Q4 2022 F5 Inc Earnings Call
Please standby were about to begin.
Good afternoon, ladies and gentlemen, welcome to the <unk> incorporated fourth quarter fiscal 2022 and financial results Conference call. At this time all participants are in a listen only mode and please be advised that this call is being recorded.
After the Speakers' prepared remarks, there will be a question and answer session. If you would like to ask a question. During this time simply press star one on your telephone keypad. If you would like to withdraw your question Press Star One again and finally, if anyone has any objections. Please disconnect at this time and.
And at this time I'd like to turn the call over to MS. Suzanne Dulong, Vice President Investor Relations. Please go ahead ma'am.
Hello, and welcome I'm, Suzanne Dulong have five's, Vice President of Investor Relations Francois logo 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 EF IV 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 Dot Com, where an archived version of today's audio will be available through January 24th 2023.
Visuals accompanying today's discussion are viewable on the webcast and will be posted to our IR site at the conclusion of our call.
To access the replay of todays call by phone dial 870, 702030, or 64736 to 9199 and used meeting I D 320941 times.
The telephonic replay will be available through midnight Pacific time October 26, 2022.
For additional information or follow up questions. Please reach out to me directly at S stopped due long at a five dot com.
Our discussion today will contain forward looking statements, which include words, such as believes 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 S. E T 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 Francois.
Thank you Suzanne and Hello, everyone. Thank you for joining us today.
I will speak first to our fourth quarter results before discussing fiscal year 'twenty, two and our outlook for fiscal year 'twenty three.
Against the backdrop of a rapidly changing environment, our team delivered fourth quarter revenue at the top end of our guidance and earnings per share above the high end of our guided range. As Q4 progressed, we witnessed increased budget scrutiny from customers and elongated selling cycles, particularly related to new projects.
A new architectural Rollouts. These dynamics were especially evident in our Q4 software revenue, while we had a strong pipeline for new multiyear subscriptions headed into the quarter customers macro concerns led to lower close rates and lower software growth than we expected.
We have some customers pause large scale digital transformation projects in favor of business as usual. We also had customers re sized projects with more conservative initial use H estimates.
And we saw foreign exchange headwinds contribute to budget and spending challenges.
With customers in both EMEA, and APAC, including customers, who delayed projects with the hope that currency would stabilize.
Conversely, Q4 marked a significant improvement in our system's revenue versus prior quarters, thanks to better availability of several critical components in the broker market.
The scarce components came out higher costs, which are reflected in our Q4 product gross margins.
However, our priority was and will remain fulfilling customer demand for systems, which stayed strong throughout the year, we were able to partially offset higher product costs and continued operating discipline and a favorable tax rate enable us to outperform our Q4 earnings per share target in the quarter.
Uh huh.
When I step back and look at FY 'twenty, two as a whole I readily acknowledge that the year did not look the way we envisioned when we began it.
Despite supply chain challenges and growing customer caution beginning in Q4, we saw persistent customer demand and our sales teams drove record breaking bookings for the year. In addition, we achieved several important milestones.
With portfolio and consumption model diversification, we drove our product mix to 50 149 software hardware a noteworthy accomplishment in our transformation journey and very different from where we were just five years ago when software represented less than 15% of our product revenue.
Second with the expansion of our application security portfolio and increasing demand for securing applications. In a P is we have grown our security business to $1 billion in revenue.
Security related revenue now represented 37% of our FY 'twenty to total revenue.
Third 69% of our total revenue was recurring in FY 'twenty, two with a double digit three year compound annual growth rate over time higher levels of recurring revenue will continue to add predictability and stability to our model.
Finally, we launched three significant new platforms during the year leveraging customer focused innovation across the continuum of deployment models. These launches included expanding and unifying our SaaS offerings to F. Five distributed cloud services as well as our next generation R series and Velo.
Since.
These milestones are representative of how significantly we have evolved the five over the last five years.
<unk> five is stronger and better balanced with a more resilient revenue base and an operating model capable of delivering significant leverage.
Over the next year, our business is likely to benefit from tailwind to our systems business as a result of improving component availability.
It's also likely to bear some wait for macroeconomic headwinds in the balance we expect to deliver FY 'twenty three revenue growth of 9% to 11%. We also expect the combination of revenue growth and operating leverage will enable us to deliver non-GAAP earnings growth in the low to mid teens, which means we are.
Also expect to deliver on our rule of 40 benchmark in FY 'twenty. Three further we are committed to operating the business to maintain the rule of 40 and double digit earnings growth on an annual basis going forward.
Frank will speak to our outlook in greater detail in his remarks before I pass the call to Hindle I will talk to several of the reasons why we believe we will deliver strong revenue and earnings growth this year.
First hybrid I T is here to stay or multi cloud infrastructure agnostic approach means we can create a more unified experience across customers disparate environments.
We are enhancing automation and driving operational efficiencies and corresponding cost efficiencies.
Our ability to create a more seamless application environment for our customers is already an advantage.
It is likely to become even more so as customers look to reduce operating costs and complexity.
