F5 Inc (FFIV) 2004 Q4 法說會逐字稿

Welcome to F5 Networks Fourth Quarter Financial Results.

I would now like to turn the call over to Mr. John Eldridge, Director of Investor Relations.

Thank you, sir, you may begin.

Thank you, Sharon and welcome all of you to our Fourth Quarter 2004 Conference Call.

Speakers on today's call are John McAdam, President and CEO; and Steve Coburn, Senior Vice President of Finance and Chief Financial Officer.

Julian Eames, Senior VP of Business Operations and Global Services, Tom Hull, Senior Vice President of Worldwide Sales;

Dan Matte, Senior Vice President of Marketing;

Jeff Pancottine, Senior Vice President and General Manager of our Security Business Unit;

Karl Triebes, Senior Vice President of Projects Development and CTO are also present and will be available to answer questions following our prepared comments.

Steve Coburn will begin today's call with a review of the financial results for the fourth quarter and fiscal 2004 and our current outlook for the first quarter of fiscal 2005.

Next John McAdam will review the Company's operations during fiscal 2004 and provide additional perspective on the Company's goals and outlook for the current quarter.

We will then open the call up for questions.

If you don't have a copy of today's press release it's available on our Web site, www.F5.com.

In addition an archived version of today's live webcast will be accessible from the events calendar page of our Website through January 18.

From 4:30 PM today until 5 o'clock PM Pacific Time October 29.

You can also listen to a telephone replay at (800)510-9771, or (402)344-6800.

Pass code for the replay is F5 earnings call.

Except for the historical information presented, our discussion today contains forward-looking statements which include words such as believe, anticipate, expect, and target.

These forward-looking statements involve risks and uncertainties that may cause the Company's actual results to differ materially from those expressed or implied by these statements.

Factors that may affect F5's results are summarized in our quarterly press release and described in detail in our SEC filings.

Please note that F5 has no duty update any subject discussed in this call.

If you have follow up questions after today's call please direct them to me at (206)272-6571.

I would like to turn the call over to Steve Coburn.

Thank you, John.

Before reviewing the Q4 results I would like to remind everyone that as expected we have reversed the valuation allowance on our deferred tax assets and have begun recording income tax expense.

For the current quarter this has resulted in a significant one time net benefit.

In the following discussion I will attempt to show how the results reported today compare to net income recorded in prior quarters and to the numbers we expect to report going forward.

Now for the results.

For the fiscal fourth quarter ended September 30 revenue and earnings exceeded the targets of 45 million to 47 million and 37 to 39 cents per share we set on our July 21 conference call.

Revenue of 50.2 million was up 59% over the same quarter last year, quarter over quarter revenue grew 6 million or 14% sequentially.

Net income for the quarter was 15.8 million or 43 cents per share.

This included a net U.S. income tax benefit of 5.5 million.

The net income tax benefit is made up of the reversal of the valuation allowance on our deferred tax assets of 7.3 million, partially offset by actual income tax expense of 1.7 million.

Excluding the income tax benefit and provision for Federal income taxes, net income for the quarter was 10.3 million, or 28 cents per share.

This compares to guidance of 20 to 22 cents per share and net income of 7.4 million or 20 cents per share in the third quarter.

Net income was 1.4 million or five cents per share in the fourth quarter a year ago.

Going forward we anticipate reporting income tax expense at an effective tax rate of approximately 37%.

Had the current quarters orders been taxed at 37% net income would have been 6.8 million or 18 cents per share.

Comparisons of future quarterly earnings should be based on this number.

North American revenue represented 59% of overall revenue and international accounted for 41%.

Revenue from Japan was up from the historically slow June quarter.

In addition we saw sequential revenue growth in both North America and Europe with a small decrease in Asia Pacific.

Product revenues represented 75% of total mix with services accounting for 25% comparable to prior quarters.

Total revenue from FirePass was approximately 4.6 million compared to 3.8 million in Q3 and the 4.5 million target we set for Q4.

As expected we had no recognized revenue from the sales of TrafficShield, the application security product we acquired with the purchase of MagnaFire (ph) on May 31.

During the quarter we had one greater than 10% distributor, Ingram Micro, at 21.8% of total revenue.

Continuing down the income statement, gross margin was 77% comparable to recent quarters and within our target range of 76 to 77%.

Operating expenses were 28.8 million at the upper end of our target range.

Our operating margin for the quarter was 20%, up from 16% in the prior quarter.

Included in our results were 1.2 million or 3 cents per share of costs associated with our MagnaFire acquisition.

Turning to the balance sheet.

Accounts receivable DSO of 41 days was below our target range and comparable to the 40 days reflected last quarter.

Inventories of 1.7 million was down slightly from 1.9 million in the prior quarter reflecting annual inventory turns of 27 times. 11.4 million in cash flow from operations exceeded our target and contributed cash and investments totaling 222.3 million at quarter end.

