Q3 2022 F5 Inc Earnings Call
Yes.
[music].
Good afternoon, and welcome to the F. Five Inc. Third quarter fiscal 2022 financial results Conference call.
At this time, all participants lines have been placed on mute to prevent any background noise.
Knowing the presentation, we will conduct a question and answer session and instructions on how to queue up will be provided at that time.
As a note todays conference call is being recorded.
If anyone has any objections. Please disconnect at this time.
I would now like to turn the call over to MS. Suzanne Dulong, Ma'am you may begin.
Hello, and welcome I'm, Suzanne Dulong, Vice President of Investor Relations.
So I will go 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 Dot Com, where an archived version of today's audio will be available through October 24th 2022.
Visuals accompanying today's discussion are viewable on the webcast and will be posted to our IR site at the conclusion of the call.
To access the replay of todays call by phone dial 8886747070, or 416, 76, $486 92 and use meeting 90 468081.
A telephonic replay will be available through midnight Pacific time July 26, 2022.
For additional information or follow up questions. Please reach out to me directly at <unk> Dot too long at a five dot com.
Our discussion today will contain forward looking statements, which include words, such as believe anticipate expect 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 Stephane.
Thank you Suzanne and Hello, everyone. Thank you for joining us today.
In Q3, we delivered above the midpoint of our revenue guidance and well above the top end of our non-GAAP EPS guidance software growth of 38% drove 4% revenue growth year over year, partially offsetting continued supply chain constraints for systems.
Overall, we delivered 5% product revenue growth, while supply chain challenges continue to limit our ability to ship systems, our demand signals remain strong and we remain ahead of our initial FY 'twenty two demand plan.
While we have not seen meaningful improvement in supply volumes in the last three months. We also have not seen further deterioration.
In general our suppliers commitments held up better in Q3 than in the previous two quarters.
Based on what we see today, we continue to expect our ability to ship systems will improve during our second quarter of fiscal 2023.
As a result of our efforts to design out the most constrained components and the additional capacity our key suppliers expect beginning in the last calendar quarter of 2022.
We likewise continue to expect that fiscal Q1, 2023 will be the low point in systems revenue.
We continue to see our growth opportunity fundamentally tied to applications. So the growing number of apps as well as increased usage and heightened business value.
In Q3, we saw strong demand as customers added scaled and secured their applications with demand for security and from our service provider vertical fueling sales in the quarter.
In fact security concerns continued to drive the majority of our customer engagements with demand showing up in both software and hardware form factors and across multiple consumption models.
In one example from Q3 and existing Big IP hardware customer and one of the world's largest banking and financial services organizations turned to five when a log forging incident revealed other vendor solutions were insufficiently protecting against zero day threats.
As a strategic partner <unk> demonstrated that our advanced web application firewall provided immediate protection against current and future vulnerabilities.
Also during Q3, a large global retailer turned to five after experiencing challenges with their existing bought defense provider over a head to head three month proof of concept against their current solution. Our distributed cloud bought in risk solutions demonstrated significantly higher efficacy and the.
Customer is now deploying <unk> to protect their apps and their customers.
We have said previously that our customers are increasingly operating both traditional and modern architectures and looking to a five to unite their strategies and simplify their operations.
In the latest example of this trend.
During Q3, an American multinational financial services Corporation selected a combination of big IP and nginx to secure and process the high volume of critical encrypted transactions globally.
Last quarter I also spotlighted, our new SaaS offering at five distributed cloud services, which we launched in February .
With this platform, we are delivering security multi cloud networking and edge based computing solutions on a unified software as a service platform <unk>.
While it is still very early we are seeing good traction and customer interest.
During Q3, our global company specializing in clinical services and customizable medical devices <unk>.
Our web application firewall and API protection solution to ensure rapid deployment of their security policy at scale and to provide global delivery of services in a hybrid multi region support model all by SaaS.
Finally service providers drove demand in the quarter as customers scale and secure forgey cores and begin to move <unk> into production in one way in the quarter, we expanded our carrier grade firewall business with a north American service provider as they continue to grow both the <unk> and <unk> traffic.
<unk>.
In another service provider win we expanded offerings with an APAC based customer to include Big IP Cloud Native network functions for its <unk> mobile core.
These recently introduced cloud native functions are perfect for moving workloads from legacy NFC to a modern cloud native architecture.
Cloud native functions enables service providers and large enterprises to realize the full benefit of the cloud automating and simplifying their operations with a more secure more scalable network.
Before I turn the call to Frank to review, our Q3 results and our Q4 outlook I will comment on the macro environment.
As I said previously we saw strong demand in Q3, and we've got a strong Q4 pipeline.
At the same time, we also observed more backend linearity in Q3, and our sales teams have noted some instances where more approvals were required to close deals.
While we are not seeing it today, we believe the combination of macro uncertainty and inflation will put pressure on customer budgets and eventually force customers to re prioritize investments.
