Good afternoon, and welcome to the F5, Incorporated First Quarter Fiscal 2022 Financial Results Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Also, today’s conference is being recorded. If anyone has an objection, please disconnect at this time. I’ll now turn the call over to Ms. Suzanne DuLong. Ma’am, you may begin.

Hello, and welcome. I’m Suzanne DuLong, F5’s Vice President of Investor Relations. François Locoh-Donou, F5’s President and CEO; and Frank Pelzer, F5’s Executive Vice President and CFO, will be making prepared remarks on today’s call. Other members of the F5 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 A copy of today’s press release is available on our website at f5.com, where an archived version of today’s call will be available through April 26, 2022. Today’s live discussion is supported by slides, which are viewable on the webcast and will be posted to our IR site at the conclusion of today’s discussion. For access the replay of today’s call by phone, dial 800-585-8367 or 416-621-4642 and use meeting ID 687-9935. The telephonic replay will be available through midnight Pacific Time, January 26, 2022. For additional information or follow-up questions, please reach out to me directly at s.dulong@f5.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 F5 has no duty to update any information presented in this call. With that, I will turn the call over to François. François Locoh-Donou: Thank you, Suzanne, and hello, everyone. Thank you for joining us today. Our strong first quarter results demonstrate our customers need to grow and evolve the applications that support and drive their businesses. Customer demand standout portfolio, driving 10% revenue growth in Q1 and our fifth consecutive quarter of double-digit revenue growth. Underpinning our top line…

Thank you, François, and good afternoon, everyone. I’ll review our Q1 results before providing our Q2 outlook and updated fiscal year 2022 guidance. As François outlined, our team delivered another very strong Q1. First quarter revenue of $687 million is up 10% year-over-year and above the top end of our guidance range. Please note, as I review our revenue mix, I will be referring to non-GAAP revenue measures for the year ago period. Q1 product revenue of $343 million is up 19% year-over-year, representing 50% of total revenue. Q1 software revenue grew 47% to $163 million representing 47% of product revenue, up from 38% in the year ago period. Systems revenue of $180 million is up 1% compared to Q1 last year. Rounding out our revenue picture, we see continued strength from our global services with $344 million in Q1 revenue. This is up 2% compared to last year and represents 50% of revenue in Q1. Taking a closer look at our software revenue, subscription-based revenue represented 81% of total software revenue, up from 77% in the year ago period. Subscription-based revenue includes a ratably recognized as-a-service offerings and our solutions sold as term-based licenses. Revenue from recurring sources, which includes term subscriptions as a service and utility-based revenue as well as the maintenance portion of our services revenue totaled 68% of revenue in the quarter. On a regional basis, in Q1, Americas delivered 17% revenue growth year-over-year, representing 59% of total revenue. EMEA was flat year-over-year, representing 24% of revenue and APAC delivered 2% growth, accounting for 18% of revenue. The strength in Q1 spanned customer verticals as well. Enterprise customers represented 71% of product bookings in the quarter, service providers represented 15%, and government customers represented 14%, including 4% from U.S. Federal. I will now share our Q1…

[Operator Instructions] For our first question we have James Fish from Piper Sander. James, your line is open.

Hey, guys. Obviously, after hours, getting a lot of the supply chain stuff and a number of your networking system peers took careful measures to ensure supplies and mitigate decommits. Why is this now impacting F5? Or why wasn’t it done last quarter? And what are you guys specifically seeing regarding your backlog that can really give us confidence that the demand side is still there? François Locoh-Donou: Hey, Jim. It’s François, and I’ll take your first question. I – so let me just start from the last point of your question, then I’ll come back to the supply issue. On the demand side, Jim, you know that last year, our backlog continued to grow. I think we exited last year with a backlog that was at the highest level it’s ever been. In Q1, if you’re referring specifically to hardware, you saw that our hardware revenue was pretty much flat, but our backlog continued to grow in our first fiscal quarter. In fact, it grew by more than 10%. So based upon the demand we saw in Q1 and the pipeline we see in Q2, we feel very, very good about our demand and the health of the demand. And so the issue that we’re facing to be very clear is not a demand issue. It absolutely is a supply issue. And the revision we’ve just done to our annual guidance is 100% linked to the supply issue. Now to the first part of your question about what we’ve been doing to mitigate the issues and why are we facing this issue now. So we’ve been talking about for several quarters that our – the issue with our supply chain has deteriorated steadily. And last year, we were not able to ship the demand, which is why our backlog…

