F5, Inc. (NASDAQ:FFIV) Q4 2023 Earnings Call Transcript

F5, Inc. (NASDAQ:FFIV) Q4 2023 Earnings Call Transcript October 24, 2023

F5, Inc. beats earnings expectations. Reported EPS is $3.5, expectations were $3.22.

Operator: Good afternoon, and welcome to the F5, Inc. Fourth Quarter Fiscal 2023 Financial Results Conference Call. [Operator Instructions] Also, today’s conference is being recorded. If anyone has any objections, please disconnect at this time. I will now turn the call over to Ms. Suzanne DuLong. Ma’am, you may begin.

Suzanne DuLong: Hello, and welcome. I am Suzanne DuLong, F5’s, Vice President of Investor Relations. Francois Locoh-Donou, F5’s President and CEO; and Frank Pelzer, F5’s Executive Vice President and CFO, will be making prepared remarks on today’s call. Other members of the F5 executive team are also on hand to answer questions during the Q&A session. A copy of today’s press release is available on our website at f5.com, where an archived version of today’s audio will be available through January 28, 2024. The slide deck accompanying today’s discussion is viewable on the webcast and will be posted to our IR site at the conclusion of our call. To access the replay of today’s webcast by phone, dial 877-660-6853 or 201-612-7415 and use meeting ID 13741762.

The telephonic replay will be available through midnight Pacific Time, October 25, 2023. 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. We have summarized factors that may affect our results in the press release announcing our financial results and in detail in our SEC filings. In addition, we will reference non-GAAP metrics during today’s discussion. Please see our full GAAP to non-GAAP reconciliation in today’s press release and in the appendix of our earnings slide deck.

Please note that F5 has no duty to update any information presented in this call. With that, I will turn the call over to Francois.

Francois Locoh-Donou: Thank you, Suzanne, and hello, everyone. Thank you for joining us. In my remarks today, I will speak to our Q4 and FY ‘23 highlights, as well as our expectations for FY ‘24. Frank will then review the details of our Q4 and FY 23 results and provide some additional color about our outlook. We delivered a solid Q4, in an environment that showed some additional signs of stabilization. We saw strength from our enterprise vertical, including technology and financial services customers, offset by softness from service providers. The result was Q4 revenue near the high-end of our guidance range. Our continued operating discipline helped us deliver earnings per share, well above the high end of our range. Our global services team delivered robust 9% revenue growth, driven by strong maintenance renewals and reflecting the benefit of price increases announced last year.

In addition, software revenue grew 11%, aided by 27% growth in subscription software. Software revenue from renewals, which have performed well all year ticked up in Q4 over Q3. And while new subscriptions remain down year-over-year, we saw some improvement compared to the first half. Strength in global services and software offset a systems decline of 25%, which reflects a lower level of backlog related shipments than we had for the first three quarters of the year. Stepping back and looking at fiscal year 2023, we adjusted to the environmental challenges we faced, resolving supply chain pressures and largely returning to normalized delivery times. We took decisive actions to adjust our operating model to the realities of the demand environment, driving meaningful improvement to our operating margins and delivering 15% EPS growth.

We also returned 58% of our annual free-cash flow to shareholders by our share repurchases. Highlights from FY ‘23 include. First, subscription renewals performed largely to plan for the year. In today’s tough IT spend environment, this is a strong signal, that customers are getting the value and return they expect from our software solutions. Second, F5 Distributed Cloud Services SaaS offerings are gaining traction with both new and existing customers. In fact, 29% of Distributed Cloud SaaS customers are new to F5. In total, we now have more than 500 customers for our SaaS services on Distributed Cloud, an increase of more than 200% since Q4 of last year. Third, we are having very good success, displacing a traditional ADC competitor, in both software and hardware form factors.

And finally, we delivered meaningful operating improvements, driving our non-GAAP operating margin up 130 basis points from FY ‘22. As we look ahead, we enter FY ‘24 in an environment that seems to be stabilizing. In fact, from a demand perspective, we saw encouraging early signs with enterprise customers in Q4, but it is too soon to say if what we are seeing is a durable trend. As we contemplate our outlook for FY ‘24, we consider a number of factors. At the macro level, we expect continued application and API growth, fueled by automation efforts and new use cases, including Generative AI. We also expect customer spending caution persist into FY ‘24, but it’s stable. And finally, we believe the tension between application and API growth and customers’ ability to sweat assets will reach a tipping point, causing them to reinvest in their application infrastructure, likely beginning sometime in FY ‘24.