We will continue to closely monitor signals from our customers and like others. We are assessing adjustments, we would make in the event that the environment or our customers toward more cautious.
We have built a stronger and more resilient to five by expanding our solutions portfolio and our consumption models.
As a result of our business transformation.
Is positioned to benefit both from software growth drivers, including Big IP Nginx, and our distributed cloud services SaaS offerings.
And what we expect will be persistent demand for systems.
As a result of our successful transformation efforts to date, we have a stronger business model that increases our confidence in our ability to deliver sustained revenue and earnings growth.
Now I will turn the call to Frank Frank.
Thank you Francois and good afternoon, everyone I will review our Q3 results before discussing our Q4 outlook, we delivered third quarter revenue of 674 million, reflecting a 4% growth year over year with 5% product growth product revenue represented 48% of total revenue in the quarter and software represented 50.
5% of product revenue.
This is the second quarter in a row, where the majority of our product revenue has come from software.
Q3 software revenue grew 38% to $179 million systems revenue of $148 million declined 18% year over year due to ongoing supply chain challenges and resulting shipment delays.
Similar to Q2, we added systems backlog of tens of millions of dollars in Q3.
Rounding out our revenue picture Global services delivered $348 million in Q3 revenue up 2% from the prior year.
Taking a closer look at our software revenue subscription based revenue contributed 82% of total software revenue in the quarter a new high.
Term based subscriptions continued represent over half of our subscription revenue with smaller but growing contributions from software as a service and utility consumption models.
Revenue from recurring sources, which includes term subscriptions software as a service and utility based revenue as well as the maintenance portion of our services revenue totaled 72% of revenue in the quarter. This is another milestone for us and is up from 66% in the year ago period on a regional basis Americas delivered.
5% revenue growth year over year, representing 57% of total revenue.
EMEA declined 7%, representing 23% of revenue in APAC grew 15% representing 19% of revenue.
Ill remind you that given current supply chain constraints, our geographic revenue distribution in a quarter is not fully indicative of demand for each given region.
Enterprise customers represented 70% of product bookings in the quarter service providers represented 18% and government customers represented 12%, including 3% from U S. Federal.
I will now share our Q3 operating results.
GAAP gross margin was 86% non-GAAP gross margin was above our guide at 83, 2%. While we continued to experience increased component prices expedite fees and other sourcing related cost. Our Q3 gross margin reflects some improvement in average selling price on systems in the quarter.
We are not ready to say, it's a trend, but we are encouraged about the overall direction.
GAAP operating expenses were $436 million non-GAAP operating expenses were $367 million. This is lower than our guided range. As a result of some investments we delayed in anticipation of potential macro headwinds that did not materialize in the quarter and lower international expenses related to the strengthened.
The dollar.
Our GAAP operating margin was 15, 9% our non-GAAP operating margin was 28, 8% or.
Our GAAP effective tax rate for the quarter was 18% our non-GAAP effective tax rate was 17, 4% largely driven by a nonrecurring benefit associated with the filing of our federal income tax return during the quarter.
GAAP net income for the quarter was $83 million or $1 37 per share.
Our better than guided gross and operating margin performance and lower tax rate contributed to non-GAAP net income of $155 million or $2 57 per share.
I will now turn to cash flow and the balance sheet, we generated $71 million in cash flow from operations. In Q3. This is net of more than $30 million of payments to partners related to securing component inventory to support future hardware builds and component expedite fees capital expenditures for the quarter were $9 million DSO.
For the quarter was 61 days similar to last quarter. This is up from historical levels due to back ended shipping linearity in the quarter, resulting from ongoing supply chain challenges.
Cash and investments totaled approximately $757 million at quarter end.
During the quarter, we repurchased approximately $250 million worth of F. Five shares or approximately one 5 million shares at an average price of $171 per share.
<unk> revenue increased 14% year over year to 1.64 billion up from 1.61 billion in Q2, largely driven by subscriptions and SaaS bookings growth and to a lesser extent deferred service maintenance.
Finally, we ended the quarter with approximately 6900 employees.
I will now share our outlook for the fourth quarter.
Unless otherwise stated please note that my guidance comments reference non-GAAP metrics.
We expect Q4 revenue in the range of $680 million to $700 million. Our pipeline indicates Q4 demand that would put our software revenue growth towards the high end of our 35% to 40% target for the year as Francois discussed. However, we are very cognizant of the broader more cautious environment and as a risk.
Salt, we see more risk at the top end of our software growth range than there was a quarter ago.
Given the Q3 strength in global services, we now expect global services revenue to grow approximately one 5% to 2% for the year. We expect Q4 gross margins in a range of 82% to 83%.
We are seeing component costs continue to rise and expect that they will be higher still next year.
As a result, we implemented an approximately 15% price increase in systems effective July one.
Given our backlog, we expect it will take some quarters for the price increase to manifest into sustainable gross margin improvements.
