Q3 2023 F5 Inc Earnings Call
[music].
Good afternoon, and welcome to the <unk>, Inc. Third.
Third quarter fiscal 2023 financial results conference call at this time, all participants are in a listen only mode. A brief question and answer questions.
Presentation, if anyone should require operator assistance during the conference. Please press star zero on your telephone keypad.
Also today's conference is being recorded.
Any objections. Please disconnect at this time I will now turn the call over to Mr. Dan too long.
You may begin.
Hello, and welcome I'm, Suzanne Dulong, Vice President of Investor Relations.
First of all I'll go to new Vice President and CEO , and Frank Pelzer, Executive Vice President and CFO will be making prepared remarks on today's call.
Other members of the executive team are also on hand to answer questions during the Q&A session.
A copy of today's press release is available on our website at <unk> Dot Com, where an archived version of today's audio will be available through October 24th 2023.
Slide deck accompanying today's discussion is viewable on the web count and will be posted to our IR site at the conclusion of our call.
To access the replay of today's webcast by phone dial 8776606853420161 to 7415 and use meeting I D 13739739.
The telephonic replay will be available through midnight Pacific time July 25th 2023.
For additional information or follow up questions. Please reach out to me directly at S 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.
We have summarized factors that may affect our results in the press release announcing our financial results and in detail in our SEC filings.
In addition, we will reference non-GAAP metrics during todays discussion. Please see our full GAAP to non-GAAP reconciliation in today's press release and in the appendix of our earnings slide deck.
Please note that F. Five has no duty to update any information presented in this call.
With that I will turn the call over to Fastweb.
Thank you Suzanne and Hello, everyone. Thank you for joining us today in my remarks today, I will speak to the quarters results and the current customer spending environment.
He will then highlight some notable customer wins from the quarter, including some emerging areas, where we are seeing good early traction overall customer caution persist with customers continuing to sweat assets amidst tight budgets and lingering macroeconomic uncertainty.
Despite the tough environment, our team is executing well and we delivered third quarter revenue at the midpoint of our guidance range with earnings per share well above the high end of our range.
From a demand perspective, we are seeing some early signs of stabilization Q.
Q3 demand played out slightly above our beginning of quarter forecast, which was up from Q1 and Q2. This year, though still off from FY 'twenty two levels.
Our global services team delivered strong 8% growth driven by a continuation of customer trends from the first half of the year, including strong maintenance renewals and price realization.
With customers sweating existing assets. We also continue to see higher maintenance attach rates on older deployments, our product revenue grew 1% with systems revenue growing 5% and software revenue declining 3% year over year, while systems revenue is benefiting from supply chain normalization and our efforts to.
Sensually work down backlog systems. The men remains constrained in contrast, we are seeing some positive signs in software demand total software revenue was down 3% year over year against a strong Q3, 2022 compare however, total software grew 32% sequentially and within software.
Our subscription software revenue grew 4% year over year to a record high of $152 million. This reflects strong growth in our software renewals and interim expansions or true forwards as well as some stabilization in new term subscriptions from the first half.
Moving from revenue to our operating results. We are also demonstrating operating discipline and driving operating leverage our Q3 non-GAAP gross margins of 82, 5% improved more than 200 basis points from Q2.
This was slightly ahead of our guidance and reflects the combination of expected supply chain easing and price realization as.
As well as some of the ancillary supply chain costs like broker and expedite fees finally, working their way out of our inventory as planned.
In addition, our Q3 non-GAAP operating margins of 33, 2% improved 600 basis points from Q2 and more than 400 basis points from Q3, FY 'twenty two as.
As a result of these improvements as well as some tax favorability, we significantly over achieved our non-GAAP EPS expectations in the quarter and now expect to deliver double digit non-GAAP earnings per share growth for FY 2023, we believe our growth opportunity is fundamentally linked to the continued grew.
Both have applications in a P eyes, and the need to secure deliver and optimize those apps any P is a.
As part of our efforts to capture that growth, we continue to drive innovation advances and integration across our product families, including five big IP F. Five nginx and F. Five distributed cloud services.
I will call out some customer highlights from each product family from the quarter, our big IP family, which serves traditional applications either on premises co located or in cloud environments continues to take share from competitors, who have failed to invest in innovation from a hardware perspective, the value proposition with our next generation platform.
<unk> is resonating with customers with our R series envelope platforms, representing more than 70% of Q3 systems bookings on the software side Big Ip's disciplined performance automation capabilities and lower total cost of ownership continues to differentiate our offering and drove multiple wins in the <unk>.
<unk>, including wins at a major American airline a multinational automobile manufacturer and a major U K retail and commercial bank. We also saw strong demand for F. Five nginx in the quarter and genetic serves modern container native and micro services based applications and a P is we continue to see large.