Capital expenditures for the quarter were $1 million and depreciation and amortization expense was 1.8 million.

We ended the quarter with approximately 610 full-time employees.

I will now briefly review the results for fiscal 2004.

Year over year annual revenue increased 48% from 115.9 million in fiscal 2003 to 171.2 million in fiscal 2004.

FirePass revenue of 12.6 million exceeded our target range for the year and accounted for 7% of total revenue.

Setting aside FirePass revenue, we saw 37% growth year-over- year in our core traffic management business.

Annual reported net income was 33 million or 92 cents per share.

Pro forma net income for the year was 27.4 million or 76 cents per share compared to net income of 4.1 million or 14 cents per share in fiscal 2003.

Now a quick overview of key metrics on a year over year basis.

Gross Margins held steady at 77%.

Operating expenses were 105.5 million compared to 84.8 million in fiscal 2003.

Inventory levels increased approximately $1 million year over year to 1.7 million.

DSOs continued to trend down during the year from 55 days a year ago to 41 days in the quarter just ended.

Capital expenditures for the year were $5.8 million.

The Company generated 40.6 million in cash flow from operations, an increase of roughly 26 million over the previous year.

Moving on to the outlook.

For the first quarter of fiscal 2005 ending December 31 -- excuse me -- we expect revenue in a range of 52 to 54 million.

We expect gross margins to remain at current levels within a target range of 76 to 77%.

Operating expenses are currently targeted in a range of 29.5 to 30.5 million.

Our Q1 earnings target is 20 to 21 cents per share after income tax expense.

This should be compared to the 18 cents per share for Q4 discussed earlier.

We believe we will continue to see DSOs in the mid 40 day level and we expect inventories to stay within a range of 1.5 to 2.5 million.

Further we believe we will generate cash flow from operations in excess of $12 million.

As in prior years we intend to provide guidance for the current quarter only.

However we would like to share several modeling assumptions that may be useful when considering projected fiscal 2005 results.

If current market conditions persist we believe the Company can achieve sequential growth both in revenue and earning for the balance of fiscal 2005.

We see gross margins remaining at current levels.

Operating expenses will increase with higher levels of business activity.

With growing revenue we expect to see continued improvement in operating margins.

However, our goal is to maintain an appropriate balance between improved profitability and reinvestment in our business model.

DSOs should remain in a current range of mid 40 days.

Capital expenditures are expected to be in a range of 6 to 8 million for the year.

Based on current market rates we expect to earn between 1.5 and 2% on cash and investments, and as previously discussed we expect to record income tax expense at an effective rate of 37%.

However, as a result of our net operating loss carry forward we do not expect to pay Federal income taxes through fiscal 2005.

With that I will turn the call over to John McAdam.

Thanks, Steve, and good afternoon, everyone.

I'll take a few minutes to cover some of the many highlights in fiscal year 2004, talk in some detail about Q4 results and then comment on our recent product announcements, the current business climate and our outlook going forward into fiscal 2005.

The F5 team has a lot to be proud of with the progress and achievements in fiscal 2004.

With our Q4 performance we delivered our seventh quarter in a row of sequential growth and revenue and operating margin.

From a financial perspective I am particularly delighted with our annual revenue growth of 48% and Q4's year-over-year growth of 59% as well as our ability to look to deliver sequential growth in our operating margins exiting the year with a 20% quarterly operating margin.

The follow-on offering at the beginning of fiscal '04 proved to be very successful with approximately 114 million in cash added to the balance sheet.

The offering combined with a strong cash growth flow from quarterly operations resulted in our going into fiscal year '05 with a very healthy balance sheet.

We continue to grow our market share during the year as well as increasing the addressable market available to us.

The acquisition of MagnaFire was a key milestone in our security strategy with the TrafficShield application fire wall solution now available for shipment in this current quarter.

We exceeded the top end of our dated range with our FirePass revenue and positioned ourselves as number two in the SSL VPN market after only one year of execution.

The introduction of the Buffalo Jump range of products and version nine of our BIG-IP software has been really well-received by our customers, partners and the industry analysts.

I will talk more about that later, but we believe that these new products will increase our technology leadership in application traffic management, as well as making new market opportunities available to us in the areas of application optimization, application delivery and application security.

We also made good progress in our partnership strategy both with solution partners via iControl and in our distribution network where we continue to add new partners especially in the security space.

As far as our Q4 results were concerned, obviously I'm extremely pleased with the performance.

In particular we saw strong revenue growth in AMIA and Japan.

Also taking into account the increase in backlog we saw solid growth in both U.S. enterprise and Federal business.

The forward-looking pipeline for all geographies is strong as we move into the first quarter of 2005.

Overall our book-to-bill ratio was once again above one for the quarter.

I was also happy with the way we manage the product transition issues associated with our Buffalo Jump announcement.

As you know we announced a our new version 9 software and a new range of products, the 1500, the 3400 and the flagship 6400.

