F5 Inc (FFIV) 2010 Q4 法說會逐字稿

Good afternoon and welcome to the F5 fourth quarter and fiscal 2010 financial results conference call.

At this time all parties will be able to listen-only until the questions-and-answer portion.

Also today's conference is being recorded.

If anyone has any objections please disconnect at this time.

I would now like to turn the call over to Mr.

John Eldridge, Director of Investor Relations.

Sir, you may begin.

Thank you Ashley.

Welcome all of you to today's conference call.

We're reviewing the results of the fourth quarter and fiscal year for 2010.

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

The other members of our Exec Team are also with us to answer questions following our prepared comments.

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

A copy of today's press release is available on our website at F5.com.

In addition, you can access an archived version of today's live webcast from the events calendar page of our website through January 19th.

From 4.30 PM today until 5.00 PM, Pacific time, October 27, you can also listen to a telephone replay at 800-947-4566, or 203-369-3552.

During today's call, our discussion will contain forward-looking statements which include words such as believe, anticipate, expect, and target.

These statements involve risks and uncertainties that may actually -- may cause our actual results to differ materially from those expressed or implied by the statements.

Factors that may affect our results are summarized in our quarterly releases 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 also want to remind you that we are holding our 2010 analyst investor meeting in New York on November 16.

If you are planning to attend the meeting and have not registered, you can register online from the link on our IR events calendar entry for November 16, or call Darlene Henderson at 206-272-6170.

And now I will turn the call over to Andy Reinland.

Thank you, John.

Q4 marked another quarter of strong sequential and year-over-year revenue growth and profitability, capping a very strong year for F5.

Following my review of our results for the fourth quarter and fiscal year 2010, I will provide guidance for Q1 and discuss our general planning assumptions for fiscal 2011.

For the fourth quarter of fiscal 2010, revenue of $254.3 million was above our target range of $242 million to $247 million, representing an increase of 10% from the prior quarter and 45% from the fourth quarter a year ago.

Book to bill was greater than 1.

Q4 product revenue of $165 million up 12% from the prior quarter and 52% from the fourth quarter of last year, represented 65% of total revenue.

Service revenue of $89.3 million increased 7% sequentially and 35% year-over-year, accounting for 35% of total revenue.

Revenue from our core application delivery networking business was $241.8 million, compared to $218.5 million in Q3 and represented 95% of total revenue.

ARX revenue was $7.3 million, up from $6.2 million in the prior quarter, and represented 3% of total revenue.

FirePass revenue of $5.2 million was down from $5.7 million in Q3 and accounted for 2% of total revenue.

This decrease was primarily driven by increasing sales of our Access Policy Manager and Edge Gateway products which incorporate many of the features and capabilities of FirePass and are included in our overall ADN solution portfolio.

As these products continue to gain traction we anticipate that sales of stand-alone FirePass will continue to decline.

Beginning next quarter we will include FirePass revenues as a component of ADN revenue and will no longer break them out separately.

On a geographic basis, we grew revenue in all theaters during Q4.

The Americas represented 60% of revenue, EMEA accounted for 22%, APAC 12%, and Japan 6%.

By vertical, telco represented 25% of revenue during the quarter, technology, including large Internet content providers, was 19%, and the financial sector accounted for 20%.

Total government revenue was 11%, including 7% from US federal.

During Q4, we had one greater than 10% distributor, Avnet, which accounted for 18.3% of total revenue.

Continuing down the income statement, gross margin in Q4 was 81.6%.

Excluding $2 million of stock-based compensation, non-GAAP gross margin was 82.4%.

Operating expenses were $131.1 million.

Excluding $17.8 million of stock-based compensation, non-GAAP operating expenses were $113.4 million.

GAAP operating margin was 30%.

Excluding stock-based compensation, our non-GAAP operating margin was 37.8%.

GAAP other income of $100,000 included a one-time $1.5 million legal settlement charge.

This charge is excluded from non-GAAP results.

Our effective tax rate for the quarter was 36.8%.

Our non-GAAP effective tax rate was 34.6%.

GAAP net income for the quarter was $48.2 million or $0.59 per diluted share, above our guided range of $0.53 to $0.55.

Excluding stock-based compensation and the one-time charge for the legal settlement, non-GAAP net income was $63.9 million, or $0.79 per diluted share, also above our guided range of $0.69 to $0.71.

For the full year, revenue for fiscal 2010 was $882 million, up 35% from fiscal 2009.

Product revenue of $561.1 million was up 38% from the prior year and accounted for 64% of total revenue.

Service revenue of $320.8 million grew 30% during the year and represented 36% of total revenue.

GAAP net income for fiscal 2010 was $151.2 million, or $1.86 per diluted share.

Non-GAAP net income was $203.8 million, or $2.51 per diluted share.

Turning to the balance sheet, in Q4, we generated $86.4 million in cash flow from operations, which contributed to cash and investments totaling $862.1 million at year end.

