F5, Inc. (FFIV) Earnings Call Transcript & Summary

Hello, everybody. Tim Long here at Barclays. Thank you for joining us for the fireside chat with F5 Networks. We have both François and Frank on the line here. Most of the discussion likely will be with François.

So guys, thanks for joining, and maybe we'll just start it off. Obviously, there's been a lot of change at the company. So François, I'd love to get your sense as to kind of where you are now with kind of portfolio of products. I mean 2 meaningful acquisitions that seem to have integrated pretty well and both seem to have very good runway ahead of them. So kind of how do you feel about the current state of your product set?

Well, Tim, thanks for having us. Yes, there has been quite a bit of change over the last 3 years at F5. And we feel we have reached an inflection point in the trajectory of the company, where we're now seeing our top line growth accelerate. And the reason for that is in part because of where we are with the portfolio. So if you look at the market that F5 was primarily exposed to 3 years ago, it was the ADC market, that's still our core market and an important part of our portfolio. That market is a kind of low single-digit growth market when you combine hardware and software. And we think we're going to continue to do very well in that market. And in fact, we have been gaining share in that market, and we're going to continue to gain share because of all the things we've done to grow our software business in the software ADC space, in particular. But the great news for us is that F5 has now a much broader addressable market. Specifically, in security, we have done a ton of organic work and the combination of that with Shape has opened up an $8 billion addressable market for us in application security, which -- where we expect to grow fairly rapidly. And then in modern applications, with the acquisition of NGINX, we've also opened up a multibillion-dollar market that is going to bubble over the next 2 years. And that is a potential significant source of growth for us. So when you look at the overall portfolio with these 3 pillars of the ADC market for traditional applications, what we're doing with NGINX for modern applications and what we're doing in security, which is already at scale, then we feel the portfolio is poised for accelerated growth.

Great, great. Yes, it's a good start here. And let's maybe just touch on cloud a little bit. You've kind of rolled out a much more detailed cloud strategy a little over a year ago. And I know AWS is a big partner as is Azure. So can you talk to us a little bit about traction in the cloud? I think you mentioned $100 million in revenues last fiscal year. So give us a little color about how those partnerships are going. We do notice there's a lot of F5 offerings on the AWS page when you're looking for on application security and manageability. So maybe give us a little sense of where we are in that partnership, how you see it driving and what's the kind of cadence of that $100 million base that you're heading into fiscal '21 with?

Well, Tim, I will give you a lot of context to it and a little bit of history because you probably remember this, Tim, but when I joined F5 3.5 years ago, what I was hearing most consistently outside of the company, certainly, even in the analyst community was that F5 is not relevant to public clouds, and public cloud or just a fold to F5. And we beg to defer on that thesis because what was very clear to me was that F5 software is very sticky and it makes applications perform and be available always on and be secure. And that value proposition would play as applications increasingly leverage public cloud. And so fast forward 3 years later, and I think we've gone from very little to more than $100 million, I think, probably faster than most independent software vendors out there in public cloud deployments. And that growth really is about 3 phases, and we're not even starting with Phase 3 just yet. So the first phase of that thing was really just making our stuff works -- making our technology work in public cloud so that a customer that wanted to bring their license in a public cloud could do that without too much trouble. And so that was a lot of work with the major cloud providers. We've done that with AWS, with Azure. We've also done that increasingly with GCP. And so we've been able to make it easier for our customers to consume F5 in public cloud. That was kind of Phase 1. Phase 2 of that was having joint go-to-market plans with the major public cloud providers. And so with AWS, as an example, when we signed the strategic collaboration agreement, in the past, we were kind of meeting in the market. So our customer would pull F5 and AWS together and say, please make this happen. But we shifted to take a more deliberate sense working jointly. And since then, we have received a large number of leads from AWS because they are in conversations that we were not a part of. And so that has provided us a further acceleration. And where we're going next is more joint kind of co-innovation with our public cloud partners. And this is really taking the best of F5 solutions and best of the public cloud providers and creating a 1 plus 1 equals 3 for a customer that they wouldn't get otherwise. A good example of that is what we've announced with AWS, where we are putting our security SaaS solution, a web application firewall in front of AWS cloud front, which is their -- one of the largest CDN in the world, if not the largest CDN today, to offer customers a great CDN experience with best-in-class security. And so that's an example of co-innovation. That's just starting, and I think that's going to be another catalyst of growth for us in public clouds. And the last thing, Tim, you mentioned, yes, we have shared that we did more than $100 million in 2020 in public cloud. That wasn't, of course, just AWS, that's across all the major public cloud providers. We do a lot with Azure as well. And it's a combination of customers bringing their license to public cloud or consuming F5 in the marketplaces of the major cloud providers. And so there's just a broad base of business now into public cloud and a flywheel that is kind of starting to turn up velocity.

