F5 Inc (FFIV) 2005 Q2 法說會逐字稿

Welcome to F5's second-quarter financial results.

All parties will be in a listen-only mode until the question-and-answer session.

Today's call is being recorded.

If you have any objections, please disconnect.

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

Thank you, sir, you may begin.

Thank you, Sarah.

Welcome to our second-quarter 2005 conference call.

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

Tom Hull, Senior VP of Worldwide Sales, Dan Matte, Senior VP of Marketing, and Carl Triebes, Senior VP of Product Development and our Chief Technology Officer, are also present and will be available to answer questions following the prepared comments.

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

John McAdam will review the Company's operations during Q2 and add his perspective on the Company's goals and outlook for the current quarter.

We will then open the call for questions.

If you don't have a copy of today's press release, it is available on our website, 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In addition, an archived version of today's live webcast will be accessible from the events calendar page of our website through July 19.

From 4:30 p.m. today until 5:00 p.m.

Pacific time April 22, you can also listen to a telephone replay at 866-505-6448 or 203-369-1869.

The passcode for the replay is F5 Earnings.

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 release and described in detail on our SEC filings.

Please note that F5 has no duty to update any information presented in this call.

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

Now I'll turn the call over to Steve Coburn.

Thank you, John.

The second quarter of fiscal 2005 proved to be another strong quarter for F5.

Revenue of 67.7 million was above the 63 to 65 million target we had set on our January 19 conference call.

EPS of $0.31 per diluted share was also above our guidance of $0.28 to $0.29 per share.

Sequentially, revenue grew 7.7 million, or 13% over the prior quarter.

Year-over-year revenue was up 27.1 million, or 67%.

North America represented 55% of revenue, with international accounting for 45%.

This is consistent with the same quarter last year.

Product revenue represented 79% of total mix, and service revenue was 21%.

Security revenue, including approximately 250,000 of TrafficShield sales, was 6.5 million, representing 28% quarter-over-quarter growth.

Sales of BIG-IP version 9, our Buffalo Jump product line, represented 47% of traffic management revenue and 50% of traffic management bookings.

During the quarter we had one greater-than-10% distributor, Ingram Micro, which accounted for 17.8% of total revenue.

The book-to-bill ratio for the quarter was greater than 1.

Moving down the income statement, gross margin came in at 76.8%, comparable to prior periods and within our expected range.

Total operating expenses of 34.5 million were above our target range of 32.5 to 34 million.

Variable sales and marketing expenses were higher on increased sales.

In addition, we added headcount in key areas to support our growth.

Our Q2 operating margin was 26%, up from 24% in the prior quarter and 14% in the second quarter a year ago.

Our tax rate for the quarter was approximately 37%.

On the balance sheet, accounts receivable DSO ended the period at 46 days.

Inventories came in at 2.1 million and represented approximately 30 turns on an annualized basis.

Cash flow from operations was 17.6 million, and we ended the quarter with 293 million in cash in -- and investments.

Capital expenditures for the quarter were 1.4 million, and depreciation and amortization expense was 1.7 million.

We ended the quarter with approximately 710 full-time employees.

Moving on to the outlook, for the third quarter of fiscal 2005 we've set a revenue target range of 70 to 72 million.

We expect revenue growth in all theaters of operation except Japan, where we anticipate a seasonal decline.

We expect gross margin will remain within a range of 76 to 77%.

Operating expenses are currently targeted in a range of 35 to 36.5 million.

For Q3 and again in Q4 we expect an -- an effective tax rate of approximately 35%.

This will result in an effective annual rate of 36%, versus our previously assumed 37%.

Our after-tax earnings targets -- target is $0.33 to $0.34 per diluted share.

We estimate DSO will continue to be in the mid-40s range.

Inventory levels are targeted in a range of 2 to 3 million, and we are currently forecasting cash flow from operations in excess of 20 million.

With that, I will turn the call over to John McAdam, who will discuss factors that contributed to our Q2 results and provide further details about our outlook for Q3.

Thanks, Steve, and good afternoon, everyone.

I was really happy with our performance in Q2, from a number of perspectives. 13% sequential revenue growth, 67% year-over-year revenue growth, as well as the improvement in our operating margin to 26%, continued to demonstrate the growth in our business.

I was particularly pleased with our sales execution in North America, especially in the large enterprise market.

Our sales penetration into major accounts in North America continues to accelerate.

Japan and Asia-Pacific also experienced solid revenue growth during the quarter.

EMEA revenue was actually down a small amount sequentially, though actual sales bookings were up, which bodes well for revenue growth in Q3.

The only weak spot was U.S. federal, where the business was essentially flat over Q1, as we continued to see delays in project implementations.

From a product sales perspective, the reaction from our partners to our new-generation version 9 BIG-IP product, known internally as Buffalo Jump, continues to be very enthusiastic.

These products made up almost 30% of our total traffic management product sales.

I was also very pleased with our FirePass SSL VPN business progress last quarter.

If you recall, I indicated I was not happy with the FirePass sales results in quarter 1.

More focused sales and channel execution, combined with market-leading product functionality in the new versions of FirePass, resulted in a solid 28% sequential growth.

We also saw a significant increase in large project size and profile of the FirePass wins in the quarter, and I am encouraged by our [inaudible] line of opportunities in the large enterprise and service provider markets.

