F5 Inc (FFIV) — Q1 2022 Earnings Call Transcript

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 A copy of today’s press release is available on our website at f5.com, where an archived version of today’s call will be available through April 26, 2022.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 to 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.

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 for our standout portfolio drove 10% revenue growth in Q1 and our fifth consecutive quarter of double-digit revenue growth. Underpinning our top-line growth is robust 47% software growth, 1% systems growth, and 2% global services growth in the quarter. In fact, both software and systems demand exceeded our expectations in Q1, contributing to our outperformance. We are at the epicenter of digital transformation and application security. We are differentiated by our focus, expertise, and the vision and technology assets to secure and deliver any application anywhere. As a result, we have seen strengthening demand across our software portfolio and persistent strong demand for our systems. Given the state of the industry since late 2020, we have been taking progressively more aggressive steps to manage supply chain risks. These include preordering components, investing to secure supply, qualifying and sourcing alternate components, and purchasing on the open market to fill gaps that arise. Over the last year, stronger-than-expected demand for systems, coupled with ongoing supply chain constraints, have gated our systems revenue growth. As a result of persistent strong system demand, our systems backlog continued to grow in Q1. Over the last 30 days, suppliers of critical components that span a number of our platforms have informed us of significant increases in decommits. These came in the form of both order delivery delays and sudden and pronounced reductions in shipment quantities. The step-function decline in components availability is significantly restricting our ability to meet our customers’ continued strong demand for our systems. The challenges in Q2, and we expect Q2 revenue in the range of $610 million to $650 million as a result. This revenue range reflects a $60 million to $80 million shortfall in our ability to ship in our second quarter versus what we would have expected absent these recent supply chain constraints. Based on the information we have today, we estimate that increased supply chain limitations are likely to have a net $30 million to $90 million impact to our prior revenue guidance for fiscal year 2022. We are aggressively working to mitigate the impact of two primary gating supply challenges near-term. First, like others in the industry, we are seeing worsening availability of specialized networking chipsets. Within the last 30 days, we have learned that deliveries for 52-week lead-time components are behind schedule and that our expected quantities have been reduced. Second, we also have experienced significant decommits for standard semiconductor components. We are working to design and qualify replacement components to resolve these standard component challenges. While we are unlikely to be able to do so in time to mitigate production shortfalls in Q2, we expect that we can mitigate the impact on the second half of our fiscal year. In addition to continuing to work with our suppliers, our sales teams also will be working with customers to fulfill their demand with alternative offerings. In some cases, customers may be able to qualify and ship demand to recently introduced platforms that are less affected by supply chain issues because they use more readily available components. The main drivers across our business are stronger than they have ever been. While near-term supply chain challenges create a headwind to our revenue growth trajectory short-term, fundamentally, we did not change the significant opportunity we have to solve our customers’ most critical application security and delivery challenges, nor will it change our longer-term growth potential. Our software transition continues to gain momentum. In fact, we now expect to be closer to the top end of our 35% to 40% software revenue growth range for the year. In addition, systems demand exceeded our plan in Q1 and remained strong headed into Q2, because of the strong demand signals we see and our confidence in our longer-term trajectory. We will continue to invest responsibly in our business and will not make any dramatic changes to our operating model short-term. While this will mean near-term pressure on our operating margin, it best positions us to continue to capture our growth opportunity and long-term earnings potential. We expect to return to our previously forecasted operating margin profile as we return to full manufacturing capacity. Our Q1 customer wins offered great insights into both our momentum and the opportunity ahead. For instance, a basic application security threat like Log4j clearly demonstrated why every application needs web application firewall protection. As a result, we are seeing heightened interest in F5’s WAF solution for both traditional and modern applications. In just one example during Q1, a customer selected NGINX with App Protect to add vast protection closer to the containers deployed by its DevOps teams. This is in addition to the advanced WAF operated by its traditional SecOps team. We also see growing demand for fraud and bot defense. As an example, in Q1, one of Central America’s most prominent banks was struggling with data security despite deploying multiple security solutions. The bank selected our Shape solution to defend against persistent automated attacks. Shape dramatically reduced the customer’s automated traffic, successfully reducing consumer friction across their digital channels. Shape is also providing broad-based analytics for improved application security and visibility. Finally, customers’ modern applications are moving into production and experiencing significant and constant swings in user demand. As a result, they need infrastructure that scales up automatically to meet user demand or down to save cloud costs. For instance, during Q1, an American multinational investment bank and financial services customer selected NGINX to help modernize the Kubernetes-based application. The customer’s existing solution was unable to provide multi-site resiliency for a service running within Kubernetes clusters. The customer selected NGINX Plus to provide multi-cluster, multi-site scaling. Customers are increasingly looking to F5 to help them solve an escalating volume of application security, delivery challenges, multi-cloud challenges, and modern app challenges like scaling Kubernetes-based apps into production. These challenges and the complexity they entail are only mounting for our customers. We see F5 as an innovator, uniquely equipped to help them build and scale both the traditional and modern application environments. And the cloud-ready capabilities we are building with our Volterra and Threat Stack integrations only enhance our positioning and appeal. I’ll now turn the call to Frank to review our Q1 results and our outlook. Frank?

