Good afternoon, and welcome to the F5 Networks Second Quarter Fiscal 2021 Financial Results Conference Call. Today's conference is being recorded. If anyone has any objections, please disconnect at this time. I will now turn the call over to Ms. Suzanne DuLong. Ma'am, you may begin.

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 session. A copy of today's press release is available on our website at f5.com, where an archived version of today's call will be available through July 25, 2021.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. To access the replay of today's call by phone, dial (800) 585-8367 or (416) 621-4642 and use meeting ID 3461547. The telephonic replay will be available through midnight Pacific time, April 28. 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'll turn the call over to François.

Thank you, Suzanne. And good afternoon, everyone. Thank you for joining us today. I am pleased to be with you and to share with you our strong Q2 results. With a second consecutive quarter of 10% revenue growth and double-digit non-GAAP earnings growth in Q2, we are outperforming both our revenue and EPS goals. It is important to note that we achieved Q2's strong results with a different revenue mix than we expected early in the quarter. We delivered exceptional systems growth of 17%, while software growth was more muted than our expectation at 20%. During this call, we will discuss the market dynamics behind our product revenue mix in the quarter. The transformation we have worked persistently to achieve has put us at the center of applications, both traditional and modern, with a truly multi-cloud approach. As a result, we are benefiting from strong and sustainable macro growth drivers ultimately powered by application growth. Business and consumers' increasing reliance on applications has accelerated all prior expectations about the pace of digital transformation. Our customers across the globe are scaling their digital assets faster, resulting in growing demand for F5's application security and delivery solutions. With our strong overall results, our conviction in our opportunity, both short and long term, is stronger than ever, driven fundamentally by accelerating application growth. We feel very good about our future given robust demand drivers and our strong and differentiated market position. I will turn the call over to Frank to walk you through our Q2 results and our Q3 outlook. Frank?

Thank you, François. And good afternoon, everyone. As François just outlined, our team delivered another very strong quarter. Second quarter revenue of $645 million was up 10% year-over-year and at the top end of our guidance range. Please note, as I review our revenue mix, I will be referring to non-GAAP revenue measures for the year ago period. Q2 product revenue of $309 million is up 18% year-over-year, representing a significant acceleration from 10% in the same period last year and even more so from flat growth in the second quarter of fiscal 2019. Product revenue accounted for approximately 48% of total revenue, up from 45% in the year ago period. The progress we are making driving double-digit product revenue growth and the increasing mix of product revenue as a percentage of our total revenue are both strong indicators of our transformation momentum and the long-term health of our business model. As François noted, we are seeing stronger-than-anticipated demand across the board. Short term, more of that demand is coming from systems, leading to the quarter's product revenue mix. Systems revenue of $201 million is up 17% compared to last year, when systems were down 11%. Systems demand was higher than anticipated in the quarter, largely from a broad-based increase in application usage and the corresponding increase in application traffic, continued growth of systems-based security use cases as well as the emergence of 5G-driven service provider demand. Against a particularly tough 96% growth comparison in the prior year period, Q2 software revenue of $108 million is up 20% year-over-year, representing 35% of product revenue. We continue to drive our transition to a subscription-based model, delivering record subscription volume in Q2, with subscriptions representing 79% of software revenue in the quarter. This is up from 73% in the year ago period. Finally, our global services revenue of $336 million is up 4% compared to last year, representing 52% 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 64% of revenue in the quarter. On a regional basis in Q2, Americas delivered 6% revenue growth year-over-year, representing 54% of total revenue. Our EMEA and APAC teams drove strong growth in their regions, with EMEA delivering 16% growth, representing 27% of revenue; and APAC delivering 15% growth, accounting for 20% of revenue. The quarter's strength spanned customer verticals, with especially strong demand from enterprise and telco. Enterprise customers represented 68% of product bookings. Service providers and government customers each represented 16% of product bookings, including 6% from U.S. federal from within the government vertical. Let me now share our Q2 operating results. GAAP gross margin in Q2 was 80.1%. Non-GAAP gross margin was 83.4%, reflecting higher systems revenue as well as higher levels of managed service solutions and our usual Q2 seasonal decline in global services margins. GAAP operating expenses were $463 million. Non-GAAP operating expenses were $342 million, reflecting our usual Q2 operating expense seasonality and the addition of 2 months of Volterra-related operating expenses. Our GAAP operating margin in Q2 was 8.3%, and our non-GAAP operating margin was 30.3%. Our GAAP effective tax rate for the quarter was 17%. Our non-GAAP effective tax rate was 20.2%. GAAP net income for the quarter was $43 million or $0.70 per share. Non-GAAP net income was $155 million or $2.50 per share. I will now turn to the balance sheet. We generated $128.5 million in cash flow from operations in Q2. Cash and investments totaled approximately $662 million at quarter end, reflecting both the cash used for the Volterra acquisition and the initiation of a $500 million accelerated share repurchase program. As a result of the ASR, we retired approximately $400 million of shares in Q2, reflecting 2.1 million shares purchased at an average price of $194.91 per share. We expect the remaining $100 million of ASR-related shares to be retired early in Q3. DSO was 52 days. And capital expenditures for the quarter were $9 million. Deferred revenue increased 7% year-over-year to $1.4 billion. We ended the quarter with approximately 6,360 employees, up approximately 200 from Q1, in part as a result of the Volterra acquisition. Now let me share our guidance for our fiscal third quarter. Unless otherwise stated, please note that my guidance comments reference non-GAAP metrics. 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. It will come as no surprise that, like others in the industry, we are seeing some tightening in our supply chain. Thus far, our team has navigated it well, particularly given stronger-than-anticipated systems demand. Obviously, this is an industry-wide challenge, and like others, we have mitigation efforts in place and we'll be watching it closely. With that as context, we are targeting Q3 fiscal year 2021 revenue in the range of $620 million to $650 million. We have accounted for the reduced supply chain visibility with a wider revenue range for our Q3 outlook, lowering the bottom end of our range by $10 million. While we do not expect to routinely provide product revenue mix guidance, we expect software growth for fiscal year 2021 will be at or around 35%, implying software growth in the back half of '21 exceeding what we delivered in Q2. Near term, we expect continued systems strength, with a slower growth rate likely in the fourth quarter. We expect Q3 '21 gross margins of 84% to 84.5%, and we estimate operating expenses of $338 million to $352 million. We also expect to achieve our fiscal year 2021 non-GAAP operating margin target of 31% to 32%. We anticipate our effective tax rate for the year will be approximately 21%. Our Q3 earnings target is $2.36 to $2.54 per share. We expect Q3 share-based compensation expense of approximately $63 million to $65 million. With that, I will turn the call back over to François.