We actually took quarters for the new platforms which represented approximately 10% of our traffic management sales in the quarter.

The majority being in North America.

Approximately 25% of those orders were shipped and represented revenue in the quarter and the remainder was put into backlog for shipping in this current quarter.

Our momentum with the FirePass product line continued last quarter as we continued to add more resalers, new product functionality and an increasing customer base using the SSL VPN solution.

We had some very impressive sales wins with customers like Union Bank of Switzerland, eBay, BMW, Barclays Bank, Banc of America, Microsoft, ABN Amro, Prudential, Chuzerops (ph), Waway, Segitel, DIRECTV, T-Mobile and various Federal and government meant wins worldwide.

Looking forward to Q1 and fiscal 2005 I believe F5 has a number of reasons to be optimistic.

The sales prospect pipeline is at its highest level ever across the geographies.

Our services business continues to grow from strength to strength.

We continue to experience a high service renewal rate from our customers and the sales revenue backlog continues to increase, all boding well for services growth in fiscal '05.

We have started to ship our new TrafficShield application fire wall solutions.

With TrafficShield, F5 is the first major networking vendor to deliver an application fire wall.

With its unique application floor model to enforce a positive security policy at the application level, TrafficShield offers the customer protection against application attacks that the existing traditional fire walls just can not detect or protect against.

Also our new SSL VPN FirePass solutions are shipping with what we believe is an unsurpassed list of features in the marketplace.

We recently announced FirePass version 5.2 which we believe delivers a most ubiquitous application access features and the most advanced security features available in the market today.

Both TrafficShield and FirePass are now available in F5's enterprise class 4100 platforms.

I mentioned earlier that we successfully introduced our Buffalo Jump products and version 9 of our software.

We believe that version 9 significantly increases our technology leadership in application traffic management.

This new generation of BIG-IP was designed using many man years of customer experience and product knowledge of traffic management.

We have not only delivered massive increases in performance, but more importantly we have added powerful new functionality.

At the core of the new architecture is TMOS a comprehensive traffic management operating system.

The TMOS fast application proxy now allows customers many more opportunities to optimize and deploy applications over the network.

The TMOS by-directional flow based architecture combined with our powerful new iRules and iControl functionality gives our customers and partners the ability to change critical functionality in their Beta center applications without having to crawl through thousands of programs to do so.

TMOS also consolidates many features on a single unified platform.

Application optimization, security features like advanced client authentication, selective cookie encryption, rate shaping, compression, and many others are now available on a single platform.

During next year we plan to make TMOS the standard architecture for all our existing products including FirePass and TrafficShield.

As well as developing the TMOS potential of becoming the operating environment for other sub party solutions.

So in summary, given the host of new opportunities available to us, I believe F5 Networks is very well-positioned as we move into this fiscal year.

I want to take this opportunity to thank the entire F5 team and our partners for their efforts and support.

And with that I will hand the call over for Q&A.

(operator instructions) Your first question comes from Jason Ader from Thomas Weisel.

Your line is open.

Mr. Ader, we are not able to hear you, check your mute button.

I guess we should move on.

Your next question comes from William Becklean with Oppenheimer.

Thanks.

Terrific quarter.

My question has to do with your distribution channel.

I've always liked the idea that you have sort of three different channels into the market.

The standard 2 tier, the OEM channels through Nokia and Ericsson, and the iControl referrals from software providers.

Could you talk a little bit about what's going on in each one of those and the relative strength in each of those three channels?

The majority of our business, by the way, comes really through the resaler channel with distributors, in other words 2 tier .

In Japan, which is really the poster child of our channel structure, who's who of the big partners in Japan work through a distribution network with companies now like Anew Distributor, CTC, Tokyo Electron, NTT nd then we have a whole host of resalers that partner with companies like IBM Global Services, NEC, customers like that.

So that's the main way that we go to market.

In North America we signed up G.E. access as our second distributor to join Ingram Micro and that's starting to come to fruition, but that's just in its early stages and below them there's a number of resalers so we are very used to that model.

It's the same in Asia Pacific and the same in AMIA.

We also do business with companies like Nokia and Ericsson.

You mentioned them as OEMs.

They really are resaler type channels and have all, we are all pretty happy with that.

And, of course, you have organizations like Dell and Hewlett Packard reselling the products.

It's pretty broad in nature.

And the iControl drivers, you've typically given a percentage of business driven by iControl.

Right, and the iControl -- just to differentiate -- the iControl partners are solution partners, so they typically don't resell the product.

Sometimes they do like Oracle, but typically they don't.

What they do is they link via the iControl architecture into a product and ad value to their product.

So for example, we do a host of work with Microsoft, with Oracle, BEA, companies like that where we basically throughout the iControl architecture add value to their solutions and effectively give them access to the network and allow them to control the network work, add functionality, add availability.

When we talk about, say 45% of our business as it was, I think, last quarter being influenced by those types of partnerships.

Thanks.

