F5, Inc. — 2024 Q2
Transcript
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Good afternoon, and welcome to the F5, Inc. Second Quarter Fiscal 2024 Financial Results Conference Call. [Operator Instructions] Also, today's conference is being recorded. [Operator Instructions]
Hello, and welcome. I am Suzanne DuLong, F5's Vice President of Investor Relations. Francois Locoh-Donou, F5's President and CEO; and Francis 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 here to answer questions during the Q&A session.
Thank you, Suzanne, and hello, everyone. Thank you for joining us. In my remarks today, I will speak to our Q2 highlights as well as our expectations for Q3 in FY '24. Frank will then review the details of our Q2 results and provide additional color on our outlook.
Thank you, Francois, and good afternoon, everyone. I will review our Q2 results before I elaborate on our Q3 and FY '24 outlook. We delivered Q2 revenue of $681 million, reflecting sales that were down 3% year-over-year with a mix of 56% global services and 44% product revenue. Global services revenue of $381 million grew 5%, in line with our expectations, which reflect our lapping the benefit of prior price increases. Product revenue totaled $300 million, down 12% year-over-year, reflecting a lower level of backlog-related systems shipments than the year ago quarter. Systems revenue of $142 million declined 32% year-over-year.
Thank you, Frank. In conclusion, F5 predicted the hybrid multi-cloud ball of fire crisis our customers now face. For the last several years, we have been innovating and evolving to create the industry's first distributed application security and delivery platform.
[Operator Instructions] Our first question comes from Tim Long with Barclays.
Maybe 2, if I could. First, Francois, I think the last few quarters, you talked about kind of competitive landscape and some disruption at some of your competitors. Could you just give us an update on that kind of win rate or what you're seeing?
Thank you, Tim. So maybe let me start with your second question, and then I'll come back to the competitive landscape. But Tim, on AI, the use case that I referred to when I talked about high-capacity load balancing for data ingestion, I think we're going to see that use case primarily in enterprises, but specifically enterprises that are running their own large language model at scale and who have a need to ingest significant amount of data, whether that data comes from their own on-premise environments or from the cloud.
Our next question comes from Samik Chatterjee with JPMorgan.
I guess for the first one, Francois, Frank, you have some strong momentum here on the software subscription revenue quarter-over-quarter. Just how should I think about sustainability of that momentum going forward? And maybe the same one, sort of a bit disappointed to see the perpetual revenue on the software side moderate this much quarter-over-quarter, but it also seems like that's the lowest we've seen it track. So is there any potentially sort of more downside to that perpetual revenue number? But any thoughts on both of those aspects and the outlook there would be helpful. And I have a follow-up.
Yes. Samik, why don't I start with that? So this is one of those areas that will fluctuate quarter-to-quarter. Obviously, with last quarter, we had several large perpetual deals that gave us in-quarter revenue and lifted that software number up. We were not surprised this is the way it's playing out internally in our model, to dip back down in Q2, and would expect other results, obviously, with the software guidance that we've given for the back half of the year. That subscription revenue at 88% of total software revenue was an all-time high for us. It's going to fluctuate, but I would expect that it's going to be higher as a percentage than obviously what we saw in Q1.
Okay. And Francois, I appreciate all your comments about sort of how you're helping enterprises with their AI, sort of particularly said investments. But I think on the investor side at least, not sure as much on the industry side, but there's a lot of debate about when enterprises do spend towards AI use cases. Is that more of them spending on-prem? Or is that on a public cloud? Any insights you're getting from the early use cases on that and how -- sort of where they choose to spend, dictate sort of how they utilize the F5 portfolio?
Yes. I think what we're seeing is it's going to be, by nature, AI implementations are going to be multi-cloud. And the reason for that is customers want to do training in certain environments. They want to do inference in other environments. For a number of verticals, they want to do inference at the edge. And also, their data is in a lot of different locations.
Our next question comes from Alex Henderson with Needham & Co.
So I was hoping you could talk a little bit about the implication of a reacceleration in application growth in the context of most of the cloud companies, and we don't have Amazon yet, but other ones such as Microsoft Azure has already seen -- seeing a reacceleration after several years of the so-called efficiency movement decelerating. That growth rate does now look like it's starting to reaccelerate. And I was wondering if you could talk about whether Hashi acquisition has any impact on you positively or negatively and what you're doing to take advantage of those 2 dynamics within the distribution VAR channels?