At the F5 level we also consider. First, we have an approximately $180 million revenue headwind from FY ‘23’s backlog fulfillment primarily in systems. Second, we expect flat to modest total software revenue growth in FY ‘24, as a result of a number of dynamics, including continued subscription renewal strength and steady Distributed Cloud SaaS revenue growth. These positive trends will be offset by a series of transitions we are executing in our SaaS and managed services offerings. And third, we expect our global services revenue will return to low-single-digit growth as we lap price increases. As a result of these factors, we expect our FY ‘24 revenue will be flat to down low-single-digits from FY ‘23, inclusive of the 6% headwind related to FY ‘23 backlog shipments.

We also expect to return to mid-single-digit revenue growth in FY ‘25. Whether we achieve the lower high end of our revenue range, we are committed to driving continued strong profitability and we will continue to manage our operating model with discipline. We expect to deliver FY ‘24 non-GAAP operating margin in a range of 33% to 34%. We are also targeting FY ‘24 non-GAAP EPS growth of 5% to 7%, reflecting growth of at least 10% on a tax neutral basis compared to FY ‘23. Our growth opportunity is fundamentally linked to the continued growth of applications and APIs and the need to secure, deliver and optimize those apps and APIs. F5 is the only Company that can deliver, secure and optimize any app and API anywhere. Our security and delivery solutions, offer a custom fit for each app and API.

Modern apps and APIs require different solutions than legacy apps. We have the right solutions for both. In addition, to delivering the right tools for the right app or API, our combination of deployable software and hardware and SaaS and managed service offerings, means we are the only vendor that can serve every app and API across all environments in a datacenter, public cloud and at the edge. We are the only Company who can do this today. And going-forward, further integration and convergence of our solutions will make it much easier for our customers to secure and deliver their apps, across all infrastructure environments. The power of our converged portfolio is resonating with customers who are able to deploy the solutions they need today, with the knowledge that F5 will be with them on every step of their multi cloud journey.

Before I pass the call to Frank, I will speak to some customer highlights from each of our product families. Our F5 BIG-IP family serves traditional applications, either on-premises, co-located or in cloud environments. BIG-IP’s data plane performance, automation capabilities and seamless integration into public cloud environments continues to differentiate the platform, and we continue to win against competitors. From a hardware perspective, the value proposition with our next generation platforms is resonating with customers with our rSeries and VELOS platforms, representing more than 80% of Q4 systems bookings. In one example of a BIG-IP wins from Q4, we displaced a competitor and a North American healthcare customer. The opportunity arose as a result of the incumbent provider’s inability to handle a mission critical upgrade to the customer’s physician portal.

The customer selected F5 BIG-IP based on its advanced application delivery capabilities, secure access management, our partnership with their healthcare records platform and confidence in our roadmap. In addition to providing the mission critical functionality that customer needed urgently, we replaced all of the competitor’s use cases with the customer, simplifying their application environment and future proofing their datacenters. F5 NGINX, delivered a very strong Q4. NGINX serves modern container native and micro-services based applications and APIs. We continue to see large enterprises adopt NGINX for their cloud and Kubernetes workloads and as those applications scale, we are seeing our NGINX opportunity scale as well. In addition, customers are also leveraging NGINX for app layer security for containers.

As an example, in Q4 when the e-commerce division of a global technology customer needed to comply with new data security standards, they selected NGINX App Protect to implement app layer security to the containers processing consumer’s credit card data. We have invested both organically and inorganically to build our F5 Distributed Cloud Services, a portfolio of SaaS and managed services. Apart from the offering transitions I mentioned, we are really excited about the future for Distributed Cloud. We are intercepting two exciting emerging growth categories, web app and API protection or WAAP and secure multi cloud networking or secure MCN, that will drive future growth for Distributed Cloud Services. In one WAAP win for the quarter, we are helping an EMEA-based banking customer evolve from its traditional WAAP security posture to a more comprehensive WAAP solution that encompasses web application firewall, as well as API protection, bot defense and Layer 7 DDoS Protection.

