Good afternoon, and welcome to the F5 Networks First Quarter Fiscal 2020 Financial Results Conference Call. At this time, all participants are in a listen only mode. Also, today's conference is being recorded. If anyone has any objections, please disconnect at this time. I'll now turn the call over to Ms.
Suzanne Adam, you may begin.
Hello, and welcome. I'm Suzanne DuLong, at 5 vice president of investor relations. Francois DeNeuis, F Five's President and CEO, and Frank Peltzer, F Five'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 and A portion of today's call. A copy of today's press release is available on our website at f5.com, where an archived version of the call will be available through April 26 2020.
The replay of today's discussion also will be available through midnight Pacific tomorrow, January 28th, by dialing 80585 8367or4166214642. For additional information or follow-up questions, please reach out to me directly atf.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 describing detail in our SEC filings.
Please note that F5 has no duty to update any information presented in this call. With that, I'll turn the call over to Francois.
Thank you, Suzanne, and good afternoon, everyone. Thank you for joining us today. I will talk briefly to our business drivers before handing over to Frank to review the quarter's results in detail. We have been investing to evolve our business to better meet our customers' changing application demands. Today, we are delivering our world class application services across a wider range of deployment and consumption models.
As a result, customers are increasingly deploying F5 in more cloud environments, driving a shift in our revenue mix towards software. Customer demand for consistent application security and reliable application performance drove 5% total revenue growth in our first quarter. Strong customer demand for security use cases, including WAF and SSLO, as well as ongoing ELA traction fueled our 50% software growth. We are very pleased with our continued software traction. We continue to expect 60 percent to 70 percent software growth for 2020, including contribution from Shapes Security which closed on Friday last week.
Our software growth was partially offset by our systems business which was down 11% as customers increasingly look to consume F5 solutions as software. Our services business was very strong in the quarter, delivering 8% revenue growth. Services is benefiting from our robust software sales over the last several quarters, including Overall, we continue to execute well against our long term strategy and are pleased by the pace of our continued transition to a software driven business. I will speak more to our business dynamics and customer wins after Frank reviews the quarter's financial results and our Q2 outlook. Frank?
Thank you, Francois, and good afternoon, everyone. As Francois noted, we delivered another quarter of strong revenue growth. 1st quarter revenue of $569,300,000 was approximately 5% year over year and near the top end of our guided range of $560,000,000 to $570,000,000. GAAP net income for the quarter was $98,500,000 or $1.62 per share. Non GAAP net income was 155,400,000 or $2.55 per share.
This was well above the top end of our Q1 product revenue of $235,000,000 was flat year over year and accounted for approximately 41% of total revenue. As Francois mentioned, software revenue grew 50% year over year. Software represented approximately 28% of product revenue in Q1, up from approximately 19% sold as annual subscriptions, including as ELAs. In fact, contribution from ELAs increased again year over year. Systems revenue of $170,000,000 was down 11% year over year as customers continue to transition to software based solutions.
Systems accounted for approximately 72% of product revenue in the quarter. Services revenue of $335,000,000 grew 8% year over year and represented approximately 59% of total revenue. There were 3 primary contributors to Services revenue's strong performance in the quarter. The primary factor is improvements to the tools and processes our team uses to identify and secure renewals. In addition, we continue to enjoy healthy services attach and renewal rates to software sold as perpetual or as subscriptions, including NGINX related sales.
And we have also seen a step up in consulting service demand associated with growing software quarter with 3% 7% of revenue, while APAC grew 8% and accounted for 20% of revenue. Looking at our bookings by vertical, enterprise customers represented 65 percent of product bookings and service providers accounted for 16%. Our government business was very strong, representing 19% of product bookings, including 7% from U. S. Federal.
In Q1, we had 3 greater than 10% distributors Ingram Micro, which accounted for 16% of total revenue, Westcon, which accounted for 11% and ARO, which accounted for 10%. Let's now discuss Q1 operating results. GAAP gross margin in Q1 was 84.4 percent. Non GAAP gross margin was 86%. GAAP operating expenses were $358,000,000.
