Good afternoon, and welcome to the F5, Inc. second quarter fiscal 2022 financial results conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star one on your telephone keypad. Also, today's conference is being recorded. If anyone has any objection, please disconnect at this time. I'll now turn the call over to Ms. Suzanne DuLong. Ma'am, you may begin.
Hello and welcome. I am 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 A copy of today's press release is available on our website at f5.com, where an archived version of today's call will be available through July 24, 2022.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.
To access a replay of today's call by phone, please dial 800-585-8367-441-6621-4642 and use meeting ID 7769889. The telephonic replay will be available through midnight Pacific Time, April 27, 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 Locoh-Donou.
Thank you, Suzanne, and hello everyone. Thank you for joining us today. As you all know, we entered our second quarter with some significant challenges that limited our ability to fulfill demand from our systems business. We are pleased to have delivered above the midpoint of our revenue guidance and at the upper end of our non-GAAP EPS guidance despite those challenges. Importantly, we continue to deliver strong results from our software business. With 40% year-over-year growth in the quarter, software represented the majority of our product revenue for the first time. Systems revenue declined 27% as a result of supply chain constraints, and our global services revenue was flat year-over-year. Our second quarter reflected another in an ongoing trend where customers continued to rapidly grow and scale both their traditional and modern applications while placing increased importance and focus on application security.
This benefits F5 and translates to continued strong demand across our portfolio. While our view towards strong demand drivers remains clear, our visibility into resolution of hardware supply chain challenges is murky. Going into Q2, we discussed two primary supply chain challenges. I am happy to report that we successfully resolved the first, which was related to standard electronic components and required us to design in and qualify an alternative source. The second challenge we discussed is related to global shortages of specialty semiconductor components. While we have made some incremental progress on this issue, we continue to expect supply constraints will limit our ability to fulfill systems demand through the end of this fiscal year. Part of our efforts to fulfill system demand included shifting customers from our iSeries appliances to our next-generation rSeries appliances, which launched in February.
We are seeing solid traction in rSeries sales, and we are ramping manufacturing. However, semiconductor constraints, primarily from a handful of suppliers, continue to limit our ability to ship iSeries and are now also impacting our ability to accelerate the ramp of rSeries. As a result, our systems revenue recovery has been delayed beyond the expectations we had last quarter. Frank will review our outlook in detail later in our prepared remarks, but as a result of the delayed systems revenue recovery, we now expect to deliver fiscal year 2022 revenue growth in a range of 1.5%-4%. This compares to our prior expectations for 4.5%-8% growth.
Our underlying demand remains strong, however, and we continue to expect to deliver software revenue growth near the top end of our 35%-40% target for the year. In light of the sustained strength of our demand and our view that the supply chain constraints are temporary, we are not making changes to our operating structure, and therefore, our margins will be impacted correspondingly near term. We obviously feel a strong sense of frustration with this change and an equally strong sense of urgency toward resolution so we can get back to reflecting the true health of the business in our reported results. We are taking every available path to resolve the issues as quickly as possible. Our suppliers expect additional capacity beginning in the last calendar quarter of 2022, which should translate into improvements during our second quarter for fiscal 2023.
While the supply chain challenges are more severe than we estimated last quarter, they are temporary. In addition to seeing continued demand for hardware, we are seeing good traction across our software portfolio, including from security use cases and our ability to bring a broader solutions portfolio to customers. I will speak to our business momentum and demand drivers before Frank reviews the quarter's results and our outlook in detail. Our customers are increasingly operating both traditional and modern architectures and looking to F5 for solutions that simplify and unite their strategies for both. As an example, during Q2, an American multinational beverage company and a longtime BIG-IP customer selected NGINX to serve its cloud and Kubernetes-based workloads and modern use cases. The customer is using NGINX to automate app content delivery, including its loyalty program and delivery services, both of which have experienced substantial growth during the pandemic.
The addition of NGINX technologies to the customer's multi-year subscription resulted in a 2x extension of the subscription upon renewal. Customers also are operating in multiple clouds and uncovering new challenges as a result. F5's infrastructure-agnostic approach to application security and delivery differentiates us from vendors who are siloed to a single environment. This means we are uniquely positioned to help customers with their multi-cloud challenges. During Q2, we were selected by the Ministry of Health for a nation in our APAC region. Not being locked into a single cloud was an important consideration for this customer. They had intentions of modernizing in a single cloud short term, but plans to expand to additional clouds in the near future. This customer selected F5 over cloud-native offerings as a result of our solution's clear value add and our cloud-agnostic capabilities.
