Good afternoon, and welcome to the F5 Networks First Quarter Fiscal 2021 Financial Results Conference Call. Today's conference is being recorded. 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. 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 A copy of today's press release is available on our website at f5.com, or an archived version of today's call will be available through April 27, 2021. Today's live discussion is supported by slides, which are viewable on the webcast and will be posted to our IR site at the conclusion of today's discussion. The replay of today's call will be available through midnight Pacific Time, January 27, by dialing (800) 585-8367 or (416) 621-4642. Use meeting ID 6055259. 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. And with that, I'll turn the call over to Francois.

Thank you, Suzanne, and good afternoon, everyone. Thank you for joining us today. Our first quarter results showed a strong momentum in our business. We delivered Q1 non-GAAP revenue of $626 million, representing revenue growth of 10%. We also delivered 70% non-GAAP software revenue growth, systems growth of 5% and global services growth of 1%. Several quarters into the pandemic, several things are becoming clearer from a macro perspective. First, the realities of the pandemic have accelerated our customers' digital transformation in both business and consumer dependency on applications. At the same time, consumers' expectations about their application experience have increased significantly. As a result of higher volumes and higher consumer expectations, our customers are ramping their investments in their applications and the infrastructure needed to securely deliver them. In addition, incumbency is a significant advantage for F5 in the current environment. Customers want a trusted and operationalized partner they know they can count on. These micro drivers play to our strength, including our strategy to invest over the last several years in pursuit of our adaptive applications vision. Our continued investments in BIG-IP for multi-cloud deployments and the deliberate and early investments in both NGINX and Shape are enabling us to rapidly grow our application security and delivery footprint in modern application environments. I will speak more to our business growth drivers and momentum, including some customer highlights from the quarter after Frank reviews our first quarter financial results and our outlook for Q2. Frank?

Thank you, Francois, and good afternoon, everyone. As we previewed in our preliminary results announcement and as Francois just highlighted, we delivered a very strong Q1. On a GAAP basis, Q1 revenue was $625 million. First quarter non-GAAP revenue of $626 million was up 10% year-over-year and well above the high end of our initial $595 million to $615 million guidance range. Please note, as I review our revenue mix, I will be referring to non-GAAP revenue measures. Also, this will be the last quarter we speak about non-GAAP revenue as we lap the acquisition of Shape. Going forward, the add-back of the Shape purchase accounting write-down is de minimis. Q1 product revenue of $289 million was up 23% year-over-year and accounted for approximately 46% of total revenue. This is the strongest product revenue growth we have delivered since Q2 of FY 2011, nearly a decade ago. As Francois noted, customers accelerating their digital transformation efforts drove growth in both our software and system sales. Software revenue was $111 million, growing 70% compared to the year ago period, which did not include contribution from Shape. Excluding Shape's contribution in Q1 of '21, software revenue grew approximately 35% year-over-year. Our mix shift continued this quarter with software representing 38% of product revenue in Q1, up from 28% in the year ago quarter. Customers' preference for flexible subscription models continues to fuel our subscription revenue momentum. In Q1, we again drove record subscription volume with subscriptions representing 77% of software revenue in the quarter. Services revenue of $337 million grew 1% year-over-year and represented 54% of revenue. Revenue from recurring sources, which includes term subscriptions as a service and utility-based revenue as well as the maintenance portion of our services revenue totaled 66% of revenue in the quarter. This is up from 63% in the year ago period. The improvement comes largely as a result of the strong subscription software momentum I mentioned previously. Systems revenue of $179 million was up 5% compared to last year. Francois will speak to the drivers of this strong performance in more detail. On a regional basis, in Q1, Americas delivered 14% revenue growth year-over-year, representing 55% of total revenue. EMEA delivered 4% growth, representing 26% of revenue, while APAC grew 7% and accounted for 19% of revenue. Looking at our bookings by vertical, enterprise customers represented 67% of product bookings, service providers accounted for 14% and government customers represented 18% of product bookings, including 6% from U.S. Federal. Let me now share our Q1 operating results. GAAP gross margin in Q1 was 81.6%. Non-GAAP gross margin was 84.4%. GAAP operating expenses were $392 million. Non-GAAP operating expenses were $322 million. Our GAAP operating margin for Q1 was 18.9%, and our non-GAAP operating margin was 33%. Our GAAP effective tax rate for the quarter was 25.1%, and our non-GAAP effective tax rate was 21.7%. GAAP net income for the quarter was $88 million or $1.41 per share. Non-GAAP net income was $161 million or $2.59 per share. I will now turn to the balance sheet. We generated $137 million in cash flow from operations in Q1. Cash and investments totaled approximately $1.5 billion at quarter end. We did not make any share repurchases in Q1. We remain committed to repurchasing $1 billion in shares over the next 2 years, including $500 million via an accelerated share repurchase program in fiscal year 2021. DSO was 50 days, and capital expenditures for the quarter were $5 million. Deferred revenue increased 10% year-over-year to $1.4 billion. We ended the quarter with approximately 6,160 employees, up approximately 50 from Q4. Now let me share our guidance for our fiscal second quarter. Unless otherwise stated, please note that my guidance comments reference non-GAAP metrics. Also, with the Volterra deal recently closed, our Q2 outlook incorporates the addition of their financials to our guidance expectations. Near term, we expect customers will continue to invest to support application growth and the modernization of their application infrastructures. We also anticipate continued focus on and investment in application security. With this in mind, we are targeting Q2 fiscal year 2021 revenue in the range of $625 million to $645 million, reflecting year-over-year growth of approximately 8.5% at the midpoint of our range. While we do not give quarterly guidance on product revenue mix, we do anticipate continued near-term strength in systems with Q2 growth likely similar to Q1. We would also remind you that our prior year Q2 software revenue growth was exceptionally strong at 96%. This difficult comparison is likely to be reflected in our Q2 '21 software growth rate being below our Horizon 2 target of 35% to 40%. This is consistent with our commentary about the potential for quarterly variability and software growth rates as we continue to scale our software business. We expect Q2 '21 gross margins of 84% to 84.5%, and we estimate operating expenses of $340 million to $352 million. As we discussed last quarter, we generally see a seasonal increase in operating expenses in Q2. We expect our Q2 operating margin to decline from Q1 and then to increase in the back half of the year to achieve our FY '21 non-GAAP operating margin target of 31% to 32%. I will remind you once more that our Q2 '21 outlook also incorporates the addition of Volterra into our operating model. We anticipate our effective tax rate for Q2 will be in the range of 21% to 22%. Our Q2 earnings target is $2.32 to $2.44 per share. We expect Q2 share-based compensation expense of approximately $62 million to $64 million. As for capital deployment, as I mentioned previously, we intend to repurchase $500 million in shares via an accelerated share repurchase in fiscal 2021. With that, I will turn the call back over to Francois. Francois?

