F5, Inc. (FFIV) Q3 2020 Earnings Report, Transcript and Summary

Good afternoon. And welcome to the F5 Networks’ Third Quarter Fiscal 2020 Financial Results Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Also, 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 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 A copy of today’s press release is available on our website at f5.com, where an archived version of today’s call will be available through October 25, 2020. Today’s live discussion is supported by visuals, which are viewable on the webcast and will be posted to our IR site at the conclusion of today’s discussion. The replay of today’s call will be available through midnight Pacific Time, July 28th, by dialing 800-585-8367 or 416-621-4642, use meeting ID 8166352. For additional information or follow-up questions, please reach out to me directly at s.dulong@f5.com. Our discussion today will contain forward-looking statements, which include words such as believe, anticipate, expect and target. These forward-looking statements involve uncertainties and risks that may cause our actual results to differ materially from those expressed or implied by these statements. 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. François Locoh-Donou: Thank you, Suzanne, and good afternoon, everyone. Thank you for joining us today. I will talk briefly to our business drivers before handing over to Frank to review the quarter’s results in detail. Despite macro uncertainty, we delivered strong third quarter results. As a company, we continue to take a human first approach. This means working to support our customers and each other as we cope with the ongoing pandemic and the resulting economic upheaval. It also means supporting each other through the social unrest and protests over the inequitable treatment of black members of our communities. At F5, our commitment to the fight against racism is a foundational part of our culture. We consider diversity and inclusion part of being an F5er. As a company, our exec team, in collaboration with our F5 Appreciates Blackness or FAB Employee Inclusion Group and our diversity and inclusion team are taking several steps to fight bias. This includes continuing our mandatory unconscious bias training for all employees. But no amount of policies or programs will achieve change if we do not make it personal. Everyday actions are what will truly make F5 a more diverse and inclusive company. I have pledged to all our employees, as has every member of the F5 exec team that we will be accountable in our words and in our actions. As part of our F5 global good efforts, we have previously committed to support STEM education grants, supporting women of color and underrepresented youth. In Q3, our FAB employee inclusion group went a step further, creating a fund and identifying partners to provide a resource for employees eager to support non-profits, working to advance basic human rights for people of color in the U.S. Over $124,000 was raised in just one month by F5ers, including the company match. We firmly believe that our commitment to our human first approach makes what we do as a business possible. This quarter, despite a multitude of challenges globally, our team outperformed our non-GAAP revenue and earnings guidance. Continued strong customer demand for software subscriptions and security use cases, drove 4% total revenue growth and fueled our 43% software growth. Our systems business was down 12%, while our services business grew 5%. In the current environment, our incumbency is a significant advantage. We are benefiting as customers accelerate their digital transformation and turn to operationalize solutions to meet both immediate and long-term business needs. After Frank reviews the quarter’s financial results and our Q4 outlook, I will talk to our business trends and customer highlights from the quarter. I will also take time today to introduce our vision for the future of applications. Frank?

