F5 Inc (FFIV) — Q3 2024 Earnings Call Transcript

Hello and welcome. I am Suzanne DuLong, F5's Vice President of Investor Relations. Francois 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 here 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 A copy of today's press release is available on our website at f5.com, where an archived version of today's audio will be available through, October 28, 2024. We will post the slide deck accompanying today's webcast to our IR site at the conclusion of our call. To access the replay of today's webcast by phone, dial 877-660-6853 or 201-612-7415 and use meeting ID 13747602. The telephonic replay will be available through midnight Pacific Time, July 30, 2024. 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. 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 today's 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 F5 has no duty to update any information presented in this call. With that, I will turn the call over to Francois.

Thank you, Suzanne, and hello, everyone. Thank you for joining us today. I will speak to our Q3 highlights as well as our expectations for Q4. Frank will then review the details of our Q3 results and provide additional color on our outlook. We delivered Q3 revenue of $695 million, which is at the top end of our revenue guidance range. We also delivered non-GAAP EPS of $3.36. This is well above the top end of our guidance as a result of our continued operating discipline as well as some tax favorability in the quarter. Total software revenue grew 3% year-over-year and 13% sequentially. Our continued strong software renewals provide an indicator of both customer satisfaction and our momentum overall. In a positive shift from last quarter, during Q3, new software revenue also contributed to software growth in the quarter. Global services grew 3% in Q3. The combination of software and global services growth largely offset systems revenue, which was $130 million, down 16% year-over-year. During Q3, we started to see some areas of improving demand after a prolonged period of budget scrutiny, evidenced by improving pipeline and close rates. As a result, our team drove strong bookings growth in Q3, including an uptick in new business. Factoring in these signals, we expect Q4 revenue in the range of $720 million to $740 million, which puts us on track to deliver toward the top end of our FY '24 revenue guidance. Our outlook is informed by three considerations: one, our growing pipeline; two, our visibility into software renewals; and three, the continued strong expansion trends from customers. We expect FY '24 revenue of approximately $2.8 billion, roughly flat with FY '23. This is despite the roughly $180 million systems backlog headwind we have had to overcome this year. Given the strong performance from software thus far this year and the good visibility we have into Q4, we now expect mid-to-high single-digit software revenue growth for the year. This is up from our prior characterization of flat to modest growth. We also expect continued operating discipline, combined with the tax favorability we saw in Q3, will enable us to achieve FY '24 non-GAAP EPS growth of approximately 12%. This is up from our prior range of 7% to 9% growth. Before Frank discusses our results and outlook in greater detail, I will recap how F5 is solving our customers' hybrid multi-cloud challenges, what we call the ball of fire by highlighting some notable customer wins from the quarter. The current state of application security and delivery for large enterprises has our customers' IT teams in crisis. They are battling increasing complexity, cost, and risks simultaneously and AI-driven applications are only making these challenges more pronounced. Only F5 can truly support the demands of today's hybrid multi-cloud application infrastructures. We are the only solution provider that secures, delivers, and optimizes any app or any API anywhere. We are highly differentiated in addressing customers' pain points in several ways. First, app security. F5 delivers the most effective and comprehensive app and API security platform in the industry. We enable our customers to consolidate point products targeting specific threats onto a single integrated platform with a suite of best-in-class capabilities and no efficacy trade-offs. Second, simplification. F5 enables the hybrid multi-cloud flexibility our customers' businesses demand with the simplicity their IT operations require. Only F5 has a solution footprint that extends across public clouds to the edge and customers' on-premises environments. Our solutions simplify connecting disparate infrastructure environments and the applications deployed in and across them. In short, we are on a mission to make hybrid multi-cloud ridiculously easy. And third, standardization and automation. F5 delivers more cost-effective and scalable IT operations. We streamline customers' operations with consistent policies, comprehensive automation, and rich analytics. This enables customers to consolidate vendors and tool sets, rationalize operational silos, and automate lifecycle management of their on-premises deployments. These three points of strong differentiation combined with the well-established role F5 plays embedded in the flow of application traffic enables us to extinguish the ball of fire for our customers in ways our competitors cannot. Let me review a few customer wins from Q3 that illustrate how F5 is differentiated and how our capabilities are delivering value for our customers. The first two customer examples I will speak to highlight our application and API security capabilities. During Q3, a US-based security products and services company launched an effort to modernize its IT infrastructure. Specifically, the customer was looking to expand beyond hardware to a hybrid cloud and SaaS-based IT and security infrastructure. The customer was an existing BIG-IP customer and selected F5 Distributed Cloud services to complement its BIG-IP estate, creating a scalable, self-managed cloud and SaaS-based solution. F5's portfolio of hardware, software, and SaaS deployment options deliver standardized application and API security across their multi-cloud and hybrid environments, enabling them to modernize at their own pace. Also during the quarter, a channel partner brought in F5 when a US state government experienced a DDoS attack that brought down its servers. We quickly completed a successful emergency mitigation and deployed a suite of F5 solutions by our Distributed Cloud services. When the threat actor changed tactics and launched application layer attacks, F5's operations team quickly activated WAF and bot defense and stopped them. As a result of F5's performance under pressure, the customer is moving additional services to F5, including their DNS and other web and application properties. Before I move on to our next point of differentiation, I