F5 Inc (FFIV) 2006 Q1 法說會逐字稿

[OPERATOR INSTRUCTIONS]

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.

Welcome to our first quarter 2006 conference call.

Speakers on today's call are John McAdam, President and CEO, Andy Reinland, Senior Vice President and Chief Finance Officer.

John Rodriguez, Senior VP and Chief Accounting Officer, Julian Eames, Senior VP of Business Operations and Global Services, Tom Hull, Senior VP of Worldwide Sales, Dan Matte, Senior VP of Marketing, Jeff Pancottine, Senior VP and General Manager of our Security Business Unit, and Karl Triebes, Senior VP of Product Development and CTO are also present and will be available to answer questions following our prepared comments.

Andy Reinland will begin today's call with a view of the financial results for the quarter and our current outlook for the second quarter of fiscal 2006.

Following Andy's comments, John McAdam will review The Company's operations during Q1 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 do not have a copy of today's release, it's available on our website, www.f5.com.

In addition, an archive version of today's live webcast will be accessible from the events calendar page of our website through April 20th.

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

Pacific time January 20th, you can also listen to a replay at -- a telephone replay at 888-568-0710, or 203-369-3775.

Pass code 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 results are summarized in our quarterly release and described in detail in our SEC filings.

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

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

And now I'll turn the call over to Andy.

Thanks, John.

During the first quarter of fiscal 2006, we achieved solid revenue growth driven by continuing strength in our core business.

Total revenue of 88.1 million exceeded our 85 to 87 million target range and was up 9% from the prior quarter and up 47% from the same quarter a year ago.

Top line growth was led by 13% growth in revenue from our BIG-IP product family.

Book-to-bill during the quarter was greater than one.

Revenue grew across all geographic regions, except Japan, where it was essentially flat with the prior quarter.

North America represented 59% of total revenue, with EMEA accounting for 17%, Japan, 13%, and APAC 11%.

Government represented 9% of revenue, with U.S. federal accounting for 6%.

Revenue from telcos and service providers was 19%.

Ingram Micro was once again our sole 10% distributor, accounting for 14.9% of total revenue.

Product revenue represented 78% of the total mix and service revenue was 22%.

Revenue from our recently acquired WAN optimization and acceleration products was 875,000 during the quarter, in line with our expectations.

Security revenue was 6.6 million, or roughly 8% of total revenue.

This was well below our internal target and down from 8.7 million in the prior quarter.

Although we are disappointed in this result, we continue to believe that both our SSL VPN and application firewall technologies will drive growth as part of our comprehensive application delivery networking solution.

John McAdam will have more to say on this subject following my remarks.

For Q1, gross margin of 78% was above our 77% target.

The increase in gross margin resulted primarily from higher adoption of software modules and increased deficiencies in our supply chain.

GAAP operating expenses were 46.7 million, within our guidance of 45 to 47 million.

Pro forma operating expenses, which exclude stock-based compensation, were 41.8 million and within our target range of 40 to 42 million.

On a pro forma basis, our operating margin was 31%, comparable with the prior quarter.

Our pro forma tax rate for the quarter was 37%.

On a GAAP basis, net income was 15.2 million, or $0.37 per diluted share, above our guidance of $0.33 to $0.34 per share.

Excluding stock-based compensation, net income was 19 million, or $0.47 per diluted share, above our pro forma guidance of $0.44 to $0.45 per share.

Our balance sheet remains strong.

Cash flow from operations was 34.5 million.

We ended the quarter with 373 million in cash and investments.

Reflecting the strong growth of our services business, deferred revenue increased 10% to 43.3 million at quarter end.

DSO was 50 days, slightly above our target range.

Inventories were 2.7 million, consistent with the prior quarter.

Capital expenditures for the quarter were 3.9 million and depreciation and amortization expense was 2.4 million.

We ended the quarter with approximately 890 full-time employees.

Moving on to the outlook, for the second quarter of fiscal 2006, we have set a target revenue range of 93 to 95 million.

We are targeting gross margin in the 77% range.

Our GAAP operating expense targets are 47.5 to 49.5 million.

Pro forma operating expense targets, which exclude stock-based compensation, are 42.5 to 44.5 million.

Our Q2 earnings targets are $0.39 to $0.40 per share on a GAAP basis and $0.49 to $0.50 per share on a pro forma basis.

We expect a GAAP effective tax rate of approximately 38% and a pro forma effective tax rate of approximately 36%.

We estimate DSOs will be consistent with the quarter just ended, at or around 50 days.

We expect inventory levels within a range of 2.5 to 3.5 million and we will-- we believe we will continue to generate cash flow from operations in excess of 30 million.

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

Thanks, Andy, and good afternoon, everyone.

With our Q1 results, F5 has now delivered sequential growth every quarter for the last three years in a row.

Clearly, a milestone that the entire F5 team should be proud of.

