example during Q2, an American multinational beverage company and a longtime big IP customer selected nginx to serve its cloud and kubernetes based workloads and modern use cases.
The customer is using nginx to automate app content delivery, including its loyalty program and delivery services, both of which have experienced substantial growth during the pandemic.
The addition of Nginx technologies to the customers' multiyear subscription resulted in a two X expansion of the subscription upon renewal.
Customers also are operating in multiple clouds, and uncovering new challenges as a result.
S. Five infrastructure agnostic approach to application security and delivery differentiates us from vendors, who are siloed to a single environment.
This means we are uniquely positioned to help customers with their multi cloud of challenges.
During Q2.
We were selected by the Ministry of Health for our nation in our APAC region.
Not being locked into a single cloud was an important consideration for this customer.
They had intentions of modernizing in a single cloud short term, but planned to expand to additional clouds in the near future.
This customer selected F. Five over cloud native offerings as a result of our solutions clear value add and now cloud agnostic capabilities.
We enable the customer to create a true multi cloud architecture with both on premises and cloud environments in a deal spanning our portfolio, including big IP hardware and software with advanced WAF and nginx, including a protect and API management.
Finally, it is clear that hybrid architectures, including on premises data centers and other service offerings are here to stay.
Applications and workloads also are increasingly containerized in mobile.
This means complexity is here to stay too and that managing applications across disparate environments will remain a challenge for customers.
Meeting that challenge is likely to require a distributed cloud architecture and platform agnostic security and delivery technologies that provide consistent protection visibility and performance for all applications legacy modern and mobile across environments.
In Q2, we took a large step forward toward helping customers better manage multi cloud complexities with the launch of our F. Five distributed cloud services.
With this platform, we are delivering security multi cloud networking and edge based computing solutions on a unified software as a service platform.
Our first solution for the platform at five distributed cloud web application and API protection our Wap.
Arguments multiple security capabilities across F. Five technologies in a soft offering.
This offering reflects the first major step in our integration of our volt to our platform and if five software security stack.
At five distributed cloud services is globally available and we are seeing strong early enterprise and service provider interest.
Salt Lake announced one of the first notable wins for F. Five distributed cloud this quarter.
The corporate information technology division of Softbank needed to improve low resource utilization and all the inefficiencies of its private virtualized infrastructure.
But its security requirements mandated on premises deployment with an option for future public cloud capabilities.
It's sort of way to bring the effectiveness of cloud native micro services and containers. So its private data center and turned to F. Five distributed cloud services.
We are leveraging F. Five distributed cloud branding to further integrate customers experience with their five by simplifying our product meaning.
You will see we have United and we named our SaaS and managed services portfolio, including shape Volk Terror in silver line under our F. Five distributed cloud services umbrella.
So expect to hear us refer to those solutions accordingly going forward.
In summary, despite our short term supply chain challenges there is a lot to look forward to from F. Five.
We have multiple current and future software drivers that are well aligned with our customers' most pressing application needs.
Between big Ips ability to serve and secure traditional apps.
<unk> ability to serve and secure modern apps.
And the exciting opportunity to grow and expand at five distributed cloud services, we are well placed to enable our customers to manage and secure the growing and rapidly evolving application of states.
Now I will turn the call to Frank to review, our Q2 results and our second half outlook in detail.
Frank.
Thank you Francois and good afternoon, everyone I will review, our Q2 results before discussing our second half outlook, we delivered second quarter revenue of $634 million above the midpoint of our guidance range and reflecting a 2% decline year over year.
Software revenue grew 40% to $152 million.
Systems revenue declined 27% to $146 million.
We delivered a 4% product revenue decline year over year with product revenue, representing 47% of total revenue in the quarter and software contributing 51% of product revenue.
Rounding out our revenue picture global services delivered $337 million in revenue.
This is flat compared to last year and represented 53% of total revenue.
Taking a closer look at our software revenue subscription based revenue represented 75% of total software revenue in the quarter. This is down a bit from the 80% mix where had had been in the last couple of quarters, but we do not see this as indicative of a trend rather it reflects some activation timing variability for a cut.
<unk> of large multi year subscription agreements as well as a small number of larger deals in the quarter, where customers preferred a capex model.