Second demand for security use cases is likely to remain resilient customers rely on our security solutions, including Ddos protection advanced vulnerability defense with web application firewall and bot fraud abuse in API protection to protect them across what feels like an ever increasing attach.
Surface with the February launch of our SaaS based F. Five distributed cloud services. We are now an attacker in a rapidly growing segment of the overall security market.
Third we expect the culmination of a resilient systems business and gradually improving component supply will contribute to drive systems revenue growth in fiscal year 'twenty three.
Beyond 2023 with customers embracing hybrid I T. We.
<unk> hardware demand will prove more resilient and longer lived than expected just a few years ago near term. We also see the opportunity to take share from traditional hardware competitors undergoing structural change.
With our breadth of form factors and consumption models makes us an ideal partner for customers, who are likely to be prioritizing their investments optimizing costs and may want to shift from one consumption model to another.
Well the hardware software Sass, our managed service.
Perpetual license or subscription.
In Opex, our Capex budget approach we are flexible.
In an environment of shifting priorities, removing friction and enabling customers to consume how and when they want is a distinct advantage.
And finally, we are a trusted and operationalized partner of the largest enterprises service providers and government entities around the world.
In good times, and especially when faced with adversity organizations tend to rely heavily on the partners. They know and trust. We have worked for decades to earn that trust our customers count on us on our deep understanding of how to protect and optimize their application.
And on our continuous innovation.
It's these factors among others, including a very sticky installed base and our growing base of recurring revenue, which helped give us confidence in our outlook for next year.
Before I conclude I will highlight two interesting customer use cases from Q4. The first is an example of a multi year subscription renewal with a sizable expansion.
In this case the customer a global retailer had a goal of automatically flexing its capacity into its public cloud environments as spiky traffic demands warranted.
The customer augmented its existing on premise big IP hardware with scalable Virtualized Big IP software in the public cloud without deep automation capabilities, we fully automated the deployment and configuration of the F. I stack, enabling them to burst capacity as needed automation also.
Simplified how their developers consume infrastructure and best of breed cloud services in an example of a net five distributed cloud services SaaS win in the quarter, we worked with a global transport company based in South America that needed to protect its multi cloud applications, but did not want the complexity or inefficiency.
<unk> of disparate cloud native services, the customer selected a five distributed cloud services as a one stop comprehensive security solution, including web application firewall advanced Bot defense API security and Ddos.
With that five the customer gained more consistent security across its multi cloud environments improved protection against bots and is now more self sufficient for its security and traffic management with a single platform to support expansion to other regions in.
In both of these use case examples F. Five delivered automated multi cloud solutions that dramatically simplified our customers operations and improve their ability to scale their businesses.
And we did so with a form factor and consumption model that best fit their needs.
Now I will turn the call to Frank.
Frank.
Thank you Francois and good afternoon, everyone I will review, our Q4 results before moving on to briefly recap FY 'twenty to results I will then speak to our FY 'twenty, three and first quarter outlook we.
We delivered fourth quarter revenue of 700 million, reflecting 3% growth year over year, with 3% product revenue growth and 2% global services growth.
Product revenue represented 50% of total revenue in the quarter and was split 49% software 51% systems.
Q4 software revenue grew 13% to $172 million systems revenue of 178 million was down 5% year over year.
Rounding out our revenue picture Global service delivered $350 million in revenue.
Let's take a closer look at our software growth are.
Our software revenue is comprised of subscription based and perpetual license sales subscription.
Subscription based revenue, which includes term subscriptions, our SaaS offerings and utility based revenue totaled $131 million or 76% of Q4s total software revenue the remaining 24% or 41 million came from perpetual license sales.
Let's talk first about subscriptions and their performance in the quarter.
Multiyear subscription renewals and our SaaS solutions performed as expected. However, as Francois noted as the quarter progressed, we began to see increased budget scrutiny from customers and elongated selling cycles, particularly related to new projects and new architectural rollouts.
While we had a strong pipeline of new multiyear subscriptions headed into the quarter. These dynamics led to lower close rates on new deals. We believe budget pressures also led to a strong mix of perpetual software sales in Q4 with an increasing number of customers per foreign Capex based consumption models revenue from <unk>.
<unk> sources, which includes term subscriptions SaaS and utility based revenue as well as the maintenance portion of our services revenue totaled 67% of revenue in Q4.
On a regional basis Americas delivered 6% revenue growth year over year, representing 61% of total revenue EMEA declined 3%, representing 23% of revenue in APAC declined 2%, representing 17% of revenue enterprise customers represented 66% of product bookings in the quarter served.
This providers represented 13% and government customers represented 21%, including 12% from U S. Federal I will now share our Q4 operating results.
GAAP gross margin was 78.9% non-GAAP gross margin was 81.4%. This was below our guidance of 82% to 83% as a result of the higher systems revenue mix in the quarter and higher cost associated with procuring and expediting critical components in the broker market.
GAAP operating expense was $445 million non-GAAP operating expense was $379 million in line with our guided range. Our GAAP operating margin was 15.4% our non-GAAP operating margin was 27, 3% our GAAP effective tax rate for the quarter was 10.4% our non-GAAP effective.
