F5, Inc. (NASDAQ:FFIV) Q2 2024 Earnings Call Transcript April 29, 2024

F5, Inc. beats earnings expectations. Reported EPS is $2.91, expectations were $2.88. F5, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good afternoon, and welcome to the F5, Inc. Second Quarter Fiscal 2024 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] 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 DuLong. Ma'am, you may begin.

Suzanne DuLong: Hello, and welcome. I am Suzanne DuLong, F5's Vice President of Investor Relations. Francois Locoh-Donou, F5's President and CEO; and Frank Pelzer, F5's Executive Vice President and CFO, will be making prepared remarks on today's call. Other members of the F5 executive team are also here to answer questions during the Q&A session. A copy of today's press release is available on our website at f5.com, where an archived version of today's audio will be available through July 28, 2024. We will post the slide deck accompanying today's webcast to our IR site at the conclusion of our call. To access the replay of today's webcast by phone, dial (877) 660-6853 or (201) 612-7415 and use meeting ID 13745541. The telephonic replay will be available through mid-night Pacific Time, April 30, 2024.

For additional information or follow-up questions, please reach out to me directly at s.dulong@f5.com. Our discussion today will contain forward-looking statements. which includes words such as believe, anticipate, expect and target. These forward-looking statements involve uncertainties and risks that may cause our actual results to differ materially from those expressed or implied by these statements. We have summarized factors that may affect our results in the press release announcing our financial results and in detail in our SEC filings. In addition, we will reference non-GAAP metrics during today's discussion. Please see our full GAAP to non-GAAP reconciliation in today's press release and in the appendix of our earnings slide deck. Please note that F5 has no duty to update any information presented in this call.

With that, I will turn the call over to Francois.

Francois Locoh-Donou: Thank you, Suzanne, and hello, everyone. Thank you for joining us. In my remarks today, I will speak to our Q2 highlights as well as our expectations for Q3 in FY '24. Frank will then review the details of our Q2 results and provide additional color on our outlook. Overall, customers remain cautious as a result of lingering macroeconomic concerns and what currently looks like generally flat IT budgets for calendar 2024. Against this backdrop, we delivered a solid Q2 with revenue near the mid-point of our guidance range. Our software subscription renewals continued to perform well, driving 20% total software revenue growth compared to a year ago, including 28% subscription revenue growth. We also delivered non-GAAP earnings per share growth of 15% with EPS of $2.91 per share at the high end of our guidance range.

As we look into our second half, we remain on track to deliver on our FY '24 revenue outlook. We expect continued strong performance from our software subscription renewals and our renewals base provides good visibility into the back half of FY '24. We also remain committed to continued operating discipline, and we are raising our FY '24 non-GAAP EPS outlook to a range of 7% to 9% growth from our prior range of 6% to 8% growth. Frank will discuss our outlook in greater detail in a few minutes. Before he does that, I will spend a few minutes speaking to the hybrid multi-cloud ball of fire our customers' IT teams are living in, explaining F5’s differentiation in addressing this ball of fire and highlighting some notable customer wins from Q2.

The current state of application security and delivery for large enterprises has IT teams in crisis. The increasing complexity and the associated cost and risk they are battling is not incremental. It is untenable, and it is growing even more so by the day. Just a few years ago, customer believed that by now, their applications would be consolidated in the public cloud. Instead, today, they are grappling with a more complex and costly set of challenges than ever before. 88% of our customers report they are currently operating applications across a combination of on-premises and cloud environments. On average, organizations are operating across 4.5 different types of environments. Most organizations have hundreds of applications, each with a set of associated APIs distributed across these multiple environments.

And because modern applications have decomposed monolithic applications into smaller components, those components are more fragmented and distributed. As a result, APIs and data also are more distributed. The result of this expansion and distribution is amplified security risks across a larger attack surface area. These challenges will be further intensified by the inevitable widespread adoption and proliferation of AI. This complexity is preventing organizations from operating at the speed of their businesses demand. Manual tasks, inconsistent security controls, operational silos, lack of available talent, escalating cloud costs and inefficient traffic routing are slowing them down. We have affectionately named this set of escalating challenges, the ball of fire.

