Q1 2023 F5 Inc Earnings Call
Greetings and welcome to the F. Five Inc. First quarter fiscal year 2023 financial results Conference call. At this time all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance. During the conference. Please press star zero on your telephone keypad as a reminder, this conference.
Is being recorded.
Now my pleasure to introduce your host Suzanne Dulong. Thank you Susanne you may begin.
Hello, and welcome I'm, Suzanne Dulong, <unk>, Vice President of Investor Relations fastball logo to new <unk>, President and CEO and Frank Pelzer executive.
Executive Vice President and CFO will be making prepared remarks on today's call.
Other members of the F. Five executive team are also on hand to answer questions during the Q&A session.
A copy of today's press release its available on our website at F. Five dot com, where an archived version of today's audio will be available through April 24th 2023.
Digital is accompanying today's discussion are viewable on the webcast will be posted to our IR site at the conclusion of our call.
To access the replay of today's webcast by phone dial 87766, Euro 6853, or 20161 to 7415 and use meaning I D 13735357.
A telephonic replay will be available through midnight Pacific time January 25th 2023.
For additional information or follow up questions. Please reach out to me directly that don't do long at a five dot com.
Our discussion today will contain forward looking statements, which include words, such as believe anticipate expect and target. These forward looking statements involve uncertainties and risks that may cause our actual results to differ materially from those expressed or implied by these statements.
Factors that may affect our results are summarized in the press release announcing our financial results and described in detail in our SEC filings.
Please note that FY <unk> has no duty to update any information presented in this call with that I will turn the call over to Faisel.
Thank you Suzanne and Hello, everyone.
Thank you for joining us today.
Against the backdrop of a continued tough environment. Our team delivered first quarter revenue at the midpoint of our guidance range and earnings per share above the high end of our range.
We came into Q1 expecting we would see deteriorating close rates and that the dynamics concentrated in EMEA and APAC in Q4 would spread to North America.
In Q1, we experienced heightened budget scrutiny and more pervasive deal delays across all geographies.
The dynamics are particularly challenging a larger transformational type projects, which for us tend to be software focused like last quarter, new multiyear subscriptions were most affected.
We noted last quarter that we were not planning on year over year growth from new software business. This year.
Whoever in Q1, it was down a double digit percentage year over year.
Based on customer feedback, we believe we are seeing the impact of financial decisions, resulting from broader economic uncertainty.
Pervasive budget scrutiny and spending caution as opposed to technological competitive or architectural decisions.
In contrast to what we saw on new software business.
Software renewals performed largely as expected in the quarter.
At the same time, improving supply chain conditions, aided our hardware revenue, making it possible for us to ship systems to waiting customers. In addition, our Q1 maintenance renewals were particularly strong which in the past has correlated with customers sweating assets.
Despite the environment, we continue to expect 9% to 11% revenue growth for the year, albeit with a different mix than we initially forecasted.
Given the demand trends of the last quarter. It is challenging to call our revenue mix with precision.
However, with supply chain improvements and the benefit of our system redesign efforts coming to fruition.
We continue to see a second half acceleration in our systems revenue.
In addition, based on the solid maintenance renewals, we experienced in Q1 and now forecast for Q2, we expect global services revenue will be stronger than we initially anticipated for the year.
As a result, we expect the combination of stronger systems revenue in global services revenue to offset software headwinds in the year. We also continue to expect non-GAAP earnings growth in the low to mid teens for FY2023.
We remain committed to maintaining double digit non-GAAP earnings growth this year and all on annual basis going forward.
And we will continue to evaluate our cost base and take further action as needed to achieve this goal.
In the current environment customers are focused on minimizing their spend and optimizing their existing investments while also continuing to drive revenue.
We are confident that we are well positioned to help them do exactly that for instance, during Q1, we closed a significant multi cloud networking win with a tier one north American service provider the customer selected F. Five distributed cloud services as the core for its next generation managed service offering based on the platforms.
Ability to deliver a scalable agile and dynamic infrastructure. This is the second such win for the platform.
And find distributed cloud services makes it possible for service providers to monetize their substantial network investments, including investments in five G. The platform enables a managed service offering that solves critical challenges for enterprise customers like simplifying the deployment and operations of applications across multi cloud and edge environments.
Customers also remain focused on application security and that's five distributed cloud services is also winning security use cases in Q1, it health care customer selected our managed web application firewall and API protection solution. After a proof of concept evaluation against both their incumbent CDN provider.
<unk> and a cloud native solution the customer selected five distributed cloud services because it proved more effective against threats, while also being easier to manage.
Our solution also met the customers' stringent regulatory requirements.
Finally customers are focused on total cost of ownership as a result, we continue to drive good traction with our next generation hardware platforms. Our theories in Dallas. These next generation platforms can dramatically reduce customers' total cost of ownership by offering cloud like benefits for on premises systems.
Clearly the enterprise spending environment has changed from six months ago that said the breadth of our portfolio positions us well the number of applications continues to grow and those applications and the infrastructure needed to deliver secure and manage them continue to get more complex.
Customers need a partner like a five who can help them simplify reduce total cost of ownership and make the most of the budgets they have.
Our broad solutions portfolio combined with a consumption model flexibility we offer squarely addresses these requirements now I will turn the call to Frank fault.
Thank you Francois and good afternoon, everyone I will review, our Q1 results before I speak to our second quarter outlook and provide some additional color on our FY2023 expectations.