Thank you, Frank. The big takeaway from our Q2 results is that, across the globe, our customers are experiencing a pronounced growth in application traffic, which in turn is driving increased opportunity for F5. Customers across geographies and verticals are experiencing application demand well ahead of initial expectations and timelines. This escalating demand is coming on the heels of a prolonged period of sweating assets in anticipation of cloud modernization efforts and more recently pandemic-induced investment reprioritization. With no signs that application usage will slow, customers are urgently working to ensure they are able to support application traffic growth. The result for F5 is strong and sustainable overall demand for application security and delivery as well as a temporary change in customer buying behavior, evident in our Q2 product revenue mix. I will stress that, while we believe the opportunity around application demand is a long-term one for F5, we expect the current trend favoring hardware-based delivery models is short-term. There remains a durable preference for software- and SaaS-based application security and delivery that will once again be evident in our results over the next several quarters. So let us dig into the quarter's demand drivers. I will frame my discussion with the 3 growth drivers we discussed at our November 2020 Analyst Day: one, ongoing software and subscription momentum; two, systems-based demand; and three, growing demand for application security in both software and systems form factors. We continue to see rising demand for application security, and increasingly, F5 is seen by customers as an application security leader. In fact, Q2 was our highest security quarter yet, with strength spanning both systems and software form factors across both traditional and modern applications. Where application security is threaded through virtually all of our customer interactions, both software and systems, for the purposes of discussion today, I've highlighted security use cases throughout both the software and systems form factor discussions. I will start our discussion with our software and subscription momentum anchored on trends we are seeing with application-driven demand. Our growth in modern applications continues to accelerate, driven by NGINX container and cloud-native deployments. We are seeing several top use cases emerge for NGINX, including API gateway, Kubernetes synchronized controller, and software-based load balancing. Customers' modernization efforts and the availability of NGINX Controller and enterprise-level app security with NGINX App Protect are also driving larger NGINX deal sizes as we anticipated. In one example, our sales team successfully layered NGINX Controller with NGINX App Protect to enable one of the largest digital product companies in APAC to modernize more than 40 digital properties, replacing multiple competitors with NGINX Plus with app protect and controller. As a result, the customer got a much better ROI in a long-term subscription framework. Customers are also increasingly aware and appreciative of NGINX's extreme versatility. For instance, during the quarter, we secured an NGINX win with a regulatory body in APAC. The customer was facing 2 distinct challenges. First, they needed to refresh their electronic payment systems. And second, they needed to deploy microservices in a VMware Tanzu Kubernetes environment. NGINX proved the ideal solution for both. In the first instance, the customer moved from NGINX Open Source to NGINX Plus for the additional functionality and the added benefit of world-class global services support. In the second, they opted for a flexible subscription agreement which gives them the ability to scale NGINX both as a software ADC and as a Kubernetes ingress controller as they grow their microservices. And they are using the controller for visibility and manageability across both use cases. Of note, NGINX was the only true multi-cloud solution they found able to work in both a VMware environment and the cloud. With pronounced application growth and an ever-expanding threat landscape, we also see continued demand for application security in cloud environments and rising demand for fraud and bot defense. With our Shape anti-fraud and anti-bot solutions, we are learning our win rate is best when there is significant automated traffic that can often circumvent traditional WAF protection. This is Shape's sweet spot. As an example, during Q2, a large credit union faced a massive credential stuffing attack, which their existing WAF could not defend. Shape could and did. While momentum in NGINX and modern application security software use cases increased in Q2, we experienced a notable shift in customers' delivery preferences for application security and delivery for traditional workloads served by BIG-IP. We continue to see growing demand for BIG-IP software in multi-cloud environments and expect the resumption of large-scale modernization efforts will remain a powerful growth driver for BIG-IP over time. Short term, however, we saw a mitigating factor to BIG-IP software demand which paradoxically was driven by continued application growth. Facing escalating application traffic, several customers opted to refresh and augment their existing infrastructure instead of transitioning to software or a cloud environment. When asked, they explained that the systems form factor offered an expedient way to get the urgent capacity their applications and users needed in a well-operationalized deployment motion. While cloud modernization and expansion are most certainly part of their future plans, they chose to deploy systems now. We expect this pattern with BIG-IP software is temporary and will moderate in the fourth quarter as customers resume BIG-IP software purchases in support of longer-term strategic projects and modernization efforts that COVID working conditions have made challenging. Stepping back, we continue to drive very positive software trends in the business. Our software subscription momentum continues, with 79% of Q2 software revenue coming from subscription-based sales, up from 73% in the year ago quarter. In terms of volume, the number of multiyear subscription agreements was up 32% quarter-to-quarter and more than 200% compared to last year. In addition, while it is early still, we are beginning to hit some multiyear subscription renewals, and we are also seeing positive signs there. During Q2, we achieved a 100% renewal rate on the long-term subscription agreements that expired in the quarter. In addition, 75% of those renewals grew over prior levels. While we've yet to hit the inflection point for renewals, we are very encouraged by these early data points. In addition, we continue to see utilization improvements. Our Q2 customer success metrics show long-term subscription customers are