As a reminder, a significant component of our subscription business is term based licenses that are not recognized ratably and as such we expect some quarter to quarter variability.
Revenue from recurring sources, which includes term subscriptions as a service and utility based revenue as well as the maintenance portion of our services revenue totaled 69% of revenue in the quarter. This is up from 64% in the year ago period.
On a regional basis Americas delivered 4% revenue growth year over year, representing 57% of total revenue EMEA.
EMEA declined 9%, representing 25% of revenue in APAC declined, 6%, representing 19% of revenue.
In the quarter, we saw some signs of softness in EMEA. We believe this is in part related to the macro and global political concerns in the region.
Enterprise customers represented 65% of product bookings in the quarter service providers represented 15% and government customers represented 20%, including 7% from U S Federal I.
I will now share our Q2 operating results.
GAAP gross margin was 81% non-GAAP gross margin was 82, 9%. We continued to experience increased component prices expedite fees and other sourcing related cost.
GAAP operating expenses were $433 million non-GAAP operating expenses were $358 million, our GAAP operating margin in Q2 was 11, 8% our non-GAAP operating margin was 26, 5%.
Our GAAP effective tax rate for the quarter was 22, 7% our non-GAAP effective tax rate was 21, 3%.
Net income for the quarter was $56 million or 92 cents per share non-GAAP net income was $131 million or $2 13 per share.
I will now turn to the balance sheet.
We generated $127 million in cash flow from operations in Q2 capital.
Capital expenditures for the quarter was $5 million D.
DSO for the quarter was 59 days.
Cash and investments totaled approximately $922 million at quarter end.
During the quarter, we repurchased approximately $125 million worth of that five shares or approximately 610000 shares at an average price of $205 <unk>.
Deferred revenue increased 17% year over year to 1.61 billion up from 1.58 billion in Q1.
The growth in total deferred was largely driven by subscriptions and SaaS bookings growth and to a lesser extent deferred service maintenance.
Finally, we ended the quarter with approximately 6700 employees up approximately 150 from Q1.
Francois shared our updated fiscal year 2022 revenue outlook in his remarks, I will recap the details of the second half outlook with you now.
Unless otherwise stated please note that my guidance comments reference non-GAAP operating metrics.
I will begin with our revised view for fiscal 2022.
Given persistent and dynamic supply chain pressures, which are limiting our system's revenue recovery near term, we expect to deliver fiscal year 2022 revenue growth within the range of one 5% to 4% for the year. This compares to our prior expectations of $4, 5% to 8% growth.
We continue to expect to deliver close to the top end of our 35% to 40% software revenue growth target for the year, We expect global services growth of approximately one to one 5% for the year, reflecting the lower expected range of system sales.
Because we believe the current supply chain challenges are temporary and do not reflect the underlying growth of the business. We do not intend to adjust our operating model near term.
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 over the next several quarters.
We expect non-GAAP operating margin in the range of 27% to 28% for FY 'twenty. Two we would expect to regain the rule of 40 operating benchmark as we return to full manufacturing capacity.
We continue to expect our full fiscal year effective tax rate will be in the range of 20% to 21% with some fluctuations quarter to quarter, we remain committed to repurchasing $500 million in shares during the fiscal year.
I will now move to our third quarter expectations. We expect Q3 revenue in the range of $660 million to $680 million.
Given component cost and the cost related to actions, we are taking to mitigate supply chain pressures. We expect Q3 gross margins of approximately 82%.
We estimate Q3 operating expenses of $368 million to $380 million.
Our Q3 earnings target is $2 18 to $2 30 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 to Francois Francois.
Thank you Frank.
In closing, we will continue doing everything in our power to mitigate supply chain impacts for our customers.
While supply chain is currently overshadowing the underlying strength of our business.
We believe constraints will begin to abate as we move through the next several quarters.
Our software and software as a service App security and delivery solutions will drive our future growth and our long term opportunity.
We have created a portfolio and a roadmap that is well aligned with our customers' strategic priorities and because of that.
We are more confident than ever in our position our strategy and our long term opportunity.
With that operator, we will open the call to Q&A.
Sure. Thanks, Frank and thank you as a reminder to ask a question you will need to press star one on your telephone keypad again that is star one to ask a question.