Your next question comes from Jason Ader with Thomas Weisel.

Your line is open.

Can you hear me now?

Hello?

Yes, sir, we are able to hear you.

Sorry about that earlier.

I don't know what happened.

Just had a couple of questions on the FirePass.

How much of that right now is coming from international markets?

Could you give us some ballpark?

You know, we typically haven't been giving --

We haven't been breaking it down.

It's not significantly different from the rest of our business.

So you're actually, you're shipping the product internationally and you're building your distribution internationally and that's been contributing to the FirePass sales.

Yes.

Oh yes.

I wasn't sure how much, how fully distributed it was outside the U. S. Okay.

And then on the Federal business, could you give us -- you've given us in the past some idea of the percentages.

Yes.

This is Dan Matte Jason, on the Federal Government business, specifically the U.S. we are running at about 10%.

10%.

Is that significantly different than last quarter?

I think it was 6% last quarter.

Okay.

And the last question I had was, on the assumptions for Q1, could you give me -- could you give us some sense of the MagnaFire (ph) and FirePass inputs there?

I don't know if you're breaking out Fire Pass still but for MagnaFire (ph), how much of the guidance comes from MagnaFire (ph)?

Let me just answer that in a second.

Before I do, because I want to be clear on this, there was some confusion at the beginning of this calendar year and looking at geographies and business.

We were giving you revenue numbers there.

Remember in my script I made it pretty clear that the order backlog for Federal and enterprise North America business was actually up last quarter.

Just to talk a bit, to be specific on the question, we discuss this a lot, we are not going to break down the guidance.

There's a lot of moving parts in our business at the moment in the traffic management side obviously we have Buffalo Jump introduced, we have the existing traffic management products, TrafficShield is brand new, we have FirePass,we have our services.

So basically we'll report on that on a quarterly basis, but it's an overall range as far as we are concerned in terms of gains.

The magnifier you're still, I think you said 10 to 12 for fiscal '05, though, right?

Fiscal, '05 I think we said 8 to 12 million.

So you are sticking with that, you are just not going to break it out on a quarterly guidance basis.

That's correct.

We will report on it, though.

Oh, will you report on it.

We will report on the security product.

One final thing, a clarification, you took order from Buffalo Jump, you said 10% of, I couldn't quite catch that, 10% of what was -- ?

So 10% of the traffic management product sales.

Okay.

The BIG-IP sales were Buffalo Jump and of that 10% we actually shipped 25% of that and took that to revenue and that 75% was backlog.

Is it 10% of the traffic management sales were bookings for Buffalo Jump and 25% of those were actually shipped?

That's correct.

Okay.

Thanks.

That you.

Your next question comes from Alex Henderson from Smith Barney.

Hi.

That's some backlog you guys put up.

How did your customers react to having delays in shipments for a Company that normally ships same day?

We didn't have any significant issues.

I mean we only announced Buffalo Jump specifically towards the end of the quarter in the September month.

So we hadn't been making any great big fanfare about that.

Obviously wherever possible where customer needed the product we did our best to get it.

So when you say your backlog here, I want to just make sure I understand, none of that is going into distribution channel and being recognized it's not part of the backlog in that process.

Absolutely.

These are going to hard customers not to your distribution.

That's correct.

So that's a pretty good chunk of change going into backlog.

Obviously it must have been a very strong last two weeks.

Has that exceptional strength in orders that occurred in the two or three weeks post offering of the product in mid-September, has that persisted into October?

What's the trajectory of that order rate?

October's on track, Alex.

I guess what I'm asking, is the strength something that's going to persist for most of the quarter or is that something that's just a lot of pent up orders there?

Oh, goodness.

You know we -- We might want to talk about linearity.

That's probably the best way to --

I mean with regard to the new products, this is Steve Coburn, with regard to the new products we still believe that we are going to be in that 20 to 25% range of new product shipments in the current quarter.

So we said, we said when we announced Buffalo Jump we felt like we could be up to 10% order rate for new products this quarter.

We are in that range.

Based on everything we are seeing, we still expect to be 20 to 25% new product shipments next quarter.

Just to give you some more color on it, because I think I now understand what you are getting at, I don't think there's was a significant pent up demand for the Buffalo Jump product as such because we really hadn't trained our sales force.

The order flow for our existing products remained pretty strong right up until the end of the quarter as well.

So that begs the follow on question, then.

How long does it take to train and get your sales force up on the full functionality of this new product and to get them fully up to speed in the selling process?

Right, well, what actually interests us, we have our international sales conference this week.

Oh, you do.

And we will be training our sales force very much on TrafficShield and Buffalo Jump, on the product.

And Dan, you might want to comment on the road show we are doing with partners as well.

Sure, absolutely.

As part of the of the overall launch activities worldwide we have been out and training partners around the world and we have actually an upcoming one in North America in just a couple of weeks, actually.

So that will be yet another phase in terms of getting out and providing more learning.

