F5 Inc (FFIV) 2006 Q4 法說會逐字稿

Welcome to the F5 conference call. All parties will be on a listen-only mode until the question-and-answer session. Today's call is being recorded; if you have any objections please disconnect. I would now like to turn the call over to Mr. John Eldredge, Director of Investor Relations. Thank you, sir, you may begin.

Good morning, and welcome to the supplemental fourth quarter and fiscal 2006 conference call for F5 Networks. Speakers on today's call our John MacAdam, President and CEO; Andy Reinland, Senior VP and Chief Financial Officer; John Rodriguez, Senior Vice President and chief accounting officer is also with us to answer questions following our prepared comments. If you don't have a copy of yesterday's press release it is available on our website, www.F5.com. In addition, you can access an archived version of today's live webcast of the events calendar page of our website through January 24th. (technical difficulty) 8 AM today until 5 PM Pacific time November 10th, you can also listen to a telephone replay at 866-470-7046 or 203-369-1480, passcode for the replay is F5 Networks.

Before we begin I want to remind you that 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 our actual results to differ materially from those expressed or implied by these statements. Factors that may affect our results are summarized in our recent 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. Now I will turn the call over to John MacAdam.

Thanks, John, and good morning, everyone. I am actually calling in from Tokyo right now. We have a partner conference kickoff for fiscal 2007 tomorrow, and we expect about 150 to 200 delegates from our Japanese partner channel to attend the event. It is really an impressive event, and our Japan team serves as a role model for leveraging blue-chip partners to resale F5 products. Partners like NTT Advanced Technology, Tokyo Electron, CTC, HP, IBM Japan, NEC, NEXCOM, Tech Matrix, Hitachi, Softbank Technology and several others should all be in attendance to get update an update on the F5 strategy for 2007.

By now you should have read our press release from yesterday, in which we announced the special committee's completion of its inquiry into the company's stock option practices, as well as providing additional financial information for the third and fourth quarters and the fiscal year 2006. The company conducted an analysis in conjunction with the board's audit committee and professional advisers to determine the accounting impact of the special committee's findings. Based on this analysis, F5 will be required to record an additional non-cash stock-based compensation expense of $22.9 million in the aggregate for fiscal years '99 through 2006. Approximately 70% of the additional $22.9 million expense has resulted from grants originally dated in calendar years '99 and 2000. Andy will go through the financial information for Q3, Q4 and fiscal 2006 in more detail in a moment. I just want to reiterate the comments I made on a regular quarterly conference call last month.

I believe that F5's market, the application delivery networking market, will remain vibrant throughout fiscal year 2007. We are in a very good position to take advantage of the opportunity in fiscal 2007 and intend to invest appropriately to maintain our technology leadership, deliver world-class customer satisfaction with our solutions and continue to grow the F5 team with the objective of maintaining market share leadership, as well as delivering sequential growth on a quarterly basis throughout the year. I will now hand the call over Andy Reinland to provide more detail on our financial results.

Thank you, John, and good morning. As we said in yesterday's announcement, the conclusion of the special committee's inquiry has allowed us to publish our income statements for Q3, Q4 and fiscal 2006. The following information is supplemental to the information we provided in our release and conference call on October 25th. In my discussion of this information I will use the term "reported" to refer to items calculated according to GAAP financial measures, and non-GAAP to refer to items that exclude the effect of stock-based compensation. Because the adjustments related to the inquiry will affect our fiscal 2005 financial statements I have not included comparisons with prior year periods.

Q3 reported net income was $17 million or $0.41 per diluted share on revenue of $100.1 million. Q4 reported net income was $17.8 million or $0.43 per diluted share on revenue of $111.7 million. Reported net income for fiscal 2006 was $66 million or $1.59 per diluted share on revenue of $394 million. On a non-GAAP basis Q3 net income was $21 million or $0.50 per diluted share, and Q4 net income was $24 million or $0.58 per diluted share. Non-GAAP net income for fiscal 2006 was $84.3 million or $2.03 per diluted share.

Continuing down the income statement reported gross margin was 77.5% for Q3, 77.8% for Q4, and 77.6% for fiscal 2006. Non-GAAP gross margin was 77.9% for Q3, 78.3% for Q4 and 78% for fiscal 2006. Reported operating expenses were $55.1 million for Q3, $63.4 million for Q4 and $215.8 million for fiscal 2006. These amounts include fees for the options inquiry of $1.8 million in Q3 and $5 million in Q4. Our reported operating margin was 23% in Q3, 21% in Q4, and 23% for the full year. Excluding stock-based compensation, our operating margin was 28% in both Q3 and Q4 and 29% for the full year. Stock-based compensation expense, the majority of which affects operating expense, was $5.8 million for Q3, $8.2 million for Q4 and $24.8 million for fiscal 2006. In addition to the balance sheet items I discussed on our last call, cash from operations was $37.3 million in Q3, $18 million in Q4 and $125.4 million for fiscal 2006.