will take a minute to highlight that our continued innovation and industry-leading security performance is winning accolades from industry experts as well as customers. During the quarter, F5 was recognized as an application security leader by several independent parties. First, F5 is rated as a leader in both security efficacy and operational efficiency in SecureIQLab's 2024 Cloud WAAP CyberRisk Validation Report. F5 Distributed Cloud WAF earns SecureIQLab's Secure by Design rating, passing the WAF vulnerability assessment with a perfect score. In addition, Enterprise Management Associates singled out F5 as a visionary in API security for our Distributed Cloud Web App and API protection or WAAP capabilities. In its Vendor Vision 2024 report, F5 is lauded for its holistic approach to API and application security, eliminating the need for customers to pay for and manage disparate API security solutions. And finally, KuppingerCole recognized F5 as a leader in the web application firewall market, spotlighting F5 as a forerunner that is setting the bar for excellence in cybersecurity defenses. The next two customer wins I will highlight exemplify how F5 is enabling the hybrid multi-cloud flexibility our customers' businesses demand with the simplicity their IT operations require. They both also happen to be examples of our continued momentum against competitors. During the quarter, a U.S.-based technology company that delivers a web and video collaboration platform selected F5 to replace its incumbent ADC provider. The customer will use BIG-IP, including WAF and DNS capabilities to consolidate and standardize their infrastructure across their on-premises and third-party data centers. F5 was selected because of our software and hardware deployment options, the efficacy of our advanced WAF, and our flexible commercial models. I will note that this also was a land and expand win. In 2020, we displaced a competitor for DDoS protection. In another example from the quarter, the large APAC-based travel agency selected F5 Distributed Cloud to enable it to address multiple challenges simultaneously. Initially, the customer was looking to streamline app delivery through a single abstract layer. In the process of proving its capabilities for this use case, F5 Distributed Cloud outperformed the incumbent security provider. As a result, the customer consolidated on F5, enabling them to stage application migration to new data centers while minimizing disruption and risk. In addition, Distributed Cloud's SaaS console and comprehensive observability features drastically reduced operational overhead for the customer. The final two customer wins I will speak to highlight how we streamlined customers' operations with consistent policies, comprehensive automation, and rich analytics. During Q3, our team secured a large land and expand deal that was 18 months in the making. The customer is a global retail and investment bank with an extensive branch network. Banking regulations require them to separate segments of their IT environments. To accomplish this, they are building a new virtualized network to run in parallel to their existing environment. They selected BIG-IP software to augment their existing BIG-IP footprint. They also upgraded to NGINX Plus from open source. BIG-IP's automation capabilities enable them to implement automation best practices across the board, saving time and reducing the potential for human error. They are now able to operationalize multiple BIG-IPs in just 20 to 30 minutes versus the days or in some cases, even weeks required previously. In addition, NGINX Plus delivers reliable and secure access to their Kubernetes applications and enables a consistent security posture across all of their application environments. The final example from the quarter I will highlight is with a global automotive company. This customer is an existing BIG-IP customer who is renewing and expanding their BIG-IP subscription for the second time. The customer is leveraging BIG-IP's automation capabilities to enable self-service application delivery and security services in seconds compared to the weeks or months it took previously. BIG-IP has significantly accelerated this customer's time-to-market for both internal and external customers. The value of BIG-IP's automation capabilities is so significant to them that their consumption has doubled with each renewal. Before I pass the call to Frank, I will close with some brief commentary about how we are enabling AI, shaping the AI revolution, and working with customers to ensure they are AI-ready. During Q3, we continued to engage with several of our major customers focusing on their AI initiatives and collaborating to address their critical AI-related challenges. Two pivotal trends have emerged from these interactions. First, the largest organizations that are building AI factories are starting to recognize that high-performance networking and security are non-negotiable for both model training and inference. Second, organizations that are using foundational AI models for inference use APIs extensively. This use case also demands top-tier performance and robust security. In both scenarios, whether constructing AI factories for model training or executing inference, F5's leading ADC platform and our distinctive capabilities in application security and delivery will have an important role to play. We are seeing and winning early AI use cases. As an example, a global automotive company selected F5 BIG-IP to rapidly and securely transfer data from data storage systems to large-scale clusters, significantly accelerating their model training process. For retrieval augmented generation use cases like this, our solutions are optimizing the performance of AI models as they access and incorporate external data sources in real-time. Separate from this customer, our entire product family is being utilized by other customers to load balance and protect AI-related API traffic. In the AI era, all communication is happening via APIs, which are increasingly distributed, running on-premises in private clouds and across multiple public clouds. F5's Distributed Cloud services is an ideal solution for organizations needing consistent management and security for their distributed AI APIs. Leveraging our long-standing partnerships with semiconductor leaders, we also are strategically positioned to advance these relationships in the AI era. Our approach remains technology agnostic, focusing on solving real-world practical AI challenges for customers. Realistically, we expect we are probably one to two years out from enterprises deploying AI in production at scale. Importantly though, F5 is not just adapting to the AI revolution; we are actively shaping it, providing the critical infrastructure that enables our customers to harness the full potential of AI safely and efficiently. Now, I will turn the call to Frank.