From a geographic point of view, all the major regions met or exceeded our expectations for the quarter.

EMEA discovered strong sequential growth over the seasonally weak summer quarter.

U.S. enterprise was up, as expected, and momentum in Asia-Pacific continued.

The Japan business was virtually flat versus the previous quarter, which was very positive, given the historical weakness and seasonality.

U.S. federal business was down sequentially, but well within our expectations.

Growth and services revenue continues to be strong, 9% sequential growth in Q1, with total deferred revenue increasing by 4 million to 43.3 entering this quarter.

From a product perspective, our core application traffic management product sales results were excellent, with BIG-IP Version 9-based products accounting for 81% of the traffic management revenue.

We were delighted to be named as the clear leader in the recently announced Gartner Magic Quadrant for the application delivery products market.

The one disappointment of the quarter was our security business, especially with our FirePass SSL VPN solution.

Sales were slow across most of our geographic regions.

We did achieve a large number of FirePass sales wins this past quarter, but the transaction profile was very biased toward smaller revenue sales.

We didn't see many large deals closing in the quarter and we believe that was a key factor in the revenue draw.

We believe the FirePass product continues to be very competitive, but the overall market dynamics have been somewhat sluggish over the last couple of quarters.

Customers do not seem to be in a hurry to move from IP technology in the short-term, but we continue to be convinced that the SSL VPN solutions offer much more flexibility overall, especially for mobile based solution requirements.

So although we are disappointed, we continue to believe that the demand for FirePass will accelerate as enterprise customers begin replacing the existing IPsec VPN infrastructure and that the availability of TrafficShield as a software module will drive incremental BIG-IP revenue.

In addition, we believe SSL VPN and application firewall technologies are integral components of a comprehensive application delivery networking solution.

As a result, we plan to continue investing in the development and integration of these technologies with our core traffic management technologies.

Last quarter, we completed the acquisition of Swan Labs in early October and started shipping product in November.

Integration of teams and products has proceeded smoothly and we plan to do a formal rollout of the new products in this coming quarter.

During Q1, we concentrated our efforts mainly in training sales and building the support organization, prior to rolling the products out on the new platform.

Sales of Swan products contributed 875,000 of revenue in the first quarter and the demand for the new products appears to be building.

We continue to make good progress on our partnerships with the application solution providers, via iControl and iRules.

For example, Microsoft showcased F5 in the Channel 9 website, which featured a 45-minute interview with members of the F5 DevCentral team.

To date, more than 20,000 viewers have tuned in to view the discussion.

If you have not yet viewed the feature, I would encourage you to do so and join the 20,000-plus people who logged on to get an insight into the F5 solution capability.

We continue to believe that our sophisticated iRules programming capability and our unique iControl API are key differentiators in the marketplace.

As far as Q2 business outlook is concerned, Andy has already talked about the overall range of 93 to 95 million in revenue and $0.49 to $0.50 in EPS, excluding the effect of stock compensation expense.

When you include the Swan acquisition, we added 100 people to the F5 team last quarter and we plan to continue hiring this quarter to maintain our business growth and technology leadership.

The overall prospect pipeline remains very strong and each geography is forecasting sequential growth, with Japan forecasting the strongest growth, given the fact that this is the financial year-end in Japan.

Also, given the strength of our deferred service revenue backlog, we also expect to see strong growth in the services revenue stream.

TMOS continues to be our crown jewel from a product perspective.

Our product road map to integrate our application traffic management and application security solutions on a single platform is in excellent shape.

As we talked about in detail at our analyst investor meeting in November, we will be announcing a foray of new products over the next 12 to 18 months, which should maintain our technology leadership position.

I would like to thank the entire F5 team and their partners for their efforts in Q1.

With that, we will hand the call over for Q&A.

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from Troy Jensen.

Your line is open.

Please state your company name.

Piper Jaffray.

Congrats on the nice quarter, gentlemen.

Thank you.

Thank you.

Couple quick questions.

Can you talk about-- I think you said 81% of sales wer for the BIG-IP platform.

John, any sense on, if you look at the install base of total F5 systems, what percent of those do you think is the new Version 9 software?

Okay.

First of all, the 81% was Version 9.

So 81% of traffic management was Version 9.

So obviously that, that transition is effectively complete.

In terms of the install base, we were running up between 20 and 25% last quarter.

I don't have the exact number, but I think it's still going to be less than 30%.

Yeah.

Okay, guys, and a follow up.

The product road map, I know you talked about two new software modules in the first half of calendar '06 and the BIG-IP 8400.

Any additional granularity you could provide, maybe some of them coming out in the first quarter here or do you think it's going to be more second quarter?

Troy, this is Dan Matte.

Last quarter we did actually announce the ASM application security module being launched on top of the BIG-IP platform.

That sort of heralded the TrafficShield application security product being available on top of TMOS.

We completed that and made it available.