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 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 operating results. GAAP gross margin was 80.3%. Non-GAAP gross margin was 83%. Along with our increased component prices, we anticipate continued pressures related to our supply chain in the next several quarters. We expect these pressures will result in some increased costs related to expedite fees and sourcing of long lead-time components. GAAP operating expenses were $438 million. Non-GAAP operating expenses were $345 million. Our GAAP operating margin in Q1 was 16.6%. Non-GAAP operating margin was 32.7%. Our GAAP effective tax rate for the quarter was 16.3%. Our non-GAAP effective tax rate was 19.5%. GAAP net income for the quarter was $93.6 million or $1.51 per share. Non-GAAP net income was $179 million or $2.89 per share. I will now turn to the balance sheet. We generated $90 million in cash flow from operations in Q1. We tend to see cash flow dip in Q1 as a result of the timing of cash receipts and billings among other factors. Q1’s cash flow is below our recent range because of two primary factors. First, we had strong multi-year subscription sales in the quarter. As a reminder, our multi-year subscriptions are generally sold on three-year terms. We built only one-third of the contracted signing with the remainder going to unbilled assets. Second, during the quarter, we also had some significant prepayments with our contract manufacturer associated with the components for future builds. DSO for the quarter remained strong at 55 days. Cash and investments totaled approximately $936 million at quarter end. During the quarter, we repurchased approximately $125 million worth of F5 shares, or approximately 539,000 shares at an average price of $232. Capital expenditures for the quarter were $11 million. Deferred revenue increased 16% year-over-year to $1.576 billion, up from $1.359 billion. The growth in total deferred was largely driven by subscription and SaaS bookings and to a lesser extent, deferred service maintenance. Finally, we ended the quarter with approximately 6,550 employees, up approximately 90 from Q4. This includes employees added with the Threat Stack acquisition, which closed in the quarter. François shared our Q2 revenue outlook and our updated fiscal year 2022 outlook in his remarks. I’ll recap our full Q2 guidance and fiscal year 2022 updates with you now. Unless otherwise stated, please note that my guidance comments reference non-GAAP metrics. Let me start with Q2. We expect Q2 revenue in the range of $610 million to $650 million as a result of supply chain-related systems production constraints. Taking into account continued component cost increases, and the costs related to actions we are taking to mitigate supply chain pressures, we expect Q2 gross margins to approximate 82% to 82.5%. As François discussed, because we believe the current supply chain challenges are transitory and do not reflect the underlying growth trajectory of the business, we do not intend to adjust our operating model. We believe doing so would risk compromising our ability to deliver future revenue growth. As a result, we are likely to see operating margin pressure in Q2 and for the next several quarters. I’ll remind you that, historically, Q2 is our seasonal low for operating margins as a result of annual payroll tax and retirement benefit resets. That said, we estimate Q2 operating expenses of $357 million to $371 million. We anticipate our full fiscal year effective tax rate will be in the range of 20% to 21%, including the impact of our 19.5% Q1 tax rate with some fluctuations quarter-to-quarter. Our Q2 earnings target is $1.75 to $2.15 per share. We expect Q2 share-based compensation expense of approximately $65 million to $67 million. Let me now review our updated fiscal year 2022 outlook. We expect fiscal year 2022 revenue growth in the range of 4.5% to 8%, reflecting a reduction of $30 million to $90 million to our prior fiscal year 2022 revenue guidance. The higher end of this range provides for the potential of some additional supplier decommits. It does not, however, assume another step-function deterioration from the level of decommit we have seen recently. We continue to be very confident in our software revenue growth range of 35% to 40% and expect to be closer to the top end of the range for the year. We also anticipate global services revenue growth of 1% to 2% for the year. Like other vendors, we have seen component costs and expedite fees escalate over the last year. As a result, in December, we announced we would be implementing a price increase of approximately 8% to our iSeries appliance platform effective February 1. We expect this pricing change will begin to positively impact gross margins in the second half of our fiscal year. We expect non-GAAP operating margin in the range of 29% to 31% for fiscal 2022, with Q2 representing the low point for the year, and operating margins improving in Q3 and Q4. We remain committed to regaining our target Rule of 40 operating benchmark, where the combination of our revenue growth and non-GAAP operating margins total 40. We also remain committed to repurchasing $500 million in shares during fiscal year. With that, I will turn the call back over to François. François?