We are also out educating the development market and revamping our message to them and tools for them by giving them more tools in the DevCentral arena as well, which we just revamped about a weeks ago.

Is it reasonable to say that the full impact of this product launch will take two or three quarters to play out to get a steady state?

Yes.

Yes, that's what we've seen in the past and we are watching it to see if it accelerates this time but that's what we are planning on.

One last question.

So how does the product flow look for next year at this point?

New product introductions?

Karl, you may want to talk about -- we discussed this before the call but we are going to get -- we will give you an idea what have we have in front of us because it's pretty exciting.

We have a number of point products planned to be introduced in the next year.

Integration is really kind of the central theme right now so what we are trying to do is leverage TMOS across using both FirePass and TrafficShield and we're also focusing on enterprise management as part of the product offering late in '05.

Just so I understand when you say point products you mean new additional products to the product line.

New platforms, yes.

New platform structures.

Yes.

So those would be extensions to the line that you are currently offering.

Absolutely.

Okay.

Great.

I'll cede the floor.

Thank you.

Great quarter guys.

Your next question comes from Tim Luke from Lehman.

Your line is open.

Thanks.

Thanks.

Very strong quarter.

I was wondering could you just clarify, the international U.S. split and then, Steve, I was wondering if you could give any color on how you see the direction of the gross margin developing?

And maybe as you ramp into a new fiscal year should we expect with the new product launches for some increase in your sales and marketing outlook?

Thanks.

Tim, let me talk about the international split.

So U.S. was 59 %, and we've already said previously of that Federal was 10%.

AMIA was approximately 15%.

Japan was in the, between 15 and 20, approximately 18, in fact.

And Asia Pacific was about 8%.

I know you said it was up in all geographies.

Should we expect very much change going forward in the in the first quarter in terms of the mix?

I'm sorry, say that again?

I think you said that you were up in all geographies and that your visibility going forward was that you expected all the geographies to be up in the --

No, let me explain that.

What I said was the pipeline is up across the board in all geographies.

The pipeline is between a three and six-month view visibility.

So in fact to be specific we believe that all geographies except Japan will be up in this current quarter and Japan will be pretty strong in the calendar Q1 quarter, or Q2.

And that's, that's as we expect.

Okay.

Tim, with regard to gross margin percentage, our belief is with the current sales mix that we are going to stay really in the same relative levels that we've been for some time now, sort of in that guided range of mid to upper 70s, 76 to 77 to be specific.

And we expect as we look out across 2005 to likely be in that range based on everything that we know today.

And on the expense side how should we --

Yes, sales and marketing expense, we expect -- and this will hold true for other components of operating expenses, we expect the absolute spend to increase with higher levels of business activity.

With increasing revenue we think we have further opportunity to improve our operating margins.

But we will be making decisions about what is an appropriate level of reinvestment in the business model and demonstrating continued growth in operating margin.

So that's something that we've been managing pretty much on a quarterly basis up to this point.

I wouldn't expect that to change looking forward next year.

Is it fair to say we would see a bigger lift in R&D than in SG&A -- than in sales and marketing, sorry?

You mean on a relative or absolute basis?

On an absolute basis it's likely that the dollars will grow.

Sales will be influenced obviously by unit volumes and our levels of sales on a relative basis, we see a lot of improvement as a percentage of sales on a relative basis that should continue going forward but we will make decisions along the way about where we are going to be investing in the business model.

Up to this point we've been investing both in sales services and product development and in the intermediate term those will be likely candidates for further investment as we look out on the horizon.

Just one clarification for John, just on, you gave the regional break out, but on Japan, you gave specific numbers for all the regions.

I think for Japan you gave a range though.

Could you just repeat what --

You mean for the quarter just finished?

Yes.

Yes, it was approximately 18%.

And then that's going to go seasonally lower going forward but then up again in the calendar first quarter.

Absolutely.

Thank you very much.

Your next question comes from Troy Jensen with Thinkequity partners.

Your line is open.

Just a couple questions, gentlemen.

First of all for Steve, I believe in couple weeks you are going to have to file the 10(K) and report the backlog, so I was wondering if you would be able to share with everyone right now.

Yeah, we do anticipate disclosing the level of the backlog, we won't discuss it on this call because we have to bed it with our auditors prior to the filing of the K.

A question for John, I know you guys exited the cashing business but what's the likelihood that you add that functionality into some of your platforms going forward?

We have that on the road map.

So we will have that reasonably soon on the new Buffalo Jump product.

Is there any Buffalo Jump clients waiting for that functionality?

Not that we are aware of.

I am looking around the room as I'm saying that.

I don't think so.

Congratulations.

It was an outstanding quarter.

Thanks.

Your next question comes from Denise Fialo (ph) from Merrill Lynch.

Your line is open.

That you.

Good afternoon.

A question on FirePass, would you be able to give us a sense please of the break out of the FirePass revenues, how much of that is coming from new security customers versus existing BIG-IP customers?