Non GAAP operating expenses were 297,000,000. Non GAAP operating expenses were at the lower end of our guidance range for several reasons including disciplined expense management, and sales commissions back in line with historical levels, down from the highs of the second half of twenty nineteen. In addition, there were some timing differences for expenses expected Our GAAP operating margin in Q1 was 21.5% and our non GAAP operating margin was 33.8%. Our GAAP effective tax rate for the Turning to the balance sheet. In Q1, we generated 144,000,000 in cash flow from operations.
This is down from last year for several reasons, including lower year over year operating margins, commission payments from strong Q4 bookings, M and A related expenses and restructuring. Cash and investments totaled approximately $1,500,000,000 at quarter end. DSO of 56 days and capital expenditures for the quarter were $22,000,000. Deferred revenue increased 8% year over year to 1,200,000,000. The growth rate is down from 2019 levels because we had lapped our 606 adoption which, as we consistently called out, was accounting for roughly half our deferred revenue growth over the last year.
We ended the quarter with approximately 5305 employees, down approximately 20 from Q4 as a result of ongoing efforts to better align spend with strategic imperatives. We continue to view cash as a strategic asset for our future growth Our near term priority will be paying down the $400,000,000 term loan a related to the shape acquisition funding. We'll look to balance that with rebuilding our cash position for strategic purposes. To repurchase shares during any open trading window. Now let me share our guidance for fiscal q 2 of 2020.
Unless otherwise stated, please note that my guidance comments reference non GAAP operating metrics. In addition, with the shape Security acquisition closed on January 24th, our guidance is inclusive of shape. We continue to make strong progress transitioning our business to a software driven model. We remain confident in our position in the market and expect increasing demand for our multi cloud application services will continue to drive revenue growth. We also expect continued strong demand for our software solutions.
In fact, in Q2, we anticipate software growth will re accelerate above Q1's 50% growth even before any contribution from shape. As we noted, when we announced the shape acquisition, shape has a subscription revenue software model with a significant deferred revenue balance. Purchase accounting will impact shape related recognized revenue on a GAAP basis principally over the next four quarters. Therefore, for that period, we will provide non GAAP revenue guidance which excludes the impact of the purchase accounting write down. We believe non GAAP revenue will provide a better reflection of our ongoing business results.
We will report 20 non GAAP revenue in the range of $580,000,000 to $590,000,000. In addition, we expect services q2220 annual revenue growth more in line with Q4 of 'nineteen. We expect gross margins in the range of 85 to 85.5 percent. We estimate operating expenses of $325,000,000 to $337,000,000 in Q2, reflecting the addition of shape and the opportunity we have to invest and scale that business. We anticipate our effective tax rate for Q2 will remain in the 21% to 22% range.
Our Q2 earnings target is $2.14 to $2.17 per share. In the quarter, we expect share based compensation expense of approximately $52,000,000 to 53,000,000 With that, I will turn the call back over to Francois. Franco?
Thank you, Frank. I am going to begin today with a spotlight on NGINX before highlighting some of the broader trends and customer wins in the quarter. First, today, we announced an important milestone for the combined F5 and NGINX. The availability of controller 3.0. Controller is our orchestration and analytics solution for NGINX.
It simplifies how enterprises manage, monitor, and automate large scale NGINX deployments. Prior to the acquisition of NGINX, F5 was working on a cloud native virtual ADC offering that featured an application centric design. We expected the solution appropriately named cloud native would set a new benchmark for how modern developer teams could deliver new apps to market faster. Immediately after the close of the NGINX acquisition in May 2019 we merged the F5 team working on our cloud native project with the NGINX controller development team. Today, as we begin only our third quarter as a combined team, we are very excited to release the converged F5 NGINX solution NGINX controller 3.0.
This controller brings together the best of NGINX controller 1.02.0, and add the application centric design and enterprise features pioneered by F Five. For context on why this new approach is so important, we first need to emphasize the fundamental shift in the way our customers manage and deliver applications. Originally, there was a divide between the application teams that developed the code and the operations team that released and managed the finished application. DevOps evolved to bridge this divide and many organizations embraced DevOps practices to deploy applications faster. As a result, organizations embraced software like NGINX open source and NGINX Plus to empower developers with control over their own infrastructure.
Although this improved developer productivity, it also created Shadow IT. Many of these developers worked outside of IT. Outside of the compliance and enterprise security requirements designed to protect applications and data. That is why we believe controller 3.0 and its application centric approach is highly differentiated. The Application Centric Design introduces a new self-service portal, configuration API, application reporting and analytics and built in security capabilities.
