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

Hello, and welcome. I am 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 A copy of today's press release is available on our website at f5.com, where an archived version of today's call will be available through October 25, 2021.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, use meeting ID 5294198. The telephonic replay will be available through midnight Pacific Time, July 27. For additional information or follow-up questions, please reach out to me directly at [email protected]. Our discussion today will contain forward-looking statements, which include words such as believe, anticipate, expect, and target. These forward-looking statements involve uncertainties and risks that may cause our actual results to differ materially from those expressed or implied by these statements. Factors that may affect our results are summarized in the press release announcing our financial results and described in detail in our SEC filings. Please note that F5 has no duty to update any information presented in this call. With that, I will turn the call over to François.

Thank you, Suzanne, and hello, everyone. Thank you for joining us today. I am pleased to share with you our very strong Q3 results. Broad-based strength across the business drove 11% revenue growth in the quarter, marking our third sequential quarter of double-digit revenue growth. We delivered 34% software growth, 13% systems growth, and 4% global services growth in Q3. F5’s business is benefiting from digital acceleration and application growth, as well as heightened demand for application security. Customers’ traditional apps are generating more revenue and more engagement than ever before. At the same time, customers also are accelerating adoption of modern application architectures like Kubernetes for new applications. With our expanded application security and delivery portfolio, we are uniquely positioned to solve our customers’ most significant modern and traditional application challenges on-premises, in the cloud, and across multiple clouds. I will speak more about our business drivers and customer highlights from the quarter after Frank reviews our Q3 results and Q4 outlook. Frank?

Thank you, François, and good afternoon, everyone. As François just outlined, our team delivered another very strong quarter. Third quarter revenue of $652 million was up 11% year-over-year and above 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. Q3 product revenue of $310 million is up 21% year-over-year, representing a significant acceleration from 3% in the same period last year. Product revenue accounted for approximately 48% of total revenue, up from 44% in the year-ago period. We continue to advance our transition to a more software-driven model. Q3 software revenue grew 34% to $129 million, representing 42% of product revenue, up from 38% in the year-ago period. Today, we offer customers annual and multi-year subscriptions, as well as a growing base of SaaS consumption models. Customers’ preference for these flexible models is driving growth in the subscription-based portion of our revenue. In fact, since Q3 of 2018, we’ve driven subscription software revenue growth at a three-year compounded annual growth rate of 118%. In Q3 2021, subscription-based revenue represented 78% of total software revenue, up from 73% in the year-ago period. Customer adoption of our multi-year subscriptions continues to grow, providing much-needed flexibility for our customers and future revenue visibility for us. These multi-year subscriptions are generally three-year term subscriptions and can be for BIG-IP or NGINX or a combination of both. With customers increasingly looking to F5 to support both traditional and modern applications, our multi-year subscriptions are more frequently including both BIG-IP and NGINX. In fact, in Q3, NGINX was part of over half of our multi-year subscription deals. We see continued strong system demand based on broad-based increases in application usage, continued growth of system-based security usages, and 5G service provider usage. In Q3, systems of $180 million is up 13% compared to last year when systems were down 12%. Rounding out our revenue picture, we see continued strength of our global services with revenue of $342 million in Q3, up 4% compared to last year and representing 52% of total 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. On a regional basis in Q3, Americas delivered 10% revenue growth year-over-year, representing 57% of total revenue; EMEA delivered 19% growth, representing 26% of revenues; and APAC delivered 3% growth, accounting for 18% of revenue. The strength in Q3 spanned customer verticals as well. Enterprise customers represented 69% of product bookings in the quarter; service providers represented 15% and government customers represented 17%, including 4% from U.S. Federal within the government vertical. I will now share our Q3 operating results. GAAP gross margin in Q3 was 81.4%. Non-GAAP gross margin was 84.1%. GAAP operating expenses were $434 million. Non-GAAP operating expenses were $349 million. Our GAAP operating margin in Q3 was 14.8% and our non-GAAP operating margin was 30.5%. Our GAAP effective tax rate for the quarter was 4.9%. Our non-GAAP effective tax rate was 14%. Our non-GAAP tax rate is lower than anticipated as a result of an election we made with our FY 2020 U.S. income tax returns filed in Q3. The election related to certain research and experimentation costs for tax purposes only and has the effect of reducing our non-GAAP effective tax rate in Q3. GAAP net income for the quarter was $90 million, or $1.46 per share. Non-GAAP net income was $169 million, or $2.76 per share. I will now turn to the balance sheet. We generated $182 million in cash flow from operations in Q3. Cash and investments totaled approximately $863 million at quarter-end. You will recall, in Q2, we initiated a $500 million accelerated share repurchase program. During Q2, we retired approximately $400 million worth of shares. In Q3, we retired the remaining approximately $100 million worth of shares, reflecting roughly 449,000 shares purchased during the quarter. The average price paid per share for the full $500 million program was $199.90. DSO was 53 days and capital expenditures for the quarter were $9 million. Deferred revenue increased 13% year-over-year to $1.44 billion from $1.28 billion. Finally, we ended the quarter with approximately 6,380 employees, up approximately 20 from Q2. Now let me share our guidance for the fiscal fourth 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 both traditional and modern applications and the modernization of their application infrastructures. We also anticipate continued focus on and investment in application security. Thus far, our supply chain team has navigated industry-wide supply chain challenges well. With all signs pointing to continued challenges for at least several quarters to come, we will continue to closely monitor the situation. With that as context, we are targeting Q4 fiscal 2021 revenue in the range of $660 million to $680 million, implying roughly 9% growth at the midpoint. We continue to expect FY2021 software revenue growth at or around 35% and feel very good about our software momentum as we close FY2021 and head into the back half of our Horizon 2 timeframe. We expect Q4 '21 gross margins of 84% to 84.5% and we estimate operating expenses of $346 million to $358 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 to be approximately 19%. Our Q4 earnings target is $2.68 to $2.80 per share. We expect Q4 share-based compensation expense of approximately $62 million to $64 million.

