Good afternoon, and welcome to the F5 Networks Third Quarter Fiscal 2021 Financial Results Conference Call. Also, today's conference is being recorded. [Operator Instructions]

I will now turn the call over to Ms. Suzanne DuLong. Ma'am, you may begin.

Suzanne DuLong - Vice President of Investor Relations

Hello and welcome. I'm 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A copy of today's press release is available on our website at f5.com where an archived version of today's call will be available through October 25, 2021. Today's live discussion is supported by slides which are viewable on the webcast and will be posted to our IR site at the conclusion of today's discussion. To access the replay of today's call by phone, dial (800) 585-8367 or (416) 621-4642, use meeting ID 5294198. The telephonic replay will be available through midnight Pacific Time, July 27th. 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 Francois.

Francois Locoh-Donou - President, Chief Executive Officer and Director

Thank you, Suzanne, and hello everyone. Thank you for joining us today. I am pleased to share with you our very strong Q3 results. Broad-based strength across the business drove 11% revenue growth in the quarter, marking our third sequential quarter of double-digit revenue growth. We delivered 34% software growth, 13% systems growth, and 4% global services growth in Q3.

F5s business is benefiting from digital acceleration and application growth as well as heightened demand for application security. Customers traditional apps are generating more revenue and more engagement than ever before. At the same time, customers also are accelerating adoption of modern application architectures like Kubernetes for new applications. With our expanded application security and delivery portfolio, we are uniquely positioned to solve our customers most significant modern and traditional application challenges on-prem, in the cloud and across multiple clouds. I will speak more about our business drivers and customer highlights from the quarter after Frank reviews our Q3 results and Q4 outlook. Frank?

Frank Pelzer - Executive Vice President and Chief Financial Officer

Thank you, Francois, and good afternoon, everyone. As Francois just outlined, our team delivered another very strong quarter. Third quarter revenue of $652 million was up 11% year-over-year and above the top end of our guidance range. Please note as I review our revenue mix, I will be referring to non-GAAP revenue measures for the year ago period. Q3 product revenue of $310 million is up 21% year-over-year, representing a significant acceleration from 3% in the same period last year. Product revenue accounted for approximately 48% of total revenue, up from 40% in the year ago period. We continue to advance our transition to a more software-driven model. Q3 software revenue grew 34% to $129, million representing 42% of product revenue, up from 38% in the year ago period.

Today, we offer customers annual and multi-year subscriptions as well as a growing base of SaaS consumption models. Customers' preference for these flexible models is driving growth in the subscription-based portion of our revenue. In fact, since Q3 of 2018, we've driven subscription software revenue growth at a three-year compounded annual growth rate of 118%. in Q3, '21, subscription-based revenue represented 78% of total software revenue, up from 73% in the year ago period. Customer adoption of our multi-year subscriptions continues to grow, providing much needed flexibility for our customers and future revenue visibility for us. These multi-year subscriptions are generally three-year term subscriptions and can be for BIG-IP or NGINX or combination of both. With customers increasingly looking to F5 to support both traditional and modern applications, our multi-year subscriptions are more frequently, including both BIG-IP and NGINX. In fact, in Q3, NGINX was part of over half of our multi-year subscription deals.

We see continued strong system demand based on broad-based increases in application usage, continued growth of system-based security use cases, and 5G service provider usage. In Q3, systems revenue of $180 million is up 13% compared to last year when systems were down 12% Rounding out our revenue picture, we see continued strength from our global services with revenue of $342 million in Q3, up 4% compared to last year and representing 52% of total revenue. Revenue from recurring sources, which includes term subscriptions as a service and utility-based revenue as well as the maintenance portion of our services revenue totaled 66% of revenue in the quarter. On a regional basis, in Q3, Americas delivered 10% revenue growth year-over-year, representing 57% of total revenue. EMEA delivered 19% growth, representing 26% of revenue and APAC delivered 3% growth, accounting for 18% of revenue. The strength in Q3 spanned customer verticals as well. Enterprise customers represented 69% of product bookings in the quarter. Service providers represented 15% and government customers represented 17%, including 4% from U.S. Federal within the government vertical.

I will now share our Q3 operating results. GAAP gross margin in Q3 was 81.4%. Non-GAAP gross margin was 84.1%. GAAP operating expenses were $434 million. Non-GAAP operating expenses were $349 million. Our GAAP operating margin in Q3 was 14.8% and our non-GAAP operating margin was 30.5%. Our GAAP effective tax rate for the quarter was 4.9%. Our non-GAAP effective tax rate was 14%. Our non-GAAP tax rate is lower than anticipated as a result of an election we made with our FY '20 U.S. income tax returns filed in Q3. The election related to certain research and experimentation costs for tax purposes only and had the effect of reducing our non-GAAP effective tax rate in Q3. GAAP net income for the quarter was $90 million or $1.46 per share. Non-GAAP net income was $169 million or $2.76 per share.

I will now turn to the balance sheet. We generated $182 million in cash flow from operations in Q3. Cash and investments totaled approximately $863 million at quarter end. You will recall, in Q2, we initiated a $500 million accelerated share repurchase program. During Q2, we retired approximately $400 million worth of shares. In Q3, we retired the remaining approximately $100 million worth of shares, reflecting roughly 449,000 shares purchased during the quarter. The average price paid per share for the full $500 million program was $199.90. DSO was 53 days and capital expenditures for the quarter were $9 million. Deferred revenue increased 13% year-over-year to $1.44 billion from $1.28 billion. Finally, we ended the quarter with approximately 6,380 employees, up approximately 20 from Q2.