Our first question comes from the line of Sammy Chatter G from J P. Morgan. Please ask your question.
Hi, Yes. This is Joe Cardoso on for Sonic tangible.
First question shall pharma supply challenges that you highlighted during your prepared remarks can.
Can you touch on some of the actions that you're taking or planning unchecked alcohol dates and the pressures from the headwinds that you're facing from the supply challenges.
Are you guys passing on higher pricing at all are you starting to see the benefits from higher pricing as some of the other networking peers in the space have done and then just relative to the underlying components that are being constrained for the two product offerings that you highlighted you know when do you start to see or when should we start to see some improvement. There you now have you been given any timeline from that supplier.
And then you know what's driving your confidence around that timeline. Thank you.
Some acres pulse I'll. Thank you for the.
Question, let me start on the pricing.
We we have been generally philosophically quite cautious about pricing with our customers.
That being said, we have seen as you know significant price increases.
So a significant cost increases and we did affect the price increase in the last few months that was in the high single digits.
And we will continue to review our cost.
And.
Kind of refined our models and look at whether we need to do anything else in coming months, but we're going to continuously review that in line with what we're seeing from a component perspective, but we've already taken the first.
<unk> factored in that in that area.
I think we want as it relates to when things do get better.
So based on conversations with our.
Suppliers suddenly can all of this is really about the semiconductor supply chain and it's really a handful of strategic suppliers that we have and we do have.
Deep and broad conversations with them on a very regular basis, including executive to executive conversations to really address the challenges that they and us are facing.
Based on these conversations.
We expect them to have improvements in their capacity.
In the fourth calendar quarter of the year.
Which should translate to improvement in our revenue in the first calendar quarter of 2023, which would be our second fiscal quarter.
We expect these improvements from them based upon their expectations of additional fab capacity.
And what we've seen in terms of their consistent milestones around increasing that capacity.
We're not sitting on our hands and waiting for just the suppliers to make improvements.
We are also driving aggressive actions.
On our side to drive improvements so what are we doing.
First is we are continuing to shift demand to our series, which is our next generation platform, because we expect that platform to be less constrained than our IC risk platform.
And from the field perspective in terms of customers taking on the R series platform, we are seeing actually excellent traction on this front.
Does the value proposition of the platform the price performance of the platform is just excellent so were aggressively shifting demand through our series we are.
Increasing the velocity of qualifying alternative sources of supply.
For both platform is actually so redesigns and qualifying additional suppliers on these platforms to alleviate the supply shortages and of course, we continue to make aggressive advance purchases.
With our suppliers, we have been doing that for several quarters.
But we continue to do that very aggressively and providing them a lot of visibility into our forecast for future quarters.
So we these actions as I said, we expect.
Better supply in our fourth calendar quarter that would translate into that.
The first calendar quarter of 2023 for improvements into our hardware revenues.
Thank you I appreciate the color guys.
Thanks your stomach.
Our next question comes from the line of James Fish from Piper Sandler. Please ask your question.
Hey, guys. Good afternoon kind of a loaded question here.
Two parts of course.
The Big question, we're getting after hours is really around that software number and in principle, all while 40% growth was strong it was against some easier comparison last quarter.
Is there any way to quantify how much of that shift towards capex purchases over software as well as how much got to wait to a future period.
On the software line occurred and then.
On the system side, what should we what should make us believe that we arent in for another hardware card here over the next quarter or two as this is the second quarter in a row cutting hardware and really I think giving us a sense around where backlog is versus the last quarter would be helpful for that.
All right, let me let me start.
Jim with the latter part of your question around <unk>.
Hardware and then let's let's go to software after that.
So.
Jim the reality is that there is so much constraints in the supply chain in the semiconductor supply chain today.
Our visibility into supply into our supply is not very long term it's actually.
Very short term and so what we're doing is giving you the best visibility that we have today just like we did last quarter.
We did not anticipate.
In our forecast when we guided for the full year last quarter, we did not anticipate yet another significant deterioration in the availability of the semiconductor components.
And also the fact that the broker market has gone completely dry and that's why we have another step down in terms of our ability to ship for the full year.
In providing the view for the full year here Jim.
Look to be appropriately conservative based upon what we know today.
Not to tell you that there is zero risk in the in the numbers, we're giving you because of course those numbers rely on.
