F5 Inc (FFIV) 2020 Q1 法說會逐字稿

Good afternoon, and welcome to the F5 Networks First Quarter Fiscal 2020 Financial Results Conference Call.

(Operator Instructions) 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.

Madam, you may begin.

Hello, and welcome.

I'm Suzanne DuLong, F5's Vice President of Investor Relations.

François Locoh-Donou, F5's President and CEO; and Frank Pelzer, F5's Executive Vice President and CFO, will be making prepared remarks on today's call.

Other members of the F5 executive team are also on hand to answer questions during the Q&A portion of today's call.

A copy of today's press release is available on our website at f5.com, where an archived version of the call will be available through April 26, 2020.

The replay of today's discussion also will be available through midnight Pacific tomorrow, January 28 by dialing 800-585-8367 or (416) 621-4642.

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'll turn the call over to François.

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.

We have been investing to evolve our business to better meet our customers' changing application demands.

Today, we are delivering our world-class application services across a wider range of deployment and consumption models.

As a result, customers are increasingly deploying F5 in multi-cloud environments, driving a shift in our revenue mix towards software.

Customer demand for consistent application security and reliable application performance drove 5% total revenue growth in our first quarter.

Strong customer demand for security use cases, including WAF and SSLO as well as ongoing ELA traction fueled our 50% software growth.

We are very pleased with our continued software traction.

We continue to expect 60% to 70% software growth for 2020, including contribution from Shape Security, which closed on Friday last week.

Our software growth was partially offset by our systems business, which was down 11% as customers increasingly look to consume F5 solutions as software.

Our services business was very strong in the quarter, delivering 8% revenue growth.

Services is benefiting from our robust software sales over the last several quarters, including the second full quarter of NGINX related sales.

Overall, we continue to execute well against our long-term strategy and are pleased by the pace of our continued transition to a software-driven business.

I will speak more to our business dynamics and customer wins after Frank reviews the quarter's financial results and our Q2 outlook.

Frank?

Thank you, François, and good afternoon, everyone.

As François noted, we delivered another quarter of strong revenue growth.

First quarter revenue of $569.3 million was up approximately 5% year-over-year and near the top end of our guided range of $560 million to $570 million.

GAAP net income for the quarter was $98.5 million or $1.62 per share.

Non-GAAP net income was $155.4 million or $2.55 per share.

This was well above the top end of our guidance range due to our strong revenue performance as well as disciplined operating expense management in the quarter.

Q1 product revenue of $235 million was flat year-over-year and accounted for approximately 41% of total revenue.

As François mentioned, software revenue grew 50% year-over-year.

Software represented approximately 28% of product revenue in Q1, up from approximately 19% in the year ago quarter.

We continue to experience strong uptake on our software solutions sold as annual subscriptions, including as ELAs.

In fact, contribution from ELAs increased again year-over-year.

Systems revenue of $170 million was down 11% year-over-year as customers continue to transition to software-based solutions.

Systems accounted for approximately 72% of product revenue in the quarter.

Services revenue of $335 million grew 8% year-over-year and represented approximately 59% of total revenue.

There were 3 primary contributors to services revenue's strong performance in the quarter.

The primary factor is improvements to the tools and processes our team uses to identify and secure renewals.

In addition, we continue to enjoy healthy services attach and renewal rates to software sold as perpetual or as subscriptions, including NGINX-related sales, and we have also seen a step-up in consulting services demand associated with growing software sales.

On a regional basis, in Q1, Americas delivered a solid quarter with 3% revenue growth year-over-year, representing 53% of total revenue.

EMEA grew 5% and accounted for 27% of revenue, while APAC grew 8% and accounted for 20% of revenue.

Looking at our bookings by vertical.

Enterprise customers represented 65% of product bookings and service providers accounted for 16%.

Our government business was very strong, representing 19% of product bookings, including 7% from U.S. Federal.

In Q1, we had 3 greater than 10% distributors: Ingram Micro, which accounted for 16% of total revenue; Westcon, which accounted for 11%; and Arrow, which accounted for 10%.

Let's now discuss Q1 operating results.

GAAP gross margin in Q1 was 84.4%.

Non-GAAP gross margin was 86%, GAAP operating expenses were $358 million.

Non-GAAP operating expenses were $297 million.