We enabled the customer to create a true multi-cloud architecture with both on-premises and cloud environments in a deal spanning our portfolio, including BIG-IP hardware and software with advanced WAF and NGINX, including App Protect and API management. Finally, it's clear that hybrid architectures, including on-premises data centers and as-a-service offerings, are here to stay. Applications and workloads also are increasingly containerized and mobile. This means complexity is here to stay too, and that managing applications across disparate environments will remain a challenge for customers. Meeting that challenge is likely to require a distributed cloud architecture and platform-agnostic security and delivery technologies that provide consistent protection, visibility, and performance for all applications, legacy, modern, and mobile across environments. In Q2, we took a large step forward toward helping customers better manage multi-cloud complexities with the launch of our F5 Distributed Cloud Services.
With this platform, we are delivering security, multi-cloud networking, and edge-based computing solutions on a unified software-as-a-service platform. Our first solution for the platform, F5 Distributed Cloud Web Application and API Protection, or WAAP, augments multiple security capabilities across F5 technologies in a SaaS offering. This offering reflects the first major step in our integration of our Volterra platform and F5 software security stack. F5 Distributed Cloud Services is globally available, and we are seeing strong early enterprise and service provider interest. SoftBank announced one of the first notable wins for F5 Distributed Cloud this quarter. The corporate information technology division of SoftBank needed to improve low resource utilization and other inefficiencies of its private virtualized infrastructure. Its security requirements mandated on-premises deployment with an option for future public cloud capabilities.
It sought a way to bring the effectiveness of cloud-native microservices and containers to its private data center and turned to F5 Distributed Cloud Services. We are leveraging F5 Distributed Cloud branding to further integrate customers' experience with F5 by simplifying our product naming. You will see we have united and renamed our SaaS and managed services portfolio, including Shape, Volterra, and Silverline, under our F5 Distributed Cloud Services umbrella. Expect to hear us refer to those solutions accordingly going forward. In summary, despite our short-term supply chain challenges, there is a lot to look forward to from F5. We have multiple current and future software drivers that are well aligned with our customers' most pressing application needs.
Between BIG-IP's ability to serve and secure traditional apps, NGINX's ability to serve and secure modern apps, and the exciting opportunity to grow and extend F5 Distributed Cloud Services, we are well-placed to enable our customers to manage and secure their growing and rapidly evolving application estates. Now, I will turn the call to Frank to review our Q2 results and our second half outlook in detail. Frank?
Thank you, François, and good afternoon, everyone. I will review our Q2 results before discussing our second half outlook. We delivered second quarter revenue of $634 million above the midpoint of our guidance range and reflecting a 2% decline year-over-year. Software revenue grew 40% to $152 million. Systems revenue declined 27% to $146 million. We delivered a 4% product revenue decline year-over-year, with product revenue representing 47% of total revenue in the quarter and software contributing 51% of product revenue. Rounding out our revenue picture, global services delivered $337 million in revenue. This is flat compared to last year and represented 53% of total revenue. Taking a closer look at our software revenue, subscription-based revenue represented 75% of total software revenue in the quarter.
This is down a bit from the 80% mix where it had been in the last couple of quarters, but we do not see this as indicative of a trend. Rather, it reflects some activation timing variability for a couple of large multi-year subscription agreements, as well as a small number of larger deals in the quarter where customers preferred a CapEx model. As a reminder, a significant component of our subscription business is term-based licenses that are not recognized ratably, and as such, we expect some quarter-to-quarter variability. 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 69% of revenue in the quarter. This is up from 64% in the year ago period.
On a regional basis, Americas delivered 4% revenue growth year-over-year, representing 57% of total revenue. EMEA declined 9%, representing 25% of revenue, and APAC declined 6%, representing 19% of revenue. In the quarter, we saw some signs of softness in EMEA. We believe this is in part related to the macro and global political concerns in the region. Enterprise customers represented 65% of product bookings in the quarter, service providers represented 15%, and government customers represented 20%, including 7% from U.S. Federal. I will now share our Q2 operating results. GAAP gross margin was 80.1%. Non-GAAP gross margin was 82.9%. We continued to experience increased component prices, expedite fees, and other sourcing-related costs. GAAP operating expenses were $433 million. Non-GAAP operating expenses were $358 million.
