In the opening of the F5 Inc. Second Quarter Fiscal 2025 Financial Results Conference Call, the operator introduces the call and explains its structure, including a listen-only mode and a Q&A session following the formal presentation. Suzanne DuLong, F5's Vice President of Investor Relations, welcomes participants and outlines the agenda: Francois Locoh-Donou, President and CEO, and Cooper Werner, Executive VP and CFO, will present prepared remarks, with other executives available for questions. The press release and related materials are available on F5's website, with an audio replay accessible until July 29, 2025. Contact information for follow-up inquiries and a disclaimer about forward-looking statements and the use of non-GAAP metrics are also provided.

In the paragraph, F5 discusses its strong Q2 performance, driven by innovation and its ability to address hybrid multi-cloud challenges. The company reported a 7% growth in total revenue, with systems revenue up 27% and product revenue growing by 12%, while software revenue remained flat. F5 achieved a non-GAAP EPS of $3.42, surpassing its guidance range. The success is attributed to data center modernization and AI preparation. Looking ahead, F5 anticipates Q3 revenue between $740 million and $760 million and has raised its FY '25 revenue growth guidance to 6.5%-7.5% based on first-half performance and current business conditions. Francois Locoh-Donou emphasizes F5's innovations in tackling customer challenges related to cost, complexity, and cyber risks.

In Q2, F5 launched the Application Delivery and Security Platform (ADSP) at their AppWorld event. This innovative platform uniquely combines high-performance load balancing and traffic management with advanced security features for apps and APIs across hybrid and multi-cloud environments. The ADSP offers consistent policies, full visibility, and AI-driven insights from a single, flexible platform, helping CISOs enhance compliance and protection while managing complex digital estates efficiently. It delivers comprehensive app and API security and deployment, unified management, deep analytics, programmable data planes, and automation. Recently, F5 announced enhancements to the ADSP's cybersecurity capabilities, improving vulnerability and threat management for modern applications.

At AppWorld, F5 unveiled several customer-centric innovations powered by their Advanced Distributed Services Platform (ADSP), focusing on two categories: AI for Application Delivery Controllers (ADC) and ADC for AI. In the AI for ADC category, they introduced three innovations. First, the iRule Code Generator, set to launch later this year, enhances F5's programmability by analyzing and optimizing iRules to improve performance and resource usage. Second, they expanded their AI assistant functionality across product families, with a significant percentage of F5 distributed cloud customers already benefiting from it. They introduced the AI assistant for NGINX One and announced a forthcoming AI assistant for BIG-IP. These innovations aim to enhance customer experiences and business growth by leveraging advanced AI technologies.

The paragraph discusses advancements in AI technologies offered by the company, focusing on improved observability and AI management tools. The new application study tool provides deep insights into app and API performance, enhancing operational efficiency and visibility. Additionally, the F5 AI gateway, now generally available, is designed to secure and manage enterprise AI by inspecting data interactions to prevent risks and ensure policy compliance. As organizations increasingly integrate generative AI, the demand for tools that provide governance and trust is growing. The company is actively innovating to meet these needs, anticipating a future where AI systems function as autonomous agents, transforming application development and infrastructure requirements.

The paragraph outlines F5's advancements in supporting AI evolution by expanding its platform with the Model Context Protocol (MCP), a standard for enabling memory and context sharing among AI agents and models. F5 integrates MCP support into BIG-IP, enhancing its capability to manage and secure AI workflows. In the shift towards context-aware AI systems, F5 is strengthening its infrastructure to support this transition. The company is succeeding in three AI use cases: securing data for AI model training and inference, managing access to AI models, and balancing loads across AI factories. Notably, F5 recently achieved significant AI wins, including a major service provider deal in the APAC region to enhance AI infrastructure governance and security.

The paragraph discusses how F5 is utilized to protect and optimize the ChatGPT interface, supporting multilingual customer support, ensuring compliance, and securing consumer voice interactions through BIG-IP's real-time AI capabilities. It highlights the security, scalability, and performance benefits of F5's solutions, including load balancing and traffic optimization, which support expanding AI workloads. Additionally, F5's differentiators are outlined: their comprehensive application and API security platform, a hybrid multi-cloud strategy that unifies app security across environments, and solutions that streamline operations with consistent policies and automation.

