F5 Inc (FFIV) 2007 Q1 法說會逐字稿

Good afternoon.

Welcome to F5's first quarter financial results. [OPERATOR INSTRUCTIONS] I'd now like to turn the call over to Mr. John Eldridge, Director of Investor Relations.

Thank you, sir.

You may begin.

Thank you, Angie.

And welcome to our first quarter fiscal 2007 conference call.

The speakers on today's call are John McAdam, President and CEO and Andy Reinland, Senior VP and Chief Financial 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; and Karl Triebes, Senior VP of Product Development; and our CTO are also with us to answer questions following our prepared comments.

If you don't have a copy of the today's press release, it's available on our Website www.f5.com.

In addition, you can access an archived version of today's live Webcast from the Events Calendar page of our Website through April 25 from 4:30 p.m. today until 5:00 p.m.

Pacific Time January 25.

You can also listen to a telephone replay at 800-284-5340, or 402-998-1028.

During today's call our discussion will contain 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 those expressed or implied by these statements.

Factors that may affect our 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.

Before we begin, I want to remind you that F5 will host a meeting for analysts and investors at the Grand Hyatt in New York City on Wednesday, February 7 from 8:00 a.m. to noon.

If you would like to attend this event and haven't already registered, please contact [Caroline Burkhart] at 206-272-6590.

If you have any questions regarding the meeting or today's call please direct them to me at 206-272-6571.

Now, I'll turn the call over to Andy Reinland.

Thank you, John.

During the first quarter of fiscal 2007, we achieved revenue of $120 million, above our guided range of $116 to $118 million.

This represents an increase of $8.3 million or 7% from the prior quarter, and a 36% increase from the first quarter a year ago.

Book-to-bill for the quarter was greater than 1.

In the Americas, revenue grew 13% quarter over quarter and accounted for 60% of total revenue.

EMEA revenue grew 6% sequentially and accounted for 17% of revenue.

Japan, which accounted for 12% of revenue, and APAC, which accounted for 11%, were both down slightly from the prior quarter.

Revenue from Telco's and service providers was 20%.

U.S. federal accounted for 6%.

We had two greater than 10% distributors, Avnet, which accounted for 14.1% of revenue and Ingram Micro, which accounted for 11.8%.

Product revenue represented 77% of the total mix and service revenue was 23%.

WAN optimization and acceleration revenue was $2.4 million.

Security revenue was $9.7 million.

Before I go into expenses and margins, I wanted to remind everyone that our results are GAAP based unless specifically defined otherwise.

For Q1, our gross margin was 78%.

Operating expenses in Q1 were $66.4 million, within our guided range.

Included in these expenses are $2.5 million in legal and accounting fees related to our recently completed options inquiry.

Also, stock-based compensation expense was $8.1 million in operating expenses, and $600,000 in cost of goods sold.

Excluding stock-based compensation, our operating margin was 30%.

Our tax rate for the quarter was 33%, below our 42% guidance.

The difference was primarily due to a one-time benefit as a result of the R&D tax credit reinstated by Congress.

Our effective tax rate excluding stock based compensation was 31%.

Net income was $22.4 million or $0.53 per diluted share, above our guidance of $0.43 to $0.45 per share.

Reflecting our strong revenue results, as well as the benefit of our lower tax rate.

During the first quarter we continued to strengthen our balance sheet.

Cash flow from operations was $46.8 million and we ended the quarter with $545 million in cash and investments.

Reflecting the strong growth of our services business, deferred revenue increased 14% to $68.7 million at quarter end.

DSO was 50 days, consistent with prior quarters and our Q1 guidance.

Inventories were $5.7 million.

Capital expenditures for the quarter were $2.6 million.

And depreciation and amortization expense was $3.6 million.

We added 85 people in Q1, ending the quarter with approximately 1,155 full-time employees.

Moving on to the outlook.

For the second quarter of fiscal 2007, we are forecasting revenue in the range of $124 to $126 million.