During Q2, we spoke with more than 1,600 customers and partners about the ball of fire at our Global AppWorld events. These events gave us the opportunity to explain how our distributed app security and delivery platform can mitigate customers ball of fire challenges. We have significantly expanded and evolved our solutions portfolio over the last several years. Today, only F5 can truly support the demands of today's hybrid multi-cloud application infrastructures. More specifically, we are the only solution provider that secures, delivers and optimizes any app, any API anywhere. F5 is highly differentiated in addressing customers' pain points in this ball of fire in several ways. First, app security. F5 offers the most effective and comprehensive app and API security platform in the industry.

While several providers offer point products for specific threat vectors, F5 has built an integrated and comprehensive suite of best-in-class capabilities, all delivered through a single platform. Why does this matter to our customers? Because our customers can consolidate solutions addressing all of their app security needs with a single platform and without making trade-offs on efficacy. Second, simplification. We make hybrid multi-cloud ridiculously easy. Only F5 has a solution footprint that extends to all environments in the ball of fire, including public clouds, at the edge and customers' on-prem environments. F5 radically simplifies the work of connecting these disparate infrastructure environments as well as the applications deployed in and across them.

Why do customers care about this? Because we enable the hybrid multi-cloud flexibility their businesses demand with the simplicity their IT operations require. And third, sterilization and automation. F5 uniquely streamlines customers' operations with consistent policies, comprehensive automation and rich analytics. This enables customers to consolidate vendors and tool sets, rationalized operational silos and automate life cycle management of their on-premises deployments. The result is far less toil for NetOps, SecOps, and DevOps teams. Why does this matter to customers? Because it results in more cost-effective and scalable IT operations. It is the combination of these three points of strong differentiation along with the role that F5 plays embedded in the flow of application traffic that create F5's unique position and enable us to extinguish the ball of fire for our customers.

We empower our customers to run at the speed their businesses demand. Let me offer a few customer examples from Q2 to illustrate how these capabilities are manifesting today in our customers' real-world use cases. The first two customer examples I will speak to highlight our application security capabilities. The first example is an API security use case. Last quarter, we spoke to the substantial increase we are seeing in the volume of API targeted attacks. Customers tell us API security is one of their most significant concerns and with good reason. APIs represent a critical avenue for attack, potentially exposing back-end systems and data. We foresaw this API crisis coming and last year, launched a comprehensive and AI-ready API security solution available via F5 Distributed Cloud Services.

Our differentiation stems from our ability to go beyond API discovery through traffic analysis. In addition, we performed continuous monitoring, code scanning, API testing analysis, threat surface mapping and enforcement. We do all of this in a holistic easy-to-deploy solution that provides complete visibility, architectural flexibility and management through a single pane of glass. During Q2, a large multinational networking and telecommunications company needed a solution to mitigate an explosive rise in API and web application attacks on its digital wallet solution. This solution supports more than 400 million wallets across 24 countries, processing over 2.8 billion transactions worth more than $40 billion every month. To protect their consumers' financial transactions on a global scale, this use case demanded the highest level of app and API security efficacy with no trade-offs on performance.

The customer is standardizing on F5's Distributed Cloud Services, application and API security as the basis for its new industry network and API security globally, ensuring coverage for new markets worldwide with heightened security for financial transactions. The second app security example is a bot mitigation use case. In Q2, a multinational beverage company leveraged our Distributed Cloud Services platform for advanced bot mitigation. During a proof-of-concept, F5 solution discovered 99% of the customers' traffic was coming from bots and it blocked millions of fragile fraudulent attempts. As a result, the customer deployed F5 across its branded marketing and consumer-facing sites and thus far, has saved near $3 million in fraud. This deployment is also an example of the success of our land and expand strategy as the customer previously deployed F5 for load balancing and WAF.

The next customer win I will highlight exemplifies how F5 is able to simplify connecting disparate infrastructures, making hybrid multi-cloud ridiculously easy for our customers. An energy company in our APAC region selected a combination of big IP VELOS hardware and distributed cloud services to improve application security and scalability while also driving operational efficiency and reducing costs. Following the acquisitions of several companies, the customers wanted a new shared infrastructure that united their disparate on-premises operating environment and position them to move to the cloud. Ultimately, this customer opted to consolidate multiple vendors on to F5, leveraging our hardware and SaaS offerings. The final two customer wins I will highlight demonstrate how we streamline customers' operations with consistent policies, comprehensive automation and rich analytics.