Now, let me share our guidance for the fiscal fourth quarter. Unless otherwise stated, please note that my guidance comments reference non-GAAP metrics. Near-term, we expect customers will continue to invest to support both traditional and modern application growth and the modernization of their application infrastructures. We also anticipate continued focus on investment in application security. Thus far, our supply chain team has navigated industry-wide supply chain challenges well, with all signs pointing to continued challenges for at least several quarters to come, we will continue to closely monitor the situation. With that as a context, we are targeting Q4 fiscal 2021 revenue in the range of $660 to $680 million, implying roughly 9% growth at the midpoint.

We continue to expect FY '21 software revenue growth at or around 35% and feel very good about our software momentum as we closed FY '21 and head into the back half of our Horizon 2 timeframe. We expect Q4 '21 gross margins of 84% to 84.5% and we estimate operating expenses of $346 million to $358 million. We also expect to achieve our fiscal year 2021 non-GAAP operating margin target of 31% to 32%. We anticipate our effective tax rate for the year to be approximately 19%. Our Q4 earnings target is $2.68 to $2.80 per share. We expect to Q4 share-based compensation expense of approximately $62 million to $64 million.

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

Francois Locoh-Donou - President, Chief Executive Officer and Director

Thank you, Frank. Our very strong third quarter results demonstrate the powerful alignment of our expanded solution portfolio and our customers' most important application needs. Across the board, our customers are massively accelerating digital transformation to keep up with current demand and forecasted growth and to meet consumers' expectations for application performance and availability. But it is not just keeping up with application growth that is a challenge. Customers are caught managing this robust growth across multiple infrastructures with applications in both traditional monolithic 3Q architectures and in modern cloud native and container-based architectures.

F5 is uniquely suited to solve customers' traditional and modern application challenges. Our flexible programmable BIG-IP portfolio secures and delivers traditional applications, whether in the systems or software-based form factor, on-premises and in the cloud. Meanwhile, our NGINX portfolio provides high performance application security and delivery for microservices in Kubernetes and container-based environments. And with our Shape Security portfolio, we also bring industry-leading fraud and bot protection against automated attacks. So let's talk about five sustainable customer trends resulting from accelerating digital transformation and driving robust demand across our portfolio.

Number one. Enterprise customer developers and DevOps teams are using NGINX to insert security earlier in the application lifecycle. NGINX with App Protect delivers robust application security for microservices with the flexibility and agility developers' demand. And just one example, during Q3, we secured an NGINX win with an information services company that services high security customers in financial, FinTech, medical insurance, and the U.S. federal government. The customer selected NGINX Plus with App Protect for its ability to deliver layer 7 WAF, reverse proxy and load balancing in a single unified solution.

Trend number two. Heightened security concerns and high profile ransomware attacks are escalating demand for top notch application security and fraud and abuse mitigation. With pronounced application growth and an ever expanding threat landscape, including high profile ransomware and credential stuffing attacks, we see growing demand for application security in cloud environments and rising demand for fraud and bot defense. And an example of the strong customer interest in our Shape solution, during the quarter, a big brand athletic shoe manufacturer selected Shape to take on a sneaker bot that was relentlessly attacking its retail site, attempting to siphon off shoes for resale. Through an exhaustive proof of concept, Shape proved far more effective than a competitor at identifying and stopping the bot attacks.

Trend number three. Customers are leveraging F5 for Kubernetes, containers and cloud native architectures. Our growth in modern applications continues to accelerate, driven by NGINX, Kubernetes and cloud native deployments. We are seeing several top use cases emerge for NGINX including API Gateway, Kubernetes ingress controller, NGINX App Protect, and software-based load balancing. Customers' modernization efforts and the availability of NGINX Controller and enterprise level app security with NGINX App Protect continue to drive larger engine deal sizes. During Q3, a large health insurance provider in the United States selected NGINX to help their teams manage their modern apps. They deployed recently introduced NGINX instance manager to track, configure and manage their businesses, NGINX open source and NGINX Plus instances. They also deployed NGINX as an ingress controller to manage secure communications between services that are both external and internal to the Kubernetes cluster. In addition, they are using NGINX to monitor pods running in a public cloud providers manage Kubernetes Service and adjust the load balancing rules based on pod availability.

Trend number four. Customers are scaling their existing hardware-based infrastructure to handle accelerating application growth, driving continued strength for BIG-IP systems. Last quarter, I spoke about the fact that some of our BIG-IP systems demand was being driven by cloud-based and SaaS providers. This global leaders are turning to F5 to help them scale their existing application infrastructures in support of continued rapid adoption and growth of their digital products and services. In Q3, this trend continued with a global SaaS-based cloud service provider, refreshing and extending their existing their BIG-IP infrastructure to efficiently and securely scale with rising demand.