Deliveries from our suppliers that are going to happen later this quarter and of course in Q4. So there is of course still some some risk.
The full year number, but we have looked to be appropriately conservative in how we've constructed it based upon all of the conversations and information we have from from our suppliers.
On the backlog.
Jim You know, we don't speak specifically to the backlog numbers, but of course, our backlog has grown again this quarter.
By multiple tens of millions of dollars.
And if you look at our demand drivers Jim there are pretty strong so demand has remained strong.
When we look at demand we are on track at the first half of the year with.
What our plan was for the for the year.
And so this is this is really a supply issue and not a not a demand issue.
Let's go to software on the phone call is going to take that yes, Jim So on the software number obviously, we do not sort of guide and in mix on any given quarter and.
If you go back in time to the first half.
If you go back to analyst day in November of 2020, and we talked about software guidance in that 35% to 40% range. After the second first quarter, we had 70% in the second quarter, we had 20% and there was a lot of question marks around will we ever be able to make that 35% to 40% range and we ended up at 37%.
For the year.
We talked about at the beginning of this year that there was going to be less volatility and variability in that number I think last quarter. It was 47% this quarter was 40%, but theres no dynamic to speak of.
A mix shift or any other factor.
It was quite a quoted easier comp, but we do think about this number of growth in terms of an annual basis, certainly not on a quarterly basis, we're quite happy with where we've ended in the first half.
And continue to expect perform in the second half to be near the top end of our 40, 35% to 40% range.
Thanks, guys, all our yogurt back.
Thanks, Jim.
Our next question comes from the line of Ami Terry There your nanny from Evercore. Please ask your question.
Thanks, a lot for taking my question.
I have.
A question on the quick clarification hopefully.
The question I really have is on the operating margin structure. So if I look at the full year guide you're talking about 27, and 28% operating margin, which was down like 400 basis points year over year, even though there was some revenue growth in the moderately year over year basis.
So I'm just wondering what's the revenue run rate do you think you'd need to.
To get back to the 30% to 33% kind of operating margin range on a quarterly basis.
And Alternatively, what do you need to see from a macro basis to perhaps a I need to get more aggressive in optimizing my cost structure love to just understand how you think of Opex as you go forward.
And then is there anything you would call out in terms of why its soft fur imply to decelerate in the back half of your fiscal year versus the front half as there's somebody on the renewals. That's happening there was just anything you would call out that would be helpful.
Sure. So why don't I start and then.
I'll turn it over to Francois so on the on the operating margin side I think what we said for the past two quarters is that our expense plan has not changed and largely that that is absolutely true.
If you take a look at where are we.
Where the expected.
<unk>.
Operating expenses in relation to.
That 8% to 9%.
<unk> regional growth range that we had in the model and where we also had our gross margin expectations that would lead you to sort of the expectation of what we what.
What we have for operating expenses for the full year and so the run rate for that 32% to 33% is exactly what we talked about at the beginning of the year, what we would need what we have seen is a shortfall in the hardware number because of the supply chain constraints, but because they are temporary we don't think it's right to change the operating.
Expenses to potentially hinder our longer term growth trajectory of the business and so that's why we have not changed the operating model.
And then just a second.
Second part of your question was about software growth.
Yeah.
First when I look at the guide for the full year right you started at low 40% growth call. It in the first half of your fiscal year and so just mathematically you're talking about things decelerating in the back half of your fiscal year. So I'm wondering if there's something with the renewals that happened in the first half or this is just being a bit more pragmatic, but just what's driving that implied b cell on software in the back half.
Oh, Yeah, no I think that's what.
Frank was talking so theres some.
Moment they'll go with that.
When you look back and that we guided to 35% to 40% growth.
First of all for our horizon two going back.
In 2020.
And we delivered 37% growth in.
Fiscal 2021.
We guided again to 35% to 40% growth this year and in fact, we said we would get to the top or near the top end of that range and we're on track to achieve that.
We've always said that we weren't looking at this on a quarter to quarter basis, but more on an annual basis in part because our software business is not just the ratable SaaS.
Model that it does include term subscriptions and therefore, there will be some variability quarter to quarter. We did say that we would see less variability quarter to quarter. This year than we did last year and we're also on track to deliver against that so there isn't a.