We estimate Q4 operating expenses of $374 million to $386 million, which would put our FY 'twenty two operating margin at approximately 29% an improvement of 100 to 200 basis points from our prior outlook.
Factoring in the tax rate benefit from Q3, we now expect FY 'twenty to effective tax rate will be approximately 19%.
Our Q4 earnings target is $2 45 to $2 57 per share.
We expect Q4 share based compensation of expense of approximately $61 million to $63 million finally, as we announced in the earnings press release, our board authorized an additional 1 billion for our share repurchase program.
This new authorization is incremental to the 272 million remaining in the existing program as.
As we have over the last two years, we expect to continue to balance share repurchases with other strategic uses of cash.
This concludes our prepared remarks today, operator would you. Please open the call to Q&A.
Thank you, Sir ladies and gentlemen, we will now begin the question and answer session.
You would like to ask a question. Please press star followed by the number one on your telephone keypad.
You would like to withdraw your question. Please press star followed by the number too.
Please standby, while we compile the Q&A roster.
Your first question comes from Sami Badri of Credit Suisse. Please go ahead.
Hi, Thank you for the question.
First thing I wanted to just clarify wise.
I think there was a reference to the backlog increasing.
Or at least.
Adding more revenues to the backlog could you clarify if the backlog exiting fiscal <unk> is actually higher than where it was exiting fiscal <unk> 'twenty. Two so that's my first question the.
The second question is there's a lot of interest in the Investor base around the software growth trajectory of the business and I know you guys discussed coming in at the higher end of the range in fiscal year 'twenty, two but could you characterize or give us indication on what fiscal year 'twenty three is going to look like just because the growth rates are rather significant.
Sami I'll take the first question then I'll, let <unk> speak to the your second question. So yes.
Backlog was higher.
A significantly higher in Q3 than it was in exiting Q2, we did not quantify that we talked about that we would do that at the end of the fiscal year. So we'll actually released the number as part of the October call and Youll see it in the K.
Okay.
And Sami I'll take the second part of your question. So obviously this is not a time, where we're guiding for fiscal 2023.
Overall, if you look at our.
Performance of the business in software.
We guided 35% to 40%.
Investor meeting about almost almost two years ago now in November of 2020.
And.
We have delivered.
That in the.
In the first year in 2021, and this year, we're delivering closer to the top brands.
End of the range of that.
Guidance, so we feel very very good.
The drivers of software growth in the business.
We've talked about including modern applications the strength, we're seeing in security.
And the.
Adoption of multi year agreements with that five driven by digital transformation and automation.
And so we'll talk more about software growth for 2023.
In.
October but when you look at 2023 frankly, the factors I think some of the factors that will affect that.
One of course like every other company as the macro environment and what would that have.
In effect on.
On our growth rate.
Today, frankly, it's too early to say because we haven't seen a fundamental change in the.
The buying behaviors of our customers across the globe based on the macro at this point.
And I think the other factors will be.
Through the pandemic.
Simeon This is specific I would say to the big IP part of our of our business.
We have seen continued demand for hardware and we have seen a number of customers that had declared that they would move to software pretty quickly.
That have actually.
Recommitted to hardware and stayed with hardware longer. So we're seeing seeing very very strong resilience and strong demand in hardware.
Sometimes at the expense of customers that would have moved to software so if that.
Is that kind of mixed shift if you will continue in 2023 that may affect our.
Software growth rate some.
But it wouldn't affect the top line because it would be more of them.
Our mix shift factor, if we continue to see that shift in.
And customer behavior.
Got it. Thank you for that color and I just wanted to just follow up on specifically service providers because that came up a couple of times on this call could you just give us some more specifics to what what exactly the inflection is at this point for why service provider customers are relying more heavily or see what specifically are these.
And the ERF portfolio.
That's most helpful or the right solution for them could you give us the specifics on.
Little bit more detail on what's going on maybe the type of service provider.
I think some either to two dynamics with our service provider business is doing very well and it's the result of.
Kind of two series of investments that are intercepting I think the market at the right time.
On the software side.
We have invested.
Heavily in cloud native functions.
It allows service providers, who want to build five G cores.
To evolve to these more cloud native environments and be able to do that with us and we have now a number of design wins in this area that are starting to go into production in this.
This quarter, we had more and more of these going into production and so it is starting into into revenue.
And our expectation is that that will that will continue but we feel well positioned for the cycle.
Kind of next generation software deployment.
Service providers both.
In the core infrastructure and at the edge.
The other dynamic that's going on with service providers.
That they continue to increase capacity.
In the <unk> environment for <unk>.
<unk> traffic specifically site traffic.
And we I think as we shared before we have continued to make investments in our hardware platforms.
To prepare for these <unk>.
Kris demands for capacity and as a result, we have been.
Been able to get to some price performance points.
<unk> Dot are really meeting the demands of high scale high capacity service provider deployments, especially in the GI Lan quoted in that part of the network for things like carrier grade firewall.