During Q2, an American auto insurance provider selected F5 Distributed Cloud Services to increase their business velocity through automation. The customer faced the ball of fire. The evolution of their multi-cloud infrastructure led to tool fragmentation, inefficient modern application deployment, inconsistent security and the lack of manageability and visibility. The customer evaluated several point solutions in addition to F5's platform approach. We demonstrated our ability to improve velocity through automation, while also providing consistent and more effective app security and faster response times. The customer ultimately consolidated on to F5 replacing their existing WAF provider with distributed cloud services. In another example from Q2, a multinational bank and financial services company expanded their F5 BIG-IP footprint.

Leveraging both software instances in public clouds and hardware and traditional data centers, F5 is enabling a fully automated self-service ADC and security solution for all of their load balancing and firewall needs. As a result, the customers speed of provisioning new application services have gone from weeks to minutes, and F5 has captured a 2x increase in spend over the last five years. Before I pass the call to Frank, I will close with some brief commentary about how we are innovating to target and capture emerging AI opportunities. There is no question that AI will accelerate the growth in the number of applications and APIs. It will also exacerbate the ball of fire. Last quarter, we spoke about F5 as an AI enabler and discussed some early use cases where customers are deploying F5 in support of AI initiatives.

In addition to innovating and evolving our portfolio to ensure we are optimizing for AI, we also are engaging customers in architectural discussions about the AI readiness of their environment. We already are working with customers on three specific AI-related challenges. The first is API security because API security is AI security. As APIs proliferate, for example, through the adoption and deployment of AI services for inferencing, there is a critical need for a solution that automatically discovers and secures those endpoints. As I mentioned earlier, F5 has the most comprehensive AI ready API security solution available today by our F5 Distributed Cloud Services. The second AI-related challenge is secure multi-cloud networking. With increasingly distributed applications and APIs, customers need high throughput connectivity across on-premises, cloud and edge for AI inference.

Distributed cloud services is unmatched in its capabilities to connect, secure and manage distributed apps and APIs across hybrid and multi-cloud environments. The third AI related challenge is high-speed data ingestion. In use cases where customers want to ingest data for multibillion parameter AI models, they need high performance low balancing, and no one is better at high throughput load balancing than F5. We expect that enterprise is broadly ramping AI adoption over the next one to two years will bring a host of additional AI fuel use cases for F5 solutions. Our platform approach, our continuing innovation and our role in the line of traffic of millions of applications that will ultimately leverage AI puts us in a unique position to partner with customers as they work to solve both current and future AI challenges.

Now I will turn the call to Frank. Frank?

Frank Pelzer: Thank you, Francois, and good afternoon, everyone. I will review our Q2 results before I elaborate on our Q3 and FY '24 outlook. We delivered Q2 revenue of $681 million, reflecting sales that were down 3% year-over-year with a mix of 56% global services and 44% product revenue. Global services revenue of $381 million grew 5%, in line with our expectations, which reflect our lapping the benefit of prior price increases. Product revenue totaled $300 million, down 12% year-over-year, reflecting a lower level of backlog related systems shipments than the year ago quarter. Systems revenue of $142 million declined 32% year-over-year. Total software revenue grew 20% over the year ago period to $159 million. Subscription based revenue contributed $140 million or 88% of the total software revenue representing growth of 28% from last year.

Within subscriptions, renewals were strong. As expected, demand for new subscriptions were flat year-over-year, given customers' current spending caution on new projects. Rounding out our software revenue, perpetual software contributed $18 million. Revenue from recurring sources contributed 75% of Q2's revenue, up from 65% a year ago. Recurring revenue includes subscription-based revenue as well as the maintenance portion of our global services revenue. On a regional basis, revenue from Americas grew 1% year-over-year, representing 57% of total revenue. EMEA declined 6%, representing 26% of revenue, and APAC declined 9%, representing 17% of revenue. Looking at our major verticals, we saw relative strength from enterprises with enterprise customers representing 69% of product bookings in the quarter.