That’s amazing color, François. And keeping on the supply chain step as a follow-up, I mean, how much of the supply capacity are we now at given the decommitments, but also it sounds like a new arrangements with suppliers. And then in addition, you guys talked about a mitigation time frame for the fiscal second half. So does this mean we should expect upside to kind of fiscal 2023 for where we’re at or is there a risk to these orders getting canceled? Thanks, guys. François Locoh-Donou: Thanks, Jim. Let me just make sure. So we don’t see any risk to orders being canceled. The demand we have is very real. Our lead times, unfortunately, have gotten progressively worse over the last five, six quarters, but we haven’t seen any change in – any increase in order cancellation, and we don’t expect to see that going forward. In terms of the timing of improvement, Jim, I want to clarify because we – there are two issues really at play here, and I want to make sure I give you visibility into both issues. So let me talk first about our fiscal year. So the $30 million to $90 million reduction to our revenue for the full fiscal year, that is linked to a struggle to get specialized networking chipsets that come from the big chip manufacturers and are kind of specialized chipset. The lack of supplier role is really what’s driving that $30 million to $90 million reduction. And we don’t expect to see – part of why we’re pointing to that reduction is that given the level of decommits we have in deliveries and the visibility that we have now from our suppliers. We don’t expect this situation with specialized networking chipset to get better until the very end of calendar 2022, which is when the new fab capacity will start flowing into parts to F5, and we will start to be able to ramp up our levels of shipments. So that’s the situation that is affecting the full year. As it relate specifically to our second quarter in Q2, we have an additional challenge, which is more standard electronic components, where we have had a significant decommit in the last few weeks that is affecting only Q2, because we expect to be able to qualify alternative parts relatively quickly and make those shipments in Q3 and Q4. So the second issue has a much shorter time frame to be resolved. The first issue is the bigger issue around the specialized networking chipset that will take several quarters before we see meaningful improvement there.

For our next question, we have Sami Badri from Credit Suisse. Sami, your line is open.

Hi, thank you. First, François, and maybe, Frank, you could also help us as well. Can you just kind of unpack the growth algorithm of software and just how we got to this point, because you essentially exceeded expectations on a very strong comp prior year? Could you just unpack what exactly it was that got you to this result? So that’s the first question. The second question is, as I hear you describe the degree and the magnitude of the supply chain constraints, it almost sounds so strong that it would almost compel the customer to change architecture because of the degree of the effect that what’s happening, right, like it service, for example, what they had in mind. So how come – what’s going on when you guys are saying the delays and essentially, what sounds like a systemic problem is not compelling customers to, say, adopt more software type architectures or solutions and sticking to specifically hardware? And then, thank you, that would be great. François Locoh-Donou: Thank you, Sami. I’ll start with the second part of the question, then we’ll go to software, and I’ll start with software and then Frank may add to it. So Sami, as it relates to the supply chain issue, I just want to put it in the perspective of what our customers are seeing and what lead times they’re seeing. Historically, our lead times were two weeks or less. They’re absolutely world-class and I mean that’s sort of pre-2021. As our lead times got worse in 2021, they extended for four to five weeks. And I would say, for the last several quarters, we’ve been in that kind of five weeks zone. For orders that are placed today by customers, the lead times have extended, but they’re going to be…

Got it. Thank you.

For our next question, we have Amit Daryanani from Evercore. Amit, your line is open.

Thank you for taking my question. I have two as well. First off, I’m hoping maybe you just help me reconcile the March quarter and fiscal year guidance. François, I sort of heard you talk about the two different component challenges that you have, but your March quarter guide, I think if I take it at midpoint implies in the first half, you’ll grow 3.7% and so. Then to you to hitch a full year guide at almost invites that you have to grow high single-digits in the back half of the year, June and September. So, am I doing this correctly? And I guess why the confidence that growth will snap back so quickly in the June, September quarter for you folks?

Sure. Amit, why don’t I start with that one and then see if François has anything to add. So, I think François, I’ll try to articulate the difference of the near-term challenges we’re having in Q2 and some of those acute standard components that are just taking a bit of time to redesign into the solution, but we are able to make up for some of that loss in the back half of the year. And so it’s more acute because of just the timing of when we realize that this part that we expected to get this quarter is now not coming until next quarter, and it’s going to come in much less than what we initially had ordered. And so this redesign that we are doing for this part is not going to be in place in time with our manufacturers to affect Q2 revenue, but it will impact – will have ability to "catch up" on that in Q3 and Q4. And so that’s what gives us confidence that Q2 is the low mark when you take the combination of the two quarters that you just said, yes, for the first half that way, but we do make up for some of that Q2 demand in the back half on top of the ordinary demand that we would normally see.

