Thanks very much for joining us. The purpose of the discussion today, and I'm posting F5 in a second, I'll introduce my speakers, but the purpose of the discussion today is actually not to discuss it. With some of our presenters, I go into billings and quarters and numbers, and I think it's important in the case of F5 is to actually talk about the big opportunity ahead of the company, how the company addresses the opportunity, both the challenges and the opportunities. It's gonna be more of a discussion of F5 101, but F5 2027, basically 101, and where is this company going and how? So I wanna present Frank Pelzer, the CFO, and Tom Fountain, Chief Strategy Officer. Thank you very much for joining us.
Thank you.
Thank you so much for having us, though.
Thanks. So I'll start with a general question. By the way, any question I'm addressing is to both of you, so feel free to jump in and step on one another. It's great to have a little bit of a fight. I'm joking. But I wanna understand, how will the company look like 3-5 years from now? Meaning, what are the opportunities you're going after? And I know it's gonna be a long answer, which is fine, but what are the opportunities you're going after, and how do you go from point A to point B? Meaning, how do you go from where you are today to where you wanna be 3-5 years from now?
Would you please start?
Yeah. So before I respond, though, I need to get our safe harbor on record. So please note that our discussion today may contain forward-looking statements, which involve uncertainties and risks, or actual results may differ materially from those expressed or implied by these statements. Please see our SEC filings for more information on these risk factors. So I think, maybe to tackle your question, let me start by putting our changes in our business in context.
Yeah.
If you rewind the clock a few years ago, I think there was a lot of excitement around the rise of public cloud, and the belief was that it would provide a whole host of benefits, which it certainly provided. But the expectation was that we would simply take all of our workloads from the data center and move them into the public cloud. The reality is far from that. For most organizations today, they find themselves with their applications and all of its related components spread across many different environments. In fact, our research of customers shows that 88% of organizations today live in a hybrid and multi-cloud world. The average organization has 4.5 different types of environments within their infrastructure.
And we've seen a very deliberate shift that organizations today now choose where to place an application based on the application's properties. And so the result is that you have this incredible complexity of different environments in which your applications are hosted. And this problem actually keeps getting worse. The modern applications today are decomposed into many different components. Those fragments are then distributed across all these different environments. Of course, security is a top-of-mind concern for every organization, and the adversary needs to only exploit sort of one of these vulnerabilities across all these different environments to be able to get into the organization.
And then you take a look at things like AI, as we enter the AI era, and that takes all of these problems and exacerbates them, even further. And so, you know, this incredible complexity and challenges around security are quite acute. You know, we've given it a name, so we affectionately refer to it as the ball of fire problem, but it's this escalating set of challenges that organizations face. We wanna solve those sets of challenges for our customers. We have a very rich history of capabilities around application security and delivery.
The drive that we've been on and that we will be on over the next several years is to really create a platform that provides the answers to these challenges across all of these different environments. So you can secure and deliver your app regardless of which environment your application sits in, and you can do it consistently then across all of those. And that will help drive significant improvements in security efficacy, so you can secure your environment better. It drives down the cost to be able to do it, and it greatly simplifies the infrastructure that IT operators have to manage.
Mm-hmm. You started your history from delivery, and you talk about security. Is delivery and security synergistic to one another? Meaning the fact that you have a, a leading position in delivery, does it help you to also be in security?
Yeah, we've found a very tight relationship between the two, in large part because of the criticality and difficulty of sitting in line in the data path. And so that allows us to deliver a whole host of delivery benefits, but we really find that today, increasingly, security is the leading conversation with customers.
Yeah.
Application security is a top-of-mind concern for organizations. They match that with significant spend against those, and we think we're very uniquely positioned to be able to combine both the delivery and security functionality across the entirety of these environments.
Frank, last quarter, software grew 20%. In the context of what we're discussing, what are the sources for growth for in the software space?
Yeah, so many. I think primary growth factors in the vector for F5 is the growth of applications and APIs. More and more customers are looking at software as the desired form factor, whether that is term-based, perpetual, or frankly, the growing number of SaaS. And so that's really where we see the primary growth factors for the whole company coming from and what we see over time. Specifically in the next couple of quarters and in FY 2025, what we've talked about is that we've got a renewal base of revenue that we have pretty clear visibility into, and it's leading to the software growth that we expect in the back half of this year, as well as double-digit growth into FY 2025.
That's largely on the heels of the renewal base, and just executing on that. If we start to see vectors like AI applications and growth around there, and we're able to take advantage, you know, that could be a tailwind to us.