achieving 100% utilization sooner than ever before. Turning to systems, part of F5's value proposition is our ability to offer our customers enterprise-grade application security and delivery solutions in multiple form factors, systems; software; and increasingly, going forward, SaaS. As I just discussed, sudden and rapidly accelerating growth in application usage led to accelerated customer demand for systems in Q2. Last quarter, we articulated several systems demand drivers. Another quarter in, we believe we have additional clarity around the drivers of our systems growth and we can break them into 2 broad categories: one, accelerating application traffic; and two, security, including emerging 5G-driven demand. To a large extent, I have already spoken to the accelerating application traffic. With surging application consumption, customers have urgent capacity demands to fulfill. As a result, several customers are opting to refresh and augment their infrastructure at a faster rate than we anticipated. Of note, they are doing so without a new systems platform from us. In some cases, the deployments coincide with the "end of software development" date we discussed last quarter, but broadly speaking, the underlying driver is the need for application security and delivery capabilities to deal with escalating application usage. We are seeing demand span geographies and customer verticals, from financial services to technology, to global SaaS providers. As a case in point, one of our biggest systems deployments this quarter was with one of the planet's largest cloud-based software companies looking to build a scale model for organic growth and the scale within their existing systems architecture. Similarly, last quarter, we had a sizable system deployment with one of the largest tech giants in support of their global web-based collaboration platform, and they scaled with their existing systems architecture. These are cutting-edge players, and in all likelihood, they will be among the first to move to software and cloud-based infrastructures in the future. However, today, because of the confluence of demand, the complexities of deploying and scaling in the cloud, and the challenges of taking on transformative projects in a COVID-influenced environment, they are solving their application and delivery challenges with systems from F5. Wrapping up our growth drivers discussion, let's talk about systems-based application security, including a new driver, emerging 5G demand. As we have said for several quarters now, our systems business is benefiting from increasing demand for security use cases. Cross-sell of application security is driving systems growth as more customers look to consolidate vendors and combine ADC and application security functionality. Among enterprise and government customers, we also are seeing strong demand for web application firewall and continued strength in identity and SSL orchestration. The new driver that developed this quarter is emerging service provider 5G demand. We expected that, as 5G traffic began to flow from the radio edge into service providers' 4G core networks, we will benefit from increased demand given our strong position in 4G Gi LAN infrastructures. We initially and conservatively estimated 5G-related demand would begin to materialize in late 2021 or early 2022. In Q2, we secured several Gi LAN expansion projects, including a large Gi LAN firewall expansion with a North American carrier. These wins and other active opportunities suggest that we are in fact beginning to see the emergence of 4G core expansion driven by 5G demand. So what does all of this mean for our business and growth going forward? Fundamentally, we expect customers to transition to more software- and SaaS-based solutions over time. We are confident that the investments we have made, both organic and inorganic, and forward momentum our teams are driving position F5 as a significant beneficiary of that transition. This is true in the short term. As Frank said, we expect our software growth in fiscal year 2021 to be at or about 35%. And it is also true in the long term as software- and SaaS-based revenue account for a more sizable portion of our total revenue. We expect demand for application security will continue to grow as application demand grows and customers scale and modernize their applications. We believe that we are exceptionally well-placed with the right perspective and toolset to solve our customers' most pressing application security challenges. Our opportunity in application security is even more exciting with the ongoing integration of F5 and Volterra, which will bring enterprise-grade F5 application security to the edge in an easily deployable SaaS model. We expect the recent high growth rates we have seen from BIG-IP systems will begin to moderate in the second half of this year. And we expect service providers' 5G-related demand will likely begin to migrate from systems to software in 2022 as their 5G cores start to hit production. In the meantime, we see demand for systems-based application security persisting over multiple quarters. Before I close our prepared remarks, I will say a few brief words about Volterra and our integration process. We launched our integration and value creation efforts immediately following the acquisition close on January 22. We are thrilled to have Ankur Singla and the Volterra team as part of our security organization, led by Haiyan Song. While we have work ahead, we are very pleased with the initial positive customer response. Early indicators show our vision of F5's Edge 2.0 is resonating with customers. We have started a pilot program concentrating on specific use cases and focused on bringing F5 security to the edge, with the goal of leveraging Volterra's organic momentum and early customer interest. Through this pilot, we will develop new business as well as derive customer behavior insights. As the first step in our long-term integration of F5's solutions and Volterra's platform, we have begun the process of strategically and methodically combining our best in web application and API protection security offerings and Volterra's innovative platform. We are also formulating our go-to-market approach and exploring ways to maximize the benefits with our channel partners. Only a few months into this integration, we are even more excited about the potential of this combination as we move into FY '22. We will continue to share our progress with you in the coming quarters. I will wrap up today's prepared remarks by thanking the entire F5 team again as well as our customers and partners. In particular, our thoughts are with the F5 team in India, their families and loved ones as they endure the extreme health risk and loss of life occurring there as a result of the current COVID-19 outbreak. With that, operator, we will now open the call to Q&A.