In Q2, F5 achieved significant customer wins in various regions by offering robust app and API security solutions. In LATAM, a major insurance company adopted F5's hybrid approach for scalable API security. In EMEA, a health insurer consolidated its security using F5's BIG-IP and cloud services. Additionally, a financial institution in EMEA employed F5's automation for network modernization and multi-cloud strategies. F5's differentiated hybrid multi-cloud approach also led to displacing a traditional ADC competitor in North America.

The paragraph highlights F5's achievements in Q2, focusing on their success in securing deals due to their advanced application delivery and DDoS capabilities, which allowed them to replace incumbent providers for several customers. It shows a significant role in the hybrid multi-cloud landscape and details strong Q2 financial results, with a 7% revenue growth to $731 million. The revenue comprised 54% global services and 46% product sales. Key metrics include a 3% increase in global services revenue, a 12% rise in product revenue driven by systems growth, flat software revenue, and a noticeable surge in systems revenue by 27% due to hardware refresh demand. Subscription-based software revenue saw a slight 2% decline, while perpetual license software grew by 9%.

The paragraph discusses F5's business performance and growth opportunities, highlighting the end-of-support dates for VIPRION and iSeries as drivers for customer reinvestment. It also emphasizes the demand for hybrid multi-cloud architectures, AI preparation, and innovation leading to competitive displacement and new customer acquisition, contributing to system strength. Recurring revenue made up 72% of Q2 revenue, with regional growth seen across The Americas (3%), EMEA (20%), and APAC (3%). Enterprise customers accounted for 69% of product bookings, government 20%, and service providers 11%. Financial metrics showed strong Q2 results, with GAAP and non-GAAP gross margins at 80.7% and 83.1% respectively, and improvements in operating margins and expenses.

In the quarter, the company reported a GAAP effective tax rate of 15% and a non-GAAP rate of 18.1%, with a one-time foreign operations benefit. GAAP net income was $146 million ($2.48 per share), while non-GAAP net income was $201 million ($3.42 per share), reflecting 18% year-over-year growth. The company generated $257 million in operational cash flow and $11 million in capital expenditures. Cash and investments were $1.27 billion, and deferred revenue rose 6% to $1.92 billion. The company repurchased $125 million in shares, leaving $1.2 billion for further buybacks. Current employment stands at 6,500. Regarding tariffs, the company faces minimal exposure due to USMCA compliance, with expected costs in the low single-digit millions offset by manufacturing efficiencies. The supply chain remains robust and is unlikely to affect lead times or product availability.

The company has provided its Q3 and full-year financial outlook, primarily using non-GAAP metrics. For Q3, they anticipate revenue between $740 million and $760 million, driven by strong demand for data center modernization and software subscriptions, with a non-GAAP gross margin of 83% to 83.5% and operating expenses between $366 million and $378 million. Q3 non-GAAP EPS is expected to range from $3.41 to $3.53 per share. Looking ahead to fiscal year 2025, the company has raised its revenue growth outlook to 6.5% to 7.5%, with double-digit growth expected in both systems and software revenue. The FY '25 non-GAAP gross margin is projected to be 83% to 84%, with an operating margin around 35%. They have adjusted their expected effective tax rate to 20% to 22% due to a one-time benefit and increased their EPS growth outlook to 8% to 10%. Additionally, they plan to use at least 50% of their annual free cash flow for share repurchases in FY '25.

In a conference call, Francois Locoh-Donou from F5 discusses the company's delivery of hybrid multi-cloud solutions aimed at reducing costs, complexity, and cyber risks in an AI-driven environment. They have introduced the F5 Application Delivery and Security Platform to provide consistent policies, visibility, and AI-driven insights from a single flexible platform, enhancing CISOs' ability to secure apps and APIs. F5 is expanding its role in the hybrid multi-cloud landscape, supporting intelligent computing infrastructure. Tim Long from Barclays asks about F5's software underperformance in Q2, its subscription pipeline, and macroeconomic risks, as well as the significance of hardware replacements in customer upgrades. Cooper Werner addresses these concerns.