Non-GAAP operating expenses were at the lower end of our guidance range for several reasons, including disciplined expense management and sales commissions back in line with historical levels down from the highs of the second half of 2019.

In addition, there were some timing differences for expenses expected between Q1 and Q2.

Our GAAP operating margin in Q1 was 21.5%, and our non-GAAP operating margin was 33.8%.

Our GAAP effective tax rate for the quarter was 22.8%.

Our non-GAAP effective tax rate was 21.4%.

Turning to the balance sheet.

In Q1, we generated $144 million in cash flow from operations.

This is down from last year for several reasons, including lower year-over-year operating margins, commission payments from strong Q4 bookings, M&A-related expenses and restructuring.

Cash and investments totaled approximately $1.5 billion at quarter end.

DSO of 56 days, and capital expenditures for the quarter were $22 million.

Deferred revenue increased 8% year-over-year to $1.2 billion.

The growth rate is down from 2019 levels because we had lapped our 606 adoption which, as we consistently called out, was accounting for roughly half our deferred revenue growth over the last year.

We ended the quarter with approximately 5,305 employees, down approximately 20 from Q4 as a result of ongoing efforts to better align spend with strategic imperatives.

We continue to view cash as a strategic asset for our future growth.

Our near-term priority will be paying down the $400 million term loan A related to the Shape acquisition funding.

We'll look to balance that with rebuilding our cash position for strategic purposes.

We also may opt to repurchase shares during any open trading window.

Now let me share our guidance for fiscal Q2 of 2020.

Unless otherwise stated, please note that my guidance comments reference non-GAAP operating metrics.

In addition, with the Shape Security acquisition closed on January 24, our guidance is inclusive of Shape.

We continue to make strong progress transitioning our business to a software-driven model.

We remain confident in our position in the market and expect increasing demand for our multi-cloud application services will continue to drive revenue growth.

We also expect continued strong demand for our software solutions.

In fact, in Q2, we anticipate software growth will reaccelerate above Q1's 50% growth even before any contribution from Shape.

As we noted, when we announced the Shape acquisition, Shape has a subscription revenue software model with a significant deferred revenue balance.

Purchase accounting will impact Shape-related recognized revenue on a GAAP basis, principally over the next 4 quarters.

Therefore, for that period, we will provide non-GAAP revenue guidance which excludes the impact of the purchase accounting write-down.

We believe non-GAAP revenue will provide a better reflection of our ongoing business results.

We will report revenue on both a GAAP and a non-GAAP basis during this time frame.

With this in mind, we are targeting Q2 '20 non-GAAP revenue in the range of $580 million to $590 million.

In addition, we expect Services Q2 '20 annual revenue growth more in line with Q4 of '19.

We expect gross margins in the range of 85% to 85.5%.

We estimate operating expenses of $325 million to $337 million in Q2, reflecting the addition of Shape and the opportunity we have to invest and scale that business.

We anticipate our effective tax rate for Q2 will remain in the 21% to 22% range.

Our Q2 earnings target is $2.14 to $2.17 per share.

In the quarter, we expect share-based compensation expense of approximately $52 million to $53 million.

With that, I will turn the call back over to François.

François?

Thank you, Frank.

I am going to begin today with a spotlight on NGINX before highlighting some of the broader trends and customer wins in the quarter.

First, today, we announced an important milestone for the combined F5 and NGINX.

The availability of Controller 3.0.

Controller is our orchestration and analytics solution for NGINX.

It simplifies how enterprises manage, monitor and automate large-scale NGINX deployments.

Prior to the acquisition of NGINX, F5 was working on a cloud-native virtual ADC offering that featured an application-centric design.

We expected the solution, appropriately named cloud-native, would set a new benchmark for how modern developer teams could deliver new apps to market faster.

Immediately after the close of the NGINX acquisition in May 2019, we merged the F5 team working on our cloud-native project with the NGINX Controller development team.

Today, as we begin only our third quarter as a combined team, we are very excited to release the converged F5 NGINX solution, NGINX Controller 3.0.

This controller brings together the best of NGINX Controller 1.0 and 2.0 and adds the application-centric design and enterprise features pioneered by F5.

For context on why this new approach is so important, we first need to emphasize the fundamental shift in the way our customers manage and deliver applications.

