Good afternoon, and welcome to the F5 Networks Second Quarter Fiscal 2020 Financial Results Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. If you have any objections, 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'm 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 portion of today's call. A copy of today's press release is available on our website at F5.com, where an archived version of the call will be available through July 27, 2020. The replay of today's discussion also will be available through midnight Pacific tomorrow, April 28, by dialing 800-585-8367 or 416-621-4642. For additional information or follow-up questions, please reach out to me directly at [email protected]. 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.

Thank you, Suzanne, and good afternoon, everyone. Thank you for joining us today. For all of us, this has been an extraordinary few months. COVID-19 has altered just about everything about our daily lives. My deepest sympathies go to those that have been personally affected by the disease, an already enormous number that sadly grows each day. At F5, our culture prioritizes the humaneness of us all. Like most companies, our first priority in a crisis is ensuring the health and safety of our employees, their families, and our communities. For most of March and April, our entire global team has been working remotely. Beyond health and safety, though, we have taken a human-first approach to this crisis. For us, that means supporting our customers and each other however we can. Over the last weeks, I have witnessed small and large acts of F5ers' generosity, perseverance, and creativity around the world. They have supported our customers through the crisis, they have donated to communities most in need, and they have lent helping hands to colleagues who are struggling. These acts of humanity are what make me so proud to be an F5er. Frank and I will speak in greater detail about COVID-19's impact on our business during our remarks today. Overall, we delivered a very strong second fiscal quarter. Our 7% total revenue growth was driven by customer demand for reliable application access and performance and consistent application security. Our analysis shows COVID-19 had a net neutral impact on business in the quarter. For the first two and a half months of Q2, we experienced minimal disruption outside of Asia. Beginning in March, we experienced accelerated activity in our access and control solutions. We worked with customers to quickly and, in some cases, massively scale access and capacity to deal with increasing numbers of remote workers. We also saw some evidence of certain customers accelerating purchases of F5 solutions to strengthen their critical application infrastructures. These tailwinds were offset by some project push-outs as customers prioritized acute COVID-19 priorities. Strong customer demand for software subscriptions and security use cases fueled our 96% overall software growth. Consistent with last quarter, our Systems business was down 11%, while our Services business grew 5%. Even considering the macro environment, our customer engagement remains very high. I will speak to our COVID-19-related actions in more detail and other customer highlights in the quarter, after Frank reviews the quarter's financial results and our Q3 outlook. Frank?