Moving on to the outlook, in addition to the guidance we provided on our last call, including the revenue target of $116 to $118 million, we expect the following. We believe gross margins will remain in the 77% to 78% range, including approximately 500,000 to $700,000 for stock-based compensation. Our operating expense targets are $64 to $67 million, including an expected $2 to $3 million in costs related to the inquiry and $7.7 to $8 million in stock-based compensation expense.

We are targeting GAAP EPS of $0.43 to $0.45 per diluted share, and we anticipate cash flow from operations in excess of $30 million for the quarter. For fiscal 2007 our GAAP tax rate is forecasted to be approximately 42% through the fiscal year. Excluding stock-based compensation, the tax rate is estimated at 36%. We will begin to pay U.S. income taxes this fiscal year with our first payment in our second fiscal quarter. We estimate our cash payments at approximately $10 million per quarter.

As a final note, I want to remind you that we began publishing non-GAAP results along with reported results in the fourth quarter of fiscal 2005 when we began reporting stock-based compensation expense. Our aim was to provide a basis for comparison with prior periods when stock-based compensation was not included. Since that is no longer necessary, we plan to discontinue the practice and report only GAAP results in our quarterly press releases beginning with fiscal Q1. As a result, I will no longer provide guidance on non-GAAP gross margin, operating expenses or EPS during our quarterly conference calls. However, I will continue to breakout the total cost of stock-based compensation for the quarter just ended and to provide guidance on stock-based compensation for the current quarters.

Now I would like to open the call for questions.

(OPERATOR INSTRUCTIONS) Samuel Wilson, JMP Securities.

Good morning, everyone. Andy, just a couple small questions for you, and I will let John get back to the partner meeting. First, when do you expect to actually put out the balance sheets, and will that be in the SEC filings? Second, with the $23 million non-cash charge is there any expectations that that will bleed over into amortization for fiscal '07? And lastly, where were the lawyer fees for Q3 and Q4, the [$6 28 million] was that in G&A?

So taking those in reverse, the fees related to the inquiry were in G&A. As far as the amortization question, no, that shouldn't bleed over, and the first question?

Balance sheet.

Yes, we are sticking to the guidance that we gave that we plan to file timely by the 10-K on December 14th, and we should stick to that. But we haven't come out with a definitive date for the balance sheet.

So I guess what I'm asking is do you expect to put the balance sheets just in the SEC filings or do you expect to have another separate press release?

We will have the balance sheets in the amended -- well basically in the SEC filings, and we won't be issuing anything prior to that.

Perfect. Thank you so much, John.

Erik Suppiger, Pacific Growth Equities.

Good morning. Say can you give us a bit of a feel for what kind of coordination you've had with the FCC and the DOJ? Is it likely that they will take any additional actions, or do you feel like in terms of penalties you have pretty much gotten that taken care of at this point?

We would not comment on that question. It is just not appropriate to do that. Really in terms of the special committee I would just refer you to the press release on it. So really no comment, apart from obviously we are fully cooperating.

Can you give us a sense for how the logistics work? At what point do they give you feedback or when do you hear as to whether or not this is resolved?

Don't really know the answer to the question.

Okay. Thank you.

Matt Robison, Ferris Baker Watts.

Nice update, guys. From the other income that was sharply up from the September quarter, was that just because you generate so much cash in the June quarter, or where there some ForEx or other sort of things of that nature in there?

I think the overall increase in our cash position is just -- and also favorable interest rates is really just helped us to garner higher other income.

So it would be reasonable given that your [client] continued to generate cash we could see that trend recurring, there's nothing anomalous about that quarter then?

No.

Okay. Thanks a lot.

Ehud Gelblum, JPMorgan.

Just a quick question, if I could on the legal expenses, I think you guided next quarter in Q1 into the $2 to $3 million range. Can you give us a sense as to, is that the run rate that we should be expecting going forward on a quarterly basis, or are those legal and accounting expenses going to tail off to zero as time, over the next couple of quarters?

Given our announcement about the state of the inquiry I think our expectation would be that we would not be incurring fees to that extent going forward.

Okay, so can we assume it hits zero over that several quarters or maybe gets $1 million we think?

I don't want to comment beyond what we gave for this quarter and give you the expectation that we see it going down. We will update it next quarter, obviously.

One last correlated question. Those fees and expenses for the most part, were they for outside legal and accounting help or did you staff up at all to cause some of that expense?

Outside professional sources.

Thank you.

Ken Muth, Robert W. Baird.