Got it. Perfect. And then I guess the second one and this almost seems silly to ask given all the hard questions you have. But on the software side, and François, you talked a fair bit about this, you did 47% growth on probably one of the more difficult compares. I think it was 70% last year. And your guidance on right down the full year would imply that your software growth will decelerate as you compare start to get easier. That seems a little counterintuitive. And I guess there’s a need to be conservative given the supplies and issues you have, but I’d love to understand why do being software decelerates after everything you talked about that business? François Locoh-Donou: Yes, Amit, it’s a good question. We don’t necessarily think it decelerates. We are early in the year – and we gave a range for the full year of 35% to 40%. We had a very strong first quarter. We feel very confident about our software growth. In fact, we said, hey we think it’s going to be more at the top end of the range. But it’s too early to be changing that view for now. And what you should take away from our sense is that – we really like what we’re on software, and we think it’s going to be a very good software year.

Fair enough and best of luck. Thanks for the time. François Locoh-Donou: Thank you, Amit.

For our next question, we have Alex Henderson from Needham. Alex, your line is open.

Thanks. So, I wanted to ask a broad general question about the behavior of enterprise’s purchasing approach, given the intense pricing pressure and supply constraints around hardware. As you’ve talked to CIO, CTO, C-suite-type people, has it resulted in a change in behavior where we’re seeing an acceleration in commitments to digital transformations mean switching prices, I think, just kicked their price up again this month. System prices are up double-digit and we’re forcing people into subscription around those hardware. A lot of people, I would think, increasingly wanting to get away from that. And that would play into your strength, I would think, to the extent that you’re such a strong player in the Kubernetes workspace workload space. So, can you address what you’re hearing from the C-suite on those thoughts about changing their behavior in a more tidy fashion? François Locoh-Donou: Hi Alex, So, I would – first, I would say, Alex, our – we know we are going through an extraordinary situation as it relates to supply. Everybody along the value chain is feeling that and you’re seeing different type of behaviors. In some case, you are seeing some suppliers in the semiconductor space who are taking advantage of that to some extent [indiscernible] prices. And that, we believe, is a short-term approach that may have some benefits. But in the long-term, it’s detrimental to relationships. And so the way we look at it is our customers and our shareholders are going to be happy if we continue to have great long-term relationships with our customers and continue to be with them as they evolve their architectures. And so as we think about how do we balance the cost pressures with price increases. We are looking at it through the lens of also maintaining strong relationships with our customers for the longer term. So what always, from our perspective, we’re always going to have that balance in how we approach things. In terms of the way our customers are seeing things in our conversations, – of course, they want to get their products as fast as possible. In the case of F5, we are not seeing them – as I said before, we’re not seeing order cancellations. We’re not seeing them double ordering solutions because F5 solutions is unique, and you can’t replace them like-for-like for something else. And frankly, also because so far, we have managed to keep our lead times that are much better than what they’re getting from other vendors. So, we are getting increasing pressure, of course, from customers to try and supply to them faster. But we’re not seeing a dramatic change in their behavior towards F5 from what we saw through last year.

If I could follow up on a separate question. The service provider business historically has been in the 20% to 23% of revenue range. It’s been coming down persistently every quarter. I think you’re talking about 15% this quarter. It seems quite clear that with your shift to software and security that you’ve shifted away resources away from them. Can you talk about to what extent you’re shifting away from – intentionally shifting away from that space in favor of your higher-growth alternative areas? François Locoh-Donou: Alex, I would not say that we are intentionally shifting away from the service provider space. We had a very strong -- through the last five, six quarters, we have very strong demand in the enterprise that has been broad-based. And so when you look at the mix overall service provider as a mix has come down. However, our service provider business itself has actually been growing very healthily over the last several quarters, including this last quarter. And also with what we’re seeing coming in the 4G to 5G transition, we see strong opportunities both in hardware and software with good service providers, with some potentially important deals to come over the next few quarters. And so no, we are actually investing into the service provider space, both for our existing platforms and Volterra that is also potentially a platform of very strong interest with our providers. We are starting to see more and more deals in the IoT space with service providers, oftentimes requiring scale to tens of millions of devices, which for that scale is served to hardware. So, we continue to invest in our service provider segment. I understand how you drew that perspective from the mix. Service provider has been only at 15% for the last few quarters, but it is growing in line with the rest of the business with very strong prospects to come.