<unk> adopt nginx for their cloud and Kubernetes workloads. We have repeatedly demonstrated that went applications are built with nginx from the ground up and those apps grow we grow with them. We saw this in several nginx growth opportunities in the quarter, including a multimillion dollar term based subscription renewal that grew.
By an extraordinary tenex from initial inception, the customer which provides a large collaboration platform is streamlining deployments in both public and private clouds using F. Five nginx as their single platform for load balancing caching and telemetric over the last several years, we have invested both.
Organically and Inorganically to build a portfolio of SaaS and managed services called F. Five distributed cloud services.
Since launching distributed cloud in February of 'twenty, two we have been expanding our offerings and building momentum for multiple security use cases are good example of this is a win with a global financial services industry application provider that wanted to standardize its web application firewall and API protection, our Wap policies and the <unk>.
<unk> in APAC, and EMEA to reduce time to delivery their existing disjointed application security and complex policy tuning was a challenge as was managing apps and api's across distributed environments with a small team today at five distributed cloud services is protecting their apps and a P eyes with Wap.
Multi cloud networking, reducing their time to delivery from months to minutes. It is early days still but we also are seeing encouraging signs that our distributed cloud services are intercepting the market specifically in two emerging categories.
P I security and multi cloud networking on API security with the growth of modern applications using containers and composed of distributed micro services. The number of API endpoints is exploding C. So tell us they struggled to know how many apa's they have where they all are who is connecting to them and to what extent they are.
Secured doing so requires robust API discovery and protection capabilities like those we offer in our distributed cloud API security service.
When a north American service provider experienced a serious cyber security incident, which caused them to lose their entire virtualization infrastructure at multiple datacenters. They turn to us for urgent health at five distributed cloud services superior features functionality and value beat a competitive offering and we worked with the customer too.
Emergency onboard the platform, including advanced WAF, and Bot defense and API security once deployed the customer immediately started migrating sites restoring their services. We are also seeing strong early traction in our distributed cloud multi cloud networking offerings launched just this past March.
85% of respondents cited in our twenties 23 state of application strategy report said they already are managing multi cloud environments securely connecting applications between on premises multi cloud and edge environments at scale is a tough task for any organization, our secure multi cloud networking solutions changed the game.
Our ability to package networking security and distribution of applications and a P. Ice is unique until now customers have been forced to manage and secure these layers in isolation, often leading to operational complexity network latency and weak security or multi cloud networking solutions reduce operational.
Complexity for our customers and make it possible for them to securely connect distributed networks and applications across public clouds on premises data centers and edge locations customers are beginning to understand the power of our secure multi cloud networks the ability to provide end to end visibility control and security.
Across all of their applications. This empowers them to move workloads to the cloud between clouds and even to the edge, while maintaining end to end visibility and consistent security policies.
Distributed cloud uniquely unifies, the visibility control and security for every application and API. So that applications can be delivered without constraints and with the security today's threat environment demands early traction for our secure multi cloud networking offerings includes a win with one of the worlds.
The largest independent providers of insurance claims management systems.
This multi cloud networking now enables their global SaaS offerings.
The customer first deployed our distributed cloud WAF in February of 2022 to protect a business critical public cloud workload in early 'twenty three the customer was abruptly asked to leave a datacenter, forcing them to lift and shift workloads to the public cloud and just two weeks they use their five distributed cloud for this emergency.
<unk> and shift in fact, the project went so smoothly that they opted to expedite moving their global data centers to public clouds now the customer has standardized on F. Five distributed cloud for their secure multi cloud networking needs spanning across multiple clouds, and protecting external and internal applications and Apis.
These are just some of the customer challenges we help tackle in Q3, while we are not in a position to predict with precision when customer spending patterns will return to more normal levels.
Five is well placed to benefit when they do we are encouraged both by the early signs of stability in Q3 and with the residents our application and API focused approach is having with customers. We are making it possible for our customers to secure deliver and optimize their applications in a P. IV with a consistent approach no matter what environment there.
Deployed in datacenter co located private cloud or public cloud and this is a critical capability and differentiator in today's hybrid multi cloud network World now I will turn the call to Frank Frank.
Thank you Francois and good afternoon, everyone I will review, our Q3 results before I discuss our fourth quarter outlook. We delivered Q3 revenue of 703 million, reflecting 4% growth year over year. Our revenue remained roughly split between global services and product with global services, representing 53% of total revenue.
Global services revenue of $374 million grew a strong 8% due to continued high maintenance renewals as well as the impacts of the price increases introduced last year product revenue totaled $328 million representing growth of 1% year over year systems revenue of 155 million grew 5% year over year software.
Revenue totaled 174 million down 3% from a tough compare in the year ago period. Our software revenue is comprised of both subscriptions and perpetual license sales subscription base revenue hit a new high in Q3 in both dollars and as a percentage of software revenue.