Thank you, Frank. Several quarters into the pandemic, it is growing clearer that COVID has accelerated digital transformation in both business and consumer dependency on applications. As a result, our customers are accelerating their digital transformation investments. Incumbency is also an advantage for us in the current environment. And together, these trends are enabling us to drive strong growth. Underneath these macro drivers and consistent with our discussion at our November analyst and investor meeting, there are 3 F5-specific growth drivers fueling our demand: one, ongoing software and subscription momentum; two, growing demand for application security; and three, resiliency in system space demand leading to moderating systems revenue declines. As we noted in November, these multiple growth drivers mean that we also have multiple paths to achieve our Horizon 2 revenue growth targets. More specifically, we do not need everything to go exactly right to achieve our goals. In Q1, we had a lot go right, and customer demand drove growth across all 3 of these drivers. I will speak to each in turn. First, we continue to see demand for software and subscription consumption across our application security and delivery solutions. I will focus first on our BIG-IP and NGINX solutions. Customers look to BIG-IP to refresh core business applications for capacity additions and to simplify traditional application delivery in cloud environments. In one example, during Q1, large financial institutions struggled for months to turn up a mission-critical application in a cloud environment. This was despite the best efforts of the cloud provider that they were working with. Frustrated, they turned to F5. In under one day, we helped them get the app up and running in the cloud with multiple BIG-IP virtual editions. This use case highlights the customer benefits we have driven as a result of our investment to modernize BIG-IP, making it easier and more efficient to use in cloud environments. Let me turn to NGINX. At the time of the NGINX acquisition, we deliberately invested in new products, accelerating time to market. Specifically, we built a joint F5 NGINX controller and rapidly ported F5 security to the NGINX platform. This quarter, NGINX delivered its largest quarter ever with broad-based strength across geographies. This strength was driven in large part by robust NGINX control attraction as well as integrated F5 security through NGINX App Protect. During Q1, we also secured a win from BIG-IP, controller, NGINX Plus and NGINX App Protect with a long-time F5 federal government customer. While upgrading its current BIG-IP infrastructure, this customer also selected NGINX to help prepare for migrating network infrastructure from physical to virtual while building out capabilities to support continualization. NGINX is leading the way in a number of modern application use cases, including cloud-native load balancing, scaling APIs and delivering Kubernetes applications in production. As applications continue to get more distributed, we expect the investments we are making to deliver API gateway, API management and service mesh capabilities will drive additional NGINX momentum. It should come as no surprise that customer demand for application security is also growing. With the ongoing pandemic fueling ever-increasing consumer use of digital channels, the threat landscape is growing significantly. With application-based attacks growing both in numbers and sophistication, customers are looking to F5 for help. The combination of our organic investment and the addition of Shape has created an enhanced F5 application security portfolio. If you map our solution set against the top application security threats, it is clear that we are very well positioned to help our customers address the most frequent incidents and the most damaging breaches. We continue to see increased interest in adding F5's enterprise-grade web application firewall protection to modern applications. During Q1, a major car manufacturer selected NGINX with App Protect when they needed a cloud-independent, portable, scalable solution that included a container-friendly web application firewall. We also are seeing growing traction for SSL orchestration. This encrypt/decrypt use case is a strategic differentiator for F5. And while it tends not to be a big revenue driver on its own, it is a strategic control point in enterprise customers' security stack, which gives us the ability to pull in BIG-IP security and Shape. Let me speak also to the traction we are seeing with Shape and, in particular, our Shape Silverline combination. Last quarter, we highlighted the benefit of making Shape's industry-leading anti-fraud solutions available to a much larger customer base through our Silverline-managed services platform. Silverline Shape Defense delivers advanced bot protection to prevent large-scale fraud. Shape AI Fraud Engine or SAFE is a cloud fraud-prevention service. As a combined solution, our Silverline Shape Defense and SAFE solutions enable sparsely resourced organizations to deploy true industry-leading capabilities. Combining Shape's anti-bot and anti-fraud capabilities with Silverline in managed service also makes it easy to quickly deploy Shape's