F5 (NASDAQ:FFIV) Q3 2020 Earnings Call

0:00 Good afternoon and welcome to the F5 Network's third quarter fiscal 2020 financial results conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you'll need to press star one on your telephone. If you require any further assistance, please press star zero. 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'm Suzanne DuLong, F5's Vice President of Investor Relations. Francois Locoh-Donou, F5's President and CEO, and Frank Peltzer, F5's Executive Vice President and CFO, will be making prepared remarks on today's call.

0:54 Other members of the F5 executive team are also on hand to answer questions during the Q&A session. A copy of today's press release is available on our website at F5.com, or an archived version of today's call will be available through October 25, 2020.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 816-6352. For additional information or follow-up questions, please reach out to me directly at s.dulong at f5.com. Our discussion today will contain forward-looking statements, which include words such as believe, anticipate, expect, and target.

1:56 These forward-looking statements involve uncertainties and risks that may cause our actual results to differ materially from those expressed or implied by these statements. Factors that may affect our results are summarized in the press release announcing our financial results and described in detail in our SEC filings. Please note that F5 has no duty to update any information presented in this call. With that, I'll turn the call over to Francois. 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 Franck to review the quarter's results in detail. Despite micro uncertainty, we delivered strong third quarter results.

2:44 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 protest 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.

3:36 This includes continuing our mandatory unconscious bias training for all employees. but no amount of policies and 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 nonprofits working to advance basic human rights for people of color in the U.S.

4:39 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.

5:28 We are benefiting as customers accelerate their digital transformation and turn to operationalized solutions to meet both immediate and long-term business needs. After Franck 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. Franck? Thank you, Francois, and good afternoon, everyone. As Francois 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.

6:23 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 our $555 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.

7:08 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.

7:55 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.

8:41 Federal. Turning to our Q3 operating results. Gap gross margin in Q3 was 81.8%. Non-gap gross margin was 84.4%. Gap operating expenses were 390 million. Non-gap operating expenses were 327 million. Our gap operating margin in Q3 was 15%, and our non-gap 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 quarter was $70 million or $1.14 per share.

9:28 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.

10:14 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.

10:59 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 Thank you for joining us. of $326 to $338 million.

11:46 We anticipate our full-year FY20 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 FY19 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 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.

12:45 However, consistent with what we have said previously, we also retain the option of repurchasing shares opportunistically in any open trading window. With that, I will turn the call back over to Francois. Francois? 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.

13:32 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 originally 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.

14:18 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, and 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.

15:10 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 prolonged 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 transformations because of COVID-19.

15:55 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.

16:49 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.

17:44 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+. 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.

18:31 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 West. This quarter, we secured a win with a multinational financial services corporation using NGINX API Gateway and F5 App Protect.

19:29 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's 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.

20:20 We are protecting both the web and mobile deployments of their new over-the-top service against credential stuffing and other threats. 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. The 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.

21:08 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 strengths and trajectories of traditional F5, NGINX, and SHAPE to create adaptive application 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.

21:55 Ultimately, adaptive applications will deliver increased revenue, reduced 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.

22:40 Let us step back a bit. To deliver engaging user experiences, many things need to happen between the application's business logic and the user. The application needs to scale as usage increases. It needs to be protected from attacks 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.

23:28 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, microservices, and even serverless. This creates the need for application services such as Ingress Controller, API Gateway, Load Balancer, Web Application Firewall, etc., 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.

24:18 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 siloed teams and high operational complexity. This fragmentation also creates inconsistent application security.

25:04 While teams work to protect the different aspects of application behaviors, the user experience of the business service often is left underprotected. 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.

25:52 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 customers' 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.

26:43 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 multi-purpose application analytics platform. Such a platform supports application insights and automation and AIOps as well as AI-enabled security and fraud protection, end-to-end digital experience management and AI-enabled business services.

27:32 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 shapes AI-powered analytics. Today, we offer the most comprehensive application services along the application path. We scale and protect our customers' mission critical business services. Our application services support more than half of the world's enterprise application workloads.

28:23 For the future, we are doubling down on application telemetry and cloud analytics. We are leveraging machine learning and AI to help our customers to discover insights about their applications and many more. 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 through multiple complementary tools designed to address specific customer challenges. The most recent of those tools is the Shape AI Fraud Engine, or 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.

29:17 Safe and Shape Recognize, another analytics-based Shape solution, are both upsell propositions. Safe enabled a higher level of fraud protection than other cloud security solutions. while Recognize minimizes friction for legitimate application users and in doing so drives increased in top line revenue for customers. Where other shape solutions target bots, Safe targets human fraudsters. Consider that a typical retailer's 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%.

30:03 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 began 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.