Got it. So it's hard for me personally, just because I've been covering you for so many years, it's hard for me personally to separate the discussion of delivery from security because I think about it together. So maybe we'll start from the delivery market. About delivery of applications, you migrated, you've migrated from, you know, the past few years, you've migrated from appliances on-prem, et cetera, to cloud delivery, modern delivery of applications. And where is this market going? What we used to call ADC market, stand alone? If I don't speak about security, I speak about just delivery. Is the ADC market a growth market? Is it growth market in terms of units, or is it growth market in terms of dollars or combined?
How do we think about your migration from existing customers having ADC platform to customers migrating to the new modern platforms of ADC standalone?
Maybe I'll start, and you can chip in.
Yeah.
You know, I think the ADC market is a low growth market, but it is continuing to grow. I think it's important to note that, you know, the early phases of this were really around adding software to hardware-
Yeah
... to be able to satisfy sort of a longer list of applications. And so it's less about from and to, but more about the combination of needing both hardware and software in the environment. And we think increasingly, SaaS gets added to that. And so-
Right
... the important thing is to be able to buy products across sort of all of those different types that work across sort of this wide range of hybrid and multi-cloud environments, everything from your private data center to your public cloud environment, and then being able to do that in a consistent way. The complexity in this ball of fire problem means that organizations really need to be able to do things like express their security policy once, and have that applied sort of across the entire range. So we describe it as delivering and securing every app anywhere-
Yeah
... and being able to provide a consistent experience to do that. And we're quite unique in delivering that set of functionality. Our traditional ADC competitors have not made the same sorts of investments.
Yeah.
While we made deliberate choices over the last several years to drive innovation in both our hardware and our software, they have not. We have made significant efforts around building commercial constructs that encourage customers to be able to consume across this wide range and grow with us over time. And again, our competitors are instead choosing much more limited set of options for customers. And then, none of our competitors are able to cover this breadth of everything from the private traditional data center all the way to the public cloud. And we are very unique in the capabilities that we have across that range.
And Tal, if I double-click on what Tom said, it is, you know, a low-growth market when you take a look at both hardware and software. When you split those components out on a unit basis, you know, we've said fairly consistently that we think it's, you know, low single digit, a mid-single-digit decline in terms of units, taking a look back at probably pre-COVID levels, because there was a lot of things that happened during COVID that distorted the growth rates of the market. But, if you think about over, you know, a long period of time, maybe starting in 2018, 2019, the unit volume has gone down and the core piece, where we probably have the biggest share of the ADC market.
Having said that, where we have seen growth is the software side of that market, and we continue to see that, as I just mentioned, in the way that people want to adopt software solutions to cover their applications that are now being born in the cloud and other places. So, we are also taking share in just the hardware piece of that market, and that doesn't mention, you know, pricing opportunities that we've got. So, we don't view that piece of the, the market as being a mid-single-digit decline for us-
Yeah
... but, we don't see that as adding to the mid-single-digit revenue growth that we've talked about for FY 2025. We see that as a headwind to it.
Okay. When you describe, I asked you about delivery, and you described delivering and securing, you're always connecting it together. Are the decisions always together? Meaning, or are there customers that are only about delivery, customers only about security? How is the market evolving?
Yeah, so of course, there are always customers that only have a specific need. But when you look at the vast majority of customers, these really do go together. I think as you described, sort of the pairing of delivery and security, we find that in the majority of the conversations really start on the security side. And so, you know, a lot of the conversations begin there. They may include delivery capabilities in order to achieve it, but security is really sort of the lead proposition in engaging with customers.
So I, I spoke with someone from the market participants, one of the professionals, and he—I told him, "Describe for me where is F5 from, like, a strategic point of, like, what do they need to do?" And he said, "They need to SaaSify their solution, that they need to SaaS every..." And the only issue is when you SaaSify, meaning it's when it's all SaaS-based, you find new competition. Like, for example, CDN companies who are trying to operate the same. So, so talk about the journey to SaaS. Talk about the competition you're seeing, and what benefits do you bring to the table, or what are the challenges? Same thing.
Yeah. So I think, maybe, the starting point for us in SaaS really in earnest was an outgrowth of an acquisition that we made a few years ago, a company called Volterra.
Yeah.