And.
That's driving strong demand and execution in the service provider vertical.
Got it thank you.
Your next question comes from James Fish of Piper Sandler. Please go ahead.
Hey, guys. Thanks for the questions here.
I wanted to go off the software question from before is there a way to think about how much the unattached software deal flow is either independent or dependent on some of the systems deal flow given you're already selling into some of the largest organizations out there and also you mentioned there Francois multiyear agreements just now is duration actually extending for software.
I'll start with the latter part of that question, Jim So no I think the trends are pretty steady.
Jim on the on the multiyear agreement typically there are three year agreements and we haven't seen a fundamental change in duration.
In terms of the first part of your question.
Ah.
If you take our software business, Jim obviously, the part of the business, that's driven by kind of net new modern applications largely started with nginx is not attached to any dynamics around hardware and our managed services and SaaS business.
Distributed cloud services.
<unk> is not attached to any dynamics around the hardware business.
With Big IP.
What youre seeing is the majority of the.
The majority of the software business.
It does not have a.
It is not attached to the dynamics in hardware. However, there are.
Customers, who are we still have a number of customers for <unk>.
<unk> from a sort of hardware first environments with software first environment.
And where we have seen changes I would say not not specifically this quarter, but over the last.
18 months is we have seen a number of customers who had declared that they would go to a software first environment sooner.
And we have seen a number of them constantly delay that and stay with a more of a hardware for us environment and I'd say, that's where you have an effect in specifically in that area of the big IP business, where.
Youre seeing.
Very strong resilience on the hardware.
And but it's affected a little bit our software growth rate.
Yes.
Alright, and then maybe for Frank.
You want to unpack your guide if this year you, especially the <unk> Street for Q4 is there a way to understand for how much during the year will be a net issue from the supply chain constraints versus that prior I believe $60 million to $90 million headwind versus the macro impact you know including in guidance.
Yes.
I think you'll probably be able to see that more specifically in Q4, when we talk about the backlog number.
<unk>.
As a policy if the if the backlog number is more than 10% of product revenue. Then we will release the actual number and that's fully our expectation.
Right now and so I think youll be able to.
<unk> pull out.
What was the difference in that change and make some assumptions on what that would've meant for the software revenue or the total revenue overall so.
If you can hold off for three months I think you'll get your answer.
Your next question comes from meta Marshall of Morgan Stanley . Please go ahead.
Great. Thanks.
You bet.
Couple of questions.
On the supply chain.
When you are expecting kind of in the second quarter or does that mean.
The redesign process.
Fleet at that point or that Barry component available do you expect to take place at that point and then maybe as a second follow on question.
How is the art theory transition from Iberia for Brexit.
Thanks.
Thanks.
Yes.
Hi.
So.
When we're talking about improvements in our.
Shipments in the second fiscal quarter of 2023, <unk> driven by <unk>.
Two factors the first is <unk>.
What we expect to be better component availability.
From our suppliers based on commitments they've made to us.
And Jen will lead from what we see they are on track with execution against these commitments.
On some of the most constrained components.
So that's factor number one factor number two is.
We have also been doing some design work to designed around our redesigned around some of the most constrained components.
And those design efforts should complete.
Towards the tail end of the calendar year.
Which would allow us to ship with the new components.
In the second quarter second fiscal quarter of 2003. So those are the two factors driving that meta.
As of today, both of those factors are really on track.
Now we're talking about things that are happening in the next six to nine months and then.
Looking at the full second half of 2023 so.
We I'll caveat that by saying there is still a ton of execution to come and commitments to be delivered by our suppliers.
But generally we are on track and I would say.
We feel incrementally better about that than we did three months ago from what we've seen from our supply commitments and our own work.
As it relates to our series.
We are.
Very happy with the ramp up of our series it actually is right now.
Fastest ramping new platform that we've had.
The ramp is happening two times faster than prior new new platform introductions.
And that's largely due to the benefits of the R series platform. So it's an investment we started a few years ago really to bring to our customers.
Several of the elements of the cloud to their on premises environment. So they are getting.
A lot of automation benefits from our series the ability to run multiple software tenants on the same platforms and so for those customers that.
Really want to automate their environments, which is at the heart of a lot of the digital transformation.
What they're getting from our series is not just it's not just the price performance benefits that you get from a new hardware platform, but also a lot of the cloud like benefits of automation and multi tenancy.
Into.
Into the platform.
That's good.
Good ramp and we are I think we're pretty excited about what our series is going to do for the business not just this year, but for the next few years.
Great. Thanks.
Your next question comes from Tim Long of Barclays. Please go ahead.
Yes.
Thank you.
A few on the software business.
First any any update on getting more consistent metrics here.
<unk> net dollar retention loved.
Love to get an update on when we could potentially see those numbers more specifically and then maybe related to it we're not going to get them now Frank.
Frank could you a little talk a little bit about kind of what youre seeing is a nice jump in software.