Thank you, François, and good afternoon, everyone. As François noted, we delivered a very strong Q3. Like last quarter, we are reporting non-GAAP revenue. Non-GAAP revenue excludes the impact of the purchase accounting write-down on Shape’s assumed deferred revenue. For transparency, we are committed to providing both GAAP and non-GAAP revenue during the period when purchase accounting will have an impact on Shape related revenue. On a GAAP basis, Q3 revenue was $583 million. Third quarter non-GAAP revenue of $586 million was up approximately 4% year-over-year and above the high end of million our $555 million to $585 million guidance range. Please note, as I review our revenue mix, I will be referring to non-GAAP revenue measures. Q3 product revenue of $256 million was up 3% year-over-year and accounted for approximately 44% of total revenue. Software revenue was $97 million, growing 43% against a particularly tough comparison of 91% growth in the prior year period. Software continues to grow as a percentage of product revenue, representing approximately 38% of product revenue in Q3, up from approximately 27% in the year ago quarter. We also continue our momentum towards a recurring revenue base with subscriptions of 73% of software revenue in the quarter. Services revenue of $330 million grew 5% year-over-year, and represented approximately 56% of revenue. Revenue from recurring sources, which includes term subscriptions as a service and utility based revenue, as well as the maintenance portion of our services revenue, totaled 66% of revenue in the quarter. Systems revenue of $159 million was down 12% year-over-year. On a regional basis in Q3, we saw strength in Americas and EMEA, with Americas delivering 11% revenue growth year-over-year and representing 57% of total revenue. EMEA delivered 6% growth, representing 24% of revenue. Against a challenging comparison in the year ago quarter, APAC was down 15% year-over-year and accounted for 19% of revenue. Looking at our bookings by vertical, enterprise customers represented 67% of product bookings and service providers accounted for 15%. Government customers represented 18% of product bookings, including 5% from U.S. Federal. Turning to our Q3 operating results. GAAP gross margin in Q3 was 81.8%, non-GAAP gross margin was 84.4%, GAAP operating expenses were $390 million, non-GAAP operating expenses were $327 million, our GAAP operating margin in Q3 was 15% and our non-GAAP operating margin was 28.6%. Our GAAP effective tax rate for the quarter was 20.4%, our non-GAAP effective tax rate was 20.2%. GAAP net income for the income for the quarter was $70 million or $1.14 per share. Non-GAAP net income was $134 million or $2.18 per share. This was above the top end of our guidance range due to our strong revenue performance, as well as disciplined operating expense management. Turning to the balance sheet, we generated $159 million in cash flow from operations. Cash and investments totaled approximately $1.2 billion at quarter end. While we have an estimated $1.3 billion remaining on our share repurchase authorization, we did not repurchase shares during the quarter, opting instead to conserve cash, given the uncertain macro environment. DSO was 47 days and capital expenditures for the quarter were $12 million. Deferred revenue increased 9% year-over-year to $1.3 billion, driven by an increase in maintenance contracts, as well as the acquired Shape deferred revenue. We ended the quarter with approximately 6,020 employees, up approximately 195 from Q2. Now let me share our guidance for fiscal Q4 of 2020. Unless otherwise stated, please note that my guidance comments reference non-GAAP metrics. Our Q4 outlook factors in the expected impact of continued global uncertainty related to COVID-19 and broader economic trends as we understand them today. Near-term we expect customers will prioritize investments that enable them to serve the immediate needs of their customers and employees. We expect to benefit from being a trusted and operationalized partner of the largest enterprises around the world. We also expect customers will scrutinize investment priorities, which could lead to longer purchasing cycles or deferred projects. With this in mind, we are targeting Q4 FY ‘20 non-GAAP revenue in the range of $595 million to $615 million. We expect gross margins between 84% and 85%. We estimate operating expenses of $326 million to $338 million. We anticipate our full year FY ‘20 effective tax rate will be in the range of 19.5% to 20.5%. This is lower than we previously estimated due to a non-recurring impact to foreign tax credits, resulting from an election we made in filing our FY ‘19 U.S. income tax return, which will impact our Q4 effective tax rate. Our Q4 earnings target is $2.30 to $2.42 per share. We expect Q4 share-based compensation expense of approximately $52 million to $53 million. Let me speak briefly on our capital allocation philosophy. With the current environment and interest rates declining, we expect to continue to prioritize building our cash position over near-term share repurchases and over paying down our Term Loan A associated with the Shape acquisition. However, consistent with what we have said previously, we also retained the option of repurchasing shares opportunistically in any open trading window. With that, I will turn the call back over to François. François? François Locoh-Donou: Thank you, Frank. I will begin by discussing some of our business dynamics and drivers. As an organization, we remain nearly 100% work-from-home and we expect the majority of F5ers will work remotely for the rest of the calendar year 2020. We are taking a phased and cautious approach to returning to our offices globally. In certain geographies, we are allowing a very small percentage of employees to return to the office on a strictly voluntary basis. We also recently lifted travel restrictions in some geographies but we ask employees to consider carefully whether travel is essential and to quarantine for two weeks following their trip. We will revisit our approach regionally as circumstances and local advisories dictate. Despite the continued work-from-home conditions, F5ers remain very engaged and productive. My thanks to the entire F5 team for their persistence, ingenuity and resiliency in these unprecedented times. Together, we delivered a very strong third quarter, despite it also being the first quarter closed without a single face-to-face customer interaction. While we are very pleased with our third quarter performance, two quarters in we also have more perspective on COVID-19’s impact on our business. Overall, demand in our business is proving more resilient in the second half than our initial post-COVID expectations. Relative to our pre-COVID expectations for the year, we are seeing evidence of three expected COVID-related headwinds. First, similar to last quarter, while we are seeing strength from overall enterprise, we continue to see caution from the most severely impacted verticals. These include transportation, entertainment and leisure, and retail which combined represent less than 10% of our bookings. Second, our ASEAN and India sales regions were acutely impacted by COVID-19 related order delays in the last several weeks of the quarter. Third, while our sales team has kept up strong virtual engagement levels with customers, the prolong lack of face-to-face engagement is causing some delays with new strategic projects. These headwinds were in large part offset by the advantages of our strong incumbency and our alignment with customers’ investment priorities, resulting in the overall resiliency we have seen in our business. We noted last quarter that customers plan to accelerate their digital transformation because of COVID-19. Our Q3 results are evidence that they are executing against that intent. Large enterprise and service provider customers are increasing their digital engagement and boosting capacity and security on customer facing applications and on platforms that enable employee collaboration. While some customers are moving ahead with large scale transformation projects, we see an increasing number of prioritizing speed and choosing to deploy solutions they have already operationalized. F5’s incumbency, broad solutions portfolio and full hardware to software functionality are clearly an advantage in this environment. With F5, customers can deploy operationalized solutions with confidence knowing their application services can evolve in step with their application and business needs. We also continue to see broad customer demand for subscription-based consumption models across all geographies. In fact, in Q3, the team closed the largest number of subscription deals ever in a quarter. In addition, a growing number of customers are leveraging our broad application service portfolio and our ability to serve both traditional and modern applications. They are choosing F5 to cover a suite of application services using a combination of traditional F5, NGINX and Shape Solutions. As an example, this quarter, we won a hybrid cloud data center redesign with the Department of Health. Our solution delivers speed, visibility, reliability, flexibility and agility, while avoiding the management complexity that comes with multiple vendors. We delivered a detailed migration plan combining highly scalable BIG-IP access policy manager, an advanced web application firewall, global and local traffic managers, along with NGINX Controller and NGINX Plus. We also secured a win to deliver a comprehensive protection strategy for a major service provider. Our solution includes F5 WAF, NGINX, Shape and Silverline managed services. From a use case perspective, application security continues to emerge as a significant customer need for both traditional and modern applications. This is driving four kinds of opportunities for us. First, it is driving core F5 security deployments in both systems and software, including DDOS, SSL orchestration and web application firewall. In one example, during the quarter, a major video conferencing and collaboration tool provider chose F5 to provide global DDOS protection. Second, the need for application security is creating demand for the combination of F5 security on top of NGINX. The power of this combination was part of the rationale for acquiring NGINX last year and we are very pleased with our early traction. Last quarter, we mentioned an NGINX API gateway win that we combined with F5 WAF. This quarter, we secured a win with a multinational financial services corporation using NGINX API gateway and F5 app, Protect. We are enabling them to scale to 10,000 transactions per second, while securing each individual API to their third-party fintech partners. Use cases like this one, enabling best-in-class security on modern application architectures are gaining momentum and we believe will accelerate the appeal of NGINX to large enterprises. The third kind of opportunity driven by application security needs relates to strong customer interest in our Shape portfolio. Customers are looking to Shape AI and machine learning enabled defense capabilities to protect against a growing number of threats, both bots and human. For instance, this quarter, we secured a Shape defense win with a media conglomerate. We are protecting both the web and mobile deployments of their new over-the-top service against credential stuffing and other plants. Finally, we are seeing growing demand for application security as a managed service. In fact, we have layered Shape onto our Silverline managed services platform. The combination means we can provide customers the ability to protect not just the application, but also how the application works. A Shape Silverline combination is ideal for customers who either do not want to own or don’t have the expertise to manage the technology. We believe application security is a meaningful opportunity for F5 and expect demand to fuel growth for several years, but