We delivered first quarter revenue of 700 million, reflecting 2% growth year over year.
Global services revenue of 360 million grew a strong 5% in part due to the high maintenance renewals Francois mentioned and also reflecting previously announced price increases our revenue remained roughly split between global services and product with product revenue down slightly year over year, reflecting softer demand across all.
Fees and representing 49% of total revenue in the quarter continued supply chain improvements enabled systems revenue of $173 million down 4% year over year Q1 software revenue grew 3% to $168 million against a tough comp last year.
Let's take a closer look at our overall software growth.
Our software revenue is comprised of subscription based and perpetual license sales subscription based revenue, which includes term subscriptions, our SaaS offerings and utility based revenue totaled $129 million or 77% of Q1's total software revenue.
Perpetual license sales of 38 million represented 23% of Q1 software revenue within our subscription business as Francois noted new multiyear subscriptions performed significantly below plan in Q1, while renewals performed largely as expected revenue from recurring sources contributed 68% of Q1's revenue.
This includes revenue from term subscription SaaS and utility based revenue as well as the maintenance portion of our services revenue.
On a regional basis revenue from Americas was flat year over year, representing 57% of total revenue.
EMEA grew 14% representing 26% of revenue in APAC declines of 1%, representing 16% of revenue enterprise customers represented 62% of product bookings in the quarter service providers represented 21% and government customers represented 17%, including 6% from U S. Federal.
I will now share our Q1 operating results GAAP gross margin was 77.9% non-GAAP gross margin was 84% in line with our guidance for the quarter and below where we expect to be for the year GAAP operating expenses were $454 million non-GAAP operating expenses were 378.
In line with our guided range, our GAAP operating margin was 13% our non-GAAP operating margin was 26.5% our GAAP effective tax rate for the quarter was 24.5% our non-GAAP effective tax rate was 21.4%.
GAAP net income for the quarter was $72 million or $1.20 per share non-GAAP net income was $149 million or $2.47 per share above the top end of our guided range of $2 25 to $2.37 per share.
E. P. S was aided in part by currency gains related to a weaker U S dollar in the quarter.
I will now turn to cash flow and the balance sheet.
We generated $158 million in cash flow from operations in Q1 capital expenditures for the quarter were $13 million DSO for the quarter was 62 days. This is up from historical levels, primarily due to strong service maintenance contract renewals in the quarter and to a lesser degree backend shipping linearity, resulting for.
Ongoing supply chain challenges.
Cash and investments totaled approximately 668 million at quarter end, reflecting the pay down of approximately $350 million in term debt remaining from our shape acquisition during the quarter, we repurchased approximately $40 million worth of F. Five shares or approximately 263000 shares at an average price of $152.
Per share deferred revenue increased 12% year over year to 1.76 billion, which is up from 1.69 billion. In Q4. This increase was largely driven by particularly strong service maintenance renewal sales, reflecting the trend of customers sweating their existing infrastructure, while recalibrating budgets.
We ended the quarter with approximately 7050 employees.
I will now share our outlook for Q2.
Unless otherwise stated my guidance comments reference non-GAAP operating metrics.
We expect Q2 revenue in the range of $690 million to $710 million with gross margins of approximately 80%. We continue to expect our gross margin will improve in the second half of the year for two main reasons first we expect some of the ancillary supply chain related costs like expedite fees will begin to abate.
With our engineering efforts to redesign around some of the more challenged components nearing completion, we expect to be less dependent on the broker market where cost for critical parts has been exorbitant.
We estimate Q2 operating expenses of $368 million to $380 million and our Q2 non-GAAP earnings target is $2 36 to $2.48 per share. We expect Q2 share based compensation expense of approximately $64 million to $66 million, given our Q1 results and our.
Q2 expectations I also want to elaborate on our FY2023 outlook, we continue to expect revenue growth of 9% to 11% for the year.
Given the demand trends, we have seen in the last four months, we expect our FY2023 revenue mix will reflect revenue contribution weighted more towards hardware and services and less towards software than we expected a quarter ago.
Our FY2023 software growth is likely to be lower than the 15% to 20%. We initially expected due to budget scrutiny and project delays pressuring new software contracts. This is offset by the probability of stronger systems growth given supply chain improvements and the benefit of our system redesign efforts coming to fruition.
In addition, based on the strong maintenance renewals, we experienced in Q1 and forecast for Q2, we now expect global services growth of mid single digits, which is up from low to mid single digits growth. We forecasted previously as Francois noted we continue to expect non-GAAP earnings growth in the low to mid teens for FY2023.
We remain committed to maintaining double digit earnings growth this year and on an annual basis going forward. We will continue to evaluate our cost base and take further action is needed to achieve this goal I will now turn the call back over to Francois Francois.
Thank you Franck and clothing I would ask you to take away three things from this call number one the despite the environment, we remain committed to delivering double digit earnings per share growth this year and on an annual basis going forward.
Number two while we believe 9% to 11% revenue growth for the year is achievable. If we get demand signals that tell us. It is not we will exercise operating discipline and adjust our cost base in order to achieve our earnings goals.
And number three we have built a strong business model with nearly 70% recurring revenue product revenue that is split 50 50 between hardware and software and global services revenue that has proven durable. The result is a diversified and resilient revenue base, which when combined with operating discipline enables.
To drive revenue and earnings growth in this environment.