Thank you, François, and good afternoon, everyone. As François noted, we delivered a very strong Q2. You will note, we are reporting non-GAAP revenue this quarter. Non-GAAP revenue excludes the impact of the purchase accounting write-down on Shape's assumed deferred revenue. For transparency, we are committed to providing both GAAP and non-GAAP revenue during the period when purchase accounting will have an impact on Shape-related revenue. On a GAAP basis, Q2 revenue was $583.4 million. Second quarter non-GAAP revenue of $585.6 million was up approximately 7% year-over-year and at the midpoint of our $580 million to $590 million guidance range. GAAP net income for the quarter was $61.4 million or $1 per share. Non-GAAP net income was $135.9 million or $2.23 per share. This was above the top end of our guidance range due to our strong revenue performance as well as our disciplined operating expense management in the quarter. Please note, as I review our revenue mix, I will be referring to non-GAAP revenue measures. Q2 product revenue of $262 million was up 10% year-over-year and accounted for approximately 45% of total revenue. As François mentioned, software revenue grew 96% year-over-year. Software represented approximately 35% of product revenue in Q2, up from approximately 19% in the year-ago quarter. Excluding the partial quarter contribution from Shape, software grew 65% in Q2. We continue to see strong uptake in our software solutions, sold as subscriptions, including long-term subscriptions. Services revenue of $324 million grew 5% year-over-year and represented approximately 55% of revenue. Recurring revenue, which includes the maintenance portion of our services revenue and subscription revenue, totaled 65% of revenue in the quarter. Systems revenue of $171 million was down 11% year-over-year as customers continue to transition to software-based solutions. Systems accounted for approximately 65% of product revenue and 29% of total revenue in the quarter. On a regional basis, in Q2, we saw strength across our global theaters. Americas delivered 7% revenue growth year-over-year, representing 56% of total revenue. EMEA grew 8% and accounted for 25% of revenue, while APAC grew 9% and accounted for 19% of revenue. Looking at our bookings by vertical, enterprise customers represented 69% of product bookings and service providers accounted for 15%. Government customers represented 16% of product bookings, including 7% from US federal. Let us now discuss our Q2 operating results. GAAP gross margin in Q2 was 83%. Non-GAAP gross margin was 85%. GAAP operating expenses were $399 million. Non-GAAP operating expenses were $327 million. Q2's operating expenses reflect our normal seasonality as well as approximately $4 million in COVID-19-related costs. This includes a $2 million increase to our global good funding for COVID-19 relief efforts and approximately $2 million related to events canceled as a result of COVID-19. Our GAAP operating margin in Q2 was 14.3%, and our non-GAAP operating margin was 29.1%. Our GAAP effective tax rate for the quarter was 26.5% and our non-GAAP effective tax rate was 20.2%. Turning to the balance sheet. In Q2, we generated $182 million in cash flow from operations. Cash and investments totaled approximately $1 billion at quarter end. As a reminder, we added $400 million in term loan debt as part of the Shape acquisition, which closed in the quarter. During Q2, we repurchased approximately $50 million of F5 shares for 442,000 shares at an average price of $113.18. We have an estimated $1.3 billion remaining on our share repurchase authorization. DSO was 52 days, and capital expenditures for the quarter were $13 million. Deferred revenue increased 10% year-over-year to $1.3 billion, driven by an increase in maintenance contracts as well as acquired Shape deferred revenue. We ended the quarter with approximately 5,825 employees, up approximately 525 employees from Q1, including 380 associates added from Shape. Now, let me share our guidance for fiscal Q3 of 2020. Unless otherwise stated, please note that my guidance comments reference non-GAAP metrics. Over the last three years, we have taken steps to significantly strengthen our business and financial model. We believe our actions have built meaningful resiliency into F5's business. For example, recurring revenue as a percent of total revenue has increased from 52% in FY 2017 to 65% in the latest quarter. Likewise, software subscription as a percentage of software revenue has increased from 22% in FY 2017 to over 73% in Q2 of 2020. Our Q3 outlook factors in the expected impact of global uncertainty related to COVID-19 as we understand it to date. As we speak to you today, we have not seen a meaningful impact on bookings or in our supply chain. Visibility is understandably less clear beyond the current quarter. As a result, we are withdrawing the fiscal year 2020 outlook we provided in December of 2019 when we announced our Shape acquisition. In the near term, we expect customers will continue to evaluate their ability to support their employees and consumers in prolonged social distancing scenarios. We expect to benefit from being the trusted and operationalized partner of the largest enterprises around the world. We also expect customers will scrutinize investment priorities, which could lead to longer purchasing cycles or deferred projects. As a result, we are targeting Q3 2020 non-GAAP revenue in the range of $555 million to $585 million. We expect gross margins at or around 85%. We estimate operating expenses of $320 million to $332 million in Q3, reflecting a full quarter of Shape-related expenses. We anticipate our effective tax rate for Q3 will remain in the 21% to 22% range. Our Q3 earnings target is $1.91 to $2.13 per share. In the quarter, we expect share based compensation expense of approximately $52 million to $53 million. Let me speak briefly to our capital allocation philosophy. With the current environment and interest rates declining, we have reprioritized building our cash position ahead of paying down the $400 million term loan A associated with the Shape acquisition. Consistent with what we have said previously, we also retain the option of repurchasing shares opportunistically in any open trading window. With that, I will turn the call back over to François.