Thank you, Francois, and good afternoon, everyone. I will review our Q3 results before I elaborate on our Q4 outlook. We delivered Q3 revenue of $695 million with a mix of 56% global services and 44% product revenue. Global services revenue of $387 million grew 3%, in line with our expectations, which reflected lapping the benefit of prior price increases. Product revenue totaled $308 million, down 6% year-over-year due to a lower level of backlog-related systems shipments than a year ago quarter. Systems revenue of $130 million demonstrates a slowing decline of 16% year-over-year. Software revenue totaled $179 million, representing 3% year-over-year growth and 13% sequential growth. Subscription-based revenue contributed $155 million or 87% of total software revenue, representing 2% growth year-over-year and 10% sequential growth. Subscription renewals remained strong in Q3 with continued solid expansion in our multi-year agreements. An exception to this trend is our Bot Defense point solution where the majority of customers are renewing, but some are opting for less sophisticated lower-cost options. Rounding out our software revenue, perpetual software contributed $24 million. Revenue from recurring sources contributed 77% of Q3's revenue, up from 75% a year ago. Recurring revenue includes the subscription-based revenue as well as the maintenance portion of our global services revenue. On a regional basis, revenue from Americas was down 4% year-over-year, representing 55% of total revenue. EMEA delivered a strong quarter with 5% growth representing 27% of revenue. APAC declined 1%, representing 18% of revenue. Looking at our major verticals, enterprise customers delivered another strong performance, representing 67% of product bookings in the quarter. Government customers also performed well representing 21% of product bookings, including 7% from US Federal. Finally, service providers represented 12% of Q3 product bookings. Our Q3 operating results were strong, reflecting our continued operating discipline. GAAP gross margin was 80.4%. Non-GAAP gross margin was 83.1%, an improvement of approximately 65 basis points from Q3 in FY '23. Our GAAP operating expenses were $396 million. Our non-GAAP operating expenses were $346 million. Our GAAP operating margin was 23.4%. Our non-GAAP operating margin was 33.4%, reflecting an improvement of approximately 20 basis points from Q3 of FY '23. Our GAAP effective tax rate for the quarter was 16%. Our non-GAAP effective tax rate was 17.5%. Similar to Q3 of last year, the lower-than-expected tax rate reflects a non-recurring benefit associated with filing our annual federal income tax return during the quarter. Our GAAP net income for the quarter was $144 million or $2.44 per share. Our non-GAAP net income was $199 million or $3.36 per share. I will now turn to cash flow and the balance sheet, which also remained very strong. We generated $159 million in cash flow from operations in Q3. CapEx was $6 million. DSO for the quarter was 54 days, in line with 51 days in Q2. Cash and investments totaled approximately $943 million at quarter end. Deferred revenue was $1.77 billion, down 1% from the year-ago period. The change is due to a higher weighting of our sales to term-based subscriptions and a corresponding lower allocation of bookings to deferred revenue. In addition, we are lapping price increases on maintenance renewals. We also have implemented some strategic go-to-market decisions, including no longer incentivizing customers towards multi-year maintenance agreements. Our share repurchases reflected our ongoing commitment to returning cash to shareholders. We repurchased $150 million worth of F5 shares in Q3 at an average price of $172 per share. Year-to-date, we have used approximately 77% of our free cash flow toward share repurchases, far in excess of our commitment to direct at least 50% of free cash flow toward share repurchases. Finally, we ended the quarter with approximately 6,500 employees. I will now speak to our outlook for Q4. We expect Q4 revenue in the range of $720 million to $740 million on the strength of our software renewals and a slight uptick in new business momentum. We expect non-GAAP gross margins of approximately 83%. We estimate Q4 non-GAAP operating expenses of $350 million to $362 million. We are targeting Q4 non-GAAP EPS in the range of $3.38 to $3.50 per share. We expect Q4 share-based compensation expense of approximately $54 million to $56 million. Our Q4 guidance implies some positive updates to our prior outlook for FY '24. We expect approximately $2.8 billion in revenue for the year. Embedded in this is the expectation for mid-to-high single-digit software revenue growth, up from the flat to modest growth expectation we had at the start of the year. We now expect our FY '24 non-GAAP effective tax rate will be in the range of 19.5% to 20%, down from our prior range of 20% to 22%. With the combination of revenue growth, continued operational discipline, and a tax rate that is improving compared to our prior expectations, we now expect FY '24 non-GAAP EPS growth of approximately 12%. This is up from our prior expectations of 7% to 9% growth. We are not revising our gross or operating margin targets for FY '24 and continue to expect non-GAAP gross margins in the range of 82% to 83%, which would reflect an improvement of 50 basis points to 150 basis points from FY '23. We also continue to expect non-GAAP operating margin in the range of 33% to 34%, which would reflect an improvement of 280 basis points to 380 basis points from FY '23. Before I pass the call back to Francois, I wanted to share some personal news. I've made the decision to retire from F5. I joined F5 in 2018 to help the team navigate a massive transition from a hardware-led company to one that was more software-led. Delivering our Q4 guidance will make FY '24, the third consecutive year where software revenue is the majority of our product revenue, signaling that we have in fact successfully completed that transition. I plan to remain with the team as CFO through the filing of our FY '24 10-K likely in mid-November. Cooper Werner, who is currently our SVP of Finance, is slated to take over as CFO upon my departure. Many of you know Cooper well. He has been with F5 for 23 years, during which he has consistently taken on new responsibilities as F5 has grown and changed. He has been SVP of Finance for the last 12 years, managing our FP&A, real estate procurement, and trade organizations. His extensive financial expertise and institutional knowledge have been pivotal in guiding our business model as we have executed our software transformation. Cooper is a strong and engaging leader and we expect him to be a great addition to the executive leadership team. I will continue to work with the team between now and November to ensure a smooth transition. With that, I'll pass the call back to Francois.