Great, great. And as you kind of move down this integration curve with the cloud vendors, are you seeing less appetite for some of the native solutions that might be competitive with F5 offerings?

So where the native cloud solutions are competitive is really not with BIG-IP. So if you take BIG-IP franchise of F5 that has traditionally supported traditional applications, very rarely, if ever, our customer have to choose or want to migrate from BIG-IP to a cloud-native solution because there's too much richness and complexity and programmability and security that customers want from BIG-IP that they wouldn't get from a cloud-native tool. Where there is competition is more in the NGINX area for modern applications that are contaminated, sometimes -- oftentimes built in public cloud, where that potential overlap of competition would happen. And where NGINX is differentiated from the native cloud is, a, it's inherently a multi-cloud solution. So anyone who cares about deploying their microservices across multiple clouds, NGINX is sort of cloud agnostic. And, b, NGINX combines a lot of functionality into 1 platform. So it's a map server, it's a web server, it's a load balancer, it's an API gateway. And so for DevOps personnel who are struggling with the tools and having to master, many, many tools for many different vendors, NGINX is a great source of consolidation and simplification into 1 platform. And that's kind of what differentiates it from native tools from public cloud providers. And you've seen that in the last 16 months, our NGINX revenue have doubled and some of that actually comes from deployment in public cloud. Actually, a very meaningful portion of it comes on deployment in public cloud.

Okay. That's very helpful. Wanted to touch on shape and security. I think when you gave the data at your Analyst Day, certainly, the security line was bigger than what I would have expected, both the stand-alone and the attach and the maintenance. So how do you view the growth there? And do you see that as still a lot of cross-sell opportunities across the kind of the legacy F5 installed base to help that growth rate on the security side?

Yes. So if you break it down, Tim, ours, we shared our total security business is approximately $750 million in 2020. Of that, $275 million of that is stand-alone security product revenue, $125 million of that is security attached to ADC in the product, and the balance is services revenue attached to security. So we're continuing to see the security attached business attached to ADC continues to grow, which is why our -- even in our hardware business, our mix of ADC versus security has shifted and continues to shift towards security because our hardware security business is growing. And so that's -- that being said, the stand-alone security business is growing faster. And so I think over time, you will see -- of that mix, you'll see total growth in security, but you'll see security -- stand-alone security continue to become a bigger and bigger portion of the overall business. Now in terms of the cross-sell opportunities, yes, there is a lot going on there. I would say 1 opportunity that we are -- we have already released as a solution to the market is porting BIG-IP security to NGINX because there's a lot of demand in the DevOps, DevSecops for kind of simple to use security, again, making NGINX a more consolidated platform and accelerating the monetization of NGINX and then we're also porting Shape capabilities to BIG-IP to allow customers to get anti bot capabilities from BIG-IP or Silverline, which is our managed service.