And finally, tend number five. Customers are leveraging BIG-IP for transformation, including cloud migration and automation initiatives. The demand we are seeing for BIG-IP systems and software is about more than just capacity additions. Customers also are choosing BIG-IP to drive transformation. When customers move traditional applications to a cloud, they are lifting and shifting with F5, choosing not to incur the time, cost and risk of refactoring their applications. And just one example in Q3. In APAC, we won a deal with a large credit issuer with a two year plan to exit their own data centers and migrate all non-mission-critical applications to the cloud. They chose a combination of BIG-IP and NGINX software with a multi-year subscription consumption model to ensure flexibility throughout the process. In another example of F5s role in app modernization, an American multinational computer technology company is embarking on a large-scale project to build their own private cloud, including repatriating cloud workloads to save costs and drive efficiency. They selected BIG-IP hardware and software as well as NGINX to execute the project.

While several of the trends I have just described also apply to our service provider customers, service providers also face unique challenges as a result of 4G to 5 G migration and growing 5G traffic demand. We see Gi LAN use cases gaining momentum globally as 5G devices are enabled. We are seeing 4G to 5 G momentum growing for F5 in two ways. First, for capacity augmentation supporting 5G rollouts. Second, with virtual network function and cloud native network function based architectures gaining traction to replace legacy infrastructures. In one notable service provider win from Q3, one of the largest mobile providers in India turned to F5 to scale its 4G network in preparation for its 5G deployment.

Before I wrap up our prepared remarks, I will comment briefly on our Volterra acquisition. The trends we are seeing across the business also bode well for the opportunity we see ahead with our Volterra platform. We continue to make good progress with our integration efforts and expect to have more to share about initial use cases and launch timing in the fall. As I mentioned last quarter, we initiated a pilot program concentrating on specific use cases and focused on bringing F5 security to the edge. Our goal is to leverage Volterra's organic momentum and early customer interest. Among service providers, the excitement and early interest related to Volterra continues to open doors not previously open to F5. The combination of application growth, our expanded solutions platform and our vision for the future of adaptive apps is resonating with customers and is well aligned with industry trends. We expect demand for application security will continue to grow as application demand grows and customer scale and modernize their applications. We believe that we are exceptionally well placed with the right perspective and toolset to solve our customers most pressing application security challenges. Our opportunity in application security is even more exciting with the ongoing integration of F5 and Volterra, which will bring enterprise grade F5 application security to the edge in an easily deployable SaaS model.

I will wrap up today's prepared remarks by thanking the entire F5 team as well as our customers and partners. With that operator, we will now open the call to Q&A.

Question & Answers

Operator

Thank you. [Operator Instructions] Your first question comes from the line of Tim Long from Barclays. Your line is now open.

Tim Long - Barclays - Analyst

Two questions if I could guys. First, curious if you could just update us on kind of how the cloud vertical is going for you guys, particularly on the software side, but also curious if you continue to see some good hardware traction there as well? And then second, just wanted to follow-up on the subscription software business. Can you talk a little bit about kind of what you're seeing with true ups and consumption? Do you continue to see accelerated usage for the offerings? And if so, what does that mean economically and what does that mean as you look into newer contracts where you might be seeing higher consumption levels than you would have anticipated previously? Thank you.

Francois Locoh-Donou - President, Chief Executive Officer and Director

Hi, Tim Thanks for the questions. I will take the first part and then Frank will take the second part So let's just talk about the cloud vertical. Generally, Tim, we continue to grow rapidly in public clouds, driven by increased software consumption of our BIG-IP systems and also rapidly growing consumption of NGINX in public cloud environments to scale Kubernetes, specifically deployments into production. And the third factor, there is the security attach rate in the public cloud continues to grow. So that's just how well we're doing in public cloud. But if you start back, I think behind your question, I just want to go back to. If you look back to where we were three years ago or four years ago when I joined F5, around the perception of F5 around public cloud, I would describe the bear thesis at the time as the following. We were told that traditional applications on-premise will not grow and would only declines. We were told that the traditional applications that would survive would be - would all move to the cloud and would be re-factored and therefore F5 would not have a role in these applications. And finally, we're told that all new applications - modern applications would be built as cloud native and container native and F5 would not have a role in these applications and all of that led to significant skepticism about the role of F5 in applications in the future.

If you look at where we're at today. Number one, traditional apps are growing, the revenue generating apps and the COVID and the consumption of everything digital growing rapidly has led to traditional apps that are revenue generating, growing rapidly, and that goes on through BIG-IP. Number two, the apps that are - not all the apps, the traditional apps are moving to the public cloud. A large number of them are not moving. But those that are moving, it's largely a lift and shift and that benefits F5 tremendously because we are absolutely attached to these apps in the public cloud and that's why our business in the public cloud is growing. And number three, as it relates to the modern apps, we have a significant and growing role in modern applications with NGINX, which is an enabler and becoming an enabler of scaling these modern applications and we have a role within BIG-IP. And so you look at the picture today, Tim, it's very different than the picture at least the bare thesis had four years ago. And if you look at where our customers are to date, they find themselves in a situation where they have traditional apps on-premise, on private cloud that are growing and they're building these new modern apps and they are on a 20-year march to manage the right balance between those environments, between modernizing traditional apps, building and scaling modern applications. And there is now a very powerful alignment between the portfolio of solutions that we have put together with BIG-IP, NGINX and our security portfolio and the challenges that our customers have to resolve to grow and modernize their applications. And that's kind of manifesting in our results, both in what we're doing in the public cloud and what we're doing on-prem. Frank, you want to address the second part?