Your first question comes from James Fish from Piper Sandler.

François, you really talked a lot about the near-term benefit from systems and the expectation for it to get software bookings later on in the year. Are there deals already engaged for that cross-sell opportunity of, say, NGINX and other parts of software that you can point to that's already happening? And maybe, Frank, is there any way to quantify? Last quarter, we heard about roughly $10 million impact from the end of development. Was there another kind of $10 million this quarter of kind of pulling of demand or no?

Jim, thank you for your question. The short answer is yes. We have a strong pipeline of software deals for both NGINX and BIG-IP that will come to fruition in the second half of the year. This quarter, we observed several software growth drivers. The first is modern applications, which is performing well, largely due to NGINX surpassing our expectations, along with the addition of the controller and security features on NGINX, and an increasing number of customers deploying modern applications in cloud-native and container-native environments. The second driver is security, which is also progressing as planned, with more customers implementing security solutions in modern or traditional application environments, both in systems and software forms. The third driver of software growth involves the deployment of BIG-IP in multi-cloud environments, particularly with some customers transitioning from systems to software-first or cloud-first setups. Although we continue to see growth in BIG-IP deployments, this quarter showed a slight moderation in that area. Many customers needing to enhance their capacity for application use and growth opted for a quicker deployment method, which is hardware, as they currently lack the time or resources to rethink their architecture and shift to software due to the COVID environment. However, we believe that this transition will resume soon, and we are very optimistic about software growth for the second half of the year and into 2022.