This customer approached us when they came under attack by a malicious foreign actor that their existing WAF could not handle. Against multiple competitors, we successfully demonstrated the superiority of our WAF offering, including our ability to protect major payment companies APIs. Early traction for our secure multi-cloud networking offerings includes a Q4 win with a large retailer In Latin America, that also offers a range of financial services to its customers. As part of its digital transformation efforts, the customer needed a solution to enable them to grow and manage their expanding body of cloud native applications. They also plan to migrate their large existing footprint of virtual machines and on-premises appliances to the cloud.

After a thorough proof-of-concept, the customer selected our secure multi cloud networking solution, because of our ability to use the customer edge to make the move 100% transparent, to both internal users and consumers. We are also seeing cross portfolio traction with customers who are operating in hybrid environments, choosing to deploy F5 across multiple form factors. In a win that highlights the synergies of our product families, during Q4 we secured a win with an APAC based financial services provider. The customer launched a multifaceted modernization project, designed to add and consolidate applications, and enable scalability to handle exponential traffic growth. They also needed help, stopping a barrage of constant automated attacks.

In a competitive bid, our combination of BIG-IP and F5 Distributed Cloud Bot Defense won out. The combination enables the customer to manage unpredictable traffic growth, customized services for each application and enhance their security posture, with our ML based AI engine. These real life use cases, offer a view to how we are enabling customers to secure, deliver, optimize and manage their applications and APIs and how we simplify the challenges of operating in a complex hybrid multi cloud world. Now, I will turn the call to Frank. Frank?

Frank Pelzer: Thank you, Francois And good afternoon everyone. I will review our Q4 and FY ‘23 results, before I elaborate on the outlook Francois shared. We delivered Q4 revenue of $707 million, reflecting 1% growth year-over-year, with a mix of 54% global services and 46% product revenue. Global services revenue of $382 million grew a strong 9% due to continued high maintenance renewals as well as the price increases, we introduced last year. Product revenue totaled $325 million, down 7% year-on-year. Systems revenue of $134 million declined 25% year-over-year, reflecting a lower level of backlog related shipments that we had in prior quarters and demand that showed some signs of stabilization, albeit at lower levels than we have seen historically.

In contrast, software revenue grew 11% over the year ago period, to a new high of $191 million. Subscription based revenue grew 27% year-over-year to $166 million, another record-high, representing 87% of Q4 total software revenue. Perpetuals and software license sales of $25 million represented 13% of Q4 software revenue. Revenue from recurring sources contributed 76% of Q4’s revenue another all-time high. Recurring revenue includes subscription based revenue as well as the maintenance portion of our services revenue. On a regional basis, revenue from Americas was down 6% year-over-year, representing 57% of total revenue. EMEA grew 16%, representing 26% of revenue, and APAC grew 4%, representing 17% of revenue. Looking at our major verticals, during Q4 enterprise customers represented 72% of product bookings.

Service providers represent 9% and government customers represented 19%, including 7% from U.S. Federal. Our Q4 operating results were strong, reflecting operating discipline and a full quarter benefit from the cost reductions announced in April. GAAP gross margin was 80.1%, non-GAAP gross margin was 82.7%, an improvement of 125 basis points from Q4 of FY ‘22. GAAP operating expenses were $394 million, non-GAAP operating expenses were $345 million. Q4 non-GAAP operating expenses as a percent of revenue was below 49%, resuming pre-2019 acquisition levels. Our GAAP operating margin was 24.3%, our non-GAAP operating margin was 33.9%, representing an improvement of more than 600 basis points from Q4 of FY ‘22. Our GAAP effective tax rate for the quarter was 13%, our non-GAAP effective tax rate was 14% below our initial expectations for the year, as a result of IRS guidance issued during the quarter, relating to foreign tax credits.

Our GAAP net income for the quarter was $152 million or $2.55 per share. Our non-GAAP net income was $209 million or $3.50 per share, well-above the top-end of our guidance range of $3.15 to $3.27 per share. This reflects the combined impact of our gross margin improvements and operating expense discipline, as well as the Q4 tax benefit. I will now turn to cash flow and the balance sheet, which also remain very strong. We generated $190 million in cash flow from operations in Q4 driven by our improved profitability. Capital expenditures for the quarter were $15 million. DSO for the quarter was 58 days. Cash and investments totaled approximately $808 million at quarter end. Deferred revenue increased 5% year-over-year to $1.78 billion. We repurchased $60 million worth of shares in Q4.