New deals versus true forwards, how how do we look at that.
Aspect of the software growth this quarter.
And then maybe the last one is.
Maybe for you Francois.
We're coming up on three years of three year anniversary of some of the really large first term deals.
Could you talk to us a little bit about.
How you think those renegotiations or renewals would be working in and how that can work into the model and maybe just a little color on that first set of deals that should be a pivotal time to renew those deals I would think and if so are those deals like some of the other business, where it's kind of the kind.
<unk> been running above run rate, so those renewals could potentially be larger than the initial contracts. Thank you.
Sure Tim Thanks, So much for the question I'll start and then I'll turn it over to Francois. So in terms of the split out on the software metrics as we've as we've talked about ongoing we're just starting to hit the second term of.
Where a lot of this business started to take off and so we're still tracking those metrics internally, we're not ready to release them externally again as I've said in the past we want to make sure that they are used in the right way and they can be predictive.
For the future outlook of the business and as we get more and more of these data points over the next coming quarters.
We do expect it's going to be more of a when not if we do release these metrics and so more to come on that.
In FY 'twenty three.
I know you had another question for Francois specifically on some of the renewals.
Generally Tim on the.
<unk>.
On the renewals.
The early indicators on the revenue expansion opportunity.
Really good.
On these.
On those large multiyear agreements what what we're seeing is continued growth in application usage.
And that's a part of what's driving the expansion in some of these opportunities.
It's early days.
<unk> said, but its going very well I would say the other the other driver.
Both renewals and new multiyear agreements is security.
Had a very strong quarter again in security.
And what we're seeing is that the.
The portfolio that we've put together that allows our customers to put security capabilities across their environments.
It's really making a difference so this quarter, we had a very strong quarter on security with big IP and <unk> and in fact, what's across all of our form factors in Big IP I think we had a very strong quarter with nginx security. This was the second quarter in a row, where we had over 100 wins of engine.
With security.
We have very strong debut.
If you will for our distributed cloud services, Wap offering which is our SaaS offering on security.
And we're bringing all of these security offering.
Over time under a single SaaS console.
Will allow our customers to push the same policy to all of their environments for protecting their applications. So that that if you will competitive differentiation, we're seeing the benefit of that both in terms of expansion of existing agreements as well as new agreements that are that are driven by our <unk>.
Security software.
Okay, and Frank if I could just to follow up on the metrics in the past and talk a little bit about.
The software growth in the subscription business is being driven by true forwards and or new deals.
In the pipeline. So could you just give us a little color what kind of mix of growth between two forward contribution in and kind of the new deal contribution.
Yeah, Tim we're not going to split that out in the quarter I think both of them were quite healthy when I take a look at.
Where we have been in the past the true for contribution was.
Was along our expectations for the growth in new business that was also.
In line with our expectations and it resulted in 38% software growth, but im not going to give a specific split between the two for the call.
Alright, thank you.
Your next question comes from Alex Henderson of Needham. Please go ahead.
Great. Thank you very much so.
Across the presentation, you've made a number of references to.
Buying behavior.
Specifically said at one point that buying behavior patterns haven't changed.
The other point you said that there is some.
Increase in the number of signatures required.
And you have weighed into your guide the expectation of continued.
Softness in the broader economy.
But can you talk a little bit about.
Where you are in terms of the pipeline of activity that you're chasing whether the activity is.
<unk>.
More robust less robust.
Then you would expect for this time of year, and particularly whether the deal sizes are bigger smaller.
How does the price increase might impact.
No.
Longevity and within the backlog, whether there is any concern.
Around.
Cancellations of orders.
Alex Let me.
Start with the last part of your question.
So no with the backlog, we have absolutely no concerns about cancellations of orders.
And that's because we haven't seen any there hasnt been any.
Trends.
Cancellations.
And also our lead times, whilst elongate it I still are still at about four months.
And relative to some of the other hardware networking players our lead times are still less.
A number of others.
And in fact, we have seen some of our orders delayed because customers were waiting to get some networking gear that had 12 months with lead times before ordering from five not only has.
Two to six months of lead times, depending on which platform you pick so we're not worried about cancellations at all.
Let me talk to.
The other dynamics.
You mentioned.
So the customer buying behavior, the implications of price increases so if I take a picture right now Alex of where we're at.
No we havent seen on a global level.
I would say with the exception of Europe , specifically I'll come back to that enrollment we have not seen a fundamental change.
In.
And buying behavior.
We have seen a little back ended linearity this quarter.
And yes, some deals that had.
A little more scrutiny in terms of the number of approvals, but when we looked at the overall demand signals in the quarter.
They were very strong.
And we didn't see a fundamental change in close rates, if you will from our pipeline.
That is I would say across the globe, it's true in Europe , specifically, we did see.
Some continued softness in very back ended linearity and we think the macro is definitely affecting buying behavior in Europe .
Already today.