For all of fiscal 2010, cash flow from operations totaled $313.6 million.

DSO was 40 days.

Inventory at the end of the quarter was $18.8 million.

Deferred revenue increased 8% sequentially to $259.4 million.

Capital expenditures for the fourth quarter were $2.5 million and depreciation and amortization expense was $5.9 million.

During the quarter, we added 110 employees, ending the year with approximately 2,010 full-time employees.

This compares to 1,645 employees at the end of fiscal 2009.

In Q4, we repurchased approximately 223,000 shares of our common stock at an average price of $89.57 for a total of approximately $20 million.

Of the $200 million authorized by the Board for repurchase in October 2008, approximately $38 million remains.

F5's Board has authorized an additional $200 million for our share repurchase program.

Now for our Q1 fiscal 2011 outlook.

We continue to see the broad adoption of our products by a wide range of customers seeking to drive efficiency, performance gains, and cost savings within their data centers and service offerings.

Combined with the growing recognition of our technology and market leadership, a strong product roadmap and the significant investments we have made in our sales force and channel, we believe we will continue to see strong demand for our solutions entering our new fiscal year.

For the first quarter of fiscal 2011, we are targeting revenue in a range of $265 million to $270 million.

An item of note, we will be adopting the FASB's new revenue recognition rules beginning in Q1 of fiscal 2011.

We anticipate the impact of these new standards on Q1 to be a deferral of approximately $1 million of product revenue.

This impact is factored into our guidance.

We expect overall gross margins of 81% to 82%, including approximately $2 million of stock-based compensation expense.

Our operating expense targets are $137 million to $141 million, including approximately $18.5 million in stock compensation expense.

Our effective tax rate for the quarter is expected to be 36.5%.

Excluding stock-based compensation, our non-GAAP effective tax rate is expected to be 35%.

Our Q1 GAAP earnings target is $0.62 to $0.64 per share.

Our non-GAAP earnings target is $0.80 to $0.82 per share.

We expect to maintain our DSO in the low 40-day range.

We anticipate inventories in the range of $17 million to $19 million.

We are targeting an increase to headcount of 125 to 150 employees, and we believe we will generate cash flow from operations in excess of $95 million.

Now, I would like to give you some general comments and guidelines related to our expectations for fiscal 2011.

We believe the momentum we see in the business continues to drive F5 forward in fiscal year 2011.

Our goal for the year is to continue to grow revenue by investing in our business and to maintain a high level of profitability by investing behind revenue growth.

With that in mind, we are confident we will grow revenue sequentially throughout the year.

We expect to see gross margins in a range of 81% to 82%.

We anticipate non-GAAP operating margins to range between 36% and 38%.

We expect stock-based compensation expense to approximate Q1 levels until our next annual grant in August.

Capital expenditures are expected to be $4 million to $8 million per quarter, and we expect our effective tax rates to average approximately 36.5% on a GAAP basis and 35% on a non-GAAP basis.

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

Thanks, Andy, and good afternoon, everyone.

I will take a few minutes to cover F5's performance in fiscal 2010, talk in more detail about our Q4 results, and then comment on our outlook and the exciting opportunities we see going into fiscal 2011.

The improvement in corporate spending patterns that we started to experience in the second half of fiscal 2009 continued to improve throughout the year.

Data center consolidation using virtualization technologies, cloud computing architectures and the continued explosive growth of mobile applications and data are all industry trends which continue to be significant growth drivers for F5 solutions.

In addition, we continue to derive significant revenues from our partnerships with large application solution suppliers, who have the ability of our products to optimize the performance, security, and availability of mission critical business applications is unparalleled.

These new architecture trends have greatly expanded and solidified F5's position as a critical infrastructure player in the data center where our products access strategic control points and are key building blocks for the dynamic data center architectures.

During fiscal 2010 we increased our technology leadership position with several new product releases and the addition of significant new functionality features to our key most portfolio of solutions.

Typical examples of this market expansion include our new Access Policy Manager solution, our WAN optimization module, the software virtualization version of BIG-IP, and our expanding portfolio of application optimization templates.

We also increased our market share in core application delivery controller market by approximately 8 points.

We invested in our go to market strategy with a number of key hires in the ARX file virtualization business, which has resulted in sequential revenue growth in the second half of the year.

Our services business continued to be a significant profit and revenue growth contributor while maintaining customer satisfaction at world class levels.

All our key financial metrics improved in fiscal 2010.

We ended the fiscal year with a stellar balance sheet with approximately $862 million in cash and investments, having repurchased approximately 75 million of common stock.

Free cash flow for fiscal 2010 was up 58% year-over-year at $301 million.

Our overall year-over-year revenue growth was 35%, including 38% year-over-year growth from product sales and 30% growth from our services business.

We also experienced quarterly sequential growth in operating margins throughout the year.

We accomplished this while investing significantly in additional headcount, increasing our total net headcount by over 360, ending the year with over 2,000 employees.