Thank you, Frank. Our very strong third quarter results demonstrated the powerful alignment of our expanded solution portfolio and our customers’ most important application needs. Across the board, our customers are massively accelerating digital transformation to keep up with current demand and forecasted growth and to meet consumers’ expectations for application performance and availability. But it is not just keeping up with application growth that is a challenge; customers are caught managing this robust growth across multiple infrastructures with applications in both traditional, monolithic architectures and in modern cloud-native and container-based architectures. F5 is uniquely fitted to solve customers’ traditional and modern application challenges. Our flexible, programmable BIG-IP portfolio secures and delivers traditional applications whether in a systems or software-based form factor on-premises and in the cloud. Meanwhile, our NGINX portfolio provides high-performance application security and delivery for microservices in Kubernetes and container-based environments. And our shared security portfolio provides industry-leading fraud and bot protection against automated attacks. So let’s talk about five sustainable customer trends resulting from accelerating digital transformation and driving robust demand across our portfolio. Trend number one: Enterprise customers’ developers and DevOps teams are using NGINX to insert security earlier in the application lifecycle. NGINX with App Protect delivers robust application security for microservices with the flexibility and agility developers demand. And just as one example, during Q3, we secured an NGINX win with an information services company that services high-security customers in financial, Fintech, medical, insurance, and the U.S. Federal Government. The customer selected NGINX Plus with App Protect for its ability to deliver Layer 7 DDoS protection, reverse proxy, and load balancing in a single unified solution. Trend number two: Heightened security concerns and high-profile ransomware attacks are escalating demand for top-notch application security and fraud and abuse mitigation. With pronounced application growth and an ever-expanding threat landscape, including high-profile ransomware and credential stuffing attacks, we see growing demand for application security in cloud environments and rising demand for fraud and bot defense. In an example of the strong customer interest in our Shape solution, during the quarter, a major athletic shoe manufacturer selected Shape to combat a sneaker bot that was relentlessly attacking its retail sites attempting to siphon off shoes for resale. Through an exhausted proof-of-concept, Shape proved far more effective than a competitor at identifying and stopping the bot attack. Trend number three: Customers are leveraging F5 for Kubernetes, containers, and cloud-native architectures. Our growth in modern applications continues to accelerate driven by NGINX Kubernetes and cloud-native deployments. We are seeing several top use cases emerge for NGINX including API Gateways, Kubernetes Ingress Controller, NGINX App Protect, and software-based load balancing. Customers’ modernization efforts and the availability of NGINX controller and Enterprise-level app security with NGINX App Protect continue to drive larger NGINX deal sizes. During Q3, a large health insurance provider in the U.S. selected NGINX to help the teams manage their modern apps. They deployed the recently introduced NGINX Instance Manager to track, configure and manage their businesses’ NGINX Open Source and NGINX Plus instances. They also deployed NGINX as an Ingress Controller to manage secure communications between services that are both external and internal to the Kubernetes cluster. In addition, they are using NGINX to monitor Pods running in a public cloud provider’s managed Kubernetes service and adjust the load balancing rules based on Pod availability. Trend number four: Customers are scaling their existing hardware-based infrastructures to handle accelerating application growth, driving continued strength for BIG-IP systems. Last quarter, I spoke about the fact that some of our BIG-IP systems’ demand was being driven by cloud-based and SaaS providers. These global leaders are turning to F5 to help them scale their existing application infrastructures in support of the continued rapid adoption and growth of their digital products and services. In Q3, that strength continued with a global SaaS-based cloud service provider refreshing and expanding their existing BIG-IP infrastructure to efficiently and securely scale with rising demand. And finally, trend number five: Customers are leveraging BIG-IP for transformation including cloud migration and automation initiatives. The demand we are seeing for BIG-IP systems and software is about more than just capacity additions. Customers also are choosing BIG-IP to drive transformation. When customers move traditional applications to the cloud, they are lifting and shifting with their Big-IP, choosing not to incur the time, cost, and risk of refactoring their application. And just one example in Q3, in APAC, we won a deal with a large credit issuer with a two-year plan to exit their own data centers and migrate all non-mission-critical applications to the cloud. They chose a combination of BIG-IP and NGINX software with a multi-year subscription consumption model to ensure flexibility throughout the process. In another example of F5’s role in app modernization, an American multinational computer technology company is embarking on a large-scale project to build their own private cloud including repatriating cloud workloads to save costs and drive efficiency. They selected BIG-IP hardware and software, as well as NGINX to execute the project. While several of the trends I have just described also apply to our service provider customers, service providers also face unique challenges as a result of 4G to 5G migration and growing 5G traffic demands. We see Gi-LAN use cases gaining momentum globally as 5G devices are enabled. We are seeing 4G to 5G momentum growing for F5 in two ways: first, for capacity augmentation supporting 5G rollouts, and second, with virtual network function and cloud-native network function-based architectures gaining traction to replace legacy infrastructures. In one notable service provider win from Q3, one of the largest mobile providers in India turned to F5 to scale its 4G network in preparation for its 5G deployment. Before I wrap up our prepared remarks, I will comment briefly on our Volterra acquisition. The trends we are seeing across the business also bode well for the opportunity we see ahead with our Volterra platform. We continue to make good progress with our integration efforts and expect to have more to share about initial use cases and launch timing in the fall. As I mentioned last quarter, we initiated a pilot program concentrating on specific use cases and focused on bringing F5 security to the edge. Our goal is to leverage Volterra’s organic momentum and early customer interest. Among service providers, the excitement and early interest related to Volterra continues to open doors not previously available to F5. The combination of application growth, our expanded solutions platform, and our vision for the future of adaptive apps resonates with customers and is well aligned with industry trends. 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 toolsets to solve our customers’ most pressing application security challenges. Our opportunity in application security is even more exciting than the ongoing integration of F5 and Volterra, which will bring Enterprise-grade F5 application security to the edge in an easily deployable SaaS model. I will wrap up today’s prepared remarks by thanking the entire F5 team, as well as our customers and partners. With that operator, we will now open the call to Q&A.