Operator, please open the call to questions.
Thank you we will now be conducting a question and answer session. If you would like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate your line is in the question queue.
You May press star two if you'd like to remove your question from the queue for participants using speaker equipment. It may be necessary to pick up your handset before pressing the star keys, one moment, please while we poll for questions.
Thank you. Our first question is from Sami Badri with Credit Suisse. Please proceed with your question.
Alright, Thank you very much for the question Lisa.
At least the opportunity to ask questions I have two.
First one is could we just decompose the services revenue growth you mentioned price increases and then maintenance renewals could you kind of split at reported number into each like what was stronger was it more renewals et cetera. If you can just decompose that the other question I have is clear.
Clearly the I T landscape has shifted and I think the big question myself and other investors are asking ourselves is if there is incremental risk through the year.
As far as demand or demand signals changing unless you see they get worse, how will those signals manifest themselves into F. <unk> business and results and a good example, a question we get is.
If things decay or deteriorate does that mean that product order sitting on your backlog get canceled is that the.
Is that kind of deterioration that would yield that kind of output.
Love to get your comments on those two questions.
Sure Sami so I'm going to start with your first question on that a lot of Francois take the second it's Frank.
So we didn't give an exact split out but I would say.
It's roughly even between the two I think the renewal rates.
Continue to go up, particularly on those services business and we've seen less discounting.
Given the environment that we see.
Are people continuing to sweat assets, putting a focus on that and taking the price increases that were put in place a couple of quarters ago, and we're starting to see the benefits of that come through to the services revenue. So I'm not going to give you the exact split but I would think of them as roughly equal between the two and I'll, let Francois talk to your second question.
I mean in terms of the overall environment.
Yes. It is the overall spending environment has deteriorated quite meaningfully over the last six months.
And we're seeing that mainly in terms of softer demand.
Then clearly what we were what we were seeing six months ago.
Now the way you would see that in our results.
It's not an order cancellations because.
<unk>.
Appliances that our customers buy from us it typically mission critical to deliver on.
Applications that actually need the capacity. So we haven't seen any trend in order cancellations, nor do we expect.
Any of that in fact.
Our customers have been pressing us to ship to them.
The backlog that we have built over the last couple of years and although the orders that there's places that we haven't delivered on.
And so we continue to work hard on our improvements in supply chain in order to be able to beat that.
Where you are seeing this different environment in our results and clearly we're seeing a number of software projects that have been.
That have been delayed a lot more scrutiny on deal and that is actually affecting our software growth rate and you're seeing that in the result.
And we've seen it frankly across the board in terms of softer demand in software ball, so softer demand in hardware this quarter.
Then we had a quarter a year ago.
Alright, thank you.
Thank you. Our next question is from Tim long with Barclays. Please proceed with your question.
Thank you.
Two if I could.
Sorry could you talk a little bit about you know the software businesses kind of which which pieces of it you're maybe seeing more of an impact than others is it some of the SaaS businesses are it sounds like a lot of the term deals.
But anything you can split apart there to let us know.
On that and then related to that what you know why are we still talking about the distinction between hardware and software. It I don't think you guys really sell.
The solutions that way so could you just.
Give us an update why we still need to look at that distinction.
Thank you.
Thank you Tim I will.
I wont I will take the two questions. So let me start on the NIM.
The question of what you know where are we seeing the softer demand on software.
I think if we if we split the software between existing contracts that have you know renewals or two forward or expansion versus new contracts.
The the renewal business on existing contracts largely performed as expected.
And where we saw most of the softer demand was on new contracts and new projects.
Which you know we have said we expected this year in the past three years, new software business had grown pretty significantly year on year, we expected coming into the year.
New software projects would be flat year on year and what we saw in the first quarter was more of a it was down double digits relative to ly.
Back to you one.
So this is where we saw more of the pressure.
Whether it affected more of a SaaS business or the term subscription.
Say it was quite indiscriminate across across product lines, what we saw.
But of course the.
The most significant impact in terms of linked quarter revenue was really in these multiyear subscription.
That's that's really what was a bigger impact on Q1 revenue in terms of the hardware software distinction.
Tim It's a good it's a good question.
Look I think this year certainly and there was also about effect last year that there is a dynamic around hardware where.
Last year, we had a lot of a lot of demand that we couldn't really ship because of supply chain issues and this year, we're looking to improve on our supply chain and be able to.
You know to ship all the orders that we've had in our backlog.
And we've made a lot of progress on our supply chain to be able to do that.
But it is true that a lot of our customers consume both hardware and software. We think that's going to continue to be a trend from our customers towards more software first environment.
And that's because of the way they want to consume the technology ultimately, but when we look at the total performance of the company.
You know we focus less on that distinction then driving earnings growth specifically in double digit earnings growth and we're absolutely committed to.
Driving that regardless of the dynamics between hardware and software.
Okay. Thank you.
Thank you. Our next question is from Alex Henderson with Needham. Please proceed with your question.
Great. Thank you very much.
Hudson.
Address a little bit about what's your backlog in systems looks like.
I think it was running 40% to 50% of four four quarter.
<unk> sales in the systems.
And I was hoping you could give us some some insights there in terms of you know.
What the backlog is at.
And then second.
Obviously getting the R series out.
In March of last year was an important milestone, but there was a lot of.
Application functionality that you needed to get them.
Built into it in order to solve individual customers.