Originally, there was a divide between the application teams that develop the code and the operations teams that release and manage the finished application.

DevOps evolved to bridge this divide and many organizations embraced DevOps practices to deploy applications faster.

As a result, organizations embraced software like NGINX Open Source and NGINX Plus to empower developers with control over their own infrastructure.

Although this improved developer productivity, it also created shadow IT.

Many of these developers worked outside of IT, outside of the compliance and enterprise security requirements designed to protect applications and data.

That is why we believe Controller 3.0 and its application-centric approach is highly differentiated.

The application-centric design introduces a new self-service portal, configuration API, application reporting and analytics and built-in security capabilities.

These combined app-centric capabilities empower developers from a centralized solution that maintains control and compliance for security and operations teams.

Controller 3.0 shifts the center of gravity from the instance of infrastructure supporting the app to the application itself.

With role-based access spanning OpDev, DevOps SecOps and NetOps, it enables deployment of a consistent set of multi-cloud application services across the application life cycle.

This enables different users to manage the tasks relevant to their role.

In summary, we expect the availability of Controller 3.0 will be an accelerator for our NGINX business for 3 reasons.

First, it expands the addressable market for NGINX to include adjacent app services in security and service mesh.

Second, it increases the average deal size by making large-scale NGINX deployments easier to orchestrate.

And third, it introduces new commercial capabilities that are attractive to NGINX's large open-source base.

Early feedback has been positive, with customers noting that Controller 3.0 expands the number of use cases and deployments of NGINX, particularly for Kubernetes, Ingress and API management.

In addition to delivering the Controller 3.0 release, NGINX had its strongest quarter yet in Q1, with the team hitting all of its significant integration and value creation milestones.

When we look at the future of F5, we are more confident now than ever before that NGINX will be a meaningful software growth driver.

We continue to see evidence that NGINX is expanding our overall footprint and allowing us to serve new applications.

This includes enabling application services consumption in native container environments.

As an example, during Q1, we secured an NGINX Plus and NGINX Controller win with a new customer, a large Australian mining company.

The customer was looking to modernize a legacy business process at its mine sites, where a single failure could result in up to $4 million in productivity losses.

By using NGINX for the API and Kubernetes in their applications, they now are able to collect and deliver over 30 different metrics.

As a result, they are better able to ensure the speedy and reliable delivery of raw materials to their destinations.

We are also seeing an uptick for NGINX inclusion in ELAs, both in concert with F5 solutions and on a stand-alone basis.

During Q1, we closed our first 100% NGINX ELA with a large streaming services provider.

NGINX Plus is enabling seamless capacity and service offering increases without disrupting critical revenue-producing applications.

The ELA construct was meaningful in this case because the customer is able to deploy additional NGINX Plus instances as subscribers increase.

In fact, when the actual number of subscribers surpassed forecasts out of the gate, the ELA provided the customer with the flexibility to immediately scale services with demand.

Beyond NGINX, we continue to gain traction in software across the other growth drivers we have consistently highlighted, including ELAs, service provider use cases, security use cases and deployments across multi-cloud environments.

I will highlight customer examples of each of these in Q1.

In fact, the first example highlights an ELA win with a large U.K.-based telecommunications provider, transitioning from hardware to software.

In this case, the customer's ADC infrastructure, based on F5 hardware, was nearing end of life.

The need to refresh provided the customer with the opportunity to rethink the design and build a flexible virtualized environment, aligned to its future business needs.

Despite a competitor touting analytics and commercial flexibility, F5 was able to demonstrate best-in-class software-based security and ADC capabilities.

In addition, our analytics and reporting outperformed the competition and reduced the customers' operational costs.

Looking at a security use case win in the quarter.

During Q1, we secured a combined systems and software win with a German health system company.

F5 is providing application security solutions, including advanced WAF, to secure a platform that allows doctors, hospitals and health insurance companies, consolidated access to patient records.

Of note, we were the only provider able to meet the customers' security requirements of delivering a highly secure and scalable infrastructure that met stringent government standards.

In an example of F5 solutions deployed in multi-cloud environments, we secured a win with one of the U.K.'s most trusted financial brands, a large U.K.-based mortgage provider.

As part of their digital transformation program, they chose to deploy BIG-IP Virtual Editions across 2 public clouds.