30:54 The fraudsters 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 does the restaurant discover 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 attacks in the hundreds of millions per day, all the way down to ultra sophisticated fraud schemes that number in the tens per day.

31:44 We see our journey to creating adaptive applications occurring in four acts, each of which brings with it new growth opportunities for F5. With acts two through four, we are also expanding our addressable opportunity. From a timing perspective, we are working multiple acts in parallel. In act one, we took steps to expand our opportunity within traditional applications. In this phase, we unlocked 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 on next-generation BIG-IP software that will further differentiate F5 in traditional applications.

32:47 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.

33:32 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 teams 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.

34:17 The addition 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.

35:06 We will leverage our broad application services and shape 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 transformations and fundamentally changing the way applications are delivered and secured. Let me wrap up the prepared remarks on today's call by thanking the entire F5 team again, as well as our customers and partners.

35:52 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. As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pounder hash key. Please stand by while we compile the Q&A roster. 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. Francois, Francois, 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 offerings there? So could you just give us a little flavor on how that's going? And then second, I was hoping you could talk a little bit about the telco business. I think you announced a a win with Rakuten again.

36:58 It might have been your second one. So if 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. Thank you, Tim. So I'll start with our solutions in the public cloud. Generally, we're 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'll 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 because 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.

38:00 I think half of the NGINX deployments are in public cloud. And so we're 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 moved to the public cloud. NGINX has a very strong value proposition to keep up in front of refactored applications, especially when they're going multi-cloud. And so FI's value proposition of multi-cloud against native tools is very compelling. So generally, continued growth in and with public cloud providers. Tim, 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 collaboration type applications and so we've had an opportunity to scale with these applications as well.

39:01 As it relates to telco and the evolution, as you know, we've had a very strong presence in the 4G, specifically in the GI land infrastructure of mobile providers and we're 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 our software. Because a lot of these 5G opportunities take advantage of the work done on virtualization. and essentially most of the opportunities now are software driven.

39:50 We have now won important design wins in environments that are essentially cloud native and container native and we've been able to win these opportunities with a combination of S5 Big IP and NGINX sitting in these cloud native environments. Our excitement about Telco and 5G is we're seeing here the kind of breadth of the application services playing an important role in these new architectures. Okay, thank you. Thank you, Tim. Your next question comes from the line of James Fish with Piper Sandler.

40:35 Your line is open. Hey, guys. Thanks for the question. Engine X 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 more the refresh in terms of purchasing more what is known through F5? And I guess also, how are you thinking about leveraging Engine X and F5 for moving it into the edge computing world? Thank you, James. I'll start with the first part of your question around what, and I want to make sure, James, you're asking about what are the catalysts that are driving growth in the NGINX business?

41:22 It's more about understanding, Francois, if this new combined architecture of having NGINX and F5 together is 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. Okay. Thank you for clarifying, James. So the answer is absolutely yes. I mean, this quarter, we have the highest ever number of multi-product deals, one by five, and largely driven by combinations of S5, Big IT, and NGINX value proposition coming together. And I'll give you a couple of examples.

42:08 We have ported S5, the app security stack, onto NGINX. And we're now starting to see a number of customers, app dev teams, wanting to take advantage of this app security. So what we call NGINX App Connect, which we introduced and Last Water is getting a lot of traction and helping accelerate the monetization of NGINX. We're also seeing, with a controller that we have introduced, traction around our API gateway and API management solution, and we're able to add that to customers that already have S5, S5 solutions. So examples of these multi-product deals, this is manifested in A large number of the term subscriptions that we sold this quarter were a combination of F5 and NGINX together. So this better together story of really bridging the world of DevOps and the world of NetOps together, giving more visibility to network operations teams into their OSS environments, that is starting to play out in our customers, and that's one of the drivers of our software group.

43:23 Your second question was around edge computing. So we today have, I would call it a light asset edge service called Silverlight, which largely offer managed web application firewalls and DDoS as a managed service. And we've now bought and shaped anti-bot technology on top of that offering. And so we are able to serve the needs of some customers that want 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, James, is that we are essentially infrastructure agnostic.

44:09 And so we, you know, our solutions can be deployed in public cloud, on-prem, on-prem, in private cloud and in partnership with CDN providers. So we have a number of partnerships as well with CDN players that can use our app security stack to protect applications that are hosted and posted at the edge. Scott, thank you for all that color and take care. Thank you, James. Your next question comes from the line of Sammy Baudry with Credit Suisse. Your line is open. Hi, thank you very much for the question and congrats on the solid numbers for the quarter. My question mainly is to do with this new vision you're 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?