Thank you, Frank. In closing, I’ll note that we are making very good progress with our Volterra and Threat Stack integration, and you will be hearing more about our resulting SaaS-based solution offering very soon. We are laser-focused on doing everything in our power to mitigate supply chain impacts for our customers. Our future growth and our long-term opportunity will be driven by our software and our imminently launching Software-as-a-Service app security and delivery solutions. While we are solely disappointed that supply chain challenges have gated our ability to fulfill customer demand for systems in the near term, we are more confident than ever in our position, our strategy, and our long-term opportunity. Our Q2 pipeline is strong, and we have good visibility into demand for the back half of our fiscal year. Our customers are faced with ever-increasing performance expectations for their applications while at the same time, scaling to meet unprecedented demand and evolving their architectures to enable production-scale container-based infrastructures. With our adaptive applications vision and our ability to serve any app anywhere, F5 brings cloud-ready solutions that close the gap between customers’ traditional and modern application environments. Finally, I extend my heartfelt thanks to the entire F5 team for their steadfast focus and execution. And thanks to our customers and our partners for being on our journey with us and providing guidance and support along the way. With that, operator, we will open the call to Q&A.

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?

Hey, Jim. It’s François, and I’ll take your first question. 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 on 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. We’ve been talking about for several quarters that 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 grew so much during the year. Things have been getting worse. At the beginning of our fiscal year, when we were doing the planning for this year, we actually took into account the number of decommits that we were getting from various suppliers and a situation that was already very tight on a number of components. Over the last 30 days, though, we have seen a step-function decline in the state of component availability from a number of suppliers. And that’s what’s caused us to revisit the view for the year and see that we wouldn’t be able to even ship the systems that we have planned to ship for the full year. To just give you a sense, Jim, the number of decommits, so we’re now seeing over 400 decommits per quarter. And we were running about 30% less than that even just a month ago. So we are – the situation is quite unprecedented. We are doing a number of things to mitigate these supply issues, working with our suppliers, of course, on escalations and allocations of supply to F5. We will be working on shifting some of our demand to – we’ve introduced new hardware platforms that are just starting to ship recently and utilize more readily available components. So we’ll be working to shift some of the demand we have to these newer hardware platforms. And we have a number of mitigation elements in place to improve the situation, but the supply chain is absolutely tight. The other thing that has changed in the last 30 days relative to where we were before is that we have been going to not just our suppliers but also when we couldn’t get the supply, we have been going to secondary markets, so on the open market through brokers to get part of our supply. And that avenue has dried up really in the last several weeks because I think everybody is in the same situation and going through that. So those are some of the changes that have happened in the supply recently.

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 your 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.

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 to six quarters. However, 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 chipsets. The lack of supplier roles 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 chipsets 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 relates 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.

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 from the 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. 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 specifically to hardware? And then, thank you, that would be great.