capabilities, which is especially useful when customers are in crisis. There are 2 interesting use cases that have emerged. First, Shape Silverline Defense is being used by several U.S. states to combat rampant fraud related to unemployment benefits. The combination of sky-high demand and limited security of fraud capabilities created an ideal environment for fraudsters who are conducting sophisticated attacks against unemployment sites as well as other unprotected state domains. With a Shape Silverline Defense solution, we can go in and offer real data about what is happening, unveiling the true scale of the threat. Once enabled, Shape's sophisticated AI and machine learning capabilities identify and block the fraudsters. Credit unions also are emerging as an ideal use case for Shape Silverline Defense. With new web and mobile banking capabilities coming online and larger transfer limits being introduced, credit unions can present an easy target for sophisticated attackers. Pressure to provide the same services as big banks is exposing them and their lack of cybersecurity and fraud capabilities. Shape Silverline Defense provides an affordable turnkey, easy-to-deploy managed security and fraud solution as evidenced by the 5 credit union wins our sales teams delivered in Q1 2021. We are as excited as ever about the use cases Shape has opened for us. Going forward, we see additional potential to leverage Shape's analytics engine to build new analytics offerings that enable us to go beyond application security to drive revenue enhancements for customers. Finally, let us talk about systems and the drivers for the growth we saw in Q1. First, I will note that our systems business is also benefiting from the macro trends I mentioned previously, namely COVID driving increased application use and accelerating investment in digital transformation. Q1 strength in systems was broad-based across geographies and industries. We identified 3 primary factors behind our strong systems performance. First, as we have discussed previously, we have seen growing demand for systems-based security use cases. Second, over the last several years, customers have gained clarity on their cloud strategies and now expect to operate in a hybrid multi-cloud world for some time to come. As a result, they are more willing to purchase systems to support capacity needs driven by accelerating digital transformation. We believe both of these drivers are sustainable. Third, Q1 also benefited from some COVID-suppressed systems catch-up. Customers who have put off systems purchases for several quarters simply can no longer defer growing capacity demands. For a very small subset of our customers that had not refreshed in a long time, a long-planned April end-of-software development milestone on one of our legacy systems contributed to their desire to act sooner rather than later. For clarity, I would note that end-of-software development is very different than the end of support. In this case, the April milestone pertains to an end-of-software development date that has been well-publicized for years, providing customers a long planning runway. We estimate this catch-up demand drove approximately $10 million in system sales in Q1. We see this as a transient systems growth driver though we do expect it to carry over into Q2. Finally, while I did not call it out as a growth driver, our expanded reach and role has also expanded our strategic position with customers. This has enhanced our ability to connect with C-level personas and also means we are more often considered for opportunities that span our application security and delivery portfolio, bridging traditional and modern applications in both hardware and software form factors. As an example, in Q1, one of the United States' leading health care providers selected BIG-IP hardware, software, security and NGINX to keep the critical care applications running nonstop while beginning to migrate to next-generation apps for their care providers. This project reemerged as a priority for the customer after being deferred last February so the customer can divert all necessary resources to fighting COVID. In closing, we are encouraged by our momentum and believe we are seeing clear signs that our organic investments and our value-creation methodology for both NGINX and Shape are paying off for customers and investors alike. We were very pleased to announce that our acquisition of Volterra closed yesterday, and the team has already begun the hard work of integration. Initial customer feedback about the combination of F5 and Volterra has been very positive. Customers are excited about the potential of F5's edge 2.0 to eliminate the pain they feel from today's closed edge platforms. Our edge 2.0 will be the first edge platform built for enterprises and service providers. It will be an open-edge platform that will allow every service to run on any server, virtual or otherwise, inclusive of public clouds. We are very excited to have the Volterra team as part of F5 and are looking forward to sharing our progress with you going forward. I will wrap up today's prepared remarks by thanking the entire F5 team again as well as our customers and our partners. With that, operator, we will now open the call to Q&A.