And Jim, regarding your second question, the end of the software development cycle we experienced at the beginning of April was one factor, but it's challenging to pinpoint the exact financial drivers behind everything. Other factors to consider include the capacity expansion that François discussed extensively in the prepared remarks, customers' depreciation schedules, and their struggles to maximize the use of their existing assets for the past couple of years. There have also been some budget reprioritizations and a few other considerations. If I had to put a number on it, I would say it is likely similar to last quarter, but many other elements contributed to the strength of hardware.

I completely understand and appreciate that. I have one more follow-up question: There were several significant breaches that occurred before your last report, and the pipeline hasn't had much time to develop. What are you observing? You mentioned strong security results, including for carriers and enterprises, but can you highlight anything specific about the security pipeline for WAF in light of those breaches? Are there areas within security that you might consider expanding into to enhance the overall portfolio?

Jim, is your question specific to WAF?

Yes.

Okay. So on and specifically on web application firewalls, Jim, we continue to see good traction there. It's one of the most in-demand use cases from our customers. We have seen that traction this quarter happen both in hardware form factors and either in stand-alone form factor or with customers sometimes bundling that with ADC. And we also see demand for web application firewalls in these modern application environments. And we're really pleased to see the traction with NGINX App Protect and which as you know is that effect we're seeing of having made the decision to port our security capabilities onto NGINX shortly after the acquisition. That's gaining a lot of momentum now. So we're getting embedded for security in these modern apps environment. And we also see that with BIG-IP. In terms of the portfolio, Jim, we really are focused on the web application firewalls, application security in general, API protection, DoS protection and bot management and mitigation. Those are really the areas of application security where we are placing focus and significant investments for the near future.

Your next question comes from Meta Marshall from Morgan Stanley.

Great. I have a couple of questions. First, do we have an organic software growth figure for year-over-year, excluding the two months of Volterra that were included? Additionally, as you are engaging in deeper conversations and sales that involve multiple products, what are you observing regarding sales cycles for cross-selling opportunities compared to standalone products?

Yes. So Meta, let me take the first question, and then I'll let François handle the second. We had mentioned that we would not break out Volterra because it is quite small. In fact, it's extremely small this quarter, with only 2 months of data. Therefore, it does not significantly impact our growth metrics. I would say it is quite immaterial to our operational results. However, it is becoming a vital asset for us, especially in future years. We are very excited about the positive response we've seen from our customer base and sales team so far. But in terms of actual revenue results, there is not much to report from Volterra. Now, I'll turn it over to François for the other question.

Yes. We are pleased to see that more customers are adopting multiple elements of our portfolio. A significant number of our multiyear subscription agreements now include various F5 products, which is enhancing our conversations with customers and strengthening F5's position in large accounts. The traction from these agreements is encouraging, with a 200% year-on-year increase in software multiyear subscription agreements this quarter compared to Q2 of 2020. This reflects the growing trend of customers shifting to term subscription agreements that allow them to easily utilize multiple products. Regarding our new point solutions, it's too early to provide details on Volterra as we are still integrating our capabilities onto that platform, including our security features. We expect to share more about upcoming deals related to Volterra in the next few quarters. As for Shape, we are satisfied with its value proposition. Customers using Shape report high effectiveness, even those who already have solutions from other vendors but continue to face attacks. Shape offers a superior solution for addressing those challenges. However, the COVID environment has complicated our sales process, particularly when demonstrating new solutions that require proof of concept. This situation has extended our sales cycles. Overall, this is the current status of our cross-selling efforts across our portfolio.

Your next question comes from Sami Badri from Crédit Suisse.

Congratulations on the solid results. François, in your prepared remarks, you mentioned escalating demand along with other supportive factors, such as 5G security and service providers moving forward. However, the key question we have is how these additional significant drivers will affect your full-year guidance. Is there a particular reason you haven't increased the Horizon 2 guidance points at this time? Or are you taking a more cautious approach regarding the growth outlook and not raising it?

Yes, Sami, there are a few points to mention. Horizon 2 spans an 8-quarter period, and we are only 2 quarters in, so it's quite early to adjust our Horizon 2 guidance. However, we can highlight that we are definitely observing a significant increase in application usage, largely because more of us are consuming online services. Consequently, our customers, whether they are traditional enterprises or cloud providers, are experiencing higher application usage. As you know, we are integrated into the technology stacks of SaaS providers and cloud companies. I've mentioned before that one company's cloud is another's data center, and we are part of those stacks. Many of our cloud provider customers are facing rising demand for their solutions, which compels them to expand their capacity, and we are directly benefiting from this trend. Therefore, we can assert that our hardware for 2021 will experience positive growth, based on our observations. Additionally, the performance of our systems for Horizon 2 will significantly exceed our initial expectations. Those are the key points we can share. There is some uncertainty due to the supply chain challenges that all vendors are currently encountering, so we remain cautious about that. As mentioned in the prepared remarks, we factored this into our guidance range, but the underlying demand remains very robust.