Frank Pelzer - Executive Vice President and Chief Financial Officer

So in terms of the true forward and the subscriptions that we are seeing, on an average in both the year two and year three, we are ahead of where our internal was and so in the double-digit uplift that we see in years two and years three. Our utilization that we're seeing in the contracts and your one is actually full by a month in the last quarter and all of this gives us increased conviction in our software as we head into FY '22.

Okay, thank you.

Operator

Thank you. Your next question comes from the line of Samik Chatterjee from J.P. Morgan. Your line is now open.

Samik Chatterjee - J.P Morgan - Analyst

Hey, hi guys, thanks for the question. I had a couple of fronts. Francois, if I can stock just on the software again here. One of the questions that we get quite often from investors and we got a lot of those this quarter is even as you kind of saw good acceleration in software revenue sequentially in the third quarter or there is a similar acceleration that's implied into the fourth quarter and then kind of into next year? So how much of that is just the momentum of the kind of existing business relative to the true ups or true forwards as well as subscription renewals that's kind of influencing that? If you can talk about the confidence into delivering that sequential improvement as we go along into next year? Thank you. And I have a follow-up as well.

Francois Locoh-Donou - President, Chief Executive Officer and Director

Thank you, Samik. So let me start on software. Yes we are, we are, as Frank just said. Our conviction in our growth in software continues to increase and continue to get stronger for a couple of the reasons. The first is, we are indeed seeing very strong utilization of our multi-year subscription agreements, getting better visibility into expansion and true forward and so far what we're seeing on expansion in true forward and even our renewals, but the performance of these aspects of our software business is well ahead of our own internal targets. So that is an important part of our confidence.

But the second part on our confidence is that we also have some catalysts in our software business that are starting to play out as we thought they would and perhaps even better. If you look at NGINX, the momentum of adoption of NGINX is accelerating in part because we have a larger set of products and modules on NGINX from the investments we made a year and a half ago. So the controller App Protect, the security beep [Phonetic] on NGINX moving into API Gateways. Those are growing the addressable market for NGINX and some of these catalyst haven't even played out and will play into 2022. We see growing demand for security, including Shape and a lot of that is consumed in software. And BIG-IP is also growing in software, as I said in public cloud and private cloud environment. So if you combine all these, you answer that, that we see a 5G opportunity that's in software in 2022 for the 5G core. Those are all catalysts that will continue to drive the growth that we expect to see software.

Samik Chatterjee - J.P Morgan - Analyst

And if you can just follow-up, maybe this is more for Frank. But when you gave initial guidance for this year you were expecting more of a topline growth of 7% to 8% and operating margins of 31% to 32%, clearly topline growth has exceeded your initial expectations. But when I look at the operating margin you're towards the lower end of the range here. So how should I think about that? Was it like reinvesting some of the incremental growth that you got or was it more of the headwinds because of the supply chain constraints? Just trying to think through why not more leverage on the operating margin as revenue exceeded expectations?

Frank Pelzer - Executive Vice President and Chief Financial Officer

Sure. So, hey Samik, a couple of factors that I will note. One is, obviously, with the revenue outperformance we've got in the natural commission expense and other things, they go towards higher expenses than what we would otherwise model at the beginning of the year. We also obviously absorbed Volterra into this model where we said we are not going to change our operating plan, but we were going to absorb those expenses and that's exactly what we did. And then just other gives and takes that put us I think more in the mid-point of that 31% to 32% range, not at the low end from our expectations.

Samik Chatterjee - J.P Morgan - Analyst

Thank you. Thanks for taking my questions.

Frank Pelzer - Executive Vice President and Chief Financial Officer

Sure.

Operator

Thank you. Your next question comes from the line of Rod Hall of Goldman Sachs. Your line is now open.

Rod Hall - Goldman Sachs - Analyst

Yeah, hi guys, thanks for the question. I wanted to just go back to the software revenue. I'm assuming that your guide is built for close to 35% growth this year. If I just simplistically say 35% and I get a detail of growth actually in Q4, round about $145 million of revenue and I guess quarter-on-quarter growth - seasonal growth a little bit slower. So I'm just curious does that makes sense to you guys? Aare you expecting it slowdown in growth or the 35% is too low? I mean, can you just kind of help us square that all up? And I have a follow-up.

Francois Locoh-Donou - President, Chief Executive Officer and Director

Hi, Rod. Look, we're not. As you know, we are not grading hardware and software separately every quarter. We've said that we would drive about 35% software growth for the year. We feel confident that we're going to - we're going to do that. And more importantly, I always look at this as the overall trend for our software business. For Horizon 2, we said the trend in our software growth will be 35% to 40% and we still feel that that's what the range is going to be for growth for FY '21 and FY '22.

Rod Hall - Goldman Sachs - Analyst

You go ahead, Frank.

Frank Pelzer - Executive Vice President and Chief Financial Officer

Yeah, absolutely. I think the only thing I would add is the same methodology that we use and giving guidance for the - since we've been talking about our software business and the back half of the year when that was looking like a pretty good uplift when we were talking last quarter, I think we bridge that quite well this quarter and leaving ourselves, we see plenty of room on the 35% for the full year. And so when we take a look, we take a look at the components that we know are coming in from the SaaS businesses, the true forwards and the pipeline activity of what we see.