Thank you, Frank. I truly cannot thank you enough for your partnership and counsel over the last six years. You have been an integral part of our executive leadership team with an immeasurable impact on F5. Your deep knowledge of software and SaaS-led businesses was instrumental to F5's successful transition to a software-led company. You have been a tireless advocate for F5, our business, and our employees and an extraordinary partner and friend. I know it's not goodbye at this point, but I really want to thank you here and now. I will also echo your comments about Cooper. I have worked very closely with Cooper in my tenure at F5 and have enormous confidence in his ability to succeed you in the CFO role. In conclusion, I will reiterate that F5 is uniquely positioned to help our customers as they move forward in a hybrid and multi-cloud reality that brings with it untenable operational complexity, considerable cost, and escalating security risks. As large enterprises across the globe are modernizing their IT infrastructures and driving IT cost optimization, they also are developing comprehensive AI strategies for their businesses. F5 is proving itself an invaluable partner in this modernization process and in enabling our customers to ready their IT infrastructure to leverage AI at scale. F5 is optimizing application security, delivery, management, and performance across hybrid, multi-cloud environments with enhanced automation and meaningful operational efficiencies. Going forward, and especially as we enter the era of AI-driven applications. We believe customers will require a hybrid SaaS platform that covers all of their app security and delivery needs regardless of form factor. This is the world we have invested for and as customers gain more confidence in their IT budgets and priorities, we believe we are well-positioned to capture our share of their spend. Operator, please open the call to questions.