For the year, we used 58% of our approximately $600 million of free cash flow for share repurchases. I note that in each of the past three years, we have met or exceeded our share repurchase commitments. Finally, we ended the quarter with approximately 6,500 employees. I will now recap our FY ‘23 results. For the year, revenue grew 4% to $2.8 billion. Global services revenue grew 7% to $1.5 billion, representing 53% of total revenue for the year. Product revenue grew 1% to $1.3 billion, representing 47% of total revenue. For the second year in a row software represented roughly 50% of product revenue. Software revenue was flat compared to last year at $664 million. This was down from our initial expectation of 15% to 20% growth as a result of customers delaying large transformational projects.

As Francois noted, software renewals performed largely as planned. We delivered $671 million in systems revenue during the year, representing 3% growth. I would now like to provide some additional information regarding software revenue. We said we intended to provide additional software revenue details as the SaaS business scale. As we said last October, we had several SaaS and managed service transitions planned. We started these transitions in FY’ 23 and they will continue through FY ‘24 and FY ‘25, leading to some short-term revenue variability that is not necessarily indicative of potential future performance. We believe that providing visibility to our SaaS and managed service revenue, and to the transitions that are underway, provides greater clarity on both our FY ‘24 revenue expectations and our expectation of returning to mid-single-digit revenue growth in FY ‘25.

Today, I will speak the three components of our FY ‘23 software revenue. The first, term subscriptions, the second SaaS and managed services and the third perpetual licenses. We intend to continue report the SaaS and managed service portion of our revenue on an annual basis going forward. In FY ‘23, revenue from term based subscriptions comprised a BIG-IP and NGINX subscriptions, contributed $353 million to software revenue, up 9% year-over-year. Under ASC 606, sales of term-based subscriptions are recognized largely upfront as software revenue. The remainder is deferred and recognized as service revenue over the term of the subscription. The majority of our term-based subscriptions are contracted for three years. Term subscriptions included both new, renewal and true forward or expansion revenue, for both annual and multi-year subscriptions of deployable software.

New revenue includes new customers, as well as new use cases or offerings sold to existing customers. In FY ‘23 renewal and true forward or expansion revenue experienced healthy year-over-year growth, offsetting the weakness in new term subscription software projects. Renewals performing largely to plan in FY ‘23 is encouraging for several reasons. First, given the current levels of customer spending scrutiny, strong renewals are a signal that customers are getting the value they demand. Second, our renewals motion is still relatively new and it is great to see confirmation that it is working as intended. The second component of our software revenue, SaaS and managed services contributed $203 million in revenue in FY ‘23, up 2% year-over-year.

SaaS and managed service is comprised of our F5 Distributed Cloud SaaS offerings. Revenue from managed services including our legacy F5 Silverline offering in our anti bot and anti-fraud offerings as well as revenue from legacy SaaS offerings. SaaS and managed service sales are recognized ratably as product revenue over the term of the subscription. At the end of FY ‘23, our SaaS and managed services ARR was $198 million, down approximately 2% year-over-year. There were four primary contributors to this performance. First, we are seeing solid early momentum from our F5 Distributed Cloud Service SaaS offerings. Second in FY’ 23 our most advanced anti-bot and anti-fraud managed service solutions underperformed relative to our plan, as a result of customer spending caution and budget scrutiny.

Third in FY ‘23, we began migrating customers from our legacy Silverline managed service offerings, to our F5 Distributed Cloud SaaS offering. And fourth, we began executing the planned retirement of legacy SaaS offerings from companies we acquired. Both the Silverline customer migrations, and the retirement of legacy SaaS offerings resulted in planned revenue churn. The third component of our software revenue is perpetual licenses, which contributed $108 million in software revenue, down year-over-year after unusually strong FY ‘22. In FY ‘23 71% of our revenue was recurring, up from 69% in FY ‘22. Several years ago, we began breaking out our security related revenue annually. This year our total security revenue which includes standalone security, attach security and security related to maintenance revenue was approximately $1.1 billion or 40% of total revenue.

Our standalone security product revenue grew 5% to approximately $475 million. We are seeing good traction with the lower end anti bot offering delivered through Distributed Cloud services as well as from security on NGINX. Our FY ‘23 security revenue growth was affected by customer spending caution, including stalled transformational projects and the underperformance of advanced anti bot anti-fraud solution as I mentioned previously. During the year, we overcame supply chain challenges and successfully returned our lead times to normal levels. As a result, our FY ‘23 product backlog returned to pre-supply chain challenge levels and we closed the year with approximately $53 million in product backlog. I will now turn to our FY ‘23 operating performance.