Our GAAP operating margin in Q2 was 11.8%. Our non-GAAP operating margin was 26.5%. Our GAAP effective tax rate for the quarter was 22.7%. Our non-GAAP effective tax rate was 21.3%. GAAP net income for the quarter was $56 million or $0.92 per share. Non-GAAP net income was $131 million or $2.13 per share. I will now turn to the balance sheet. We generated $127 million in cash flow from operations in Q2. Capital expenditures for the quarter was $5 million. DSO for the quarter was 59 days. Cash and investments totaled approximately $922 million at quarter end.
During the quarter, we repurchased approximately $125 million worth of F5 shares or approximately 610,000 shares at an average price of $205. Deferred revenue increased 17% year-over-year to $1.60 billion, up from $1.58 billion in Q1. The growth in total deferred was largely driven by subscriptions and SaaS bookings growth and to a lesser extent, deferred service maintenance. Finally, we ended the quarter with approximately 6,700 employees, up approximately 150 from Q1. François shared our updated fiscal year 2022 revenue outlook in his remarks. I will recap the details of the second half outlook with you now. Unless otherwise stated, please note that my guidance comments reference non-GAAP operating metrics.
I will begin with our revised view for fiscal 2022. Given persistent and dynamic supply chain pressures, which are limiting our systems revenue recovery near term, we expect to deliver fiscal year 2022 revenue growth within the range of 1.5%-4% for the year. This compares to our prior expectations of 4.5%-8% growth. We continue to expect to deliver close to the top end of our 35%-40% software revenue growth target for the year. We expect global services growth of approximately 1%-1.5% for the year, reflecting the lower expected range of systems sales. Because we believe the current supply chain challenges are temporary and do not reflect the underlying growth of the business, we do not intend to adjust our operating model near term.
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 over the next several quarters. We expect non-GAAP operating margin in the range of 27%-28% for FY 2022. We would expect to regain the Rule of 40 operating benchmark as we return to full manufacturing capacity. We continue to expect our full fiscal year effective tax rate will be in the range of 20%-21% with some fluctuations quarter to quarter. We remain committed to repurchasing $500 million in shares during the fiscal year. I will now move to our third quarter expectations.
We expect Q3 revenue in the range of $660 million-$680 million. Given component costs and the costs related to actions we are taking to mitigate supply chain pressures, we expect Q3 gross margins of approximately 82%. We estimate Q3 operating expenses of $368 million-$380 million. Our Q3 earnings target is $2.18-$2.30 per share. We expect Q3 share-based compensation expense of approximately $63 million-$65 million. With that, I will turn the call back over to François. François?
Thank you, Frank. In closing, we will continue doing everything in our power to mitigate supply chain impact for our customers. While supply chain is currently overshadowing the underlying strength of our business, we believe constraints will begin to abate as we move through the next several quarters. Our software and software-as-a-service app security and delivery solutions will drive our future growth and our long-term opportunities. We have created a portfolio and a roadmap that is well aligned with our customers' strategic priorities, and because of that, we are more confident than ever in our position, our strategy, and our long-term opportunities. With that, operator, we will open the call to Q&A.
Sure thing, sir, and thank you. As a reminder, to ask a question, you will need to press star one on your telephone keypad. Again, that is star one to ask a question. Our first question comes from the line of Samik Chatterjee from JP Morgan. Please ask your question.
Hi, yes, this is Joe Cardoso on for Samik Chatterjee. You know, my first question is just on the supply challenges that you highlighted during the prepared remarks. Can you touch on some of the actions that you're taking or planning on taking to help alleviate some of the pressures from the headwinds that you're facing from the supply challenges? Like, are you guys passing on higher pricing at all? You know, are you starting to see the benefits from higher pricing as some of the other networking peers in the space have done? Then just relative to the underlying components that are being constrained for the two product offerings that you highlighted, you know, when do you start to see or when should we start to see some improvement there? You know, have you been given any timelines from the suppliers?
You know, what's driving your confidence around that timeline? Thank you.
Maybe it's François Locoh-Donou. Thank you for the question. Let me start on the pricing. You know, we have been generally philosophically quite cautious about pricing with our customers. That being said, we have seen, as you know, significant cost increases. We did effect the price increase in the last few months. That was in the high single digits. We will continue to review our costs and kind of refine our models and look at whether we need to do anything else in coming months. We're gonna continuously review that in line with what we're seeing from a component perspective. We've already taken a first action in that area. As it relates to when things do get better.
Based on conversations with our suppliers, Samik, all of this is really about the semiconductor supply chain, and it's really a handful of strategic suppliers that we have. We do have deep and broad conversations with them on a very regular basis, including executive to executive conversations to really address the challenges that they and us are facing. Based on these conversations, we expect them to have improvements in their capacity in the fourth calendar quarter of the year, which should translate to improvement in our revenue in the first calendar quarter of 2023, which would be our second fiscal quarter. We expect these improvements from them based upon their expectations of additional fab capacity and what we've seen in terms of their consistent milestones around increasing that capacity.