Thank you, Frank. I mentioned previously that we have embraced a human-first approach to the COVID-19 crisis. I will speak to what that means in terms of our response for our employees, our communities, and our customers. First, for our employees. We implemented work-from-home for our Asia Pac teams in January and reached a global-wide work-from-home state by mid-March. We also implemented progressively more stringent work-related travel restrictions as the quarter progressed and canceled or postponed large in-person events. Our human-first approach also means that we embrace and encourage flexibility. We want to ensure that F5ers have the time and space to deal with emergencies, but simply the new realities of working from home. Most importantly, today, we are making a pledge to our employees that there will be no layoffs at F5 in fiscal year 2020. In this time of adversity and difficulty, we want to remove any worry our employees may have about their jobs or providing for their families. We believe having this certainty will enable us to better focus on our customers and their needs. We are confident that, though there may be macro uncertainty around the second half of our fiscal year, we have built a resilient business that will allow us to weather that uncertainty without making substantial changes to our workforce. Turning to our community response. As I have shared in my last two annual shareholder letters, F5 has recently taken a stronger stance in our communities because we believe we have a role to play. As a result, our COVID-19 response includes actions to help our communities globally. Our global good program, established in 2018, includes paid time-off for employees to volunteer and charitable donation matching, as well as opportunities for employees to participate in localized philanthropic campaigns and community impact grants. In response to COVID-19 related needs, we increased our global good funding by $2 million, dedicating a total of $2.5 million to be allocated three ways: first, targeting localized response, supporting the communities where we live and work. Second, through employee-directed giving and good employment including Tech for Good COVID-19 response grants. We are also leveraging our resources to support healthcare, nonprofit, and educational organizations. These organizations are taking heroic steps to keep us all safe during this global crisis, and we want to help them with any security and technology challenges so they can stay focused on doing their essential work. For instance, on March 17, the same day as the United States first shelter in place was announced in San Francisco, we launched a program designed to help organizations handle exponentially increased website traffic demands. We are providing one year of free NGINX Plus where needed. Today, more than 20 healthcare, educational, and nonprofit organizations are taking advantage of this assistance. Since then, we have made additional services available for free to assist healthcare, education and other nonprofits, including remote access and security solutions, as well as 5,000 free service hours. Our human-first approach also includes doing what it takes to ensure our customers can protect their employees while continuing to serve their customers. I am very proud of the way the F5 team has confronted and conquered new and impossible to foresee challenges, often under extreme circumstances. For most of our customers, COVID-19-related remote application access quickly became a priority. In fact, by mid-March, we were experiencing a 400% increase in access-related support calls. Customers needed to quickly and securely scale remote access capabilities, and that is where we were there to help. With thousands of employees suddenly working from home, we enabled one of the largest banking and investment institutions in the United States to scale its VPN access from 400,000 to 500,000 remote users. This ensured uninterrupted secure financial services to customers around the world. We also upgraded the traffic management solutions at a major multi-hospital health system in the U.S., allowing six hospitals and 10 specialty centers to continue providing exceptional care to patients. In another example, we helped a multinational mass media conglomerate increase network capacity within one day, so that 100,000 additional employees could work from home in the U.S. and London. Understanding the urgent need to continue supporting consumers with their prescriptions and health insurance claims, a Fortune 10 Retail Healthcare Corporation added 160,000 remote workers to its network in under 24 hours. And these are just a handful of the access and remote work-related challenges our teams moved mountains to solve for customers in Q2. We continue to see strong demand coming from key growth areas, including subscriptions, security, and NGINX. Our 96% software growth points to solid sales execution and continued customer adoption of our BIG-IP software for application delivery and security. During Q2, we saw continued rapid acceptance of our subscription-based offerings, both for one and three-year terms. As customers look to accelerate automation efforts, the flexibility of our subscription models enables them to take full advantage of their F5 investment. A quarter into its launch, we also are seeing promising early wins for NGINX Controller 3.0. Controller's application-centric design incorporates a self-service model, configuration API, application reporting and analytics, and built-in security capabilities. These features appeal to new NGINX customers, as well as current NGINX customers looking to scale. We are beginning to see real traction with our F5 and NGINX better together vision. In fact, we secured an NGINX win with F5 security in the quarter at an existing F5 customer, a leading oil and gas company in the Middle East. The customer has been working to consolidate its critical applications across all its operating companies into its main data center. With literally hundreds of applications, the customer was facing massive challenges, and one of the biggest was API management. Security was also a key concern, given the industry and the increased risk of attacks. They opted to deploy NGINX for API management with F5's advanced WAF for API security. As you know, the Shape acquisition closed in late January. Shape is already contributing and expanding the competitions we are having with customers. It has been roughly three months since we closed the acquisition, and our teams have hit the ground running. Integration is going very well. As we did with NGINX, we immediately augmented the Shape engineering efforts with F5 cybersecurity engineers to accelerate delivery of Shape's next-generation products. Near-term, we are leveraging our BIG-IP and civil line managed services presence to demonstrate Shape's capabilities to F5 customers and reduce the friction of implementing Shape solutions. F5 sellers have already identified dozens of Shape opportunities in F5 accounts, including securing our first joint win with a large Canadian banking customer. The customer was an existing F5 BIG-IP customer and began experiencing account takeover attacks on their web application. With the customer's permission, we turned Shape on in full mitigation mode and blocked a major attack that amounted to 90% of their total traffic. We believe there is significant opportunity for Shape's current and next-generation solutions within F5 accounts and with new logos. Longer term, Shape's machine learning and AI-powered capabilities also will scale and extend F5's broad portfolio of application services. With Shape, we will expand our ability to optimize and protect customers' applications in an increasingly complex multi-cloud world. As we work through this COVID-19 crisis, we expect customers will shift their concern from application access to application security. Attackers prey on curiosity. The desire for information about COVID-19 or stimulus checks, combined with the increased use of personal and home devices offers ample opportunities for bad actors. Post-crisis, we expect customers will increasingly look toward cloud-based and MSP-based solutions for better user experience, lower cost, and better security as they look to accelerate their digital transformations. We are confident that the investments we have made to evolve F5 have positioned us well for the shift ahead. We are creating an application services platform that will help customers accelerate their digital transformations and fundamentally change the way application services are delivered and secured. For many enterprises today, application services live in operational silos with multiple vendors often managed by different teams. It is an inefficient process that makes managing user experience a complex and often manual task. When applications were static with infrequent changes and updates, this approach can survive, but that era has long passed. Today's world is dynamic with new applications based on microservices. The manual siloed approach creates too much friction and application delivery, and security become real hindrances to digital transformation efforts. We have built the broadest portfolio of application services to enable our customers to eliminate silos. Through our organic efforts and the acquisition of NGINX, we have expanded the breadth of our application delivery services to address the needs of both traditional and modern applications. Likewise, through the work of our teams and the acquisition of Shape, we have consolidated powerful application security services into our portfolio, including DDoS, WAF, API security, and anti-bot protection. Our customers increasingly choose us to cover a suite of application services because they care most about the user experience, about the application, not the infrastructure that underpins it. And we see that trend accelerating as we move increasingly to software-deployed services. In closing, as Frank noted when he discussed our Q3 outlook, COVID-19 has brought with it a degree of uncertainty. While we may not be able to control the duration of the pandemic or our customers' short-term investment priorities, we are confident that we have built a resilient F5 that can withstand short-term uncertainty and emerge stronger. Over the last several years, we have transformed F5. We have built a strong base of recurring revenues. We have strengthened our position in key verticals globally, including government, financial services, and technology. We have a great balance sheet and an exceptionally strong operating model. We have future-proofed F5 with organic and inorganic investments to establish our position in modern environments and our leadership in application security. What is more, we are trusted and operationalized in the critical infrastructures of the largest enterprises around the world. Because of all of this, we are confident we will weather the storm. We have good near-term visibility and are confident that longer-term, the investments we have made position us well. In short, we remain committed to our multi-cloud mission to enable and secure every app anywhere. We are confident our vision, our investments, and our innovation are well-aligned with both near and longer-term customer demand. My sincere thanks to the entire F5 team and our partners for their perseverance and can-do attitude and for driving a great quarter despite adversity. Through this crisis, the team has been tested and proven resourceful and customer obsessed. I feel very confident we will continue to rise to the challenge of whatever may come next. With that, operator, we will now open the call to Q&A.