Needs in order to replace the I series.
And I was hoping you could give us an update on where you are on that and do you think that that.
Then creates post say.
The June quarter, a refresh cycle on the large install base of ice series.
Yeah, Alex let me start with the backlog question a minute turn it over to Francois for your second question so on backlog, but.
But we've talked about is that we will disclose that once a year if it's material in any more than 10%, but we weren't going to talk specifics on any one given quarter I will say.
Similar to Q1 last year, when we talked about a percent move up.
We were down a bit more than 10% this quarter and backlog from where we ended.
In Q4 and that was largely a result of our ability to ship.
Based off of some of the product Redesigns that we were able to achieve and so we were quite happy with.
Sure.
Seeing that reduction in backlog from a customer satisfaction standpoint.
Then transfer I think we'll talk to your second question.
So I like the on the R series.
There were there have been two factors that have sort of gate that the ramp in both of the R series over the last.
Several quarters since we launched it first is what you mentioned the number of use cases and applications that are serious cover relative to the ice series and second was our ability to build and ship our series, which has been significantly constrained with some other components.
The good news is both of these factors are going away over the next couple of quarters. So on the on the supply chain factors.
We are seeing better component availability and.
Also access to broker markets, where we are where we are still constrained we still have constraints on our series.
Still had in Q1 and we'll see.
But a lot of the redesign efforts that we have already done will be complete by the end of our second quarter and so we are seeing lead times on our series a.
We'll be improving in our second quarter and beyond.
And then the second aspect in terms of the application. The number of use cases that are series can cover well pretty much be at parity with ice series if not in the June quarter in the September quarter. So in both cases, there's a lot of progress there is a lot of demand.
For our series.
I think you should expect.
Our series will certainly grow into FY 'twenty four.
Become the vast majority of what we what we ship in terms of appliances.
Yeah.
Great. Thank you.
Yeah.
Thank you. Our next question is from Cemig chatter G with J P. Morgan. Please proceed with your question.
Oh, hi, Thanks for taking my question I guess for the first one if I can.
So I'll ask you to sort of shed a bit more color on.
In terms of budget scrutiny, which regions as well.
I think we're having a hard time hearing you may want to speak up.
Hi can you hear me now.
Yes, much better.
So first question was really more about sort of France with Cummins on the budget scrutiny that you see which regions maybe towards verticals as well are you seeing the most sort of scrutiny from and where do you stand in relation to like as you sort of are in the early days of fiscal Q in terms of either what you're buying it in terms of <unk>.
Woodson psyche, you continue to see those sort of conversion cycles get extended our timeline get extended or are you starting to find that sort of level set to longer duration in terms of the conversion cycles and have a follow up thank you.
Just to make so in terms of where we saw softer demand in software.
It was.
Across the board in terms of verticals and geographies.
You remember in Q4 I said.
The international.
EMEA and Asia Pacific in particular were quite affected we actually did see that clearly in North America as well.
<unk> this quarter.
And it was also.
I would say across most of our verticals.
I think it was more pronounced.
In the technology.
Sector.
You know a lot large tech company is going through substantial.
The revisions of their of their budgets.
To some extent I would say financial services.
These or perhaps where were the effects were more pronounced in terms of the.
The rest of the year, it's too early to have full visibility.
On the rest of the year I would say our expectation is that the dynamics that we have seen in our first fiscal quarter.
The software will largely continue.
In our second fiscal quarter, but beyond that.
It's too early to speak to the visibility.
Got it.
Thanks, Thanks for that fund so for the follow up I mean, you mentioned custom with us sweating the assets a bit more which is sort of you're recapturing some of that on the services side, but in terms of the system to demand and.
There is obviously a supply chain piece here, but how are you thinking about sort of the upside to system demand as some of the maybe software transformation projects get delayed and drives some level of sort of utilization of hardware appliances, which always had sort of a.
Great performance, so how you're sort of looking at the upside on the system side from that.
As well how would you quantify that.
I think Cemig D in terms of the systems demand.
We said earlier, we also we also saw softness in systems demand. This quarter. So that's the effect on our budgets and scrutiny from our customers that largely affected both the software and the hardware demand to an extent.
The upside in demand frankly is sorry in.
In hardware revenue for the year is we set at the beginning of the year. We felt our hardware revenue forecast was really a shipping forecast and the upside in the stronger second half that we see in hardware is really driven by ability to ship.
More hardware, so you should see a step increase.
In in our hardware revenue in Q3, and Q4 from the first half of the Europe because of the improvements we've made on supply chain in terms of demand specifically.
I don't think the pressures on the software would necessarily create stronger demand on hardware at this point in time in the environment, because I think our customers are really trying to sweat their assets and you know try.
Try and limit the utilization to not exceed the capacity that they already have in place to to the extent. They can I think that can only go on for so long.
Which point they won't they won't have to buy and add capacity.
But I do think that the improvement in supply chain lead times improve we will see some demand that is latent that has.
<unk> has been gated by the fact that we're not able to chip. So a lot of customers because we haven't been able to ship orders that they placed 234 or five months ago and they haven't been able to project or implement their solution are not able to place the next quarter and I think as we as we resolve that.
Should see some improvement there and demand from these customers.
Okay got it.
Thank you thanks for taking my questions.
Thank you. Our next question is from Amit <unk> with Evercore. Please proceed with your question.
Yep. Thanks, taking my question I guess I have two as well.