We're not sitting on our hands and waiting for just the suppliers to make improvements. We are also driving aggressive actions on our side to drive improvement. What are we doing? First, we are continuing to shift demand to rSeries, which is our next generation platform, because we expect that platform to be less constrained than our iSeries platform. From the field perspective in terms of customers taking on the rSeries platform, we are seeing actually excellent traction on this front because the value proposition of the platform, the price performance of the platform is just excellent. We're aggressively shifting demand to rSeries. We are increasing the velocity of qualifying alternative sources of supply for both platforms actually.
You know, redesigns and qualifying additional suppliers on these platforms to alleviate the supply shortages. Of course, we continue to make aggressive advanced purchases with our suppliers. We have been doing that for several quarters, but we continue to do that very aggressively and providing them a lot of visibility into our forecast for future quarters. With these actions, as I said, we expect better supply in our fourth calendar quarter that will translate into the, you know, first calendar quarter of 2023 for improvements into our hardware revenue.
Thank you. Appreciate the color, guys.
Thank you, Samik.
Our next question comes from the line of James Fish from Piper Sandler. Please ask your question.
Hey, guys. Good afternoon. Kind of a loaded question here, with two parts, of course.
The big question we're getting after hours is really around that software number. François, while 40% growth is strong, it was again some easier compare than last quarter. Is there any way to quantify how much of that shift towards either the CapEx purchases over software as well as how much got delayed to a future period, what on the software line occurred? You know, on the system side, what should make us believe that we aren't in for another hardware cut here over the next quarter or two, as this is the second quarter in a row of cutting hardware. Really, I think giving us a sense around where backlog is versus the last quarter would be helpful for that.
All right. Let me start, Jim, with the latter part of your question around hardware, and then let's go to software after that. So Jim, the reality is that there is so much constraint in the supply chain, in the semiconductor supply chain today that our visibility into our supply is not very long term. It's actually, you know, very short term. What we're doing is giving you the best visibility that we have today, just like we did last quarter. We did not anticipate in our forecast. You know, when we guided for the full year last quarter, we did not anticipate yet another significant deterioration in the availability of these semiconductor components, and also the fact that the broker market has gone completely dry.
That's why we have another step down in terms of our ability to ship for the full year. In providing the view for the full year here, Jim, you know, we've looked to be appropriately conservative based upon what we know today. That's not to tell you that there is zero risk in the numbers we're giving you, because of course, those numbers rely on, you know, deliveries from our suppliers that are going to happen later this quarter and of course in Q4. There is, of course, still some risk in the full year number, but we have looked to be appropriately conservative in how we've constructed it based upon all of the conversations and information we have from our suppliers.
On the backlog, Jim, you know, we don't speak specifically to the backlog numbers, but of course, our backlog has grown again this quarter by multiple tens of millions of dollars. If you look at our demand drivers, Jim, they're pretty strong. Demand has remained strong. When we look at demand, we are on track at the first half of the year with, you know, what our plan was for the year. This is really a supply issue and not a demand issue. Let's go to software, and Frank's gonna take that.
Yeah, Jim. On the software number, obviously, you know, we do not sort of guide in a mix on any given quarter. You know, if you go back to Analyst Day in November of 2020, and we talked about software guidance in that 35%-40% range. You know, after the first quarter, we had 70%, in the second quarter, we had 20%. You know, there was a lot of question marks around, will we ever be able to make that 35%-40% range? And we ended up at 37% for the year. You know, we talked about at the beginning of this year that there was gonna be less volatility and variability in that number.
I think, you know, last quarter it was 47%, this quarter it was 40%. There's no dynamic to speak of, you know, a mix shift or any other factor. It was quote-unquote, "an easier comp," but we do think about this number of growth in terms of an annual basis, certainly not on a quarterly basis. We're quite happy with, you know, where we've ended in the first half, and, you know, continue to expect perform in the second half to be near the top end of our 35%-40% range.
Thanks, guys. I'll yield it back.
Thanks, Jim.
Our next question comes from the line of Amit Daryanani from Evercore. Please ask your question.