Okay. Great, great. And then maybe on NGINX, if you could talk a little bit about the success of the first integrated product you guys have rolled out. And I think people are pretty excited about Kubernetes and kind of the growth rate there. And obviously, NGINX has a really, really strong position. So is there any reason to believe that, that business shouldn't be kind of along for the ride as Kubernete goes? How do we think about kind of correlation of revenues or traction for F5 as that ramps?

Yes. No, we are very excited about the potential for NGINX in Kubernetes environment. NGINX is the #1 ingress controller into Kubernetes environment in the market today. We have just released a service match, which is going to accelerate the role that NGINX plays inside of those Kubernetes clusters going forward. And so this is going to be a source of substantial growth for NGINX. You probably saw we doubled our revenue in 2020, but also the deal sizes of NGINX have grown since the acquisition by more than 50%. And that was before we released the new solutions that we think are going to grow the deal sizes even further. And specifically, the controller, the NGINX controller that we have released. It allows customers to deploy more instances of NGINX at scale without having to manage individual instances and spend a lot of time manually orchestrating these instances. So that's going to be, we think, another catalyst for NGINX. I'd add, when we acquired NGINX, NGINX was very early in the monetization of the platform. And really, the only thing that was being monetized was the load balancer with a little bit more features and enterprise support. But what we saw was that NGINX was a platform that you could build all these service modules on. And in fact, we were seeing other players have used NGINX to build and monetize. Some of the public cloud players have done that. CDN -- some of the CDNs are built on NGINX and other -- like Avi had built on their low balance or based on NGINX. So we said, look, we want to have the platform, and there's so much opportunity to monetize multiple elements. And so since then, we have built an API gateway solution, we have built the control, we have added security for the platform. And so the potential monetization of the platform today is much greater than it was 16 months ago at the time of the acquisition.

Okay. Great. And is that -- I'm assuming as those hit the market, that's big -- good revenue opportunity for you. Are there other monetization tools that you see looking forward?

Yes. Those will -- are hitting the market now. The controller is out, our security solution is out about a quarter ago. And then API gateway and API management will continue to make headway into that -- the maturity of our solution. And so we're looking forward to this thing contributors in 2021 and beyond.

Okay. Great. I wanted to touch on another topic, and that's kind of the telco business in 5G and open RAN and all that. I think you guys have had maybe even a second contract with Rakuten in Japan. And obviously, there's going to be a big high-profile open RAN network here in the U.S. So can you talk a little bit about F5's kind of telecom exposure and opportunity as the networks evolve from 4G to 5G? Obviously, a lot more data, a lot more applications. So it seems like it will play right into you. So maybe just give us a sense as to what kind of uptick in importance we could see from F5 in telco networks?

So today, Tim, we play in -- primarily in telco, we played with mobile operators, mobile carriers. And historically, F5 has been very strong in what's called the Gi LAN, which is a portion of the core network of a mobile provider where we serve a number of functions such as traffic optimization, what's called carrier-grade network address translation or traffic steering, basic policy enforcement, those kinds of things. Again, F5 has been a platform that has consolidated all these functions in the Gi LAN of a 4G network. And so we have that very strong place. We also do firewalls, application firewalls, carrier grid firewalls still in that part of the network. As things move to 5G, there are really 3 opportunities that open up for F5. The first one is that, as you said, our 5G radios get deployed, there will be more traffic on existing 4G core networks. And that should translate to capacity upgrades for places where F5 is already in the network, right? So we will see capacity upgrades in 4G core networks. The next opportunity is you will see that a number of carriers will not completely change their core architecture immediately, but they'll change. They will bring 5G radio, and they will keep a 4G core initially. And so that creates a need to -- between the 4G core and the 5G edge, a need for translation, translation of protocols between 4G and 5G. And F5, because we are full proxy, we are ideally placed with our software to take advantage of that opportunity for translation between 4G core and 5G, 5Gs. So that's a software opportunity that's materializing for F5. We have already a couple of design wins. With a couple of large carriers around that. And then the third opportunity is mobile edge compute. As more and more things are processed at the edge, we have with our service mesh solutions, an opportunity to play into the mobile edge compute framework and that's a software opportunity. And when you think about the horizons of these opportunities, I think you'll start to see in the second half of 2021, some of these deployments start to ramp and then going into 2022 more materially.