This provided the growth capability to support an ever-increasing number of online banking customers and enabled consistent application services and security across the cloud and data center.

Before we move to Q&A, let me say how very enthusiastic we are to begin our integration work with our colleagues from Shape Security.

To recap briefly, we believe the combination of F5 and Shape changes the game in application security.

Shape is a leader in anti-fraud and abuse protection, solving a mission-critical problem for large enterprises.

Together with F5's world-class portfolio of application services, Shape and F5 will deliver the most comprehensive application security portfolio available.

Beyond accelerating our growth momentum and more than doubling our addressable security market, Shape's machine learning and AI-powered capabilities also will scale and extend F5's broad portfolio of application services.

With Shape, we will expand our ability to optimize and protect customers' applications in an increasingly complex multi-cloud world.

With the Shape transaction closing last week, the teams already have begun the integration process led by members of our Chief Strategy Officer; Tom Fountain's team under our value creation program.

This is the same team that executed the very successful integration of NGINX, and we are confident they will do the same with Shape, leveraging lessons learned during the NGINX process.

We are very pleased that Derek Smith, Shape's CEO will continue to lead the team as part of F5.

In closing, digital transformation has changed the competitive stakes for nearly every business on the planet.

Beyond delivering a compelling, reliable user experience, customers need partners and solutions that allow them to do more and move faster.

At F5, we envision a future where all businesses can deploy new applications or make changes to existing applications in minutes, not days.

We are transforming F5 to make that vision a reality for our customers to enable, support and secure every application across any environment with a consistent set of enterprise-grade services.

My sincere thanks to the entire F5 team for driving another great quarter.

My thanks also to our partners, our customers and our shareholders for joining us on our journey.

I will remind you that our Analyst and Investor Day is scheduled for March 3 in New York.

We look forward to seeing many of you there.

With that, operator, we will now open the call to Q&A.

(Operator Instructions) Our first question comes from Tim Long with Barclays.

Two questions, if I could.

First, Frank, I think you talked about last time, the cloud-related businesses, which are still in early phase, were a meaningful portion of the total software revenues.

Could you just give us an update on how the cloud vertical did for you?

And did you see some sequential growth there?

And if not, were there ELA impacts or some other impacts?

And then secondly, the Services strength that it sounds like the year-over-year growth rate will tick back a little bit next quarter.

But could you just talk, looking out the next several quarters or year, should that line start to become under a little bit more pressure as the weight of the system revenue declines hits the longer-term model?

Tim, it's François.

I'll take the first question and then Frank will comment on the Services question.

On cloud revenues, Tim, we said last quarter that they represented a meaningful portion of our total software revenues.

And that portion is -- continues to grow because our cloud business is growing even faster than our overall software business.

And that's driven by a couple of things.

One is, we have made our software solutions much easier to deploy in cloud environments with integrations with essentially all the large public cloud providers.

We have added some automation and orchestration capability that enable our customers to include our solutions in automation environment and then in their CI/CD development pipelines, much easier than in the past.

And third, I think we're continuing to see just significant growth in the marketplaces of our -- of the large public cloud providers, where our solutions are also available for purchase on a utility basis.

So when you look at the consumption models that we've enabled, both the technology and the commercial models that we've enabled, they've significantly reduced or eliminated any friction associated with using F5 in public clouds.

Our ELA is a good example of that, where customers buy an agreement for 3 years and then they can deploy licenses in any environment, including in public clouds and port licenses from 1 public cloud to the other or 1 public cloud to back to on-prem.

So all of that leads to a growth in our cloud software revenue, which I think we said last quarter or in the last 6 months of 2019, when we had growth in our software business of 90% for Q3 and Q4, that our cloud business has grown even faster than that, and it continues to be on a very strong growth trend.

And Tim, in relation to the Services revenue, obviously, we were really pleased with having 8% year-over-year growth in Q1.

That was obviously above what we had guided to the last time we talked about the service revenue components, which was all the way back at AIM of 2018 when we talked about a mid- to low growth during the Horizon 1 time frame, so this is great performance to see.

What we're seeing actually is also an increase in the attach rates across all the cohorts of aged contracts.

And so it's not really, from our perspective, any decline in hardware that is impacting over a longer period of time the decrease in the Services revenue business.