Your first question comes from Sami Badri from Crédit Suisse.

Great. Congratulations on a strong quarter and for highlighting some significant trends and drivers in your business. Francois, I want to revisit almost a year ago when the pandemic first began, and you mentioned the pros and cons it brought. Some deals were delayed, while others picked up speed. In fiscal 1Q, you experienced some catch-up demand, and in fiscal 2Q 2021, you saw a potential recovery of demand. Are you observing that all the deals funded a year ago or throughout 2020 are now returning in full force, at least in 2021?

Sami, thanks for your question. The short answer is no. Regarding what we refer to as catch-up demand, there are a few customers, and I would say a small portion of those customers, who have been waiting to add capacity due to uncertainties related to COVID or a lack of resources and their ability to implement changes, and they are now starting to refresh. However, if we look back at the deals that were deferred at the beginning of the pandemic, there were some software deals, specifically software transformation deals, that were delayed. We are beginning to see those come back, but not in significant numbers yet. I believe that is still something we can expect in the future.

Got it. Got it. My other question is to do with systems revenue. And I know we had the Analyst Day relatively recently, where you did guide a little bit differently the systems versus what you're guiding today and reported fiscal 1Q and then guiding to fiscal 2Q with 5% growth. Now based on some of the underlying industry drivers that you highlighted and some of the customers that have identified F5 gear as like the go-to gear for security measures, does your overall Analyst Day guide boost or negative growth in systems in fiscal year 2021? And for Horizon 2, does that kind of now go away? Now we're looking at a little bit of a different trajectory.

Well, Sami, we need to revisit the factors driving our hardware business. Currently, there are two main macro trends benefiting the company. Firstly, there is increased spending on applications infrastructure, which we have positioned ourselves to capitalize on for the long term. Secondly, our strategic advantage comes from the integration of hardware, software, cloud, and security solutions. This combination allows us to engage in more strategic discussions with our customers and be viewed as a reliable partner for their future plans. All of this positively impacts our overall business, including our systems division. If you examine the factors driving our systems business, there are two long-term drivers and one that is more temporary. We previously mentioned at Analyst Day that the growth in our security offerings has positively impacted our systems business. This quarter, we saw security growth outpace overall demand again, which supports the systems business. The second long-term driver is that we have customers who, a few years ago, indicated they were either fully committing to the cloud or pausing their systems business to rethink their architecture for public cloud adoption. Many of these customers have now developed a clear cloud strategy and acknowledge that they will be operating in hybrid-cloud environments for an extended period. They are now willing to incorporate hardware into their long-term architecture. Consequently, some customers who previously refrained from purchasing hardware are now returning to refresh or expand their systems capacity. And so I think those 2 aspects are longer term, Sami. There is one transient driver, which is a subset of our customers that really had to make a refresh because it is end-of-software development. We think that was about $10 million in the quarter. We think that kind of carries on in Q2, but that's a really short-term demand. So when you take all of that into account, Sami, we're not changing our Horizon 2 guidance, but yes, there is the possibility that our hardware business will do better in Horizon 2 than what we saw at AIM. We certainly think that for FY '21, it's likely to do better than what we had in our overall Horizon 2 guidance.