Rod Hall - Goldman Sachs - Analyst

Okay. And then, Frank, I had one for you on deferred revenue. I was just looking at your long-term deferred increments versus your short-term and I see a pretty good sized long-term deferred revenue increased in June over March. I'm just curious can you can you talk just about the duration of the deferred revenue and what specifically is driving the big increase in the long-term part of it? Thanks.

Frank Pelzer - Executive Vice President and Chief Financial Officer

Sure. Yeah, absolutely right. So it seems like we keep saying this, but we had yet another record number of multi-year subscription agreements that bring in deferred revenue into that long-term bucket. Also, we had a very strong Shape quarter as well as other things that have got multi-year contracts. I believe the average duration on most of those is two and half to three years. And so that's what you're seeing the growth in the long-term deferred revenue.

Rod Hall - Goldman Sachs - Analyst

Great, okay. Thanks a lot. I appreciate it guys.

Frank Pelzer - Executive Vice President and Chief Financial Officer

Yeah, thank you, Rod.

Operator

Thank you. Your next question comes from the line of James Fish from Piper Sandler Your line is now open.

James Fish - Piper Sandler - Analyst

Hey guys, great quarter. Not to go back of the topic, but on the subscription side first. I guess, how should we think about kind of next year's true up in renewal opportunity understanding the fiscal '19 base is bigger than the fiscal '18 base, but we are having some of these true-ups come this fiscal year. I guess, can you kind of help us bridge the transitions here of how we should think about this true up and renewal activity happening? And it sounds like we should think about it's kind of 110 to 120 kind of net retention rate. Is that the right way to think about it?

Frank Pelzer - Executive Vice President and Chief Financial Officer

Yeah, it's the right way to think about it. And there is also an additional component with 606. So the reason why that lapping is important and what you see in 1'9 as opposed to the previous quarters and why I have said for the past probably six or seven quarters that the back half of FY '22 is going to be interesting when things start to look more consistent than the revenue growth is that once you actually sign those new term subscription agreements, there is a whole new revenue recognition component associated with that. And so the true forwards are interesting, but that becomes the new baseline in which the new deal is signed. And then in those three-year agreement, 63% of that comes to product in the quarter that it is assigned and the balance of that is ratably deferred into the services revenue bucket over the course of that three years. And then the true forward obviously have got an additive component to the product revenue in years two and year three. But that lapping year is actually when we see more pickup in the product revenue on the software side.

James Fish - Piper Sandler - Analyst

Makes sense, Frank. And it does look like your bookings or billings were up very nicely here at 25%, not a metric we typically talk about with you guys. But as the software piece is becoming a bigger and bigger piece it does make some sense to talk to. First, are you guys planning on introducing any new metrics here as we think about fiscal '22, known ARR metric or talking more to billings? And then secondly on that billing strength this quarter, was it more on the product side or whether just really strong maintenance attached to these virtual BIG-IP and NGINX licenses? Thanks, guys.

Frank Pelzer - Executive Vice President and Chief Financial Officer

Yeah, I'll speak to the metrics question and let Francois take the back half. We continue to evaluate additional disclosures of metrics. I can't make any promises of when that's going to come, but we continue to think about what's going to be the most relevant for the users of our financial statements.

Francois Locoh-Donou - President, Chief Executive Officer and Director

And then, Jim, on the second part and where the traction is coming from. There are two areas that I would point to you that's driving the increase in subscription revenue. One is security. We had a very strong quarter with Shape and in certain verticals, retail, financial services, the tech verticals, online gaming where we are - the customers have a heightened sense of the threat environment and awareness of the factors, and we're able to mitigate a lot of automated attacks. But not just mitigate bot attacks, but also more increasingly profile their traffic more intelligently, leveraging with AI technology, which results in improved customer experience. And so it's making us really sticky in these environments and in these verticals.

The second thing in security is we're seeing bed [Phonetic] SecOps teams and DevOps teams increasingly wanting to deploy security earlier in the lifecycle of an application and that points to the security capabilities of F5 that we reported on NGINX, and so we're seeing NGINX security start driving growth in our security portfolio. And since some both Shape and NGINX are driving subscription-based revenues, you're seeing that increase there.

Then the second area I would point to is just more general adoption of modern applications. One of the things that we are seeing over the last six months and I think it's accelerated this quarter is Kubernetes is going into production. A lot of customers have done development and test to these microservices, container-based applications and they're now looking to scale these applications. In a lot of cases, they're running into trouble and NGINX has all the capabilities to help them scale their Kubernetes clusters and it's driving an acceleration in NGINX adoption, in addition to the fact that NGINX now has multiple products controller, API Gateway, etc. So when you look at these factors, it's accelerating adoption in NGINX. One of the - I think the most obvious manifestations of this is we have very strong momentum with NGINX, not in just any customer, but in our top 1,000 customers, the penetration of NGINX is growing and very strong. In fact, just this quarter, if you look at - Frank said we had a record number of multi-year subscription agreements and NGINX was part of more than half of those multi-year subscription agreements for the first time. So it point both to the growth we're seeing with NGINX and Shape, but it also points to what I said earlier around the powerful alignment of our portfolio to the hybrid challenges that our customer states.

James Fish - Piper Sandler - Analyst

Thanks, guys.

Francois Locoh-Donou - President, Chief Executive Officer and Director

Thanks, Jim.