Your first question comes from James Fish with Piper Sandler. Your line is open.

Hey, François and Frank, first off, congratulations on an incredible quarter given the market conditions. I also hope everything is well with your families and the F5 team. I'll start by noting that you appear to be one of the few infrastructure companies that is likely to provide guidance even for the next quarter. Frank, what leads you to feel the need to do so? And what gives you confidence that it wasn't simply a large pull-in of demand, particularly regarding the software demand for fiscal Q2?

Thank you for your question and for the well wishes. We wish the same for you and your family. In reviewing the prepared remarks from François and myself, we have not yet observed a significant impact on our demand. There were various factors at play towards the end of the quarter. We believed it was wise to follow the SEC guidance to provide our best perspective to investors, and this reflects our current view. I would also like to mention that the revenue range is three times what we typically experience, which we believe accounts for the prevailing uncertainty. We felt this was the responsible course of action for our investors.

And James, just to add to that, on the second part of your question on why we are confident it is not just a pull. We looked carefully at what we were able to close this quarter, and we tried to assess the impact of COVID-19 on our numbers. And when we look at what's happened, we actually did see some deals get pushed out into the following quarter. Now a number of these deals have now closed in April. But we did see some deals get pushed out as a result of COVID-19, either because people couldn't physically get the deals done or because they just shifted to other immediate priorities. And conversely, we also saw some things that were pulled in by some customers. And so when you balance those things out, we actually landed where we expected to land. And so if you look at our second quarter, we feel that COVID-19 essentially had no real impact when you balance the puts and the takes.

Got it. That makes a ton of sense, guys. I just want to dive into the enterprise vertical as my follow-up. How should I think about the vertical exposures within that understanding? Usually, it's a large financial services exposure. But just wanting to understand across the board, especially in some troubled areas like energy, retail and travel or hospitality-related?