So maybe just going back to this product systems discussion a little bit yeah, I guess, the risk or the fear folks would have has loosened the macro remains soft and I D. I T budgets remain under pressure why wouldn't customers push out of sweat that appliance appliances more and so then you know maybe it's all about how do you have confidence that the supply and so systems business with.
Coverage in the back half.
If the macro remains challenging in the backlog can remain strong.
Well I would say look.
What we're where we have strong visibility is for us to achieve the revenue forecast, we havent hardware, we don't necessarily need a very strong.
Uh huh.
Fundamental recovery in hardware demand than we have than we have today.
Because of the visibility we have on revenue and our ability to ship, including our backlog in terms of what I think.
The real question as to when do I think this recovers and demand picks up again.
It's difficult to predict but what I can tell you is that the fundamental drivers of what gets customers to buy our <unk> hardware or software or are still there. They are tied to the growth in applications and applications continue to grow the complexity of these applications.
And the deployment model. The fact that these applications increasingly live in hybrid and multi cloud environments. All of these drivers are fundamentally there so demand can be suppressed.
For a period of time, a couple of quarters three quarters four quarters.
But where we have a ton of confidence is that it is going to come back.
Because the fundamental drivers of our business and what are customers doing.
Are still there and will continue.
<unk> I should say.
Attacks on applications that drive demand for security for applications.
So all of those things are part of.
Uh huh.
What gives us a lot of confidence that it's going to come back in this current environment.
Fact that we've built the flexibility that we have built around our consumption models and our deployment models plays very well because some customers have pressures on capex, all those on opex and our ability to serve them one way or the other.
<unk> is one mitigate if you will and it's one of the aspects that we think.
<unk> provides the resilience that youre seeing in our in our business and operating model.
Got it that's really helpful. And then if I could just touch on the software side I know you folks talked about you know and they believe the growth will be sub the 15% to 20% range that you'd talked about previously is always think about what the new range would be or what does it what does the trajectory of software. It looked like as we go through fiscal 'twenty three and then does this alter at all what you're seeing.
Our longer term expectations, you've had from the software business beyond just this year.
Thank you.
Let me start with the last part it does not alter our long term view.
Because of the drivers that I've just taken you through.
We think our customers will continue to deploy software.
And Oh, sorry will continue to deploy our software in cloud and hybrid cloud environment, we think that the.
Architectures are evolving to be multi cloud architectures and that absolutely favorites at five.
I go back to where we were five years ago. When we were hearing customers, saying everything is going to go to a single cloud location and we're not sure we're going to need a a.
And that's five ADC today, we are positioned what are the architectures are going they're going to multi cloud, we're very well positioned in these architectural conversation and so what we're not seeing is a shift away from a fight from an architecture perspective.
Being just financial decisions and pressure. So we're very confident that the drivers of long term software at work for a five security modern applications and multi cloud environments are going to be there and drive the 20% plus growth that we've talked about in the long term.
In the shorter term.
Yes, we have said, it's less likely that we will be in the 15% to 20% range we mentioned.
There is a path to get there, it's a narrow path than it was a quarter ago.
Because it would imply.
Change in the second half in terms of the demand patterns that we have.
We have seen in software so.
Whether things would rebound this quickly for us to be able to see that that's unclear and that's why that's why we're saying.
That it's less likely that we will deliver 15% to 20% growth you will note. However.
I admit that.
I've mentioned, our business and operating model earlier a part.
Part of the benefit of the balanced model that we have built is youre seeing the improvements we've made on supply chain and allow us to have perhaps upside on the hardware revenue and also upside on the services revenue. So on balance we feel our 9% to 11%.
<unk> revenue range is still achievable.
Thank you. Our next question is from meta Marshall with Morgan Stanley . Please proceed with your question.
Great. Thanks, maybe two questions for me one.
If you could just kind of lay out maybe most often what some of these larger news software deals are associated with you know are they tied to kind of cloud migrations are.
Security upgrades or you know kind of thinking about hybrid architectures that would just be helpful to kind of figure out what what other indicators, we could be looking at when thinking about the software and.
New software growth coming back and then maybe just on the second question.
You know product gross margins are saying depressed for a little bit longer.
You know just how are you guys thinking about kind of the progression of <unk>.
Getting rid of some of these supply chain costs are broker fees throughout the year just in the time that it might take to get back to some other product gross margins we've seen in the past.
Thanks, Matt I'll take the first one first we will take the second one on gross margins.
The so the the large software projects that are out there they're tied to all of the factors you mentioned are but they're typically.
Infrastructure modernization or application modernization. So these would be companies that are that have had say our hardware.
In their environment and they are deciding to move either partially or wholly to a software first environment. This could be a private cloud or it could be a public cloud.
In addition, with lift and shift.
More often than not.
They are actually setting up these software environments, while keeping a part of their application of states on hardware. So they will pick a set of applications that they really want to modernize and move to an environment that's more automated.
Whether it's in a public cloud or even in their own private cloud, whether it's higher levels of the automation that give them faster time to market, a better deployment, timeframes et cetera et cetera.
So that's the type of project for the large kind of multi year subscription. We are also a number of other projects that are now within generics. There just typically new applications, new modern applications that have been in test and development and they are moving into production and when they move into production there was a need for a strong.
Networking and security capabilities that nginx brain as a complement to for example, kubernetes orchestration. So we're seeing a lot of these a lot of these projects and now with our distributed cloud offerings.