That we then put significant organic investment against to really mature that, and perhaps most importantly, bring together our capabilities from our BIG-IP and our NGINX franchises, to bring that functionality all into a converged platform, which we launched in February of 2022. And so that marked a significant moment in our journey, because it completed the portfolio of the different delivery types of technologies that we wanted to provide. And you know, it is the base upon which we are doing this sort of consistent experience across all of these different environments. With that, we obviously began to compete with CDNs, who we've not historically really directly competed with.
But we think we've got a pretty significant differentiation in that we are able to extend the customer's environment all the way from their traditional environment through the cloud and into their public cloud instance. And you contrast that, for example, with the CDN vendors or the SaaS pure plays, none of them are able to extend into either of those. And the customer challenge here really is about being able to secure and deliver that entire range of things. It's not about just doing it for a small-
Yeah
... portion of it. You know, you look at things like, you know, to use several of those technologies, customers have to do pretty unnatural things with hairpinning of traffic and things like that, that with our solution is not needed. You're able to secure and deliver your apps in your on-prem environment, in the... and from the public cloud, as well as sort of your own kind of far edge environments.
I'd add, Tal, that we are well into our transformation journey from, you know, what I would say is the way we typically went to market prior to Volterra acquisition, is we sold a product.
Yeah.
We showed up when it was time to sell the product again, right? And, when you're actually SaaSifying your product, you're SaaSifying your company, and you're having a whole new mentality in the way you think and approach a customer. So, it's not just about selling, and it's the LAER model of land, expand, and make sure renewals and other factors.
Right.
We are in that journey, well into that journey. One of the groups in Tom's organization is our customer success group. They are all about making sure a customer is getting the utilization and value out of their solutions all the way through the usage, not just, you know, when it's time to refresh a product three to five years later.
Right. That's exactly the question I have. We talked a lot about product, but forget the product for a second.
Mm-hmm.
Because you made acquisitions, you have a complete portfolio. The question is whether you are ready in terms of your own internal company-
Yeah
... salespeople, compensation, et cetera, and whether the channel is ready.
Yeah.
Meaning you used to sell your product in a certain way, now it's more of a SaaS model. Is your channel willing to do it, or do you get pushback? So talk about not the product side, but rather the other parts of the organization and go to market. Where are you in terms of being ready to offer SaaS?
Do you want to start that one?
Sure. So I think you characterized it well, that, you know, and ranked it as well, that our traditional business was really around sort of these large mostly refresh-based cyclical transactional engagements with customers. Over the course of the last five years, we have very dramatically changed and quite intentionally changed our sales engagement with customers to be one around a continuous engagement model that includes things like customer success and thinks about the entire life cycle, land, adopt, expand, and renew, in order to ensure that the customers realize the value. Along with that, we've been quite deliberate about our channel partners. As a company, we are very committed to our channel model and working with channel partners and ensuring that they see success.
We have worked through sort of who are the set of channel partners that have the right capabilities, that bring us into the right opportunities for the portfolio we have today. We've been doing that work over the last several years, and we feel very good about the channel partnerships that we have in place. In fact, recently, we've done quite a lot of work around distributed cloud and training our partners on the platform, and enabling them to be able to bring it to customers. You know, we talked just last quarter about 1,500 channel partners that we had trained on distributed cloud, and we're seeing just great success.
The channel partners are very bullish on the story, this ball of fire problem, the solution that we are presenting to it, and specifically our SaaS capabilities in addressing it.
Got it.
We still have got some work to do. We're not completely there.
Yeah.
You know, specifically, I think it's probably another year or two worth of... We have obviously raised our operating margins, and we've tried to be critical on, you know, the investments that we're willing to make, and the growth that we expect out of those investments. Where we have not slowed, and we've actually accelerated, is in our IT transformation internally, to better support a SaaS business, and making sure all of those workflows are tied together in an automated way to make sure we get the productivity, we get the data, we get all the telemetry in the, in the way to you have to think about a SaaS business. And, we are well in that journey, but there's still more, more work to, to do.
Yeah.
So let's translate it in numbers. Your, your guidance for this year was 1% revenue growth, but there is a lot of headwind from last year, depletion of backlog, and can you take us through kind of what's included in this 1%? What are the, the big buckets of growth inside?
Sure. So let me clarify. For total company, we actually, at the beginning of the year, guided to, flat to actually low single-digit decline, and then we tightened that up in the last quarter to, say, - 2% to flat.
Right.
And so it's actually not 1%-
-1%.