Thank you. Your first question comes from the line of Tim Long from Barclays. Your line is now open.

Two questions if I could, guys. First, curious if you could just update us on kind of how the cloud vertical is going for you guys, particularly on the software side, but also curious if you continue to see some good hardware traction there as well. And then second, just wanted to follow-up on the subscription software business. Could you talk a little bit about kind of what you are seeing with true-ups and consumption? Do you continue to see accelerated usage for the offerings? And if so, what does that mean economically? And what does that mean as you look into newer contracts where you might be seeing higher consumption levels than you would have anticipated previously? Thank you.

Hi, Tim, thanks for the questions. I will take the first part and then Frank will take the second part. So, let’s just talk about the cloud vertical. Generally, Tim, we continue to grow rapidly in public clouds, driven by increased software consumption of our BIG-IP systems and also rapidly growing consumption of NGINX in public cloud environments to scale Kubernetes, specifically deployments into production. And the third factor there is the security attach rate in the public cloud continues to grow. So, that’s just how well we are doing in the public cloud. But if you step back, I just want to go back to – if you look back to where we were three years ago, or four years ago when I joined F5, around the perfection of F5 is around public cloud. I would describe the bare thesis at the time as the following: We were told that traditional applications on-premise would not grow and would only decline. We were told that the traditional applications that would survive would all move to the cloud and would be refactored and therefore, F5 would not have a role in these applications. And finally, we were told that all new applications, modern applications would be built as cloud-native and container-native and F5 would not have a role in these applications, and all of that led to significant skepticism about the role of F5 in applications in the future. If you look at where we are today, traditional apps are growing—the revenue-generating apps and the COVID-19-related consumption of everything digital are growing rapidly, and that goes on for BIG-IP. The apps—not all the apps—the traditional apps are moving to the public cloud. A large number of them are not moving. But those that are moving, it’s largely a lift and shift and that benefits F5 tremendously because we are absolutely attached to these apps in the public cloud and that’s why our business in the public cloud is growing. And number three, as it relates to modern apps, we have a significant and growing role in modern applications with NGINX which is an enabler of scaling these modern applications.