What it actually is, is more of the mix of things that come through as subscription where that subscription looks more like a SaaS subscription.

And a lot of that revenue gets recognized -- almost all of that revenue gets recognized in the product side and not the Services side.

And so we continue to see strong growth in the Services revenue, probably even above where we thought when we thought about this in March of 2018.

But over a longer period of time, we do see those services revenues coming down in terms of growth rates, but that's really more of a mix issue than anything to do with a systems versus a software sale.

Your next question comes from James Fish with Piper Sandler.

If I can squeeze in 2 as well.

Enterprise still grew about 5% this quarter, yet the industry, not everyone is seeing that kind of strength.

I guess, can you guys just go into what's going on in enterprise specifically, that is showing that resiliency?

James, thanks for the question.

The -- generally, on the enterprise, we continue to see spending patterns that are -- we've got to call them relatively healthy.

In -- they're not as healthy as they were in 2018, but we haven't seen a change overall from the spending patterns that we saw in 2019.

So we seem to continue on that trend.

There are some changes or variations by geography.

And as you know, we've pointed several times that we were seeing softness in Europe and in the U.K. and DACH, in particular, and I think, we continue to see that today.

But overall, the spending patterns are healthy.

When you look, by the way, if your context is that of other perhaps providers in infrastructure of data centers, what we're seeing more and more, James, is the spending with us is tied to applications and the growth of applications not tied to data center infrastructure per se.

So perhaps, over time, you'll see more and more of that difference.

But the spending patterns, I relate to, is what we see with our customers' application projects.

Got it.

And just a follow-up on that.

I mean, it was a slight miss on what we were all expecting on products for the quarter.

Were there any pause in orders ahead of the combined NGINX Plus F5 Controller?

And why do you expect unattached software to accelerate next quarter?

James, that's 2 separate questions.

I will start with the first one on product revenue growth.

Product revenue growth was flat.

And indeed, it could have been a little better than that.

What we saw in Q1.

I think there were really a couple of factors in Q1.

One is, there was some lumpiness in some large deals that we expected.

In Q1, we also did a relatively important realignment of our North America sales organization in part to prepare to better focus on certain verticals and to also evolve the alignment of our teams given the evolution that's going on in our portfolio with the new SaaS solution, NGINX coming in, Shape coming in.

And I think that realignment caused a bit of a short-term pause on momentum, but it's also for the better, and we'll see the benefits of that for the rest of the year.

So I think those were 2 of the factors, specifically on product revenue growth.

Your second question about why we expect stronger revenue growth in Q2 for software specifically?

I think this issue of large deal lumpiness does apply also to large software deals, and we have a very robust pipeline of software deals going into Q2.

And so we're pretty confident that we'll see a very strong growth in Q2.

Your next question comes from Sami Badri with Crédit Suisse.

I wanted to touch up on the percentage of enterprise wins that are tied more to security use cases versus more of the legacy business, or I guess, you could say more ADC-like product sales.

So just trying to understand, has the importance of security for your customers shifted even further to the forefront of their decision making?

Or would you say it's very comparable to how it was over the last year or so?

I'm just trying to understand, has there been a big shift forward in terms of importance of security use cases?

Sami, even though we don't -- today, we don't break out our security revenues specifically, we continue to see strong growth in our security business.

And as I said before, we see more growth in our security business than the rest of the portfolio.

And so the answer to your question is, yes, we continue to see more and more of our deals driven by security use cases.

In a lot of cases, these deals also pull other application services that you would classify more as application delivery services.

But increasingly in a meaningful portion of our business, security is the use case that actually pulls the deal together.

The second factor that kind of accelerates that trend, if you will, is that, in a multi-cloud environment, we are seeing double the security attach rate to our solutions that we were seeing on-prem.

And so given that more and more of our business is becoming a multi-cloud in terms of the deployment, we are seeing an increase of our security business.

And that -- all of that, by the way, we expect to see that accelerate with Shape and the synergies that we expect to drive between the Shape portfolio and the F5 portfolio.

Got it.

And then I kind of just want to touch back on to the Services growth rate that you saw in the quarter.

Obviously, 8% is a positive surprise for most people looking at your model.

And you identified 3 factors for what's driving that.