If you kind of do the pro forma analysis on the gross margin side and you add back your 500,000 to $700,000 it seems like your gross margin would be ticking up sequentially. Is that just due to mix in both product and geography, or is something a little bit better off right now?

No, you know I think broadly looking at our expectations it just has to do with the focus and attention we put on managing gross margin. And we've talked a lot in the past about the gross margin task force and the initiatives we put in place to do everything we can to manage and improve that gross margin as it anchors our income statement. So we just expect that from some good results from those initiatives.

And on the operating expense that you gave, the guidance there and you put the gross margin through you kind of come up to about a 29.5 to a 38.5 operating margin. You guys on your last call you thought that the operating margins would trend down because of your investments. Is that still something we should think about on a sequential basis going throughout fiscal '07, that the operating margin would trend slightly down based on your investments?

Yes, that is the intent. We'll see how it comes out but we do believe by the end of the year we will be in the high 20s for operating margin.

Thank you.

Scott McCabe, Lehman Brothers.

Congratulations on closing this up and giving the numbers out, first of all, and most of my questions have been answered, but if you could just give any insight into where share count might be heading next quarter? If I missed that, I apologize.

Yes, you know the fully diluted share count is greatly affected by a number of variables. What we model is that it increases quarter-over-quarter about half one million shares.

Okay, and actually quick question on tax. It seems like it has fluctuated a bit and come down if you back out the legal expense. I was wondering going forward if there is going to be a significant amount of variability, if things can hold pretty stable around 36%?

We believe that it will be about 36% on a pro forma or non-GAAP basis, pretty consistent throughout the year, but things could change. Last year we had the benefit of an R&D tax credit which expired after the first quarter. There is still a lot of talk that might be reinstated and if it does, we will see a benefit from that. If they make it retroactive, we will see a big benefit from that but right now we're just sticking with the 36%.

Great. Thanks a lot.

Reg King, Nollenberger Capital Partners.

Andy, I was hoping that you could review just a couple of numbers you went over. Can you review the -- I think you gave us the non-GAAP gross margin for Q3 and Q4.

Yes, so the non-GAAP gross margin for Q3 was 77.9%, and for Q4 it was 78.3%.

Okay, and then I think in the expense guidance you were giving a [mid loss] but right after the legal and accounting expenses of $2 to $3 million, I think you gave another number there. It was a $7.7 million.

Oh, yes, what I was saying was that the range for stock-based compensation included in operating expenses, the guidance for that number was $7.7 to $8 million for this Q1.

Okay. And so 500 to 700K, what was that, Andy for?

The stock-based compensation that would be in our cost of goods sold.

Okay. And I think the rest of my questions have been answered. Thank you.

(OPERATOR INSTRUCTIONS) Manny Recarey, Kaufman Brothers.

Just a clarification, Andy, about the guidance on the operating margin. Are you expecting it to dip to sequentially to the kind of the low or the upper 20% range, are you supposed to -- is it going to be at the upper 20% by the end of the year?

I think it will trend to the upper 20%. I mean, if you factor in the fees related to the inquiry where it will be the high 20s this quarter, next quarter payroll taxes kick in for us because it is the beginning of the calendar year. So we will have to wait and see the impact of that in Q2. And then with the investments that we've been talking about that we are driving to make in the business adding the 80 to 100 people this quarter, other investments that we are making to take advantage of the opportunity we see in our core business, by the end of the year we will trend to the high 20s pretty concretely.

Okay. Thank you.

Cameron Cooke, Janco Partners.

I was wondering if you guys updated anything on the headcount expectations in terms of growth for '07?

Didn't talk about '07 in total, just talked about for Q1 where our goal is to have 80 to 100 and then broadly talked about the investments we plan to make over the year.

So no further clarification there going forward?

No.

Okay. Thank you.

Munjal Shah, Piper Jaffray.

This is Munjal Shah for Troy Jensen. I had a question on OpEx. You mentioned it would grow from (inaudible) if I look at the range it is 61 to 65 on a pro forma basis, plus an increase of about $6 to $7 million. And if you could just clarify a little bit more where there would be more on the marketing or R&D, what the investments will be.

The way we came to our operating expense guidance was obviously looking at legal fees trending down and then coming back with investments that we intend to make is how we arrived at that guidance.

And the investments will be more focused on both research and sales areas?

Yes, I would say sales, headcount related to the sales, headcount for R&D, as well as additional spending on prototyping product development there. And then also service, customer satisfaction, keeping it at a high level is a priority for us.

Thanks a lot.

At this time I am showing no further questions.

Thank you very much for joining us, and we look forward to talking with you all next quarter. If you have any follow-up questions, you can give me a call at 206-272-6571. Thank you.

Thank you, and this does conclude today's conference; thank you for your participation and you may disconnect at this time.