Thank you. Congratulations and best of luck, Frank, and Cooper, congratulations on the new role. I wanted to discuss the software side with either Frank or Francois. I know you typically don't share all the specifics, but the sequential growth appears surprisingly strong this quarter. Can you provide insights into what drove the impressive new business, and is it possible to quantify that? Regarding renewals, are these stronger true forwards? Is there better dollar retention? How should we, at a high level, interpret the two aspects of what's improving in software right now? Additionally, I have a follow-up regarding hardware.

Sure, Tim. Thank you for the kind wishes and for your question. Yes, Cooper is going to excel in the role. Regarding the software, as you know, we will provide updates on some of the ARR metrics at the end of Q4, so I won't go into too much detail on that. However, I can say that our NRR remains outstanding across the business. The subscription renewals are particularly strong, and we’re seeing some expansion there. We did mention some challenges in the bot business, which is affecting those numbers slightly. The standout factor has been the new business activity, which we observe in our pipeline; in some cases, we see hardware deals transitioning into software deals during negotiations. Overall, the guidance we provided was based on not expecting much new business activity, yet we ended the quarter at the top end of our guidance, suggesting an increase in new business activity.

Okay, great. And then just quickly on hardware. I know is still a challenge, but it does seem like other pockets of networking are starting to see a bottom. How do you feel about where we are at these levels given that most of the backlog comparison is hopefully behind you?

Hi Tim, it's Francois. I believe we have observed hardware stabilize over recent quarters as customers have managed their inventory. Many customers are still optimizing their assets in the current macro environment, but we are beginning to see a shift. For this year, we are at the levels we expect, but looking ahead to next year, the demand signals for hardware appear promising. We anticipate that hardware will not decline next year and may even increase compared to this year. Several factors contribute to this, including a robust pipeline of technology refresh activity from customers who have managed their inventory or can no longer optimize their assets. We are noticing strong close rates in this pipeline, particularly in the service provider sector, where significant programs for capital expenditure on hardware are emerging. Additionally, artificial intelligence is becoming a driving force for hardware demand, especially among large enterprises or service providers that are constructing substantial AI infrastructures. One key challenge in creating these large GPU clusters is the expense associated with training models. Our technology, particularly the high-capacity and high-performance traffic management solution BIG-IP, is ideally positioned to enhance the efficiency of these large AI operations and reduce their costs. We have already secured a few opportunities in this area, and while it will take time to develop, we see it as a promising catalyst for fiscal year 2025.

Okay. Thank you. Appreciate it.

Thank you, Tim.

Great. Thanks. Maybe to start following up on Tim's question, just in some of that better pipeline, is that Distributed Cloud, is that NGINX, clearly you're kind of talking about some of the systems upside, but just if any more kind of disclosures around what kind of the makeup of that better pipeline is? And then maybe as a second question, I know you noted better expansion as well. Is that coming from kind of new products or customers expanding in their product portfolio within F5 or higher volumes? Thanks.