Our subscription revenue totaled $152 million or 87% of Q3's total software revenue and as Francois mentioned grew 4% year over year perpetual license sales of 22 million represented 13% of Q3 software revenue revenue from recurring sources contributed 75% of Q3s revenue with.
<unk> is a new all time high as a result of the strong subscription contribution recurring revenue includes subscription base revenue as well as the maintenance portion of our services revenue on a regional basis revenue from Americas grew 3% year over year, representing 57% of total revenue EMEA grew 16% representing 26.
<unk> of revenue in APAC declined, 6%, representing 18% of revenue looking at our major verticals. During Q3 enterprise customers represented 66% of product bookings service providers represented 13% and government customers represented 21%, including 8% from U S. Federal are.
Q3 operating results were strong, reflecting our previously announced cost reductions and overall operating discipline GAAP gross margin was 79.8% non-GAAP gross margin was 82.5% an improvement of more than 200 basis points sequentially.
GAAP operating expenses were $457 million non-GAAP operating expenses were 346 million slightly lower than our guided range and reflecting a partial quarter benefit from the cost reductions we announced in April .
Our GAAP operating margin was 14.7% our non-GAAP operating margin was 33.2% representing a sequential improvement of more than 600 basis points, our GAAP effective tax rate for the quarter was 16.4% our non-GAAP effective tax rate was 18.1%. This is below our target.
Range for the year, largely driven by a nonrecurring benefit associated with the filing of our annual federal income tax return during the quarter. Our GAAP net income for the quarter was $89 million or $1.48 per share. Our non-GAAP net income was very strong at 194 million or $3.21 per share.
Well above the top end of our guided range of $2 78 to $2 90 per share. This reflects the combined impact of our gross margin improvements and operating expense discipline as well as a Q3 tax benefit I will now turn to cash flow and the balance sheet, which also remains very strong we generated 165.
And cash flow from operations in Q3, driven by our improved profitability and strong cash collections capital expenditures for the quarter were $15 million DSO for the quarter was 56 days down from 62 in Q2 and closer to her historic range as a result of earlier invoicing related to improved shipping linearity.
As our supply chain continued to stabilize cash and investments totaled approximately 696 million at quarter end deferred revenue increased 9% year over year to 1.79 billion driven by the high service maintenance attach rates, we've seen throughout the year and continued growth in subscription as a percent of our software.
Mix as we committed to on our last call, we repurchased $250 million worth of shares in Q3. Finally, we ended the quarter with approximately 6500 employees, which reflects the head count reductions we announced in April I will now share our outlook for Q4, we expect Q4 revenue in the range of six.
<unk> hundred $90 million to $710 million with gross margins of approximately 83% unless otherwise stated my guidance comments reference non-GAAP operating metrics with the full quarter benefit from the cost reductions announced in April we estimate Q4 operating expenses of 338 to 350 million incorporating our.
Year to date results, we have now narrowed our estimates for FY2023 effective tax rate to approximately 20% for the year. As a result, we are targeting Q4 non-GAAP earnings in the range of $3.15 to $3.27 per share. We expect Q4 share based compensation expense of approximately 55 to 57.
Million year to date, we have used 68% of our free cash flow towards repurchases. We remain committed to returning cash to shareholders and continue to expect to use at least 50% of our annual free cash flow toward share repurchases I will now turn the call back over to Francois Francois.
Thank you Frank.
Customers made up five the standard for securing the levering and optimizing traditional applications.
Now with compelling and differentiated solutions for modern applications and a P eyes as well as those mission critical traditional apps, we are being architected into new areas and use cases across our portfolio.
Our holistic application and API focused approach enables newfound consistency across environments and across hardware software and SaaS deployment models, which reduces risk lowers operating costs and delivers better digital experiences in clothing I ask that you take away three things from this call.
Number one we are seeing some early and encouraging signs of demand stabilizing.
Number two we are seeing demonstrable proof points that the differentiated solutions portfolio, we are creating through a combination of organic and inorganic innovation and technology integration is well aligned with how application architectures are evolving.
And number three we are delivering on the operating discipline, we committed to and expect to produce additional leverage in FY 2024.
Operator, please open the call to questions.
Thank you we will now be conducting a question and answer session. If you'd 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.
Press Star two if he like to remove your question from the queue.
For corporate for participants using speaker equipment, it may be necessary to pick up your handset before pressing the sarkies one moment. Please while we poll for questions.
Thank you. Our first question is from Ray Mcdonald with Guggenheim Partners. Please proceed with your question.
Thanks for taking the questions.
Maybe first for Frank how did the true forward portion of renewals performed this quarter relative to the left and assuming it is improved which it seems like it has do you think we're at the tipping point, where customers simply need to add capacity, which will continue to drive relative strength in renewals going forward or is it too early to tell whether or not that's bottomed.
Alright, thanks, so much for the question so the true forge.