We're also offering SaaS solution.
That is I would say nascent part of our business.
But it's a different model of deployment, where it's typically a long tail of applications that would not have had the traditional ADC and followed them in the past our.
Customers are choosing to protect them with a SaaS security solution for that five so those are I would say the three types of implementations.
But of course, the multiyear set of subscription or more anchored on the first model that I mentioned.
Meda in relation to gross margins, particularly product gross margins.
Our view of that for the year has not changed and we talked about the supply chain improvements.
Starting to benefit our product gross margins really in the latter half of this year, even all the way up into Q4.
But the real benefit that we were gonna see is going to be an FY 'twenty four in terms of product gross margin improvement, we still had purchase price variance and expedite piece that we're working through.
The components that make up our our box builds.
Through this year and we still have got a few critical components, where we are having to go into the broker market. So.
Largely we will start to see improvement in Q4, but more of it you will see in FY 'twenty four.
Great. Thank you.
Thank you our next question.
From James Fish with Piper Sandler. Please proceed with your question.
Hey, guys. Thanks for the questions.
On the software number.
I don't get the reluctance to not give a number at this point I'd get we're kind of missing the 15% to 20%.
But the main question, we're getting after hours so any any clarity on that would be helpful. Frank and should we be assuming that kind of net new business double digit decline in new recurring software should continue for the remainder of the year or are you expecting this to kind of improve as that new business comp gets easier.
In the second half of the year and just I have a quick follow up after.
Sure and I appreciate the question Jim.
Again, it is Francois mentioned.
A second ago, we are not updating our 15% to 20% guidance because we do still see a path to get there again, it's a harder path.
I think that.
We're not necessarily expecting a change in environment and part of the reason why we're not updating the back half is because the visibility is cloudy right now in terms of demand and when we came into the year, we talked about over 50% of the.
The revenue that we expected as part of that 15% to 20% growth was going to come from new business activity.
And that we didn't expect that to grow but we didn't expect to see the types of percentage declines that we saw in Q1, and so just with the lack of visibility that we've got right now we don't have a new range to offer to you today.
But we do feel like it's less likely that we will be in that range.
Okay, and then Francois.
I'm surprised no one's asked about it at this point, but on.
On the strategy side with this lilac deal.
While I like what's the competitive advantage and is it more aligned with our product overlap against some of your newer competitors like like an akamai or cloud or is it more to be able to offer that SaaS like experience inside a customer's environment and just trying to understand why couldnt that get done with nginx in Baltar already thanks, guys.
Yeah.
Thank you.
Jim So.
Yes on the lilac, let me start with a you know we acquired both Tara.
A couple of years ago, and really launched the platform with our security offering about a year ago.
And we've seen you know.
Very very good traction with distributed cloud services over the last 10 months. So we want to build on that traction. We recently started with the CDN offering.
And the distributed cloud services platform that was based on an OEM agreement with light like and this was essentially a tuck in acquisition to in source that technology and the team.
In order to be able to secure the offering for the longer term and also work with this team to continue to improve on the on the offering and deliver increasingly innovative edge services on the the hotel platform. So we're pretty excited about the team joining us.
Being able to accelerate innovation on that front and it completes.
Our offering in terms of web application firewalls, API security Ddos protection anti bot and now CDN into the <unk>.
Into the bouquet of services that we offer on distributed cloud.
Okay. Thanks Francois.
Thanks, Jim.
Thank you. Our next question is from Simon Leopold with Raymond. Please proceed with your question.
Hi, guys. This is Victor Chu in for Simon Leopold on you you noted that the fundamental demand around that five software still largely intact, but are there specific factors that you can point to that gives you confidence that the slowing isn't a reflection of more secular headwinds like cloud migration versus you know so the cyclical slowing that you're Uh huh.
Okay.
Yes, Victor I think you know.
It's interesting because I would say that.
Migrations to the public cloud, if you want to call it lift and shift migration.
We have seen that to be more of a tailwind too.
<unk> than a headwind, but even more than that what we have seen over the last couple.
A couple of years is that you know.
Customers are not migrating applications to a single cloud increasingly customers are leveraging multiple different environment for their applications in multiple public clouds private cloud and on premise and that actually is an architectural model that.
Is ideally suited for the portfolio that we have built which is essentially an infrastructure agnostic portfolio of application security and delivery services and so we feel very strongly that as that trend accelerates in large enterprises and that multi cloud and hybrid cloud becomes more and more of the mainstream.
Deployment way that enterprises deploy their application portfolio it.
It is going to drive growth for S. Five.
And specifically for our software and SaaS services.
So that's where our confidence comes that I mentioned those drivers earlier.
Multi cloud environments security modern applications, all three will contribute to the long term growth of our software, which is why we feel our views on that are absolutely intact. What we are seeing right now.
Again, its not an architectural or competitive.
Issue. It is it is largely a macro driven.
Very cautious spending environment that is kind of indiscriminate.
Across our across product lines.
Well I mean, the supplier to do that.
Kind of a.
Macro headwinds, we're starting to see do you see did you observe any of those trends that you mentioned regarding both the hybrid.
Cloud trends.
Yeah.
See you observe those trends.
That kind of gives you.
Other companies.
That you know that that will resume when things normalize.
Yes, Victor I mean.
We saw them, which is why if you look at our.
Software growth in 2020, one I think he was in a I.