In terms of other things that are coming up, platform wise, we talked about the 8400 as well, which will be our entry into the 10 gigabit space, and you can look for announcements eminently on that platform.

And also from the module standpoint, coinciding with the 8400, you'll see us talking about the global traffic management module and link controller modules also being ported over onto the TMOS platform as well.

Sounds like the platform could hit soon, but any sense on when the modules will actually be available?

Same thing.

So in other words, they are actually finished [inaudible] and manufacturing and you're going to see in this quarter sooner rather than later.

Okay, perfect.

Just the last question and I'll open it up.

Security, was the number 6 .6?

Yes, 6.6 million.

And can you break that out between FirePass and TrafficShield?

Yeah, it was approximately a million for TrafficShield.

Perfect.

Thank you.

Congrats, guys.

Thank you.

Thank you, and our next question comes from Alex Henderson.

Your line is open.

Please state your company name.

Citigroup.

Hey, guys, I thought I would ask a couple of questions here.

First off, you made a comment in the presentation that the weakness was in the uptick of secure socket layer, implying people were staying with IPsec.

Are you suggesting that the overall security of VPN's appliance market was stronger than what you saw in the secure socket layer piece, or are you suggesting that just the conversion to secure socket layer is a slower pace than you had anticipated?

Hey, Alex, this is Jeff.

Yeah, what we're seeing is that SSL VPN is still being rolled out in mainly pilot programs inside large corporations.

Some corporations, early adopters, are rolling it out on a broad basis, but the broad rollouts in the majority of customers is not there, and we believe at least from what we can find in the marketplace, a lot of that is due to the installed IPsec not being amortized, written off, if you will.

So it's really a transitional issue.

And the reason that we saw a slight downturn this quarter is really because of the size of the deals.

We did a lot of deals, a large number of deals, but a lot of them were smaller in terms of actual dollar size.

I guess what I'm trying to get at is the-- are you suggesting that people are, have slowed down purchases of VPN equipment all together, or are they rolling out the, the IPsec stuff still where they have incremental needs for capacity and-- I mean it's my understanding that market's still growing at a pretty good clip.

Right.

They are still rolling it out in the sense that the early adopters are rolling out SSL VPN.

The people who have installed bases of IPsec continue to roll that out.

I see.

But over time, what we see is those pilot projects being rolled out on a broader basis and we're already seeing that in the early adopters.

Basically in the mobile environment we're seeing a quicker move to SSL VPN.

I see.

Second question on the gross margin side, obviously a nice pop in software content helping your gross margins on product.

I guess the question is, is some of that a function of upgrading the install base with the newer software modules and therefore not sustainable, or do you see the higher margin percentage as sustainable at this higher level?

You hadn't seen a lot of movement in that line in the past.

Yeah.

It's not so much from the install base.

It's a lot of the software is actually with new sales.

That's the majority.

In terms of whether it's sustainable or not really I think is in our control.

We've talked about this a number of quarters, which is obviously software modules will give us flexibility and we're still of the viewpoint of maintaining that flexibility of view and that's why you hearing a guidance in the range we gave it.

Okay, one last question and I'll cede the floor.

On the competitive front, my impression, not a lot of activity out of Cisco.

A lot of noise, but not a lot of activity.

Can you talk a little bit about that?

Can you talk a little bit about what you're seeing at NetScaler and, which reported last night some pretty good numbers, and what you're seeing at Juniper?

Yeah, we haven't seen any significant change over the last three quarters when really the competitive environment was getting discussed and looked as it was changing.

We haven't seen much at all.

Obviously you can see that on the part of the core business, the results there.

So Cisco, no change whatsoever, you know, still at relatively weak, quite frankly in the traffic management space.

NetScaler, we have seen them again, but again, similar profile to before.

There have been situation where is we've seen them discounting quite dramatically and then we haven't seen much of Juniper at all.

Okay.

Thank you very much.

Thank you.

Our next question comes from Jiong Shao.

Your line is open.

Please state your company name.

Lehman Brothers.

Thank you very much.

In the past, you told me about the backlog.

I was wondering, would you be able to talk about whether or not a backlog was up or down?

And also, could you please comment on the booking trends by region in the December quarter?

Yeah.

First of all, Andy says book-to-bill was greater than one, so he said that in his script, so obviously the backlog has been up.

Yeah?

Okay.

Then in terms of booking trends, we don't go through it by geography, but most, you know, in fact I think nearly every geography was up.

Mm-hmm, okay.

No more granular than that.

Okay, John, would you be able to add, just on linearity through the quarter, could you comment on that?

Yeah, the linearity was slightly up actually from previous quarters.

It was in the low-50s in the last month.

Okay.

One last question, would you be able to talk about the revenue contribution from the sales margins for the quarter?

No, we're still not-- that's data that we're keeping internal.

Okay.

All right.

Fair enough.