So, Jim, as you know, the largest vertical for F5 are financial services, government, telco, and technology to a large extent. And so these verticals are at least at the moment, at least one step removed from the immediate effect of the crisis relative to other verticals. And we've seen that in our enterprise business. If you look at the verticals that are most impacted, at least most directly impacted to date, by the crisis, which would be the ones you mentioned, so retail, transportation, travel and entertainment, hospitality industries. Those verticals taken altogether represent less than 10% of our enterprise business. So, our exposure there is limited.

Got it. Thanks. And congrats again, guys and best wishes.

Thanks a lot, Jim.

Your next question comes from Tim Long with Barclays. Your line is open.

Thank you. Two quick ones, if I could. First, when you think about the kind of the access control security, some of the pieces of business that really accelerated in the second half of March. Could you just give us a little color on how you view the sustainability of that? Is this kind of a bubble or will there be some more follow-on to that type of business where it could represent a real market share more within that piece of the market? And then, secondly, can you talk a little bit about cloud business and how you did maybe with some of the larger hyperscales or the cloud vertical, however, you're comfortable talking about that? If you can give us a sense on how that vertical is shaping up? Thank you.

Thank you, Tim. Let me clarify the Q2 results and what contributed to our strong performance in both hardware and software. The access portion of our portfolio, linked to work-from-home enablement, did see an increase, but it remains a small part of our business and wasn't a significant contributor to the overall results. The real drivers were the usual elements of our strategy and transformation. In software, we've made progress in automation and orchestration, allowing us to engage with new modern application environments through our BIG-IP software and increasingly with NGINX. We've also developed new commercial models, with a rapid adoption of subscription-based consumption by customers. About 73% of our software revenue this quarter came from subscriptions, showing a substantial acceleration. Additionally, we saw strong security attach rates for software, both on-premises and in the cloud. Combining these factors, they have driven growth in our software business. Specifically regarding the cloud, we're experiencing robust growth in our cloud segment as customers implement our software with major cloud providers, benefiting from higher security attach rates in public cloud compared to on-premises. We are also starting to see promising early signs from our partnership with AWS at the front end of our business. All of these elements contributed to our growth, but it's important to note that, unlike others who might have experienced a significant one-time spike from the work-from-home segment, this only plays a minor role in our portfolio and was not the main driver for the quarter.

Okay. Very helpful. Thank you.

Your next question comes from Sami Badri with Credit Suisse. Your line is open.

Got it. Thank you. First, impressive quarter and performance during the challenging times. I just want to double-click into the systems revenue decline of 11% again this quarter, and you obviously saw a noticeable uptick in software revenue even without Shape? Just given the work-from-home dynamics we are seeing, do you see customers moving faster in this direction where they're going to consume more software than systems in a more permanent way, just given the economic backdrop and the health care, and I think of all the different implications we're dealing with at these times. Do you see this new move to virtualizing everything and no more systems more as, kind of, the typical deal or contract-type you're going to start seeing more often going forward? And would the pendulum to systems ever swing back from here? That'd be great.

Sami, hi. In short, yes. We are seeing both trends. Some customers manage large applications, including those for collaboration and work-from-home, and they require more hardware to support these applications, so I believe this demand will continue. However, as a result of this crisis, the shift towards software is likely to persist and even accelerate. I've mentioned before that our customers have become more adept at building private clouds alongside their public cloud infrastructure. As the ecosystem evolves, there's a growing emphasis on developing modern application environments, driving a software-first approach. Over the past year, we've observed more customers adopting both software-first and cloud-first policies, and I expect both to gain momentum. There's also an increasing trend towards consuming these technologies on a subscription basis, as seen in our one-year and three-year subscription agreements, where more customers prefer an OpEx-based model. Overall, I anticipate acceleration in these areas. Furthermore, looking beyond the software and hardware shift, I believe our customers will increasingly rely on applications to generate value. We've referred to this as the era of application capital, where applications are viewed as the most valuable assets. This has become even more relevant during the crisis. I expect the growth of applications to continue and that the value created from them will rise, making application security and delivery increasingly crucial, which was part of our rationale for acquiring Shape and NGINX last year.

Got it. Thank you. And then just on your software segment, you've already answered some questions regarding software performance and the public clouds and your AWS partnership. But in the actual quarter, do you see any contributing sales from Rakuten, just because they did launch their actual service very recently, I just want to know if there was any kind of sell-through and software specifically to Japan?