We set out our plan at the beginning of the year, we had higher expectations won't be seen throughout the course of this year that having been said it was a strong quarter.
For renewals and included in that would be our true Ford number.
It's early to indicate that we've seen an absolute bottom and things are going to grow from here what would I was incredibly encouraged though from the.
The expansion that we saw in some of our second terms.
As Francois mentioned were quite high on a few large deals and we are seeing stabilization right now in the demand environment, which is better than what I can say for the last couple of quarters. So.
Again early signs, but but.
Not yet ready to call it a trend.
That makes sense and maybe if I could a follow up for Francois.
You mentioned Youre, obviously seeing signs of macro stabilization here can you unpack that a little bit more I mean, how broad based is the stabilization maybe from a vertical perspective and from a product perspective or are you seeing you.
Each vertical kind of stabilize or is there kind of give and takes between where the spending is kind of more firm than others.
Arena.
So.
I think it's best to maybe contract a little what we saw this quarter versus what we saw in the first two quarters of the year.
You know what hasn't changed first.
The customers.
Continue to scrutinize spend.
We continue to see deals being delayed some deals being pushed out.
And we continue to see behavior across all verticals.
Customers are looking to the first spend as much as possible and sweating their assets, where they can do that.
Behaviors have not changed.
As a result.
Even though we saw stronger demand in Q3 than you know first.
What does the year demand was still lower than from the 2022 levels.
What has changed is number one.
We didn't see things getting worse, this quarter and I'm, saying in general across vertical than it did in the first half of the.
The ear.
So we feel we have kind of reached a stable level I think in our March quarter. There was.
A lot of uncertainty specifically in the financial services sector.
Right after the bank failures, there was uncertainty still.
Phil about interest rate debt ceiling.
In the U S specifically.
And so you know.
And in financial services almost came to a halt.
With that I want to call. It almost irrationality has come out now so there's still you know deal delays and scrutiny, but even those deals are being scrutinised they are getting.
I saw that specifically for that vertical I think that's changed.
And then I think what we've seen in a couple of areas that had been delayed where customers really needed to implement these projects and they have move forward with this project and I would say that's been the case.
Financial services.
In a couple of other enterprise vertical SAP.
Average providers I would say are still watching to sweat their assets as much as possible and we're seeing that.
We continue across the board.
Great. Thanks for the color I appreciate it.
Thank you. Our next question is from some weak energy with Jpmorgan. Please proceed with your question.
Yes, hi.
Thanks for taking my question, Firstly, if I can sort of.
Go back to the comments about the stabilization of demand and dig.
Dig into that a bit more I mean, you did.
Come into both the stabilization in a quarter when we saw systems revenue decline.
Significantly as you sort of walk through the backlog. So I'm just wondering when we integrate those commensurate applicable to hardware and software is is that should we be interpreting this as sort of a more normalized mix based on what youre seeing in the macro.
That's sort of as we think about fiscal 'twenty four.
That you instead of looking at the $700 million.
8 billion annualized sort of number as being at least where the floor is where youll drag be if the macro remains the same is that the way to bring the demand stabilization coming.
Hi.
Okay. So let me unpack that there was that.
A lot in there.
So.
When I talked about demand stabilization, it's really the fact that if you look at the first two quarters of the year things were getting progressing they were worth worth in March than they were in January and they were watching January then we felt that we're in.
Number.
But when you back to where we were.
At the end of June we didn't feel things have worsened until things stabilize.
That's really the origin of my my commentary as it relates specifically to hardware.
We have demand has been soft on hardware.
Throughout the year.
And it's been soft largely because of the microenvironment and customers are sweating their assets.
Also our customers needed to digest a lot of shipments that we have now been able to make customers have placed orders last year, they have not been able to get the equipment.
Get the equipment and get it installed and deployed so all of that is happening.
As a result, we have worked through our backlog.
And our backlog has come down significantly.
Which is why youre seeing hardware, where it is in Q3 and frankly when you look at even.
Next quarter Q4.
I would expect hardware to probably be even down from the levels you saw in Q3.
In terms of where where demand is that where demand is that today as it relates to you know what this means for 2024.
As you would expect it's too early for us.
<unk> 2024.
We've stated in the past that.
Cycles of this nature in the past have been four to six quarters.
We feel we are three quarters into it.
So you can infer from that where potentially demand would return we do expect by the way.
To return.
In 2024, when exactly we don't know when.
But we do expect demand across the board to returning hardware demand to be.
Higher next year than it is however, I would ask you to keep in mind that because.
We have been able to ship so much of our backlog, we said last quarter that it would be six to eight points.
Win on total revenue growth next year.
Based on.
The way we work the backlog this year and so I would keep that in mind, when you're thinking about revenue for next year.
Got it okay, Okay and front a question that I'm getting a lot from investors really is about.