Dynamic if you will.
In terms of the software business and what we have seen in the past the renewals that you just referred to the trends on those on these renewals are very very encouraging as well as the two forward and the expansions on the.
The agreements that we signed in the past.
So we are generally very pleased with our software drivers we're seeing.
Thank you very much.
Your next Alex Henderson of Needham Your line is open.
Great. Thank you very much I wanted to go back to the comment you made.
About EMEA slowing a little bit and the decline in revenues in EMEA and APAC versus the growth in the U S.
And.
Contrast that with the extremely strong demand conditions that youre dealing with obviously outstripping your supply can.
Can you.
Talk to why there was such a splay between the U S results and.
The international results and.
When you talked about Europe , specifically, you mentioned a slowdown in demand there as a result of the economy.
Can you feather that into the <unk>.
The overall demand picture a little bit please.
Yes, So let me.
So what we saw in the in our second fiscal quarter, there and I would say really kind of starting in February and beyond is.
A slowdown of demand in Europe .
We think it's kind of accelerated a little bit into the last month of the quarter, which was in March we think it is attributed to.
Macroeconomic conditions of course, the Ukraine, Russia War, even though our business in.
In Russia is very small so there was no really direct impact.
Territorially.
But in terms of the whole sentiment in Europe .
<unk> inflation and potential economic slowing down.
We think that has caused some customers to be a little more cautious.
Scrutinized spend a little more and potentially to delay delay some.
Promoters that they would otherwise make.
Now in the Big scheme of thing.
Not talking about multiple tens of millions of dollars here.
It's effectively a smaller effect on that but it was noticeable and often our trends that we felt that.
We should pointed out in part because we don't yet know how this will play out in Europe in the.
In coming quarters, and whether with.
With the continuance of the conflict.
And more inflation.
Whether this will continue and to what extent.
We also had.
Very strong.
Demand in the Americas in the enterprise in the enterprise space as well as service providers of the world.
Contrast, a little bit with that.
And Alex I do have to add.
This is where you start to see or you may not see the clearer picture in terms of demand of bookings versus just recognized revenue because of the constraint that we have in hardware and so normally.
The quarters before there would be at a tightened link.
But when we take a look at where some of the bigger backlog of activity was happening. It was more in the Americas that got shipped out in the quarter associated with the revenue recognition of that of that system, which is going to skew this number a little bit more.
It is you're more biased to systems and that's unless the software is that part of it.
And is there any change in your supply chain in your pipeline in Europe in April that would suggest continued.
Erosion and the conditions, there and then I'll cede the floor. Thanks.
Yes.
The the answer to your first question is is no. There is no specific activity.
As a whole Europe .
Europe , probably a slightly higher weighted towards hardware.
In APAC slightly.
Towards hardware in bookings.
And then some of the other businesses, but it's not dramatic.
I think what you will what you will see is just where we've got more backlog.
The aging of that backlog, that's some of the first things that will get shipped out.
We will skew some of these hardware numbers and the overall revenue by Geo number.
Until we get fully caught up on some of these supply chain constraints and so as we talked about last quarter. We are trying to very much take a customer centric.
<unk> towards meeting.
This demand with the limited supply that we've got and that is going to just skew. These numbers a little bit that we did point out because of some of the delays.
Bookings that we saw in EMEA, particularly in my three when you add the.
The geopolitical concerns really creep up.
That's what we saw we wanted to point that out on the on the demand side of the equation too.
And Alex just to your question about April I think the pipeline for EMEA for Q3 actually looks better than what we saw in Q2, but we are cautious because of the macro environment.
Currently.
Great. Thank you very much for that clarity.
Absolutely.
Your next question comes from the line of Paul Silverstein.
Colin please.
Please ask your question.
Once again, Paul Silverstein Your line is open.
If you're on mute please UN mute your line Paul.
There seems to be no response from the line of Paul We will now be proceeding to the next question coming from the line of Sami Badri of <unk>.
<unk> Suisse. Please ask your question.
Hi, This is Ryan on for semi.
Thanks for taking the question. So basically our first question is for customers, who historically one system.
Whether that will all parks into.
<unk> given the constraints, we're seeing for the past quarter.
And I have a follow up.
Yes.