So, Tim, in terms of the true forward and the subscriptions that we are seeing, our average in both the year two and year three, we are ahead of where our internal plan was in the sort of low double digits uplift that we see in years two and years three. Our utilization that we are seeing in the contract in year one is actually pulling in by a month in the last quarter and all of this gives us increased conviction in our software as we head into FY 2022.

Okay. Thank you.

Thank you. Your next question comes from the line of Samik Chatterjee from JPMorgan. Your line is now open.

Hey, guys. Thanks for the question. I had a couple, François, if I can start obviously from the software again here. One of the questions that we get quite often from investors and we got a lot of those this quarter is, even as you kind of saw good acceleration in software revenue sequentially in the third quarter, there is a similar acceleration that’s implied into the fourth quarter and then kind of into next year. So, how much of that is just the momentum of the existing business relative to the true-ups or true forward, as well as subscription renewals that’s kind of influencing that if you can talk about kind of the confidence into delivering that sequential improvement as we go along into next year? Thank you. And then I have a follow-up as well.

Thank you, Samik. So, let me start on software. Yes, we are – as Frank just said, our conviction in our growth in software continues to increase and continues to get stronger for a couple of reasons. The first is, we are indeed seeing very strong utilization of our multi-year subscription agreement getting better visibility into expansion and true forwards. And so far, what we are seeing on expansion true forwards and even our renewal that the performance of these aspects of our software business is well ahead of our own internal targets. But the second part is, on our confidence is that, we also have some catalysts in our software business that are starting to play out as we thought they would and perhaps even better. If you look at NGINX, the momentum of adoption of NGINX is accelerating in part because we have a larger set of products and modules on NGINX from the investments we made a year-and-a-half ago. So, the Controller, App Protect, the security piece on NGINX moving into API gateways, those are growing the addressable markets for NGINX and some of these catalysts haven’t even played out and will play into 2022. We see growing demand for security, including Shape, and a lot of that is consumed in software. And BIG-IP is also growing in software, as I said, in public cloud environments. So, if you combine all these, you answer that we see a 5G opportunity that’s in software in 2022 for the 5G core. Those are all catalysts that we’ll continue to drive the growth that we expect to see in software.

Got it. And if you can just follow-up, maybe this is more for Frank. But when you give initial guidance for this year, you were expecting more of a top line growth of 7% to 8% and operating margins of 31% to 32% and clearly, top line growth has exceeded your initial expectations. But when I look at the operating margin, you are kind of towards the lower end of the range here. So, how should I think about that? Was it like reinvesting some of the incremental growth that you got? Or was it more of the headwinds because of the supply chain constraints? Just trying to think through why not more leverage on the operating margin as revenue exceeded expectations?

Sure. So, hey, Samik. A couple of factors that I will note. One is, obviously with the revenue outperformance we got natural commission expense and other things that go forwards higher expenses and what we would have otherwise modeled at the beginning of the year. We also obviously absorbed Volterra into this model where we said we are not going to change our operating plan but we were going to absorb those expenses and that’s exactly what we did. And then, just other gives and takes that put us I think more in the midpoint of that 31% to 32% range, not at the low end from our expectation.

Thank you. Thanks for taking the questions.

Thank you. Your next question comes from the line of Rod Hall of Goldman Sachs. Your line is now open.

Yes. Hi, guys. Thanks for the question. I wanted to just go back to the software revenue. I am assuming that you are guiding software close to 35% growth this year. If I can put the 35% in, I get a deceleration of growth actually in Q4 round about $145 million of revenue and I guess quarter-on-quarter growth – seasonal growth a little bit slower. So I am just curious is that – does that make sense to you guys? Are you expecting a slowdown in growth or the 35% if you will? I mean, can you just kind of help us square that all up and I have a follow-up.

Hi, Rod. Well, we are not, as you know, we are not guiding hardware and software separately every quarter. We’ve said that we would drive about 35% software growth for the year, and we feel confident that we are going to do that. And more importantly, I always look at this as an overall trend for our software business. For Horizon 2, we said that our trend in software growth would be 35% to 40%, and we still feel that that’s what the range is going to be for growth for FY’21 and FY’22.

Okay.

Rod, I think anything on that... sorry.

You go ahead.

Yes, absolutely. I think the only thing I would add is, with the same methodology that we use and given guidance for the – since we’ve been talking about our software business, and the back half of the year when that was looking like a pretty good uplift when we were talking last quarter. I think we bridged that quite well this quarter and leaving ourselves obviously plenty of room on the 35% for the full year. And so, when we take a look, we take a look at the components that we know are coming in from the SaaS businesses, the true-forwards, and the pipeline activity of what we see.