Hi, Meta. So the comments I just made were specific to hardware where, in fact, we have seen a stronger pipeline of tech refresh. But generally, our pipeline has been strong and that applies as well to NGINX and Distributed Cloud. Where this come from, Meta, is we've talked about the ball of fire and you've heard this term, but generally, our enterprise customers are really in a crisis because to be able to deliver the digital experiences that they have to deliver, they have to operate in these hybrid and multi-cloud environments, and the complexity of these environments is escalating. So to give you an example, if you go back a year ago, we had about 20% of our customers that operated in more than six infrastructure environments and that has doubled in the last year to now 40% of our customers operating in these environments. And that creates a risk because of inconsistent security policies between this cloud and that cloud in this on-prem environment. It drives up operational cost, it forces them to use multiple vendors where they could use less vendors or consolidate on one. And all of these constitute this daunting complexity that we are on a mission to simplify. And so it's really the portfolio that we have put together with NGINX, Distributed Cloud and BIG-IP that creates effectively a single platform that can extinguish this ball of fire and really simplify hybrid and multi-cloud environments for our customers. In my prepared remarks also, I mentioned a couple of examples of that. We had a big security company that was using BIG-IP and used Distributed Cloud to augment their footprint and standardize their security across multiple environments, leveraging the portfolio of F5. So the pipeline that we're seeing across these product lines is really an effect of hybrid and multi-cloud complexity being very present for our customers and us having multiple products to really address that complexity and simplify the operations of our customers.

Great. Thank you.

Hey guys, thanks for the questions here and congrats to you, Frank, on retirement, and Cooper, on the promotion. Looking forward to working with you more, Cooper. Maybe not to pick on something you guys mentioned here, but on the Bot Manager side, Shape has been kind of problematic over the last year or so based on what you guys have said? I guess, what are you guys doing to try to change the trajectory of Bot Manager and how are you thinking about any potential security bundles between Bot Manager WAF and API security pieces, especially given you talked about customers looking at lower-cost alternatives?

Thank you, Jim. I'll address that. In our Bot Management solution, which is a premium managed service and a specific solution, we have encountered challenges because it is focused on the high end of the managed services spectrum. Most customers find significant value in the solution and continue to renew their subscriptions. However, some customers are looking for more affordable options and prefer having Bot as part of a broader platform bundle. Our approach is to transition that advanced Bot technology into our F5 Distributed Cloud platform. Now, Bot is integrated into our SaaS offering, and we are commercializing it as part of that bundle. We are seeing strong interest in this approach. For instance, our WAAP as a service customers, who purchase a bundle including WAF, Bot, API security, and DDoS, have doubled in number over the last year. These customers are leveraging our platform and its offerings. This marks a shift from a high-end point solution to one that is integrated into a platform and bundle, which aligns with our customers' preferences.

Got it. And Frank, for you, one of the questions I'm getting here after ours is around you guys talked about raising fiscal Q4 kind of outlook. Last quarter, you guys kind of gave some color around fiscal '25. So growth rate goes up this year, should we continue to expect the dollar numbers that you outlined last time as kind of a good proxy for fiscal '25 at this point or are you still feeling confident in those growth rates on higher numbers? Thanks, guys.

Yes, absolutely. I appreciate the question, Jim. So look, we'll have more to say in October about FY '25. We're not updating anything as of now for FY '25. My starting point would still be go back to what I said in October of a mid-single-digit growth off of a flat-to-low single-digit FY '24. And you'll probably triangulate around to the number where we are. We are still in the process of our FY '25 planning process. What we absolutely will do is deliver 35% operating margin off of that revenue number. And that is largely based off of the confidence that we've got in the subscription renewals and how they are playing out. The one thing that I'd probably add is if you take a look as I just want to make sure there's no confusion as we look ahead into next year versus maybe what happened in this quarter, we do expect more of that growth to come in the back half of FY '25 because of just where we see the subscription renewals and the larger ones really happening in the back half of '25. And so I would expect the first half to be relatively flat, maybe slightly up depending on what happens with some of the new business activity and if that momentum continues. But more of that growth is going to come in the back half of FY '25 of what we did in FY '24. So I just want to directionally give you that's the way we're thinking about the business.

Helpful. Congrats again on retirement, Frank.

Thanks so much. I appreciate it, Jim.

Hey, good afternoon. Thanks for the question. I just have two. First on software. I was wondering if you could comment on how the potential headwinds related to the retirement of the legacy SaaS businesses and migration of Silverline to DCS has gone relative to expectations. I was just wondering if you could update us, I think previously you had said an up to $65 million headwind there. And then second, in your prepared remarks, you talked about no longer incentivizing customers toward multi-year maintenance. I was wondering if you could just provide a little bit of additional color on why there's a good market change there. Thank you very much.