Tax rate was 14.1% GAAP net income for the quarter was $89 million or $1.49 per share non-GAAP net income was $158 million or $2 62 per share.
I will now turn to cash flow and balance sheet, we generated $154 million in cash flow from operations in Q4 capital expenditures for the quarter were $9 million DSO for the quarter was 60 days similar to last quarter. This is up from historical levels due to the backend shipping linearity in the quarter, resulting from ongoing.
Supply chain challenges cash and investments totaled approximately 894 million at quarter end deferred revenue increased 14% year over year to 1.69 billion up from 1.64 billion. In Q3. This increase was largely driven by subscription and SaaS bookings growth and to a lesser extent deferred.
Service maintenance.
Finally, we ended the quarter with approximately 7090 employees.
I will now briefly recap our FY 'twenty two results.
For the year revenue grew 3% to 2.7 billion product revenue of 1.3 billion grew 6% from the prior year and accounted for 49% of total revenue.
As Francois noted we achieved a significant milestone in the year with software representing 51% of product revenue software revenue grew 33% to $665 million for the year, while systems revenue declined 13% to 652 million Global services grew 2% to 1.4 billion FY 'twenty two software grew.
<unk> came from both subscriptions and perpetual license growth since FY 19, we have driven total software revenue growth at a 41% compounded annual growth rate subscription software at a 58% compounded annual growth rate and perpetual license at a 10% annual growth rate in FY 'twenty two.
Revenue from term based subscription models, including renewals and inter term expansions or true fords continue to represent the majority of our software subscription revenue with the launch of F. Five distributed cloud services in February we have introduced a new growth vector for our software business with a SaaS based consumption model we have.
Thrilled with the early customer traction for the platform, but scaling ratable SaaS revenue takes time, we are transitioning all of our previously available SaaS services, including solutions from shape and silver line managed services to F. Five distributed cloud services, creating a unified delivery platform for customers, we fully expect F.
Five distributed cloud will be a meaningful contributor to our revenue in the future. We will look to disclose both its revenue contribution and other relevant ratable revenue metrics as the business grows and matures our software revenue growth is driving us towards higher recurring revenue base in FY 'twenty, 269% of our revenue was recurring up for.
66% in FY, 'twenty, one and reflecting an 11% compound annual growth rate since FY 19, we closed FY 'twenty two with approximately $231 million in product backlog, the vast majority of which systems space. This is up more than 80% from approximately 125 million in product backlog in FY <unk>.
<unk> 'twenty, one while backlog orders or cancel we continued to see very low to nonexistent cancellation rates too.
Two years ago, we began disclosing the portion of our revenue derived from security solutions. Francois mentioned, we delivered 1 billion and security revenue in FY 'twenty, two representing 37% of total revenue we estimate our Standalone security product revenue, which includes solutions sold exclusively for security use.
<unk> and either software SaaS, our hardware deployment models grew to approximately $440 million. This reflects a 30% compounded annual growth rate since FY 19, I will now turn to our FY 'twenty two operating performance GAAP gross margin in FY 'twenty two was 80%.
non-GAAP gross margin was 82, 6% our GAAP operating margin in FY 'twenty, two was 15% and our non-GAAP operating margin was 28, 9% our GAAP effective tax rate for the year was 16.4% our non-GAAP effective tax rate for the year was 18.1% our FY 'twenty two annual tax rate was lower than <unk>.
<unk>, primarily due to a discrete benefit from filing our fiscal year 2021 state income tax returns GAAP net income for FY 'twenty, two was 322 million or $5.27 per share non-GAAP net income was $623 million or $10 and 19.
For sure.
I will now share our outlook for FY 'twenty three inlets.
Unless otherwise stated my guidance comments reference non-GAAP operating metrics as Francois noted, we expect to deliver 9% to 11% revenue growth in FY 'twenty. Three this view incorporates a balance between tailwind to our systems business from gradually improving component availability during the year and macroeconomic.
Winds. It also factors in current customer caution in FY 'twenty three we expect the dynamics around budget scrutiny and caution around new projects will be similar to what we experienced in Q4 as a result, we expect software growth of 15% to 20% for the year, we expect systems revenue growth in FY 'twenty three with growth weighted towards.
The second half when supply chain risks related to critical components begins to abate. Finally, we expect low to mid single digit revenue growth from our global services shifting to our operating model, we expect supply chain pressures to remain acute in the first half of the year and to gradually improve in the second half this dynamic will impact our FY <unk>.
Three operating model trends likely outweighed, our usual seasonality specifically revenue gross margin and operating margin expansion are expected to be more weighted in Q3, and Q4 of FY 'twenty three we expect FY 'twenty three gross margins of approximately 81% with the combination of moderating supply chain costs.
And price realization from our previously announced price increases flowing through as we progress through the year. We expect continued operating expense discipline will result in non-GAAP operating margin in the range of 30% to 31% for the year, we expect our FY 'twenty three effective tax rate will be 21% to 23%.