I don't know if we've got that specific detail, Denise.

I know that anecdotally it's definitely coming from new customers.

We are seeing a lot of new customers coming in via the FirePass channel but obviously given that we've got a good customer base of BIG-IP we focus on that as well.

We could maybe try and find that information but I don't think we've got it readily available.

Asking it this way just o get a better sense, are most of the sales from FirePass, could you quantify how much of it is going through security bars?

Yes, the great majority is going through -- I think existing bars also sell security or security bars, which I guess is almost the same thing, but that said, the great majority.

The one thing we've seen about FirePass that's interesting, and I think is an opportunity, is as the actual deal size in FirePass from an order perspective tends to be smaller than BIG-IP.

I think that's the nature of a new market and also a new product from us.

So we would expect that to continue.

So the transaction tends to be smaller and they are very value-added resale oriented.

Right, but would purchases, for example from FirePass, also be done in pairs similar to BIG-IP?

Yes, yes, more often than not.

One other question just on inventory levels, just I recall that inventory should have probably jumped up to about two, maybe just under 3 million.

I'm wondering whether or not you have any concerns about availability for the new version 9 or I should say Buffalo Jump product for next quarter in terms of shipment, and what appropriate inventory levels might be going forward?

This is Julian Eames.

The reduction in inventory was mostly component parts based on the old product rather than Buffalo Jump.

So obviously we measured our whole supply chain from beginning to end.

It's a long process working with our contract manufacturer and, no, we have no concerns about making the shipments.

Any target inventory levels or --?

Yes, we expect inventories this quarter to be in a range of 1.5 to 2.5.

So we have acknowledged the possibility they may be going up this quarter as we continue our transition to the new products.

Super.

Thanks for the clarification.

Your next question comes from Joanna Makris with Adams Harkness.

Hi, good afternoon.

Wondering just to follow up on the geographic mix question, how does MagnaFire (ph) impact your future geographic mix?

Where do you expect that product to have the most impact geographically?

And then secondly if you could comment a little bit on wireless as a percentage of sales, if possible, and just anecdotally how that business is going.

This is Jeff Pancottine.

On the traffic shield piece basically we rolled out traffic shield through North America and AMIA first.

And follow on in Japan and APAC.

The first quarter here it will be shipping only in the U.S. and AMIA and around second quarter -- end of second quarter we will start shipping it fully international.

Then as far as the wireless piece of the business goes, this is Dan Matte, we are running at about 12%of sales for that metric.

Thank you.

Your next question comes from Ryan Hutchinson with W. R. Hambrecht.

Your line is open.

Great quarter.

Couple quick questions here.

In the past you've given overall government revenue as a percent of sales, I believe ast quarter it was 11%.

Could you update us there and I have one additional?

Certainly.

We are looking at the Federal U.S. government business is running at about 10% Ryan.

I believe in the past you gave an overall government number?

It's approximately, and remember we have a lot of partners in Japan, we may not know about some of the sales but our best estimate is about 16%.

Okay.

Great.

I have a technical question here.

There's a lot of chatter out there about the importance of some of the new features you're offering specifically compression.

Some of the smaller vendor are making a lot of noises about that?

Could you talk about how you stack up against the competitors there and then just give a view as to the importance you believe compression is to the platform?

Then finally just in terms of what percentage of customers do you think actually will use, or are using compression?

Thanks.

Sure.

This is Dan Matte again.

As far as compression goes with version 9, the new version of software we introduced in September, we obviously offer that and really I will take a step back to explain why this is very, very important to us moving forward.

The traffic management operating system that John was explaining earlier really is the foundation for F5 to be able to offer many, many different types of advanced services that allow people to move work that traditionally gets done on application servers on to the network.

It saves them massive amounts of labor and gives them better control being able to do it that way.

Compression is one of the examples of what we did there.

Comparing what we offer on the compression standpoint to some of the up start people in the marketplace, we have actually advanced beyond what's being offered out there already by being able to do things like compress data based on conditions that exist in the network at that point in time.

So for example if something is over a wireless connection or a very slow connection we can compress to a maximum degree whereas if somebody is on a relatively faster compression we would do --excuse me, a faster connection we do less compression, so make th work match what's required by the end user.

As you will see when we move forward with version 9 and follow on offerings from, based on the traffic management operating system it makes it very easy for us to add on more and more functionality to let people continue to shift work on to the networks.

Thank you very much.

Great quarter.

Your next question comes from Sam Wilson with JMP Securities.

Your line is open.

This is Jonathan Curtis for Sam Wilson.

A couple of questions.

What was CapEx -- you may have already covered this -- CapEx for the quarter and cash flow from operations?

Yes, this is Steve Coburn, capital expenditures were $1 million for the quarter.

And cash flow from ops was 11.4 million.

Then two more quick follow up questions.

Did you recognize any revenue from FirePass sales at M. T. T.?

Yes, we did.