Okay. And then, Frank, I had one for you too on deferred revenue. I was just looking at your long-term deferred increments versus your short-term. And I see a pretty good size in long-term deferred revenue increase in June over March and I was just curious, can you talk to us about the duration of the deferred revenue? And what specifically is driving the big increase in the long-term part of it? Thanks.

Sure. Absolutely right. So, it seems like we keep saying that we had yet another record number of multi-year subscription agreements that bring in deferred revenue into that long-term bucket. Also we had a very strong Shape quarter, as well as other things that have got multi-year contracts. I believe the average duration on most of those was 2.5 to 3 years. And so, that’s what you are seeing growth in the long-term deferred revenue.

Great. Okay. Thanks a lot. I appreciate you guys.

Thank you, Rod.

Thank you. Your next question comes from the line of James Fish from Piper Sandler. Your line is now open.

Hey guys. Great quarter. Not to go back to the topic, but on the subscription side first, I guess, how should we think about kind of next year’s true-up in renewal opportunity understanding that fiscal ’19 base is bigger than the fiscal ’18 base. But we are having some of these true-ups come in this fiscal year. I guess, can you kind of help us bridge the transition tier of how we should think about this true-up in renewal activity happening? And then, it sounds like we should think about it as kind of the 1.10, 1.20 kind of net retention rate. Is that the right way to think about it?

Yes, it’s the right way to think about it. And there is also an additional component with 606. So, the reason why that lapping is important than what you see in 2019 as opposed to the previous quarters and why I have said for the past probably six or seven quarters that in the back half of FY’22 is going to be interesting when things start to look more consistent, and the revenue growth is that, once you actually sign those new term subscription agreements, there is a whole new revenue recognition component associated with that. And so the true-forwards are interesting. But that becomes the new baseline in which the new deal is signed. And then, in those three-year agreements, 63% of that comes to product in the quarter that it is signed, and the balance of that is ratably deferred into the services revenue bucket over the course of that three years. And then, the true-forwards obviously have got an additive component to the product revenue in years two and years three. But that lapping year is actually when you see more pick-up in the product revenue on the software side.

Makes sense, Frank. And it does look like your bookings and billings were up very nicely here 25%, not a metric we typically talk about with you guys, but as the software piece is becoming a bigger and bigger piece that makes consensus part two. First, are you guys planning on introducing any new metrics here as we think about fiscal ’22, an ARR metric or talking more to billings? And then, secondly, on that billing strength this quarter, was it more on the product side or was it just really strong maintenance attached to these virtual BIG-IP and NGINX licenses? Thanks guys.

Yes, I’ll speak to the metrics question and let François take the back half. We continued to evaluate additional disclosures of metrics. I can’t make any promises of when that’s going to come. But we continue to think about what’s going to be the most stronger for the uses of our financial statements.

And then, Jim, on the second part where the traction is coming from, there are two areas that I would point to that’s driving this increase in subscription revenues. One is security. We had a very strong quarter with Shape and in certain verticals, retail, financial services, the tech verticals, online gaming, where we are seeing the customers have a heightened sense of the fact environment and awareness of the fact vectors, and we are able to mitigate a lot of automated effects. But not just mitigate bot attacks but also more – it increasingly fulfills that our traffic is more intelligently leveraging Shape’s AI technology, which resulted in improved customer experience. And so, it’s making us really sticky in these environments and in these verticals. The second thing in security is we are seeing SecOps teams and DevOps teams increasingly wanting to deploy security earlier in the lifecycle of an application. And that points to the security capabilities of F5 that we ported on NGINX. And so we think NGINX security is driving growth in our security portfolio. And since both Shape and NGINX are driving subscription-based revenue, you are seeing that increase there. Then the second area I would point to is just more general adoption of modern applications. One of the things that we are seeing over the last six months, and I think it’s accelerated this quarter, is Kubernetes is going into production. A lot of customers have done development and test with the microservices/container-based applications, and they are now looking to scale these applications. In a lot of cases, they are running into trouble, and NGINX has all the capabilities to help them scale their Kubernetes clusters, and it’s driving an acceleration in NGINX adoption in addition to the fact that NGINX now has multiple products: controller, API gateway, etc. So, when you look at these factors, it’s accelerating adoption in NGINX. One of the most obvious manifestations of this is, we have very strong momentum with NGINX, not in just any customer, but in our top 1,000 customers, the penetration of NGINX is growing very strong. In fact, just this quarter, if you look at – Frank said, we had a record number of multi-year subscription agreements, and NGINX was part of more than half of those multi-year subscription agreements for the first time. So, it points both to the growth we are seeing with NGINX and Shape, but it also points to what I said earlier about the powerful alignment of our portfolio to the hybrid challenges that our customers face.

Thanks, guys.

Thanks, Jim.