Yes, I'll begin by addressing the transition in the SaaS business. Progress is going as we anticipated. We currently have approximately $65 million in legacy revenue within the $200 million annual recurring revenue we mentioned in October. Some of this comes from products we've retired, and some is services we plan to migrate to our Distributed Cloud platform. These migrations have begun, and while we are still in the early stages of this two-year journey, things are mostly on track. In our Bot Manager business, we are experiencing some churn at the high end, as some customers are renewing while others are opting for lower-end or platform-based solutions. Conversely, our SaaS platform on Distributed Cloud is experiencing strong growth and new customer adoption, fueled by our comprehensive bundle of offerings. I previously mentioned WAAP as an outstanding product, and our traction is also being driven by our API security solutions. Securing APIs is increasingly challenging for enterprises, and this will grow in significance due to the advancements in AI. We have been gaining substantial traction here because we offer the most comprehensive API security solution, which includes code scanning, comprehensive discovery of APIs, and protection. This solution significantly reduces the time spent on manual testing and analysis through automation. Year-on-year, we have seen the number of API customers triple since last year. These are the trends shaping our SaaS and managed services business.

Regarding maintenance, this pertains to our ongoing hardware and software services. Our global service organization is exceptional and has consistently fostered strong customer relationships, leading to very high attach rates for these products over an extended period. Over time, we typically offer discounts for these services upfront and aim to recoup some of that discount during each renewal cycle. We have observed that due to our impressive attach rates, the quality of service we provide, and our ability to generate cash flow, we do not require three years of upfront cash to retain customers. The service and product naturally maintain those customer relationships. Consequently, we have reduced the need to incentivize with higher discounts and multi-year maintenance agreements. This summarizes the deferred revenue related to our services business.

Great. Thanks, Francois. Thanks, Frank.

Yes, sure, Mike.

Thank you.

Great. Thanks. First off, let me congratulate the two people involved in these changes. Frank, it's wonderful working with you, and I look forward to collaborating more with Cooper, who has been fantastic over the years. My first question is regarding any changes in sales staffing levels. Have you noticed any increase in poaching by competitors? There has been some talk about a couple of your competitors making management changes, pulling some strong salespeople from F5. Is that true or not? My second question relates to the broader environment. As we consider the focus on efficiency and extend Zuck's comment over multiple years, it seems that trend is winding down. Are we beginning to see stability in the application space, with applications starting to grow again? Can we use that as a directional indicator for F5's outlook? For example, if we observe strong sales or application growth within cloud companies, does that suggest a positive outlook for you?

Hi, Alex. Let me address your two questions. First, regarding our sales and staffing levels, our sales team has significantly lower attrition than the industry average, which can be attributed to the strong culture and leadership we have at F5. I'm extremely proud of our sales team, the relationships we've built with large enterprise customers, and how effectively they serve our customers. It's encouraging that competitors are interested in hiring our talent, but recreating our enterprise go-to-market strategy, developed over more than 20 years, is a much larger challenge than just a few new hires. We have a robust network of thousands of channel partners who actively promote F5 and foster customer relationships. Therefore, I feel very confident about our go-to-market organization and our ability to attract and retain top sales talent. Now, about your second question regarding F5's outlook, it is indeed quite positive. The trend you mentioned concerning customers' application rationalization is beneficial for us because our business depends on the number, complexity, and distribution of applications. We've observed that customers are increasingly placing their applications across various infrastructure environments; I noted earlier that around 40% of organizations operate in more than six different environments. While this offers customers flexibility, it also introduces significant complexity. We have developed the only platform in the industry capable of securing, delivering, and optimizing any applications or APIs regardless of their location. We are truly the only infrastructure-agnostic provider in the market for application security and delivery. This trend of application distribution, which will be accelerated by AI, presents a major opportunity for us. AI introduces the challenge of data gravity, meaning models need to be close to where the data resides. Consequently, we're seeing an increase in the distribution of applications and components related to AI. This dynamic aligns perfectly with F5's capabilities in addressing these complex challenges.

Great. Thanks for the clarity.

Thanks for taking the question. First, Frank and Cooper, congratulations on the job switching. Best of luck to both of you. First of all, this might be a tricky question for you to answer, but one of the anecdotes we've picked up is regarding Broadcom's price adjustments on VMware, and the thought was that this was affecting your business because it was perhaps shifting budgets for your customers. Now clearly, you put up a very strong software number this quarter. And I'm wondering if this is either despite what's happening with the VMware pricing or if there's some other explanation and maybe this number would be even better if not for that.