GAAP gross margin in FY ‘23 was 78.9%. Non GAAP gross margin was 81.5%, down 110 basis points from FY ‘22, as a result of higher supply chain costs in FY ‘23. Our GAAP operating margin for FY ‘23 was 16.8% and our non-GAAP operating margin was 30.2%, up 130 basis points from FY ‘22, as a result of our previously announced cost reductions. Our GAAP effective tax rate for the year was 18.7%. Our non-GAAP effective tax rate for the year was 18.3%. Our FY ‘23 annual tax rate was lower-than expected, primarily due to IRS guidance issued during the fourth quarter related to foreign tax credits. GAAP net income for FY ‘23 was $395 million or $6.55 per share. Non-GAAP net income was $705 million or $11.70 per share, representing growth of 14.8% over FY ‘22.

Francois, outlined our annual and longer term outlook at the start of the call, I’ll recap that with some additional color. I will also provide our outlook for Q1. With the exception of revenue, my guidance comments reference non-GAAP metrics. In our FY ‘24 outlook, we’ve made the following assumptions. We expect customer spending caution will continue into FY ‘24, but we also expect customers will begin to reinvest at some point in the year. We expect our global services revenue will return to low-single-digit growth as we lap price increases. We have approximately $180 million revenue headwind in systems from FY ‘23’s backlog fulfillment. We expect to continue to take share in the traditional ADC space with BIG-IP in both hardware and software form factors.

Within our software revenue, we expect continued strength from our term subscription renewals and continued growth from our F5 Distributed Cloud SaaS offerings. As I’ve discussed previously, we will have some planned revenue churn as we work through the SaaS and managed service transitions I discussed. We expect these transitions will be largely complete in FY ‘25. In FY ‘23 and in ARR associated with the transitions is approximately $65 million, a little more than half of which is associated with offerings we intend to transition onto Distributed Cloud over the next two years. The net of these assumptions, combined with the current demand levels leads us to expect FY ‘24 revenue in the range of flat to down low-single-digits from FY ‘23.

Excluding the $180 million or 6% headwind from our FY ‘23 backlog reduction, our guidance range would reflect low to mid-single-digit revenue growth in FY ‘24. Whether we achieve the bottom or top end of this range, largely depends on when customers resume more normal levels of spending. We expect some continued quarter-to-quarter variability, as a result of upfront revenue recognition related to our term subscription offerings. Regardless of our revenue performance, we remain committed to driving strong profitability. From an operating perspective, we expect gross margin will improve in fiscal year ‘24 to the range of 82% to 83%, this is primarily the result of supply chain related cost pressures, working their way out of our model. We expect our continued operating expense discipline will result in FY ‘24 non-GAAP operating margin in the range of 33% to 34% for the year.

On a percent of revenue basis, this would put our operating expenses roughly in line with 2018 levels, at roughly 49% of revenue. We expect our FY ‘24 effective tax rate will be 21% to 23%. In FY ‘24 we expect to deliver 5% to 7% non-GAAP earnings growth, which translates to at least 10% year-over-year growth on a tax-neutral basis. Finally, we expect to use at least 50% of our annual free cash flow for share repurchases, consistent with the approach we have discussed previously. As of the end of FY ‘23, we had $922 million remaining on our previously announced authorized share repurchase program. We also want to take the opportunity to speak to our expectations beyond FY ‘24, as we believe it will help signal how we intend to run the business longer term.

As Francois noted we expect mid-single-digit revenue growth in FY ‘25. We expect to drive additional gross margin improvements, and to deliver gross margins between 83% and 84%. We expect to grow our operating expenses slower than revenue, resulting in an operating margin of at least 35%. We will continue to prioritize profitability, adjusting our operating model if needed to enable us to deliver at least 10% compounded annual non-GAAP EPS growth. Finally, we intend to continue to use at least 50% of our annual free cash flow towards share repurchases. I’ll conclude with our expectations for Q1 of FY ‘24. We expect Q1 revenue in the range of $675 million to $695 million. We expect gross margins in the range of 82% to 83%. We estimate Q1 operating expenses of $332 million to $344 million.