One of them was new tools.

So given that this just played out in this quarter, should we expect similar high single-digit growth or even in the same ballpark of growth in services for the rest of the year as these 3 factors continue to drive the business forward to continue to drive more services renewals, or should we expect like a moderation on the growth rate?

Sami, I think we gave some fairly specific guidance for Q2, in particular, that probably gets you to a number that Tim was getting to, which is slightly down from where we printed Q1, but still very healthy in terms of a growth rate for Q2.

As we look out over the course of the year, that services growth rate may start to modulate down, particularly as we get more and more traction with some of the pure SaaS-type revenue models that we discussed.

But I think it's safe to say that the overall services growth rate is going to be higher than probably what we thought about at the end of our Horizon 1 guidance, when we talked about this in March of 2018.

Your next question comes from Samik Chatterjee with JPMorgan.

François, if I can just start off with a more longer-term question.

I mean, you've been making investments, both organic as well as inorganic, since you kind of took over and have been aligning the company to growth areas.

Now as you think about the transformation, can you kind of help us think about which innings you are in given that Frank's comment to prioritizing debt paydown seem to indicate you're kind of done with most of the heavy lifting in terms of the transformation that you envision?

Thank you, Samik.

Well, let me start with what's driving this transformation, Samik.

We have a belief.

So if you look at us versus other players in the industry, we have a very strategic position in that we are in line of the traffic between application and users for a very, very large number of applications.

And with the acquisition of NGINX, we extended our reach very significantly, and we're now part of the flow for several hundred million applications.

Our belief is simply driven by the fact that the number and complexity of applications in the future is going to increase and increase exponentially from where we are given everybody's digital transformations.

And as a result, we have an opportunity to extend that strategic position to more applications and also unify more applications, more application services for each of these applications.

And that's really what we have been doing with this transformation.

Our priority is to do it organically.

But when in the selective scenarios where we see an opportunity to accelerate that unification or within a window of time, we have decided to do that inorganically, and you've seen 2 instances of that.

Where we are in this transformation?

I would say we are in the early innings because we think we are actually in the very early innings of the digital transformation of our customers.

So I expect that the growth opportunity for F5 as we succeed in unifying these application services for these new multi-cloud environment is well ahead of us and is very significant.

Got it.

And if I can quickly follow up for Frank.

Frank, how should we think about the trajectory for OpEx beyond 2Q's level?

I think you said $325 million to $337 million.

So beyond that, how should we be thinking about the trajectory?

Yes, Samik.

So I will just go back to what I said, pre the Shape acquisition in terms of Q2 is always our seasonal low point in the OpEx cycle, and we tend to tick up in Q3 and Q4, in terms of operating margin expansion.

We still feel very comfortable with the guidance that we put out for the year of 30% to 32% for the year.

And so directionally, I think Q2 will be the low point, and then we'll move back up from there in Q3 and Q4.

Your next question comes from Paul Silverstein with Cowen.

Your next question comes from Rod Hall with Goldman Sachs.

I just wanted to ask a couple of things on the Shape acquisition.

I think you guys called out these non-GAAP adjustments to revenue.

And I wanted to just come back to those, I wasn't -- I'm not sure I fully understand that.

So maybe if you could go back into a little bit more detail on exactly what that is?

And then I wanted to also on Shape, just ask -- maybe you said this earlier, but what was the contribution?

Or what is the contribution of Shape to the guidance?

It seems like, I think you guys had said there was an ARR of $70 million, growing at 50%.

And kind of if I do some rough math on that, I get to $5 million as maybe revenue contribution maybe it's less than that, maybe more.

But I'm just trying to get some idea of what's in the guidance from Shape?

Sure, Rod.

So we're not specifically actually breaking out guidance for Shape.

The reason why we did that with NGINX is because NGINX actually closed after we had given guidance.

And so when we reported NGINX, we tried to be specific on what was the relationship of our recognized revenue versus what we had guided to and then the contribution from NGINX.

But with Shape, we've guided with it, and we're not breaking that out at this time.

In terms of what we said in -- what François talked about, when we actually announced the Shape acquisition, in the non-GAAP revenue, with a SaaS-based business model, and you see this quite frequently in software SaaS land, where companies acquire with a -- companies with a very large deferred revenue balance given the way revenue comes into those SaaS models, where there's a significant write-down in that revenue as part of purchase accounting.