These combined up centric capabilities and power developer on a centralized solution that maintains control and compliance for security and operations teams. Controller 3.0 shifts the center of gravity from the instance of infrastructure supporting the app to the application itself. With role based access spending, updev, DevOps, SecOps, and NetOps, it enables deployment of a consistent set of multi cloud application services across the application lifecycle. This enables different users to manage the tasks relevant to their role. In summary, we expect the availability of controller 3.0 will be an accelerator for our NGINX business for 3 reasons.
First, it expands the addressable market for NGINX to include adjacent app services in security and service mesh. 2nd, It increases the average deal size by making large scale NGINX deployments easier to orchestrate. And third, it introduces new commercial capabilities that are attracted to NGINX's large open source base. Early feedback has been positive, with customers noting that controller 3rd auto expands the number of use cases and deployments of NGINX particularly for Kubernetes, U. S.
And API management. In addition to delivering the controller 3d auto release, NGINDAX had its strongest quarter yet in Q1 with the team hitting all of its significant integration and value creation milestones. When we look at the future of F5, we are more confident now than ever before that NGINX will be a meaningful software growth driver. We continue to see evidence that NGINX is expanding our overall footprint and allowing us to serve new applications. This includes enabling application services consumption in native container environments.
As an example, During Q1, we secured an NGINX Plus, an NGINX controller win with a new customer, a large Australian mining company, The customer was looking to modernize a legacy business process at its mine sites where a single failure could result in up to $4,000,000 in productivity losses. By using NGINX for the API and Kubernetes in their applications, they now are able to collect and deliver over 30 different metrics. As a result, they are better able to ensure the speedy and reliable delivery of raw materials to their destinations. We are also seeing an uptick for NGINX inclusion in ELAs, both in concept with F5 solutions and on a stand alone basis. During Q1, we closed our first 100 percent NGINX ELA with a large streaming services provider.
NGINX Plus is enabling seamless capacity and service offering increases without disrupting critical revenue producing applications. The ELA construct was meaningful in this case because the customer is able to deploy additional NGINX plus instances as subscribers increase. In fact, when the actual number of subscribers surpassed forecasts out of the gate, the ELA provided the customer with the flexibility to immediately scale services with demand. Beyond NGINX, We continue to gain traction in software across the other growth drivers we have consistently highlighted, including ELAs, service provider use cases, security use cases, and deployments across multi cloud environments. I will highlight customer examples of each of these in Q1.
In fact, the first example highlights a yearly win with a large UK based telecommunications provider transitioning from hardware to software. In this case, the customer's ADC infrastructure based on F5 hardware with nearing end of life. The need to refresh provided the customer with the opportunity to rethink the design and build a flexible, virtualized environment aligned to its future business needs. Despite a competitor touting analytic and commercial flexibility, F5 was able to demonstrate best in class software based security and ADC capabilities. In addition, our analytics and reporting outperformed the competition and reduced the customer's operational costs.
Looking at a security use case win in the quarter. During Q1, we secured a combined systems and software win with a German health system company. As Kai is providing application security solutions, including Advanced WAF, to secure a platform that allows doctors, hospitals, and health insurance companies consolidated access to patient records. Of note, we were the only provider able to meet the customer's security requirements of delivering a highly secure and scalable infrastructure that met stringent government standards. In an example of F5 solutions deployed in multi cloud environments, we secured a win with 1 of the UK's most trusted financial brands, a large UK based mortgage provider.
As part of their digital transformation program, they chose to deploy big IP virtual additions across 2 public clouds. This provided the growth capability to support an ever increasing number of online banking customers and enabled consistent application services and security across the cloud and data center. Before we move to Q And A, Let me say how very enthusiastic we are to begin our integration work with our colleagues in shape security. To recap briefly, we believe the combination of F5 and shape changes the game in application security. Shape is a leader in anti fraud and abuse protection, solving a mission critical problem for large enterprises.