We expect gross margin in the 77% to 78% range, including approximately $0.5 million in stock based compensation expense.

We expect operating expenses between $70.5 to $73.5 million.

This includes approximately $11 million of stock-based compensation expense.

The increase in stock-based compensation expense reflects grants to executives and new employees.

Annual grants to executives had been deferred during the options inquiry.

Going forward, we anticipate grants to executives and employees, with the exception of new hires, to be awarded on the same day.

Our target date for these grants is August 1.

We expect our tax rate going forward to be 39%.

Excluding stock-based compensation, our effective tax rate would be 35%.

As we stated on last quarter's call, we expect to begin paying U.S. federal income taxes during the quarter and estimate a cash payment of approximately $10 million.

Our earnings target is $0.44 to $0.46 per share.

We will continue to invest in the growth of the business and anticipate adding between 100 and 120 employees this quarter.

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

We expect inventory levels within a range of $6 to $8 million.

And 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.

I was very pleased with our start to fiscal year 2007.

In Q1, we saw some solid sequential revenue growth in our three main product lines; application traffic management, security and WAN optimization.

Our core market, the application delivery controller market continues to be very robust and represented approximately 90% of the quarterly revenue.

From a geographic perspective, the Americas led the way with a solid 13% sequential increase in revenue.

EMEA also delivered sequential increase in revenue.

Japan and APAC were down slightly from the previous quarter.

And we expect to see a continuation of sequential growth in this current quarter from Japan and APAC and I will talk about that later in the outlook discussion.

Our overall services business continues to grow from strength to strength, with total deferred revenue increasing by almost $9 million to almost $69 million entering the quarter.

From a technology perspective, I believe we continue to increase our competitive advantage, especially in our core application delivery controller market.

Our new flagship product, the BIG-IP 8800, has been released from beta phase to manufacturing and will be available for customer shipments in this coming quarter.

Along with the new high end 8800 platform comes a very significant new release of our TM/OS operating system.

This new version of TM/OS comes with a wealth of new features and improved performance.

Formal announcements of these technologies and partner training will take place during this quarter.

This is our first release with the software architecture acquired from Montreal including clustered [multi-accrual] setting technology.

Combined with the new high end 8800 platform, the clustered multi-accrual setting version of TM/OS has enabled us to deliver leading edge performance and throughput way ahead of our competitors.

We have seen improvements such as 50% faster Layer 7 performance over our current high end 8400.

We're also seeing SSL and compression throughput improvements of up to 100% with the new 8800.

Clearly, making it the undisputed leader in the marketplace today.

In addition, the new software enables true virtualization, allowing customers to create discrete partitions and administrative demands on a single system to manage separate applications from multiple business units.

I will not go into any more detail on our product road map, as we intend to provide a comprehensive overview at our investor and analyst meeting in New York on February 7.

However, I would like to mention another key product milestone that we achieved last quarter.

As we have articulated in several previous calls, our overall solution strategy is based on the functionality, performance and modularity of our TM/OS architecture.

Over the last year, we added software modules including Global Traffic Manager, link controller, ESM and application security manager and WebAccelerator.

Previously, these solutions could only have been implemented by purchasing stand alone hardware appliances.

We have also indicated our intention to add FirePass and WANJet as solutions running on TM/OS.

All of these solutions are products which we acquired or developed internally.

During the first quarter, we took a major step in a new direction with the introduction of our messaging security module, MSM.

MSM has been created in partnership with Secure Computing to deliver an anti-spam solution that will block unwanted e-mail at the edge of the network.

MSM can eliminate up to 70% of spam e-mail before it reaches existing anti-spam systems.

The BIG-IP MSM module leverages the reputation data from Secure Computing trusted source identity engine.

This is very significant, as it is the first time we offered a solution on top of TM/OS, most of which was developed externally.

We have seen keen interest for the MSM solution and have already taken orders for the product.