Your next question comes from Alex Henderson from Needham.

I was hoping you could talk a little bit about what you think the impact might have been from the SolarWinds hack. And to what extent your software, your systems, your cloud capabilities are seeing an acceleration in demand. If you've heard from any of your CIO, CTO, CFOs, CEO contacts or even Board contacts, whether companies are increasing their spend on IT or specifically security as a result and to what extent you think that will translate to F5 demand?

Alex, you're asking if they're increasing spend on cloud and security as a result of what?

The SolarWinds hack.

Okay. Not necessarily directly, Alex. There is heightened awareness among CISOs and security organizations. Our security trends have been strong over the past several quarters. The factors that have accelerated security for us include more customers shifting to software and incorporating additional security use cases as they do so. The same is happening as they transition to the public cloud, integrating more security measures in that environment. Additionally, with the acquisition of Shape, we've observed that since the pandemic began, as more businesses move to digital channels, there is an increase in fraud. Consequently, our anti-fraud solutions are experiencing robust demand. I mentioned a few use cases in my prepared remarks, but this trend is evident across both large and small companies; there is an uptick in online fraud, and we are well-equipped to safeguard against it.

If I could follow-up. So clearly, you guys are seeing an increased correlation between your appliance sales and your software sales, you're suggesting that's from hybrid cloud. But hybrid cloud has been in place for quite a while. Is it also possible that the launch of the Beacon product and the integration of NGINX back into the appliances accelerate and expand your ability to tie together the enterprise IT spending for campus and data center with the cloud integration and, therefore, pulling both as a result?

Yes, there is definitely a stronger demand for F5 driven by our overall portfolio. We're still in the early stages with Beacon, but NGINX plays a significant role here as part of our involvement in modern applications. The challenge we face is that traditional and modern applications are often viewed separately, but large enterprises frequently engage in application modernization. This means they typically have a traditional application supported by BIG-IP, and as they modernize, they do not completely refactor it but instead add new modern components. NGINX is ideally positioned to support these new microservices. Consequently, the combination of NGINX and BIG-IP offers a comprehensive solution for these modernization efforts, creating synergy that drives growth.

Your next question comes from the line of Tim Long from Barclays.

Two quick ones, if I could. First, could you guys talk a little bit about the organic software revenue growth line, Frank, understanding the tough compare. But maybe just talk a little bit about how we should look at that line in the future. Are we going to see it being a little bit less lumpy, particularly as we've seen deferred revenue really, really grow pretty strongly. So is that something you expect to normalize around a higher number as we get through some of the tougher compares? And then second, I think at your Analyst Day or somewhere around there, you talked about $100 million cloud revenue number. Could you just give us a little color in the quarter, whether it's qualitative or quantitative, around how the cloud-specific software businesses did for F5?

Yes. Tim, it's Frank. Let me start with the first part, and then I'll turn it over to Francois for the second. In terms of the organic growth in the quarter, we talked about 35%. And in the second quarter, we talked about that being likely lower than that 35% to 40% range that we've given you for Horizon 2, based off the tough comp that's coming up at 96% in Q2 of 2020. And as the business continues to scale and as we get more of it from recurring subscriptions, we do expect to have some more normalization in that and not necessarily see the same swings. But as we talked about from the beginning when we discussed software revenue, gosh, almost 3 years ago now, we said that it will be lumpy for this time as we continue to build up scale in the model. But overall, we are not changing at all our Horizon 2 outlook of a compounded annual growth rate of 35% to 40%. Francois, do you want to add anything on the cloud side?

Yes. On the cloud side, we experienced very strong demand. The growth in public cloud actually exceeded the organic software growth rate you've observed, which has been consistent over several quarters. Regarding software demand, while we expect some variability, the overall drivers are very strong. For instance, we reached an all-time high in multiyear subscription agreements this quarter, many of which include multiple software solutions from F5, including NGINX. NGINX had its best quarter ever, and we are seeing significant growth as customers deploy modern applications. We made strategic investments in NGINX last year, particularly in the controller and app security, and these are positively impacting the size of our deals and the number of opportunities we can pursue. With the combination of strong cloud demand, an increase in subscription agreements, NGINX's performance, and upcoming catalysts like new subscription use cases for Shape, we feel very optimistic about our software for Horizon.