Thank you very much.

Thank you.

Our next question comes from Samuel Wilson.

Your line is open.

Please state your company name.

Good afternoon, gentlemen.

I'm not trying to beat a dead horse on the SSL VPN side, but could you-- it sounds very market-based, not very competitive-based.

Did you have you any competitive losses that might have surprised you throughout the quarter?

When you say surprise you, you're always surprised at any loss.

If you look at the overall trend of competitive losses, no.

No, we haven't seen a big change in any competitive environment, and in fact, it's interesting, if you look at the SSL VPN market over the last year, there's been lumpiness and there's no question about that.

And as far as lumpiness is intended to be on deal size, and as Jeff said, the deals were actually tended toward the low side.

The pipeline is actually quite strong.

So, no, we don't believe it's a competitive thing.

We think it's-- we really do believe it's more of a market issue.

And then on the Swan Labs acquisition, could you just give us some sense, you started selling that in November.

Was that some backlog of business that Swan had already won, or was that kind of the first pass as people went out and started-- your sales force started selling the product, kind of the initial uptake and what the feedback's been so far?

Well, some of it was from the pipeline this one, but the majority actually came after, towards the end of the quarter when we really had released it to the field.

And are you seeing kind of deals that previously you weren't part of, kind of these two-sided branch office type of deals thaw weren't part of in the past?

You know, I think it's a little bit early for that, Sam, to be honest.

Okay.

We're only talking about months.

Got it.

[inaudible] So I would rather not make that statement.

It's a bit too soon to do that.

Perfect.

Thank you very much.

Our next question comes from William Becklean.

Please state your company name.

Yeah, Oppenheimer.

John, you've always talked about the amount of business that's driven by the application software providers.

Can you give us that number and talk a little bit about what you are doing to continue to promote that source of sales for F5?

Yeah, I'll pass this to Dan, but you have the Microsoft example that we were very excited about, but, yeah, Dan can answer that.

Yeah, absolutely.

The-- in terms of percentage of business that was driven by iControl were actually over 50% last quarter and the growth is incredibly balanced.

We're seeing great stuff out of Microsoft, great stuff out of Oracle.

I call your attention to some stuff like Oracle putting out their 10g Grid Control module for their Enterprise Manager, which is downloadable from Oracle's site, uses iControl to control the devices through their Enterprise Manager.

So really we continue to work on all fronts there and many of the activities that we're doing through DevCentral to continue to get the developer crowd and community enthused about finding a different way to make the delivery of their apps always secure, fast and available, just continues to grow.

So we're seeing increased registrations there and lots of good things coming on that front.

Didn't you just have a big DevCentral contest among your users?

What was that all about?

Yes, actually we announced the winner of our iControl, or excuse me, iRules contest last quarter, where basically we put out to the user community the challenge to submit what they thought were the most interesting iRules out there and how to influence and change, use the intelligence in the network to better deliver their applications.

So we saw a lot of very, very interesting entries into it.

We had people, network-- excuse me, network computing judging it, some people from ZapThink in the XML space, you know, lots of current analysis as well, judging the iRules-- as well as us internally, and picked some winners and that's all DevCentral site, devcentral.com, if you want to look.

Great, thanks, Dan.

Our next question comes from Ryan Hutchinson.

Please state your company name.

WR Hambrecht.

Congrats on a good quarter, guys.

Just a few questions, here.

Just in terms of BIG-IP as percentage of traffic management revenues at 81%, was that down from last quarter?

Can you give me that number from last quarter?

Yeah, that's right, because apparently last quarter we were asked, we didn't know, and we said we'd get back and didn't.

It's up from last quarter.

I think the number from last quarter, it was 72.

72.

Are you asking BIG-IP or Buffalo Jump Version 9?

Version 9, the 81%.

Okay.

So it was 72 and it's now 81.

Okay, great.

And then on the application security gateway product, I believe it's down from 1.7 to 1 million roughly.

Is that being driven by customers evaluating that as a module, installing the overall purchasing decision?

It's a number of things.

First of all, they are not exactly-- this is one of the issues we're going to have moving forward.

These aren't exactly link for link comparisons because as we do software modules, of course the actual margin's higher, but the revenue's lower.

Right.

So there's more hardware previous quarters than this quarter.

So the comparison's not as obvious as it sounds, but it's still a situation where it's a nascent market.

We're doing a lot of evangelizing, we feel that we have to have quite a lot of professional services involved and we're actually doing some product stuff to try and reduce that, but that's really the situation.

What's the delta, then, between the hardware sales that were lost to the migration to the module itself roughly?

I don't think we've got that.

Okay.

Yeah.

Okay, and then one final on the competitive front, specifically in this WAN optimization app acceleration space with Swan Labs starting to build some initial momentum here, clearly it sounds like '06 is going to be the battle ground in that space.