we are not stopping there. I am going to spend the remainder of our prepared remarks outlining for you where we are taking F5, how we intend to leverage and combine the respective strength and trajectories of traditional F5, NGINX and Shape to create adaptive applications and open new addressable market opportunity. We see a future where an application like a living organism will naturally adapt based on the environment. It will grow, shrink, defend and heal itself as needed. The combination of application services, telemetry and automation will enable it to become an adaptive application. Ultimately, adaptive applications will deliver increased revenue, reduce costs and better protection for application owners. We have been sharing this vision with our customers over the last several quarters and the feedback has been resoundingly positive. Our vision strongly aligns with where enterprises see the greatest opportunities for their applications and their businesses. Through our organic and inorganic investments, we are well on our way to delivering this vision for customers. We are creating an application services platform that will help customers accelerate their digital transformation and fundamentally change the way applications are delivered and secured. Let us step back a bit. To deliver engaging user experiences, many things need to happen between the applications business logic and the user. The application needs to scale as usage increases. It needs to be protected from attack and its availability must be maintained to meet end-user expectations. These are elements that are typically not in the functional requirements of the application and typically not addressed when the application was built. DevOps and site reliability engineering can help address these non-functional requirements. However, non-functional requirements are becoming more complex as the number of microservices based applications increase. Furthermore, business applications are increasingly distributed over a multi-cloud environment. They often have multiple generations of application architecture components in them namely three tier, web, mobile, micro services and even serverless. This creates the need for application services such as Ingress controller, API gateway, load balancer, web application firewall, et cetera, which need to be injected in a standard way between the application business logic and the end-user. Application services help applications operate securely at scale and distributed application services enable fast and secure digital customer experiences. While ideally, we could seamlessly insert and integrate application services in the application path, today it is not that simple. A typical enterprise IT needs to stitch together multiple application services from multiple vendors to deliver an application to customers. Our customer research showed that 59% of organizations use 10 or more application services. For most organizations, each of these application services is managed separately with its own management tools. This results in silo teams and high operational complexity. This fragmentation also creates inconsistent application security. While teams work to protect the different aspects of application behaviors, the user experience of the business service often is left under protected. Finally, this piecemeal approach limits visibility across the application delivery chain, making it impossible for enterprises to get a holistic view of the business impact. We are creating a unified platform to solve these challenges for our customers. We are delivering real value to customers, simplifying operational complexity, providing business insights and protecting the user experience end-to-end. We are also uniquely positioned to deliver a new level of application insights and automation. F5’s BIG-IP instances, along with NGINX software, support more than 400 million application workloads across the globe. We support application delivery with purpose built hardware in virtual machines, in container software and in native cloud services. Our solutions are truly multi-cloud supporting applications in customer’s data centers, in private clouds and in public clouds. This means, we are ideally positioned to help customers to collect a rich set of business telemetries through these application services, information like application latency, step information in an online purchase or the location information for end-users. The business-related telemetry we collect, combined with our proven AI-powered analytics engine from Shape, can help customers discover insights about their applications and business transactions. BIG-IP and NGINX application services translate these insights into application configuration policies to automate application delivery. With the addition of Shape, we are setting the bar higher and marching toward a multipurpose application analytics platform. Such a platform supports application insights and automation and AI ops, as well as AI-enabled security and fraud protection, end-to-end digital experience management and AI-enabled business services. For example, telemetry data about browser signature or customer credentials can help identify that a request to a retailer’s website is actually generated by a bot, not a human. This kind of information can be used to help identify fraudulent transactions. We are developing this comprehensive application analytics platform, leveraging telemetry from our rich set of application services and Shape’s AI-powered analytics. Today, we offer the most comprehensive application services along the application path, which scale and protect our customers’ mission-critical business services. Our application services support more than half of the world’s enterprise application workloads. For the future, we are doubling down on application telemetry in cloud analytics. We are leveraging machine learning and AI to help our customers to discover insights about their applications, business flows and user experiences. As a result of the investments we have made over the last several years, we have the major components required to realize our vision. We will accomplish this level of application insights and automation from multiple complementary tools designed to address specific customer challenges. The most recent of those tools is the Shape AI fraud engine or SAFE. SAFE is a cloud fraud-prevention service. We created and refined the initial version in a matter of weeks in response to fraud that first became visible in Shape’s analytics and telemetry data. SAFE and Shape recognized another analytics-based Shape Solution are both upsell propositions. SAFE enables a higher level of fraud protection than other cloud security solutions, while recognized, minimizes friction for legitimate application users and in doing so, drives increase in topline revenue for customers. Where other Shape Solutions target bot, SAFE targets human fosters, consider that a typical retailers web traffic is 95% bot traffic. Shape enterprise defense can block more of that bot traffic than other cloud security solutions, typically more than 99%. Once the bot traffic is identified and blocked, we then can zoom in and begin to analyze the much smaller volumes of human traffic and to identify very subtle, low volume, fraudulent behavior. Let me share a story about how SAFE works using a customer example. In this case, the customer is a $30 billion market cap nationwide restaurant chain, with COVID-19, more customers than ever before begin ordering food online. Bad actors were eager to take advantage of these new patterns. In one month, the chain lost $600,000 to an incredibly clever discount scam that used fake credit cards. The front stores would use social media to advertise 70% or 80% discounts on meals, if customers ordered and paid through them. The fraudsters then used fake credit cards or other payments to place orders at the restaurant. Food is prepared and picked up only later that the restaurant discovered that the payment method was invalid. With SAFE, we delivered a 90% plus reduction in fraudulent orders. With SAFE and Shape recognized, F5 delivers a complete set of application security capabilities that span high volume bot attack in the hundreds of millions per day, all the way down to ultra-sophisticated fraud scheme that number in the 10s per day. We see our journey to our journey to creating adaptive applications occurring in four acts, each of which brings with it new growth opportunities for F5. With Acts 224, we are also expanding our addressable opportunity. From a timing perspective, we are working multiple acts in parallel. In Act 1, we took steps to expand our opportunity within traditional applications. In this phase, we unlock new growth opportunity by adding automation and orchestration to our existing software solutions. We made them lighter weight. We made them easier to procure, consume and deploy. We made upgrades easier. The majority of the software growth of this year and last comes as a result of these actions and we believe there is additional growth ahead. We continue to innovate our next-generation BIG-IP software that will further differentiate F5 in traditional applications. The addition of NGINX took us into Act 2, opening a new addressable opportunity for F5. NGINX enables us to serve modern application environments and cloud native applications. In fact, half of NGINX deployments are in the public cloud. NGINX also brought us modern application services, including API gateway and API management, Kubernetes Ingress control and microservices proxy. NGINX enables us to win against competing software vendors and cloud-native services that lock customers into a specific architecture putting infrastructure and development teams at odds. We took a different approach with the new version of NGINX Controller, our orchestration and analytics platform. We expect controller will bridge the divide between dev teams building modern apps and the infrastructure team that need to secure scale and monitor them. We believe Act 2 brings significant growth opportunity and complements our existing BIG-IP footprint. Act 3 is all about application security, where the last decade was focused on network security, we believe the next opportunity is application security. We started this act organically focused on traditional applications. The ambition of NGINX gives us the opportunity to expand application security to modern applications. And the addition of Shape adds significant capabilities to serve both traditional and modern applications, doubling our application security opportunity from $4 billion to $8 billion. We are well on our way to establishing ourselves as the leading security player for our traditional application security solutions. We are very early on in our efforts to apply best-in-class security to modern applications with the combination of F5 and NGINX, and we are only beginning to tap the potential of growth for Shape. In Act 4, we will leverage analytics to drive automation and deliver business insights. We will leverage our broad application services and Shape’s powerful analytics to deliver AI-enabled security and fraud protection, digital experience management, application performance management, and AIOPS and analytics-enabled business services. Through our existing investments, we are well on our way to delivering this vision for customers. We are creating a differentiated application services platform that will enable adaptive applications, helping customers accelerate their digital transformation and fundamentally changing the way applications are delivered and secured. Let me wrap up the prepared remarks from today’s call by thanking the entire F5 team again, as well as our customers and partners. We are more confident than ever that our vision, our investments and our innovation are well aligned with both near and longer term customer demand. With that, Operator, we will now open the call to Q&A.