Okay. Great. Great. François, I did also want to touch on the service business. It doesn't get as much discussion, but it is more than half the revenues right now. So when you look at that business, how do you see opportunities there other than just kind of the standard maintenance attached? What other type of dynamics could be in that business to kind of help at least keep a level of growth to it?

So Tim, we said that our services business, that the growth would actually moderate, would go to low single digits kind of in the near-term and then low single digits to flat in the longer term. That's largely a factor of more and more of our business moving to software subscriptions. And as you know, as we do that, accounting rules dictate that more a greater portion of the revenue gets recognized as product. So as you see that moderation, you will see also an accelerating growth in product revenue as a result of that shift to software subscription. The good news in our software business is that the services attach rate on our software that we're seeing are very similar to the service attach rate on our hardware, which have been very high historically. So that provides a good floor, a good stability, a good predictability into the services business, which, as you rightly pointed, has been a very strong engine of performance for F5, and I think it's going to continue to be so.

Okay. Great. And then maybe just the last on the product front. You mentioned hardware with the security hardware growing. Obviously, the ADC is undergoing this transition to virtual. But it does seem like it's normalizing at least somewhat around a more stable type of decline. So how do you think about that? Is there, over time, a little bit of change in investment in that business? So are there offsets to that decline that might be a little bit more positive overall to F5 given that you know that it's going to be a declining business?

Yes. On the hardware specifically, Tim, I think there, again, we have said that we've seen kind of double-digit declines in the 2019 perhaps and we're seeing that decline moderate. And we said that in our horizon, too, it would moderate to high single-digit decline. And now -- but the reason for that is because the mix of security in our hardware business overall is greater than it was, and it continues to grow. And then the second reason is there are a number of use cases, whether it's SSL encryption, decryption or IoT use cases that actually require the throughput of our hardware and especially in some of the verticals that we serve. Another use case is FIPS, which is a type of technology that's quite important in government applications and also the financial services sector requires that. And that is really implemented in hardware. And so there are a number of use cases in the verticals we serve where the hardware demand is going to continue for a long period of time.

Okay. Good. Maybe I have time for 1 more. And Francois, feel free to field this one. But the capital return discussion that you guys talked about on the Analyst Day was also pretty well received. It is a very cash flow generative company. So it seems like you could meet those targets and still invest pretty well in growth in the business with the accelerating growth you're talking about. So how do you view that capital return level that you're doing? And do you view that as something that's sustainable?

Frank, do you want to take that one?

Yes. No, I'm happy to. Thanks for the question, Tim. So look, we've largely rebuilt the strategic cash option that we've outlined as a priority post the NGINX and Shape acquisition. And what we tried to find them is to strike a balance between what we view is adequate cash for the operations as well as strategic investments that we may want to make in the future with the adequate return of capital to our shareholders. And all of those factors drive what we're saying is our guiding North light, so the rule of 40 and double-digit EPS growth. And so we think that we've struck that balance with what we talked about over $1 billion of capital return with an accelerated share repurchase this year and more evenly distributed share repurchase in FY '22 and then 50% of free cash flow going forward from FY '23 and beyond. But all of that will allow us to, I think, have an adequate return of capital to shareholders as well as pursue targeted M&A, which accelerates our adaptive application vision. But as we stated, we're not going to do that with any impact to the promises that we made for our operating model for Horizon 2. So operating margins intact, EPS intact, regardless of any strategic acquisitions that we do.

Okay. Great. Well, thank you very much, both of you. Where we are running up at the end of the time here. So appreciate your time. Congrats. It has been a good run lately. So keep it up and be safe everybody, and we'll talk soon.

Thanks so much, Tim.

Thanks for having us.