I'll start so.
You know, we just broadly speaking we have not seen.
A hardware to software substitution in the business.
And the reason for that is that when customers for customers to move to software.
Generally they have top considerations from not just a fight but other providers in their environment.
And generally these other providers also have elongated lead times.
They also have to have bumps some architectural work to move to a virtualized environment, which a number of customers.
<unk> done if they're still on hardware, so they're not ready to move to.
Due to software.
And for those reasons, what we've seen is the majority of customers who have larger states on hardware.
The lead times, the Tianjin I lead times alone is not a factor that is moving them to two software now for those on the margin who can make that move we are working aggressively with them too.
That happened, but we have seen that to be a marginal a very marginal phenomenon today.
Whether that will change in the future if I if our lead times continue to be elongated is yet to be seen but we've not we've not seen any meaningful hardware software substitution today.
Gotcha Gotcha I appreciate the color on that so my follow up is.
So does the reduction in the guidance imply that 2023 could be a much bigger revenue here or is this demand that is essentially pulling away given the extent of that.
Yes.
But we don't think we don't think demand is going away.
Let me be clear about that we have.
Seeing very strong demand.
We haven't seen any trend in any order cancellations in any form we havent seen any loss of business to competitors because generally.
Other vendors also have challenges with lead times and despite all of the challenges that we're having our lead times are worse than they used to be but they are kind of in the mix with <unk>.
With all the folks there and.
We continue to see strong demand from our customers across the board.
So we don't think that.
Our lead times and our challenges in shipping.
We're right now are causing demand destruction, if you will.
Going into next year.
This is we're not guiding yet.
2023, but of course, it's going to be about how fast.
Can we get back to shipping to demand and.
With the visibility that we have right now.
We think effectively our fiscal Q1 is going to be more of the same.
It may even be a low point and what we see from <unk>.
Availability of supply to date.
We think we will start to see improvement in our second fiscal quarter for 2023.
And our expectation is that we would be back to shipping to full demand.
In the capital.
Okay.
Yeah.
Okay I appreciate the color.
Good morning.
Your next question comes from meta Marshall from Morgan Stanley .
In my opinion.
Great. Thanks.
I just wanted to get a sense.
Maybe kind of breaking down.
Our theory.
In a way.
Okay.
Okay.
If our timing.
But we had understood. This is more of a general componentry on the Irish areas versus the more specialized chips on the Irish areas are those both kind of start for calendar Q4.
And then just in terms of getting customers to transition from a serious or series is that timeline or kind of evaluation process going as quickly as you thought.
Yeah.
Hi, Matt.
Let me start with the last part yes.
Yes, the answer is yes.
We.
We made the decision to make our series the software that runs on our series backwards compatible with I series, several quarters ago, and it's serving us well today, because it's shortening the qualification cycles for the R series relative to what it would have been in prior cycles and so the qualification of our.
Series with customers, but also the demand.
<unk> is very strong.
Because the value proposition for this platform. This next generation platform plays well to where customers are going in terms of having both traditional and modern applications.
So by these platforms.
In terms of the transition timeline meta.
We've always said it takes roughly six quarters to make that full transition and so our expectation is we're going to continue to ramp our series and by the time that we exit our fiscal 2023, we expect to be.
Almost a near 100% of serving the demand of our customers primarily with our with our series and that will ramp through the next the next five six quarters.
Your.
Second question was about I series, and our series constraints. So.
No.
Right now the.
Ballpark constrained by semiconductor.
Components.
But we are shifting.
More of the demand to our series because we expect our series to be less constrained because its a newer platform.
Going into the new year.
Because there are less parts effectively on our series that have these constraints then on ice series. So that's why we are aggressively shifting the demand to our series.
But we're also doing some work of course on I series to be able to continue to meet demand in the next few quarters for customers that.
Really needs to be on that platform for a number of reasons.
Got it so when you say calendar Q4, that's more for resolution of our series a.
Are you serious it was kind of ongoing series of calendar Q4.
Yes R series is calendar Q4, I series, we should see some improvement in that in.
And also calendar Q4 in terms of the supply we get there.
However, going into the new calendar year, we will be continuing to shift to our series, though our series will progressively become the majority of the both the demand and the revenue and shipments great.