And we expect to deliver non-GAAP EPS growth in the low to mid teens for the year as Francois noted with results in these ranges we would achieve our rule of 40 target for FY 'twenty three we are committed to maintaining it and double digit earnings growth going forward on an annual basis, our FY 'twenty three outlook incorporates.
The expectation that we will allocate 50% of our free cash flow for the year to share repurchases consistent with our balanced approach and the commitment we made at our last analyst day included in this expectation is that we pay down the $350 million remaining on our term loan related to the shape acquisition when it matures in January of 'twenty.
'twenty three.
I will now speak to our outlook for Q1 FY 'twenty three we expect Q1 revenue in the range of 690 to 710 million with gross margin of approximately 80%. We estimate Q1 operating expenses of $370 million to $382 million and our Q1 non-GAAP earnings target is $2 20.
Five cents to $2 37 per share, we expect Q1 share based compensation expense of approximately $61 million to $63 million.
I will now turn the call back over to Francois Francois.
Thank you Frank.
To reiterate a few key points. We believe we are positioned to deliver FY 'twenty three revenue and earnings growth, we are well aligned with our customers' most pressing application challenges, including easing the complexity of protecting increasingly distributed applications and.
In managing and scaling complex hybrid it environments with a 1 billion dollar and growing security business and an increasing mix of SaaS based solutions, we are well positioned for the future our.
<unk> and successful transformation efforts to date have substantially expanded our portfolio driving balance in a hardware software mix. As a result, we have a stronger business model and increased confidence in our ability to deliver sustained revenue and earnings growth in the balance of what we see are likely both tailwind resulting from.
Improving component availability and macroeconomic headwinds in FY 'twenty, three we expect to deliver meaningful top line growth and double digit earnings growth.
In FY 'twenty, three and beyond we expect to continue to exercise operating discipline driving to the rule of 40 and double digit growth on a sustainable basis annually. This concludes our prepared remarks today.
Operator would you please open the call to Q&A.
Thank you very much Mr locally to new.
And gentlemen at this time any questions or comments into press star One and just a reminder, if you find your question has already been addressed you can remove yourself from the queue by pressing star one again take our first question. This afternoon, Graham and long of Barclays.
Thank you.
A few here if I could.
Number one.
Yeah, all related software here.
About three years ago, I think is when you started with the pretty large term deals.
And there was a few really big quarters there.
Just curious on those handful of deals that really contributed a lot back then they should become come up for a three year renewal.
Could you just talk a little bit about those deals in aggregate.
Were they renewed where they renewed larger.
You know, what what kind of you know.
Upside can we see them or where those deals lost or pushed out and then I have more follow ups.
Hi, Tim it's Francois.
So b as.
As far as what we've seen both throughout 2022, which was really the the.
First year, where we had a number of these deals to renew and what we saw in Q4 of 2020 to.
Renewal on these large deals were very strong.
And by that I mean that they they renewed and in addition, the you know the expansion that we've seen on these deals has been really healthy. So we're really happy with the renewables.
As it relates to what we saw overall in Q4.
The where we had a shortfall was really on new business.
And it really was we had the pipeline going into the quarter for a stronger number into software.
On new business in particular, and the close rates ended up not being what we expected them to be because we saw a different customer behavior towards the end of the quarter.
As per the mentioned in the in.
In the prepared remark around deal being.
Laid some being resized.
And and some being postponed by customers largely as a reaction to macro environment pressure than expectations for the recessionary environment. So all of that dynamic really only played out.
In new business, but as far as the existing deals that we needed to renew.
They happened with.
Our strong renewal rates and good expansion.
Okay and then.
Yeah, you updated the security number there which is helpful.
Also at that analyst day years ago, you gave a $100 million.
Revenue number into into the cloud vertical I'm, hoping you could give us some kind of update on how our business to the cloud vertical.
Has transpired over the over the year.
Tim I don't have an update for you there our cloud business in general has continued to grow pretty substantially what we are seeing more and more is customers.
Arguments there on Prem a private cloud environment.
Environment with applications going into public cloud and they are leveraging for that are.
Software of course, but not just big IP software, but increasingly we're seeing them do that with the with nginx software and what we're seeing more and more is hybrid cloud being here and being here to stay with large enterprises.
Who want to automate the environments, both on Prem and in the public cloud and we've positioned our technology to be able to do both so would be.
With the growth that we're seeing in hybrid cloud environment, our business of course in the public cloud and the number of applications. We support in the public cloud has grown.
Okay. Thank you.
Thank you well go next now to Sami Badri at credit Suisse.
Hi, Thank you very much for the question. So I had two for the team. The first question is on comment prompts law that you just made that kind of piqued. My interest here you said that hardware revenue is likely more durable and may take share I think you said either from companies.
Existing customers or something along those lines now can you just give us some color here are you taking share from software companies hardware companies. Other form factors, maybe you could just expand a little bit on that comment a little bit different from what we've been used to hearing before the other question is for the systems revenue growth.
The path to fiscal year 'twenty three.
Thanks, Frank historically, there's been a discussion where fiscal <unk> 23 is the low point of systems revenue capture and then we ramp up through the year and fiscal <unk> was the kind of peak of systems revenue.