Your next question comes from Paul Silverstein from Cowen.

Appreciate it. Before I ask my questions, I was hoping Frank could clarify two basic issues. One, Frank, is my math correct that Shape generated approximately $22 million in the quarter, considering your comments about organic and total growth for software?

Actually, it was higher than that. We didn't get the exact number, but it's higher. There was some slight growth over what we experienced in Q4.

All right. I suspect I know the answer to the next question, but I'll ask. Francois, you made the statement multiple times that you had the best record in NGINX quarter, which means you clearly know what the specific NGINX revenue was. Is that a number you're willing to share with us? I hope the answer is yes.

No, we haven't provided a detailed breakdown of NGINX recently, but as we shared at our Analyst and Investor Day, NGINX revenue has doubled alongside an increase in deal size. This trend is continuing or even accelerating.

Yes, I understand. However, I find it puzzling that you seek recognition without providing us with the specifics. Moving on, I have a key question regarding operating leverage. You have expressed a clear intention to enhance operating leverage this year and in the coming years. I assume this means you plan to increase operating expenses at a slower rate than revenue growth, which is obviously the straightforward calculation. The main question is whether you intend to adjust operating expenses based on variations in revenue growth, whether it exceeds or falls short of your Horizon 2 fiscal '21/'22 projections. Essentially, which factor influences the other more: does revenue dictate operating expenses, or is it the other way around?

Yes, Paul. So what we talked about is the 31% to 32%. And that's what we are targeting. If we find opportunities for investment to continue to drive that revenue growth, we will make those investments. Having said that, we are committed to that 31% to 32% in FY '21 and the overall Horizon 2 outlook that we gave you as well as the long-term model. And so that's the way we are managing the business. We are very excited to see the 10% growth this quarter and the 8.5% for next quarter implied in the midpoint of our guidance range, and those are both obviously above the Horizon 2 outlook and the factors that go into the rule of 40%, we ended up at 43% this quarter. And so we're really happy with that continued progress. But that rule of 40% is the North Star that we continue to strive for within the business.

I understand from your comments and Francois' comment that visibility today is better than it was 90 days ago or even a year ago. However, I'd like to know if you have any questions. How does today’s visibility compare to previous periods? Has it improved, or has it remained steady?

Yes, our visibility continues to grow and remains strong, and we're excited about the outlook we've provided.

Your next question comes from the line of Meta Marshall from Morgan Stanley.

Apologies. This might be circling around some of the other questions that were asked. But you had noted a couple of quarters ago that people were kind of heads down amidst COVID and that they were buying physical additions before. They continue to buy physical additions. They were buying virtual, they continued. You spoke, Francois, about people kind of having a little bit more of a framework of what their hybrid architectures look like. But I guess I'm just trying to get a sense of, is there still a contingent of customers who were just kind of heads down and just trying to address the problems with their current architectures, and that could be kind of with the systems revenue for now. And then just maybe some of the puts and takes on the lumpiness in the service provider revenue and just understanding some of that is project-based, but just maybe that tracking a little bit under traditional kind of percentage of revenue would be helpful.

Meta, let me start with the service provider. Our bookings or demand in the service provider sector increased year-on-year, and we continue to see strong demand for 4G solutions. We're beginning to notice some capacity increases related to 5G, but we believe that the greater demand for 5G is likely still 6 to 12 months away. Overall, the trends in our service provider business have remained stable. Regarding enterprise customers, some are still hesitant to move forward with certain projects, and that is still the case. What we're observing is that our established position with many customers and our operational capabilities, whether in hardware or software, give us a significant advantage. Many customers continue to make incremental improvements and may return to larger transformational projects later. Additionally, since hardware still constitutes the majority of our business with several customers, this greatly benefits our hardware segment more than our software segment.

Your next question comes from the line of Rod Hall from Goldman Sachs.

I wanted to see if you guys could give us some indication of what you're thinking for services growth in Q2? And then I have a follow-up on that.

Yes, we didn't split it out specifically, Rod. I think it's going to be in those low single digits. My guess is it's higher than the 1% that you saw this quarter, but I'm not expecting it to be in the mid-single digits.

So like 2% or 3%, Frank, something like that?