I believe you have a point based on some anecdotal evidence. I've heard from a few customers that, in the short term, they have adjusted their budgets due to the price increases related to VMware and Broadcom. However, I haven't observed this as a widespread trend among a large number of customers. I think it's a temporary reaction to the current situation, and I expect things to stabilize in the future. This is my only support for the anecdote you mentioned.

Great. As a follow-up, regarding your perspective on the opportunities related to enterprise adoption of AI, do you anticipate that your prospects will align with traditional server sales? I assume that in the case of GPU clusters, NVIDIA manages its own internal load balancing, which may not apply to your situation. I wanted to confirm that. Thank you.

If you look at the big trends emerging in AI, there are two main concerns: cost and security. Regarding costs, some digital innovators are building large AI factories and investing heavily in GPU clusters, but they face challenges with utilizing these GPUs effectively. Our high-capacity data ingestion and load balancing solutions can enhance the efficiency of these AI factories by balancing traffic across multiple AI clusters, which helps lower the cost per query for these infrastructures. This presents an immediate opportunity with our existing products for companies developing such factories. Long term, the opportunity will extend to all businesses looking to implement AI and perform inference in their environments. A significant concern will be how to secure these AI models, and we believe that API security is crucial in safeguarding data and AI workloads. For this reason, we've made significant investments in API security and are already seeing a threefold increase in our API security customers year-over-year. While this growth hasn't been driven by AI yet, we anticipate that AI will play a major role in this area moving forward.

Perfect. Thank you.

Great. Thanks for taking my question. I just wanted to first echo the congratulations to both you, Frank and Cooper as well. My first question is really around the mix shift between software and hardware. It just seems like over the last few years, that mix shift to software has been maybe a little bit slower than expected with many customers preferring to stick to their hardware form factors. I'm just wondering as we enter a new upgrade cycle here in fiscal year '25, could something change? Could we see a more rapid shift to more software solutions this time around?

We discussed the dynamics of hardware and software and identified the catalysts for hardware in the coming year. It's important to emphasize that we do not impose a particular delivery model on our customers. Our role is to advise and assist them in making informed choices, allowing them to decide what works best for them. Unlike some SaaS providers that require large enterprises to change their business practices to adopt their solutions, we approach our customers on their terms. Whether they want to begin with hardware and then incorporate software, use a hybrid model, or implement SaaS for specific applications, we offer unmatched flexibility and choice in the industry. This sets us apart from traditional vendors that focus solely on hardware-software clients and from pure SaaS players that lack hardware-software consumption models. This approach aligns with the needs of large enterprises. Looking ahead, while we have promising expectations for hardware, we also anticipate continued growth in software, aiming to return to double-digit growth next year. Ultimately, the critical factor for our customers is the integration of both hardware and software to address their unique challenges.

Got it. That's helpful. As a quick follow-up, when you successfully cross-sell F5 customers to some of the Distributed Cloud Security solutions, are you usually replacing another vendor, or is there a significant opportunity for new areas like API security where they might not have a dedicated solution yet?

So it's both. It's a combination of both. We've shared, I think, earlier in the year that about two-thirds of our distributed cloud customers are BIG-IP customers or existing F5 customers and about one-third are net new customers to F5, they have never had a relationship with F5. So we're also acquiring new logos with Distributed Cloud. However, as it relates to customers with whom we are cross-selling, sometimes it is customers who had to go to a pure SaaS player before F5 had a SaaS solution. And so therefore had to increase their complexity because they would use F5 on-prem and they would either use a public cloud player for some applications or a CDN or edge player for applications, thereby creating complexity and multiplicity of vendors. And now that we have F5 Distributed Cloud and we've built some integrations, they are coming back to us saying, actually, I can have a single vendor for all of my application delivery and security. I can have consistent security across all my environments. That is way simpler for me and therefore, that's a better solution for me. So yes, at times, this is displacing SaaS players essentially that had gone into the environment. And sometimes it is greenfield. It's a set of applications that they were perhaps not yet protecting and for which Distributed Cloud comes with our full application security bundle and solves a big problem of security and complexity for them.

Great. Thank you.