We are targeting Q1 non-GAAP EPS in the range of $2.97 to $3.09 per share. We expect Q1 share-based compensation expense of approximately $58 million to $60 million. I will now turn the call back over to Francois. Francois?

Francois Locoh-Donou: Thank you, Frank. Before we open the call to questions, I want to address our view on F5’s AI opportunity. At the highest level, we believe customer’s use of AI will accelerate the growth of applications and APIs and the corresponding need to deploy, manage and secure them, which is what we do best. We also believe AI inference, the process of using a train model to make predictions on never seen before data will become increasingly distributed. Organizations will need to support it anywhere from datacenters to manufacturing floors to public clouds. We believe every application and API will soon require inference just as they require security and traffic management. With our rich history of delivering innovative ML based security solutions, including bot defense, protection against denial of service attacks and anti-fraud and our role in the flow of application traffic, we are uniquely positioned to secure AI workloads, wherever they reside and to empower our customers to run AI wherever they need it.

In conclusion, we are leveraging our incumbency and our position in the flow of 40% of the world Internet traffic, to deliver hybrid, multi-cloud solutions that dramatically simplify application and API deployment, security and management for our customers. We are also significantly reducing our customer’s total cost of ownership. We are uniting and automating all of our customer’s apps and APIs across their datacenters, cloud and edge environment. We are encouraged both by the early signs of stability we saw in the second half of ‘23, and with the residence our converging portfolio is having with customers. We have an install base of 20,000 customers, all of whom have an acute and significant multi-cloud challenge. Other than F5, there is no one company that can address this challenge.

With F5 Distributed Cloud services, we have created a platform to drive SaaS growth in the future. In closing, I’ll reiterate the three pillars of our long-term operating model, which will enable us to drive double-digit earnings on a compound annual growth rate. Number one, delivering sustained mid-single-digit revenue growth, supported by our differentiated positioning in attractive end markets, along with our durable high margin global services business. Number two, driving non-GAAP operating margin expansion, which we will achieve through gross margin improvement and operating discipline. And number three, returning cash to shareholders, via share repurchases, using at least 50% of our annual free-cash-flow. Operator, please open the call to questions.

Operator: Thank you. Ladies and gentlemen, at this time we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Amit Daryanani with Evercore. Please proceed with your question.

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Q&A Session

Amit Daryanani: Yep. Good afternoon. Thanks for taking my question. You know, I guess, Francois maybe to start with, you talked about software growth being flat to have been up modestly, but that included some of the headwinds around the business transition is taking place on the managed services side. I didn’t appreciate this, but is the headwind from this transition $65 million or is it half that number? And maybe just flush out how much that is and what are the transitions that you’re doing?

Francois Locoh-Donou: Hi, Amit. So in, in total, so we talked about it roughly $200 million in SaaS and managed services. In that $200 million there is about $65 million of revenue stream, that essentially are going to go away. Now, but that’s more than half of that is revenue streams coming from a legacy managed services platform Silverline, that we are retiring. But we intend to migrate the customers over to Distributed Cloud. So we would expect you know a portion, if not a significant portion of that, you know of that revenue stream to go on to Distributed Cloud over time. The other a little less than half of that $65 million are offerings that we are retiring completely that, you know, when we looked at our portfolio and looked at the offerings we wanted to rationalize, that we felt were underperforming.

We decided to retire these offerings completely to, you know, focus on the products that are going forward and successful rationalize our cost and improve our efficiency.

Amit Daryanani: Got it, that is really helpful to get — understanding the split on the $65 million. And then you know, I think, Francois you in your comments you sort of talked about, you’re seeing encouraging signs from enterprise customers in September quarter. Can you just perhaps talk about what are these signs, is it just the assets are running at high utilization, you can’t sweat them anymore. And is there any sort geo vertical, we’re just trying see these initial positive signs that you may have from customer demand.

Francois Locoh-Donou: Amit there, I wouldn’t say there is a particular geography where we are — where, that’s really different than others. I would say, North America has been probably more solid and stable than our Asia and European markets. If we look at verticals in terms of where we’re seeing stabilization, I think the enterprise market, we’re seeing more stabilization. The service provider market has been soft. That’s for a number of factors service providers continue to sweat assets, and, and be really ruthless in their prioritization, the 4G to 5G transition is a little slower than anticipated. So service providers in general have been soft than we’re kind of expecting that to continue. What we were encouraged by, especially, in the second-half of the year, but specifically in Q4 is in the enterprise space specifically, we saw some customers that had been sweating their assets, and got to kind of at the end of that cycle and started demanding hardware again or ordering hardware again.