Great. Thank you.
Yes.
Yes.
The next question is from Simon Leopold of premium James Please ask your question.
Hi, guys. This is Victor Chu in for Simon Leopold.
Are you guys gonna be entrenched public cloud adoption impacting the uptake of <unk> subscription and the cloud.
You know that you don't anticipate any customers prematurely moving away from systems deployment to virtual deployments, but can we see customers accelerating.
The shift to workloads move more workloads into the public cloud.
Given the constraint in supply is that something that could encourage them to move in that direction.
I think Victor over the long term, we will continue to see customers.
Rebalancing their environment to these multi cloud environments I think our belief system, which frankly has been I believe for the last.
Several years is that ultimately.
The applications would land will lend on the best.
Infrastructure environment for the application and in a lot of cases that won't be public cloud in some cases that will be a private cloud.
All of the cases that will continue to be a traditional private data center with hardware environment.
I don't think that the current supply chain challenges will fundamentally alter that future destination and thats future distribution of applications.
And so and we also can see it from the customer behavior that we're seeing today I think for customers that.
You really need capacity for their applications and Couldnt get hardware.
The best way the best plan B, if you will for that is to move to F. Five software.
On on virtual machine, but to do that of course customers need to also have the service available and those those also have.
Elongated lead times in a number of cases.
But moving to a cloud public cloud is an entirely different kind of architectural consideration.
And it takes planning it takes quite a bit of time and so we don't think that the supply chain challenges are particularly accelerating our move to the public cloud.
But generally we think the destination for all of our customers who are small multi cloud most of our customers are already multi cloud environment.
And and we intend to and we've designed our portfolio to solve them for these multi cloud environments.
Yeah.
That makes a lot sense, what about for customers that are on the fence or in the process of.
Yeah.
Travelling their workflows already between on premise and public cloud.
Not.
Going to encourage them to move one way or the other specialty you envision either.
Yeah.
I think customer, who you know who maybe for.
Greenfield environment, Victoria, where customer are just deploying new workloads as they could go to a virtualized environment and they have the either the servers in house available or they could.
Use.
Five software in the public cloud, which many thousands of our customers do that today.
That would be a way to get to where they want to be.
Faster.
Yeah, I would say that's a minority of situations today.
But it's a it is a possibility for customers that are not.
Building Greenfield environments.
Okay. That's helpful. Thank you.
Our next question comes from the line of Jim Suva of Citigroup. Please ask your question.
Thank you could you give us a little bit of color on the operating margin trajectory and kind of the steps as far as the timing and the magnitude of those steps you talked about several of them in your prepared comments, but how should we kind of think about the timing in each of those steps. Thank you.
Yeah, Jim why don't I start and then.
<unk> got anything to add by all means please to the.
So francois sort of laid it out in a couple of questions ago on where we see.
The hardware side of the business over the next call it three to four to five quarters.
And we think that largely the operating margin is going to ramp back up along with that shipment of hardware back to where we get to our rule of 40, but in the immediacy of the certainly over the next couple of quarters.
We're going to be below that.
37 are the 27 to 28, Mark that we had set.
And.
A lot of that is largely due to the step down in our gross margins.
That are impacting as well as the less revenue coming from our systems business and so.
Those combinations are putting pressure on the operating margin in the near term, but we do expect to get back to our rule of 40, the operating plan when we work our way through.
Some of these.
Uh huh.
Supply chain constraints.
Great. Thanks, so much for the details.
Yes.
Our next question comes from the line of Rod Hall of Goldman Sachs.
Please ask your question.
Yeah, Hi, guys. Thanks for the question.
I just wanted to come back to the full year guide change.
I'm calculating a midpoint about $91 million a reduction there and I guess it's.
Due to ongoing supply chain challenges then.
I'm curious what the duration of that changes in other words are you expecting most of that happened sooner here and then you think your supply comes in better.
We get to September or do you have visibility all the way to the end of the fiscal year and that encompasses just.
91 million could you just kind of give us an idea on timing there.
Yeah, Rod I'll start on that one, but so look I think as we lay it out in our models.
The lower point on the hardware side is likely not near term.
In Q4 Q1.
As we see.
<unk> pressures that we've experienced for the past couple of quarters continue on I think Francois noted.