Thank you. Your next question comes from the line of Meta Marshall from Morgan Stanley. Your line is now open.

Great. Thanks. A couple of questions. You've mentioned a couple of times you had a record quarter with Shape Security. Last quarter, you mentioned there have been some delays in proof-of-concept. So just wanted to get a sense of, is some of that strength of proof-of-concept resuming? Is it kind of the security breaches that we've seen that have driven some of that strength? And then, maybe just a second question, maybe for Frank is, kind of the SaaS application or cloud customer vertical, something that we should consider as being more than 10% of the business at this point? Or just anything that would give us a sense of the size of that customer base at this point. Thanks.

So, Meta, let me start with Shape. So, last quarter, we did mention we had some proof-of-concepts that were taking a long time, and that was exacerbated by the fact that customers are not in the office. And so, pulling off this proof-of-concept and reducing the length of the sales cycle has been difficult. We still have that issue. And I would say, for customers that are not under any kind of immediate significant pain and can take their time to make their decision, that is still a factor and we hope that factor succeeds in the coming quarters, but it's still there. On the other hand, we also have a number of customers who are either under attack and need an immediate solution, and oftentimes the solution they have in place is not effective enough for sophisticated attacks. Or they have a heightened sense that they are on borrowed time and need to put in place the most effective mitigation possible. For those types of customers, the sales cycle is pretty rapid. And in this quarter, we had more of these customers come to us. I would say, there is also a maturing of the go-to-market, with teams being able to identify the verticals where this is mostly the case and focus their efforts. So, that's why the traction on Shape is accelerating. And then on your second part, Meta, on the cloud vertical, we don't break it down on a quarterly basis in terms of quantifying exactly how much that is. But, here is what I would say: When we look at where F5 is growing the fastest at the moment, if you take all companies that are either in technology or in e-commerce or whose products are digital services. So it would include all the cloud providers then, the SaaS providers. If you put all of these in a bucket, this is the area of the business for F5 that is growing the fastest at the moment. It’s implicit why that is, because all digital services are growing rapidly and the consumption of these services is growing rapidly.

Great. Thank you.

Thank you. Your next question comes from the line of Alex Henderson from Needham. Your line is now open.

Great. Thanks. And I think you pretty clearly proven that you guys are a real play on the transition to the cloud with these quarters. I wanted to get into a couple of the items here. The first one is the conversion rate of NGINX to NGINX Plus. It's just pretty clear that since your acquisition of NGINX, the percentage of—or the market share percent of NGINX has definitely gone up. I understand it's up in the 67% plus range now, up from like 60%. And on voice share has gone from over 20% to low teens. So, clearly demonstrating that it's becoming the de facto standard. But can you talk about the conversion rate of NGINX to NGINX Plus and how that impacts your business? And the second piece of that same question is, if you've got a 5% increase in your subscription rate in the quarter in software, I think the standard kind of rule of thumb is around 2.2 times impact on the rate of growth as you convert from perpetual to software subscriptions. So, if it’s up 5%, does that mean it understated your growth in the true underlying growth rate by roughly 10% to 12%? Thanks.

Hey, Alex. I'll take the first part and Frank will take the second part. In terms of conversion of NGINX to NGINX Plus, so, as you noted, Alex, NGINX is getting a lot of traction. It’s now the most deployed web server in the world with north of 500 million websites using the technology. And so, yes, an important motion with NGINX is the conversion to NGINX Plus. We have steadily gotten better about that in two ways. Number one is, because there is a broader set of products that can be offered either as part of NGINX Plus or in conjunction with NGINX Plus, the security capabilities, the API Gateway and now a controller that makes it much easier to deploy and manage these instances. There are more reasons for customers using Open Source to want to have access to the commercial capability. And then, the second part is, what we have found out is, a number of large enterprise customers are not aware of how many Open Source instances they have, how many versions they have, and/or they underestimate by sometimes a factor of 10 the number of NGINX Open Source instances we have. And so, we've been able to bring to them a new technology we call NGINX Instance Manager that allows them to discover the Open Source instances that they have. And oftentimes prompts them to look at that portfolio and ensure that it has the right support and oftentimes leads into NGINX Plus to have access to better features and better versions. So, that’s kind of what we are seeing in terms of better conversion rates on NGINX. But I would say, we are also getting Greenfield deployments with folks who did not have NGINX Open Source in their portfolio. Because, as I said before, scaling these Kubernetes clusters and scaling these container-based applications is a challenge for many customers and what they find is NGINX is a platform that consolidates a lot of functionalities into one platform. And so, they don't have to deal with five or seven different vendors for different capabilities. So, all of that is why we are seeing that traction.

