Francois Locoh-Donou
President, Chief Executive Officer and Director at F5
Thank you, Suzanne, and hello, everyone. Thank you for joining us today. Our team delivered second-quarter revenue at the midpoint of our guidance range and earnings per share above the high end of our range. These results come despite persistent macro uncertainty, which has led to broader and more severe customer budget scrutiny, impacting both our software and hardware demand. We have strong conviction that customers' constrained spending is a temporary headwind and that we are well-positioned as a trusted and innovative partner for customers as they look to secure, scale, modernize, and simplify their hybrid and multi-cloud application environments.
In my remarks today, I will speak to the quarter's results, the near-term spending dynamics we are seeing, and why we remain confident in our positioning and growth opportunities longer term. First, on our Q2 performance. We delivered 11% revenue growth in Q2 as a result of stronger-than-expected system shipments and strong maintenance renewals. Our systems revenue grew 43%. As positive as this is for the quarter, it is more a reflection of our team completing comprehensive board redesign efforts ahead of plan than it is a demand marker. You will recall that last year rather than just wait for supply chain to improve, we initiated multiple board redesigns with a goal of designing out the hardest-to-get components and opening up new supply. The successful completion of this work is making it possible for us to fulfill waiting customer orders sooner than we anticipated. And as expected, we have seen no order cancellations in the process.
Our global services revenue grew 8% driven by continued strong renewal rates, which improved across nearly all cohorts. Wrapping up our Q2 results, we also delivered opex within guidance and non-GAAP EPS of $2.53 per share, above the top end of our guided range. So, the quarter's results were strong, but they obscure underlying customer spending patterns. Since our December quarter, we have seen customers scrutinizing budgets and deferring spend for anything except the most urgent projects. These dynamics were even more pronounced in Q2 when we saw previously approved projects going through multiple additional levels of approvals. In some cases, approvals are reaching the C-suite of Board level only to be delayed or downsized. The impact of this extreme spending caution is most evident in our Q2 software revenue which declined 13% year-over-year. This was well below our expectations for the year and our long-term growth expectations. We believe there are several reasons why we are seeing this kind of impact in our software revenue. These include the relative size of the software projects we tend to be involved in and the percentage of our software revenue derived from term subscriptions.
First, the majority of our software growth to date has come from transformational type projects of size often six to seven-figure deals. We are seeing larger projects come under more scrutiny resulting in delays sometimes by multiple quarters or downsizing into smaller, more incremental additions. Second, the majority of our software revenue comes from term-based subscriptions, which have upfront revenue recognition. As a result, when we see a decline in new term-based subscriptions as we have in the last few quarters, it is immediately evident in our software revenue and much more so than it would be if our software was predominantly writable or fast-driven.
Now, there is some good news to point to in software. We have a base of software renewals which is growing. Our renewals consist primarily of second-term multi-year term subscriptions, and similar to Q1, in Q2, our software renewals performed largely as expected. In addition, our SaaS and managed services revenue is growing and we expect it will become a more significant and predictable contributor to our software revenue over time. The spending patterns I have described were not limited to our software demand. We also experienced softer systems demand in the quarter as customers push the capacity of their existing systems, sweat their assets, and work to deploy delivered systems into production. We expect these headwinds on both software and systems will persist at least through the end of this fiscal year. As a result, we now expect low- to mid-single-digit revenue growth for FY '23. This is down from the 9% to 11% growth we previously forecasted.
I will now speak to my third point: why we are confident that the current demand environment is temporary and why we are uniquely positioned to help customers simplify their hybrid multi-cloud challenges. We are confident that current demand levels are temporary for several reasons. First, because of the direct commentary we are getting from customers. Customers are telling us that the delays we are seeing are a matter of budgets and approvals, not competitive pressures or architectural shifts. During Q2, I met personally with roughly 100 customers and partners. It was clear from my discussions with customers that they expect F5 will be a key part of their future hybrid and multi-cloud architectures as the only company capable of securing and delivering applications and APIs in all environments. Partners too are leaning into the new F5 and our rapidly expanding set of distributed cloud services are accelerating that movement. Second, because of our win rates. While the direct customer commentary is reassuring, we also consistently analyze our win rates. When we look at the first half of FY '23 compared to the first half of FY '22, we see broadly steady win rates across our theaters and product lines confirming we continue to win our fair share of the deals we are involved in. Third, our factored pipeline which accounts for the probability of a deal closing is up from where it's been the last couple of quarters, suggesting customer activity is increasing and deals are reaching a higher level of maturity. This too is encouraging, but given what we have seen in the first half, we believe it is prudent to remain conservative on expected conversion of this factored pipeline.
Fourth, our strong maintenance renewals signal customers are delaying purchasing decisions by sweating assets. We see this in the substantial attach rate increase on all the deployments where you would expect the behavior of sweating assets would be most pronounced. We also are seeing a substantial increase in deferred maintenance revenue compared to prior-year trends. This behavior is consistent with what we have seen during past periods of macro uncertainty, with apps and APIs continuing to grow, however, customers can only postpone investments so long if they want those apps and APIs to remain performant and secure. In the meantime, we are focused on controlling the things we can control, including operating with discipline and ensuring we are prepared for when customer spending resumes. This includes reducing our cost base. We are reducing our global headcount by approximately 620 employees or approximately 9% of our total workforce. We expect these actions, combined with other cost reductions, including rationalizing our technology consumption, applying additional scrutiny to discretionary projects, and reducing our facilities footprint will drive ongoing operating leverage. In addition, we are substantially reducing the size of our corporate bonus pool in 2023 and further reducing travel. As a result, we expect to deliver FY '23 non-GAAP operating margins of approximately 30% and non-GAAP earnings growth of 7% to 11%. Further, the leverage from these cost reductions, combined with our anticipated gross margin improvement, positions us to deliver meaningful non-GAAP operating margin expansion and double-digit non-GAAP earnings growth in FY '24. While customers are spending only where critical near term, they continue to face significant challenges ahead, including creating engaging digital experiences, managing resource constraints, and addressing technical debt.
Their business velocity and long-term growth will rely on finding ways to connect and protect applications and APIs across distributed environments. With our unique ability to secure and deliver applications and APIs across all environments, we are differentiated in our ability to help customers with these challenges. We believe this position will drive sustainable long-term growth. As we have evaluated and adjusted our business, in addition to reducing cost, we have also intensified our investments in areas we believe will drive the highest mid- and long-term impact for our customers, including software and hybrid and multi-cloud.
Now, I will turn the call to Frank. Frank?