I wanted to discuss U.S. federal demand. The presidential administration has actively worked to raise funds and modernize infrastructure. You mentioned that your numbers for U.S. federal in fiscal Q2 were relatively in line, but as we look at the rest of the year, can you provide an update on how things are progressing with U.S. federal? This would help us get a clearer picture.

I think, Sami, we don't see a fundamental change in the demand trends. The Fed business has been pretty strong, and we expect this to follow kind of normal patterns and given what we see in the pipeline today.

Your next question comes from Tim Long from Barclays.

I have two questions. First, can you provide an update on the cloud vertical, which was reported as $100 million last fiscal year? How has growth trended in this area? Secondly, regarding the software ramp for the second half of the year, it appears that visibility is quite good. Could you elaborate on that? After several quarters of flat growth, it seems like there could be significant dollar growth. Should we anticipate any enterprise licensing agreements or similar items in the figures to support sequential revenue increases, given that most of it will be subscription-based? If not, would there need to be a large scale of subscription deals? Any insight you could share would be appreciated.

Thank you, Tim. I'll begin by addressing the second part of your question regarding software growth in the second half of the year, and then I'll return to the first part. In the second half, we have several catalysts and drivers that are gaining momentum. I previously mentioned NGINX, but the environment for modern applications is also expanding. We have multiple subscription agreements in the pipeline, and the key point is that the number of multiyear software subscription agreements we are signing is growing at an extraordinary pace. From Q1 to Q2, these agreements increased by about 30%, and on a year-over-year basis, the volume of subscriptions surged by 200%. This trend is ongoing, and we can see it clearly. We are approaching a critical point for renewing these subscription agreements, although we believe this will be more significant in 2022. Currently, the renewal rates for agreements nearing their end and those with over a year left in tenure are performing excellently. These catalysts are crucial. Security remains a significant growth driver for our software, along with the cloud. Now, regarding the first part of your question, the cloud continues to be a growth driver for our software, but this quarter, its growth rate was somewhat slower. We believe this is due to a slowdown in the number of customers migrating applications to the public cloud, particularly traditional applications. This trend mirrors what we see in our hardware business, where customers have delayed hardware deployments in favor of cloud migration. Many of these customers, after maximizing their existing assets for an extended period, are now facing increased capacity demands that need immediate attention. The most operationally efficient way to address this situation is to utilize hardware. Additionally, in the context of the ongoing COVID environment, transitioning from hardware to software or from hardware to cloud often requires re-architecture or collaboration among multiple teams, which is more challenging right now. As a result, fewer customers are currently able to make these transitions. However, we believe that the overarching trend towards cloud migrations will continue in the long run, even if this quarter was slightly less optimistic.

Your next question comes from Samik Chatterjee from JPMorgan.

Great. François, I wanted to start by discussing the implications of shifting our spending priorities toward more systems, as well as the 5G expenditures you mentioned. When you consider both of these factors together and look at the long-term picture, is the expectation still that systems will see a decline in the mid-single-digit range? Or does this reprioritization and the increased investment in 5G affect your long-term outlook for systems? I have a follow-up question as well.

Samik, the definition of longer term can vary. Focusing on Horizon 2, I believe that in 2021, our systems business will see growth for the full year. When considering both 2021 and 2022, I expect the performance in systems will exceed our initial forecast of a high to mid-single-digit decline, and I anticipate significant improvement. However, predicting beyond Horizon 2 is premature. Specifically regarding the hardware ADC space, we expect hardware ADCs to continue their ongoing decline after Horizon 2. Conversely, in the realm of hardware security, we are still witnessing growth, which enhances our overall mix. While it is early to draw conclusions about developments past 2022, we can note that many carriers are now deploying their 5G radio infrastructure. The first 5G smartphones emerged in Q4 of 2020, and numerous spectrum auctions have occurred. Consequently, we are beginning to observe 5G utilization transitioning from devices to the radio, reaching the carrier core networks. Currently, most carrier core networks remain 4G, where we hold a strong position, and the capacity demands are being met through upgrades to 4G, giving our hardware business a favorable boost that I expect will last for several more quarters. Looking ahead to 2022, many carriers will begin rolling out their 5G core networks, which will be virtualized, thereby creating a software opportunity for F5. We have already achieved significant design wins for these 5G cores and are currently conducting initial office applications and pilot projects as we prepare for broader production in the next 6 to 12 months. So right now, we have a hardware expansion opportunity, which will transition to a software opportunity in 5G cores for F5 within the next year.