And so to try to give the users of our financial statements a better sense for what the long-term growth rate is going to be as opposed to a muted revenue, we are going to be reporting both GAAP and non-GAAP revenue to give better comparability in years to come.

And Frank, just 1 other thing to clarify.

You guys said that Services would grow at about the same rate.

So I guess, like 6%, and that including Shape, looks to me like it drops out about $260 million of product revenue in the guided quarter.

I mean, that's -- is that a correct way to look at that?

That number isn't exactly the -- what is familiar to me.

But I think it's not so far off.

I think the rate that we had probably for Q4 last time was, I think, 6.5%, 6% to 6.5%.

Yes, it was 6.3%.

Yes.

So we -- so you're thinking almost exactly that growth rate?

Yes.

There is no Services revenue for Shape.

Your next question comes from Fahad Najam with Cowen.

I'm trying to also understand the software revenue trend.

So in terms of your software revenue, can you help us understand how much of it is recurring and how much is ELA?

We really haven't split that out in the past.

In terms of -- is it reasonable to assume that majority of software revenue is still coming from ELAs?

The -- no, it's not.

When we take a look -- I think we talked about a few quarters ago, the pure percentage of recurring revenue of our total revenue was 60% plus, and we continue to build, and that's exactly what we saw in Q1.

Okay.

And then if I may ask 1 more question on -- regarding the Shape Security.

If we assume that almost all of Shape Security is security revenue, would you be breaking out your security revenue as a stand-alone now that Shape is closed?

We don't anticipate doing that at this time, Fahad, but we're talking about several different KPI metrics for AIM in March and TBD on what we decide there.

Your next question comes from Amit Daryanani with Evercore.

This is [Lexi] on for Amit.

So I guess what we're wondering about is when we're looking at the 60% to 70% growth in software moving forward, how much of that is organic versus M&A driven.

And then on the organic side, what are the top 2 or 3 contributors to that growth?

Well, I -- let me start with -- as you know, we're not breaking out Shape and NGINX versus the F5 business prior to Shape and NGINX, but let me give you some indicators.

Last year, the F5 software grew about 60% year-on-year.

There was a very small contribution of NGINX in the second half of the year to that growth.

We guided after the NGINX acquisition to growth in software in our Horizon 1, which includes 2020, that was 35% to 40%.

As you can see, we are well above that.

We were at 60% for the full year last year, 90% in the second half, and we are at 50% this quarter.

So this just gives you a sense that the growth in, I'm going to call it F5 traditional software, prior to even NGINX and Shape, is very significant, and that's driven by a few things.

It's driven by the work that we've done on making our software easier to consume in private clouds and automated environments, it's driven by the work that we've done in subscribing our software in public clouds, and it's driven by the work we've done in enabling new consumption models, ELAs, subscription, utilities, et cetera, in all environments.

And that's what F5 has done, but it's also, as a primary driver, coming from our customers' desire to move from, sort of, hardware first posture to software first posture.

And we're seeing that change in our customers, both in enterprise and in the service provider world as service providers start more and more virtualizing their infrastructure.

So there are very strong demand drivers from our customers to move to a software consumption of F5.

When we look at 2020, we do expect strong contribution from NGINX and from Shape to achieve or exceed our 60% to 70% guidance.

And [Lexi], the only thing I'd add is that we did say during the prepared remarks that even without Shape, we did expect Q2 software growth to be above the 50% level that we experienced in Q1.

Your next question comes from Alex Henderson with Needham.

I was hoping we could talk a little bit about the NGINX acquisition relative to the selling process and the new products that you're introducing here.

So as I understand it, the value of NGINX is predominantly in selling to application coders and DevOps people that are generally focused on an application-specific project and have had little success selling the Controller because that's generally sold back to NetOps and IT administration.

Conversely, your historical footprint at F5 has predominantly been selling into the NetOps and IT stuff, but you didn't have really good access to the coding community DevOps community.

As you've introduced this 3.0 and are now bringing that back through the F5 distribution architecture, are you going to then integrate that into Beacon and then have the full value of the controls from the BIG-IP through the NGINX Controller to essentially manage the people who are in the NetOps -- I should mean, the DevOps/coder community.