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 sort of pre-2021. As our lead times got worse in 2021, they extended to four to five weeks. 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 in the range of six to 18 weeks depending on the platform and the specific product that a customer is ordering. While these lead times are, of course, worse than we’ve ever had them, they’re still in the zone of kind of 4 to 4.5 months at the high end, which other vendors around the industry can confirm, and you’ll find that those lead times are not worse than anybody else. And I think our customers have adjusted to having longer planning cycles for the environment that they’re building. So we are not seeing customers as a result of extended lead times start to completely rethink their architectures. I think if our lead times were to become 12 months or more, we would see a much different behavior. We don’t see that and we don’t expect that even with the challenges that we’re having at the moment shipping to customers. So that’s on the first part of your question, Sami. On the software question, we did indeed have a very strong software quarter. The three drivers of growth in software as part of our strategy are essentially all going to plan. Let me start with the first part. We have seen broad-based strength in enterprise for software for BIG-IP. Specifically, I would say financial services and service providers were strong this quarter. We also saw kind of more resumption of customers who wanted to move to software and had put that a little bit on pause in the first quarters of the pandemic. We’re seeing more of those customers moving with their migration to software-first architectures, even for traditional applications. This is helping with very strong second term renewals and true forwards for our multiyear subscription agreements. The second aspect is modern applications, which we largely support with NGINX. We did over 500 deals with NGINX this quarter, which is a record. We’re continuing to see the size – the average size of deals increase, because of the additional products we have released as part of NGINX. We are also seeing a lot of applications that are in Kubernetes environments go into production and scale. Customers are realizing that their networking and security issues associated with Kubernetes are pretty challenging. NGINX is really the ideal complement to Kubernetes to address these challenges. We’re seeing a lot of traction in these deployments. The third driver is security. Security continues to grow faster than our overall product revenue. This quarter, we saw strength in security across the entire portfolio, with increased adoption of our web application firewall. The Log4j vulnerability brought awareness to numerous customers, either without a WAF or whose WAF hadn’t been activated to protect their perimeter. Those with a WAF in place were able to protect their perimeter and gained more time to patch their infrastructure. We also see more customers moving beyond web application firewall and adding Anti-Bot and API security as a bundle. We continue to catch up with NGINX Security. Shape had a strong order. We probably had our best quarter in terms of new logo acquisition, starting to see broader-based adoption in new segments like service providers and also internationally, partly because of product maturity and partly because of market maturity. We’re also seeing traction with cloud marketplaces, completing the integration of Shape into Salesforce.com e-commerce platform, making both technologies visible to all players in that marketplace alongside other integrations we're initiating with cloud providers. When you consider all three drivers of software, we truly had strong momentum and execution, and we are pleased with where we are on software.

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 heard you talk about the two different component challenges you have, but your March quarter guidance, I think if I take it at the midpoint implies in the first half, you’ll grow 3.7%, and then to hit a full-year guide, you’d almost have to grow high single-digits in the back half of the year, June and September. Am I doing this correctly? And I guess why the confidence that growth will snap back so quickly in the June and September quarters for you folks?

Sure, Amit, why don’t I start with that one and then see if François has anything to add? I think François, I’ll try to articulate the difference of the near-term challenges we’re having in Q2 and some 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. So it’s more acute because of just the timing of when we realized 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 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 – we will have the 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 for the full year would imply that your software growth will decelerate as you compare start to get easier. That seems a little counterintuitive. 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?

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. What you should take away from our sense is that we really like what we’re doing on software, and we think it’s going to be a very good software year.

Thanks. So, I wanted to ask a broad general question about the behavior of enterprises' purchasing approach, given the intense pricing pressure and supply constraints around hardware. As you’ve talked to CIOs, CTOs, C-suite-type people, has it resulted in a change in behavior where we’re seeing an acceleration in commitments to digital transformations? I think just let their prices, kicked their prices up again this month. System prices are up double-digit, and we’re forcing people into subscriptions around those hardware. A lot of people, I would think, are increasingly wanting to get away from that. Can you address what you’re hearing from the C-suite on those thoughts about changing their behavior in a more tidy fashion?

Hi Alex, I would first 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 types of behaviors. In some cases, you are seeing suppliers in the semiconductor space who are taking advantage of that to some extent. We believe this is a short-term approach that may have some benefits but in the long-term, it’s detrimental to relationships. 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. As we think about how we balance cost pressures with price increases, we are looking through the lens of maintaining strong relationships with our customers long-term. 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 has unique solutions that cannot be replaced like-for-like by something else. We are getting increasing pressure from customers to 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?