Okay, François, as a follow-up, I'm looking at the growth trends across different regions and trying to understand the variability. The Americas was the best-performing region for you last quarter, but its growth rate has slowed down significantly while still increasing. In contrast, EMEA and APAC are contributing to growth this quarter. Is there something specific affecting this, such as the sales force? What is really causing this variability in performance by region?

There isn't really anything significant to mention. In the service provider sector, we have seen important expansions in EMEA and APAC that contribute to growth, but I wouldn't focus too much on the quarter-to-quarter variability across different regions. Overall, the demand we are experiencing for both hardware and the software subscriptions I mentioned is strong and consistent across all regions.

Your next question comes from Alex Henderson from Needham.

I was hoping you could discuss the shift to hardware regarding the integration of the Beacon technology and the platform launched last spring, which connects the Kubernetes NGINX products to the BIG-IP. To what extent are you observing updates in these systems, considering that IT administrators and CIOs can regain some control in the DevOps process and use integration between BIG-IP and the NGINX product to establish guardrails for DevOps teams? Is this part of the current situation, or is it simply that last year's lockdowns affected installs, leading to an aging installed base that now requires upgrades? Can you provide more clarity on this? Additionally, with Kubernetes adoption reportedly doubling from last year and 96% of companies opting for multi-cloud solutions, could you elaborate on your integration efforts with HashiCorp and how this partnership is evolving?

Alex, it's Kara. I'll start with your questions. Regarding the shift to hardware, we've discussed several factors contributing to the strong demand we're currently experiencing. One key factor is the strength of our product portfolio and how customers are recognizing F5's relevance in modern applications and security use cases. This is influencing our current trends. However, I really believe that as François mentioned in the script and during the Q&A, the robust demand we're observing is primarily tied to this latter aspect you mentioned. So, that's my response to your first question. For your second question about our work with Hashi, we have an ongoing partnership with them. We have several integrations within the BIG-IP platform, including significant use of Terraform integrations that enable automation for our customers and streamline their deployments in public cloud environments. Additionally, we are also working on integrations with their orchestration tools like Consul to automate the deployment and provisioning of BIG-IP offerings.

Your next question comes from Jeff Kvaal from Wolfe Research.

Frank, can we start with you with a question on the guidance, please? Could you help us parse kind of what you're thinking at the high end and the low end and what the impact of the systems mix would be in there? I mean, typically, when companies widen a range, they often widen it on both ends. You widened it on the lower end, and I'm just wondering what kind of expectations and variables are built into that range.

Sure, absolutely, Jeff. So when we're looking at all the factors coming into setting guidance expectations in a normal cycle, if there weren't any supply chain concerns, we would have said $630 million to $650 million, with $640 million as the midpoint. And taking into account what I talked about in regards to just some less visibility than we would normally like on some of the supply chain components, we wanted to make sure that we gave the additional room of the $10 million on the low end. And so that's a result of the range. In a perfect world, it would still be that $20 million range, but we just wanted to be cautious with our outlook.

Are you more concerned that you might not get what would have been at the midpoint, the $640 million number? Or are you more concerned that the mix might shift more heavily to systems than you thought?

No. When we consider the expected mix and our projection of approximately 35% for software this year, we feel confident about that outlook for software. We did not provide specific figures for services, and the remaining aspect is the systems side. In assessing the $10 million of risk, we identify that risk primarily within the supply chain, not on the demand side. As mentioned, demand remains quite strong.

Lastly, we all look forward to a smoother trajectory in the software side of the business. You mentioned that this March quarter was the last really tough comparison period. How close are we to having a less volatile software number from quarter to quarter?

Yes, I can't say with absolute certainty, Jeff, but I believe there are two factors to consider for the latter part of Horizon 2. Looking at the entirety of FY '21 and FY '22, we anticipated this to be a 96% comp quarter, which meant we expected some variability. In the previous quarter, we experienced a 70% comp with Shape and 35% without it. This range was consistent with our expectations, and we believe it will be smoother moving forward. There will still be variability, but we will gain more clarity as we begin to lap some of the multiyear subscription agreements in the latter half of FY '22. We have four more quarters of variability ahead, but I don’t expect the fluctuations to be as pronounced as what we saw between Q1 and Q2 of this year. Starting in the lapping period, the denominator will increase significantly, reducing the impact of swings. Additionally, as the SaaS segment of our subscriptions continues to grow, it will contribute to smoothing things out. While we may experience some choppiness in the meantime, I believe the situation will begin to stabilize in the latter half of '22 and beyond.