Alex, and then, for the second part of your question, I would love that apps to work for all of our software bases, it does actually for the SaaS ratable piece of our software base. But with the adoption of 606 for our term subscription-based model, that one evens out a bit closer to the perpetual and subscription revenue recognition. And so, that has—your math does work as that SaaS portion of our revenue continues to grow and the ratably recognized portion. But it's not completely apples-to-apples for all of those factors.

Okay. And if I could just follow-up one last quick question. So, clearly as the dominant player in Kubernetes code as infrastructure, could you talk a little bit about your ability to hook into HashiCorp and to what extent your tight integration with HashiCorp is driving your adoption rates? Clearly, they are setting up to come public and as they do, code as infrastructure, CICD pipelining, and obviously there is the role of Kubernetes that goes to center stage and you are obviously a critical piece of that?

Yes, I would say. It’s Kara.

Hi, Kara.

We have hooks from a number of our products into Hashi's portfolio and we do have a strong, strong—we see customers looking for our integrations that are built into their. So for example, a few integrations from BIG-IP and the console that enable deployments and provisioning of BIG-IP resources through Hashi's console offering, as well as other integrations that we have. But I would say that Hashi is but one example of a broad set of automation and orchestration capabilities that we've enabled across our portfolio. So, both NGINX and BIG-IP can be automated and provisioned and configured via a set of declarative APIs and our customers use that through Hashi. They use it through things like Ansible, Terraform, as well as the number of other automation technologies.

Excuse me. Your next question comes from the line of Fahad Najam from MKM Partners. Your line is now open.

Thank you for taking my question. I guess, I had a very high-level question on your subscription revenue. The disclosed number that you have 73% of it being subscription. Can you give us a sense of how much it was from SaaS revenue? Was there any term revenue, a term software?

Fahad, it’s Frank. It was 78% this quarter, 73% the year-ago quarter and we don't split out those components at this point. But I do appreciate the question.

Okay. If I could, maybe ask kind of figuring out in terms of the opportunity you had in software growth. Can you help us understand in terms of the true-ups on land and expand nature of your business? Can you give us some or share some data points, quantifiable data points that kind of show you landing and expanding on yourself, called customers who adopted your set of solutions, but as and then expands along with F5’s traditional software solutions? Just kind of understanding how much of a true-up are you enjoying as you integrate more of Shape and Volterra solutions going forward?

Fahad, I don't know if I will get to what I think you want, which is an average of the true-ups or expansion that we are seeing at renewal with our customers. But let me just give you a few data points. So first of all, our subscription offers really started in earnest in 2019. And so, we are in the very early stages of going through these certainly the renewal of the multi-year subscriptions that now expired and gone to three years. In terms of the ones that have gone through one year and so we've already had a chance to do the true-up. We are generally seeing expansion in consumption that is very healthy. So we are very happy about that. One of the things, Fahad, that we have worked on and I think now we're getting to a very good position is, in the first year it used to take a long time for customers to get to 400% utilization of what they had committed to. I think the first sort of deals we did, it took north of 20 months for customers to get to that. We have steadily brought that down to now customers in roughly five months or so get to 400% utilization of their subscription and so beyond then they expand. So we are gaining very healthy consumption and as a result very healthy true-ups. Renewals, it's early days. But I can tell you, we have had some renewals where we were close to 3x what they had committed to in the first multi-year subscription. Of course, not all of them are that way. But it's just to give you a range of what we see there. So those are some of the things that give us good visibility into next year and good confidence and continued growth.

Thank you so much.

Thank you. Your next question comes from the line of Amit Daryanani from Evercore. Your line is now open.

Perfect. Thanks for taking my question. I guess, I have two as well. First off, I just want to just touch on systems growth and what you've seen so far, it sounds to be much better than the Horizon 2 long-term target. So, remind us what is driving that growth? And should we think what this means for Horizon 2 growth for the systems segment?

Yes. Amit, what's driving the systems growth, I think there are a few micro factors in the sense that I think the IT spending environment right now is fairly healthy. And there is also a lot of consumption of digital services by consumers and that in turn is fueling growth in application, so, growth in demand for applications. I would say that is kind of the biggest micro factor, because what we see is a lot of our customers, when they are refreshing their appliances, they don't go just for a refresh, they go for a refresh and capacity expansion. And sometimes it's capacity expansion and transformation because they want to move into a private cloud environment. And that's driven by there just more traffic and more usage of it even in their traditional applications. We see, as I said earlier, growth with digital and SaaS service providers and for them the growth comes from – they are sometimes their services, the demand for their services, whether it's collaboration platforms or e-commerce platforms or even SaaS providers; the demand for their services are growing rapidly and we are built into their infrastructure. And I would say, generally, there is also a fundamental change in stance, Amit, from go back three, four years ago, I would regularly hear from customers four years ago, look we don't want to buy more hardware because we're going to move everything to the cloud. We are going to be out of our data centers. We've got to figure out our architecture, and at the time we said there was a pause because people were thinking their architecture. There is not a single CIO that has told me this in the last twelve months. Every one of them – I think a lot of people have learned from the first implementations in public cloud, sometimes the cost and time associated with refactoring applications. And generally, I think people are more comfortable that they are going to be in a hybrid environment for a very long time to come. It's not forever. And so they are comfortable growing their on-prem presence with hardware where it makes sense and leveraging the public cloud for other initiatives. And I think that that halo, that environment is very different than it was four years ago. And then, the last factor that has an impact on our systems business, Amit, is security. I said earlier that we had very strong growth in SaaS security with Shape subscription, security with NGINX. But we also have very healthy double-digit growth in hardware security, and that's because all of these apps need to be secured and customers are aware of the risks. So, they are moving forward with application security.