Thanks a lot for taking my question. You know, Ace, I have a question, a quick clarification, hopefully. You know, the question I really have is on the operating margin structure. You know, if I look at the full year guide, you're talking about 27%-28% operating margin, which is down, I don't know, like 400 basis points year-over-year, even though there is some revenue growth in the model on a year-over-year basis. I'm just wondering, like, what's the revenue run rate do you think you need to get back to the 32%-33% kinda operating margin range on a quarterly basis?
Alternatively, you know, what do you need to see from a macro basis to perhaps say, "I need to get more aggressive in optimizing my cost structures"? I'd love to just understand how you think of OpEx as you go forward. Is there anything you would call out in terms of why is software implied to decelerate in the back half of the year or fiscal year versus the front half? Is there something in the renewals that's happening there, or just anything you would call out there would be helpful?
Sure. Why don't I start and then I'll turn it over to François? On the operating margin side, I think what we said for the past two quarters is that our spend plan has not changed, and largely that is absolutely true. If you take a look at, you know, where the expected point of, you know, operating expenses in relation to that 8%-9% original growth rates that we had in the model, and where we also had, you know, our gross margin expectations, that would lead you to sort of the expectation of what we have for operating expenses for the full year.
You know, the run rate for that 32%-33% is exactly what we talked about at the beginning of the year and what we would need. What we have seen is a shortfall in the hardware number because of the supply chain constraints, but because they are temporary, we don't think it's right to change the operating expenses to potentially hinder a longer term growth trajectory of the business. That's why we have not changed the operating model.
Amit, your second part of your question was about software growth?
Yeah. You know, I guess, François, when I look at the guide for the full year, right? You started at low 40% growth call it in the first half of your fiscal year. Just mathematically, you're talking about things decelerating in the back half of your fiscal year. I'm wondering, is there something with the renewals that happened in the first half or this is just being a bit more pragmatic, but just what's driving that implied decel on software in the back half?
Oh, yeah. No, I think that's what you know, Frank was talking about this a moment ago, that you know, when you look back, Amit, we guided to 35%-40% growth for you know, first of all, for our Horizon 2 going back to 2020. We delivered 37% growth in you know, fiscal 2021. We guided again for 35%-40% growth this year, and in fact, we said we would get to the top end, near the top end of that range, and we're on track to achieve that.
We've always said, Amit, that, you know, we weren't looking at this on a quarter-to-quarter basis, but more on an annual basis, in part because our software business is not just a, you know, ratable SaaS, you know, model, that it does include term subscriptions, and therefore, there would be some variability quarter to quarter. We did say that we would see less variability quarter to quarter this year than we did last year, and we're also on track to deliver against that. There isn't a, you know, a different dynamic, if you will, in terms of the software business than what we have seen in the past.
The renewals that you just referred to, the trends on those, on these renewals are very, very encouraging, as well as the true forward and the expansions on the, you know, the agreements that we've signed in the past. We are, you know, generally very pleased with the software drivers we're seeing.
Perfect. Thank you very much.
You are next, Alex Henderson of Needham. Your line is open.
Great. Thank you very much. I wanted to go back to the comment you made about EMEA slowing a little bit and the decline in revenues in EMEA and APAC versus the growth in the U.S. You know, contrast that with the extremely strong demand conditions that you're dealing with, obviously outstripping your supply. Can you talk to why there was such a splay between the U.S. results and the international results? When you talked about Europe specifically, you mentioned a slowdown in demand there as a result of the economy. Can you factor that into the overall demand picture a little bit, please?
Yeah. Let me start there. You know, what we saw in our second fiscal quarter there, and I would say really kind of starting in February and beyond, is a slowdown of demand in Europe. We think it kind of accelerated a little bit into the last month of the quarter, which was in March. We think it is attributed to macroeconomic conditions, of course, the, you know, Ukraine-Russia war, even though our business in Russia is very small, so there was no really direct impact territorially.
In terms of the whole sentiment in Europe around inflation and potentially the economy slowing down, we think that has caused some customers to be a little more cautious, to scrutinize spend a little more, and potentially to delay some, you know, some orders that they would otherwise make. Now in the big scheme of things, you know, we're not talking about multiple tens of millions of dollars here.
It's effectively a smaller effect than that, but it was noticeable enough in our trends that we felt that we should point it out, in part because we don't yet know how this will play out in Europe, you know, in coming quarters and whether with the continuance of the conflict and more inflation, whether you know, this will continue or and to what extent. We also had, you know, a very strong demand in the Americas, in the enterprise space, as well as for service providers overall. So that contrasts a little bit with Europe.