Sami, you know we announced Rakuten, I think it was three quarters ago, as a customer, you're right, it did launch this quarter and we are part of the infrastructure. They are on a subscription agreement with us. So, as they launch and expand the services, there'll be opportunities for us to expand with them. But I wouldn't comment specifically on their numbers in a given quarter.

Got it. And then I have one last question. On Services, last quarter you grew 8%. This quarter you are growing 5% and maybe could you just give us some guidance on how you should be thinking about this, maybe this is a question for Frank on how you should be thinking about your Services segment throughout kind of like the dynamics we're seeing today just because there has been quite a bit of variance in that growth rate?

Yes. I understand, Sami, and obviously 8% was a very strong quarter that we noted last quarter. We said that it would be a little closer to what we saw in Q4 for Q2, and that would have implied something around $327 million. We saw a little bit of push in some of the professional services projects, which is why we ended up where we did in terms of a growth rate for next quarter on an absolute dollar basis, I would expect something close to what we did in Q2, but it could have some fluctuations of $2 million or $3 million in either direction.

Got it. Thank you very much.

Thank you, Sami.

Your next question comes from Rod Hall with Goldman Sachs. Your line is open.

Hi, guys, Thanks for the question. I wanted to see if you could maybe comment on linearity in the quarter just to help us understand how normal that was? And then I have a couple of follow-ups to that.

Linearity in the quarter was what we typically anticipated. We were on track until the first week of March when the situation intensified in the U.S. and Europe. There was a point during that time when we were uncertain about the remainder of March. However, we noticed some delays while a few customers actually accelerated their activities. Ultimately, the linearity aligned with our initial expectations for the quarter.

Okay Frank. Could you comment on Tim's question regarding work from home? What accelerated at the end of the quarter? I would have expected it to be related to work-from-home, but it seems that wasn't significant. Could you clarify the relationship between those two points for us to better understand what occurred?

We experienced a couple of developments towards the end of the quarter that made up for some delays. One was related to our offerings that support remote work and application access for end users. The other factor was some customers who, anticipating possible supply chain challenges, expedited orders for a few projects. These were the two elements that picked up speed and balanced out other deferred items.

Great. Okay. Thank you. Appreciate it.

Your next question comes from Alex Henderson with Needham. Your line is open.

Thank you very much. You have been shifting your business focus from data center spending to application spending, and the growth in applications has significantly impacted your results this quarter. Can you discuss the extent of your penetration in the Kubernetes environment? I understand that over 67% of the ADCs deployed in Kubernetes are NGINX. How has this been linked to driving additional F5 products, particularly in the security space like WAF, which is often used in this context, as well as traditional F5 products that have not been prominent in this sector? Lastly, could you share how this trend is influencing your position in the CI/CD process for companies moving in that direction? Thank you.

Thank you, Alex. I'll begin with the latter part of your question and then return to the first. We've made significant progress over the past two years on our BIG-IP software to enhance its form factors and develop automation templates that integrate well into CI/CD environments. A key factor driving the growth of BIG-IP software is our ability to adapt to these automated settings. More customers are maturing in their digital transformation efforts and seeking increased velocity, which is leading them to deploy our solutions in these environments. Regarding your question about our compatibility with Kubernetes, NGINX is extensively used in Kubernetes setups, often serving as an Ingress controller. BIG-IP can also function as an Ingress controller, giving us both capabilities. This past quarter, we've observed an acceleration in the synergy between F5 and NGINX; in modern application environments where NGINX excels, DevOps engineers are increasingly recognizing the importance of security. We've successfully secured deals where NGINX served as an API gateway and F5's security WAF was integrated to deliver a comprehensive API security solution. We expect to see more such deals with the controller we announced in January. This controller simplifies the deployment of multiple modules and scales NGINX instances quickly and with minimal complexity. It also allows us to combine traditional NGINX use cases with the F5 WAF, among other functionalities we're integrating under that controller. Overall, we see F5 effectively bridging both modern and traditional environments.

So to the extent that Kubernetes goes from what 10% of applications today to something in excess of 50%, that should pull your growth along with it.

We expect to see accelerated growth due to our position in front of Kubernetes clusters, as well as our upcoming role inside those clusters, which we will discuss further in relation to our new product initiatives.

Your next question comes from Meta Marshall with Morgan Stanley. Your line is open.