Capture just could we just go through that systems path, just you understand the glide path a little bit better.
Yep.
Yeah.
Sami I'll take the first part and I think Frank will take the second part.
On my commentary on hardware.
Let me just comment on the three segments quickly, let me start with the.
The ADC segment.
In the ADC segment, we have been taking share from our traditional competitors.
Throughout 2022, and before and we we feel that this is happening for a couple of reasons.
Number one we have continued to invest in our hardware franchise.
And have brought new features and capabilities.
That help customers automate their environment.
And as a result, when customers are really.
Trying to create these hybrid cloud implementations, where they have to have hardware on prem, but they also need to have applications in public cloud. They can go to F. Five as a.
The partner that can help them.
Balance the load between public cloud and on Prem environment. A good example of that I'll give you we have a customer a global retailer.
That really needed to deal with spikes traffic.
On their website.
In the peak retail season, they're using F. Five on Prem for hardware and they're using our virtual edition in the public cloud and they are bursting.
The public cloud with our virtual edition, where necessary, but built with us automation that allows them to go from one to the other so the investments we've made there.
Really created a unique proposition for Friday, DC business, and we're seeing more and more customers want to move to these automated hybrid cloud environments.
The second.
Element driving hardware is security we continue to grow.
Our security hardware business.
Across application security encryption decryption and protection against Ransomware.
And in Asia.
And then we've also seen a straw.
Long performance and resilience in the service provider.
Market for hardware.
Driven by <unk> traffic.
Where we have seen augmentation of capacity.
Both <unk> and now <unk> infrastructure.
These are the drivers really on the.
The hardware business.
Of course, we have been challenged to ship all of that demand as you have seen with the backlog in 2022, but we expect that to steadily increase through 2023 Franck and semi.
Broadly speaking on your question it is a bit still of a supply chain issue.
Where we see the supply chain right now it's actually improves.
And in generally fewer vendors decommissioning to us an improvement in component availability.
There remains a few critical components.
We still got increments on.
We were fortunate in Q4.
In Q1, some of our ability to go to the broker market access those components I can't promise that we will continue to be able to do that because these have been in and out of the market.
What I feel strongly about is that certainly Q3, and Q4 are going to be the big shipping quarter for us for.
Systems.
Mix between Q1 and Q2.
Feel less confident about that today, but there are a lot of efforts that our engineering team has been successful in re spinning and redesigning.
Some of those have come in early.
Balance of those should be done by the end of Q2, the beginning of Q3 and Thats what gives us confidence in the back half.
Right.
Other in Q1 as the low point of Q2 was the low point that is still.
TBD, depending on a few of these critical components, but the good news from our perspective.
Supply chain is definitely improving broadly they're just still a few things that are that are at risk for us.
Got it thank you I appreciate it.
Thank you the next now to Alex Henderson of Needham.
Okay.
Great. Thank you so much.
I was hoping we could talk a little bit about the mechanics.
We're assuming into the current quarter and in toward year.
<unk> you.
You talked about.
Some pipeline erosion.
During the quarter you talked about.
Closure rates are weakening.
Delays in projects. So I was hoping you could talk about what youre, assuming when you look forward in terms of those metrics are you assuming they stay at the current depressed rates rebound back to where they were prior or get worse from here and.
And particularly.
Are the projects that have been delayed.
Expected to stay delayed or canceled outright given the environment.
Hi, Alex.
So when we look to 2023.
Our guidance for software specifically.
What our assumption is that the what we have seen in terms of the the renewal.
Existing multi year subscriptions.
The healthy renewal rates that we're seeing on these projects continues.
And we've seen that throughout 'twenty, two and from the utilization that we see in these projects from customers, we don't expect a materially different behavior from customers on renewal rates.
We are on the other hand, assuming that we will see more projects.
Delayed.
Or that they will be re size and size down by my customers.
And that they will continue to be way more scrutiny.
Especially these big multi year projects.
They were in the last year, and so that will affect.
The new business in terms of new multiyear subscription agreements and so.
We don't expect we're not planning on a year over year growth coming from these large new project.
In 2023.
And for.
For reference Alex when you look at the total our total software business.
The.
The new business still represents over half of our total software business.
So we have a it's still a meaningful dependency on this new business and that's the part that will be affected in 2023 with its macro environment now.
Now.
If you go beyond 2023.
We actually expect that.
The rate of these new projects will come back up we expect to continue to have a healthy rate.
Of renewals and expansion and over time, we also expect.
SaaS and managed services business.
To scale and grow and so with these factors.
We still consider.
As a long term growth rate for our software with 20% plus growth rate.
To be the right target for us.
Great and one last question.
Systems business can you talk about the mechanics around the transition from the I series to the RF series as 23 progresses would you expect.
By the back half, but more of the product, but clearly it's going to be more but.
A larger percentage meaning.
Meaningful percentage change in the mix between INR.
Yes, Alex we expect that the transition between I series in our series will accelerate in 2023.
And especially in the back half of 2023.
I don't have the exact mix for you here, but I think Alex you should be.