As far as the Q2 outlook is concerned, Andy indicated that we continue to see sequential growth in our business.

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 their financial year-end.

Growth forecast in the Americas and APAC is more modest, in line with typical seasonality.

Included in the Americas forecast is the federal business, which we do expect to be down sequentially similar to last year.

We also expect to see continued growth in our services business.

As I stated in last quarter's conference call, we believe our core market in application delivery networking is very robust and currently has a number of growth drivers that should maintain growth opportunities throughout 2007.

Trends such as data center consolidation, virtualization and [server] oriented architectures in the enterprise, combined with the increased traffic with video, mobile and voice-over-IP traffic in the service provider segment, all contribute to growth opportunities for our application delivery networking solutions.

For that reason we remain committed to our growth strategy.

And as Andy mentioned earlier, we're planning to add between 100 to 120 new members to the SI team during this coming quarter.

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

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

Thank you.

Troy Jensen please state your company name and you may ask your question.

Piper Jaffray.

A quick question Andy.

Could you go over some of the guidance numbers again?

Just specifically the stock-based option expense baked in the operating lines?

In the operating expenses, it's going to be $11 million of stock-based comp.

And in the COGS it's going to be $0.5 million.

Okay.

Got you.

So if I run these numbers, and I assume they're more of the top end of the range, that gets to what, $0.65 pro forma?

Does that sound roughly correct?

Yes, roughly.

Okay.

Perfect.

And then John, can you talk about the 8800?

Any sense that customers may have been waiting for that product at all?

Or maybe give us some insights as to how the 8400 performed in the December quarter.

Yes, I when I talked last quarter about the beta tests that were going on, we had approximately 40 beta sites, so there's clearly an interest in the product.

Whether they were waiting or not, I don't think that's a specific issue, actually.

And in terms of the 8400, we did see good demand for that.

We don't give out the actual numbers by product but we did see good demand, especially in sort of the Internet service provider market, as well as the high end enterprise.

Got it.

All right, gentlemen.

Keep up the good work.

Thank you.

Jiong Shao your line is open.

Please state your company name and you may ask your question.

Lehman Brothers.

Thank you very much.

A couple questions.

First question is on the stock comp as well.

Could you just remind us how that works?

The vesting period for employees and executives and you say you grant it once a year.

Is that then pro rata into every quarter and exactly how that works?

And you definitely have $1 million stock comp level this current quarter.

Is that going do be sort of at the level going forward or do you think it may trade off or trend up?

So that's the first question.

The second question, I was hoping you can talk a little bit about your progress.

In terms of the stock comp, the increase -- in fiscal 2006, because of the inquiry, we didn't give any stock awards, which is by the way restricted stock, I should say that, to executives.

So we actually -- the Board agreed to do that last quarter, hence you're seeing the increase.

We also gave stock compensation for new hires, not for every new hire but depending on the new hire position.

So we do that.

And that will clearly continue as we hire aggressively.

It's typically done on an annual basis.

As Andy said, it will be done on August 1 next year.

What was the other question?

About -- which we don't update on future quarters, John, but I would say that in my comments I talked about that we anticipate awards going out on August 1.

And we'll just have to see how that affects the run rate on the expense because there's a number of variables that factor into that, as you know, stock price variation, volatility, realization.

Samuel Wilson.

Please state your company name and you may ask your question.

Hello?

Thank you.

Samuel Wilson, your line is open.

Is the line open now?

Hello.

It is.

I can hear you now, Sam.

Good afternoon, gentlemen.

Can you discuss linearity in the December quarter and generally how it was versus previous December quarters?

And second, just give an update on the telco business and what you're seeing there and sort of just color around how that's been proceeding.

Thank you.

So, linearity in the December quarter was 47%.

And over the last couple quarters, that's been pretty comparable.

You look a year ago and it was a pretty big improvement, actually.

47% in the last month.

In the last month of the quarter.

Got it.

In terms of the Telco business, --?

Sam, this is Dan.