Yes, something like that.

Okay. And then I wanted to come back and just clarify what you guys said in response to Paul on the organic software. Maybe, I guess, the more direct question is what the Volterra contribution would be in Q2. Can you give us any idea on that?

It's minimal. We mentioned that it would be less than $10 million for the full year when we announced the acquisition. So, it will be minimal, Rod. It's not a figure we plan to break out.

Okay. Just to clarify, the $10 million mentioned for Q1—Francis, you indicated it would also apply to Q2, but it wasn't clear. Are you suggesting there will be another $10 million in Q2, or should we expect it to be a smaller amount? Can you provide a rough estimate of what that figure might be for Q2?

Yes, Rod, it was about 5 growth points in the quarter. And it may be something similar to that. There's obviously a declining revenue stream between Q1 and Q2 for systems on the product side. And so it's hard to say exactly, but it probably is a little less than $10 million, but I wouldn't say it's dramatically less than $10 million.

And then Frank, that falls to 0 after Q2, right? So it's just a Q1, Q2 phenomenon, you think?

I can't provide any guidance beyond that, but the date we previously mentioned was April '21, two or three years ago. It may extend beyond that. For some customers, this is a two- or three-generation-old product, and I can't pinpoint when they will go through that upgrade cycle. However, our estimate is that it will mostly be completed by next quarter.

Your next question comes from James Fish from Piper Sandler.

So a little bit on the guide and the results here. You said it wasn't budget flush a few weeks ago and talked about project deferral and increased app infrastructure investment. I guess, could you, in any way, break out how much of it was project deferral from product quarters coming into the quarter here versus kind of increased activity and pipe around that app infrastructure investment versus, frankly, share gains?

I believe the main drivers are primarily related to increased investments in application infrastructure, which are being propelled by a faster pace of digital transformation and the growing use of digital channels across all companies. This trend is contributing to enhancements in application infrastructure and capacity. Additionally, our strengthened position with customers plays a significant role, as they feel more confident making hardware purchases from F5, knowing we also support them with software, modern applications, and public cloud deployments. Customers no longer see F5 as just a hardware supplier; they recognize us as their partner for broader solutions, which opens up further opportunities in hardware as well. Those two elements are the key factors. Some customers are still catching up after delaying refreshes during the pandemic, but this is less impactful than the first two factors.

That's helpful, Francois. Last one for me and going off of Rod's question, obviously, it was announced a couple of years ago, just making sure we should think about it as $10 million for fiscal Q2. Or could it be more? And really, my question is, are there other systems over the next 12 to 18 months that are on a similar path that we should be reminded of?

Yes. For fiscal Q2, you should consider it as $10 million or less, so we believe it will be lower than this quarter, as Frank mentioned, but we can't specify exactly how much. Additionally, regarding other systems that may be in a similar situation, there isn't any comparable effect expected in the next 18 months.

Your next question comes from Jason Ader from William Blair.

Guys, I'm curious, would you say it's possible that the growth outlook for your ADC business has actually hit an inflection point?

I believe that while we are maintaining our overall growth outlook for Horizon 2 at 7% to 8%, recent trends suggest that our systems business may perform better than we originally expected. It's important to remember that our Horizon 2 guidance included three key growth drivers. First, we are experiencing strong momentum in software and software subscriptions, with a 70% year-on-year growth this quarter. This growth reflects the effectiveness of our subscription model, which we initiated 2.5 years ago. The second driver is the strong demand for application security, enhanced by our acquisition of Shape and the use cases we've discussed. The third driver involves a moderation in the decline of our systems, which we anticipated would shift from double-digit declines to high or mid-single-digit declines. When we developed our guidance, we noted that it wasn’t essential for all three drivers to perform perfectly in order to reach our 7% to 8% growth target, giving us multiple pathways to achieve our goal. Currently, in this first quarter, all three drivers are performing well, which raises the possibility that we could exceed our expectations. Specifically, we see strong trends in hardware.

Can you remind us about the kind of organic growth excluding the three acquisitions? What were you indicating regarding that growth in Horizon 2?

The growth for Horizon 2 was between 35% and 40% for all software, and the only organic component, excluding pre-Volterra, was just one quarter of Shape, which was the first quarter we just had. Everything else was organic.

Okay. So I guess what I was asking is the kind of the non-NGINX kind of ADC business, that was going to be flat to slightly up. I mean, could the outlook for that be more something like mid-single-digit growth going forward?