Sales of TrafficShield, our new application firewall solution, were below our internal projections, mainly due to the fact that the application firewall market is still at a very early adoption stage.

The interest level in TrafficShield continues to strengthen, but we are still in the early stage of a market where the customers want to evaluate and pilot the product before moving to full production status.

Given the experience we have seen with TrafficShield sales cycles, we now estimate a range of 1.5 million to 2.5 million for fiscal year '05, and between 2.5 and 4 million for this calendar year.

Nevertheless, I remain very excited about the potential for TrafficShield opportunity, especially when it's available as a software module on BIG-IP, and I will talk more about that later.

So overall, I feel good about the progress last quarter in our security business.

The fire channel is gaining momentum, the profile of enterprise sales wins is improving, and the competitive -- competitiveness of FirePass and TrafficShield is very strong.

We are making excellent progress in our product development road map to integrate our security solutions on top of our traffic -- traffic management operating system, TMOS.

Our first priority is to have TrafficShield running on TMOS as an optional software module.

As we have said on previous calls, TMOS is a very important element of our future strategy.

We already offer a number of add-on software modules on TMOS, like advanced authentication, compression, rate shaping, etc., and you should expect to see more modules being announced in the near future.

I am convinced that the F5 products occupy a very strategic position in the customer's overall -- overall solution architecture, and TMOS really allows us to leverage that critical real estate.

I believe that the delivery of TrafficShield running on TMOS will prove to be a very strategic milestone for F5 that really differentiates us from our competitors and is a -- is a tremendous proof point on the power and flexibility of the TMOS architecture.

Our software and architectural roadmap, combined with a -- a very peripheral hardware design roadmap, should keep us in a very competitive position for the foreseeable future.

Okay, regarding Q3 outlook, Steve has indicated that we see the sequential growth of our business continuing, and that is reflected in our target revenue range of 70 to 72 million and our expectations for continued improvement in earnings.

As I think about guidance, the following factors are significant.

Our fundamentals are strong.

First and foremost, the pipeline of business going into Q3 is very solid.

The [inaudible] results we have seen in April are also very encouraging.

We have market-leading products with Buffalo Jump, FirePass and TrafficShield.

We expect to see Q3 sequential growth in North America, EMEA and Asia-Pacific, and we also expect continued growth in our services business.

Of course, there are some seasonal factors to take into account.

We expect Japan to be down quarter-on-quarter, as in previous years, and we are assuming U.S. federal spending will remain tight.

And as far as the environment is concerned, there's clearly some uncertainty in the overall spending environment.

That being said, F5 has experienced growth in excess of the market and we expect that to continue in Q3.

The value propositions of our products is compelling, both from an ROI and an -- and an efficiency perspective, as customers use our solutions to optimize, deliver and secure their mission-critical business applications over the network.

Once again, I'd like to thank the entire F5 team and our partners for their efforts in Q2.

And with that, we'll hand the call over for Q and A.

At this time if you would like to ask a question, please press star, 1 on your touchtone phone.

Once again, that is star, 1 on your touchtone phone to ask a question.

Your first question comes from Alex Henderson.

Your line is open, and please state your company name

Thanks.

Citigroup.

A couple of just technical questions.

What was the headcount?

710.

And you lowered your tax guidance for the back half of the year.

Should we assume the lower tax level at 36 in '07 -- in CY '06?

Yes, I think, basic -- basically now for internal planning purposes we are assuming 36 for next year.

Okay, and the services gross margins came in a little lower than -- that had been the trajectory.

What -- what was the cause of that?

Yes, a couple of things.

We -- we are seeing a lag effect on the -- the growth in services revenue, based on our deferral and amortization methodology for recognizing that revenue, so it does lag behind the growth rates that we've seen on -- on product.

Secondly, we've added more personnel in the support area, really, to support the new products, the TrafficShield product, and we currently are supporting two versions of the BIG-IP.

My -- my view is on the margin that I -- I think our expectations are that we're going to be in a range of -- of 73 to 75%, where we've kind of been historically, going forward.

So you'd expect the service gross margin to gradually rebound?

I -- I do, because I think the nature of the -- the costs -- the cost additions are sort of step-function in their nature, and I expect the growth rate in services revenue to -- to increase as we amortize some of the bookings that we've seen from the product sales.

For example, this quarter our deferred revenue was up 3.4 million, driven principally by service bookings.

Okay, a slightly different subject, option issuance.

The FAS rules on options obviously are still somewhat in flex.

What are your plans on reporting options?

If you decide to report options, will you report pro forma or will you report as is, and also will you change your option -- option issuance as a result of that -- that circumstance?

Yes.

This is Steve.

I'll answer the first part of the question, Alex.

I think it's likely that we would report pro forma going forward at the time we adopt.

We currently are evaluating the recently revised rules related to equity compensation expense, and expect to provide guidance on this matter next quarter.

And just -- just to -- to add to that, Alex, in case anybody's in any doubt, we -- we are very, very committed to continue with giving options to employees, because we think it's very critical for retention and recruitment, and our intention is to keep with it.

Okay, and did you give a book-to-bill on the quarter?

Yes, we said it was greater than 1.

Great than 1.

And one last question, then I'll cede the floor.

Linearity during the quarter, any swings between January, February and March, particularly in the U.S., on linearity?

Yes, overall -- overall bookings linearity for us, I mean we -- looking over the past four quarters plus, we've been in a range of -- of 40 to 50% bookings in the last month of the quarter.