From the telco, we saw obviously a change from 25% in the previous quarter, down to 20% this quarter, which was something we'd signaled on the prior call.

We knew going into the holiday season that the service providers were locking down many of their networks from that standpoint.

But in terms of the applications that we're being used for, we're really pleased with the types of penetration we're getting there.

Seeing us being used in mobile data optimization applications, lots of voice-over-IP and SIP implementations in the cable area.

So overall, quite pleased with our progress in that vertical.

Terrific.

Thank you very much, gentlemen.

Thank you.

Erik Suppiger, your line is open.

Please state your company name and you may ask your question.

Good afternoon.

A couple things.

First off, just on the stock comp, the $11 million, can you give us a breakout on how that would correlate with the three line items?

We haven't done that, Erik.

We're looking at that and we'll make a decision later about how we're going to disclose the breakout.

But I don't have it in front of me right now and we haven't given that out.

Okay.

Secondly, Europe has been a very strong performer for you in the past December quarters.

It was up but it wasn't up as much this year.

Is there anything going on in Europe?

Yes, we did see a little bit of a slowdown in the U.K., actually.

Nothing -- we don't think there's any systemic there.

And in fact, we expect the U.K. to have a fairly strong business result this current quarter.

But what we did see was less of the larger deals in the U.K. and that did have somewhat of an impact.

Okay.

And then lastly, on the telco front, where do you think -- we had -- was -- should we look at the previous quarter as an anomaly coming in at 25% or where do you think we might want to start modeling that as we look forward?

It's a tough -- that's tough to tell because all the aspects of our business are growing but probably in the range of 20% to 25% is where it's going to be sitting in the medium term.

Any thoughts in terms of visibility as we go into March?

Do you think you might have a rebound?

You said holidays cause a pause.

Does that come back this quarter.

I'm not going to say by percentage because that's a tough call.

But we expect the telco business to up sequentially in this current quarter.

All right.

Very good.

Thank you.

Thank you.

Matt Robison, your line is open.

Please state your company name and you may ask your question.

Congratulations, guys.

Questions, how much cash from options?

From options?

Options exercised.

Yes, it was just over $7 million.

Okay.

Usual question.

How many DevCentral users, the comparable number, I guess, was 11,500.

Matt, this is Dan.

So, we're over 13,000 this past quarter and also we had about 3,500 downloads of the iRule Editor as well.

Is there -- this may be kind of a tough question since you probably have a lot of mixed applications running on your new sales.

But can you characterize how much your business in the core sales you would attribute to the server proxy type of role versus more traditional load balancing?

I'll start and Dan can maybe give more detail but the answer is quite significant.

So, in other words, if you look at the way the usage model of our customers.

As soon as you start using iRules, as soon as you have any sort of I controlled type capability, you're moving away from simple load balancing and you're looking at application optimization and security.

So, I don't have an exact percentage but we know it's pretty high.

Yes, Matt, we did last quarter, actually, a survey of our DevCentral users.

And some of the results that came back were some indicators, as John mentioned, of who is using iRules or what percentage of the respondents were using them.

We found that over half had iRules in production on their systems out there.

And so those people certainly would be taking advantage of the higher level of functionality and adding more and more value to the apps as they flow back and forth across the BIG-IP in that case.

Plus you've got the --.

The DevCentral would almost by definition by iRules users I would think.

A lot of them, yes.

Yes, many of them would be.

Plus, there's the other -- not complication but other extra that takes you away from load balancing, which are the software modules.

So, any BIG-IP that's definitely running software module is doing much more than load balancing.

I missed part of your commentary.

The secured computing was an interesting announcement you had in the quarter.

Where should we expect you to go with other iRules applications like that that you're going to package up and productize to work with complimentary equipment?

There are many -- in general, we're always looking at what sort of additional appliances we can in essence turn into iRules and execute on the BIG-IP.

More on top of TM/OS more precisely.

So when we look at that, there are a lot of different things.

How do you measure performance?