We won't give an exact number but, yeah, we did.

It's very much in the initial stages, though.

So it was a small percentage of the overall total.

Then one final question, any revenue from TrafficShield this quarter?

Do you mean the quarter-to-quarter?

Excuse me from the September quarter?

No, there wasn't.

Thank you very much.

Your next question comes from Brent Bracelin with Pacific Crest Securities.

Your line is open.

Obviously a very impressive quarter here.

Wanted to spend some time talking about the core BIG-IP business which obviously had a significant amount of upside this quarter.

Where were you guys surprised in that BIG-IP product line, was it one particular channel that did better than you expected through HP or Dell?

Was it an acceleration in share gains from competitors or was there an influx in customers embracing the platform?

Just would like to get your perspective on why you saw upside in this quarter, particularly given a lot of the Buffalo Jump product went to backlog?

Yeah, I mean it was very much across the board so it wasn't like any specific one off channel hit or, frankly, any big customer, one off big customer.

We did have some big wins, but not substantially different from any other quarter.

The thing that was very encouraging, very, very encouraging was that during the transition to Buffalo Jump, as I said earlier, the existing product line was still very strong.

And I'm convinced the reason for that is the return on investment that traffic management, if used properly gives our customer base and the mission criticality of it.

So it's saving the customers money, it's also very important for the mission-critical application.

So even a lower number of customers were aware of Buffalo Jump they decided to deploy the existing applications.

The beauty about Buffalo Jump is is it it gives us a lot more opportunity to improve that return on investment and to do more and more applications.

It really was across the board.

I don't think there's anything specific we would point to.

So there's no real change in the kind of mix of kind of new customer versus revenues from existing customers?

New customers was up a little bit this quarter but not a big change.

Okay.

Great.

And I know you talked about blade service for awhile but that market does seem to be seeing some traction.

I know it's going to be like $1 billion in revenue market in '04.

Did you guys see any kind of add on sales of software into the blade environment and is there any life there to that product line?

There is some life.

We did see some sales.

Actually it was up from the previous quarter, but I've got to put that in absolute perspective.

It's a very, very small percentage of our business, not really material to be honest.

You know, it's been one area where we just haven't seen the application mix suiting our solution.

When we talk about our confidence moving into 2005, and I actually said this a year ago, we are not really including the blade control opportunity as part of that confidence.

If it comes as upside that's awesome.

We are not moving out of the market, we haven't made any decision to do that but it's just been a tiny proportion of our business and we don't see that changing.

Okay.

Fair Enough.

Then my last question would be on, if you look at the security products on the MagnaFire (ph) -- actually the add on software to the BIG-IP platform, are you guys, or do you plan on breaking out add on software product revenue on a go forward basis or, again, you are not going to get that granular with guidance?

I don't think we will be that granular.

Obviously there's upside in margin as we do that and to maybe come (inaudible) from that but we won't be that granular, but obviously we have our own internal estimates of what areas like compression and rate shaping will be.

We think we are being pretty conservative and it's all in the mix of the guidance that Steve talked about in the 76 to 77% going forward.

Okay.

Great.

That you.

Very impressive quarter.

Your next question comes from Erik Suppiger.

Your line is open, and he comes from Pacific Growth Equities.

Congratulations on a very good quarter.

Thank you.

SSL VPN has been decelerating in the last couple quarters, both in terms of percentage growth but even in terms of dollar growth.

Can you comment a little bit, one, were you seeing any pricing issues or anything this quarter?

And, two, do you think that we could start to see that to accelerate any time soon?

Yeah, we haven't been seeing any pricing increases, decrease I should say.

What I said earlier was the one area I think we have the opportunity with SSL VPN is to get the deal size up.

At the moment we are seeing a lot of, making a lot of sales to a lot of customers which obviously bodes wells as we move forward.

But the deal size is still pretty small.

There are some indications that that may start to grow and I think that's when you start to see it being an acceleration in terms of an overall percentage.

Having said that, just in case -- just to remind everybody, we paid 25 million for Euro at the time when we said we would do between 8 and 12 million of revenue in the fiscal year and we exceeded that.

So we are very happy with that and to get more than half the cost of the (inaudible) in revenue in your first year and to move to number two in market position we feel really good about it, but like everything, like Buffalo Jump like BIG-IP we are not happy, we want more.

On the hiring front, your growth is going very well.

Can you comment where you might like to take your headcount or any comments on that front?

Yeah, Eric, we've been, this is Steve Coburn, we've been adding around 20 heads or so over the last several quarters.

I think looking out at 2005, and this is all subject to tuning based on what revenue growth rates are as we go forward, but I think we are expecting 20 to 30 hires a quarter.

Okay.

Then lastly can you just -- what was the growth in Japan?

I didn't catch the percentage from last quarter?

Can you just comment what that was?

We will try to find that for you Erik.

Very good.

It was 18% last quarter and the quarter before it was 11%.

Okay.