For the quarter we're reporting now, we're in the lower end of that range.

Is that indication of difficulty in closing deals at the end of the quarter?

We -- we did see some slippage of deals, Alex, in -- in March, obviously similar to a lot of people, especially in -- in the enterprise.

Interestingly enough, most of that slippage actually came in in early April.

Now don't be too excited about it.

It's really early days, but -- but it did, and that's why I say that April actually started strong.

But, yes, we did see some slippage.

So -- so April picked up a little bit better than normal seasonal, then?

It did, yes.

Okay.

Thank you very much.

I appreciate your time.

Your next question comes from Samuel Wilson.

Your line is open, and please state your company.

JMP Securities.

After Alex's 15, I have two small ones.

One is, can you talk just a little bit about the federal government?

I notice it was flat last quarter and -- and -- with last quarter.

Is that a budgeting issue, a little bit what's going on there?

And secondly, are you making any fundamental changes to TrafficShield?

Are you accelerating the development of TrafficShield on the BIG-IP platform, kind of what's your thoughts there, in terms of development of TrafficShield?

Yes, okay.

In terms of the first one with federal, it's definitely a budget, in -- in terms of projects just being delayed.

It's not competitive in any way.

Actually, a -- a federal team are probably listening to me, and I do believe we've been doing a good job here, but it's tough out there in federal.

So the good news for us is that it does tend to be project-oriented and it's a pretty small percent of our business, but that's about all we can really add there.

In terms of -- of TrafficShield, I -- I'll ask Karl Triebes if he wants to comment as well, but it's actually a very high priority for us to have TrafficShield running on top of BIG-IP.

We -- we're hearing a lot of interest from the customers, and we're very happy with the progress, but we're not going to give a date yet.

I'm saying that even before Carl speaks.

Yes, that's correct.

It is a high priority in the development organization to integrate that on top of our TMOS operating system, and it -- it actually paves the way for future integrations of other products as well, so there's actually two reasons to do it.

One is for the TrafficShield functionality, as well as for future functionality we may want to add to that framework, or we will add to that framework.

Go it.

And then -- actually, I'll just leave it at that.

Thank you very much.

Your next question comes from Joanna Makris.

Your line is open, and please state your company name.

Hi.

Adams Harkness.

I'm wondering if you can comment a little bit on maybe a portion of your sales that are coming from BIG-IP version 9, relative to the -- the mix between new versus existing customers?

Yes.

It's really across the board, both existing and new.

We've seen some -- some projects that were brand new that are pretty significant in size, hundreds of thousands, and we've seen some hundreds of thousand paid-dollar orders from the customer base.

So there's no -- I wouldn't say there's a -- there's no major differentiation trend -- trend from the rest of -- of our core business.

That tends to be in the 40 to 60% range, 60% existing, 40ish percent new.

Okay, and then on TrafficShield, can you talk a little bit about the integration that's been done to date within the channel, i.e., is there any selling of the TrafficShield products through the iControl partners at this point?

Okay.

It's -- remember it's not through the [inaudible] group, it would be through our value-added resale and -- and our distribution channel.

We've done some work with iControl partners, but that -- that's a slightly different subject.

That -- that's more with a view to building in some -- some policies and some technology hoops, but in terms of selling it, we've started signing up partners to do that.

It's been a little bit slower than -- than FirePass, I think, because of the -- the early market adoption and because of the complexity.

We do keep hearing -- sorry to just beat on this -- we do keep hearing about the -- this requirements for running on BIG-IP, so I think that's been a slow-down factor as well, but you'll see that -- you'll see that continuing to partner what -- -- what we're doing over the next couple of quarters.

Thank you.

Troy Jensen, your line is open., and please state your company name.

ThinkEquity Partners.

Congrats on a -- on the great results, guys.

Thank you.

Thank you.

A couple quick questions.

Sorry.

A couple quick questions.

Could you, John, maybe talk about integrating caching capabilities?

I think you guys have talked about that previously, just curious to get a timeline from you.

Okay.

Go ahead, Dan.

Sure.

This is Dan Matte, Troy.

You -- we have talked about caching previously, and in fact, we already have it out in operation in some customers right now, and you can look forward to some announcements from us in the very near future on that.

You -- you may notice I -- I say it in my script, in the very near future we'll be adding some software modules.

The emphasis is on -- is on "near."

And as Dan says, we've got it running in some customers.

All right, perfect.

A quick question for Jeff, maybe on the security side, with Microsoft's remote server access capabilities.

Do you see that as any type of competitive threat to the SSL VPN?

First of all, sorry, Jeff's in Japan right now.

Sorry.

Hopefully selling stuff, so he -- he's not on the call today.

Dan, I don't know if you want --

Yes, sure, I can tackle that, Troy.

As far it -- it goes, and -- and with RAS services and -- and stuff like that, really people are -- are using FirePass and the SSL VPN technology group in general, sort of as a -- as an alternative to get into their network resources.

So really, I mean, I guess they are somewhat of a -- of a competitive alternative, but I think in terms of either the deployment and additional levels of protection that can especially be afforded on the client side, SSL VPN and FirePass, in particular, offer a lot of benefit.

Got it.

One last question, and I'll get out of queue here.

Steve, have you guys thought through maybe what a long-term operating margin goal would be?

Troy, you know we're -- we're pretty much still of the same position we were last quarter when we discussed this.