Together with F5's world class portfolio of application services, shape and F5 will deliver the most comprehensive application security portfolio available. Beyond accelerating our growth momentum and more than doubling our addressable security market, shapes, machine learning, and AI powered capabilities also will scale and extend F5's broad portfolio of application services. With shape, we will expand our ability to optimize and protect customers' applications in an increasingly complex multi cloud world. With the shaped transaction closing last week, the teams already have begun the integration process led by members of our Chief Strategy Officer, Tom Fountain team under our value creation program. This is the same team that executed the very successful integration of NGINX, and we are confident they will do the same with shape leveraging lessons learned during the NGINX process.
We are very pleased that Derek Smith, shape CEO, will continue to lead the team as part of F Five. In closing, digital transformation has changed the competitive stakes for nearly every business on the planet. Beyond delivering a compelling, reliable user experience, customers, new partners and solutions that allow them to do more and move faster. At F5, we envision a future where all businesses can deploy new applications or make changes to existing applications in minutes, not days. We are transforming F5 to make that vision a reality for our customers.
To enable support and secure every application across any environment with a consistent set of enterprise grade services. My sincere thanks to the entire F5 team for driving another great quarter. My thanks also to our partners, our customers, and our shareholders for joining us on our journey. I will remind you that our analyst and investor day is scheduled for March 3rd in New York. We look forward to seeing many of you there.
With that, operator, we will now open
Our first question comes from Tim Long with Barclays. Your line is open.
Thank you. Two questions if I could. 1st, Frank, I think you talked about last time the cloud related businesses, which are still in early phase, were a meaningful portion of the total software revenues. Could you just give us an update on how the cloud vertical did for you? And, did you see some sequential growth there And if not, were there ELA impacts or some other impacts?
And then secondly, the services strength, it sounds like the year over year growth rate will kick back a little bit next quarter, but could you just talk looking out, the next several quarters or year, should that line start to become under a little bit more pressure as the weight of the them, revenue declines hits the longer term model. Thank you.
It's a mess, Francois. I'll take the first question and then, Frank will comment on the services question. On the cloud cloud revenues, Tim, we said that the representative is a meaningful portion of our total software revenues. And that portion continues to grow. It's about cloud a business is growing even faster than our overall software business.
And that's driven by a couple of things. One is we have made our, core solutions much easier to deploy in in cloud environments. With integration with, essentially all the large public cloud providers. We have added some, automation and orchestration capabilities that enable our customers to include our solutions in population environment, and then in their CICD development pipeline, much easier than than in the past. And third, I think we're continuing to see just significant growth in the marketplaces, of our, of the large public cloud providers where our solutions are also available, for purchase on a utility basis.
So when you look at the consumption models that we've enabled, now both the technology and the commercial models that we've enabled, that significantly reduced or eliminated any friction associated with using F5 in public clouds. Our ELAs are a good example of that where customers by, an agreement for, for 3 years, and then they can deploy licenses in any environment, including in public clouds and port licenses from one public cloud to the other or one public cloud to back to on prem. So all of that leads to growth in our cloud, software revenue, which I think we said, last quarter or in the last 6 months of 2019, when we had growth in our software business of 90% for Q3 and Q4, but our cloud business had grown even faster than that. And it continues to be a very strong growth trend.
And Ken, in relation to the services revenue, obviously, we were really pleased with having 8% a year over year growth in Q1. That was obviously above what we had guided to in the last we talked about the service revenue components, which was all the way back at the end of 2018, when we talked about mid to low, growth during the horizon 1 timeframe. So this is, this is great performance to see. What we're seeing that actually is also an increase in the attach rates across all the cohorts of age contracts. And so it's not really, from our perspective, any decline in hardware that is impacting, you know, over a longer period of time, the decrease in services revenue business, what it actually is, it's more of the mix of things that come through as subscription where that subscription looks more like a SaaS subscription and a lot of that revenue gets recognized, almost all that revenue gets recognized in the product side and not the services side.
And so, we continue to see strong growth in the services revenue, probably even above where we thought when we thought about this in, in March of 2018. But over a longer period of time, we do see those services revenues, coming down in terms of growth rates, but that's really more of a mix issue than anything to do with, a systems versus a software sale.
Your next question comes from James Fish with Piper Sandler. Your line is open.
Hey guys, thanks for the question here. If I can squeeze into as well. Enterprise still grew about 5% this quarter yet the industry, not everyone's seeing that kind of strength.
I
guess, can you guys just go into what's going on in enterprise specifically that is showing that resiliency Thanks.