45:12 is 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, you know, begins to be more mainstream with your customer base? Tommy, thank you. Look, some of this is still to play out, but I think of the consumption examples that you've mentioned, it's all of the above. By the way, I should say we are already seeing elements of that vision coming to play today. We're seeing that with, I just mentioned, customers deploying F5 and NGINX together. In this quarter, what we see is in this environment, customers want to consolidate on vendors that offer a strong breadth of application services and so there's a number of deals we've already won this quarter where essentially we're taking out some niche players and niche solutions that our customers may have had but as they look at their future needs they kind of look at the vision of where I find it going and they already take three or four of these application services together to chain a digital experience and so we're starting to see that happen in real time in the opportunities that we're winning today.

46:36 and today that's happening. We've seen deals that are a combination of hardware and software, deals that are a combination of on-prem and public cloud. We're seeing that with customers protecting a combination of traditional and modern applications and we're now starting to see that with a shape contributing to this vision with the integrations we've already made with shape and our server line offering and customers consuming that as a managed service. So we are early days in that. The realization as time goes on of this vision is going to get much bigger. And as you saw in the four acts that we presented, I think over time, the opportunity for F5 gets much larger.

47:22 But you're 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. 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'll 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?

48:09 Like, should that relationship continue as adaptive applications continues to accelerate? I mean, broadly, the answer is yes because, you know, a lot of our customers want to move to the software-first environments and these software-first environments give them the flexibility to deploy ultimately the vision for adaptive applications. It gives them a lot more flexibility to insert new application services, to take the benefits of automation and orchestration and ultimately to leverage the work we're doing in analytics. So over all of these trends, point to you'll continue to see our systems business decline and you'll continue to see our software grow. Overall, you'll see that the majority of the business of the company will be software.

49:09 Got it. I'm sorry to ask the third one. There's a lot in this earnings call tied to your telecom and service provider opportunities. You've had significant traction with Rakuten. Obviously, the theme of virtualizing Thank you very much. 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, etc.? Because the idea of virtualizing cores for telcos is, I guess we can all agree, is pretty complicated stuff.

50:04 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. I think the way to think about this is every carrier is going to be different in their transition from 4G to 5G. Some will not use that. But overall, if you look at the 5G architecture and the end state of where people are going, We feel very, very good about the work we've done, the special thought that F5 brings to these 5G architectures to be inserted in large carrier infrastructure, whether it's in the U.S.

51:00 or actually in Asia or in Europe. And we have already some important design ways beyond Rakuten in that space. So I think you should read from that that we have pretty good conviction around the role that we're going to play in 5G infrastructure going forward. All right. Thank you very much, Francois. 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 kind of the vision you're 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 kind of some of the AI, et cetera, capabilities, how much of that do you need to kind of look outside to bring those capabilities in-house?

51:57 And I have a follow-up. Hi, Samik. So if you look at the analytics platform, so when we... made the acquisition of Shape. There were multiple reasons we felt strongly this was a great combination with FI. One was, of course, the business that Shape was in, the anti-fraud business. And as I've shared with you, we really think we've entered the era of application capital where most fraud is going to be on applications. And Shape is capturing that sector with trend. And in fact, we already saw that. and I can come back to that later. But the anti-fraud business was one of the big reasons for the acquisition.

52:45 The second big reason for the acquisition was around technology and it was the large amount of money and time that Shape had invested in building an AI-powered analytic 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 has been done with the acquisition. Overall, we don't rule out that as we march toward this vision of adaptive application 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.

53:33 Thank you. And if I can just follow up, the guidance you showed for fiscal fourth quarter is a narrower range on the revenue rate 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're seeing in relation to kind of 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? Sorry, this is Frank. So Thank you. Thank you. Your next question comes from the line of Meta Marshall with Morgan Stanley.

54:43 Your line is open. Great, thanks. And you noted in an answer to a previous question about multi-product deals picking up, 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're buying versus open-ended deals? and then maybe second question, any just update on the AWS partnership and any traction you've been able to make without sales or without in-person sales? So on the LA, the demand continues to be very strong but I would say there are kind of two stories there.

55:30 One of the effects we're seeing in this COVID environment is that Customers, there are some strategic kind of transformation that customers are pushing out, you know, largely because they have to tend to, you know, more near-term priorities. So that in a way, you know, there's some large potential ELA's that could have happened this quarter that will happen more down the road, but at the same time, We did more ELAs 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 S5 products. So Big IT plus NGINX, and now we've started with the shape as well. So that's where we're at on the ELAs. And as it relates to the AWS partnership, we're making very good progress.

56:30 We're getting a lot of visibility from AWS in terms of new opportunities. We are where we thought we would be at this point in the relationship and I think we'll see further acceleration in 2021 because we're working on joint solution integration and also now working with AWS migration partners to accelerate the work we're doing for migration of workflows. So overall, good traction so far and expect even more in 2021 from the joint collaboration. Great. Thanks. Congrats. Thank you.