Alex, I would not say that we are intentionally moving away from the service provider space. We have had very strong demand in the enterprise over the last five to six quarters. While the overall mix of service provider business has decreased, our service provider business itself has been growing steadily over the past several quarters, including the last quarter. We see great opportunities in both hardware and software with reliable service providers, and we anticipate some significant deals in the coming quarters. We are actively investing in the service provider sector for both our existing platforms and Volterra, which is also likely to be of strong interest to our providers. There are increasing opportunities in the IoT sector with service providers, which often need to handle tens of millions of devices, and that scale is achieved through hardware. We continue to invest in our service provider segment. I see how you could interpret our mix in that way. While the service provider segment has been at 15% for the last few quarters, it is growing alongside the rest of the business, with promising prospects ahead.

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.

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 $140 million this quarter?

Rod, it’s in the ballpark on 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 add roughly 10%, 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 the 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?

Rod, it’s a great question. First, I want to remind you that the opportunity to substitute hardware for software is really in our BIG-IP platform. The drivers of software growth are across the entire portfolio. The first thing you have to remember here is that the behavior of our customers as it relates to hardware hasn’t changed. The hardware demand continues to be strong. We saw broad-based demand in the enterprise on systems. Security use cases continue to drive systems demand, and we see existing security customers expanding their F5 security footprints in hardware. Depending on application growth, traditional application growth also continues, and therefore, our hardware demand to support those applications remains very strong. The issue we have is the supply problem. The second reason you’re not seeing a big substitution effect is our lead times are not long enough to completely change purchasing decisions. However, I think our lead times would have to really extend well beyond six months for just a lead time factor to cause our customers to really change and look at software. Now, we are working with customers to shift demand to our software if our lead times get much worse, but we don’t expect that will shift multiple tens of millions of dollars from one consumption factor to the other.

Great. Thank you. I just wanted to get a sense – you noted kind of the shortages you’re seeing, which are two-pronged, both on the specialized chips and the more standardized components. Just wanted to get a sense of whether the deterioration you saw was more severe in one or the other in the quarter? And just what guidance kind of implies the top and 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 networking peers kind of build inventory pretty significantly or attempt to build inventories significantly over the course of the last year. Just as we move forward, getting out of this kind of change, what are your thoughts on inventory stocking going forward? Thanks.

Yes, Meta just a couple of – let me start with the last part of your question. We have been buying components with extraordinarily long lead times. Some of the components that were committed at the very beginning of the calendar year for us were ordered more than 52 weeks ago. We have several hundred components today that have more than two years of lead time. We have been getting ahead of us for the last 18 months, making very strong advanced buys in anticipation of issues getting commitments from suppliers that have, in some cases, after 52 weeks of waiting, come back and said they can't meet expectations. Now to your question regarding whether one issue is more severe than the other. I think there are two dynamics. The first issue, which is the specialized networking chipsets from the large specialized chip manufacturers, that issue is going to take a while to improve. It’s about wafer capacity and more capacity coming online for us to get the products we need. This is what’s driving the $30 million to $90 million reduction. To be clear, we haven’t assumed another step-function deterioration from our current levels. Regarding the second, in-quarter issue of Q2 with standard components, this really is – it’s dependent on the acute timing of a couple of parts that were significant. We will qualify alternatives available in the market, and will recover starting in Q3, but we’re simply unable to ship due to timing.

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, and 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 is obviously 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. 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 is to be determined 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 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 deal wins 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?

So the true forwards are somewhat weighted towards the back half due to the second term of the multiyear subscription agreements, resetting the revenue recognition cycle.

I appreciate you 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 guidance reflects your view on when the new supply from those new fabs will come online. That hasn’t changed over the last 90 days, right? You didn’t expect to benefit from those coming online earlier than you now expect? Or what changed with the decommits from your current suppliers, the specialized or core 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, if they’re not shifting orders for hardware, then you’re 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 your prior guidance — that’s sort of basic math, isn’t it?

Pretty much. I mean, forecasting backlog exactly is probably not feasible. But yes, our backlog will increase by multiple tens of millions of dollars starting this quarter 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 lack of visibility and confidence as to additional decommitments? 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?

Well, that’s a great question. And look, absent the significant supply chain challenges, you would have probably seen a range closer to about $20 million, and the range is now twice that for two reasons, both related to supply. The first is that decommit in standard components – our teams are sort of working 24/7 to qualify and design alternatives to those parts. 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 to ship before the end of March to the customers. So there is added uncertainty that comes from that. The other 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 also adds to that uncertainty.