We -- we had set up a -- a target model awhile ago, being 18 months ago or so, that said we think we've designed a business model that should yield operating margins on a sustained basis between 20 and 30%.

Well, we've been well -- well inside the -- the lower end of that range.

We're in sort of the midpoint the last couple quarters.

I think as we approach the upper end of that, we will reassess and -- and recalibrate what we think our longer-term target model will be, but -- but are not doing that at this time.

Great.

Well, keep up the good work, guys.

Your next question comes from Erik Suppiger.

Your line is open, and please state your company name.

First, congratulations on a solid quarter there.

Thank you.

Can you comment on lead times?

What were they at the end of the quarter and -- and what did they do during the course of the quarter?

Were there any issues there?

Yes, this is Steve, Erik.

We did have some shipping delays during the quarter that persisted from the -- from the previous quarter that impacted our -- particularly our January and -- and February shipments.

We -- we were able to work through many of those issues by quarter-end, and we expect it will be a better -- we think we have that situation in a better place and under control going forward.

But we did experience some shipping delays during the quarter.

What -- what are the lead times at the end of the quarter here?

You know, that varies by -- that varies by component, so it -- I think it's very difficult to -- to generalize.

I mean, some of the actions and steps that we're taking are hardening our forecasting capabilities to -- particularly at the mix level, to really get a solid look at a unit level on that to help us manage the -- the ordering and the lead times on the supply chain.

We will buy down some lead times and carry component parts in inventory where it makes sense to do so going forward, and in some cases we're looking at, and have made some changes, in terms of our suppliers going forward, to help us manage that lead time and be a little more effective in addressing those issues.

Okay, and then you said the bookings in the third month of the quarter here were at the lower end of your 40 to 50% range.

How come you saw a pick-up in DSO?

Really a couple of reasons for the DSO pick-up.

One -- one was that we saw a tipping of the domestic/international mix to international, where we have extended payment terms, where we had almost 5 percentage points of swing quarter -- quarter-over-quarter.

That was a big part of it.

Another aspect of it -- I made a reference to the increase in our deferred revenue for the quarter, which was one of our biggest increases that we've seen maybe ever in deferred revenue, going up 3.4 million, and that has -- that has a -- an effect of extending the DSO because what happens is that deferred revenue is included in the accounts receivable balance for which we do that calculation, but it's not included in the revenue that's in the -- in the calculation.

So between those two factors, we did see the -- the four-day increase in the DSO.

Okay, then finally, on the competitive front, any comments either from -- any comments discussing the traditional players, and then maybe any comments on some of the start-ups.

Have you seen any more of the -- the emerging players here on the application acceleration side?

I'll -- I'll answer quickly, and maybe Dan could -- could talk as well, but we haven't really seen any significant change in the profile.

So, in other words, in -- in the traditional players, if you like, Cisco in particular, and to some degree Nortel, but mainly Cisco, we -- we're still in a very, very strong competitive position in that area.

And then from the [inaudible], specifically NetScaler or Redline, again we haven't seen any significant change.

I mean, obviously Buffalo Jump was the -- the -- the big milestone for us that gave us pretty-- pretty huge competitive advantage.

That's why we've been seeing the growth.

Yes, absolutely.

You can look back to things like the [inaudible] report, for example.

In the quarter in which we introduced version 9, you can see a significant change in terms of the rate of growth of some of the -- the other category in which the upstarts are -- are counted.

So definitely that's having an impact in the marketplace.

Very good.

Thank you.

Thanks.

Your next question comes from William Becklean.

Your line is open, and please state your company name.

Oppenheimer.

Application front-ends are getting a lot more visible now.

Could you give us some idea of how penetrated you think that market is, and over what period of time it will take actually to -- to meet the full demand for application traffic management front-ends?

Yes, I'll -- again, I'll give my opinion, and -- and you may want to -- to follow up, but I -- I look at it not so much from a strict -- strictly marketing point of view.

I tend to look at it from an account penetration perspective, and when -- when you look at our -- our business over the last couple of years, and that's pre-Buffalo Jump and not post-Buffalo Jump, well, I guess there's more of an application front-end aspect to it.

The -- the -- quite honestly, when we sell into a Fortune 500 for the first time, it may be 50,000 or 100,000-type project.

And if we execute properly, we can find many more projects in these accounts and we can turn these accounts into million dollar annual accounts, and sometimes two, sometimes three, sometimes more.

So I believe, in terms of the opportunity for us, in terms of optimizing and securing applications in the network, we're at the beginning stages of it, and I think the market is pretty big.

I couldn't give you a number, because I -- I -- I don't know that, but I though it's a big opportunity.

Bill, this is Dan.

I -- I -- you know, it's interesting, there are a lot of different terms out there for different functions that these -- these types of devices are providing on the -- on the network, so AFE, Application Front End, was one coined by a very particular analyst, and I guess the way that I look at it is that what's going on in -- in the AFE market, and the -- the acceleration piece of it specifically, really is -- is a subset of what we've been talking about from application traffic management.

So I think over time what you will see is that that functionality winds up being consolidated into -- into other types of devices out there in the marketplace.

And then I think the other thing to point out, and really goes to the point that John was making in terms of penetration, in terms -- in terms of large enterprises, is that because of the strategy that we've taken with -- with TMOS and the ability that we give people to offload many, many services, including things that were done specifically in the application, even some programming stuff onto the network, just gives people tremendous economic returns.