And Alex, just as a reminder, that 15% is of bookings, not of revenue and certainly not a total revenue. So as a proxy, you think you can go about it in relation to the product revenue, but that’s what it’s in relation to.

Thanks.

Thank you, Alex.

For our next question, we have Rod Hall from Goldman Sachs. Rod, your line is open.

Hi, guys, thanks for the question. I wanted to start by clarifying the backlog number. I think, François, you said it grew just over 10%. And I think you guys had called out $125 million of backlog last quarter. So is it right to think that, that backlog is in the ballpark of a $140 million this quarter?

Rod, it’s in the ballpark for the system side. What François was referencing was the systems piece of the backlog, which, as we said in our K was the vast majority of that $125 million, but I just want to make sure you understand the net inflations…

Okay. Could you just shave a little something off the $125 million and up by 10 plus, and that puts us in the ballpark. Okay, thanks Frank, that’s helpful. And then I wanted to just kind of ask a bigger picture question. You guys last year were talking about systems being stronger because people were locked down and they couldn’t test software in. This kind of comes back to what people might be thinking here. So, now you’re in a situation where you can’t supply systems people want. I don’t get why – because it looks to me like you’ve raised your software guide by maybe $12 million or $13 million from your midpoint of your $35 million to $40 million to the $40 million. But then you’re cutting your systems guide by $30 million to $90 million, so quite a bit more than that. So you’re not really getting that – it just seems like you should get an accelerating trade towards software if that dynamic last year is starting to unwind in your favor this year. So, I still don’t fully understand why the software is not going up more to compensate for the hardware weakness? François Locoh-Donou: Rod, it’s a great question. So, I first want to remind you, Rod, that the – where there is an opportunity to substitute, if you will. Hardware for software is really in our big IT platform. But the drivers of software growth are across the entire portfolio. So that’s the first thing you got to remember. Second, when you say, "Hey, why is there not more a substitution in the IP of hardware for software, but it’s the first reason is because hardware demand is not weak. So that the hardware – the behavior of our customers as it relates…

Great. Okay, François. I really appreciate all the color. Thank you. François Locoh-Donou: Thank you, Rod.

Our next question, we have Meta Marshall from Morgan Stanley. Meta, your line is open.

Great. Thank you. I just wanted to get a sense – you noted kind of the shortages you’re seeing are two-pronged, both on the specialized chips and the more standardized components. Just wanted to get a sense of was the deterioration you saw more severe in kind of one or the other in the quarter? And just what guidance kind of implies the top, bottom of the range? Does one have to improve more than the other to kind of achieve those? And then maybe just a second question for me. We’ve seen a, the networking peers kind of build inventory pretty significantly or attempt to build inventories pretty significantly over the course of the last year. Just as going forward, getting out of this – sort of this kind of change on your thoughts on inventory stocking going forward. Thanks. François Locoh-Donou: Yes, Meta just a couple of – let me start with the last part of your question. So we have been buying components with extraordinarily long lead times. Some of the components that were committed at the very beginning of this – that the calendar year for us were components that we had ordered more than 52 weeks ago. We have several 100 components today that have more than two years lead time. So we have been getting ahead of us for the last 18 months and making very strong advanced buys in anticipation of issues getting commitments from suppliers that, in some cases, after 52 weeks of waiting are coming back when the deliveries are due and saying, it’s not going to happen in the quantities you expected or the timing you expected. And so that – and we’ve been able to manage that through the last several quarters, but we’ve seen even a step function…

Got it. Thanks. François Locoh-Donou: Thank you, Meta.

Our next question, we have Samik Chatterjee from JPMorgan. Samik, your line is open.

Hi, yes. Thanks for taking my question. I guess if I start with the non-supply question here. I think, François, you mentioned there’s no change in how you think about the business longer term, you’re not changing your operating model here, given some of the temporary issue, you’re seeing here, you reiterated buying back about $500 million of the stock. What’s the inclination or what’s the appetite to maybe aggressively do a bit more on the buyback given that the outlook for the business longer term hasn’t changed, but this temporary setback, obviously, is going to drive some weakness on the share price?