Great. Thank you. What is the strength of your capital structure and flexibility from the cash flow you guys were generating, but just wonder with the disruption in the private markets, and just your comments around the evolution of the security environment, how does that change your thoughts on acquisitions, or M&A? And then maybe second question, just a little bit more nitty, but how much should we consider professional services as a portion of services revenue, and just ability to actually recognize them that revenue, or ability to professional services to be recognized with what's inability that trouble right now? Thanks.

Meta, I'll start with the second question, it's Frank, and then I'll turn it François to address the M&A question. So, on the professional services, we have the capability of providing those services remotely for the large majority of our customers. There are some federal where we do need to actually be in person, and we've gotten that permission and if the employees feel comfortable, we are allowing that, but it's by far the exception as opposed to the rule. It's professional services as a whole in relation to our services a very small percentage of our total services bucket, most of our services revenue are associated with maintenance type relationships. But we have been able to provide a lot of those services remotely.

And Meta, to your question around how we think about M&A. I want to pull back up here, and share my perspective, over the last 12 months, we spent $1.8 billion in aggregate in the acquisition of Shape and NGINX, which as I said before, were driven by the belief that applications would become even more valuable assets to our customers in that application delivery across modern and traditional environments would continue to grow. And application security is, we believe, the security issue of the next decade. And so we feel very, very good about the strategic position that we have now when you combine the assets from F5, NGINX, and Shape. And so when we look at the near future, our focus really is on value creation from NGINX and Shape. We think there's a lot of growth to come from what we've done there and operating leverage to come from what we've done. Our focus is on creating value with that, also on continuing to rebuild our cash position and maintaining a very strong operating model. And so that's where we're focused in the short-term, and not on further M&A for the time being.

Got It. Thanks guys.

Your next question comes from Paul Silverstein with Cowen. Your line is open.

Guys, good evening. I was only going to ask one question, but I want to break the trend. Serious now. First off, Frank, if I did the math right, that shape was around $15 million, assuming all of its revenue is software and organic growth would have been something on the order of 4.3%, so Shape was about 3 percentage points of the growth?

Yes, you're about $1.2 million high. It was just over $14 million, Paul, but in that ballpark.

And that's obviously on software?

Yes, software.

But Paul, overall software growth was 96%. And if you exclude Shape, it would have been around 65%.

Understood. I apologize for going back to this, but I want to ensure I fully understand. Regarding the accelerated purchases, François, did you say that those were not significant to the overall picture? Therefore, it should not create a significant issue in the next two, three, or four quarters in terms of impacting future performance?

Yes, that is correct.

All right. Third, I believe you mentioned AWS, and I'm not sure if you were speaking loosely, but when discussing the linear drivers for the quarter, you brought up AWS and the relationship. I'm uncertain if you meant that it is actually generating revenue or if you were referring to the early funded actions going well that will contribute to revenue later on. Which one is it? If it is generating revenue, could you provide any insight on that, even if it's too early for it to be significant?

Paul, it's the latter. It's too early to be meaningful. So, it's more revenue down the road. What we are seeing today is two great areas of progress. One is considerable progress on joint development of combined solutions. And two is we are now getting quite a lot of leads from AWS. So if you recall in the past, we would meet at the customer front. Part of the reason we did this agreement is because we know a lot of our customers would like to leverage AWS. But, in a lot of cases, AWS is in conversations that F5 was not a part of. And as a result of this agreement, AWS is now pulling in F5 into these conversations and providing a lot of leads to us that we didn't have visibility to before. But those are great leading indicators, but revenue is further down the road.

I have one last question, which is a bit broader. If I interpreted the numbers correctly, on a regional basis in both this quarter and the previous December quarter, it seems that all three major regions showed similar growth in the mid-single-digit to high-single-digit range. Previously, we observed significant variability across regions, with some growing while others declined inconsistently. Additionally, from a vertical perspective, it appears telecom was down. I recognize that this sector tends to be quite erratic on a quarterly basis. However, there’s a belief that telecom services could be among the more resilient areas amid the ongoing pandemic challenges and may even improve over time. Could you share any insights on this, along with your comments regarding the regions? Thank you.

Paul, you are right that all three regions are experiencing mid-single-digit growth. Regarding telecoms, I would highlight that the work from home situation is likely to increase spending in the wireline area, but F5 has more exposure to the wireless sector. As a result, our performance in telecom is more influenced by what we expect to see in early 5G deployments. With increased spending on 5G and the resulting capacity upgrades, we anticipate benefits for F5. However, our connection to wireline telecom spending is much weaker.