What, from a technology perspective, are you guys adding to the platform in terms of addressing chatty protocols and things like that that you don't have today, that's preventing you from winning deals from, say the likes of Riverbed and some of the other vendors?

This is Karl, I can answer that question.

Right now we're in the process of releasing the wide-area file support with that, and we believe we are a unique solution.

We're actually trying that on a number of customer sites right now and we're planning on a full release of that here in the short-term.

So that's on top of some of our other competitive functionality, such as TDR, which we believe is actually has an advantage over the competitor products as well.

So, we believe that we have base competitiveness and then we're adding these different higher level protocol proxies to help manage these, like you said, chatty protocols.

Then in the medium term, remember our strategy, and it's the same with FirePass, as it is with WANjet and Web Accelerators to have these running on TMOS.

And that's very differentiated.

And so, I think in the medium term we have a very, very good story for the customer.

Okay, and then can you guys address both wider dictionary compression and object caching to date?

I'm sorry.

Could you repeat that?

Byte caching, or what's characterized as dictionary compression, and then object caching?

Can you guys address that to date?

In terms of your caching protocols?

Yes, we can.

So we do both dictionary based, we have our own proprietary dictionary-based compression.

We also do, like you said, caching on top of that as well.

Okay, great.

Thanks, guys.

Thank you.

Thank you.

Our next question comes from Matt Robison.

Your line is open.

Please state your company name.

Ferris, Baker Watts.

Nice quarter.

You mentioned some nice statistics last quarter regarding DevCentral.

You mentioned this Microsoft story related to that.

I think you said you had 5700 users in the fourth quarter.

Can you come up with a comparable number for what you saw in the first quarter?

Absolutely, Matt.

This is Dan Matte again.

We finished out the quarter with 6500 registered users, so we added just about 1000 over the course of the quarter, because when we reported the number last time it was as of the earnings call, so we had that 5700 at that point in time.

Things that are behind driving that, we've had a lot of new content.

We launched something called DCTV, or DevCentral Television, with video clips and how to tackle different technical issues, the iRules contest that we talked about before.

New things as well, like an anti-phishing iRule that was posted up there for people to take advantage of.

That's been very, very popular, and some other interesting areas, too, like how to get things like BIG-IP to generate RSS feeds based on what's going on the network, so some really, really interesting topics that are being discussed there.

And the other one's housekeeping, you mentioned the depreciation and amortization.

Can you break out the depreciation?

No, I don't have that in front of me.

I don't have it.

I'll catch up with you guys later on that.

I'll get back to you on that.

Yeah, the rest of my questions were asked.

Thanks.

Okay.

Thanks.

Thank you.

Our next question comes from Alex Henderson.

Please state your company name.

Hasn't changed, still Citigroup.

I wanted to ask a question on the development side.

Cisco made a lot of comments about trying to go to application-specific security.

It seems pretty clear that they want to work with the software vendors to develop linkages to their product, which we have yet to really see.

Have you had any conversations with anybody in the software community, most notably your key partners, such as Oracle and Microsoft, of an indication of a willingness to work with Cisco on that, or an indication that they have seen anything that would suggest that Cisco has something to interface to or-- anything along those lines, any crumbs about what exactly Cisco's trying to do on that front?

No comment on that one, I'm not going to talk for Microsoft or Oracle.

But what we can say is that we've certainly had conversations with these companies as related to that.

But, you know, we can't--

I'm not following your statement there.

So, you're saying you've had conversations with companies in the software industry that have seen something from Cisco that they are interfacing with.

No, nothing to do with Cisco.

To do with F5 and those companies.

Well, clearly you are.

Right.

I knew that five years ago.

[inaudible] comment Microsoft-Cisco relationship.

No, what I'm asking is, have you heard from any of your software vendors of an indication that they are working with, or starting to see a product that has iControl-like interface, even without the TMOS and even without the iRules, but at least an iControl-type interface that would allow them to actually integrate the software applications to a product?

No, no.

The answer to that's no.

Okay.

Just wanted clarity on that point to make sure we weren't missing anything.

Thanks.

Thank you, and our next question comes from Erik Suppiger.

Your line is open.

Please state your company name.

Pacific Growth Equities.

Congratulations.

Thank you.

The guidance you gave, looks like you're looking for about 5 to 7 million growth in the March quarter.

That's reasonably aggressive relative to last quarter and this is typically not a strong of a seasonal quarter.

What is it that you see that's in your pipeline that's giving you greater confidence going into March?

I mean it's all the basics, Erik.

It's obviously the size of the pipeline.

It's the forecast coming up from all the geographies, I think I mentioned at the end of my summary, they're all forecasting that we can see growth.

We can see growth in the services business as well.

You know, it's the same system that we've used for a number of years.

Why is the services so strong this quarter?

The backlog's been growing.

The tax rate's good, and the renewal rate's good.

I mean it's in very healthy shape.