Sumit that exiting exiting 2023.
The large majority of what we will ship will be our series.
Rather than nice series.
Great. Thank you very much I'll cede the floor.
Thank you we take our next question now from Senate Chatterji at J P. Morgan.
Hi, Thanks for taking my question I guess for the first one I'm just.
Trying to understand your guidance systems revenue for fiscal 2000 <unk>.
You had a big step up here in the systems revenue from buying.
From the broker market.
Just wanted to understand a few of them.
Bidding that you can sort of continue on that path.
In Chile, <unk> is sort of where you build on top of him by going into the broker markets and buying from there to satisfy sort of demand from your customers or if we were to do that is there more downside to the gross margin expectations that you outlined in terms of premium.
And I have a follow up thank you.
Sure It makes sense.
Start with that and so it makes sense.
The assumption is actually that.
<unk>.
Erez and improving gross margin as we work through quarters, largely because we are not actually dependent on the broker market to get some of these critical components.
We have gone through our Redesigns and response and we are now shipping.
Product without the critical components.
Plagued us for the past six to eight months and so that work is expected as I said to be largely completed by the end of Q2 beginning of Q3.
And.
And that is baked in is our assumption into our gross margins our operating margins for the year.
Yes, I mean, I think the general.
Yes.
Let me just to answer that.
The general what we've seen in the supply chain just over the last 90 days.
Generally we've seen more stability.
Then we had in the prior quarters.
And by that I mean, we're seeing.
Less decommit than we had seen before although decommit continue to happen.
Uh huh.
We are hearing from suppliers that they are starting to get a little more capacity at fabs.
On their supply.
And generally specifically to us we have seen also.
Progress made by our suppliers on extending capacity.
These these aspects give us more confidence in hardware going into 2023.
But I would say a form pointed we.
Probably the biggest factor for US is the engineering work that we've done inside of that $5. Two designed around the most constrained components part of that has already delivered and more will deliver.
In the next.
Three to six months and Thats why we feel we should have a very strong back half of the year on hardware.
Okay got it.
I guess.
Second question on the phone know pure.
Relative to your portfolio and particularly with the growth in software starting to moderate a bit youre seeing customers breakfast or sort of a capex model.
Thanks, Martin in relation to your portfolio, but that's sort of different from what we are shooting for most of the other.
Companies.
To see customers move more towards an opex model, particularly if they are concerned about the macro and I am wondering if you think theres something there in terms of how the virtual editions, let's say, they're up in terms of the convenience of spinning them setting them up.
The magnitude of the architecture changes.
One has to do there.
Are there alternatives there that you're thinking of in terms of making that transition easier for customers that doesn't look like a big lift and shift for them in some cases, because it does sound like youre seeing multiple sort of trend that's different from what are you hearing customers really prefer going into a tough macro.
Okay.
Yes, I think.
The general trend.
At a macro level.
I think over time, there will be more customers.
That are.
<unk> subscriptions and buying SaaS services.
Then there are today I think thats, the general macro trend in the industry and I think we will.
Follow that trend.
The good news for four or five is that we have positioned our portfolio to be able to serve.
All of these consumption models perpetual license subscription.
Yes.
And also to be able to serve.
Customers.
In hardware or software.
And software as a service.
And so we're we feel this is an advantage is that there are a number of customers. So bye.
Behaviors by customer segment.
And theres different behaviors are different points in time already in the quarter. We have seen some customers that have opex pressure and still want to move forward with the project, but we werent that project to be capitalized.
And so these are customers that would have gone to an opex subscription model and because we are able to offer a capex projects. We are able to move forward with the project, but they would not have been able to move forward otherwise.
And so I think a.
Year of constrained budgets in 2023, we are going to see more of that.
Potentially some customers going to capex, others that warrant capex moving to Opex and the flexibility that we offer we believe it is actually.
Strong advantage over time, I think the trend that I described at the beginning is still the trend.
But the flexibility that it provides.
Quite a strong advantage.
Thank you thanks for taking my questions.
We'll go next 19, Paul Silverstein at Cowen.
Thanks, Francois Franco apologize if this already been asked I'm actually going back and forth between two different costs.
Going back to your comments about softness.
Delays, the downsizing et cetera can you quantify for us how many customers. How many projects you are talking about is this widespread or is this a handful several handfuls of very large projects that you're referring to in terms of just how pervasive.
The weakness that you are referencing.
Okay.
Yes.
I would say Paul first of all it was most acute in EMEA and <unk>.
It was the combination of.
Of course.
Inflation.
Currency.
Currency exchange volatility.
And folks feeling.
The crisis coming in wanting to really were strained budgets. So this is where it was most acute in terms of the number of customers.
It's not hundreds of customers.
And it's probably more but it is definitely in double digits.
Number of deals where we saw that typically those are those are deals that are million dollar plus plus deals.
And so that just gives you a sense of the.
The impact of these deals being being pushed out.
First one failure was most of it in EMEA and Asia Pac was that the comment.
Yes.
Was there any appreciable weakness in North America U S in particular.
We saw a little bit of this in North America, but overall.