[Operator Instructions] Your first question comes from the line of Tim Long with Barclays. Your line is open.

Thank you. Yeah. Two quick ones if I could. Frank or François, first, could you just give a little color on how the performance was in the cloud or hyperscale space where you guys obviously have been increasing the service offering there, so could you just give us a little flavor on how it’s going? And then second, I was hoping you could talk a little bit about the telco business. I think you announced a win with Rakuten again, it might have been your second one. So you could just talk a little bit about how you see your solutions positioning in a 5G world, maybe more so than what we saw in the 4G world for the telco vertical? Thank you. François Locoh-Donou: Thank you, Tim. So I will start with the -- our solutions in the public cloud. I mean, generally, we are seeing a continuation of the trend of the past few quarters, which is that our footprint in public cloud is accelerating and growing faster and I will give you a couple of components of that. First, of course, our partnership with AWS continues to increase the number of opportunities that we have in public cloud. Largely AWS is making a number of opportunities visible to us that were not before, so that’s helping and contributing to accelerate our growth in public cloud. We are also seeing with NGINX, a large number of deployments. I think kind of half of the NGINX deployments are in public cloud and so we are now seeing an opportunity to be in front of modern applications in public cloud, but also applications that were traditional applications that are being refactored and move to the public cloud. NGINX has a very strong value proposition to keep up in front which factored application, especially when they are going multi-cloud and so F5 value proposition of multi-cloud against native tool is very compelling. So, generally, continued growth in and with public cloud providers. So you mentioned hyperscalers as well. I will say that we are part of the infrastructure of some of the hyperscalers providing a number of customer testing applications such as collaborating -- collaboration type application and so we have had an opportunity to scale with these applications as well. As it relates to telco and the evolution, as you know, we have had a very strong presence in the 4G, specifically the GI LAN infrastructure of mobile providers and we are about to transition into 5G. We are seeing a substantial ramp-up in the number of 5G opportunities and that is a very strong upcoming catalyst for -- it’s a very strong upcoming catalyst for our software, because a lot of these 5G opportunities take advantage of the work we have done on virtualization and essentially that most of the opportunities now are software driven. We have now won important design win in environments that are essentially cloud native and container native, and we have been able to win these opportunities for a combination of F5 BIG-IP and NGINX filling in this cloud-native environment. So our excitement about telco and 5G is we are seeing here the kind of breadth of the F5 application services playing an important role in these new architectures.