So AFE certainly has caught people's attention over the past little while.

We know that we've made a huge impact with version 9.

We'll make an even bigger impact with the modules that are rolling forward, and we think that we have the absolute best strategy with TMOS into the future.

Thank you.

Your next question comes from Ryan Hutchinson.

Your line is open, and please state your company name.

W.R. Hambrecht.

Thanks, great quarter.

A couple questions here.

Just on the housekeeping front, in the past you've given a -- a breakout in Japan as percentage of revenue, as well as Asia and EMEA.

Could you provide that, as well as the -- I guess the government versus the U.S. government?

Yes, I'm just getting the data in front of me, so correct me if I'm wrong here.

North America was approximately 55%, international 45, which is what Steve mentioned in -- in his talk.

Of -- of the international, EMEA approximately 16%, Japan approximately 18%, and APAC 11%.

16, 8 and 11?

18.

18.

Oh, Japan was 18, yes.

Right.

So 16 for EMEA, 18 for Japan and 11 for APAC.

And -- and then the -- the government and the U.S. government?

The U.S. government was approximately 4%.

And I think you've given government as well in the past.

I think it was 9% last quarter?

Yes, I think it was near 7.

7?

Okay, great.

Because of the U.S. number.

Okay, and then correct me if I'm wrong here, but I think on terms of the product roadmap, on last quarter's call we talked --

Hello?

Oops, Ryan, you're gone.

We lost you there. [Inaudible.] Hello?

Just one moment.

Okay, your next question comes from Jiong Shao.

Your line is open, and please state your company name.

Lehman Brothers.

Thank you very much.

A couple of questions, guys.

First [inaudible] on Japan, there have been a lot of commentary about the -- this particular regional market from other networking companies.

I was wondering, can you just talk about the overall demand for -- for networking equipment and for [inaudible] from -- from where you stand?

Okay.

So if you look at the results, we were, as I say -- just a note in the previous question, we -- it was [inaudible] 18%.

That compares with a year ago at the same quarter to 22%, so we're -- we're certainly down a little bit from a year ago.

Last quarter is the financial year-end, so it tends to be strong for us, but the -- certainly having looked at the external environment, clearly the spending there seems to be reasonably tight.

When we look at forecast that we're -- the guidance we've given for this quarter, we have assumed that Japan would go down, having said that, based on that and previous years.

The big thing we've got going for us in Japan is our partner group.

We have a real list of who's who reselling our products in Japan, whether that's a -- a number of NTT departments, NEC, Tokyo Electro and CTC, the largest integrator, IBM Global Services, Hewlett-Packard.

So on one market we have [inaudible] in our market, so, yes.

Does that give you summaries?

Last quarter you commented that Japanese customers seemed to be acting slower in embracing version 9.

So I was wondering, did you see any improvement in -- in their purchases of the BIG-IP version 9 this quarter?

No, actually, and I'm not sure I'd use the word improvement, because we expected it to be traditional products before version 9, so that was no surprise to us.

What we do expect now is to see some movement towards version 9 this quarter.

Okay.

My second question is on your headcount.

I - I see you -- my -- if my math is right, you hired about 60 people this quarter, and I think previously you had said 20 to 40 people a quarter, something like that, a little bit ahead of plan.

And also your [inaudible] grew 10%, almost as fast as your top line.

So I was wonder whether or not that math is right, and do you think going forward your -- your hiring plan may -- may perhaps go down a little bit for the rest of the year?

Well, first -- first things first.

Our outpays didn't grow as fast as our top line, in the sense that our operating margin increased, which obviously is [inaudible].

We had a nice, healthy jump in the operating margin.

And we did -- you're absolutely right, we did say that we -- we were looking at between 20 and 40 at the beginning of last quarter, and frankly decided to -- to do more investment, given the -- the growth that we're seeing and the potential moving forward, so we did move towards 60.

In many areas there were -- were sales, sales support and sales at [inaudible], an obviously forward-looking, thoughtful investment there.

We hired in product development, we hired in marketing, and we hired in services as well.

Okay, just -- but going forward do you think you -- it's going fall back to the 20 to 40 addition every quarter?

Yes, we'll be probably be looking in the 20 to 40 range.

And always remember that we do tend to be pretty anal in the way we run the business, so if we see more of an investment opportunity, we'd make that decision one way or the other, but yes, that -- that's a good assumption.

Okay.

My last question is on the share count.

The share count was a bit higher than what I had.

I was wondering, do you -- is there anything in particular you -- you -- you can sort of comment on?

You know, I think for internal planning purposes looking forward, I think we would expect the share count to increase 600,000 to 800,000 shares per quarter, slightly higher than we've been saying before, which we were saying about a half million before.

So we have -- we have seen a little greater increase than that over the last couple quarters, so I -- I would set an expectation of 6 -- 600 to 800.

Okay, great.

Thanks, guys.

Solid numbers.

Thanks.

Your next question comes from Ryan Hutchinson.

Your line is open, and please state your company.

W.R. Hambrecht.

Can you hear me now?

Yes.

I'm not sure what happened there.

Okay, product gross margins, is that -- the primary driver there, can I view that as an uptake on some of these BIG-IP add-on modules?

And if so -- well, that's the first question, and second of all, should we expect that -- those levels to continue here in the high 60s -- 6 -- 76.8% so?