Alex, I do have to add the this is where you start to see, or you may not see the clearest picture in terms of demand of bookings versus just recognized revenue, because of the constraint that we have in hardware. Normally, you know, in quarters before, there would be a tight link. You know, when we take a look at where, you know, some of the bigger backlog of activity was happening, it was more in the Americas that got shipped out in the quarter associated with the revenue recognition of that systems, which is gonna skew this number a little bit more.
Is Europe more biased to systems and that's and less to software? Is that part of it? Is there any change in your supply chain in your pipeline in Europe in April that would suggest continued erosion in the conditions there? I'll cede the floor. Thanks.
Yeah. The answer to your first question is no, there's no specific activity. I mean, as a whole, Europe probably is slightly higher weighted towards hardware, and APAC slightly towards hardware in bookings, than some of the other businesses, but it's not dramatic. I think, you know, what you will see is just where we have got more backlog, and the aging of that backlog. That's, you know, some of the first things that will get shipped out, and will skew some of these hardware numbers, and the overall revenue by geo number, you know, until we get, you know, fully caught up on some of these supply chain constraints.
As we talked about last quarter, we are trying to, you know, very much take a customer-centric view towards meeting this demand with the limited supply that we've got, and that is gonna just, you know, skew these numbers a little bit. We did point out because of some of the delays of bookings that we saw in EMEA, particularly in month three, when you had you know the geopolitical concerns really you know creep up, that's what we saw, and we wanted to point that out on you know the demand side of the equation too.
Alex, just your question about April. I think the you know the pipeline for EMEA for Q3 actually looks better than what we saw in Q2, but we are cautious because of the macro environment in Europe currently.
Great. Thank you very much for that clarity.
Absolutely.
Your next question comes from the line of Paul Silverstein of Cowen. Please ask your question. Once again, Paul Silverstein, your line is open. If you're on mute, please unmute your line, Paul. There seems to be no response from the line of Paul. We will now be proceeding to the next question coming from the line of Sami Badri of Credit Suisse. Please ask your question.
Hi, this is Ryan on for Sami. Thanks for taking the question. Basically, our first question is, for customers who historically want systems, whether they will opt into the software given the constraints we're seeing for the past quarter. I have a follow-up.
Yeah, I'll start. You know, we just broadly speaking have not seen a hardware to software substitution in the business. The reason for that is that for customers to move to software, generally they have to have considerations from not just F5, but other providers in their environment. Generally, these other providers also have elongated lead times. They also have to have done some architectural work to move to a virtualized environment, which a number of customers you know haven't done if they're still on hardware, so they're not ready to move to software.
For those reasons, what we've seen is the majority of customers who have, you know, large estates on hardware, the lead time, the change in our lead times alone is not a factor that is moving them to software. Now, for those on the margins who can make that move, we are working aggressively with them to make that happen, but we have seen that to be a very marginal phenomenon to date. You know, whether that will change in the future if our lead times continue to be elongated is yet to be seen, but we've not seen any meaningful hardware to software substitution to date.
Gotcha. Appreciate the color on that. My follow-up is, does the reduction in the Q4 guidance imply that 2023 could be a much bigger revenue year, or is this demand that it's essentially going away given the extent of 30 days?
No, we don't think demand is going away. Let me be clear about that. We have, you know, we are seeing very strong demand. We haven't seen any trend in, you know, any order cancellations in any form. We haven't seen any loss of business to competitors, because generally, you know, other vendors also have challenges with lead times. Despite all of the challenges that we're having, our lead times are worse than they used to be, but they're kind of in the mix with other folks there. You know, we continue to see a strong demand from our customers across the board. We don't think that our lead times and our, you know, challenges in shipping hardware right now are causing demand destruction, if you will.
Going into next year, you know, we're not guiding yet to 2023, but of course, it's going to be about, you know, how fast can we get back to shipping to demand. With the visibility that we have right now, you know, we think effectively our fiscal Q1 is gonna be more of the same. It may even be a low point in what we see from availability of supply to date. We think we will start to see improvement in our second fiscal quarter for 2023. Our expectation is that we will be back to, you know, shipping to full demand, you know, in the back half of our fiscal 2023.
Got it. Appreciate the color. Thanks so much.
Thank you.
Your next question comes from the line of Meta Marshall of Morgan Stanley. Your line is open.
Great, thanks. I just wanted to get a sense of maybe kind of breaking down the iSeries and rSeries, you know, whether the resolution of some of the supply chain issues.
exit of our fiscal 2023, we expect to be almost at 100% of serving the demand of our customers primarily with rSeries. That will ramp through the next five, six quarters. Your second question was about iSeries and rSeries constraints. Right now they both are constrained by semiconductor components. We are shifting more of the demand to rSeries because we expect rSeries to be less constrained because it's a newer platform going into the new year. There are less parts effectively on rSeries that have these constraints than on iSeries. That's why we are aggressively shifting the demand to rSeries.