Got it. That is truly helpful. And if I could just maybe ask you to clarify a little bit more for me. I think a lot of folks tend to think that if the software business grows 35%, systems has to be planned. It’s a bit of a either or math sometimes for people. Is it fair to say, given what you just outlined with hybrid being the reality that you could have systems growth and software growth be more durable over time versus not?

Yes. It’s potentially a possible scenario. I would separate though, when you look at our software business, you've got NGINX and Shape. And I don't think there is any relationship between the growth of that part of our software portfolio and the growth in hardware. When you look at BIG-IP per se, this is where we have seen and we try to continue to see some customers that we would have expected to have moved to software form factor right now that are delaying or reconsidering in part because of COVID-19, in part because of the immediate demand that they see on their application. So that's where there is a—I would say there is some level of give and get on hardware and software. But overall, the software transition for us is absolutely accretive to the business and right now the drivers that we are seeing in our hardware business, we feel there are couple of one-offs that we talked about last time around our EOSB of seven products. But I would say the majority of the drivers we're seeing right now are pretty sustainable.

Perfect. Thank you. Congrats on a nice quarter.

Thank you.

Thank you. Due to time constraints, we will take our last question today from Simon Leopold of Raymond James. Your line is now open.

Great. Thank you for taking the question. I wanted to see if you can talk a little bit from a market vertical perspective. In particular, federal was low for you guys this quarter at 4% of revenue and were coming into what's normally your strong seasonal federal quarter. So I want to understand whether there is something different in the current cycle in terms of your federal business? Or whether we should expect federal to be strong in your September quarter? And then on Enterprises, if there is a way you could maybe characterize where we are in terms of kind of a post-pandemic recovery, is there some aspect to the current business that we may be could characterize as catch-up spend compared to the weaker spending we saw a year ago due to the pandemic? Thank you.

Simon, thank you for the questions. So, let me start with the Fed question. There is nothing particular for this quarter in terms of our bookings. They were in the range of what we typically expected in a quarter like this for the Fed. We do expect a strong seasonal quarter in the Fed in our fourth fiscal quarter and we continue to be well-placed to win some business there. There is, as you know, a lot of additional focus on security in that vertical and we are well placed to win and protect against some of the threats that we are seeing from our government customers. So, I think that's where our focus is with the Fed and that will continue. As it relates to your question on the Enterprise, Simon, remind me, is the question is are we going to see the same drivers?

Well, I guess, what I am trying to get at is, is there some element of the growth you are seeing now that goes away that is more about the cycle as opposed to the longer-term secular trend. I am trying to really discern between the two. So you've got a relatively easy comparison with we get it, datacenter spending a year ago. And so, at some point than may be a year that peters out. So there is a cyclical aspect and a secular aspect of your business. I am trying to discern the two.

Okay. Well, Simon, it's a great question and I think specifically, in our hardware business, I think the elements are both. And you are asking me which one is the 80:20. And I don't know that I have a good answer for you. I would say, yes. There is some of the aspects that are—I would say, cyclical is; A, I think the spending environment right now is healthy. I think there is a little bit of a catch-up demand from in our case FY ’19 and FY ‘20 where people were kind of very cautious in the early parts of the pandemic and I think those two are somewhat cyclical. I think the aspects that are more durable are things like what we are seeing in the tech sector where I think the demand for digital services is just going to continue to grow and I don't see that stopping anytime soon. And I think, generally, demand for traditional applications in hybrid infrastructure is also going to continue to be solid and I think that's the durable piece. And then the last element that's durable is security. I said we have healthy double-digit growth in hardware security and I think demand for security is going to continue for the foreseeable future. So, both elements are part of what we are seeing right now and I think time will tell in a couple more quarters just to see how much of each is contributing.

Okay. Thank you.

Thank you. And this concludes today’s conference call. Thank you for participating. You may now disconnect.