Okay. Thank you. François Locoh-Donou: Thank you, Tim.

Your next question comes from the line of James Fish with Piper Sandler. Your line is open.

Hi, guys. Thanks for the question. NGINX was picking up for us ahead of the quarter and I was just wondering is the new integrated architecture starting to lead towards more wins with that architecture or is it a refresh of it -- or is it more of the refresh in terms of purchasing more what it’s knows through F5? And I guess also, how are you thinking about leveraging NGINX and F5 for moving it into the edge computing world? François Locoh-Donou: Yeah. Jim, I will start with the first part of your question around what -- and I want to make sure, Jim, you are asking about, what are the catalysts that are driving both in the NGINX business?

It’s more about understanding, François, if this new combined architecture of having NGINX and F5 together is leading towards more wins with customers or if it’s customers right now just spending to keep the lights on and buying what they knew before? François Locoh-Donou: Oh! Okay. Thank you for clarifying, Jim. So the answer is absolutely yes. I mean, this quarter, we have a higher set of number of multi-product deals 195 and largely driven by combinations of F5 BIG-IP and NGINX value proposition coming together and I will give you a couple of examples. We have ported F5 app security tack on to NGINX and we are now starting to a number of customers of that team, wanting to take advantage of the fast security. So what we call NGINX, which we see last quarter, is getting a lot of traction and helping accelerate the monetization of NGINX. We are also seeing with the controller that we have introduced traction around our API gateway and API gateway and API management solutions and we are able to add that to customers that already have F5 solution. So examples of these multi-product deals that this is by fact that is a large number of return subscriptions that we sold this quarter were a combination of F5 and NGINX together. So this better to get a story of really reaching the world of DevOps and the world of NetOps together are giving more visibility to network operations team into their all of this environment that is starting to play out and our customers, and that’s one of the drivers in our software growth. Your second question was around edge computing. So we today have, we call it a light asset edge service called Silverline, which broadly offer mass web application firewall and we offer the managed service. And we have now bought in Shape anti-bot technology on top of that offering and so we are able to serve the needs of some customers that want edge capability. We don’t intend to go in a CapEx-intensive way into the edge computing market ourselves, but our fundamental value proposition of the company is that we are essentially infrastructure agnostic and so we -- our solution can be deployed in public cloud, on-prem, in private clouds and in partnership with CDN providers. So we have a number of partnerships as well with CDN players that can use our app security in fact to protect applications in the whole study posted in the edge.