Operator

Thank you. Your next question comes from the line of Meta Marshall of Morgan Stanley. Your line is now open.

Meta Marshall - Morgan Stanley - Analyst

Great, thanks. A couple of questions. You've mentioned a couple of times, we had a record quarter with Shape Security. Last quarter you mentioned there had been some delays in proof of concept. So just wanted to get a sense of - will some of that strike those proof of concepts resuming? Is it kind of the security breaches that we've seen that have driven some of that strength? And then maybe just a second question, maybe for Frank is kind of the SaaS application or cloud customer vertical, something that we should consider as being more than 10% of the business at this point or just any anything that would give us a sense of the size of that customer base at this point. Thanks.

Francois Locoh-Donou - President, Chief Executive Officer and Director

So, Meta, let me start with Shape. You saw - last quarter we did mention we had some proof of concepts that we're taking a long time and that was exacerbated by the fact that customers are not in the office and so are pulling off this proof of concept and reducing the length of the sale cycle was difficult. We still have that issue. And I would say for customers that are not under any kind of immediate significant pain and can take their time to make their decision, that is still a factor and we hope that factor succeeds in the coming quarters, but it's still there.

On the other hand, we also have a number of customers who are either under attack and need an immediate solution and oftentimes the solution they have in place are not effective and offer a sophisticated attacks, or they have a heightened sense that they are on borrowed time and need to put in place the most effective mitigation possible. And for those type of customers the sales cycle is pretty rapid. And this quarter, we had more of these customers come to us. I would say there is also a maturing of the go-to-market, which seems to be able to identify the verticals where this is mostly the case and focus their efforts. So that's why the traction on Shape is accelerating.

And then on your second part, Meta, on the cloud vertical. We don't break it down on sort of on the quarterly basis in terms of quantifying exactly how much that is. But here is what I would say. When we look at where F5 is growing the fastest at the moment. If you take all companies that are either are in technology or in e-commerce or these products or digital services, so it would include all the cloud providers, then the fast providers. If you put all of these in a bucket, this is the area of the business for F5 that is growing the fastest at the moment and it's [Indecipherable] why that they - because all digital services are growing rapidly and the consumption of these services are growing rapidly and that's driving growth for us across our entire portfolio, Shape, NGINX and BIG-IP benefiting from that. And I would note that it's an interesting trend because again if you go back four years ago where you would have thought that the tech companies who are perhaps the most aggressive at moving to the cloud. adopting cloud native and continue enabled architectures would not be the customers that would stay on BIG-IP appliances, and where you would have expected perhaps F5 momentum to be less in the future. It's the complete opposite now where our momentum in that sort of vertical is very strong.

Meta Marshall - Morgan Stanley - Analyst

Great, thank you.

Operator

Thank you. Your next question comes from line of Alex Henderson from Needham. Your line is now open.

Alex Henderson - Needham & Company - Analyst

Great, thanks. I think you pretty clearly proven that you guys are a real play on the transition to the cloud with this quarter's. I wanted to get into a couple of the items here. The first one is some the conversion rate of NGINX to NGINX Plus. It's just pretty clear that since your acquisition of NGINX, that the percentage of - or the market share percent of NGINX has definitely gone up. I understand it's up in the 67% plus range now, up from like 60%, and on voice share has gone from over 20% to low teens. So clearly demonstrating that it's becoming the de facto standard. But can you talk about the conversion rate of NGINX to NGINX Plus and how that impacts your business?

And the second piece of that same question is if you've got a 5% increase in your subscription rate in the quarter in software, I think the standard kind of rule of thumb is around 2.2 times impact on the rate of growth as you convert from perpetual to software subscriptions. So it is up 5%. Does that mean it understated your growth in the true underlying growth rate by roughly 10% to 12%? Thanks.

Francois Locoh-Donou - President, Chief Executive Officer and Director

Hi, Alex, I'll take the first part and Frank will take the second part. In terms of conversion of NGINX to NGINX Plus. So, as you noted, Alex, NGINX is getting a lot of traction, its now the most deployed web server in the world with north of 500 million websites using the technology. And so, yes, an important motion with NGINX is the conversion to NGINX Plus. We have steadily gotten better about that in two ways. Number one is because there is a broader set of products that can be offered either as part of NGINX Plus or in conjunction with NGINX Plus, the security capabilities, the API Gateway and now a controller that makes it much easier to deploy and manage these instances. There are more reasons for customers using open source to want to have access to the commercial capability.

And then the second part is - what we have found out is number of large enterprises, customers are not aware of how many open source instances they have, how many versions they have, and/or they underestimate by sometimes a factor of 10 times the number of NGINX open source instances we have. And so we've been able to bring to them a new technology we call it an NGINX instance manager that allows them to discover the open source instances that they have, and oftentimes prompts them to look at that portfolio and ensure that it has the right support and oftentimes into NGINX Plus to have other access to better features and better version. So that's kind of what we're seeing in terms of better conversion rates on NGINX. But I would say we're also getting greenfield deployments with folks who did not have NGINX open source in their portfolio. Because as I said before, scaling these Kubernetes clusters and scaling these container-based applications is a challenge for many customers and what they find is NGINX is a platform that consolidate a lot of functionality into one platform and so they don't have to deal with five or seven different vendors for different capabilities. So all of that is why we're seeing that traction.