Now when you when you look forward around.
What we think we will see.
In coming months, our pipe, let's start with our pipeline.
Is strong for Q4 and it is about what we would expect to have.
As of today four for our Q4 pipeline, we have a number of large deals specifically in software in Q4 is always a quarter with some of the largest deals and.
And we have that pipeline of large deals to deliver against the deliver against our guidance.
That being said what what we are cautious about is.
Of course, we see the dynamics and the macro environment.
I think the combination of inflation.
In the U S and elsewhere.
And also outside the U S foreign exchange, which.
Ends up making <unk> more expensive to customers in Europe , Latin America and Asia.
Those increases in cost to customers will force them to make prioritized prioritization calls on their investment.
And we think that that May result.
In some deals being pushed out.
Or.
Current prioritization of projects than what we're currently expecting we haven't seen any sign of that to date, but our view is that given given that every other networking vendor out there has made increases in prices.
<unk> us.
Customers at some point, where budgets are not going up exponentially and they'll have to make these prioritization calls I think thats. The the macro effect that we we think we are likely to see in the next few months.
Your next question comes from semi Chatterji of J P. Morgan. Please go ahead.
Great. Thank you.
Thanks for taking my questions.
I just wanted to start with you've talked.
About the price.
Spending from your customers.
She is the environment you're in.
But also sounds like you're already starting to prepare.
<unk> followed that to some extent.
Curious about hearing how you're thinking about the levels, you can pull or changes or re prioritization in terms of if I, even <unk> would you sort of inquiries more incentives on the on the software business will focus more on security like what are the levels, you're thinking you can sort of.
Drive towards as you do see the customer behavior is changing because of the macro and then just a quick follow up I mean, the 15% price increase on systems would have beaten the order trends that you've seen thank you.
Just the last part of your question about the 15% price increase what was your question about that.
Any color on the order trends since stating the price increase pushing through the price increase.
Okay.
So let me just start with that part of the question. So.
Yes, we did have a price increase.
That took effect on July one.
And.
As a result of that.
We had a number of orders that were pulled into.
Our third quarter by customers wanting to order early to not not be affected by that price increase when we look at the demand signals for Q3, we normalized out these orders that were pulled in and even if you normalize out for these orders it was actually a strong I would say a strong too.
Strong demand quarter.
In terms of the order trends post the price increase.
We are early in the in the quarter and the linearity that we're seeing today is not really different than what we would see in the first month of the quarter.
To your second quarter or the first part of your question around how we're preparing for what May transpire in the macro.
You will see that we are.
Being cautious so we're not I want to be clear, we're not seeing any change in our demand signals to date, but given.
Everything else that's going on in the macro.
We have out of out of caution cigna.
Significantly slowed down hiring.
In the last months across functions.
There were some kind of investment initiatives that we had that we had we have delayed.
To see more clearly what's going to transpire in the macro.
And if we push forward with these investments are not so right now to make its more on the.
Management of our Opex and Opex run rates that we have.
Focused.
If you will allow preparation and readiness our incentives for software for our teams are pretty strong and theyre going to continue to remain strong and hopefully you've seen that in the results, we're having on our software growth rates.
Okay, great. Thank you thanks, Chris.
Once this thing.
Our next question comes from Rod Hall of Goldman Sachs. Please go ahead.
Yeah, Hey, guys. Thanks for the question I wanted to come back to the comment I think Francois you made it.
The backend loaded nature of the quarter and kind of the Dsos.
I guess I was curious about that.
The drivers of the backend loading I mean, you guys are saying, you're not seeing demand impacts, but I wonder what.
How would you.
How would you characterize the drivers for the backend loaded nature of the quarter was there a particular type of product you were selling more in the back into the quarter was there a promotion or something like that and then I'm curious also on the Dsos, whether you think next quarter those might come back down again.
So yes, let me start with the DSO side of the question and then let Francois.
Talk about some of the backend linearity of it.
So the DSO a lot of that.
Rod I think is going to be a little more linked to.
Not bookings, but just frankly when things can be shipped and it's the components that came in in the back half, but then add the shipments go out the bill doesn't go out associated with that and that drove the increase in the AR balance which is the calculation for your DSO. So.
Is likely going to see will return to normalcy, when we get into the back half of FY 'twenty three.
And that's when that's when we're going to.
Dsos come back down I will note that the quality of the quality of those receivables that we haven't seen any aging increase it just happens to come after the end of the quarter. So I will expect dsos as Francois mentioned in the in the shipping side in the back half of FY 'twenty three to see when that is going to start coming down in that.
Our balance coming down.
Yeah, and rod on the backend loaded quarter.
Yes, it was more back ended but on a very very strong.
In quarter, and so I think.
I mentioned earlier that we saw at the very end of the quarter Samardo being some orders that we felt should have come in Q4 that came in Q3, we attribute some of that too.
Customers ordering ahead of the price increase I think if you normalize that out.