Government customers performed well, representing 19% of product bookings, including 7% from U.S. Federal. Finally, following the strong Q1, service providers represented 13% of Q2 product bookings. Our Q2 operating results reflect the usual seasonal patterns as well as our continued operating discipline. GAAP gross margin was 79.3%, non-GAAP gross margin was 82.1%, an improvement of approximately 170 basis points from Q2 of FY '23. As expected, our operating expenses ticked up in Q2, given payroll tax resets as of January 1 as well as costs associated with our Global AppWorld events. Our GAAP operating expenses were $400 million. Our non-GAAP operating expenses were $349 million. Our GAAP operating margin was 20.5%. Our non-GAAP operating margin was 30.9%, reflecting an improvement of approximately 370 basis points from Q2 of FY '23.

Our GAAP effective tax rate for the quarter was 18.4%. Our non-GAAP effective tax rate was 20%. Our GAAP net income for the quarter was $119 million or $2 per share. Our non-GAAP net income was $173 million, up approximately 13% from Q2 of FY '23. Our non-GAAP EPS was $2.91 per share, up approximately 15% from Q2 of last year. I will now turn to cash flow and balance sheet, which also remained very strong. We generated $222 million in cash flow from operations in Q2, up 57% from $141 million in the year ago period. The significant increase is largely the result of an increase in cash received from customers and the timing of collections compared to billings. CapEx was $9 million. DSO for the quarter was 51 days, down from our unusually high 67 days in Q1 and reflecting our improved product availability and a return to normalized shipping linearity, which supported strong cash collections.

Cash and investments totaled approximately $910 million at quarter end. Deferred revenue was $1.81 billion, up 1% from Q2 of FY '23. Our share repurchases reflect our ongoing commitment to returning cash to shareholders. We repurchased $100 million worth of F5 shares in Q2 at an average price of $184 per share. Year-to-date, we have used approximately 68% of our free cash flow towards share repurchases. Finally, we ended the quarter with approximately 6,450 employees. I will now speak to our outlook for Q3 and our updated view on our FY '24 outlook. First, I will speak to Q3. We expect Q3 revenue in the range of $675 million to $695 million. We expect non-GAAP gross margins in the range of 82% to 83%. We estimate Q3 non-GAAP operating expenses of $340 million to $352 million.

We are targeting Q3 non-GAAP EPS in the range of $2.89 to $3.01 per share. We expect Q3 share-based compensation expense of approximately $55 million to $57 million. I will now turn to our FY '24 outlook. We have good visibility to and confidence in our subscription renewals in our second half. This visibility leads us to expect our second half of FY '24 will be stronger than our first half, reflecting the cyclicality associated with the timing and cadence of our subscription renewals. Our outlook does not assume a significant improvement in macro environment. As Francois mentioned, we expect FY '24 revenue growth that is flat to down 2% from FY '23. This outlook is consistent with our prior FY '24 revenue outlook, albeit with more specificity on the range given we're halfway through the year.

We are not revising our gross or operating margin targets for FY '24 and continue to expect non-GAAP gross margins in the range of 82% to 83%. We expect non-GAAP operating margin in the range of 33% to 34%. We now expect our FY '24 tax rate will be in the range of 20% to 22%, a slightly wider range than our prior estimate of 21% to 22%. Finally, we are raising our non-GAAP EPS growth expectations. We now expect FY '24 non-GAAP EPS growth between 7% and 9%. This is up from 6% to 8% range we provided last quarter. I will now turn the call back to Francois. Francois?

Francois Locoh-Donou: Thank you, Frank. In conclusion, F5 predicted the hybrid multi-cloud ball of fire crisis our customers now face. For the last several years, we have been innovating and evolving to create the industry's first distributed application security and delivery platform. Today, we are the only provider capable of securing, delivering and optimizing any application, any API regardless of its location, be it in a data center, any one of the public clouds, as SaaS or at the network edge. Today's hybrid and multi-cloud reality brings with it untenable operational complexity, considerable cost and escalating security risks. Broad-based enterprise adoption of AI will only compound these challenges. F5's three points of differentiation, best of breed app security, our ability to simplify connecting disparate infrastructures and our ability to streamline operations through standardization and automation set F5 apart from the alternatives.

When combined with the role we play in the line of application traffic, these differentiators position us to extinguish the ball of fire for our customers empowering them to run at the speed their businesses demand. Operator, please open the call to questions.

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