I think it was about 37% and if you look at our software growth in 2020, the first three quarters of 'twenty two prior to the change in the environment.
Our software growth was also close to 40%.
So we and it came from.
Three drivers more more deployment modern applications that we serve with nginx now with distributed cloud services.
More needs for security and photo of applications.
We started with all security solution shaped distributed cloud Big IP.
And more deployments in multi cloud environments without large customers.
Okay, great. Thank you that's helpful.
Okay.
Thank you. Our next question is from Tom Blakey with Keybanc capital markets. Please proceed with your question.
Hi, everyone and thank you for taking my questions here.
I guess my first question is also on both questions on software as well.
The numbers you've given.
For us here or you can kind of back into I believe strong double digit growth.
And the renewal kind of true up business in the quarter is there anything one time in that number or anything that kind of.
Would lead us to believe that that can you know you don't have any visibility into that into fiscal 'twenty three that growth kind of remaining.
Yes.
We did not experience any sort of one time benefits I think the.
However, you want to think about the perpetual business.
Versus the <unk>.
Subscription business, but there was nothing unusual in the quarter.
Yes, Im sorry, Im just focusing on the subscription business with regard to renewals in trucks, and then and then as you mentioned.
I'm sorry, Frank.
No no no absolutely.
Okay, and then and then just on the perpetual side, you've been a little bit above.
No trend line in the last couple of years.
The trend line over the last couple of years, where what kind of visibility do you have into this perpetual business line in the pipeline there comments from Francois maybe.
And then maybe if you could yeah Chuck.
So I suppose that with your comments about pause and a slowdown in spending just doesn't really jive with.
You kind of like beating the last couple of quarters pretty handily from a perpetual license perspective that'd be helpful.
Yes, Tom let me start with that and the France all wants to add he certainly can again, we think some of the power of our model is the flexibility of the way customers want to consume and in some cases people have.
Opex budgets and in other cases, they are capex budgets and so.
Certain instances I think they'd rather consume on a capex basis, and some of that will come through in perpetual.
Not something that we try to spend a ton of time forecasting the split between the two we're happy when the revenue falls in either and and so you know for the last couple of quarters. You may have seen that tick up from what was sort of the you know.
Low thirtyish million dollar a quarter business to the upper 30 low $40 million.
But generally those are customer.
Preferences in how they want to consume our solutions.
Okay. So.
So just.
Same type of visibility that you're always having perpetual software okay. Thank.
Thank you very much.
Thank you. Our next question is from Jim Suva with Citigroup. Please proceed with your question.
Thank you very much your commentary about the hardware being stronger, especially with your outlook and such and the mix shift to more towards the act, which will impact things I understand it all but the question is is that impacted at all due to the supply chain issues during the past year or two in that.
B.
Customers are absorbing some of the ordering is that they did and then this is going to face a headwind because normally I would think about customers buying both the hardware and software together.
Jim is it affected by the supply chain.
Answer to that is yes, because we we have a lot of orders that we were not able to ship a last year and we have made.
A lot of improvements in supply chain.
Our suppliers in the general environment, and our own redesign of our platforms that give us better visibility on what we're gonna be able to ship to customers.
Over the next three quarters.
We've always said, we wanted to be able to get all of this.
These orders to our customers as soon as possible and reduce our lead times.
Which we believe actually it won't be a tailwind to demand when we've been able to reduce our demand. So yes. It is affected by that.
But it is all that's part of why we see this upside in our hardware for the year, it's because our view today of what we'll be able to ship has actually improved from where it was three months ago.
Okay that makes a lot of sense and then just given the macro cautiousness, how should we think about capital deployment.
Stock buyback M&A has seen any changes there or are you kind of courting not holding up reserving a little more for organic.
<unk> or how should we think about capital deployment versus maybe six.
612 months ago.
Yeah, Jim So it really has been our outlook on capital deployment has not changed we still expect you.
Spend 50% of our free cash flow on share repurchase this year.
And as you as we mentioned earlier, we did pay down the term loan debt associated with the shape acquisition, which was a little over 350 million use of cash in the quarter and so that.
That reflects the change in our cash balance and the $40 million share repurchase we did in Q1.
And we obviously announced lilac, which was an undisclosed sum it was a small acquisition that we did today and so the balance of the activities and how we said we're going to use our capital has not changed and we don't anticipate that it will change going forward.
Thank you so much for the clarifications, it's greatly appreciated.
Absolutely.
Thank you. Our next question is from Fahad <unk> with loop capital. Please proceed with your question.
Yes.
Thank you for taking my question.
I wanted to revisit the software.
This is again.
If you look at perpetual is.
Grown fairly steadily.
So can you.
Maybe.
Help us understand in terms of the renewals.
What is the net retention rates, all maybe anything cohort analysis.
You said it was in line. So maybe if you can just elaborate a little bit more and then Furthermore.
I guess the question also is.
How should we be thinking about your exposure to legacy applications versus new modern applications and if there's anything you can share with us on how that mix is trending.
Yeah.
Alright, let me, let me start with the.
Legacy had modern applications and how the mix is trending.
I would say, it's actually trending in line with the population of applications overall, which is that legacy applications are growing I would say in the single digit percentage range in terms of the number of these applications out there deployed.
In the world, whereas modern applications, we think are growing in the 30% range.
In terms of the number of them that are going into.
Production.