Okay.

Is the Swan piece a meaningful part of that growth?

Because I know you had been holding back for a number of months.

Is that pipeline there incrementally going to be adding to the growth?

We expect the Swan business to actually grow, but not by a significant amount.

I mean we-- for example, we're not changing our original year's forecast for that business.

Okay.

Where are you in terms of training your sales force on Swan and your resellers?

Pretty good shape.

We did a lot in October at the sales conference, but we're really starting to roll out this quarter, mainly with the partners, of course, and the geographies.

And how many sales people did you add during the quarter?

In sales and marketing, we added 45 people.

Okay, next question --

-- sales and engineer support.

And lastly, you had 50-day DSO's.

That's up a little bit, and you guided for 50 days in the March quarter.

What makes you think that your DSO's are going to stay a little higher than your target?

You know, the deferred revenue growth that we've seen, which has been pretty strong over last quarter and this quarter and going forward as we expect, that effects it, and the linearity a little bit.

We talked about it being up just slightly, in the low 50s range and that's affected it a little bit.

And that's what we see for the next quarter.

The international split.

International, yeah.

Regionally, internationally as we penetrate new markets and different areas have, tent to have a little longer-term.

So we're kind of adopting to that as well.

So is this something that's going to remain at this level?

It may well do it, yeah.

We'll only give a quarter in advance in specific, but it may very well.

Very well.

Congrats, and thank you.

Thanks.

Thank you, our next question comes from Manny Recarey.

Your line is open, please state your company name.

Good afternoon.

Kaufman brothers.

Most of my questions have been answered.

I have one more.

Going at the competitive question from a slightly different angle here, with Cisco obviously focusing more, and Juniper making the acquisition, do you see anything that they have done over the past quarter or two that you feel looking out six or 12 months that the competitive environment is going to change significantly?

Over the next-- what period did you say there?

Sorry.

Over the next 6 to 12 months.

It's not obvious to us.

I mean you can never really say because we don't know everything that these companies are doing, of course.

We try to watch, but we don't.

But it's not obvious to us that we can see any significant change, and our job obviously is to make sure what we are doing keeps us ahead and I think our road map is extremely strong.

Okay, thanks.

Yeah.

Thank you.

Our next question comes from Ehud Gelblum.

Your line is open.

Please state your company name.

Hi, thank you.

Can you hear me?

Yes.

Great.

Couple questions.

Following up on the previous question about the telecom revenue that seemed to increase fairly strong this quarter, did you see evidence-- can you comment a little bit on the linearity throughout the quarter of all of your revenue and then does that telecom revenue growth, did that come more at the end and did you see any sort of budget flush kind of as you moved into December, any more than normal?

As we said, we did see-- the linearity was in the low 50s for the last month, the overall.

The telco really wasn't-- telco was just normal business.

That didn't have any effect, didn't seem to stand out, so there was no-- nothing to report there.

The telco business, by the way, was I think 19%, which was up a percent from the previous quarter, but obviously pretty solid.

We saw some pretty good wins, by the way.

We had a very good win in Japan on a Voice over IP project that is related to a number of Voice over IP rollouts.

So that's got us excited because we have a way of mapping the opportunity there to the number of consumers that move to Voice over IP and it's the first time we've seen that type of win.

What was the other-- what was the final?

Budget.

Oh, no, we actually didn't see a significant amount of budget flush.

When we compared it-- and, remember, this is very subjective.

Sure.

Because you're listening to the sales force who quite often, you know, maybe don't want to admit that there's budget flush, but definitely if we compare it with last year, we would say it's much less.

Less this year than last year?

Yes.

Very interesting.

So the 50% plus in the final month of the quarter is in line with what you would normally expect as opposed to be--

A little bit higher, just a little bit higher.

Okay.

Your operating margins, if we could hit on that quickly.

Operating margins were 31% consistent with last quarter.

In line with your new guidance, where do you think they can kind of-- where should we be modeling them and going forward?

How should we looking up?

Staying at the 31% level, or is there opportunity as more of the software modules come into the mix, new gross margin improvement is actually going to fall straight to the bottom line?

The guidance that we're giving is we're going maintain operating margin in the low 30s and that's principally because we're going to invest in the growth of the business and continue to do that through the year and then in line with that, any, any upside we get from software modules or supply chain management related to gross margin, we're also going to leverage that back into the business, either through investing in service, which we have plans to do, working closer with our channel, incentivizing them, as well as the sales force.

So that's the plan at this point.

Okay.

Thanks.

Finally, if you look at some comments you made last quarter when you talked about FirePass, again, don't want to go-- kind of go back in there too far, but I think you had said some comments that the pipeline seemed to have a lot of large deals and you felt very confident at the time.

Now, it seems like some of the shortfalls seem to be that the large deals didn't come through and that there's more small deals out there.

What--

That's absolutely correct.