57:16 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've already done phase one and positioned into phase two with Kubernetes and application growth driving that vector. It's pretty clear that for the next X 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 three and phase four, 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 three, or is that already happening? And when does phase four kick in?

58:39 Thank you. Thank you. Let me take you through the timeline. Act 1, which is really on F5, providing app delivery against traditional applications, of course is happening right now, largely driven with our big IT platform. And a lot of the work that we have done over the last two or three years has been moving to software-first environments. There's a lot of innovation in our models. that have gone on to be successful in the more automated, orchestrated software environment, 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.

59:26 Act 2, which is F5 getting in front of modern applications, really started with the acquisition of NGINX. And you're right, Alex, about the penetration of Kubernetes environments. We are accelerating in that space, and yes, we do intend to gain share in the modern application space, because we were a share before. And that is something that's starting to play out now, and I think it's going to play out for the next several years. I would say we're still in the early inning of us, A, being part of modern applications, and B, monetizing that presence. The stuff we've 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 built, all of these things are starting to provide traction on Act 2. Act 3 is really around protecting both traditional and modern applications.

1:00:30 We have started that organically with F5. That's why our security business was part of our software growth. But that is being accelerated with SHAPE and we intend to port the SHAPE capabilities across the DSI portfolio. So we've already ported the SHAPE capabilities on Silverline, which is a managed security service, but we'll have our SHAPE capabilities with AID, we'll have it with NGINX. So Act 3 is already contributing today, but you should expect it to contribute even more in the future. So I would say Act 2 and 3, over the next couple of years, will contribute meaningfully. Act 4, I think, in terms of material contribution to our financial performance, I would say Act 4 is really beyond the next couple of years. From a technology perspective, we already have a lot of components.

1:01:27 We started engaging with customers around some of the The solutions that resonate the most with them are leveraging analytics to give them the right insight for their application. Shape actually has already started releasing a couple of solutions that do just that. 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 partner We have a solution that is tailor-made to be deployed in microservices and container-native environments, such as Kubernetes. and it is the leading selection of web server in those environments for modern customer facing digital experiences.

1:02:39 And so we think with NGINXs and 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 Francois spoke about. I knew I could get Kara on there somehow. Thanks guys. Your next question comes from the line of Paul Silverstein with Cowan. Your line is open. Thanks. I appreciate it. Francois, I was hoping you could tell us what was the SHAPE contribution of revenue and related to that, obviously, what was the organic software revenue growth in the quarter? And then I've got a quick follow-up. So it was a little less than $20 million. And so without SHAPE, I think the number would have been 14%.

1:03:32 14% for organic revenue growth. Okay. Just an observation, a question relates to an observation. First of all, your 5G commentary was different this go around than what you said historically. Historically, you've made the comment, the observation that you wouldn't see meaningful 5G revenue until there was meaningful take up of 5G services. because what you did was later in the cycle dependent upon the takeover of those services in terms of number of users and the intensity of use. And your commentary on this call seemed to be very different in terms of same traction. Now, I'm just trying to understand exactly what you're saying. And before you respond, the other question would be, your Asian and India commentary, I just want to make sure I understood it.

1:04:22 Are you saying that not only did it get hit hard early on, but you haven't seen any improvement? 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. Well, let me start with ASEAN. I think it's still, you know, the business there is still impacted. In India, and then to be specific, I'm talking about India and a few other countries in the 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 the last really 60 days and it's kind of ongoing.

1:05:16 On 5G, I think I've said two things. in the past. One is I said, you know, once we would see 5G radios deployed, that we would start to see capacity upgrades in the core. And I would say, to a large extent, we haven't seen those yet, and I think they're still to come. I do think in the very short term, some carriers have diverted some spend that would have gone on wireless infrastructure into our line to address work-from-home issues that increase capacity, issues on fixed infrastructure. That's true for carriers that combine wireless and wireless infrastructure. But what I'm seeing as it relates to 5G opportunities for F5 is we are now seeing a red pop in opportunities in 5G, and we have already some design wins.

1:06:21 that give us confidence in the role we're going to play. So, you know, I would expect to see that start to contribute to us next year. Exactly, you know, when I would be able to pinpoint, you know, which quarter, as you know, that, you know, service providers, if you can't predict things that accurately, but I would expect that next year we would see those contributing. Thank you. Hey, Francois, 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're now down at 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're starting to generate?

1:07:12 Sure. We'll have more to talk about this. Thank you, Paul. Thanks, Paul. Thank you for attending. You may now disconnect.