I would say there wasn't a meaningful.
I would say change in customer behavior in North America to date now in our in our guidance Paul.
We are.
Assuming that we will see more of this in North America.
This scrutiny on budget.
And deals being delayed and pushed.
Pushed out, but I mean to give you. An example of the behavior, Paul we had some <unk>.
Companies that were.
Large multinationals with multiple billions of euros of revenues.
Changing their process to say that any deal above $200000 has to be approved at the board level.
So that gives you a sense of the level of scrutiny, we saw especially in Europe and Asia Pac.
But that behavior was a lot less in North America today.
And Youre concerned about North America in terms of looking forward Thats, just being prudent or are there signs based on your conversations with North American customers that would caution you about the future outlook.
I wouldn't say, we've not heard.
Directly from North American customers to date.
They were going to change their patterns and do this.
So I would say, it's a combination of being prudent and feeling that just.
B.
North America will not be immune to these these changes in customer patterns over time, whether it happens this quarter or two quarters from now I can't predict that Paul.
But our working assumption is that we're going to see it here in North America.
Just to tie this up transforming last one here Juniper Tonight announced.
So with you they referenced a little bit of the macro that you're referencing but not meaningful either in the quarter and their guidance and I'm just wondering at the risk of asking an unfair question is it something specific to your product market that would account for the discrepancy between what you appear to be experiencing.
And what they appear to be experiencing or I mean, it sounds more widespread or more generic and it sounds more FX plus perhaps the Russian impact on Europe in terms of.
Terms of whites worse outside of North America.
Or meaningfully different but any thoughts you can share.
Yes.
A couple of things.
Yes.
On that.
First of all I should say the what I've described is something we've seen mostly.
In the enterprise segment.
No.
I wouldn't say that we've seen a substantial change in our.
Approach in the service provider segment service provider was strong throughout 2022 and were strong in Q4, so that's a.
That's a difference in terms of the segment.
That I'm focused on here.
And then as it relates to.
Going forward as I said, we've seen we have not to date.
Seen it in North America, but we expect that.
That we will see I should also add.
What I'm seeing is the behavior I do nothing is specific to our product segment.
It's.
Processes that are changing in our customers that effect.
Spend.
In general.
So the deals that I mentioned were pushed out we havent seen actually any deals lost to competitors.
<unk> dynamics haven't changed.
We still.
Continue to win.
Our more than our fair share of deals. So I don't think its that five specific or product specific I think it certainly in Europe and Asia Pac I think it's broader.
Is it balanced across both or is it mostly Europe .
It's balanced across both.
I appreciate the responses. Thank you.
Thank you we'll go next Matt to meta Marshall at Morgan Stanley .
Great. Thanks.
I just wanted to get a sense of whether your customers. What are the biggest inhibitors to kind of the R series transition today and I'm still opt in for Iced Aries.
And then should we assume that the vast majority of the gross margin headwinds are primarily due to the broker purchases for the ice areas or are they kind of across both inr's areas. Thanks.
Thank you Peter.
So.
The biggest headwinds to transitioning to our series.
There are two really only two one is qualification of the products of our customers that don't operate our series today. They have to go through a qualification cycle.
But we have.
<unk> done some things to make that cycle as short as possible.
And the second.
Issue is component availability and our ability to ship.
Demand on our series those are the two gates meda.
No I should say, what we are seeing so far is that the ramp to <unk> in terms of demand is the fastest ramp that we have ever seen in a transition.
From one generation to the next and we expect that to continue because of the.
Our capabilities in our series of course price performance is one but the ability to operate in this more automated environment.
Customers want to have when they they want to balance traffic between.
On Prem and cloud or private cloud and public cloud environments. So that's why we're seeing a faster ramp to.
R series, and then as it relates to broker buys affecting gross margin that is that is true both on the IC reason our series.
Great. Thank you.
Thank you we'll go next now to James Fish at Piper Sandler.
Hey, guys I just wanted to circle back to Ralph Alex's question from earlier a little bit.
Appreciate the color.
B perpetual versus term.
But is there a way to think about how each of these three buckets finished the year in aggregate and as we're thinking about this 15% to 20% growth you.
You had mentioned that still over half the business and software is on new but roughly where should we finished then.
For new business versus renewals in fiscal 'twenty three for software.
And so I appreciate the question Jim.
We are not splitting out those components at this point, but I think some of the guidance that Francois said in his discussion point on if you take a look at.
The midpoint of our guidance on software range and more than half of that coming from new business that will sort of give you some sense for.
The renewals plus the <unk> plus the SaaS business is less than half of that number.
As we think about how that's going to continue to grow I'm not going to say at the end of FY 'twenty three but clearly as we take a look out particularly.
Particularly as the SaaS business matures more and more over the coming years, we expect that contribution to come down such that that new business contribution to the overall, 20% growth rate.
Is not nearly as strong as it has been at the point, where we have to to where we are today and so that's the anticipation that we got in the longer term.