Due to time constraints, we will take our last question from Paul Silverstein from Cowen.

That means I could ask five questions, but I'll limit myself to three. First, I want to apologize to François, as I know you've already addressed this in previous responses. If you have fully explained it, I apologize, but I need to confirm something. It seems reasonable to say that the investment community may not fully recognize the strength of your hardware. I want to make sure I understand you correctly: you are stating that the software weakness, compared to your original expectations, is solely due to several customers unexpectedly choosing traditional hardware systems because of urgent needs and the demand for strong application growth and security. Is that accurate, or is there something more going on? Is there any fundamental weakness in software demand?

No. If you look back, there are two factors regarding the software growth rate at 20% compared to the 35% to 40% for Horizon 2. First, as Frank mentioned, it was a high comparison relative to last year. The other primary factor is that customers paused or moderated their migrations to software due to operational constraints. This is reflected in the higher hardware numbers and the lower software growth, particularly with BIG-IP. In other areas of our software portfolio, such as NGINX and security, we experienced strong growth; in fact, NGINX grew faster than overall product revenue. However, the softness in BIG-IP software can be attributed to customers unexpectedly choosing hardware over software in several cases. I would also add that overall demand for F5 technology remains strong. As these customers continue to deploy BIG-IP, it expands our footprint, and when they eventually migrate to software, they will do so with us. We have demonstrated this over the last three years. For customers who chose hardware, this is just a temporary delay in their transition to software, and there is indeed a substitutive effect where customers are pausing on software in favor of hardware due to the unexpected surge in application demand. Given the COVID environment and the challenges in re-architecting and collaborating across teams, they opted to proceed with hardware.

Understood. So that's a form factor choice in your indicating. I suspect those customers choosing to remain on the hardware will eventually migrate to software, but it's not indicative of weakness in software per se. It's a form factor choice. Let me move on: I appreciate you mentioning that NGINX grew faster than overall growth. Any metrics you can cite with respect to Shape? Or anything above what you just said about NGINX in terms of quantifying what you're seeing from those 2 acquisitions? I recognize that Volterra is still at a very nascent stage, at least it sounds like it is, but anything you could add in terms of revenues, order book or other metrics that you can offer providing more color as to the progress on Shape and NGINX?

We shared some important metrics about the growth in ARR for Shape since the acquisition and the increase in the number of customers. While we have continued to see growth in customers, the growth in ARR for Shape this quarter wasn't as strong as we had hoped. This is mainly because for customers requiring a proof of concept, the current environment poses challenges. When customers are not in the office and need to collaborate across teams and integrate different systems for proofs of concept, the process becomes more complicated. It requires more time and motivation from customers. When customers are facing significant challenges and attacks, decisions are made quickly. When they are not under pressure, the pace slows down, which is what we observed this quarter with Shape. However, when considering the effectiveness of the solution and customer satisfaction, as well as its ability to block a growing number of automated attacks, we are very pleased. We believe that the issues related to operationalizing proofs of concept and transitioning to a sales cycle are temporary and will improve as we move past the COVID situation.

Finally, François, I would like to clarify something in response to a previous question. Regarding the macroeconomic recovery and regional observations, I understand it's still early, but since the U.S. and U.K. seem to be progressing faster than Europe and possibly other countries in terms of vaccination rates, do you have any data concerning the order book in the U.S. and U.K. or other metrics that could indicate what we might expect from other countries and regions as we gradually return to normalcy?

I would generally say no, Paul. When I review our spending patterns, this quarter seems similar to the last quarter. As you may recall, three years ago, we noticed that uncertainty around Brexit was affecting our numbers significantly in Europe, leading to noticeably different spending patterns. However, this quarter and the previous one do not show that kind of disparity. Instead, we observe a trend where everyone is transitioning to digital, utilizing their digital channels more extensively, which is steadily increasing our application traffic. We're witnessing the same phenomenon across Latin America, Europe, North America, and Asia. There isn't a noticeable difference associated with COVID or vaccination rates impacting our business at this time.

I will now turn the call back over to the presenters.

Thank you all for joining today. We appreciate it. As we said, the call is recorded and the replay will be available on our website. Have a great day.

This concludes today's conference call. Thank you for participating. You may now disconnect.