Generally, on the enterprise, we continue to see, spending patterns that are, I mean, you gotta call them relatively healthy. In, it's not as healthy as they were in 2018, but we haven't seen a change, overall from the spending patterns that we saw in 2019. So we still continue on that trend. There are some, changes of variations by, by geography. And as you know, we've pointed several times that we were seeing soft test in the in Europe and in the UK and back in particular.
And I think we continue to see that today. But overall, the spending patterns are, are healthy when you look, by the way, it's your your context is that of other, perhaps providers in infrastructure, of data centers. What we're seeing more and more, James is suspending with us is tied to applications, and the growth of applications, not tied to data center infrastructure per se. So perhaps over time, you'll see more and more of that, of that difference. But the spending patterns I relate to is what we see with, our customers applications project.
Got it. And just to follow-up on that. I mean, it was a slight miss on what we were all expecting on products for the quarter. Were there any pause in orders ahead of the combined NGINX plus F5 controller? And why do you expect unattached software to accelerate next quarter?
James, that's that's 2 separate questions. I will start with the first one on product revenue growth. Product revenue growth was flat, and indeed, it could have been a little bit better than that. What we saw in Q1, I think there were really a couple of factors in Q1. One is, there was some lumpiness in some large deals, that that we expected.
In Q1, we also did, a relatively important realignment of our North America, sales organization, in part to prepare, to better focus on certain verticals and to also evolve the alignment of our teams given the evolution that's going on in our portfolio with a new SaaS solution NGINX coming in, shit coming in. And I think it's that that realignment cost a bit of a short term, falls on momentum. It's also for the better, and we'll see the the benefits of that, for the rest of the year. So I think those were, 2 of the factors specifically on product revenue were Your second question about, why we expect stronger revenue growth in Q2 for software specifically? I think this issue of a large deal lumpiness does apply also to large software deal.
And we have a a very robust pipeline of software deals going into Q2. And so we're still confident that we'll see a very strong growth in Q2.
Thanks guys.
Thank you, James.
Your next question comes from Sami Badri with Credit Suisse. Your line is open.
Hi, thank you. I wanted to touch up on the percentage of enterprise wins that are tied more to security use cases versus more of the legacy business or I guess you could say more ADC like product sales. So just trying to understand, has the importance of security for your customers shifted even further to the forefront of their decision making, or would you say it's very comparable to how it was over the last year or so just trying to understand has there been a big shift forward in terms of points of security use cases?
Hi, Sammy. Even though we don't, you know, today, we don't break out our security revenues, specifically, we continue to see, strong growth in our security business, and and I said before, we see more growth in our security business than the rest of the portfolio. And so the answer to your question is, yes, we continue to see more and more of our deals, driven by, security increases, in a a lot of cases, these deals also pull all the application services that you would classify more as application delivery services. But increasingly in the main proportion of our business, security is the use case that actually pulls the deal together. The the second factor that kind of accelerates, the alternative world is that in a multiple environments, we are seeing all the security attach rate, to our solution that we are seeing on prem.
And so given that more and more of our business is becoming multi cloud in terms of the deployment, we are seeing an increase of our, of our security business. And that all of that, by the way, we expect to see that accelerate with shape. And the synergies that we expect to drive between the shaped portfolio and the, the F5 portfolio.
Got it. Thank you. And then I kind of just wanted to touch back onto the services growth rate that you saw in the quarter. Obviously, 8% is a positive surprise for most people looking at your model. And you identified 3 factors for what's driving that.
One of them was new tools So given that this just played out in this quarter, should we expect similar high single digit growth or even in the same ballpark of growth and services for the rest a year as these 3 factors continue to drive the business forward, to continue to drive more services renewals or should we expect like a moderation on the growth rate?
Timmy, I think we gave some fairly specific, guidance for Q2 in particular that probably gets you to a number that Sema was getting to, which is slightly down from where we, where we printed Q1, but still very healthy in terms of a growth rate for Q2. As we look out over the course of the year, that services growth rate may start to modulate down, particularly as we get, more and more traction with, with some of the pure SaaS type revenue models that we discussed. But I think it's safe to say that the overall services growth rate, is going to be higher than probably what we thought about, at the end of our Horizon 1 guidance, we only talked about this in March of 2018.