But no, no, but -1%. And so in the components of that, Tal, let's start with global services, which is still a little bit more than product in terms of revenue. I think in FY 2023, we ended about 53% of our total revenue came from global services, and that piece of the business is really tied to maintenance, and maintenance around perpetual hardware and software. We do have a small allocation, 37% of our flexible consumption programs that also ratably recognizes into that services stream. And obviously, everything we do around the SaaS products don't have any attributions to services. And over time, we see that as flat to low single-digit growth.
And the reason for that is because some of that shift to SaaS, and, you know, just the dynamics that are going on in the market. So that's, that's the component that we have said is, you know, it actually started off very well at 7% growth, 5% growth last quarter, but it will trail down in the back half to be closer to that. The next piece is, I would say the software side, which is, roughly about, 23% or so of revenue, total revenue in FY 2023.
We talked about that being, you know, flat to modest growth, really driven by the fact that we did not expect to see, you know, a ton of new business growth, and our renewal base, you know, coming into the year was about that.
Yeah.
What we said last quarter is that, you know, if we actually end up there, we're gonna be disappointed because we actually started off in the first half of the year better than what we had modeled.
Yeah.
We didn't update it, but we did sort of give an indication that we think we're gonna be higher than that, for the full year. That's really driven by all the dynamics that we've talked about. The last piece, which was 24% of total revenue, in FY 2023, is the systems piece, the hardware side of the business. That's the side that's really leading to the negativity this year, because, of the $180 million of backlog, the headwind that we had coming into this year.
Right.
And that was really based off of sales that happened in 2022. We obviously had supply chain crises of things that we couldn't ship out during that period of time. We were able to improve that in Q1 and really improve it in Q2 of last year, which led to a really difficult comp in our systems business. What we have said is that the demand, actually, in bookings is growing over what we saw in 2023, but not enough to make up for $180 million of headwind from that backlog that was recognized in 2023, that was really based off 2022 sales. So that's the totality of how we get to, you know, -1% at the midpoint. And, you know, we're continuing to work at that.
What we also said is that, when we take a look at the back half, you know, the pipeline is rather healthy, and now it's about execution.
Yeah. If I think about the longer term, what is the potential for software to grow, and what do you think will happen to systems?
Yeah. So, we haven't really talked beyond 25 yet in terms of expectations. If in my crystal ball, which is arguably cloudy, you know, systems is probably the hardest thing to predict, but it is in that realm of I do think it's mid-single-digit decline in terms of unit demand, and what we do on pricing may make up for that. What we do in competitive wins in the space may make up for that, but it's not likely gonna be, you know, much of a grower for us. Maybe we get it to flat, maybe a little bit of growth, maybe a little bit of decline, but in that range for systems over a longer period of time. I think that's reasonable to expect....
Software, we have talked about double-digit growth in FY 25, largely driven off of the renewal base, and that being the first year where we've got renewal upon renewal. And so, you know, when that motion really started in 19, the first renewal cycle, and almost all of our contracts are sold in flexible consumption programs on 3-year increments. And so 2025 is that first year where you've got the second term plus the end term on top, and we'll continue to see that. And there's, you know, some very good renewals that are-
Yeah
... that are to come, and so that gives us a lot of confidence around that double digits. And I, I think, look, you know, our placement and our need for our technology in AI applications, you know, could provide a tailwind even as early as 25, but we're not trying to get ahead of ourselves. We really do believe that that base of spending starts at the bottom of the stack, and it's really at the chip level now, move up, and will increasingly move up the stack as time goes. And, you know, for us, that may be more of a 25 event.
Right. I have a follow-up question on the software 2025 growth you mentioned with the renewals. I remember when you spoke about renewals before, there is some kind of revenue recognition that brings it upfront, the revenue. Like, 62% is recognized upfront, if I remember. And then there is the overage, it's also recognized upfront. So when you talk about strong growth, double digits, is it, is it because of the revenue recognition, meaning a lot of it being recorded upfront, or is it even on the bookings level? When you look at it on a-
Yeah
... kind of trying to normalize as much as you can for a revenue recognition timing.
Yeah, it's so you all driven on the bookings upfront, and then the new activity is the bookings that will continue to drive-
Yeah
... that number up. I would say over the last couple of years, as the growth rate has slowed from what we're, where we're 35% down to, you know, relatively flat last year, and what we're talking about is relatively flat this year. That is really more of a factor of not having necessarily those transformational activities adding into that base, but, offset by, you know, some of the growth that we have seen in the True forward pieces of the business. And what I've talked about is that, you know, converting that NRR, and converting that to an NRR base is a highly manual process, but we have seen, you know, levels that are, I would say, world-class-
Yeah
... in that term, in the flexible consumption programs, the term piece of that revenue stream. The dynamics, I can't get away from just 606-
Right
... and the revenue recognition associated with it. And so, that double-digit growth is going to be based off of those interim contracts or the second term, or even the new contracts coming into place, that do have that 63% in the quarter in which it's signed-
Right
... that is recognized then, and then the rest of it goes into services with a little bit of an exception of the True Forward that you get from the premium programs.