Yes, we did have -- I don't know, about a 70 basis point improvement in our product margins over the quarter.

We're still in the early days of the software modules, though, and that was -- we will see some variation in that, depending upon mix and component pricing and attach rates on software modules, etc.

I think the -- the reality is we're just training our sales force this quarter on -- on the sale of the software modules, so looking forward we expect to see some improvement, and that's really what's been standing behind our expectation.

We need several quarters to understand what the longer-term attach rates are going to be.

We really focused in the first quarter of release training the sales guys on selling the base platform.

This quarter they're coming in for training on software modules, as well as some other factors.

So I'd say we still need another quarter or so to understand what those attach rates are going to -- natural run rates are going to be.

Okay, great.

And then just one final one.

I think you guys talked about product roadmap last -- last call.

We talked a bit about Montreal and I think what was said, obviously is early '06, but I think you indicated that you expect a quote, unquote -- a fairly big product before that.

Can we get an update there?

Well, we still -- it's still the same.

Okay.

We're -- we're not giving specific dates on it.

There -- there -- there's going to be two things before Montreal, more than two, but two specific ones.

Obviously we've talked a lot about TrafficShield integration, so you'll hear about that.

And also we will have some -- some point products, one of them being pretty large that will also come before it, but we really don't want to give a date yet because it could slip a month or so.

Things are progressing well, that's how -- Do you want to talk about it?

Yes, I was going to mention, yes, we -- we do have some big things in the pipeline and we're -- we're pursuing them vigorously, so I expect [inaudible] one big thing later this year and then start -- the beginning of next year.

But, again, I think it's going well.

And -- and when you say point product, can you -- can you help us understand what that means?

Well, yes -- yes -- that's a BIG-IP -- it's a BIG-IP version.

Okay.

Is it targeted at the branch?

The -- the one I'm talking about is to the high end.

Okay.

The branch is another subject altogether, and we're doing -- we're doing stuff in that as well, but again, we're not really in a position to talk in detail about it.

Fair enough.

Thanks, guys.

Ehud Gelblum, your line is open, and please state your company name.

Excuse me, Mr. Gelblum, your line is open, and please state your company name.

I'm sorry.

This is Kim Anderson in for Ehud.

I was on mute.

I apologize for that.

I just wanted to ask you a few questions about the security business, and it was up quite a lot more than we had anticipated, I'm assuming fueled by the FirePass product.

Can you talk a little bit about the specific actions that you took during the quarter, you rectified the weakness last quarter?

Yes, I mean it's -- it's pure bread and butter stuff, and Tom might want to comment [inaudible], but it's -- it was all about sales and channel execution from a tactical engagement point of view.

We also had announced before the quarter a lot of new terrific functionality in the product that real -- really differentiated us in areas, for example, like endpoint security.

So we knew we were going into the quarter with a -- with a stronger product set, but at the end of the day it was about focusing on the channels, creating them, engaging in deals and really setting up the pipeline.

Yes, I'd just say our hat's off to the sales team for really going out and building the pipeline and pulling the deals in.

Okay.

So a lot of movement there.

Yes, and feel good about it.

The other thing I mentioned was the profile of the deals.

The deals that we've seen, they are much more mission critical-type applications, number one, and also the size of the larger deals went up as well, and that tends to mean a better adoption within the enterprise which -- we've only got one quarter so I don't want to declare that yet, but it's certainly a good indication towards that.

Okay, and is Juniper's NetScreen product your primary competitor in that space, or who are you seeing?

No, that's it.

Okay.

It's mainly the -- the [inaudible] product that Juniper has.

Okay, great.

And then back to the competitive landscape for the traffic manage -- excuse me, the traffic management products, when you go up against -- is it primarily against Cisco and Nortel -- when you go up against these guys are you in each situation --or -- is it a competitive situation, or are they even there at all, because your product seems to be quite differentiated from what Cisco and Nortel to have offer?

That -- that's correct, and it's mainly Cisco, and the reason it's mainly Cisco is because they tend to dominate the enterprise accounts and -- and, to some extent, the service providers that we are selling in to, so by definition they tend to be there, and quite often they'll have a -- a traffic management customer base in -- in those accounts.

And it's -- it's all about what you say that's about functionality, and -- and to some degree performance, but mainly functionality, and we believe we're way ahead.

Okay, great.

Thank you.

Your next question comes from Rohit Chopra.

Your line is open, and please state your company name.

Hibernia.

Thank you.

I had just a few questions.

John, you had mentioned in your comments towards the end that there was some uncertainty in spending, and I wanted to know what specifically you heard from some customers that made you say that.

Related to that, I wanted to know if you've heard about customers breaking large projects into smaller ones and possibly spreading those projects over a longer period of time?

One of the -- one thing that happened last quarter was that you had supplier issues, and this time you mentioned that you had shipping delays, so I just wanted to know if you had any supplier issues this quarter.

And the last question is about TrafficShield.

You've sort of taken those expectations lower for last two quarters, and I really wanted to understand what the disconnect was between your forecasting and maybe what customers had told you before, where you had forecasted that demand, other than the fact that you're saying there's a longer adoption period.

Okay.

Right, so look -- I'll take that.

I think there's three main points.

First of all, in terms of the -- the comments I made about the -- the -- the spending environment or the -- the -- the -- the technology economy environment, that really didn't come so much from customers.

