F5, Inc. (NASDAQ:FFIV) Q3 2023 Earnings Call Transcript
F5, Inc. (NASDAQ:FFIV) Q3 2023 Earnings Call Transcript July 24, 2023
F5, Inc. beats earnings expectations. Reported EPS is $3.21, expectations were $2.86.
Operator: Good afternoon, and welcome to the F5, Inc. Third Quarter Fiscal 2023 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will [Technical Difficulty] presentation. [Operator Instructions] Also, conference is being recorded. If anyone has any objections, please disconnect at this time. I will 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 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 A copy of today's press release is available on our website at f5.com, where an archived version of today's audio will be available through October 24, 2023. The slide deck accompanying today's discussion is viewable on the webcast and will be posted 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 13739739.
The telephonic replay will be available through midnight Pacific Time, July 25, 2023. For additional information or follow-up questions, please reach out to me directly at s.dulong@f5.com. Our discussion today will contain forward-looking statements, which include words such as believe, anticipate, expect and target. These forward-looking statements involve uncertainties and risks that may cause our actual results to differ materially from those expressed or implied by these statements. We have summarized factors that may affect our results in the press release announcing our financial results and in detail in our SEC filings. In addition, we will reference non-GAAP metrics during today's discussion. Please see our full GAAP to non-GAAP reconciliation in today's press release and in the appendix of our earnings slide deck.
Please note that F5 has no duty to update any information presented in this call. With that, I will turn the call over to Francois.
Francois Locoh-Donou: Thank you, Suzanne, and hello, everyone. Thank you for joining us today. In my remarks today, I will speak to the quarter's results and the current customer spending environment. I will then highlight some notable customer wins from the quarter, including some emerging areas where we are seeing good early traction. Overall, customer caution persists, with customers continuing to sweat assets amidst tight budgets and lingering macroeconomic uncertainty. Despite the tough environment, our team is executing well and we delivered third quarter revenue at the midpoint of our guidance range, with earnings per share well above the high-end of our range. From a demand perspective, we are seeing some early signs of stabilization.
Q3 demand played out slightly above our beginning of quarter forecast, which was up from Q1 and Q2 this year, though still off from FY '22 levels. Our global services team delivered strong 8% growth, driven by a continuation of customer trends from the first half of the year, including strong maintenance renewals and price realization. With customers sweating existing assets, we also continue to see higher maintenance attach rates on all the deployments. Our product revenue grew 1%, with systems revenue growing 5% and software revenue declining 3% year-over-year. While systems revenue is benefiting from supply chain normalization and our efforts to substantially work down backlog, systems demand remains constrained. In contrast, we are seeing some positive signs in software demand.
Total software revenue was down 3% year-over-year, against a strong Q3 2022 compare. However, total software grew 32% sequentially. And within software, our subscription software revenue grew 4% year-over-year to a record high of $152 million. This reflects strong growth in our software renewals and interim expansions or true forwards, as well as some stabilization in new term subscriptions from the first half. Moving from revenue to our operating results. We are also demonstrating operating discipline and driving operating leverage. Our Q3 non-GAAP gross margins of 82.5% improved more than 200 basis points from Q2. This was slightly ahead of our guidance and reflects the combination of expected supply chain easing and price realization, as well as some of the ancillary supply chain costs like broker and expedite fees.
Finally, working their way out of our inventory as planned. In addition, our Q3 non-GAAP operating margins of 33.2% improved 600 basis points from Q2 and more than 400 basis points from Q3 FY '22. As a result of these improvements as well as some tax favorability, we significantly overachieved our non-GAAP EPS expectations in the quarter and now expect to deliver double-digit non-GAAP earnings per share growth for FY 2023. We believe our growth opportunity is fundamentally linked to the continued growth of applications and APIs and the need to secure, deliver and optimize those apps and APIs. As part of our efforts to capture that growth, we continue to drive innovation, advances and integration across our product families, including F5 BIG-IP, F5 NGINX and F5 Distributed Cloud Services.
I will call out some customer highlights from each product family from the quarter. Our BIG-IP family, which serves traditional applications either on-premises, collocated or in-cloud environments, continues to take share from competitors who have failed to invest in innovation. From a hardware perspective, the value proposition with our next-generation platforms is resonating with customers with our rSeries and VELOS platforms, representing more than 70% of Q3 systems bookings. On the software side, BIG-IP's data point performance, automation capabilities and lower total cost of ownership continues to differentiate our offering and drove multiple wins in the quarter, including wins at a major American airline, a multi-national automobile manufacturer and a major UK retail and commercial bank.