The paragraph discusses the company's software and hardware business performance. For software, growth is weighted towards the second half of the year due to significant renewal opportunities anticipated in Q3 and Q4, which the company had predicted. Two-thirds of the software revenue is expected to come from renewals, with particularly strong visibility and insights into customer renewals and expansions. The company is optimistic about achieving a double-digit growth rate for the year. Regarding hardware, there was a 27% year-on-year increase in revenue this quarter, attributed largely to a strong refresh cycle, which is expected to continue until 2026. Many customers are updating outdated assets, and there is a significant portion of the installed base due for a refresh in the next two quarters. The hardware growth is driven by more than just refresh efforts.

The paragraph discusses three main tailwinds in the hardware business, driven by customer adoption of hybrid and multi-cloud architectures, which involve data center modernization, investment, and readiness for AI. Additionally, displacing competitors is contributing to growth, along with the increasing demand for AI-related use cases, including security. Furthermore, the overall business strength is attributed to the flexibility offered by F5 in deploying applications across various environments, whether on-premise, in public cloud, or through Software-as-a-Service, making F5 a preferred partner. Following this explanation, Ryan Koontz from Needham & Company asks about F5's opportunity in competitive displacement.

Francois Locoh-Donou discusses the company's strategy for expanding its market presence in application delivery and security (ADC) by displacing less-performing competitors. He identifies two main opportunities: entering new accounts or those where they are not the primary provider, and consolidating within existing accounts by replacing competitors' point products. The company is in early stages of the first opportunity, having secured hundreds of accounts but still seeing significant potential for growth. The second strategy involves using F5's new application delivery and security platform to enhance functionality and analytics, aiming to accelerate the replacement of competitors' products. Overall, the focus is on long-term growth through these strategies.

The paragraph discusses the integration of F5's product families, including BIG-IP, F5 distributed cloud, and NGINX, into a unified application delivery and security platform. It mentions the flexibility of their consumption models, which include hardware, perpetual licenses, subscriptions, and SaaS, to accommodate customer needs and consolidate functionality within large accounts. Despite strong hardware system growth in the first half of the year, F5 anticipates a deceleration to high single-digit growth in the second half. The company's total revenue guidance was slightly increased to a range of 6.5% to 7.5% for the full year.

The company has raised its revenue guidance conservatively due to potential macroeconomic volatility, despite not observing any changes in customer buying behavior or demand patterns. They've closely monitored factors like pipeline creation and deal closure times, seeing no recent changes. While projecting full-year guidance, they've opted for a cautious stance in case the macro environment worsens. In terms of AI use cases, the largest opportunity currently lies in data delivery for AI models, where their BIG-IP hardware facilitates secure and rapid data transfer between data stores and AI applications. The other use cases are anticipated to be more significant in the future.

In the paragraph, the discussion revolves around security and the deployment of AI-powered applications, including a new AI gateway solution that has recently been released and is gaining initial traction. Another early opportunity is AI factory load balancing, where BIG-IP plays a significant role. A question from Samik Chatterjee of JPMorgan Chase addresses concerns about hardware revenue potentially being boosted by preemptive purchases due to anticipated tariff increases and whether this trend is widespread across the hardware portfolio or due to product end-of-life situations. Furthermore, he inquires about a decline in software perpetual revenue and seeks insights into customer engagement trends. Francois Locoh-Donou responds by stating that no hardware pull-in was observed in Q2, and Cooper is expected to address the software-related inquiries.

In the second quarter, the company observed a stable demand pattern with no significant early ordering from customers trying to avoid anticipated price increases, unlike in the first quarter. This stability was seen across their hardware and software businesses. A potential concern for future demand lies with U.S. federal government customers due to budgetary disruptions, but this sector represents a small part of their business. For software, most customers favor a subscription model over perpetual licenses, aligning with typical Q2 trends. Overall, demand followed expectations without major fluctuations.