Yes. We don't break that out. The answer is no. It wasn't going to be flat. It was going to grow much faster than that. But we don't break out specifically the software growth percentage of BIG-IP versus NGINX. Frankly, increasingly, as I showed earlier, those solutions are actually used in the same subscription agreements to support customers that have traditional and modern applications that need to scale. And so they have become increasingly synergistic and kind of driving growth for one another but the software growth number that we shared, including BIG-IP, NGINX, Shape as part of our security portfolio.

Your next question comes from Samik Chatterjee from JPMorgan.

And squeezing me in here. I guess, Francois, from what I hear, related to your comments here, it does sound more like what you're seeing is you didn't really need kind of software, systems and services to kind of fire on all cylinders. But given where you are today in the first half, you would exceed the 7% to 8% Horizon 2 revenue growth target this year if things continue this way. And so I just wanted to confirm that's what you're implying. And then if you can help me think about sustainability of that higher than kind of 7% to 8% growth rate into next year given the momentum that you're seeing in the business? And I have a follow-up.

Samik, I think just to be clear, we're not changing our guidance for Horizon 2 of 7% to 8%. That remains our view on Horizon 2. If we're speaking specifically about FY '21, Samik, if you look clearly in the first half, our expectation, if you look at the midpoint of guidance for Q2 is we will exceed the 7% to 8% just on the basis of the first half. And frankly, if the trends that we're seeing right now were to continue, there's a possibility we could exceed that as well for FY '21. But we're not here guiding for FY '21. If you're asking about the underlying drivers that I see in the business for growth, I think the drivers we're seeing for both software and security are very strong and very sustainable. And in hardware, some of the drivers we're seeing that I've talked to are actually sustainable. There is a change there that we're seeing in how customers are approaching deployment of traditional applications in this hybrid-cloud environment. And the place that they're giving F5 in their go-forward plans and the strategic position we occupy now, I think that is sustainable. There are a couple of things that I think are transient, that are not. And so how much of that will play out in terms of FY '22 and beyond, it's really too early to say that now.

Okay. And then a quick follow-up here for Frank. Frank, I'm calculating about a $25 million OpEx increase from 1Q to 2Q. Can you clarify how much of that is from Volterra?

Yes. We're not providing a specific breakdown, but I would estimate it's in the mid-single-digit millions range. However, this is not something we plan to separate out in the future because it is too minimal relative to the total figures.

Okay. We'll take our last question today from Amit Daryanani from Evercore.

So I guess, maybe just on the systems side, I know it's been discussed a bit, but given everything you've talked about, which is not all the stuff that was held up last year is back yet, and I would imagine that perhaps the share gain narrative that hasn't been talked about could be somewhat powerful as well. Could we see a scenario where that systems business actually accelerates in the back half of the year? And if not, I guess, what are the caveats of that statement?

Amit, I didn't catch the last part of your question. The first part is whether the systems business could accelerate. What was the second part?

Yes. I guess, if I think about all the stuff that was held up last year that still has to come back into the funnel, plus the share gain potential you could have in terms of just picking up a little bit more share, I would imagine that systems business could accelerate as we go through fiscal '21. And so I'm curious, what would be the caveats or the reservations from that dynamic?

It's a valid question, Amit. When considering the long-term trends for F5 and our direction as a company, we anticipate that, following the acquisition of Volterra, we will achieve double-digit growth in the long run. This growth will primarily come from software, software subscriptions, and SaaS. We do not foresee our hardware business contributing to growth moving forward. This is our perspective, and nothing in the past three months has led us to alter this long-term outlook. In the short term, while we may not see acceleration surpassing the second half of 2021, we are not dismissing that possibility considering the current dynamics with our customers.

Got it. And if I could just clarify this, the modest or the deceleration that you're talking about in the software business in March versus December, is that just a reflection of your compares are very difficult in the March quarter? Or is there something else you'd call out that's driving that modest decelerate again?

No, that's what we called out, and that's our feeling, and it's just a much harder comp that we had in Q1.

Yes, the comparison is more challenging because last Q2, our growth rate was around 95% or 96% year-on-year. While the comparison is tougher, the fundamental dynamics and drivers for software demand remain very strong across our offerings such as NGINX, Shape, subscription agreements, and overall security. Therefore, we are very confident that the momentum will continue to strengthen.

That concludes our call today. Thank you for joining. You may now disconnect.