We also saw strong demand for F5 NGINX in the quarter. NGINX serves modern, container-native and micro-services based applications and APIs. We continue to see large enterprises adopt NGINX for their cloud and Kubernetes workloads. We have repeatedly demonstrated that when applications are built with NGINX from the ground-up, and those apps grow. We grow with them. We saw this in several NGINX growth opportunities in the quarter, including a multi-million dollar term-based subscription renewal that grew by an extraordinary 10x from initial inception. The customer, which provides a large collaboration platform is streamlining deployments in both public and private clouds using F5 NGINX as their single platform for load balancing, cashing and telemetry.
Over the last several years, we have invested both organically and inorganically to build a portfolio of SaaS and managed services called F5 Distributed Cloud Services. Since launching distributed cloud in February of '22, we have been expanding our offerings and building momentum for multiple security use cases. A good example of this is a win with a global financial services industry application provider that wanted to standardize its web application firewall and API protection or WAP policies and deployments in APAC and EMEA to reduce time to delivery. Their existing this application (ph) security and complex policy tuning was a challenge as was managing apps and APIs across distributed environments with a small team. Today, F5 Distributed Cloud Services is protecting their apps and APIs with WAP and multi-cloud networking, reducing their time to delivery from months to minutes.
It is early days still, but we also are seeing encouraging signs that our distributed cloud services are intercepting the markets, specifically in two emerging categories, API security and multi-cloud networking. On API security, with the growth of modern applications using containers and composed of distributed microservices, the number of API endpoints is exploding. CISOs tell us they struggle to know-how many APIs they have, where they all are, who is connecting to them and to what extent, they are secured. Doing so, requires robust API discovery and protection capabilities like those we offer in our distributed cloud API security service. When a North American service provider experienced a serious cyber security incident, which caused them to lose their entire virtualization infrastructure at multiple datacenters, they turn to us for urgent help.
F5 distributed cloud services, superior features, functionality and value beat a competitive offering and we worked with the customer to emergency onboard the platform, including advanced WAP both defense and API security. Once deployed, the customer immediately started migrating sites restoring their services. We are also seeing strong early traction in our distributed cloud multi-cloud networking offerings launched just this past March. 85% of respondents cited in our 2023 State of Application Strategy Report said they already are managing multi-cloud environments, securely connecting applications between on-premises, multi-cloud and edge environments at-scale is a tough task for any organization. Our secure multi-cloud networking solutions changed the game.
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Our ability to package networking, security, and distribution of applications and APIs is unique. Until now, customers have been forced to manage and secure these layers in isolation, often leading to operational complexity, network latency and weak security. Our multi-cloud networking solutions reduce operational complexity for our customers and make it possible for them to securely connect distributed networks and applications across public clouds, on-premises data centers and edge locations. Customers are beginning to understand the power of our secure multi-cloud networks, ability to provide end-to-end visibility, control and security across all of their applications. This empowers them to move workloads to the cloud between clouds and even through the edge, while maintaining end-to-end visibility and consistent security policy.
F5 distributed cloud uniquely unifies the visibility, control and security for every application and API, so that applications can be delivered without constraint and with the security today's threat environment demands. Early traction for our secure multi-cloud networking offerings includes a win with one of the world's largest independent providers of insurance claims management systems. F5's multi-cloud networking now enables their global SaaS offerings. The customer first deployed our distributed cloud WAP in February of 2022, to protect a business critical public-cloud workload. In early '23, the customer was abruptly asked to leave a datacenter forcing them to lift and shift workloads to the public cloud in just two weeks. They used F5 Distributed Cloud for this emergency lift and shift.
In fact, the project went so smoothly that they opted to expedite moving their global data centers to public clouds. Now, the customer has standardized on F5 Distributed Cloud for their secure multi-cloud networking needs, spanning across multiple clouds and protecting external and internal applications and APIs. These are just some of the customer challenges we help tackle in Q3. While we are not in a position to predict with precision when customer spending patterns will return to more normal levels, F5 is well-placed to benefit when they do. We are encouraged both by the early signs of stability in Q3 and with the resonance our application and API-focused approach is having with customers. We are making it possible for our customers to secure, deliver and optimize their applications and APIs with a consistent approach, no matter what environment they're deployed in, datacenter, collocated, private cloud or public cloud.
And this is a critical capability and differentiator in today's hybrid multi-cloud network world. Now, I will turn the call to Frank. Frank?
Frank Pelzer: Thank you, Francois, and good afternoon, everyone. I will review our Q3 results before I discuss our fourth quarter outlook. We delivered Q3 revenue of $703 million, reflecting 4% growth year-over-year. Our revenue remained roughly split between global services and product with global services representing 53% of total revenue. Global services revenue of $374 million grew a strong 8%, due to continued high maintenance renewals as well as the impacts of the price increases introduced last year. Product revenue totaled $328 million, representing growth of 1% year-over-year. Systems revenue of $155 million grew 5% year-over-year. Software revenue totaled $174 million, down 3% from a tough compare in the year-ago period.