Got it. Thank you for all that color and take care. François Locoh-Donou: Thank you, James.

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

Hi. Thank you very much for the question and congrats on solid numbers for the quarter. My question mainly is to do with this new vision you are laying out the Adaptive application vision. Is this predominantly going to be offered in the form of an ELA or a very, very flexible consumption agreement with your customers and where exactly that will be consumed, is it going to be multi-cloud, is it going to be predominantly offered to customers scaling applications and public clouds? Can you just give us more of an idea on how mechanically the numbers are going to work or your revenue sources are going to work once this kind of like really rolls out and begins more -- begins to be more mainstream with your customer base? François Locoh-Donou: Sami, thank you. Look, some of this is still to play, but I think on the consumption examples that you have mentioned, it’s all of the above. We are -- by the way, I should say, we are already seeing elements of that vision coming into play today. What we see that with, I just mentioned a customer deploying F5 and NGINX together. This quarter, what we see in this environment, customers want to kind of consolidate on vendors that offer a strong breadth of application services and so there’s a number of deals we have already won this quarter, where essentially, we are taking out some niche players and niche solutions that our customers they have had. But as they look at their future needs, they kind of look at the vision of where F5 is going and they already take three or four of these application services together could change the digital experience and so we are starting to see that happen in real-time in the opportunities that we are winning today. And today that’s happening, we see deals combination of hardware and software, deals with a combination of on-prem and public cloud. We are seeing that with customers protecting a combination of traditional and modern applications. And we are now starting to see that with a Shape contributing division with the integrations we have already made with Shape and our Silverline offering and customers consuming that as the managed service. So you are -- we are early days in that. The realization as time goes on of this vision is going to get much bigger and that you saw in the 4 acts that we presented. I think, over time, the opportunity for F5 gets much larger. But you are already seeing some of these consumption models and consolidation of application delivery and application security across multiple types of infrastructure, that’s actually starting to play out right now.

Got it. Got it. Thank you for that color. And, kind of, like taking what you just said and just kind of framing the way we should be looking at the forward-looking business here, is as adaptive applications continues to scale, we will expect services software, NGINX, Shape to kind of be attached to that. But when we look at like some of the reported metrics that you guys have delivered on systems growth specifically and these kind of double-digit declines, should we expect this trend to essentially continue with systems continuously to be declining, whereas the rest of the business is growing, like, should that relationship continue as adaptive applications continues to accelerate? François Locoh-Donou: I mean, broadly, the answer is yes, because the -- a lot of our customers want to move to the software-first environment. And the software-first environment gives them the flexibility to deploy ultimately the vision for adaptive applications, give them a lot more flexibility to start new application services, to take the benefits of automation and orchestration, and ultimately, to leverage the work we are doing in analytics. So, overall, of these trends point to -- you will continue to see our systems business decline and you will continue to see our software growth and the -- overall, you will see that the majority of the business of the company will be software.

Got it. Got it. And I am sorry to ask the third one. There’s a lot in this earnings call tied to your telecom and service provider opportunities. You have had significant traction with Rakuten, obviously, the theme of virtualizing network cores is now coming to the U.S. with the DISH being a very, I want to say, first big batter here that has to prove itself and the infrastructure. Should it kind of go -- should people be making the assumption that since you guys were very effective at insertions with Rakuten in a virtualized core abroad that your advantages and your know-how and how to do this in certain use cases and functions in the U.S. cores, should we basically have some conviction in this idea or would you say that this is going to be completely different. There’s going to be a new bidding process, et cetera, because the idea of virtualizing cores for telcos is, I guess, we can all agree, it’s pretty complicated stuff. So, we just want to get an idea on how big or if traction is going to be one of the big drivers for F5 going forward in telco and SP? François Locoh-Donou: Sami, I think, you should -- the way to think about this is, every carrier, I think, is going to be different in their transition from 4G to 5G. Some will look for and some will not use that. But, overall, if you look at the 5G architecture and where kind of the end state of where people are going, we feel very, very good about the work we have done, the special software F5 bring to these 5G architectures to be inserted in large carrier infrastructure, one is in the U.S., actually in Asia or in Europe and we have already some informed design wins beyond Rakuten in that space. So, I think, you should read from that, that we have pretty good conviction around the role that we are going to play in 5G infrastructure going forward.

Got it. All right. Thank you very much, François. François Locoh-Donou: Thank you, Sami.