We're also doing some work, of course, on iSeries to be able to continue to meet demand in the next few quarters for customers that really need to be on that platform for a number of reasons.
Got it. When you say calendar Q4, that's more for resolution of rSeries, iSeries is kind of ongoing, rSeries is calendar Q4.
Yes, rSeries is calendar Q4. iSeries, we should see some improvements in also calendar Q4 in terms of the supply we get there. However, you know, going into the new calendar year, we will be continuing to shift to rSeries. rSeries will progressively become the majority of both the demand and the revenue and shipments.
Great. Thank you.
The next question is from Simon Leopold of Raymond James. Please ask your question.
Hi, guys. This is Victor Chiu in for Simon Leopold. Are you guys observing any trends of the public cloud adoption impacting the uptake of F5 subscription in the cloud? You know, that you don't anticipate any customers prematurely moving away from systems deployments to virtual deployments, but can we see customers accelerating you know, the shift of workloads, more workloads into the public cloud, given the constraint in supply? Is that something that could encourage them to move in that direction?
You know, I think, Victor, over the long term, we will continue to see customers, you know, rebalancing their environment to these multi-cloud environments. I think our belief system, which frankly has been our belief for the last, you know, several years, is that ultimately, the applications will land on the best, infrastructure environment for the application. In a lot of cases, that will be public cloud. In some cases, that will be a private cloud. In a lot of cases, that will continue to be a traditional private data center with hardware environments. I don't think that the current supply chain challenges will fundamentally alter that future destination and that future distribution of applications. We also can see it from the customer behavior that we're seeing today.
I think for customers that, you know, really need capacity for their applications and can't get hardware, the best way, the best plan B, if you will, for that, is to move to F5 software on, you know, on virtual machine. To do that, of course, customers need to also have the servers available, and those also have elongated lead times in a number of cases. Moving to a cloud, a public cloud, is an entirely different kind of architectural consideration. It takes planning, it takes quite a bit of time. You know, we don't think that the supply chain challenges are particularly accelerating a move to the public cloud. Generally, we think the destination for all of our customers is multi-cloud. Most of our customers are already in multi-cloud environments.
you know, we intend to, and we've designed our portfolio to serve them for these multi-cloud environments.
That makes a lot of sense. What about for customers that are on the fence or in the process of, you know, straddling their workloads already between on-premise and public cloud? Is this not going to encourage them to move one way or the other? It's not something you envision either?
Well, I think customers who, you know, maybe for greenfield environments, Victor, where customers are just, you know, deploying new workloads, if they could go to a virtualized environment and they have either the servers in-house available or they could you know use F5 software in the public cloud, which many thousands of our customers do that today, that would be a way to get to where they want to be faster. You know, I would say that's a minority of situations today. It's a possibility for customers that are building greenfield environments.
Okay. That's all. Thank you.
Our next question comes from the line of Jim Suva of Citigroup. Please ask your question.
Thank you. Could you give us a little bit of color on the operating margin trajectory and kind of the steps as far as the timing and the magnitude of those steps? You talked about several of them in your prepared comments, but how should we kinda think about the timing in each of those steps? Thank you.
Yeah. Jim, why don't I start and then, you know, if François has got anything to add, by all means, please do. You know, François sort of laid it out in a couple of questions ago on where we see the hardware side of the business over the next, you know, call it three to four to five quarters. We think that, you know, largely the operating margin's gonna ramp back up along with that shipment of hardware back to where we get to our Rule of 40. In the immediacy of it, you know, certainly over the next couple of quarters, we're gonna be below that 37% or the 27%-28% mark that we had set.
A lot of that is largely due to the step down in our gross margins that you know are impacting as well as the less revenue coming from our systems business. You know, those combinations are putting pressure on the operating margin in the near term, but we do expect to get back to you know our Rule of 40 operating plan when we work our way through some of these supply chain constraints.
Great. Thanks so much for the details.
Yeah.
Our next question comes from the line of Rod Hall of Goldman Sachs. Please ask your question.
Yeah. Hi, guys. Thanks for the question. I wanted to come back to the full year guide change. I'm calculating at midpoint about $91 million of reduction there, and I guess it's due to, you know, these ongoing supply chain challenges. You know, I'm curious what the duration of that change is. In other words, are you expecting most of that to happen sooner here, and then you think your supply comes in better as we get to September? Or do you have visibility all the way to the end of this fiscal year and, you know, that encompasses this $91 million? Can you just kinda give us an idea on timing there? Thanks.