Frank Pelzer - Executive Vice President and Chief Financial Officer

Alex, and then for the second part of your question, I would love that app to work for all of our software base, it does actually for the SaaS ratable piece of our software-based, but with the adoption of 606 for our term subscription based models that one evens out a bit closer to the perpetual and subscription revenue recognition. So that has to - your math does work as that SaaS portion of our revenue continues to grow and the ratably recognized portion, but it's not completely apples to apples for all of those.

Alex Henderson - Needham & Company - Analyst

Okay. And if I could just follow-up one last quick question. So clearly as the dominant player in Kubernetes code as infrastructure, can you talk a bit about your ability to hook into HashiCorp and to what extent your tight integration with HashiCorp is driving your adoption rates? Clearly there setting up to come public and as they do, code as infrastructure, CICD pipelining and obviously there is the role of Kubernetes goes to center stage and you're obviously a critical piece of that?

Kara Sprague - Executive Vice President and General Manager, BIG-IP

Yeah, I would say. Its Kara. We have looked from a number of our products into Hashi's portfolio and we do have a strong, strong - we see customers looking for our integrations that are built into their. So for example, a few integrations from BIG-IP and the combo that enable deployments and provisioning of BIG-IP resources through Hashi's console offering as well as other integrations that we have. But I would say that Hashi is but one example of a broad set of automation and orchestration capabilities that we've enabled across our portfolio. So both NGINX and the BIG-IP can be automated and provisioned and configured via a set of declarative APIs, and our customers use that through Hashi, they use it through things like Ansible, TerraForm as well as the number of other automation technologies.

Operator

Excuse me. Your next question comes from the line of Fahad Najam from MKM Partners. Your line is now open.

Fahad Najam - MKM Partners - Analyst

Thank you for taking my question. I guess I had a very high level question on your subscription revenue, that the close number that you have 73% of it being subscription. Can you give us a sense of how much of that revenue was a term revenue, term software?

Francois Locoh-Donou - President, Chief Executive Officer and Director

Fahad, it was 78% this quarter, 73% the year ago quarter, and we don't split out those components at this point, but I do appreciate the question.

Fahad Najam - MKM Partners - Analyst

Okay. If I could maybe ask Kind of figuring out in terms of the opportunity you had in software growth, can you help us understand in terms of the true-ups on land and expand nature of your business? Can you give us some or share some data points, quantifiable data that kind of show you landing and expanding on your self called customers who adopted your set of solutions, but as Internet expands along with that traditional software solutions. Just kind of understanding how much of a true-up are you enjoying as you integrate more of Shape and Volterra solutions going forward at all?

Francois Locoh-Donou - President, Chief Executive Officer and Director

Fahad, I don't know if I will get to what I think you want, which is an average of the true-ups or expansion that we're seeing at renewal with our customers. But let me just give you a few data points. So first of all, our subscription offers really started in earnest in 2019. And so we are in the very early stages of going through these and certainly the renewal of the multi-year subscriptions that have expired and gone to three years. In terms of the - the ones that have gone through one year and so we've already had a chance to do the true-up. We are generally seeing expansion in consumption that is very healthy. So we're very happy about that. One of the things, Fahad, that we have worked on. And I think now we're getting to a very good position is - in the first year or less, it used to take a long time for customers get to get to 400% utilization of what they have committed to. I think the first sort of deals we did it took north of 20 months for customers to get to that. We have steadily brought that down to now customers in roughly five months or so to get to 400% utilization of their subscription and so beyond then they expand. So we're gaining very healthy consumption and as a result very healthy true-ups.

Renewals, it's early days. But I can tell you we have had some renewals where we were close to 3 times what they had committed to in the first multi-year subscription. Of course, not all of them are that way, but it's just to give you a range of what we see there. So those are some of the things that give us good - better visibility into next year and good confidence and continued growth.

Fahad Najam - MKM Partners - Analyst

Thank you so much.

Operator

Thank you. Your next question comes from the line of Amit Daryanani from Evercore. Your line is now open.

Amit Daryanani - Evercore ISI - Analyst

Perfect. Thanks for taking my question. I guess I have two as well. First off, I just want to just talk on systems growth and what you've seen so far it sounds to be much better than the Horizon 2 all the long-term target. So you just remind us what is driving that growth? And should we think what this means for Horizon 2 growth for the systems?

Francois Locoh-Donou - President, Chief Executive Officer and Director

Yes, I mean - the, what's driving the systems growth. I think, there are few micro sectors in the sense that I think the IT spending environment right now is fairly healthy and there is also a lot of consumption of digital services by consumers and that in turn is fueling growth in application. So growth in demand for application. I would say that is kind of the biggest micro factor because what we see is a lot of our customers when they're refreshing their appliances, they don't go just for a refresh, they go for refresh and capacity expansion and sometimes it's capacity expansion and transformation because they want to move in a private cloud environment and that's driven by there just more traffic and more usage of it even their traditional applications. We see, as I said earlier, growth with digital and fast service providers and for them the growth comes from - they're are sometimes their services, but demand for their services whether it's collaboration platforms or e-commerce platforms or even SaaS providers, the demand for their services are growing rapidly and we are built into their infrastructure and so that drives demand for our hardware, our systems into their infrastructure.