That came from watching results from our peers and competitors.

We were quite frankly a little bit surprised at some of the misses that we saw, and that's got our attention.

You then combine that with the fact -- what I did see was -- in March we did see some slippage, not a tremendous amount, but we did see some slippage.

But I also said that a lot of that slippage actually was closed in early April, so there's a bit of conflict here.

But we -- I think we're -- we -- it's not -- it's not something we're going to ignore, and that's something we've taken into account when we we're looking -- when we give guidance for our target range this quarter.

So that's not really been asking customers.

I haven't -- I can't honestly say I've seen customers splitting projects.

There may be some examples of that, but not -- yes -- no, and I'm looking at Tom as I'm saying that.

There's no -- we -- we haven't seen any significant pattern there at all.

So it was mainly looking at some of the results that have been going on this quarter from a lot of our peers and competitors.

In terms of -- let me go to TrafficShield, and then Steve can maybe talk about the suppliers -- the supply -- supply chain issue.

In TrafficShield, you're absolutely right.

We -- we have dropped our forecast from last quarter.

We actually said 8 to 12 for the calendar year, and you have -- we -- we've dropped that fairly significantly.

Not for any sinister reason, I can assure you.

It's -- it's -- when we look at the -- the -- the focus that we've got from a channel perspective, we're spending most of our time on Buffalo Jump.

We're spending a lot of our time on FirePass.

The same with our partners.

And we've had some bandwidth issues in that, and that's one of the reasons we've been investing.

But the real, real issue with TrafficShield, in our view, is the -- the early adoption cycle of that solution.

We think that -- customers want to prototype it, they want to pilot it, they want to check it out in an ordinary environment before they put it production, and we've seen sales cycles that have been pretty long.

And remember, just to put in this perspective, last quarter was first full three-month quarter we had selling TrafficShield.

So that was first one, so if you like that sort of excuse.

Now the exciting thing about TrafficShield is that feedback we're getting from customers when we talk about our roadmap, and maybe to some degree we've been causing our own problem her in terms of talking about that roadmap, but we think it's very important to let our customers know that.

In terms of the software module going on BIG-IP, the excitement level is very high, and that's why it's now a number one priority in the product roadmap.

Yes, regarding reference to shipping delays during the quarter, we -- as we've said, we did -- did see -- see those, and those were related to supply chain issues, particularly lead times on component parts.

So it is the same issue.

Those aren't two different issues.

The -- the shipping delays were caused by lead time issues on component parts for -- for some of the platforms.

Okay, good.

Thank you.

I appreciate it.

Your next question comes from Brent Bracelin.

Your line is open, and please state your company name.

Hello?

Hello.

Pacific Crest Securities.

Thank you.

I guess I wanted to follow up on the BIG-IP, John.

You know, I'm looking at my model, it looks like we have nine consecutive quarters here of sequential growth, another stellar quarter for BIG-IP.

We did see some slowdown in IBM's XA6 server business, it's had some shortfalls in the software and -- and networking space.

I thought it would be helpful if you just kind of revisited the growth drivers of kind of BIG-IP.

It would be helpful for me specifically if you could talk a little about -- a little bit about 3G, kind of wireless trends, what was the impact of telecom specifically on this quarter, what was the impact that you saw from kind of the web services space, and then also what was the impact that you saw from some of the iControl partners that's helping drive growth sort of in the core BIG-IP product line?

Okay, yes.

So the first thing, some of the drivers, and Dan, if -- anybody give me reminders here -- I mean, remember what we're doing here is that we are -- BIG-IP is effectively optimizing and securing applications running in the network.

So depending on the application, whether it's Microsoft apps or Oracle apps or Siebel apps, we can provide a reduction in cost in terms of the number of servers and massive increases in efficiency by using BIG-IP to do that.

So whether it's compression, whether it's SSL encryption, it's a big ROI-type sale, and also optimizes at the same time.

You can sometimes see between three and ten times performance improvement if you put a version 9 BIG-IP product in front of your -- your app, so very much focused on apps, while saving money and increasing efficiency, and as the number one driver.

On apps being deployed, there's -- we don't see any slowdown of that across the Internet.

That's -- that's -- that's something -- it may not be new apps for the company, but they're -- they're deploying them over the Internet and making them accessible through the Internet, so that's the -- the core driver.

Also just -- we mentioned Intel.

The whole NT and Linux drive towards horizontal computing is a big, big drive for -- for BIG-IP, and that's because it reduces the cost of spending in the data center by using Intel-based NT and Linux solutions, but it increases the number of processors and the number of systems, and therefore the traffic management optimization becomes a -- a greater value proposition.

In terms of 3G, it's interesting that you -- that would -- we -- definitely 3G, but generally mobile and wireless, is -- is definitely still a big driver of our business.

In fact, last quarter was the first quarter that actual telco outshone finance as -- as the top [inaudible].

So some of that is focusing on service provider, but a lot of it is mobile that's been doing that.

In that -- in the telco space, was that north of 10, 15%, or -- ?

I think it was near 20%. 19 -- 19%.

Wow.

Okay.

And then web services, Dan, I don't know if you -- do you want to comment?

Yes, absolutely.

So the web services piece you can definitely tie directly into may of the iControl initiatives.

So iControl -- when we look back at the previous quarter, continued to drive approximately 40% of our -- of our sales over the quarter, so looking at implementations that people have done that are influenced by or driven by iControl with partners like Oracle and Microsoft.