Got it. Thank you.
Your next question comes from Samik Chatterjee with JP Morgan. Your line is open. Hi,
thanks for taking the question. So if I can just start off with a more longer term question, I mean, you've been making investments both organic as well as in organic since you kind of, took over and have been aligning the competitive growth areas now. You think about the transformation, can you kind of, help us think about which innings you're in given that Frank commands, sir, to prioritize and get paid on, seem to indicate you're kind of done with most of the heavy lifting in terms of the transformation that you envision.
Thank you, Saliq. It well, let me start with what's driving this transformation. Like, we we have a belief to to look at, you know, asked us to stop the players in the industry, we, we have a very strategic position in that we are in line of the traffic between application and users for a very, very large number of applications. And with the acquisition of NGINX, we extended our reach very significantly and we're not part of the flow for several 100,000,000 applications. I don't believe it's simply given by the fact that the number and complexities of applications in the future is going to increase, and increased exponential from where we are given everybody's social transformation.
And as a result, we have an opportunity to extend that strategic position to more applications and also identify more applications, more application services for companies applications. And that's really what we have been doing with this transformation, our priority is to do it organically. But when in the selective scenarios where we see an opportunity to accelerate that unification, for, you know, within a window of time. We have decided to do that inorganically, and we've seen 2 instances of that. Where we are in this restoration, I would say we are in the early innings because we think we are actually in the very early innings of the digital transformation of our customers.
So I expect that the growth opportunity for a size as we succeed in, in, unifying these application services for these new multi cloud environments. Is well ahead of Austin is very significant.
Got it. And let me quickly follow-up for Frank. Frank, how should we think about the trajectory for OpEx beyond 2Q level, I think you said 3.25to3.37. So beyond that, how should we be thinking more
Yeah. It's me. So I would just go back to what I said, pre the shape, acquisition in terms of Q2 as always, are seeing a little seasonal low point, in the in the, OpEx cycle, empty tend to tick up in Q3 and Q4. In terms of operating margin expansion. We still feel very comfortable, with the guidance that we put out for the year of 30 to 32 for the year.
And so, directionally, I think, you know, Q2 will be below point and then we'll back up from there in Q3 and Q4.
Great. Thank you. Thanks. Okay.
Your next question comes from Paul Silverstein with Cowen. Your line is open. Paul Silverstein. Your line is open. Your next question comes from Rod Hall with Goldman Sachs.
Your line is open.
Yeah. Hi, guys. I just wanted to ask a couple things on the shape acquisition. I think you guys called out these non GAAP adjustments to revenue, and I wanted to just come back to those. I wasn't I'm not sure I fully understand that.
So maybe if if you could go back into a little bit more detail on exactly what that is, And then I wanted to, also on shape, just ask Nicky said this earlier, but what was the contribution or what is the contribution of shape to the guidance. It seems like, I think you guys had said there was an ARR of 70,000,000 growing at 50%. And kind of if I do some rough math math on that, I guess, is 5,000,000 bucks is maybe revenue contribution. Maybe it's less than that, maybe more. But I'm just trying to get some idea of what's in the guidance from shade.
Thanks.
Sure, Rod. So we're not specifically actually breaking out guidance for shape. The reason why we did that with NGINX is because NGINX actually closed after we had given guidance. And so when we reported, NGINX, we tried to be specific on what was the relationship of our recognized revenue versus, what we had guided to and then the contribution from NGINX, but with Shay, we've got it with it, and we're not breaking that out, at this time. In terms of what we said in what Francois talked about when we actually announced the Shape acquisition and the non GAAP revenue, with a SaaS based business model and you see this quite frequently in software, saasland where companies acquire with a companies with a very large deferred revenue balance, given the way revenue comes into that SaaS models, where there's a significant write down in that revenue as part of, purchase accounting.
And so, to try to give the users of our financial statements, a better sense for what the long term growth rate is going to be as opposed to our muted revenue. We are going to be reporting both GAAP non GAAP revenue, to give better comparability in years to come.
And Frank, just one other thing to clarify. You guys said that, service we've grown about the same rate. So I guess, like, 6%. And that including shape looks to me like it drops out about $260,000,000 of product revenue in the the guided quarter. I mean, that's is that a correct way to look at that?