So we did see a rebound in hardware orders in the fourth fiscal quarter. Coming from A, we think some customers having sweated their assets, but also, you know, it took a long time for us to ship equipment to a number of our customers in 2023. And in Q4 we saw some of these customers that finally had received their hardware and had been able to deploy that to start ordering again. So we were encouraged by those trends.

Amit Daryanani: Got it. Thank you very much.

Operator: Our next question comes from the line of Alex Henderson with Needham. Please proceed with your question.

Alex Henderson: Great, thanks so much. Looking back at your prior longer term expectations, I think you had talked about growth rate in software in excess of 20%, and high to mid-single declines in systems. Can you give us an update on what do you think those percentages might look like in longer term once you get through the wobble in FY ‘24?

Francois Locoh-Donou: Yes. So, Alex, we’re — so today we’re talking — so I don’t want to talk about what’s beyond FY ‘25, I’m going to talk about FY ‘24 and ‘25. Beyond FY ‘25, I think our view of our end markets haven’t really changed. And so you know in the future that opportunity to return to 20%-plus growth in software, is there based on the end markets that we are targeting. But let’s talk about FY ‘24 and FY ‘25. So FY ‘24 we’ve talked about growth in software being you know flat to modest. And that, if you take the three components of software that we’ve, we just talked about, we expect, you know, frankly, the perpetual base of the business to be roughly flattish. We have a similar view on the SaaS and managed services part of the business based on the transitions we’re going through.

And potentially, you know in the term subscription part of the business is where potentially we would see some modest growth. Going into 2025 from a revenue perspective, we don’t necessarily expect growth from perpetual or the SaaS and managed services business because of the transitions that we’re going through. But we have strong visibility into our — the renewals and expansion in our term subscription business. The expansions which are very strong from what we’re seeing and we expect that to continue and be amplified in 2025. So in 2025, we would expect you know software growth to return to double-digit, really powered by our term subscription business.

Alex Henderson: I see. Just if I can follow-up on, you talked about your backlog having been normalized, but you’ve also had orders out for components that were driven off of the tight supply environment. When do you expect the full normalization of the component costs, you know, in your cost of goods sold, is that already achieved or is that going to be something that’s going to feather in over the next year maybe, year and a half?

Frank Pelzer: Alex, it’s Frank. So largely most of that has been achieved but there is still some of the purchase price variances that are coming through in FY ‘24. By FY ‘25 we expect that to be fully out in a normalized level.

Alex Henderson: Could you give some sense of what the ‘24 variance would be?

Frank Pelzer: Alex, I think it’s probably in the range of 25 to 50 basis points of where we’ll see improvement just based off of that, in comparison to expectations for gross margins in FY ‘25.

Alex Henderson: Great. Thank you so much.

Operator: Our next question comes from the line of Samik Chatterjee with JPMorgan. Please proceed with your question.

Samik Chatterjee: Hey, thanks for taking my question. I guess Francois just relative to your fiscal ‘25 outlook for mid-single-digit, I’m just curious if you’ve changed your view about what the long-term trajectory in systems demand looks like, particularly as you mentioned, you’ve seen orders pick up a bit. And maybe you can also talk about, when you talked about AI demand, do you expect — how do you expect it to play out between systems, related to sort of software within your portfolio? And I have a quick follow-up. Thank you.

Francois Locoh-Donou: Samik. Thank you. These — so over a long period of time I think we, you know, we think that the hardware business would be more of a you know low-single, low-single-digit decline or overtime. However, that is a statement you know that is based on a normal, first a normalization of the hardware business, and we’re not there today. And that’s been as you know, the demand was much softer in 2023. And so we actually expect our hardware business to rebound in 2024, and we saw some signs of that already in this fourth quarter. And you know the — I’m giving you more of a long-term trend kind of beyond 2025. But you know I think at least for 2024, we expect to rebound in the hardware business. In terms of where AI will play in our business, so the way to think about it Samik is, we — the portfolio that we’re putting together, which is hardware, software and SaaS, we expect, you know, that will enable our customers to secure and deliver their API and their applications in any environment.