That would normalize a little more of the linearity of the quarter.
The other factor is Europe .
Which was in fact backend backend loaded linearity, we think that's got to do with the macro and the scrutiny there.
And if you if you normalize out these two factors.
There was probably also an element that we started to see around more customers I want to say outside of Europe .
More approval cycles in the orders and so it may have pushed the motors that we may have expected in the second month to happen in the third month of the quarter.
And first of all can I just follow up on one thing there.
So youre, saying most of the types of orders you would've seen where systems kind of ahead of the pricing increases is that the right way to characterize the kind of the type of order you saw on the backend or.
Yes, thats phenomenon around.
Sort of orders very late in the quarter to avoid the price increase would have been more about systems.
Then for software what I think we had a more kind of normal linearity.
Great. Okay, alright, thanks, a lot I appreciate it.
Thanks, a lot.
Your next question comes from Amit <unk> of Evercore. Please go ahead.
Yes. Thanks.
Taking my question.
As well I guess, maybe to start with on the software side right.
The higher end of that 35% to 40% growth rate this year.
Is there anything you would call out that's more onetime in nature that you'd be healthy profit growth in fiscal 'twenty, two laser <unk> big deal or something.
And then if you do end up in this slower macro environment in 'twenty, three does that help or hurt your software business over time.
Amit Let me, let me start with that and I'll, let Francois I'll take the back half of your question. So.
There is nothing that is abnormal to what our expectations were.
We will note that we did have.
Large deal activities that happened three years ago that repeated themselves that repeated itself. This year and that's going to be part of the normal process in <unk>.
It's why we have potentially quarter to quarter volatility.
Even on larger numbers as these numbers, increasing the denominator of that fluctuation will again be muted and decreased but we've.
You talked about some large deal activity in FY 19 that repeat itself.
This year and Thats always been part of our expectations, even going back to <unk>.
I'm in November of 2020, when we thought about what the horizon two outlook would be.
Yes.
Second part of your question.
So the question is whether if we are in a recession in 2023 does that help or hurt our software business.
<unk>.
Well.
I will just.
Gives you some some thoughts on how I think about this.
On the one hand.
I think one thing we've seen in past recessions is people hunker down and not stock.
New things, but continue to thing to do the things that they've been doing.
And so what that would mean is for our customers that are on hardware.
<unk>.
It's likely that some of these customers with the site with besides just continue to stay on the hardware tween rather than start a whole new architecture, New project. They hadn't done that already and if you look at it that way that would favor a hardware business.
And Les our software business for where there's this big IP.
Opportunity between hardware and systems.
On the other hand.
The vast majority.
Alrighty of our software business is subscriptions and we think there are a number of customers that would prefer to move to the opex model in that environment rather than new.
New large capex outlays and that would favor more of our software business, but if you step back from it.
I think the way we look at it as we are.
Now built the business model.
That we think is actually quite resilient.
Because we can meet our customers where we're.
They are.
With hardware form factors software form factors as term subscriptions of perpetual and even SaaS and managed services form factors and so if we have customers that.
Want to add security capabilities to their environment, but they want to start with.
Our lower expense and appear as you go model our SaaS offerings.
Are going to get traction very rapidly they already are.
And that would favor that in 2023, so overall.
We feel that we've got the resilience in the model to be able to meet customers in the in the economic model that makes more sense for them in a recessionary environment.
Perfect. Thank you for that and then kind of just follow up on the system side.
You made some comments on fiscal Q1, and 'twenty two will be the low point, that's it seems revenue.
Was that an absolute revenue statement or excuse me on a year over year declines will peak over there and then really if I look at all the stuff you have on the system side from the backlog with the price increases.
<unk>.
Is there a reason why we don't see your hardware business showed positive growth next year.
So yes, let.
Let me start with that and let Hanwha <unk>.
We were giving an absolute in terms of revenue dollar value for when Q1 would be the low point.
And our systems revenue and that is purely a result of.
The components that are needed to ship when we see those schedules coming in as Francois mentioned.
The volatility associated with <unk> has gone down.
From what we have experienced in recent quarters that having been said the.
Commitments that we have we will show that that will be the low point of what we can actually produce to that to that volume and so that's why on a dollar basis.
We expect Q1 to be the low point.
Let's see your second part the second part of your question Amit.
Whether we would expect hardware to show positive growth next year.
Our expectation would be yes that our hardware would show positive growth next year. If of course, we are able to.
Have the recovery profile.
Our supply availability that we have talked about so we are on track with that profile for now and if that confirms I would expect our hardware revenues to be greater next year than they are this year.
Because we're not.
<unk>.
Our backlog frankly is so large today that even if in a recessionary environment the hardware demand was too.
The less than it is this year and to be clear this year the hardware demand is much higher.
Then.
The revenue we're printing.
Even if the demand was to be less.
We would.
We would be able to ship more revenue than we have this year.