What could have happened--

In the preceding quarter, the pipeline had big deals, and the pipeline still has big deals, so as we move into this quarter, actually the profile of larger deals is pretty significant versus what we actually booked.

Sowe'll see what happens, but that is exactly what happened.

We saw a reluctance in the closing of the large deals.

Those same large deals are still out there, they just haven't been closed ?

Mm-hmm, yep.

Interesting.

Okay, thank you.

Okay.

Thank you.

And our next question comes from Ken Muth.

Your line is open.

Please state your company name.

Hi, Robert W. Baird.

You guys obviously had a lot of record growth here in the revenue line and your customer support, do you feel that it's adequate and up to speed with how fast your top line is growing?

And do you need to invest some of that margin back into the business like you alluded to?

Yeah, the short answer is yes, and I'll ask Julian to comment in a second.

But we are-- we're hiring pretty aggressively in customer support for exactly that reason, that the business top line is growing and it's pretty critical that we keep, maintain that quality of service for the customers.

Okay, and then how many--

Julian was going to comment on that.

Sorry.

I think when we really accelerated the growth a year ago, we got caught out a little piece there, but since then, we've been investing ahead of the curve and all the statistics, both internal measurements and external customer satisfaction measurements that we survey every month have shown great improvement, again, right back to where we would want them to be.

Okay, and then how many resellers did you have at the quarter end and what is kind of your goal so add number of resellers for '06?

Well, overall resellers, we added approximately 20 this quarter, so our total reseller number worldwide partners in total is well over 450.

I think it could be approaching 500, and as far as plans to add for the quarter--

We typically have been adding in the mid to high 20s every quarter.

And, again, looking for opportunities in the different regions around the world to continue to add where it makes sense and continue to invest in our existing partners, you know, with training and different programs to increase their focus on our products.

Okay, and would you say just kind of as a percent of revenue that your resellers are kind of equally aligned with the U.S., EMEA, Japan and Asia PAC, or is there any one area that you would focus on?

We're focusing everywhere, to be honest with you.

Models change slightly between different regions, depending on whether we're early into a different particular country or we've been there for a very long time.

North America operates a bit differently, just because of the history of the company.

So, again, very channel-focused.

We plan to win with our channel partners.

So we continue to focus energy all over the world.

Okay, thank you.

Thank you, and our next question comes from Joanna Mackris.

Your line is open.

Please state your company name.

Hi, Adams.

As you start to move more aggressively into the service provider market with 10 gig, how should we think about that overall revenue opportunity?

Is it, in your mind, kind of equal to what we saw with Buffalo Jump last year?

Is it a slower market to take shape?

How are you thinking about that in terms of what it could impact your top line growth over the next 12 months?

Well, if you look at a lot of the drivers in their business, a lot of them are in the telco space, areas like Voice over IP, mobile, that type of thing, streaming data, so the drivers are all there and we have-- we have effectively, I think I've said this before, we didn't completely ignore the service provider market, but we've not had a massive focus on it over the last few years, and we've-- we're changing that, so we've been putting more focus on it.

We've been hiring sales people that are actually specifically focusing on that market only and therefore by definition, we would expect some more return because of that.

So I'm not going to put any number on it and certainly it's almost impossible to compare it with Buffalo Jump because that's more of a product introduction that is on a global basis, but, yeah, we think it's a good opportunity.

Thank you.

Thank you.

And our next question comes from Brent Bracelin.

Your line is open.

Please state your company name.

Thank you, Pacific Crest Securities.

Most of the questions here have been kind of marked off the list here.

But I will follow up with kind of a question on the BIG-IP 8400.

Any color on kind of the early feedback from some beta users on that product, first question?

Yeah, actually we've gotten really positive feedback, especially like Japan has come back and given us a lot of glowing comments on the platform itself.

We've gotten good feedback on the new performance that the platform brings out with it, so and our new ASIC that's part of it.

Very positive comments.

We've actually had a very long beta.

We've actually been in beta for four and a half months with that.

It's time we introduced the platform.

So we've had a number of customers testing it and so far it's been very popular.

Okay, great.

And then last question, we have seen a bit of a renaissance with the Internet Infrastructure Group, continue to see Yahoo! this week raise their capex spend, forecast for next year.

Are you guys seeing any sort of movement there on the internet vertical where, you know, some more of the traditional customers, three, four years ago are coming back to you, or is there any trend you see on that side of the business that you guys are actually capitalizing on?

We've seen some pretty significant things in that state and a lot of the growth that we got last quarter was related-- I don't want to mention names specifically, was directly related to that trend.

I mean we've-- one customer that we got-- to the tune of over $1.5 million in exactly that space, so yes.

Thanks again.

Thank you.

Our next question comes from Alex Henderson.

Your line is open.

Thanks.

I was wondering if we could go back to the sales staffing question.