Does that bring power back to the NetOps people in a way that they've been losing in the past?

Can you talk a little bit about that dynamic?

Yes.

Thank you, Alex.

The short answer to all this is, yes.

But let me give you a bit of context.

So if you look at where NGINX had gotten traction in terms of revenue is really offering their data plane above the open-source capabilities in the data plane, offering additional features in the data plane and as well as support.

And that's really how NGINX so far in the current model had monetized their technology.

The Controller adds whole new dimension to that, so the DevOps community.

Because, number one, it makes it a lot easier to deploy and manage large-scale implementations of NGINX data planes across a number of applications.

And so if you look at the folks who really, to date, have been able to use NGINX, it's folks who are very sophisticated DevOps people and have the skills and expertise to integrate these deployments and manage them on their own.

And so with the Controller, it offers essentially an easy button that allows a much larger group of people that perhaps don't have the same sophistication to now use NGINX technology and use that technology on a large scale.

So that's kind of the first driver.

The controller also integrates application-centric design, which really is targeted at more of the enterprise users, including what we call super NetOps users in large enterprises.

And so it does give an ability for the NetOps people to still have visibility of what was on in the infrastructure under their applications, and the DevOps people to have a self-service model to deploy their applications faster and make changes to their applications very quickly.

So we -- at the time of the acquisition, we said that F5 and NGINX together were going to bridge the divide between NetOps and DevOps and the Controller is really the manifestation of that strategy, and it's really the first offer in the market that truly bridges the divide and allow these 2 communities to work in concert, serving the needs for seed of DevOps and serving the needs for visibility and compliance from the NetOps people.

This Controller will indeed integrate in a technology called Beacon, which will give visibility and analytics across all F5 environment, NGINX, BIG-IP and other environments.

So that's the convergence.

We think this is a very important launch for our NGINX business, because in addition to the capabilities around DevOps and bridging the divide, it also does increase the deal size for NGINX products because it makes large-scale deployments easier and offer new and exciting capabilities for a number of open-source users that may want to move up a tier and use the control as a commercial technology.

Your next question comes from Simon Leopold with Raymond James.

This is Victor Chiu in for Simon Leopold.

Can you just give us an update on where the telcos stand regarding the shift to software implementations of ADC and the outlook there?

Simon, we are continuing to see an acceleration in telcos starting to move to virtualization.

We saw a couple of large deals, again, in that space this quarter with large service providers, and this is driven by essentially readiness for 5G and also the desire for service providers to be able to move faster when they need to make changes to their infrastructure, and overall, be able to reduce their cost.

What we're seeing somehow is service providers kind of keeping their more hardware-based infrastructure in place and starting kind of greenfield software implementations for virtualization.

Over the long time, I think these will converge.

But for now, those we see -- in the service providers that we work with, we see these as 2 separate environments for the time being.

Overall, the trend is accelerating.

Your final question comes from Jeff Kvaal with Instinet.

Your final question comes from Meta Marshall with Morgan Stanley.

A quick question on the AWS partnership, just any update there that you could give?

And then I assume because you revalidated the 32% to 33% operating margin target, but just on the mid- to high single-digit dilution target and kind of breakeven on 24 months for Shape security, have any of those expectations changed?

That's it.

Meta, I just want to be clear, when we talked about 30% to 32% operating margin.

Sorry, 30% to 32%.

Yes.

I just wanted to be sure that we're clear on the numbers, but, go ahead, François, if you want to talk about AWS.

Yes, Meta.

So we've made good progress on execution of our road map with AWS on the strategic collaboration agreement.

We have been prioritizing the sort of highest impact opportunities.

Both teams are now working very well in the field, we're seeing a number of new opportunities surface that we didn't have access to before.

And if you recall, in Q4, I said that that's what we expected in part because part of this agreement was that number of AWS solutions architects who face customers every day were going to be trained on F5 solutions, and we expected them to bring opportunities back to F5 that perhaps we would not have seen before, and that's exactly what we have started to see.

So it's early days in the partnership, and we said that I think it was -- we expected it to really give us some meaningful results in the second half of 2020.

But from what we're seeing so far, we're pretty bullish about what we can accomplish together with AWS.

Thank you for joining today's call.

This concludes the call.

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