Alex, thank you. So on the potential reacceleration, if confirmed of applications, we think it has potentially 2 implications. The first one is more customers deploying more applications in hybrid and multi-cloud environments. And I've just talked about the implications of that, which for us, we think, are net positive because it creates more requirements for security and networking across clouds.
And the distribution part of the question, taking advantage of those dynamics to drive channel?
Well, there is not really an impact into how we would change our approach to distribution of what we would do into the channel. We would -- the dynamics in terms of how we meet in the market and work with Hashi will, I think, continue unchanged for the most part. So -- only as far as we're concerned. I don't know what decisions IBM may make around what they want to change in the go-to-market for Hashi. But as far as we're concerned, I think customers see us as complementary, often want us to work together, and we'll continue to do that in the market.
Our next question comes from Meta Marshall with Morgan Stanley.
I just wanted to probe a little bit into kind of your talk about flat IT budgets or just macro cautiousness from customers. There's a number of things. There's the strength in the dollar. There's prioritization of AI investments. I'm just -- guess I'm just trying to get a sense of the macro caution. Is any of that driven by FX or just kind of budget prioritization? Or is it just kind of wallets across the board being more cautious?
Thank you, Meta. So on budget, I should say first of all, the macro environment, Meta, has remained stable. So we haven't seen a fundamental change from last year in terms of customers' sort of appetite to spend. What has changed, I think we shared it last quarter, is the sort of unpredictability that we were seeing a year ago around deal delays and cancellations and last-minute pushouts. That has largely abated. But overall, customers remain cautious. This was also, for a number of customers, the first quarter of the calendar year. So they've just gotten their budgets. I think we saw probably a little more caution on CapEx, specifically on hardware, given the current macro environment.
Just -- yes, just whether it's taking the form of -- kind of on the ADCs versus other portions of the portfolio?
Yes. So we are -- I think it's a combination because a lot of the -- what we're seeing more opportunities with existing customers that are both ADC and other portions of the portfolio, especially in this multiyear subscription agreements that continue to do very well and our vehicle that customers love because it gives them the flexibility.
Our next question comes from Michael Ng with Goldman Sachs.
I just have 2. First, just as a follow-up to the earlier question around software, I was just wondering if you could talk about the components of subscription software between term base and SaaS, how did those perform. And then second, on services, I can appreciate we're lapping some of the price increases that I think were first implemented in -- I think it was July of 2022. Could you just remind me if there are opportunities to periodically increase pricing on services? What has that time line been historically? And is this 5% growth a good way to think about services growth going forward?
Yes. Michael, why don't I take that? Look, on the sort of components of the subscription business in terms of SaaS and ARR, that one, ARR versus the term base, we talk about that annually, but it's not something we talk about quarterly. But the components of those businesses, we're really excited about what we're seeing for Distributed Cloud adoption, particularly the value proposition around WAAP and specifically API security that Francois just mentioned as well as our multi-cloud networking. So those are great.
Our next question comes from Amit Daryanani with Evercore ISI.
I have 2 as well. I guess, Frank, maybe just start with you. I think in the past, you talked about software growth for the full year being flat to, I believe, up modestly, I think was the statement. Given the performance you just saw this quarter, which I think was much better than expected on software, how do you think the back half of the year stacks up on the software side?
Sure. So look, we had a strong software growth number in Q2. It was in our expectation range. And largely, software to date in the first half has been ahead of our software expectation. But having said that, we did not change our outlook from flat to modest growth, but I think we'd be disappointed if we weren't at the higher end of that or better by the end of the year given the strong first half performance that we saw.
Got it. Perfect. And then if I just follow up on this, customers having to deal with the ball of fire [ likely ], kind of characterize that dynamic. I'd sort of love to understand, what does that mean that you solve that ball of fire problem for your customers? What does that mean to F5's long-term growth rate as you think about that? And crucially, do you think there's anyone out there -- who do you think is your competition when it comes to solving that ball of fire from an end-to-end basis across load balancing and security?