Your next question comes from the line of Samik Chatterjee with J.P. Morgan. Your line is open.

Hi. Thanks for taking my question. If I could just follow-up firstly on Sami’s question here about the vision you are laying out for application services. Just curious how to think about kind of when you think about all the pieces for Act 4, how much of that is organic versus inorganic and some of the AI, et cetera, capabilities, how much of that do you need to look outside to bring those capabilities in-house and I have a follow-up. François Locoh-Donou: Hi, Samik. Well, if you look at the analytics platform, so when we lay the acquisition of Shape, there were multiple reasons we felt strongly this was a great combination with F5. One was, of course, the business that the Shape was in at the anti-fraud business. And as I have shared with you, we really think we have entered the era of application capital where most cloud is going to be on applications and Shape is factoring that secular trend and that in fact, we already saw that we already saw that an acceleration of that this quarter with COVID, and I think I can come back to that later. But the anti-bot business was one of the big reasons for the acquisition. The second big reason for the acquisition was around technology and it was the large amount of money and time that Shape has invested in building an AI-powered analytics platform. And so the reason you see that here and that core part of our vision already realizing is in fact because of the technology assets from Shape. So the M&A as it relates to that essentially have been done with the acquisition. Overall, we don’t go out with that as we march towards this vision of adaptive applications, down the road, we might want to accelerate certain things inorganically, but in terms of analytics specifically we have a big head start with the acquisition of Shape.

Got it. Got it. Thank you. And if I can just follow-up, the guidance you issued for fiscal fourth quarter is a narrower range on the revenue right to the last quarter. So it does imply you have more visibility now, just kind of, again, wanted to get your kind of get what you are seeing in relation to customer activity, particularly cadence through the quarter, are the sales cycles compressing a bit relative to what you saw last quarter or is that driving the higher visibility here?

Samik, this is Frank. So I think our approach was very similar to last quarter. We obviously have had our quarterly business reviews with our sales team. We feel like the guidance that we have given is appropriate and because it was the first quarter that we were living in a post-COVID world, I think, we wanted to give a little bit more of a range, but I think we do feel a bit more comfortable going into Q4 with the visibility that we have got on that activity that we could tighten that up by $10 million.

Okay. Thank you.

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

Great. Thanks. You noted in an answer to a previous question about multi-product deals picking question. But just any commentary you could give on pickup in ELAs or just interest in ELAs in this environment, maybe are there people just wanting to know more what they are buying versus open-ended deals? And then maybe second question, any just update on the AWS partnership and any traction you have been able to make without sales or without in-person sales? François Locoh-Donou: Meta, so on ELA is the demand continues to be very strong. And -- but I would say, there are kind of two tale of the stories there. One of the effects we are seeing in this COVID environment is that customers -- there are some strategic kind of transformation that customers are pushing out, largely because they have to tend to more near-term priorities. So that in a way, there’s some large potential ELAs that could happen this quarter that will happen more down the road. But at the same time, we did more -- in terms of volumes of transactions, we did more ELAs this quarter than we did ever before and those ELAs were often a combination of multiple F5 products, so BIG-IP plus NGINX and now we started to see Shape as well. So that’s where we are at on ELAS. And as it relates to the AWS partnership, we are making very good progress. We have -- we are getting a lot of visibility for AWS in terms of new opportunities. We are -- where we thought we would be at this point in the relationship and I think we will see further acceleration in 2021 because we are working on joint solution integration. And also now working with AWS migration partners to accelerate the work we are doing for migration of workload. So, overall, good traction so far and expect even more in 2021 from the joint collaboration.

Great. Thanks. Congrats. François Locoh-Donou: Thank you, Meta.