Sure, Samik. So let me start with that one. We talked about the $500 million of share repurchase, maybe more ratably throughout the course of the year. We’ve established auto-mandatory repurchase programs associated with that. And so – but I’m not going to get into the ins and outs of the execution of that program, but it is – that we haven’t changed the level of commitment that we intend to make. It’s still $500 million. When exactly that triggers a TBD as we see how the stock plays out. But we do not anticipate moving that program up from $500 million because we want to stay balanced on the strategic reasons, why we entered into that kind of balance in the first place.

Okay. Got it. And just a follow-up on software. You’ve talked particularly last year about the true forwards that you will kind of benefit from or will be a deal win in terms of growth this year. How should we think about the trajectory of those? Are those more weighted towards the back half? I think in general, as we look at the risk in terms of your software guide. I think to an earlier question, it does imply some moderation in growth, which I think is more you just waiting for execution. But is there an impact there on the true forwards being more weighted for certain half of the year? François Locoh-Donou: So the true forwards there – there’s some seasonality to them. What we talked about is really the second term of the multiyear subscription agreements coming into play, which resets the whole cycle of revenue recognition with the new – with the second term, and those were weighted in the back half.

Okay, great. Thank you. François Locoh-Donou: Thank you, Samik.

Due to time constraint, we will take our last question from Paul Silverstein from Cowen. Paul, your line is open.

I appreciate for squeezing me in and appreciate all the questions in response to some supply chains. So I apologize that I’ve got yet another – and perhaps just to be clear already, but I just want to make sure I understand what you’re saying. If the $30 million to $90 million – if I understand you correctly that $30 million to $90 million shortfall relative to your – I trust your view, your understanding of when the new supply when those new fabs will come online hasn’t changed over that 90-day period. You didn’t expect to benefit from those coming online earlier than, what you now expect what changed with the decommits from your current suppliers, the specialized or core the available chipsets. Is that correct?

Yes. Both assertions are correct, Paul.

All right. François, is it a given that if you’re not losing, if your customers aren’t shifting to your software, the customers are purchasing the hardware, if they’re not shifting to your competitors, is it a given that your backlog will increase by $30 million to $90 million, whatever the ultimate shortfall relative to 90-day ago expectation. That’s sort of basic math, isn’t it? François Locoh-Donou: Pretty much. I mean its forecasting back log exactly is – we’re probably not going to do that. But yes, our backlog will increase by multiple tens of millions of dollars starting this quarter, of course, in Q2, but even for the full year, yes, we expect our backlog to increase because we cannot ship the demand.

If I could squeeze a little more. I’m going to apologize – I started to be clear, but given that you’re almost a full month into the quarter, why the significant range in the guidance for the quarter? Is it just like the visibility and confidence as to additional decommit’s, it’s just not – it’s sparse for like a better way to put it. What accounts for that dramatic range in the near term? I mean, you’ve only got two months left in the quarter. And I assume you had to build up supply previously as everybody else has been doing in terms of advanced ordering in order to ship against whatever you had expected, once again, why such a dramatic range? François Locoh-Donou: Well, that’s a great question. And look, absent the significant supply chain challenges that we have, you would have probably seen a range that would be closer to sort of $20 million and the range is twice that for two reasons, and they’re both related twice that the first reason, Paul, is that this decommit with all this standard component, our teams are sort of working 24/7 to re-qualify to find alternative parts and be able to solve some of that in quarter – and so that’s – but we don’t know yet if we’re going to be able to do all of that kind of design work and get that to manufacturing and be able to ship these parts before the end of March – sorry, these products before the end of March to the customers. So there is an added uncertainty that comes from that. And then the second part of that uncertainty is also in quarter, we are looking to shift some of the demand to the newer platforms that are more readily available and how fast we can ramp those platforms, there’s also some uncertainty associated with that. So those are the two elements of supply that could go one way or the other that add a little more uncertainty to the call, and this is why you see the range. But I want to be very clear. Both are related to supply. They’re not related to some worries we would have about demand – and that the reason we of course, are working 24/7 to do this. It’s because ultimately, our North Star is getting products to our customers. And we understand that the lead times are extended for them, and we want to be able to satisfy the demand as fast as possible for customers that are waiting on this for their applications that are growing. So that’s our upstart, but that explains the range fall.

I appreciate the responses. Thank you. François Locoh-Donou: Thank you, Paul.

Ladies and gentlemen, this concludes today’s call. You may now disconnect.