Yeah. Rod, I'll start on that one. Look, I think, you know, as we lay it out in our models, you know, the lower point on the hardware side is likely not near term. It's in Q4 or Q1, as we see, you know, the continued pressures that we've experienced for the past couple of quarters continue on. I think François noted some of the green shoots that, you know, will be coming in calendar Q4 that will start to impact and ramp up for us in, you know, calendar Q1 of 2023, and you'll start to see that improvement. On the system side, you know, I don't think the low point is this quarter.
I think the low point is more in Q4 or Q1 of 2023.
2022.
2022. Well, Q1 of 2023.
Oh, Q1 2023, Q4 2022.
Yeah.
Okay. Then I also wanted to just check in with you regarding, you know, back on the demand side of things. Are customers indicating to you that that's temporary? I also noticed your DSOs have jumped up to 59 days. I assume that's due to supply, but are people now starting to order further out, or, you know, why are we seeing that jump in the DSOs? I guess two questions in there really. Sorry about that.
Yeah. Let me start on the DSO side, and then I'll let François pick up the first one, Rod. No changes at all. This is purely a factor of, you know, when we were, you know, a lot of leading up to this quarter had been a lot of the shipments and therefore, you know, the billing going out for that hardware earlier on in the quarter. In this quarter, it was a little bit more in month three. You know, just by nature of the AR balance going up, that's the DSO calculation. There is nothing in terms of any dynamic, you know, to see there.
It's just more a function of that AR balance going up on things that are, you know, in the legitimate net thirty-day window cycle. Nothing there.
Yeah. Rod, in terms of customer behavior, we have seen both. You know, some of our customers who are planning ahead and have the means to plan ahead and order ahead, we started to see their behavior move to ordering well ahead to take into account the extended lead times.
At the same time, we also see other customers who are pushing out and delaying orders, you know, in part to create leverage and say, "Hey, I'll place the next order once you have shipped the order that I placed a few months back." When we net out those two behaviors, we land in about the same place, which is demand is kind of where, you know, where we expected it to be, and it continues to be strong. What we are not seeing is lost demand due to supply chain delays. That's been the trend for the last several quarters, including this last quarter.
Great. Okay, guys. Thanks a lot for the questions. Appreciate it.
Absolutely, Rod. Thank you.
Due to time constraints, we will take our last question from Jason Ader at William Blair. Your line is open.
Hey, this is Sebastian on for Jason. Thanks for taking the question. I just have one clarification, and then an open-ended question. Just in terms of the supply chain issues, last quarter you mentioned about $60 million in revenue being pushed out of fiscal year 2022 for the specialized networking chips. I just wanna make sure those lead times haven't changed at all and that's still the expectation, and it's really, like, the standard components and those lead times that have been pushed out further than expected and pushing revenue into fiscal year 2023. Is that correct?
Let me just clarify that. The entire you know, you're right about $60 million last quarter and where you know the additional down guide this quarter, all of that is linked to specialty semiconductor components. Now, some of that is networking chipsets and we also have challenges with you know components, semiconductor components that are not specific, specifically networking chipsets, but they're more on the power side and power distribution, power shaping type of components. It's the combination of all of that that's causing the delays in shipments and therefore the delays in revenues.
Got it. Okay. That's helpful. As a follow-up, maybe a bit more open-ended for you, François. In terms of as you guys shift more of your revenue to software subscription managed services, is your relationship with the partner channel, the VARs, the MSPs, changing at all? Are you becoming less reliant on them to generate revenue, or are you still sort of as you have been historically reliant on that channel to drive revenue growth?
No. You know, our partners, and, you know, distributors and resellers and our key partners and systems integrators, they continue to be a really important part of our ecosystem. Part of what we have wanted to do as we've moved to software is embark them on that journey with F5 such that, you know, the transformation of F5 towards a software-centric business model can also benefit their model. A number of them are, you know, actually frankly, some of them were ahead of us, and, you know, were part of helping us accelerate our own transformation.
We're seeing that a number of them have embraced these new models and have, you know, found great ways to add a ton of value to our customers in a software-centric model. In fact, that has contributed to our software growth over the last several quarters. No, we're going to continue with a partner-centric model, and we're gonna continue to, you know, innovate with our partners to bring great software solutions to our customers.
Got it. Thank you. That's all I had.
This concludes today's call. You may now disconnect.