Some of the green shoots that will be coming in calendar Q4 that will start to impact and ramp up for us in calendar Q1 of 'twenty, three and you'll start to see that improvement.
But on.
On the systems side.
I don't think the low point as this quarter I think the low point is more in Q4 Q1 of.
23.
22, starting from Q1 of 23 to 123 to 422.
Okay, and then I also wanted to.
Just.
Check in with you regarding the.
Back on the on the demand side of things do you are customers, indicating to you that.
That's temporary and.
I also noticed your dsos that jumped up to 59 days.
And that's due to supply, but our people now starting to order further out or why are we seeing that.
That jumped in the Dsos I guess two questions in there really sorry about that yeah. Let me start on the DSO side, and then I'll, let francois pick up the first one right. So no no changes at all this is purely a factor of.
When we.
A lot of leading up to this quarter had been a lot of the shipments and therefore, the billing going out.
For that hardware earlier on in the.
Quarter and in this quarter was a little bit more in in month, three and so just by nature of the AR balance going up that's the DSO calculation. There is nothing in terms of any dynamic to see there.
It's more of a function of that AAR balance going up on on things that are.
And the legitimate.
And that 30 day window cycle, so nothing there.
Yes.
In terms of customer behavior.
We have seen both so some of our customers are.
Who have I.
I guess, perhaps who are planning ahead and have the means to plan ahead and order ahead, we started to see their behavior moves to ordering well ahead to take into account the extended lead times.
But at the same time, we also see other customers, who are pushing out and delaying orders.
Uh huh.
In part to create leverage and say Hey, all cloud place. The next order once you have ship the order that I place a few months back and so when we net outflows to behaviors. We lend at about the same place, which is demand is kind of where where we expected it to be.
And it continues to be continues to be strong what we are not see it.
Is lost demand.
Due to supply chain.
Supply chain delays.
<unk>.
That's been the trend for the last several quarters, including this last quarter.
Great. Okay, guys. Thanks, a lot for the questions I appreciate it.
Absolutely Rob Thank you.
Yeah.
Cheesy time constraints, we will take our last question from Jason Adder at William Blair. Your line is open.
Hey, this is Sebastian on for Jason Thanks for taking the question.
I have one clarification on an open ended question. So just in terms of the supply chain issues last quarter, you mentioned about $60 million in revenue being pushed out in fiscal year 2022 for the specialized networking chips I just want to make sure those lead times haven't changed at all and that's still the expectation and it's really like the standard components and those lead times that have been pushed out.
Further than expected and pushing revenue into fiscal year 'twenty three does that is that correct.
So let me let me just clarify that.
The the entire.
You're right about $60 million last quarter.
The additional.
Down guide this quarter.
All of that is linked to specialty semiconductor components now some of that is networking chipsets.
And we also have challenges with.
Components semiconductor components that are not specific specifically networking chipset, but they're more on the power side and power distribution power shaping type of components.
And it's the combination of all of that that's causing the.
Lays in shipments and therefore, the delays in revenues.
Got it Okay. That's helpful and then as a follow up maybe the more open ended for your front door.
In terms of as you guys shift Morgan revenue to two software subscription managed services is your relationship with the partner channel. The Vars. The MSP is that changing at all are you, becoming less reliant on them to generate revenue or are you still sort of historical as you have been historically reliance on that channel to drive revenue growth.
No we don't.
Our partners.
And.
Distributors and resellers and our.
Our key partners and systems integrators.
They continue to be a really important part of our ecosystem and part of what we have.
Wanted to do is we've moved to software is embarked them on that journey with.
Five.
Such that the.
The transformation of our five towards a software centric business model can also benefit their model and a number of them.
Actually frankly, some of them more ahead of us.
And you know.
Where we're part of helping us accelerate our own our own transformation.
But we're seeing that a number of them have embraced these new models and have.
Have found great ways to add a ton of value to our customers in a software centric model and in fact that has contributed to our software growth over the last several quarters. So no. We're we're going to continue with a partner centric model.
And we're going to continue to innovate with our partners to bring a great software solutions to our customers.
Got it. Thank you that's all I had.
And this concludes today's call today's call you may now disconnect.
Okay.
[music].
Okay.
[music].
Yes.
[music].
Okay.