And François, in the regional, what you're seeing from a regional perspective? The fact that it's all converging with the same growth rates, are you seeing the same trends throughout the world? Are there any meaningful differences from region to region?

There are a few areas of weakness, particularly in China and North Asia, specifically in China and Korea where we observed some softness. We also experienced some softness in Latin America. However, the rest of the world showed strength across the board. Those are the main differences we've noted this quarter.

I appreciate it. I'll pass it on. Thank you.

Your next question comes from Amit Daryanani with Evercore. Your line is open.

Thanks for taking my questions. I guess two for me. First off the 96% growth on the software side, I think is at 65% on an organic basis, obviously, it’s fairly impressive. I'm sure it's going to be a big sticking point for investors to understand how much of this is sustainable versus not as you go forward. So, any insights on how much of this should be sustainable as we go forward and how should one think about the June quarter with regard to the software segment?

So, I want to be very clear, as this is a recurring theme. I don't believe any of these trends are related to a one-time pull due to COVID-19. As I mentioned before, the impact of COVID on our business was essentially net neutral. Some aspects were pulled in, while others were pushed out, and that reflects our current situation. The fundamental factors that contributed to the growth in our software business are related to automation, orchestration, and our entry into modern app environments, including Kubernetes. The ongoing rise of security use cases, our cloud acceleration, our subscription business, and the contribution from NGINX are all long-term drivers that will persist quarter after quarter. Looking ahead to the next two quarters, Q3 and Q4 of this year, we had 90% growth in software in each of those quarters last year. Thus, the year-on-year comparisons in Q3 will be more challenging than in Q2. However, I believe the drivers will remain strong. It's also important to remember that growth in software can be uneven due to the smaller base. For instance, in Q1 of 2020, we achieved 50% growth in software. There were concerns at the time that our growth was slowing down, but we indicated that we expected stronger growth in Q2, and indeed we did see stronger growth in Q2 compared to Q1. This is meant to provide a comprehensive view of our software growth from quarter to quarter.

Really appreciate that. And then just as a follow-up, when I think about the 65% of sales that you guys are talking about as recurring businesses today, is it really to think about this how much of this is maintenance versus subscription versus other things? And is that 65% number, a good rule of thumb for your profits as well as that's recurring? Thank you.

I believe we've provided enough information to analyze the situation. The services segment still constitutes a significant portion of our recurring revenue. Additionally, we noted that subscriptions represented over 73% of software sales in the quarter. When combining these two elements, over 65% of our total revenue is recurring. Regarding profitability, we maintain very strong gross margins across our portfolio. Our approach to operating expenses is aligned with the overall portfolio rather than focusing on any single area. Our gross margins in services revenue are notably high, and our software revenue also reflects strong margins, although we do experience some impact from managed services and hardware. Nevertheless, our gross margins remain close to 85%.

Your last question comes from Samik Chatterjee with JPMorgan. Your line is open.

Hi, guys. Thank you. This is Joe Cardoso on for Samik Chatterjee. Thanks for fitting me in. Just two quick questions here. One is, I just was curious to see if there was any correlation relative to the deals that you guys highlighted that were pushed in and pushed out, or brought in and pushed out? And then relative to your gross margin, and I understand this might be a little nitpicky, but came in towards the low end of your guide. I just was wondering if there was any incremental pressure that you guys saw there relative to 90 days ago when you guys gave the original guide. Thank you.

Yes. Can you clarify the first part of your question regarding the correlation of deals that have been pushed in and out? Could you expand on what you mean by that?

Yes, sure. So, you guys highlighted that during the quarter, you saw some deals be brought in and some deals pushed out relative to the COVID-19 net-net, you guys didn't see an impact much on the COVID. So, I was just wondering if there was any correlation relative to the different deals that you saw get pushed out and then brought into the quarter, if there's any correlation between them, e.g., like how did you guys see hardware deals get pushed out?

The answer is no. The deals that were brought in were primarily due to customers concerned about the supply chain who wanted to quickly strengthen their critical infrastructure or needed solutions for remote access and enabling work from home. The deals that were pushed out were mainly from customers who had to work from home and were unable to process these deals, or those whose immediate priorities shifted due to the pandemic, leading them to cancel or delay projects. There wasn’t a consistent correlation regarding hardware, software, or even by segment; it was more about the individual situations of each customer.

And in terms of the gross margin question, we are on the low end because of Shape more than anything else.

Okay. Thank you, guys.

Thank you.

Ladies and gentlemen, we have reached the end of the allotted time for the question-and-answer session. This concludes today's conference call. You may now disconnect.