Very good.

That you.

Your next question comes from Larry Petrone from Decision Economics.

Your line is open.

Just a follow-up question to Ryan,s question earlier.

I was just curious if you felt the upgrades to version 9, or associated I should say, with version nine in effect change, to some extent, the competitive landscape for you?

In other words, does the product competition going forward increasingly come from the private companies and the Web application front end market rather than the Ciscos and the Nortels of the world who don't seem to have changed their product platforms a whole lot over the past several quarters.

This is Dan Matte speaking.

I think in terms of the overall competitive landscape, certainly the biggest competitors we continue to see are the Ciscos and Nortels just by virtue of the number of people and distribution channels and other aspects of their business.

From the application front end standpoint sort of a new label that's being applied to some of the products out there.

I think when we look at what's going on in the marketplace we look at what we offer in version 9, and most importantly we listen to what the market is telling us, what our prospects and customers are saying.

And they really want these functions coming from a major networking vendor such as F5.

I don't really think that the overall landscape is going to change in a big, big way.

Certainly the market will want these additional functions that we are able to deliver as modules on top as a traffic management operating system and I believe that we will be able to offer them the best solution possible coming from F5.

Just to add to that, and Dan talked about this and I mentioned it, I really wouldn't underestimate the traffic management operating system, TMOS.

As we move forward we are pretty convinced that that's going to be a major differentiation for us, not just with traffic management, because that's going to be the beef, but also the fact that we can add all this application functionality, for example, TrafficShield, that we think is a big buyer to entry versus complete system.

A follow up, then, do you expect that TMOS and the functionality in the version 9 potentially opens up some new market verticals for you that previously had been difficult for you to get into?

Absolutely.

Yeah, absolutely.

One of the things with traffic management operating system it gives us just a huge advantage when people talk about adding intelligence to the network and TMOS actually does it.

With the ability to go in and manipulate the traffic as it flows through, we are able to do a lot of different things.

If we don't have something sort of radio buttonnized if you will, or preprogrammed into the device people can customize it for their own uses.

So some of the places that we see the product being pointed toward or used for now are going deeper into people's architectures, down to the database level.

We see it can be used in conjunction with voice-over IP applications, there are just a number of different places that this can be used and customized using our iRules language.

That you.

(operator instructions) Your next comes from Alan Davis with McAdams, Wright and Ragen.

Nice finish to the year.

I just had a couple of quick questions.

With TrafficShield adding 8 to 12 million in terms of your guidance next year, just curious if you wanted to update us on what you expect out of FirePass this year and would it be fair to expect maybe twice what traffic shield is going to do?

I was also curious about the telecom vertical and total.

I know wireless is 12% of sales, I think telecom was about 14% last year.

I was wondering if you can update us on that percentage?

And then lastly on ASPs and where you expect that to trend, not absolute dollar-wise, how would you characterize where we may see ASPs going with the new products in fiscal '05?

Okay.

First of all, on Fire Pass we are just not being that granular I'm afraid.

We are really only really giving guidance on a quarterly basis and as I mention what we will do is report on security and we'll report on traffic management.

So sorry about that, but we are not giving that data out.

Regarding the ASPs I think there is room for the ASPs to grow, especially with Buffalo Jump and the fact that you can add functionality.

We are still to see that and we will get more data to get a real good feel for what that can be, but I think there's some are definitely some upside.

What we have seen in order now is definitely growth.

In other words, the number of $100,000 orders increasing the number of 500 thousand dollars orders, increasing and the number of $1 million plus orders increasing.

I would expect that trend to continue.

Regarding telecom, do we have that data?

I think it varies by quarter.

The quarterly number, the telecom number that I gave out before was 12% and that's pretty much in line with where it's been for over the course of the year.

Okay.

Just wanted to make sure I wasn't differentiating wireless versus telecom.

So when we are talking about the wireless, for example, people like Ericsson, Nokia, building our products into their solutions, that would comprise the majority of that percentage.

Okay.

Great.

Thanks, guys.

Your next question comes from Alex Buroughs from Deutsche Bank.

Your line is open.

Asked and answered, thank you.

Your final question comes from Eric Suppiger with Pacific Growth Equities.

Your line is open.

Wanted to just follow up on the Japan point.

Can you just discuss, you had some phenomenal growth out of Japan, can you discuss what caused that?

And secondly you are looking for a flat or down quarter, I guess you had said, coming up.

Why would that growth not continue?

There was absolutely zero surprise in terms of the fall from business in Japan with no -- I've seen this for a number of years which is that the strongest quarter is the one that ends in March because it's end of the financial year so we see that as very strong and again we expect that to happen as I said earlier.

The half year is the other strong quarter in Japan that half year was the quarter just finished.

And it's very much in line with what we expected and what we have seen in previous quarters.

Very good.

Thank you.

Thank you.

Okay, I think that being the last question, thanks for coming and we will talk to you in the next quarter.

Thank you.