The paragraph discusses the transition of the iSeries and VIPRION systems within the company's installed base, noting that these two product families comprise over half of the installed base and have upcoming end-of-software-support dates in 2026 and 2027, respectively. This transition presents a significant opportunity over the coming years. The company has implemented a general price increase of 5% across its portfolio, with a larger hike for the rSeries due to its price-performance advantages. However, these changes have not yet significantly impacted financial results due to the recent implementation of the price increases.

The paragraph discusses the impact of subscription renewals on software growth. The speaker explains that their software business relies heavily on renewals, as they primarily operate through a flexible consumption program with 3-year contracts. This cycle results in a strong renewal base in the latter half of the current year, contributing to software growth. Looking ahead, there's an anticipated headwind in FY '26 due to a flattish performance in FY '23, but a tailwind is expected in FY '27. Despite the headwind, the company is experiencing increased expansion rates across its portfolio, maintaining confidence in ongoing growth.

The paragraph discusses the company's outlook on growth, emphasizing the potential for increased software adoption by customers beyond FY '25. During a Q&A session, Mike Richard inquires about the company's performance with federal (Fed) customers and expectations moving forward. Francois Locoh-Donou responds, stating that their Fed business performed well in Q2, with no significant disruptions. However, there is some concern about potential disruptions in Q3 and Q4 due to dynamic situations across different agencies. Despite this, the security projects they are involved in are prioritized by the agencies. Additionally, EMEA showed strong performance in the quarter, aligning with company expectations.

In the article paragraph, it is explained that the international business, particularly in EMEA and Asia, performed as expected, with North America also showing strong results. The notable growth in EMEA was due to a weak comparison from the previous year. Operator Meta Marshall from Morgan Stanley asked about fiscal Q3 expectations and potential changes in international customer behavior due to a weakened dollar. Cooper Werner responded, stating that early Q3 is showing strong results, aligning with expectations, and that the weakening dollar provides some pricing benefits internationally. However, there hasn’t been any significant pull-in or changes in customer behavior despite these currency fluctuations.

The paragraph addresses questions about software growth drivers, particularly the role of renewals and new products. Tal Liani from Bank of America questions why growth doesn't stem from new products or markets when renewal activity is low, suggesting growth mainly comes from renewals. Cooper Werner responds by highlighting that renewals are expected to drive growth over time due to the mature subscription model. As the renewal base expands annually, it becomes a significant revenue opportunity, especially with the potential to expand on this base. However, revenue may appear uneven in individual quarters due to the three-year cycle of upfront revenue recognition associated with renewals.

In the paragraph, Francois Locoh-Donou discusses the company's growth strategy, highlighting that while new projects offer opportunities to engage new customers, the primary revenue growth driver is renewing existing business. He mentions that the company is already generating revenue from AI and sees increasing momentum in this area. He notes that AI-related growth is partly driven by customers expanding data centers in anticipation of AI advancements. The company is also innovating in AI, having launched an AI Gateway to secure AI applications and a new platform that incorporates AI to enhance application delivery and security.

The paragraph highlights the growth opportunities for F5, particularly in the AI sector, as they focus on consolidating functionality and expanding within their customer base. It emphasizes the company's strength in securely and quickly moving data, critical in addressing AI challenges. François Locoh-Donou ranks the primary drivers of increased demand for systems, identifying tech refresh as the top driver, followed by data center modernization and multi-cloud architectures. These trends, which include aspects of AI readiness, contribute to the company's confidence in ongoing and new business growth.

The paragraph discusses the company's strategy and outlook for growth, primarily focusing on the software segment. It highlights that current growth is primarily driven by contract renewals rather than new sales. The company has strong visibility into how customers are using their software and engages early with customers to plan renewals. There was significant growth in the first quarter, especially in larger deals, and they have confidence in continued growth in the second half of the year. The company also notes potential opportunities for growth from new sales as an upside. The speaker then concludes the conference call, expressing anticipation for future discussions about the company's evolving role in the hybrid and multi-cloud space.

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