That number isn't exactly what is familiar to me, but I think, you know, it's it's not so far off. I think the rate that we had probably for Q4 or last time was, I think, 6.6.56.5.
Yeah. 6.3.
Yep.
So you're thinking almost exactly that growth rate?
Yes. There is no services revenue for shade.
Right. Okay. Yeah. Thank you, Frank. That's that's helpful too.
Thanks.
Your next question comes from Fahad Majam with Cowen. Your line is open.
Thank you for taking my question. I'm trying
to also understand the software revenue trends. So in terms of your software revenues, you help us understand how much of it is recurring and how much is ELA?
So we really have to split that out, in the past.
In terms of, is it is it reasonable to assume that majority of software revenue is still coming from ELAs.
The, no, it's not. When we take a look, I think we talked about a few quarters ago, the pure percentage of recurring revenue of our total revenue, was 60% plus. And we continue to build. And that's exactly what we saw in Q1.
Okay. And then if I may ask one more question on, regarding the state security, if we assume that almost all of your security, security revenue, would you be breaking out your security revenue as a standalone now that shape is closed?
We don't anticipate doing that at this time, Fahad, but, we're talking about a several different KPI metrics, for AIM, in March and, you know, TBD on what we decide there.
All right. Thank you so much questions.
Sure. Thanks, Tom.
Your next question comes from Amit Dariani with Evercore. Your line is open. Hi. Thank you for taking
the question. This is Lexi on for Almit. So I guess what we're wondering about is when we're looking at the 60 to 70% growth in software moving forward, how much of that is organic versus M and A driven. And then on the organic side, what are the top 2 or 3 contributors to that growth?
Alright. Let me let me start with, as you know, we're not breaking out, you know, shape and NGINX versus the, the NetSpark business prior to shape and NGINX But let me give you some, some indicators. Last year, the s 5, software grew about 60% year on year. There was a very small contribution of NGINX in the second half of the year, so that growth. We guided, after the engineering acquisition to growth in software in our Horizon 1, which includes 2020, That was 35% to 40%.
As you can see, we are well above that. We were at 60% for the full year last year, 90% in the second half. And we are at 50% this quarter. So this just gives you a sense that the growth, in, I'm gonna call it s 5 traditional software prior to the NGINX and shape is very significant, and that's driven by a few things. It's driven by the work that we've done on, making our software easier to consume in private clouds and automated environments, is driven by the work that we've done in, putting our software in public clouds and is driven by the work we've done in enabling new consumption models, ELA's subscription utilities, etcetera, in all environment, and that's, the the thing that S5 has done, but it's also, as a primary driver coming from our customer's desire to move from, sort of hardware first postures to software for first postures.
And we've seen that change in our customers, both in enterprise and in the service provider world that service providers start more and more virtualizing their infrastructure. So there are very strong demand drivers from our customers to move to a software consumption of F5. When you look at 2020, we do expect contribution from, from NGINX and from shape, to achieve or exceed our 60% to 70% guidance.
Lexi, the only thing I'd add is that we did say during the prepared remarks that, even without shape, we did expect Q2 software growth to be above the 50% level that we experienced in Q1.
Your next question comes from Alex Henderson with Needham. Your line is open.
Great. Thank you very much. I was hoping we could talk a little bit about the Ingenics acquisition relative to, the selling process and the new products that you're introducing here. So as I understand it, the value of Ingenics is predominantly in selling to application coders, and DevOps people that generally focus on an application specific project and have had little success selling the controller because that's generally sold back to net ops and IT administration. Conversely, your historical footprint at F5 has predominantly been selling into the NetOps and IT stuff, but you didn't have really good access to the to the coding community, dev ops community.
As you've introduced this, 3.0 and are now bringing that back through the F5 distribution architecture are you willing to then integrate that into beacon and then have the full value of the controls from the big IP through the Ingenics controller to potentially manage the people who are in the, net ops, I spent the dev ops slash coder community. Does that bring power back to, the net ops people in a way that they've been losing in the past. Can you talk a little bit about that dynamic?
Yes. Thank you, Alex. Short answer to all this is yes. But let let me let me give you a bit of context. So if you look at, where NGX had gotten traction in terms of revenue is really, offering their data plan, you know, above the open source capabilities in the data plan, offering additional features in their data plan, and as well as support.