Our software revenue is comprised of both subscriptions and perpetual license sales. Subscription base revenue hit a new high in Q3 in both dollars and as a percentage of software revenue. Our subscription revenue totaled $152 million, or 87% of Q3's total software revenue and as Francois mentioned, grew 4% year-over-year. Perpetual license sales of $22 million represented 13% of Q3 software revenue. Revenue from recurring sources contributed 75% of Q3's revenue, which is a new all-time high as a result of the strong subscription contribution. Recurring revenue includes subscription-based revenue as well as the maintenance portion of our services revenue. On a regional basis, revenue from Americas grew 3% year-over-year, representing 57% of total revenue; EMEA grew 16%, representing 26% of revenue; and APAC declined 6%, representing 18% of revenue.
Looking at our major verticals, during Q3, enterprise customers represented 66% of product bookings, service providers represented 13% and government customers represented 21%, including 8% from U.S. Federal. Our Q3 operating results were strong, reflecting our previously announced cost reductions and overall operating discipline. GAAP gross margin was 79.8%. Non-GAAP gross margin was 82.5%, an improvement of more than 200 basis points sequentially. GAAP operating expenses were $457 million, non-GAAP operating expenses were $346 million, slightly lower than our guided range and reflecting a partial quarter benefit from the cost reductions we announced in April. Our GAAP operating margin was 14.7%. Our non-GAAP operating margin was 33.2%, representing a sequential improvement of more than 600 basis points.
Our GAAP effective tax rate for the quarter was 16.4%. Our non-GAAP effective tax rate was 18.1%. This is below our target range for the year, largely driven by a non-recurring benefit associated with the filing of our annual federal income tax return during the quarter. Our GAAP net income for the quarter was $89 million, or $1.48 per share. Our non-GAAP net income was very strong at $194 million or $3.21 per share, well above the top end of our guided range of $2.78 per share to $2.90 per share. This reflects the combined impact of our gross margin improvements and operating expense discipline as well as a Q3 tax benefit. I will now turn to cash flow and the balance sheet, which also remains very strong. We generated $165 million in cash flow from operations in Q3, driven by our improved profitability and strong cash collections.
Capital expenditures for the quarter were $15 million. DSO for the quarter was 56 days, down from 62 in Q2 and closer to our historic range as a result of earlier invoicing related to improved shipping linearity as our supply chain continued to stabilize. Cash and investments totaled approximately $696 million at quarter end. Deferred revenue increased 9% year-over-year to $1.79 billion, driven by the high service maintenance attach rates we've seen throughout the year and continued growth in subscription as a percent of our software mix. As we committed to on our last call, we repurchased $250 million worth of shares in Q3. Finally, we ended the quarter with approximately 6,500 employees, which reflects the headcount reductions we announced in April.
I will now share our outlook for Q4. We expect Q4 revenue in the range of $690 million to $710 million with gross margins of approximately 83%. Unless otherwise stated, my guidance comments reference non-GAAP operating metrics with the full quarter benefit from the cost reductions announced in April, we estimate Q4 operating expenses of $338 million to $350 million. Incorporating our year-to-date results, we have now narrowed our estimates for FY '23 effective tax rate to approximately 20% for the year. As a result, we are targeting Q4 non-GAAP earnings in the range of $3.15 to $3.27 per share. We expect Q4 share-based compensation expense of approximately $55 million to $57 million. Year-to-date, we have used 68% of our free cash flow towards repurchases.
We remain committed to returning cash to shareholders and continue to expect to use at least 50% of our annual free cash flow towards share repurchases. I will now turn the call back over to Francois. Francois?
Francois Locoh-Donou: Thank you, Frank. Customers made F5 the standard for securing, delivering and optimizing traditional applications. Now, with compelling and differentiated solutions for modern applications and APIs as well as those mission critical traditional apps, we are being architected into new areas and use cases across our portfolio. Our holistic application and API focused approach enables new found consistency across environments and across hardware, software and SaaS deployment models, which reduces risk, lowest operating cost and delivers better digital experiences. In closing, I ask that you take away three things from this call. Number one, we are seeing some early and encouraging signs of demand stabilizing.
Number two, we are seeing demonstrable proof points that the differentiated solutions portfolio we are creating through a combination of organic and inorganic innovation and technology integration is well-aligned with how application architectures are evolving. And number three, we are delivering on the operating discipline we committed to, and expect to produce additional leverage in FY 2024. Operator, please open the call to questions.
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