On an annual basis, and so over time, there will be a lot more of the modern applications than the legacy applications.
But where this gets blurred, though is that we're also seeing a number of legacy applications get modernized where.
Folks are adding modern component to an application that is already in production has already been generating revenue.
And this is ware.
<unk> five has a specific advantage is that yes, we played modern applications.
With components like Nginx and increasingly our distributed cloud services, yes, we play in legacy or traditional applications with platforms like Big IP.
But for a lot of our customers. They want to have implementations that involve modernizing our legacy application and especially in an environment where.
Customers are looking to consolidate.
Vendors to simplify their operations our ability to deliver on both of these requirements and actually deliver a single commercial vehicle, where you can have both your modern and legacy application services.
It is critical and so that's one of the.
The way that we've positioned the company to be able to serve both needs over time, it will skew more towards modern applications that they grow faster.
Got it.
But we're not offering any new metrics on software like net retention rates I will say that.
As we mentioned for the renewal side of the business, which includes the.
The SaaS businesses the.
You know the the true for associated with the.
The business and some of the second terms over a multi year subscription agreements as largely came in as we expected the shortfall that we experienced was largely due to the new software business.
Just didn't drive growth in the way that we would have expected in Q1.
I have one more follow up.
Frankly, now that you know you've had a few years post nginx shape acquisitions under your belt can you maybe give us an update on how the progress is and integrating these acquisitions into FY <unk>.
Is it are you able to sell and integrate these acquisitions and up sell your solutions any update on how the integration or is that.
And how do we think about next year.
I'm sorry in fiscal 'twenty three.
Oh, yes, absolutely.
So let me let me take them quickly in order I would say on nginx and shape. The integrations are largely complete.
And so on nginx, you've already so they're they're complete both from a if.
If you will product perspective in terms of capabilities have ported from there five or big IP onto engine. So we can we can offer for example security on nginx.
And increasingly we're offering our customers a single pane of glass to be able to get visibility on both nginx and our big IP deployment.
They're also complete from a go to market perspective.
Whereby we have now enable our mainstream go to market marketing and sales resources to be able to promote and engage customers on nginx.
We've done the large thing on shape, we're a little behind that but I would say almost 80% there where we now have.
The integration is complete shape, it's available in big IP, our customers, who are big IP can turn on shape anti bot capabilities quickly shaping is also available in our distributed cloud platform.
Platform.
Standard anti bot defense offering and.
And we've also done a lot of the go to market integration by the way those integrations from what I can say from a go to market. There are quite critical because they have allowed us.
To continue to drive a.
Better operating leverage from our sales and marketing perspective. So if you look at our sales and marketing expense I think it was 31% or so of revenue in 2020 and its 29% in 2022.
Despite the you know the revenue pressures, we had it because of the supply chain. So you'll see operating leverage there and you look at our overall.
Opex as a percentage of revenue has gone from roughly 54, 5% in 2020 down to 50% to 51% implied in our FY2023 guidance. So the integrations have also enabled us to drive the right synergies and operating leverage.
And then in terms of the.
I know, what you're asking about Voltaire out of course is newer.
And so we're still going through that but we've already done a chunk of the integrations by deploying all of our security capabilities onto that platform that we call now distributed cloud and we're getting quite a bit of traction where all of that is going is that ultimately.
We are going to offer our customers a single console in a single pane of glass from which they can manage all of their security policies.
I wish they can get visibility to all there they're a deployment.
Without five whether it's hardware software a fast and whether it's in legacy a moderate environment and in that regard.
We're positioning to be quite a unique player that can cover all of these models.
That's agnostic to the underlying infrastructure.
I appreciate the answers thank you.
Yeah.
Thank you due to time constraints, we will be taking our last question from Ray Mcdonough with Guggenheim. Please proceed with your question.
Great. Thanks for fitting me in just two if I could.
I understand youre, not giving any new software metrics right now, but can you talk about how contract duration trended on renewals.
You know I understand you were selling.
Three year term license deals in that cohort and it's really the first cohort of renewals that you're seeing.
This year are you seeing any contraction of contract duration.
And then the second question would be you know.
I appreciate the comment around double digit EPS growth in the commitment there, but how should we think about cash flow growth and cash flow margins normalizing as you kind of lap the change towards more annual invoicing terms this year.
Yeah.
Sure race.
Why don't I take both of those the first in terms of changes in duration of the contracts. We are certainly sensitive and monitoring that but we have not seen.
Any discernible change in contract duration.
On the second term renewals are on the primary contracts that we are putting in place and so that has not impacted us at this stage in terms of.
The commitment to our double digit EPS growth and cash flow.
We are.
We will see the benefits of some of the slowdown in the new flexible consumption programs.
That will then yield more actual cash in the back half because we're not adding on is.
As much of the.
<unk>.
Upfront revenue recognition in relation to.
The cash that we are receiving so we will start to see the benefit of that and see that normalize out a bit.
Part of the other benefit that we're going to see for our cash flow and debt.
Supply chain issues that we had in.
The.
Extra purchase price variance and expedite fees those will largely come out and those will help our cash flow from operations. So.
Both of those I think we'll start to see a normalization, but it is one of the more difficult areas to predict.
In the model going forward.
Makes sense, thanks for the color I appreciate it.
Thank you this concludes today's call.
Question and answer session.
This is the end of todays conference you may disconnect. Your lines at this time. Thank you for your participation.