And I would say, generally there is also a fundamental change in stance, Amit, from when you go back three, four years ago. I would regularly hear from customers four years ago, look we don't want to buy more hardware because we're going to move everything to the cloud, we're going to be out of our data centers. We've got to figure out our architecture, and at the time we said there was a pause because people were thinking their architecture. There is not a single CIO that has told me this in the last 12 months. Every one of them - I think a lot of people have learned from the first implementations in public cloud, sometimes the cost and time associated with refactoring applications. And generally, I think people are more comfortable that they're going to be in a hybrid environment for a very, very long time to come. It's not forever. And so they're comfortable growing their on-prem presence with hardware where it makes sense and leveraging the public cloud for other initiatives. And I think that that halo, that environment is very different than it was four years ago.

And then the last factor that has an impact on our systems business, I mean it is security. I said earlier that we had very strong growth in SaaS security with Shape subscription, security with NGINX. But we also have very healthy double-digit growth in hardware security and that's because the - all of these apps need to be secured and customers are aware of the risks, so they're moving forward with application security.

Amit Daryanani - Evercore ISI - Analyst

Got it. that is really helpful. If I could just maybe ask you to clarify a little bit more for me. I think a lot of folks tend to think that if the software business grows 35%, systems has to be planned, its a bit of a either [Indecipherable] sometimes for people. Is it fair to say given what you just outlined with hybrid being the reality that you could have systems growth and software growth be more durable over time versus not?

Francois Locoh-Donou - President, Chief Executive Officer and Director

Yes, is the potentially a possible scenario. I would separate though. When you look at our software business, you've got NGINX and Shape, and I don't think there's any relationship between the growth of that part of our software portfolio and the growth in hardware. When you look at BIG-IP per se, this is where we have seen and we try to continue to see some customers that we would have expected to have moved to software form factor right now that are delaying or reconsidering in part because of COVID, in part because of the immediate demand that they see on their applications. So that's where there is a - I would say there is some level of give and get on hardware and software. But overall, the software transition for us is absolutely accretive to the business and right now the drivers that we are seeing in our hardware business, we feel the couple of one off that we talked about last time around our [Indecipherable] of certain product. But I would say the majority of the drivers we're seeing right now are pretty sustainable.

Amit Daryanani - Evercore ISI - Analyst

Perfect, thank you, and congrats on a nice quarter.

Francois Locoh-Donou - President, Chief Executive Officer and Director

Thank you.

Operator

Thank you. Due to time constraints, we will take our last question today from Simon Leopold of Raymond James. Your line is now open.

Simon M. Leopold - Raymond James - Analyst

Great, thank you for taking the question. I wanted to see if you can talk a little bit from a market vertical perspective, in particular federal was low for you guys this quarter at 4% of revenue and we're coming into what's normally your strong seasonal federal quarter. So I want to understand whether there is something different in the current cycle in terms of your federal business? Or whether we should expect federal to be strong in your September quarter? And then on enterprises, if there is a way you could maybe characterize where we are in terms of kind of a post-pandemic recovery, is there some aspect to the current business that we may be could characterize as catch up spend compared to the weaker spending we saw a year ago due to the pandemic? Thank you.

Francois Locoh-Donou - President, Chief Executive Officer and Director

Simon. Thank you for the questions. So the - let me start with the Fed, the Fed question. There is anything - there is nothing particular for this quarter in terms of our bookings, they were there were in the range of what we typically expected in the quarter like this for the Fed. We expect a strong seasonal quarter in the Fed in our fourth fiscal quarter and we continue to be well placed to win some business there. There is, as you know, a lot of additional focus on security in that vertical and we are well placed to win and protect against some of the threats that we're seeing for our government customers. So I think that's where our focus is with the Fed and that will continue.

As it relates to your question on the enterprise, Simon, remind me the question, the question is are we going to see the same drivers?

Simon M. Leopold - Raymond James - Analyst

Well, I guess what I'm trying to get at is there some element of the growth you're seeing now that goes away that is more about the cycle as opposed to the longer-term secular trend. I'm trying to really discern between the two. So you've got a relatively easy comparison with we get it, data center spending a year ago. And so at some point there may be a year that peters out. So there is a cyclical aspect and a secular aspect of your business. I'm trying to discern the two.

Francois Locoh-Donou - President, Chief Executive Officer and Director

Okay. Well, Simon, it's a great question and I think specifically in our hardware business I think the elements of folks. And you are asking me which one is the 80, 20. And I don't know that I have a good answer for you. I would say, yes, there is some of the aspects that are I would say cyclical is; A, I think the spending environment right now is helping. I think there is a little bit of a catch-up demand from - in our case FY '19 and FY '20 where people were kind of very cautious in the early part of the pandemic and I think those two are somewhat cyclical. I think the aspects that are more durable are things like what we're seeing in the tech sector where I think the demand for digital services is just going to continue to grow and I don't see that stopping anytime soon. And I think generally demand for traditional applications in hybrid infrastructure is also going to continue to be solid, and I think that's a durable piece. And then the last element that's durable is security. I said we have healthy double-digit growth in hardware security and I think demand for security is going to continue for the foreseeable future. So both elements are part of what we're seeing right now. And I think time will tell I think in a couple of more quarters just to see how much of each is contributing.

Simon M. Leopold - Raymond James - Analyst

Okay, thank you.

Operator

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Q3 2021

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