Yeah.
And so, if we sold the same amount every year, it would look like a ratable model. Unfortunately, you know, not every quarter is the same, and not every year is the same, so we do get some volatility and some fluctuation. That will start to be muted as more of our revenue is coming from our SaaS platform and distributed cloud in particular. And that's really where we're seeing a lot of the growth and the expectations. And with AI application security, as Tom said, that will be a huge factor in that business. But that is, I've got to even look beyond 2026 -- like-
Got it
... that's gonna be, you know, more meaningfully-
Got it
... out until it actually is a contributor to the overall, you know, $2.8 billion of revenue that we've got.
Got it. By the way, is there any question from the audience before we wrap it up? No, so I'm gonna continue with my line of questions.
No, please.
I have a few more. I wanted to ask you about orders. And when you talk, you know, we talk a lot about revenues, but revenues, there is a problem with revenues because there is backlog and there is timing of recognition, et cetera. Can you talk about the concept of orders and the concept of the current environment? Because on the call, I'm gonna mix kind of two things together. On the call, you talked about customers sweating assets right now. So talk about what do you expect from, on that front of customers sweating assets, and then talk about kind of what you see in terms of orders, or what are your expectations in terms of orders, regardless of the timing when it's recognized? Yeah.
Yeah. Tom, you want to start on the sweating?
Yeah. Why don't I start maybe on the sweating of assets? So we've been seeing customers for a number of quarters now, sweat assets. That really means that they're driving greater utilization of their existing systems, and forgoing, at least for a period of time, the replacement cycle that they would have otherwise gone through. We see that most pronounced in some of our data. So we do quite a bit of cohort analysis, where we look at the aging of our installed base, what the maintenance attach looks like. And what we see in that data is that, over the last several quarters, basically every cohort has increased maintenance, meaning that they're buying maintenance longer than they would have historically. That's particularly pronounced in the 4-6-year period.
That's noteworthy 'cause for many of these systems, 3-6 years is kind of a typical replacement cycle.
Yeah.
So it's suggestive that right about the time people would otherwise replace it, they're instead choosing to elongate the cycle a little bit. We think that that eventually has to give way. You can only run these networks and these environments hot for so long. It's hard to predict exactly when that's going to turn, but it's quite clear from customers that it will need to. We've looked historically back in prior sort of cycles, and what we've seen is that the elongation of maintenance is right now at about the peak that it's ever been, which again suggests that we're sort of hitting the end of what exactly customers will be able to sweat assets for.
But calling which quarter and exactly when that changes, hard to predict.
Right. In terms of orders, I'm gonna translate it into demand, Tal, just to-
Yeah
... make it easy in terms of, in terms of way to think about it. So, I think, you know, we overperformed the demand that we expected in 2022 going into the year.
Yeah.
We weren't able to ship it. So, when we thought about what that business was gonna do, and when we talked about the growth rate that we expected at the beginning of FY 2022, we actually hit that in terms of orders or demand, but we weren't able to fill it because of-
Yeah
... supply. What we didn't anticipate in 2023 was probably how much some of that order activity, the demand activity, would fall, and particularly for new projects. And where we were able to catch up on some of our systems demand being shipped out, we didn't see it in new activities, either in systems or software, and that led to, you know, us having to lower our expectations in Q2 of FY 2023.
Yeah.
We've been fairly consistent with what we called at the beginning of FY 2024, that we do think that, you know, the demand is gonna be an improvement on 2023, but not to the levels of what we saw in 2022 and even 2021.
Right.
And that's really driven by, you know, I would say, sort of, a macro pause, a sweating of the assets, other things that can only take so long. But it's really, as Tom said, hard to call. Is it Q3? Is it Q4? Is it Q1 next year? Like, it, it's-
Right
... it's tough to say.
Right. Absolutely. Okay, Frank and Tom, thank you very much. We ran out of time, but it was excellent. I think we covered everything we wanted. Thank you.
Thanks so much, Tal.
Thank you.
Appreciate it.