So as companies out there continue to adopt web services and use that as the common language to standardize across their applications and -- and get them to work together, iControl is just a natural fit, and we speak the same language as them, so that continues to also be a very strong driver for us.

And then just one quick follow-up on the -- on the telecom space, just given strength there you saw.

Was that relatively broad-based?

What's your visibility into that market?

Is that market -- tends to be kind of lumpy, or do you -- do you have some -- some visibility into some -- some large orders in that vertical specifically?

No, we definitely have visibility, and it's pretty broad-based as well, so we're talking about doing business with companies like Deutsche Telekom Sprint, Verizon.

It -- it's pretty much across the board, and it tends to be very project based.

Okay, great.

Thank you.

Your next question comes from Eric Suppiger.

Your line is open, and please state your company name.

Pacific Growth Equities.

Say, on the -- on your services organization, have there been any challenges with scaling that and meeting customer demand requirements as you introduce the ex -- I'm sorry -- the new operating system?

The short answer is yes, although it's challenges that we think we're up for.

The real challenges have been the fact that we did 67% growth year-over-year this quarter and we did 66% growth the year before, and that was on top of a very, very solid year last fiscal.

So we're growing pretty aggressively, and that's why we've been investing.

Steve mentioned one of the reasons that -- that the service margins were down was because of investments, that we've been investing in people.

The other -- the other strength in the organization has been the fact that we have introduced a new product line with TrafficShield and new product line with FirePass, very similar in nature to the skill set needed, but, yes, there -- there's no question about that.

But I think it's something that -- that we're in top on

Well, then -- then, I guess the question is, do you feel like you're at a point now where you can manage the -- the growth that you've had, or is it still a -- a game of catching up?

You know, I'm hoping the growth is always there, Erik.

So I -- I -- I like growth to be the number one challenge for the Company, so I think that that will continue.

That -- and that was slightly flippant.

I think we're catching up, to put it in overall perspective.

It's worth mentioning another topic that's very related to this question, advantages it's got.

Sure.

Erik, so this -- this is Dan.

As John said, with DevCentral, which is a site that we've had as part of F -- F5's overall web presence, it was designed as a place for people to share information on how to use some of these more advanced functionalities, whether it's iControl-related or iRules related, which was introduced in the version 9 capability of BIG-IP.

And we've just seen a tremendous amount of growth in -- in that.

I think we're over 3,500 users registered to the site.

We're to the point where users are answering questions for each other, so we're seeing a proliferation of expertise on the subject matter out there.

And so we're -- we're looking at -- at how is it that we -- that we get people educated on the -- on the power and how to use what our products are capable of doing.

Certainly by starting up communities like this is one of the ways that we can achieve leverage.

And then secondly, is the FirePass -- is that disproportionately selling into Japan?

Is it a higher concentration in Japan?

No, no it's not.

It's -- it's -- the one -- one other interesting thing I don't think we mentioned -- we're not always going to get into this type of detail, but FirePass was -- was strong in all geographies, U.S. included.

Japan was up, but not -- not significantly versus other geographies.

Very good.

Thank you.

Thanks.

Your next question comes from Ryan Randall.

Your line is open, and please state your company name.

Thanks very much.

Cannell Capital.

I just have a -- a very quick question on the security segment of your revenues.

You guys said you did like 6.5 million.

I think 250,000 was TrafficShield.

Does that -- does that get the FirePass to about 60 or 50?

Is that the way to look at it?

Yes.

Okay, cool.

Thanks very much.

Okay.

Your next question comes from Will Crouse [ph].

Your line is open, and please state your company name.

Hi. [Inaudible] Capital Growth.

And I was going to try to get an idea what sort of traction your new features are getting.

So what -- what percentage of your -- your BIG-IP customers are using your new features, the -- the compression, acceleration?

Yes, we haven't -- we don't actually -- we're not getting as detailed as that.

Yes.

There's been a pretty high take-up, SSL being number one, compression being number two.

All of our products have been installed on customer bases, but we're -- we haven't actually given out percentages.

And as Steve said earlier, until we -- we feel better about what the take-up and the pattern is going to be, we're going to leave off that for the time being.

Okay.

Okay, so -- does that mean that in the -- in the future you may do that, or does it just mean that -- ?

We -- we may, yes.

Okay.

Thank you.

Thanks.

I think we'll have one more question, and then we'll wrap up.

Your final question comes from Samuel Wilson.

Your line is open, and please state your company name.

It's a follow-up from JMP.

Two things.

John, I -- I apologize, I missed how much business did you say came from telecom and what's been the trend recently?

It was 19% in the quarter.

I can't remember exactly what it was last quarter.

Here, I've got it.

Is it trending up, down?

Up -- up -- up from 15 to 19.

Okay, and then just -- I know this is an off-the-wall question, but do you sell anything at all in the blade server market anymore?

Oh, God.

And that's going to be our final question, Sam?

No, it's been tiny, very tiny, and -- and -- and quite honestly, we've not been putting much focus on it.

Well, [inaudible], I mean, is -- is it at all a focus of the development teams anymore?

Not significant.

Okay, thank you.

All right.

Okay, well, with that I think we'll close the -- the call, and we'll talk to you next quarter.

Thanks a lot.

Thank you.

That concludes today's conference call.

You can disconnect at this time.