What additional things can we do for security?

There are many, many areas that we're looking at, Matt, to try and follow up on that.

All right.

I'll yield the floor and try to get onto some of that stuff later on.

Thank you.

Rohit Chopra your line is open.

Please state your company name and you may ask your question.

Wedbush Morgan.

Just a couple of questions.

If you could talk about the competitive environment and pricing?

And then maybe address the issue of use of cash?

I think on the last call you indicated that there was a report going to be presented to the Board.

And the Board was going to make a decision sometime in early January.

So, I thought maybe that would be a good time to ask that question.

Yes.

So first of all, competitive landscape, really not seeing much change in the competitive landscape.

If we're seeing any changes, we believe we're more competitive than we've ever been.

And I'm talking specifically about the application delivery controller market.

With the new products we've been announcing, we've been leading our competitors, frankly, in the dust.

So, no big change there.

And that has had the impact you might expect in terms of pricing and gross margins.

You could tell from the results that Andy talked about, are very stable.

As was indicated a number of times [but I assumed out label] because we may want to use the flexibility moving forward.

So, I feel very good about our competitive position.

Regarding the use of cash, we had a very detailed discussion with the Board at the lasT Board meeting in January.

We looked at a number of options.

We've actually decided, certainly, for the medium term not to take any action right now.

The main reason is that we're really in a very, very fast moving market here.

We think the continued expansion opportunities and growth opportunities and we want to keep maximum flexibility so that we can take an opportunity if it presents itself.

So, we actually haven't -- we've decided really not to take any action.

Thank you.

Thank you.

Ranjini Chandirakanthan, your line is open, please state your company name and you may ask your question.

Good afternoon.

From Thinkequity.

Just curious on the feedback of integrating FirePass and WANJet into TM/OS, what are customers saying?

The response we've gotten has been very positive with FirePass on TM/OS because it improves its performance significantly in a number of ways, from concurrent user count to [WAA] throughput.

And we're not talking about like 2X, we're talking about order of magnitude.

So, the feedback has been very positive with regards to that.

But their main question is;

When do I get it?

Got it.

And what about WANJet?

WANJet, same thing.

It doesn't have the performance.

It also gives it a lot of capabilities to interwork with our enterprise management system.

And so, that's been very positive as well.

We're going to go through this in a lot of detail at the February 7 meeting.

Okay.

Great.

And just one last thing on the service provider market and competition.

I know you had several partnerships with other telco vendor providers.

I'm curious if your competitors are doing the same thing?

Are they partnering with others or is it really just Cisco and Nortel with their own equipment in that area?

This is Dan.

So, I think it's still primarily Cisco and Nortel in that area.

We really haven't seen any significant moves, certainly, in the past year with changes in partnerships with other players out there.

There are some older ones that have existed for some time but frankly, we see those sort of dwindling in importance.

Thanks a lot.

Brent Bracelin, your line is open.

Please state your company name and you may ask your question.

Pacific Crest Securities.

Wanted to dig a little bit into the security business.

It looks like this was the second quarter you saw good sequential growth there.

It looks like the best year-over-year growth in over a year.

What do you think kind of is driving that?

And could you talk a little bit about the pipeline in that market and why you're starting to see a rebound there?

Well, first of all, it's mainly FirePass that is the growth factor.

And we are slowly but surely starting to see more moves towards SSL VPN as an access technology, which is obviously a good sign.

Do you want to add any more specifics?

Yes.

Absolutely, Brent, I think to follow along with what John said, FirePass, certainly product improvements have driven a lot of the changes that we've seen just in terms of market adoption.

In terms of where we are from a market share standpoint.

Certainly we've improved that significantly over the past four quarters.

So we're quite pleased with that.

So things keep marching along from that standpoint.

As well, we're seeing with the application security module coming on too, that certainly helped us in the overall security area.

And mobile is -- I've actually mentioned this in previous quarters.

Mobile is definitely a big driver of the FirePass solution.