And that's really how NGINX so far in the in the current model had monetized, their their technology. The the controller, I'll need to mention to that sort of DevOps, community because Number 1, it makes it a lot easier to, deploy and manage, large scale implementations of NGINX data plans across a number of applications. And so if you look at the full who really, it's great, have been able to use NGINX. It's folks who are very sophisticated DevOps, people and have the skills and expertise to integrate these deployments and manage them on their own. And so with the controller, it offers essentially an easy button that allows, a much larger group of people that perhaps don't have the same sophistication to now use nginx technology and use that technology on a large scale.
So that's kind of the first driver. The controller also integrates, application centric design, which really is targeted at more of the, enterprise, users, including what we call supernet ops, users in, in large enterprises, And so it does, it does give an ability for the NetOps people, to still have visibility of what goes on in the in the infrastructure under their applications and the dev ops people, to have a self-service model to deploy their applications faster and make changes to their applications very quickly. So we, at the time of the acquisitions, we said that F5 and NGINX together, we're going to bridge the device between NetOps and DevOps. And the controller is really the manifestation of that strategy. And it's really the 1st offer in the market that truly bridges the device and allow these 2 communities to work in concert, serving the need for speed of DevOps and serving their needs for visibility and compliance, from the Metox people.
This, controller will indeed integrate in, in a technological beacon, which will give visibility and analytics, across all F5 environment, Nginx, big IP, and, and other environments. So that's the that's the convergence We think this is a very important, launch, for our NGINX business. Because in addition to the capabilities around DevOps and bridging the device, it also does increase the deal size, for NGINX products. Because it makes large scale deployments easier and enough for new and exciting capabilities, for a number of open source users that may want to move up a tier and use the controller as a commercial technology. Great.
Thank you very much. That's pretty clear.
Your next question comes from Simon Leopold with Raymond James. Your line is open.
Hi. This is Victor Chiuan for Simon Leipold. Can you just give us an update on where the telco stand regarding the shift to software, implementation of AC and then kind of the outlook there?
Hi, Simon. We we are continuing to an acceleration in, telcos starting to move, to virtualization. We saw a couple of large deals again in that space this quarter with large service providers. And this is driven by essentially readiness for for 5 g, and also the desire for service providers to be able to move faster when they need to make changes to their infrastructure and overall, be able to to reduce their their costs. What we're seeing for now is service providers kind of keeping their, more hardware based infrastructure in place.
And starting kind of greenfield software implementations for virtualization. Over the long time, I think these will convert, but for now those, we see in the service providers that, we work with, we see these as 2 separate environments for the time being. Overall, the trend is accelerating.
It's helpful. Thank you.
Your final question comes from Jeff Kvavel with Instinet. Your line is open. Jeff Kvaal, your line is open. Your final question comes from Meta Marshall with Morgan Stanley. Your line is open.
Look at there. I get the benefit from Jeff. Quick question. On the AWS partnership, just any update there that you could give. And then I assume because you revalidated the 32 percent to 33 percent operating margin target, but just on the you know, mid to high single digit dilution target and kind of breakeven on 24 months for shared security.
Have any of those expectations changed? That's it. Thanks.
Ma'am, I just wanna be clear, when we talked about, 30 to 32 percent operating margin.
Or,
sorry, 30 to 32. Yes.
Yeah.
I'm just wanted to make sure that we're clear on the numbers, but go ahead Brent Foster and talk about AWS.
Yes, Meta. So we've made good progress on execution of our roadmap with, AWS on the strategic collaboration agreement. We have been prioritizing the sort of highest impact opportunities. Both teams are now working very well in the field. We're seeing number of new opportunities surfaced that we didn't have access to, before.
And, if you recall, in Q4, I said that that's what we in part because part of this agreement was a, a number of, AWS solutions architects who face customers every day. We're going to be trained on F5 solutions, and we expected them to bring opportunities up to a 5. But perhaps we've not seen before, and that's exactly what we have started to see. So it's, you know, it's own days, in, in the partnership and we said that I think it was we expected it to really get us a meaningful result in the second half of twenty twenty. But from what we're seeing, so far, we are, you know, we're pretty bullish about what we could accomplish together with AWS.
Great. Thanks.
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