The investor the expecting the inflection again in terms of application growth because of AI use cases.
Really more about your applications Gordy <unk>, how do you think they're positioned to navigate sort of that inflection and application growth and how.
How do you think about the challenges in managing that growth as well at the same time.
So you know for us in AI.
We're of course, I think like a lot of other companies that if we've got focused in three areas one that enphase generic to other companies, which means we are looking to leverage the new kit.
Abilities to enhance our productivity.
And.
As you know we're focused on earnings growth, we said, we want to deliver double digit earnings growth, which we are now confident we will this year, but continuing to drive that.
We want to drive more productivity over time and these tools wood wood.
It would help us do that in certain areas.
The other two areas that are really specific to our business to me is one we have been using AI already, especially now security products part of the rationale for the shape security acquisition was also to bring in AI capabilities and AI expertise in the company that has allowed us to profile.
Application traffic at a very granular level, which is an incredible powerful capability and we're going to enhance these.
These capabilities with new machine learning models.
Going forward and I would expect that in security in particular, you will see us.
Move more and more to AI enabled security, which is where increasingly what we think it will take to solve security problems.
And we have a lot of data being in front of 40% of the world.
Websites.
Yeah.
We have sorry, powering over 300 million web site and being in 24 or 40% of the world's web application. We feel we have a lot of access to data that can fuel. These.
These machine learning models, we will also see.
Some opportunities in terms of new workloads.
It is still early days.
Probably harder to define in the short term, but what we see some big company.
A lot of the new AI related workloads, we think half two attributes that will be interesting for a fine number. One is these are kind of next generation modern workloads built with an API first approach, which will create a lot more API connections and API calls and accelerate this explosions of API.
Those API to be connected and secured.
An orchestrated and we are levered to that opportunity.
In API and API security and number two.
Workloads or the data that you have to ask it is quite distributed which also will accelerate adoption of multi cloud architectures and we are levered to that multi cloud opportunity.
And so we think those two attributes of AI related workloads will play well to the to the opportunity for upside down the road.
Okay. Okay, great. Thank you thanks for taking my questions.
Thank you. Our next question is from Simon Leopold with Raymond James. Please proceed with your question.
Great. Thanks for taking the question I was looking at really where the system's revenue had been prior to the pandemic and wondering how you would think about the idea that a normal revenue run rate might be in that sort of $170 million to $180 million a quarter clearly a lot of <unk>.
Jane Stover since I guess late 2019.
Could you maybe help us think about sort of the puts and takes.
Even if we don't know the timing to sort of get a better sense of what should be the sort of base run rate for hardware.
Yeah.
Five.
I don't think we're.
We can.
Kind of direct you to what is or should be the baseline right for hardware, but but I think what we can share with you is this.
Our perspective is that the trajectory of the hardware in terms of the number of units that we have out there.
Should be declining in the mid single digit percentage.
And it could be a little more than that it could be a little less than that.
But it's in that zone and when you look at the sort of overall normalized trend of.
The number of units we have no obligation number hardware units that are out there.
They.
And you look at a longer trend in the last couple of years you'd see that kind of the trend that we're seeing over the last couple of years. If you just look at revenue of course, that's been substantial disruptions.
The pandemic has been a positive one the supply chain has been a negative on the macro has been a negative one but if you. If you ignore the short term disruption and you just look at a long term trend of the you know the number of hardware units you have out there you should think about it.
Kind of declining in the mid single digits now I would add though Simon that part of what we think is that.
It is an important strength of the F type model.
Is that we now deploy in <unk>.
Hardware software and software as a service.
And we're seeing that customers really value the flexibility that they have in the model.
Because not all applications are in the same environment.
And they want the ability to sometimes have application sponsored by hardware in their private data Center then maybe other applications supported by software SaaS and what we're seeing inside of a single large enterprise two or three of these deployment models come through and what customers value the consistency of delivery.
Delivery policies and security policies across these consumption models and so we're going to continue to offer the flexibility and it's core to who.
How we intend to continue to drive earnings growth in the business.
That's helpful and just maybe as a follow up in terms of the software trajectory what sort of signals might you suggest we look for.
In terms of sort of.
Things getting better and things getting back on normal apart from just sort of the macro.
Kind of advice would you give the analysts.
Simon.
In terms of specific metrics more to come in terms of the.
Delivery approach the principal was describing one of the reasons why we have gotten away from trying to specifically guide to a mix is because again, we give customers flexibility and we do not try to specify which one we think is the better approach, we leave that to the customer to make that decision for themselves and so.
We will see some some fluctuation and volatility between what software and what's hardware I think when we actually see the SaaS business, particularly around distributed cloud over the next few years become much more substantial that volatility will continue to decrease as more and more of that business will come to us and a ratable fashion and so.
As that business continues to grow you can be looking.
As for more metrics around that that will give.