Okay, great.

So, you wouldn't attribute any of the change to kind of an industry changes or changes in pricing.

It sounds like those are all specific things associated with the FirePass product itself.

Yes.

Not changes in pricing but as Dan said, definitely changes in our competitive features.

Okay, great.

Just one quick follow-up on the software module, obviously you spent some time to talk about kind of the MSM module, growing interest in that.

How would you gauge the interest in third party software modules?

Obviously, you're going to have to work with a lot of the third a party vendors.

How willing are they to deport to TM/OS?

And how much -- how long would it take to port some of those modules to TM/OS?

So again, this is Dan, Brent.

From -- to answer the length of time question first.

We've actually seen some examples where people frankly have been very surprised with how quickly they're able to get something across in to TM/OS.

Just the quality of the ATI that we have, to be able to work with us, the software development kits and all that types of stuff.

We've had people say; "I had budgeted a month and it only took me three or four days to get it done."

So, that's great.

In terms of the willingness to actually get something on top of it, a lot of times people have solutions that are out there that customers will come back and say; "I like what your product does but installing yet another appliance in my data center is going to complicate my life.

Troubleshooting that much more difficult.

Adds another hop to my network, et cetera, et cetera, et cetera."

So, we are actually a great vehicle to market for some of these solutions.

And of course, in those cases as well, there's a revenue sharing opportunity for them as well.

So, I think lots of incentives for them to cooperate with us.

Great.

We'll look forward to asking more questions next month.

Thank you.

Mark Sue, your line is open.

Please state your company name and you may ask your question.

This is Jennifer Tennenbaum for Mark Sue, RBC Capital Markets.

Just a housekeeping question.

The $8 million in stock compensation, will you break that out between the three line items on operating expenses or you're not going to do that?

No, we're not going to do that.

Okay.

And then just could you talk about the federal government during the quarter, what you saw there?

Obviously, it was up sequentially.

Well, the federal government was 6%, attributed 6% of the revenues, which is pretty positive.

That sort of higher end, especially after the financial year-end.

In other words, that 6% in the December quarter is a pretty good number.

I did say, by the way, that we expect the federal business to be down in this current quarter.

But overall, we think it's a good market, it's a strong market.

It's probably very underpenetrated, actually.

And we would over time expect it to be similar to the growth of the enterprise business.

And then just in -- also on Europe, which countries did you see perform the strongest in the quarter?

In Europe?

Yes.

So, I mentioned that the U.K. had a little bit of a hiccup, mainly with some of the big deals.

Germany was pretty strong.

Was pretty prong.

Scandinavia countries was pretty strong.

Southern Europe was good as well.

Thank you very much.

Thank you.

Cameron Cooke, your line is open.

Please state your company name and you may ask your question.

Hi.

I was wondering if you could just -- the $11 million on the stock comp was that pretax and then the $8 million is tax affected?

Is that correct?

The $8 million was the actual in our Q1.

The $11 million is the expected in Q2.

Okay.

Those are both tax affected numbers?

No, they're pretax.

Pretax.

Okay.

And average deal size in the quarter?

Pretty consistent with what it has been.

Approaching $160.

Okay.

Average invoice.

Thank you very much.

Thank you.

Kim Watkins, your line is open.

Please state your company name.

You may ask your question.

Hi, this is Kim Watkins in for Ehud Gelblum at J.P. Morgan.

First, I wanted to ask about, now that you're rolling out or introducing the 8800 and also migrating the WANJet and FirePass onto TM/OS, are you seeing any customers delay purchases, any latent demand building there?

No, we really haven't seen much of that.

And that's pretty historically we've been good in that.

Mainly because if you look at our product line, 8400 was best of breed and so of a competitive nature.

So I don't think that's a significant factor in terms of delays.

And certainly, with WANJet to some degree you could argue there's a delay in the sense that it's not quite as competitive.

I made that very clear last quarter.