Of the 20 plus percent growth rate and those are the dynamics that we see compounding upon themselves, particularly as we reached the second or the third or the fourth our renewal cycle within these flexible consumption programs on top of the growth in the SaaS platform. That's frankly still nascent in its overall revenue contribution to the company.
Got it and maybe just to switch gears off of software and topline stuff, but on the free cash flow side.
That conversion rate continues to come down and I guess, its something youre not talked about around unbilled receivables given the term transition.
And some of the inventory purchases, but at what point does that free cash flow conversion rates begin on slide.
Quite tired and start normalizing.
A little bit more on is there a way to kind of normalize the cashflow for those higher inventory purchases growing up.
Yes.
Jim is certainly our hope is that the.
The double purchases for the platform that we had this year the expedite fees.
And the purchase price variances, we believe.
Hopefully peaked out.
In.
In FY 'twenty, two maybe the beginning of FY <unk>.
'twenty, three but that things will start to improve from there and we'll really be looking at.
A convergence point that is that is much healthier than what we have seen so far in FY 'twenty two.
So we do expect free cash flow certainly tick up in FY 'twenty three much more so than what we saw in FY 'twenty two.
But.
I'm not going to give you an exact forecast of it at this time.
Dynamics that have driven that down.
We are starting to dissipate and wellness made even further once these redesigns are done and we are purchasing components at a much better.
Better rate as well as.
More and more of the second and the third year clips and where youre not getting as much revenue as you are for free cash flow.
The flexible consumption programs.
Thanks, Brian .
Yes.
Thank you well go next to Simon Leopold of Raymond James.
Hi, This is Victor Chu in for Simon Leopold.
The delays from international customers was this primarily driven by FX, maybe maybe can you help us quantify the demand impact that you've observed from goods become relatively more expensive.
For international customers.
A quick housekeeping question, we were under the assumption that transact mostly in U S dollars at a correct assumption.
Yes.
Yes.
Yes, that's a correct assumption.
So the question that was driven by FX.
Yes.
Of course had a large.
Impact on that.
But of course, if you.
Specifically I would say in the world of hardware, it's your customer purchasing in euro and yen and we've done in our pricing for use of the two price increases that have increased hardware a little over 20% and on top of that <unk> had significant devaluation of the currency.
Your budget does not baidu was much as.
As it did in software that is a little less pronounced because there hasnt been as much of a price increase in software.
<unk>.
Despite that we saw this.
These deal delays in software, primarily internationally and I would say, it's a combination of inflation and currency devaluation and.
Just macroeconomic environment and people but.
Bearing for a tough economic environment and changing their approach to the spend.
Okay.
So your outlook assumes that the FX environment kind of stays as it is.
Kind of in.
Incorporate any improvement in that.
On your outlook for next year.
That's correct.
Okay. Okay.
Okay. Thank you very much.
Okay.
Thank you well go next to David <unk> at Evercore.
Yeah.
Hi, This is Lauren on for Amit.
Can we first start on backlog and kind of how youre thinking about maybe a potential worked out in fiscal 'twenty three kind.
Kind of your comfort around maintaining gross margins at around 80%.
In the second.
The EPS guide for the full year is low to mid teen growth that the Q1.
Guide implies about down 12%. So how are you thinking about kind of the ramp as we go throughout the year.
Thank you.
Sure so.
Why don't I start on the back half of that question on the ramp.
Obviously the year over year Q1 to Q1, we did not have the same.
Yeah.
Headwinds in revenue in Q1 last year that we do this year associated with.
And so that is anticipated in our guidance on.
A decline in Q1, but.
Ramping fairly dramatically, especially as we get to Q3 and Q4 and so.
Those will.
That's the end of the back half of the question.
And then the second question is on acute.
The first part of the question, yes, sorry.
I apologize I'm backlog pipeline, so as we as we think about backlog for the year and.
And working down that backlog.
I'm a customer satisfaction standpoint, we would like to work down that backlog as quickly as possible we are actually getting multiple requests.
From our sales force on how quickly can we get.
Boxes out in order to improve the outlook for new orders coming in and so as quickly as we can work down that backlog as well.
Where we end up at the end of the year I do not know the blend between the demand environment that we expect to see.
Versus.
Our capacity to ship, which is mostly what are what our outlook on systems revenue is based on.
Okay.
Yes.
Got it thank you.
Yes sure.
Thank you and due to time constraints, we will take our last question. This afternoon from Jim Suva of Citigroup.
Thank you very much.
I heard you mentioned something about second half of fiscal 'twenty three being more back.
Half loaded for demand or I guess deliverable with that on both the hardware and the software and it was it more from your discussions with your customers or more just you can't get all the components together to complete the various items because I'm just trying to wonder on the software side. It seems like it will be a little bit early to say back half.
<unk> for something.
Nine months from now thank you.
Jim the guidance was.
Purely about the ability to ship systems and the rework that were doing in the component availability for those new builds and so thats our expectation is that.
Q3, and Q4 are going to be a much stronger systems revenues quarters than Q1 and Q2 for us.
Thank you for the detail that's great. Thank you.
Right.
Thank you and this will conclude today's call you may now disconnect.
Please wait the conference will begin shortly.
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