Some some more forward looking.
<unk>.
Where that expectation in that software revenue will come.
Thank you very much.
Thank you. Our next question is from James Fish with Piper Sandler. Please proceed with your question.
Hey, guys.
Following up on a few of the questions asked here already but.
What are you seeing demand wise or demand stabilization between the products side, meaning on the ADC side versus security in and really asking also what percentage of your customers are actually using products from both as we're trying to understand what penetration opportunity you guys have left.
Hey.
Jim.
So let me let me give you a sense by byproduct and sort of what we're seeing in terms of demand. So.
We're as I said the hardware demand has been soft.
Where it has been the softest in the ADC space, where customers are really.
Looking to.
Delayed delayed purchase orders and where they can sweat their assets.
Security stand alone security has been more resilient.
Then in than in ADC.
But security that is attached to ATC of course is affected in the same way that <unk>.
<unk>.
We have also seen strong demand for nginx, we had quite a strong quarter on demand for nginx for largely modern application deployment as well as renewal and expansion from existing opportunities.
And where we are seeing.
Also very strong growth, but of course from a small base is in our distributed cloud.
Opportunity, which is really in security.
Offering application security in front of a lot of applications, but deploy the service.
Increasingly seeing more opportunities for API security.
Which is a nascent but growing and exciting market and also securing multi cloud networking so connecting applications across cloud at doing so in a secure way. These areas are growing rapidly, but from a small base.
And this is what we're seeing.
A different trend in demand now.
I think it is kind of.
When you look at the overall portfolio. This is how we see the various demand levels.
Makes sense and frankly, maybe for you you guys keep mentioning.
Expansion opportunities and expansion rates being pretty strong I.
I know youre, not quantitatively, giving them, but can you qualitatively.
Kind of give us some color around what you saw versus the first half of the year with net retention rates be it on recurring revenue or just the recurring software piece and also trying to understand how much of growth is being constrained by the transition to recurring sources, particularly on the SaaS side of things as you.
Collect more revenue over time, but what's upfront thanks guys.
Sure.
Yes that dynamic.
I would be excited to see.
Jim, but we have not yet seen that where the SaaS. It pieces overtaken the term base subscription side of the business that still has the majority of our software revenue on in terms of.
Net retention rates it was strong in the quarter.
It is that part is part of our renewal base of revenue, which has been frankly much closer to plan the new business New business activity was challenged in the quarter in relation to what we expected to do at the beginning of the year.
Much better than what we had seen in the first half of the year and so in totality again.
The net retention that we have seen in our recurring base of revenue in the renewal base of revenue has been growing and strong, but the new business opportunities that we see those are the ones that are still challenged in relation to what we expected to do at the beginning of the year, but they were largely in line slightly better than the revised expectations that we set last quarter.
Thanks, Brian .
Thank you. Our next question is from Matt on Marshall with Morgan Stanley . Please proceed with your question.
Great. Thanks.
Maybe first question.
Was there any difference in the mix that you ended up seeing in the quarter versus expectation I guess I'm, just asking because the backlog seems to have been exhausted.
But yes, the systems number with maybe a little bit lighter than I expected. So just are more customers kind of updated now for virtual editions as they move back towards thinking about hybrid cloud.
And then I have a second question just on.
He made a point of talking about the share gain opportunities just what has been the best entry point.
Or a targeted sales program to kind of identify and go after some of those customers. Thanks.
Thank you and then in a way two questions.
<unk>.
It comes down to this.
<unk> ability of the model we've built.
Offering hardware software and SaaS.
So.
No.
As part of your question was there any.
Relative to our expectation is such that it makes hardware software.
Okay.
We were pleased to see that.
Bigger software deals that we had been expecting for a while actually did come through.
And we're not delaying and show that that helped the overall software performance for the quarter.
Still not.
Returning to of course 22 level in terms of new projects and starting this new especially big software transformational projects.
But at least the ones that are absolutely necessary for customers to move through with them.
So that's one.
On the software side of thing after you on hardware.
Thanks.
Expect it to be shipping our backlog throughout the.
At year end, we're pleased that we're able to do that we're pleased that we are returning to normal lead times. Our lead times are almost at normal levels at two weeks, which is really important for our customers to get their equipment. Because we think that will be a catalyst for future demand once they've digested these projects and implemented them.
In terms of share gains.
Uh huh.
We have been in the ADC traditional ADC market specifically.
We believe that we are we are gaining share.
Largely because of the investments we've made in next generation platforms and next generation software and the flexibility of the model we are delivering so.
We do no matter, we have rolled out the R series and <unk> platforms. This.
This quarter I think over 70% of the.
Shipments.
Made in hardware on the new R series platform, so adoption of that platform.
Been phenomenal we think it's the fact that adopt.
Adoption, we've seen in a transition like that ever.