So, we are missing some competitive functionality that we will get with TM/OS that Karl talked about like management capabilities.

But I wouldn't really call it delay, more of the fact that we get more competitive.

Okay.

And then when you actually start rolling out the 8800, is that going to can cannibalize the 8400 or do you think that allows you to penetrate a new market segment?

I think it's more a new market segment because it's part of a product range that's already in place that goes from our 1500 upwards, 3400, 64, 68, 84 and now 88.

Okay.

And then one more question on distribution.

I think I heard you say that Avnet was 14% of revenue.

I haven't heard Avnet on the distributor list before.

And I also heard, I think, GE Access come off.

So, can you talk a little bit about your distribution channels and how that's changed?

There's a very simple reason for that.

So, Avnet acquired GE Access recently so that's the reason for the change there.

Thanks for reminding me of that.

Thank you.

Thank you.

Bill Choi, your line is open.

Please state your company name and you may ask your question.

Jefferies & Company.

First, a clarification.

On the tax rate going forward, is that 35% excluding stock options on a quarterly basis going forward or is that for the full fiscal year?

It's the quarterly rate that we think will hold through the year.

So the annual might be more like 32%, 33%, something around that rate?

When you net -- it will be lower because of the one-time benefit we have this quarter.

But I don't know -- I haven't figured out exactly the annual rate.

And so the rate that we should also use for fiscal '08 would be 35%?

For -- yes. '08?

Yes.

Now, the 8800, just wanted to dig into that a little bit more here.

You anticipate the telco business to be up sequentially.

I would imagine that telco segment you're also including the general service providers, Web hosting companies.

Is that largely due to 8800 becoming generally available?

I think it's larger than just driven by that specific product.

So the growth in that segment is -- I think would happen whether the 8800 is there or not.

Now, having said that, the 8800 is an ideal solution for that market.

But we think the market -- the growth is there anyway for our solutions.

Have you guys noticed -- you've been beta testing it for a while.

So, everyone has been anticipating the GA of this product. have you noticed any pent-up demand order rate so far into it?

And then just looking at this product overall, what kind of pricing premium are you anticipating getting here as you set the pricing?

And generally what percentage of the enterprise would need this kind of high-end box?

How important is it versus just having a good enough box?

And perhaps what happens to prices going forward on the 8400?

Are you going to reduce it as the 8800 comes on-board?

Now, first of all is what we've said it's finished beta.

It's released to manufacturing.

But we haven't made the formal announcement of the product yet.

We have a date for that.

But we're -- that's a date that will be made public when the date arrives.

And that's when we start our training, our press and that.

We'll also talk about pricing on that.

So we haven't done that yet.

So really we're not answering the question because that's all imminent and it's going to happen this quarter.

It's just we haven't specifically released a date.

Any comment on just kind of the pent-up demand you would anticipate on this product?

Well, it's our flagship product.

It's at the high end of the range and we expect it to be into the high end enterprises and the high end telco.

And we'll make sales of that product and I think it will pool the rest of the range into the account as well.

But we're not -- in terms of specific numbers, no, we're not going to give that.

We've not done that in the past.

Okay.

Thanks.

Thank you.

Tim Long, your line is open.

Please state your company name and you may ask your question.

We're going from 72, 73 to 65.

So could you just talk a little bit about, is that all the headcount additions that we should think about?

I'm sorry to interrupt but we didn't hear the beginning of your question.

I'm sorry.

The -- looking at pro forma numbers from December quarter to March quarter, it looks like 73 or so to 65.

Could you just quantify a little bit?

Is this pretty much all head count related or are you expecting a change in gross margin first?

And then if you could maybe just give us an update on the status of Montreal as well, that would be great.

Go ahead.

In terms -- when you say 73 to -- the numbers that you threw out there, are you talking operating expenses or --?

I'm talking pro forma EPS, if we're taking about the stock options expenses from the GAAP EPS.

Are you also backing out legal from that when you're looking forward?

No.