So can you talk to us a little bit about what the growth in sales staff is, what the gross in sales quota is on a year-over-year basis, what the percent change looks like on the bad bar footprint and how that correlates to growth going forward, what the issues are that would cause us to think that that wouldn't be a linear scaling?

We wouldn't comment by the way on the internal quarters.

We don't--

I'm not asking what the dollar value.

I'm just asking what the growth might look like.

But in terms of the numbers of-- we can talk about that.

Andy, if you would.

Yeah, year-over-year, I think we added over-- well over 100 people in the sales area.

That includes quota carrying heads, field sales engineers that support that sales and inside sales people.

So considerable investment.

So on a percentage basis that increase represents what type of increase?

Over the year, roughly 30%.

We ended with sales and marketing at 360 at the end of the quarter.

And then obviously as Andy said in the first quarter, it was over 40 that we added.

Generically speaking, is the sales quota stable, or is it increasing on a per salesman basis?

Well, it varies.

One of the big factors in the sales quarter, and Tom might want to comment, but it's related to how long the person's been with the company.

So obviously if you're only in the company in the first quarter, your quota is small, and it gets longer.

It's very much linked to, as we hire, how long the people are with us.

So, just by definition, if we are hiring net, hiring and our attrition rate's pretty good by the way, so by definition that quarter's--

You mean low, I assume?

Yes.

They are going up.

It's a combination of existing employees who have been with the company for a couple years, a year.

Is it--

-- New hires that come in that are on a much higher ramp.

Is it reasonable to think of a 5 to 10% quota increase as sort of a typical one year-over-year for a typical salesman?

We don't give that information out, Alex.

Okay, and then the VAD VAR-- it seems like the rate of increase in VAD VARs to your footprint is slowing on a percentage basis because the number of VAD VARs you're adding are roughly comparable to each quarter.

Can you talk to the scope and size issues and whether there's anything that would cause the dollar revenues that they are able to pull through to be different than the existing install base?

I think the thing to-- and that's, as a statement, that's true in terms of percentages, is over time has been going down.

But that's very much in our control.

The key with VARs and solution partners, is building relationships.

So the key is to actually get the VAR on, get them dedicated to a product line and then they start to ramp that way.

So we've got much more opportunity ramping existing VARs with new product lines, like line optimization, than we have with setting up new VARs.

Because we've got pretty adequate coverage right now.

So your expectation is that the growth in the company produces is going to be more of a function of increasing sales at existing VARs than adding new VARs?

Yes, overall, that's correct.

I mean we've got a whole host of authorized resellers that buy on a quarterly basis that we don't really report because they are just buying for particular opportunity.

The ones we're reporting on are key partners that we're adding that are going to invest in F5 and grow with us.

Okay.

Thanks.

Thank you.

[OPERATOR INSTRUCTIONS]

I think we'll make this the last question, actually.

We're almost up on time.

Okay.

Thank you.

Our next question comes from Jiong Shao.

Your line is open.

Thank you.

From Lehman Brothers, again.

I understand F5 is in a process of moving towards 100% two -tier distribution model.

First I wanted to confirm that with you and note that is the case.

And if it is, can you give us an update where you are today and how that change may or may not impact things like revenue, DSOs, et cetera?

Yes.

No, that's not really the key.

I think what you may be hearing about is the registration program in North America, which will have an effect in terms of moving more to the distribution model, which we've already got, by the way.

That's why Ingram Micro and GE are two big distributors in North America.

But that's the only major change that's been happening over the last year.

Tom, do you want to comment on the registration process?

Yeah, I mean I think you may have heard that as part of that registration program there is motivation to ship more of our gold tier partners to buy through distribution and so that's a North American program.

When you get out internationally, again, we are, you know, typical distribution, two-tier model.

Right.

-- outside of North America.

So, so just a quick follow-up, i think we are talking about the same thing-- for North America, in the December quarter, what's the percentage of the resellers were buying directly from you and then obviously from distribution and what's the goal for that within couple quarters?

I don't think we have those numbers to hand-- yeah, we don't have that data.

Sorry.

That's fine.

But quickly, though, the distribution, you always use sale out for North America for revenue, from distributions anyway.

Just wanted to confirm that, if that's okay.

If you look at the percentage-- Ingram Micro has been a while now, or only greater than 10% customer, and those numbers, the percentage with Ingram Micro hasn't really changed that much.

Actually down a little bit this quarter, but not changed that much.

We have added GE and that's been pretty successful, but there's not been a massive change there.

Okay.

And the revenues on sale out.

I missed that.

Excuse us?

What?

The revenues through this is on sale out basis.

Oh, yes, it, is absolutely.

Great.

Just wanted to confirm.

That's correct.

Thank you.

Okay.

Alright, well, with that, thanks a lot for dialing in and obviously we'll talk to you next quarter.

Thank you.

Thank you.

This does conclude the conference call.

You may disconnect at this time.