And it speaks to the capabilities of these new platforms and new software that brings benefits to the <unk>.
Hardware on Prem environment.
And so the combination of these investments we've made.
And the Capex model the Opex model that we offer are continuing to offer perpetual and subscription models really is powerful.
And relative to our competitors in the ADC space. We are we are taking share and in some cases, specifically taking customers away.
Two five.
Because of the investments we've made we are also.
Going strongly after the.
The WAF market that is.
Web application firewall API security Ddos protection as a service. This is a market where we are a new entrant with distributed cloud, but we are gaining customers very rapidly and aggressively attacking the incumbents in the market.
We are quite differentiated.
Security and fraud defense in particular and also in that networking applications between cloud security opportunity being a new and emerging market, where our distributed cloud has a very strong offering. So these are areas, where we feel we are gaining share and hopefully we will continue to gain share in quarters to come.
Great. Thank you.
Thank you. Our next question is from Alex Henderson with Needham <unk> Company. Please proceed with your question.
Great. Thanks.
So.
Last year, you had a pretty steep decline in your systems business you cited the supply chain and.
Now you're up.
Low single digits, and Youre, suggesting that your backlog has already been resolved that.
Really.
It doesn't imply a particularly strong headwind as we go forward of 6% to 8%. So can you reconcile why that headwind of 68% with D. There given.
You haven't really produce meaningful strong topline growth in that business and then Conversely.
You're citing a 6% to 8% headwind going forward.
Your comps on the software side, we're extremely difficult over the last year, but now I've got quite easy.
With declines in the September quarter last year.
We are setting up for pretty easy comps over the next year. So.
I look at the software side of it is it reasonable to think that we're going to now see a meaningful shift to software growth and therefore, it is still possible to produce revenue growth on the product side.
As we go into 2024, I know you don't want to give guidance, but.
You have given guidance on 6% to 8% headwind and so what what should we be thinking about as the offset to that.
And these easy software comps.
Yeah, Alex it's Frank I'll start and CFO Francois wants to add anything but.
The long and short the 16% is more specific to the systems business and that's specifically related to the level of backlog that we had going into FY2023 and so obviously, it's been a boost to our recognized revenue in relation to where the demand has been.
For FY2023.
But looking ahead at FY 'twenty four that's the 6% to 8% that we've referenced which is largely associated with.
With the hardware business the demand side of the equation has been challenged in both obviously, it's been better in Q3, and then what we saw in the first half of the year, but it's stabilized at a lower much lower level than where we were in FY 'twenty two and so we do expect there to be a change and we do expect.
Specifically in systems to see.
Larger change that where we have been in FY2023 in terms of demand.
That intersection between.
That 6% to 8% total revenue headwind that.
That we saw as recognition in 'twenty three that will not be there in 'twenty four.
The piece where we're.
We're hesitant to know exactly what point in 2004.
We'll see that change in the system to spend on the software side of the equation.
We have seen great traction obviously in the renewals that we mentioned.
We have seen.
A challenging new environment, so far that will likely also change.
But we are seeing that change likely come in the form of SaaS.
SaaS revenue, which will not necessarily recognizing the same rate in FY 'twenty four is what we've seen in our term based agreements and so it's too early to tell right now exactly how that will all play out we'll have more to talk about that in the next on the next call, but that's the early indication and the way to reconcile some of the comments that we made.
Thank you Frank and I would just.
So that is absolutely clear when we talked about.
The six to eight points headwind, it's not demand headwind. We in fact, we expect demand next year.
In hardware to be higher.
And then this year, but it is a shipments headwind that's impacting recognize revenue.
To be clear about that.
So just just to clarify it sounds like you don't expect your software revenue to recover.
Enough to offset the headwind.
On hardware and it sounds like.
Hardware expectations for demand is less than the headwind as well are we thinking of that.
The outlook should be fairly flat or even down on the revenues because that's the implication you're giving us on.
These commentary relative to the product side of the equation.
Well look.
Alex we're not we're not ready to guide for 2024.
What we've said about the 6% to eight point headwind on total revenue is no different than we said last quarter and it is simply math, we said look.
We want to make sure that one knows that.
<unk>.
This year.
Given that we're shipping all of our backlog.
We're shifting the equivalent of six to eight points more of revenue than the demand. We've had for hardware, we're not ready to guide for where revenue would be in 2024, but it is clear that that six to eight point headwind is going to challenge growth for next year that being said I also want to be clear.
We have been on a march of double digit earnings growth.
And we want to remain on that March.
Paul that we took a number of actions to drive earnings growth. This year and we're confident we will achieve double digit earnings growth.
We had said from 2022, when we started with the supply chain challenges that we expect it to work through these challenges.
In our model and start showing the improvements in the back half of 2023 and you're seeing this quarter.