Because if you're looking at the increase in stock comp, it has about a $0.20 effect on the EPS.

So --.

Yes.

So, our guidance is $0.44 to $0.46 on a GAAP basis.

So I guess the question is then on the GAAP basis, the downtick from this quarter, is it all stock options or is there anything on -- or is the headcount affecting the pure operating margin of the Company?

Yes, and it's primarily tax based.

If you're looking at on a GAAP basis, it's the tax which is about $0.04 in stock-based comp.

Okay.

And then on just Montreal?

This is Karl, I can give you a quick update.

The last conference call we had stated that Montreal would release manufacturing at the end of the calendar year and we're on schedule for that right now.

So, we continue to make progress against that goal.

And we'll give you a much more detailed update on February 7.

Thank you.

Gabe [Lowy,] your line is open.

Please state your company name and you may ask your question.

Thank you.

Unterberg.

Nice quarter.

Questions have all been answered.

Thank you.

Manny Recarey your line is open.

And please state your company name.

Kaufman Brothers.

Good afternoon.

I just have one question.

If I remember correctly, on your last conference call you spoke about investments that you were going to make because you see opportunity in the WAN optimization market.

And the effect it was going to have was lower your pro forma operating margin to -- from over 30% to under 30%.

And this quarter the operating pro forma operating margin was about 30%.

So, I was wondering if you could give any update on that?

Do you still expect that negative impact to happen?

Yes, it's our expectation that over the course of the year we trend down to the high 20's.

But I'd clarify it by saying that it wasn't specifically attached to WANJet specifically.

It was broad opportunity across the organization, our core market, what will be WANJet, as well as FirePass.

And obviously, we're adding a lot of sales and service people as well.

Okay.

And so, the outperformance in that in this quarter would be attributed to just the higher revenue?

Yes.

Steven Freitas, your line is open.

Please state your company name and you may ask your question.

Hi, good afternoon.

It's BMO.

My question is, with severe virtualization becoming more prevalent now in enterprise data centers, I was wondering if you could discuss the complexity of load balancing of virtual servers versus physical servers?

And in that vein, does the BIG-IP natively load balance virtual service today?

We actually -- the BIG-IP has been load balancing virtual servers for many, many years.

The fact that we're now applying this terminology "virtualization" It's independent of the capabilities of the platform.

So, we don't care if it's a server, application, virtual servers, it looks all the same to the BIG-IP.

And the fact of the matter, what we're doing now is actually extending management capabilities to the BIG-IP to allow to you manage these different virtuals and virtual servers on the back end by different groups.

John mentioned the administrative domains capabilities in his entry speech.

So yes, so it's something we natively have done and continue to do very well.

It's one of our core competencies.

Very good.

And then on the new platforms with a lot of capacity coming onstream, do you virtualize the partition capacity, can the platform do that today?

We have capabilities like rate shaping that can virtualize by virtual or by different capacities or whatever you want to -- however you want to divide up the resources in the system, we can manage it based on, again, this rate shaping functionality.

Very goo.

And then just finally on the security revenue, could you break that out, or if you haven't already, between FirePass and app FireWall?

So, FirePass was $7.9 million this quarter and $1.8 for the application for FireWall products.

Okay.

Thank you, [Yan Zoi],

your line is open.

Please state your company name and you may ask your question.

This Yan Zoi calling in for Ryan Hutchinson from WR Hambrecht.

I was just wondering if you could break out worldwide government versus U.S. government?

Yes, worldwide was -- well, total was 12% and federal was 6%.

So, there's a little bit of state and local in that other 6% but you basically can get there.

Thanks a lot.

Thank you.

That concludes today's question and answer session.

I'd now like to turn the call back over to John McAdam for closing remarks.

Okay.

Thanks everybody.

And hopefully we'll see a number of you on February 7.

And if not, we'll talk to you next quarter.

Thanks a lot.

Thank you.

That concludes today's conference.

You may now disconnect from the audio portion.