At this stage I'm not going to speak to demand on our hardware business for next year, because there's so many.
Loans, and we know we're going into a macro environment.
But specifically speaking to what hardware revenue could be I would say, yes, assuming that supply is there.
And I mean, I will perfect. Thank you.
I will reconfirm, what Francois said last quarter Q1 will be the low point.
We will see a build in Q2 from there as some of the Redesigns and components become more available.
We expect Q3 to be higher yet still because of.
We're able to ramp production, even more on the new platforms.
And then ultimately by Q4, we may actually start to begin to bring down backlog.
Because of availability, but we do expect it to take a linear up.
Curve on the revenue for systems next year.
Got it thank you very much.
Okay.
Your next question comes from Jim Suva of Citigroup. Please go ahead.
Thank you and I just have one question brand saw in your prepared comments you mentioned additional signatures in a little bit more time to get deals to be completely approved I'm wondering does this also allowed the cto's more time or more contemplation.
To do virtual instances more.
Software VM type.
Production orders from you or is it kind of the cadence of what Theyre looking at kind of as you expect I'm just kind of wondering what the elongated closing time does it actually allow them to kind of take a step back and look at the whiteboard, a little bit more about the solutions that they're buying from you. Thank you.
Thank you Jim So we're we're having.
Jim I think the.
The expanded nature of our portfolio today, where we are able to engage our customers with a SaaS offering.
A software offering or.
Hardware offering where.
They want to look at that.
Or a combination of all of the above for their capabilities for addressing multiple applications in different environment.
That's creating great strategic kind of architectural conversations with our customers, but they are happening early on in the cycle.
So by the time, we get into a project that's been defined and scopes by teams and getting into an approval cycle. I don't think it's a question of our CTO stepping back and saying, let me reconsider all of that.
I think it's more of the.
In the in the first few quarters in the pandemic there was such a rush to add capacity that I think people were just.
Moving.
Orders as soon as they were coming into the queue and now.
Especially perhaps with people knowing maybe there's a recession around the corners.
They're making sure that the right levels of approvals existed in organization and they take their time and when they make a decision. It's a full go so I think it's more of that effect, Jim then a step back around.
Architecture, which does happen, but it is happening upfront early on without the customers' technology teams and our own technology technical teams.
Got it. Thank you so much and I appreciate the clarity.
Thank you.
Ladies and gentlemen, due to time constraints, we will take our last question from Simon Leopold of Raymond James. Please go ahead.
Thank you I wanted to get a quick clarification and then a broader question on the clarification front.
Francois you indicated growth towards the high end for the software business for the year and I think that might imply a sequential decline from systems business in the September quarter, and I want to verify that and if it if it is down sequentially I just wanted to get a better understanding of why because it sounds like.
Supply chain constraints.
Somewhat better or the same so not sure on that point and the broader question I wanted to see if you could talk a little bit more about unpacking your enterprise verticals.
In the past you used to disclose more detail about the composition of your enterprise customers and in light of the concerns about a potential recession I think it would help to get a better understanding of the profile of these enterprise customers in some sense that you have very little to no exposure to the SMB market.
Within that enterprise vertical and where your vulnerabilities might be thank you.
Let me start and I'll, let francois pick up on the on the back half of your question. So.
As you know, we as a policy don't.
Really guide to specific mixes within the components of our product revenue.
Did say last quarter that we expect.
Q4, Q1 to be the low point of our systems revenue purely due to supplier.
Supplier commitments and what we could actually ship and.
So I'm not going to address are we going to be down sequentially quarter over quarter in terms of dollar revenue.
But directionally I was saying last quarter and still feel that Q4, and Q1, but with the low points. We're saying now specifically Q1 may be lower than Q4, I wasn't saying, specifically, what Q3 Q4 was going to be in relation to Q3.
The supply so on the supply chain dynamics you are correct, we are seeing a bit of a stabilization on most of the components, but we do have.
But we what we call the Golden screw.
Component to building boxes, meaning that you have to have everything obviously to do it and there are still a few.
Components associated with our builds that are constrained and continue to be constrained and so if for whatever reason those are freed up which is not our expectation we can do better than this but that's that's not the expectation that we want to set for you there is still though broadly.
Supply chain is getting better for most components. There are still a few in our specific builds that are constrained.
Talked about physical Q2, being better not because those suppliers are able to ship us more but more because of the redesign efforts that will likely go into effect.
In the back half of R. R.
Our fiscal Q1 that will help us with the improvements in builds in Q2.
And so the second part of your.
Question, we have no virtually no exposure to the SMB segment.
So our exposure is really large enterprises.
And of course service providers and government, but those are the three three.
Three verticals, we serve and in the enterprise space, it's really the the.
The large enterprises around the world.
Thank you.
Ladies and gentlemen, this concludes your conference call for this afternoon.
I would like to thank you all for participating and ask that you. Please disconnect your lines.
Okay.
Yes.
Okay.
Got it.