Gross margin made a step improvement as they started to work out for these expensive component and we have been quite disciplined around price realization with the price increases that we drove last year and you saw some of that operating margins made a 600 basis point jump.
And we expect to continue this operating leverage next year. So this is you know.
Our plan on continuing to drive earnings growth.
Okay. Thanks.
Thank you. Our next question is from Michael <unk> with Goldman Sachs. Please proceed with your question.
Hey, good afternoon I just have two questions. The first is on this trend that software.
It's clear you had strength in renewals and true forwards.
Last quarter, there was some weakness in new deals I was just wondering if you were seeing.
Some improvements there and.
Whether you think software revenue can grow in the September quarter, and then I just have a quick follow up.
Sure Michael Thanks for the question, Yes, we did see an improvement in the new business activity, though it was still down from where we were a year ago and so it was a positive sign to see again as Francois mentioned earlier some of the irrationality.
Come out of the buying behavior still many more deal approval levels than what we would've seen a year ago, but the deals are actually getting approved so we're really happy to see that come through.
And.
Obviously, not guiding to a mix on software versus hardware sequentially.
But we do have.
Lot of faith in the software business, obviously last quarter was a challenging quarter. This quarter came back closer to the expectations that we have for the business.
And we will talk more about the actual outcome next quarter.
Great. Thanks, Frank and I, just wanted to circle back on some of the double digit earnings growth commentary.
In the past you guys have said.
You expect double digit earnings growth for fiscal 'twenty, four as well more so on cost cuts recognizing the uncertainty in the topline.
Is that still the case and do you still expect at least 300 basis points of margin expansion next year. Thank you.
Absolutely so yes, Michael when we made those comments.
We had had.
An outlook of 7% to 11% were higher now on EPS for where we're going to be in FY 'twenty. Three we're really happy about that some of that is coming from the tax benefit and so when we take a look at our pretax.
Income for FY 'twenty four it is certainly our aspiration to be done.
Double digit.
Things like tax and share repurchase and stock price of the share repurchases come into play it's just too early to.
Give any specific guidance further than that on FY 'twenty four but we're really really happy with the progress that we've made the leverage that we're seeing particularly in our gross margins and operating margins. It's exactly what we thought was going to happen and more to come on FY 'twenty four.
The second part of the question around operating margin.
Look we said, we expect that operating margins in <unk>.
24 to be around 33%.
And we still we still feel that that opportunity is there and we tend to drive to that.
Thanks, Frank Thanks, Thanks Francois.
Thank you. It was just time constraints. Our last question is from Sebastian <unk> with William Blair. Please proceed with your question.
Okay.
Hi, Thanks for squeezing me in guys.
Can you, maybe just talk a little bit about how competition for advisors changed, particularly as you've entered some of these new markets like API security multi cloud networking and then maybe expand a little bit on some of the key points of differentiation is allowing you to take share from incumbents here.
Can you just repeat the first part of the beginning of the question.
Yes, just maybe could you talk a little bit of a tough competition has changed as you enter these new markets around API security multiplied networking et cetera.
Yes. Thank you.
So like so in API security.
It's a nascent market there are.
You know a few start ups that are in the mix, but what what a couple of things about API security one is.
It is a big data problem because you have a lot of companies are dealing with a lot of API calls.
And detecting freight patterns requires really being able to find a needle in a haystack, sometimes it's sophisticated attackers.
And so to really wean and API security you really have to have.
AI and ml capabilities as well as the capacity to mitigate these attacks and where we're at five is differentiated in our ability both to discover Apis and all the ipi patterns and then too.
Protect against Ipi attacks and mitigate potential attacks and we're seeing that players that don't have the capabilities to do both.
Don't don't have the same kind of competitive position so.
So that's that's where the landscape is an API security and.
Pressing quickly as well in the market now with distributed cloud in the multi cloud networking space.
It's again.
<unk> market, but we think is going to grow rapidly because we're seeing most of our customers are now using multiple clouds.
State of application security set of applications.
Strategy report.
We found that close to 90% of our customers are now using multiple clouds and increasingly they need to connect applications a portion of applications across these clouds.
And what we're seeing in the competitive landscape. There is there are a couple of players that have capabilities to do that really at layer three IP networking layers, maybe there can be later, but we sit we're seeing increasingly enterprises need not just layer three to layer for networking, but also.
Seven security too.
To really connect these application securely and one has to go with the other and essentially.
<unk> is now with all of the integrations, we've made on our distributed cloud taking from our organic innovation and thinking from our acquisitions.
From shape in stack and Altera.
And some capability some big IP, we're essentially the only player today that can secure application and API across cloud across any environment.
And connected applications and Apis across cloud in any environment securely and we think that that is where this market is going to play out.
Going forward, so we're pretty excited about opportunity in this space.
Great. Thank you Thats very helpful.
Okay.
Thank you. This concludes today's call you may now disconnect.
Goodbye.