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

Thank you very much. I was hoping you could talk a little bit about the timeline between the various phases you described in your presentation. Clearly, you have already done Phase 1 and positioned into Phase 2, with Kubernetes and the application growth driving that vector, it’s pretty clear that ex number of years that’s going to be a very high rate of growth. I was wondering if you could give us a little granularity around that. Do you expect to gain share as a result of your high rate of penetration in Kubernetes and increasing Kubernetes deployment as a percent of new applications, and therefore, gain share within the application market? And then the second question is as you move into the Phase 3 and Phase 4, how do you see those ramping in as a contribution to the software growth rates? Is that a stutter for a year or so and then get a real head of steam around it to get into the Phase 3 or is that already happening and when does Phase 4 kick-in? Thank you. François Locoh-Donou: Okay. Thank you. Let me take you through the timeline of it. So, Act 1, which is really F5 providing app delivery against traditional application. Of course, is happening right now, largely driven with our BIG-IP platform and a lot of the work that we have done over the last two years, three years have been moving to software-first environment with a lot of innovation in our model that has gone on to be successful in a more automated, orchestrated software environments including public cloud. And I would say, a lot of the growth you have seen in our software today has really come from Act 1. Act 2, which is F5, getting in front of modern applications, really started with the acquisition of NGINX. And you are right, Alex, about the penetration of Kubernetes environment. We are accelerating in that space, and yes, we do intend to gain share in the modern application space because we worked there before. And that is something that’s starting to play out now, I think, it’s going to play out for the next several years. I would say, we are still in the early innings of A, being part of modern applications, and B, monetizing that presence. But the stuff we have done with taking app security, the application security solution from F5 and putting that on NGINX as an example. The new NGINX Controller, the new application services like API gateway that we build, all of these things are starting to provide traction on Act 2. Act 3 is really around protecting both traditional and modern application. We have started down organically with F5, that’s why our security business was part of our software growth. But that is being accelerated in good shape and we intend to port the Shape capability across the F5 portfolio. So we have already ported chip capabilities on Silverline, which is our managed security service, but we will have our Shape capabilities with BIG-IP, we will have it with NGINX. So Act 3 is already contributing today, but you should expect them to continue even more in the future. So I would say, Act 2 and Act 3 over the next couple of years will contribute meaningfully. Act 4, I think, in terms -- if you are thinking in terms of material contribution to our financial performance, I would say, Act 4 is really begun the next couple of years. From a technology perspective, we already have a lot of components. We started engaging with customers around some of the solutions that resonate the most with them, around leveraging analytics to give them the right insight for their application. Shape actually has already started releasing a couple of solutions that we just had. But I think in terms of that becoming a material contributor to us, we think that’s beyond the next couple of years.

If I could just follow-up. It’s my understanding that you guys are the dominant controller that’s used in Kubernetes deployments today and if Kubernetes increases as sharply as a percentage of new applications, doesn’t that, by definition, drive share gains?

Hi, Alex. This is Kara. With NGINX we have a solution that is tailor-made to be deployed in microservices and container native environment such as Kubernetes and it is the leading collection of web servers in those environments for modern customer facing digital experiences. And so we think with NGINX at its presence in hundreds of millions of those kind of consumer facing modern applications, we have a good head start for then inserting some of those security capabilities and the analytics capabilities that François spoke about.

I know I could get Kara on there somehow. Thanks, guys.

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

Thanks. I appreciate. François and Frank, I was hoping you could tell us what was the Shape contribution to revenue and related to that, obviously, what was the organic software revenue growth in the quarter and then I have got a quick follow-up?

Paul, so it was a little less than $20 million and so without Shape, I think, the number would have been 14%.

14% organic revenue growth?

Correct.

Oh! Okay. Just an observer -- a question related to observation, First of all, your 5G commentary was different this go around than what you said historically. Historically, you have made the comment, the observation that you won’t see meaningful 5G revenue until there was meaningful take-up of 5G services, because what you did with later in the cycle dependent upon the take-up of those services in terms of number of users and the intensity of use. And your commentary on this call seem to be very different in terms of same traction. Now I am just trying to understand exactly what you are saying and before you respond the other question would be, your ASEAN and India commentary, I just want to make sure I understood it, are you saying that not only did it get hit hard early on, but you haven’t seen any improvement, was it -- is it still in the doldrums or are you seeing any signs of that coming back relative to the impact of COVID-19, appreciate it. François Locoh-Donou: Paul, let me start with ASEAN. I think it’s still -- the business there is still impacted. In India -- and then to be specific, I am talking about India and few of the countries in ASEAN region, either because of first lockdowns or second waves and countries going back into lockdown such as Singapore. But, generally, in that region, we have been impacted throughout for the last really 60 days and it’s kind of ongoing. On 5G, Paul, I think, like, I think, I said two things in the past. One is, I said, once we would see 5G radios deployed that we would start to see capacity upgrade in the core, and I would say, to a large extent we haven’t seen those yet and I think there is still to come. I do think in the very short-term, some carriers have diverted from spend that would have gone on wireless infrastructure into wireline to address work-from-home issues that increase capacity, issues on fixed infrastructure and that’s true for kind of carriers that combine wireless and wireline infrastructure. But what I am seeing, as it relates to 5G opportunities for F5 is we are now you know seeing a ramp-up in opportunities in 5G and we have already some design wins that give us confidence in the role we are going to play. So I would expect to see that start to contribute to us next year. Exactly when I would be able to put or pinpoint, which quarter is, as you know, that service providers, you can’t predict that accurately, but I would expect that next year we would see those contributing.

And François, one quick follow-up, if I may. Once upon a time, F5 was a 40% operating margin company and I understand you all needed to make investments to reposition the company, but you are now down to 28% and change. Any thoughts on if and when we see a healthy rebound in operating margin and you start to leverage the revenue growth you are starting to generate?

Sure. Paul, we will have more to talk about this when we talk about our next quarter, as well as when we reschedule the end presentation. But I do feel like we are closer to the bottom here, and I think, you will see with the Q4 guide that we have given, we are ramping back up from here and expect to see that continue.

Appreciate it. Thanks guys. François Locoh-Donou: Thank you, Paul.

Thanks Paul.

This concludes the time we have for today’s session. Thank you for attending. You may now disconnect.