Well, thank you. There are multiple dimensions to solving the ball of fire, and we don't think we really have competition that can address it as exhaustively as we are addressing it. So the first aspect is the completeness of the application services that are required to solve it, which very few, if any company really has, because it goes from all of the application delivery services like load balancing authentication, but also web application firewall, all of the security services, API security, DDoS, multi-cloud networking, all of these capabilities you have to have to solve the ball of fire. Part of the complexity for customers is that they have had in the past to rely on multiple different vendors to be able to solve the ball of fire. So that's one aspect is the ability to bring it all together.
Our next question comes from James Fish with Piper Sandler.
Francois, I think we get the product strategy here. So my question is more directed at Frank. So talking about stronger renewals on the subscription side in the second half, Frank, is there any way to quantify this magnitude? Or what is giving the confidence in those second half numbers, especially after -- this quarter came in a little bit lighter than we're used to seeing F5's report and implies a sizable fiscal Q4 ramp to roughly $40 million-ish kind of sequential ramp here in fiscal Q4. And additionally, have you seen any changes in subscription durations?
Sure. Absolutely, Jim. So I appreciate the question. And when we take a look at the results of this quarter in relation to our expectations, where we saw a softer performance was in the system side, not the software side of the business. And when we take a look at the back half of the year, that's really where we saw the strength of the pipeline in that area as well as for the renewals that we have in the outlook. And those renewals specifically are coming in -- in both quarters, they are stronger than what we have seen in Q2, but they just ramp up because of the nature of when the deals were done 3 years ago in Q4. And if you take a look back 3 years ago between Q3 and Q4, I think you'll see a similar dynamic in the software growth that we expect. And so that is really that $40 million swing that you're referring to between those 2 quarters. So that's really the visibility. It's the strength that we've seen in the renewals. It's the true forwards sense and the second or the interims of what's available to renew in Q4.
Anything on the duration side of what you're seeing?
The duration side really has not changed. These are not universally, but almost always 3-year deals.
Our next question comes from Ray McDonough with Guggenheim Partners.
Maybe to start, Frank, as we think about cash flow dynamics going forward with term renewals and the opportunity in the back half, as you just discussed, and as renewals generally become a larger portion of the mix, combined with the product availability you mentioned earlier in the call, should we expect cash flow margins to continue to trend up from here as well?
Ray, it's a great question. So the biggest dynamic of the cash flow changes between the quarters right now continue to be maintenance that just outweighs some of the subscription revenues that we've seen. And so the dynamics that you're implying absolutely are happening just on the smaller base of the overall cash flow that is coming out of that deferred revenue bucket, which is still largely maintenance related.
Great. Maybe just a question for Francois. We've talked a lot about bringing hybrid multi-cloud environments kind of together and simplifying the management of that. And I'm just wondering, when we take a step back, you announced the Distributed Cloud Console at AppWorld, I believe. What's been the reaction within your conversations with customers? Are you seeing interest that's resulting in cross-selling it or even better renewal or expansion rates, even if it's not direct, just as a result of maybe the offering being out there and customers being more comfortable with the road map? Any thoughts there would be helpful.
Yes. So the reaction at AppWorld on Distributed Cloud has been very positive. And most -- let me just give you some numbers there, Ray. So of the -- we shared in October that we had over 500 customers on Distributed Cloud. The number has grown since then, and we will share that number. And we said we would share it annually, so we'll share it again in October. But over 2/3 of the customers on Distributed Cloud are existing F5 customers that were typically BIG-IP customers that choose Distributed Cloud as a complement to a hardware or software on-prem implementation, and in part because of our ability to, in the future, bring both the hardware, software on-prem and the SaaS services to a single pane of glass. And the other 1/3 of customers are net new customers to F5.
Due to timing, our last question will be from Sebastien Naji with William Blair.
Two for me. The first one, just following up on the competition question from the beginning. In those instances where you are displacing one of those ADC competitors going through a disruption, how do you typically land? Is it more heavily weighted towards like appliances or software or SaaS?
Well, thank you. Let me start with the question on AI and the type of attacks. So we are already using AI today to block significant attacks, including automated attacks on a number of applications. This quarter alone, we blocked several billion API attacks in our Distributed Cloud capability. And a lot of that uses AI and automation, machine learning, specifically, in AI to block these attacks.
Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.