As far as Q4 is concerned, I was very pleased with our results.

Revenue growth of 45% year-over-year, including 52% year-over-year product growth should put us in a strong position for continued market share gains.

From a geographic perspective, North America completed a stellar year with yet another strong performance driven by large multimillion dollar ADC project wins and a strong quarter from our US federal team.

Having said that, the success in Q4 was broad based with all major geographic regions exceeding our internal targets.

We continued to see progress with our ARX file virtualization product sales.

The investments we made in our go to market strategy with ARX are starting to bear fruit, and we expect ARX to be a growth driver in fiscal 2011.

Our services business delivered yet another solid quarter completing a tremendous year.

The Fed revenue continued to grow last quarter which bodes well for continued growth in 2011.

Overall our Q4 financial performance was excellent.

Quarterly free cash flow of almost $84 million was a record for the Company.

Our non-GAAP operating margins of almost 38% exceeded our internal targets.

As far as the outlook is concerned, Andy provided our projected revenue range as well as some of the high level expectations for fiscal 2011.

While it is appropriate to be cautious about the global economic situation, we remain committed to a strategy of investing behind revenue.

I feel very optimistic of the future of F5 as we enter 2011.

We enter the year in a very strong competitive position.

I am very excited about our product roadmap.

We will present our roadmap in detail at our upcoming analyst investor meeting scheduled for mid-November.

I will not go into the details here regarding our product roadmap but you will hear more about our plans for a host of exciting new products and additional software features.

The roadmap deliverables will expand and enhance our technology and leadership position and increase the barrier to entry for our competitors and open new addressable markets.

As I said in my introduction, F5 enjoys a position of being in the sweet spot of business and industry trends, and the investments we have made in our sales channel should allow us to take advantage of this position.

The F5 team should be proud of our progress and accomplishments during fiscal 2010.

I would like to take this opportunity to thank the entire F5 team and our partners for their tremendous efforts last year and I look forward to their continued support in fiscal 2011.

We will now hand the call over for Q&A.

Can we have Q&A now, please?

We will now begin the question-and-answer session.

(Operator Instructions) One moment please for your first question.

Your first question comes from Erik Suppiger.

Your line is open.

Good afternoon.

Congratulations.

Thank you, Erik.

I guess first off, the margins on the quarter were very, very good and it looks like you're expecting to keep them at these levels.

Do you think that it's prudent to continue at this level to 2011, or do you anticipate stepping up your investments from these levels which would bring your operating margins down?

Well, I think we're pretty committed to continuing to invest to drive the top line, but as we look at the year and what we think is going to lay out, we think we can both invest and stay in this operating margin range.

So we felt it was prudent to lay that out for you.

Very good.

And on the service provider side, can you comment how much of that is being driven by wireless carriers at this point?

This is John, Erik, maybe Dan could comment as well.

But we -- a lot is the answer.

We wouldn't give the specific percent.

I don't actually know that.

But we know there was a number of multimillion dollar deals that were related very, very closely to mobile traffic growth last quarter, and we see that continuing.

Certainly the big majority is based on mobile traffic.

Absolutely.

Erik, this is Dan.

The types of things that they're using us for continue to be putting us in front of the end user traffic increasingly and solving problems like traffic steering, like integrating and off loading some of the authentication with the directory services with the diameter of stuff that they do.

Very, very heavy use of iRules as well to customize our behavior in their environment.

So we're quite pleased with the progress we've been making in both the mobile and wire line carrier side.

It's also pretty global in nature as well.

Very good, thank you very much.

Your next question comes from Tal Liani.

Your line is open.

Hi, guys.

My questions are about the financials.

What I did, I calculated the sequential increase in revenues every quarter since September last year, and then the sequential increase in profits, and your margin contribution, the marginal -- how much of it flows down to the bottom line has gone up tremendously from 33% in December to 78% this last quarter.

So I'm going back to the question that was asked before.

When you gave the guidance for the next year, you said 36% to 38%.

But you were also conservative with your guidance before.

So I'm wondering, if revenues continue to grow at 10% a quarter, like you have grown the last five quarters, what prevents you from reporting operating margins that continue to go up, or what prevents 50% to 80% of this incremental revenues to filter down to the profit line?

Thanks.

Yes, I mean, you're absolutely right.

And we've talked about this in the past that if we do exceed our targets, then we could see operating margins spike higher, and actually we saw that a number of times through this last year, that led to us having now eight quarters in a row of operating margin expansion.

So, Tal, I certainly don't argue with your premise there.

We don't really see any big change in the model, which is, as we said earlier, invest behind revenue, and then of course the key metric from an expense perspective is hiring.

You can see we're increasing the hirings this coming quarter.

I expect that will continue, but they're the main metrics.

Now, if I go back and ask about the revenue growth, this year, you had the tremendous revenue growth on a quarter-to-quarter basis, and on a year-over-year basis, of course.

So looking in 2011, can you break down your -- the underlying growth of the market and then discuss the secular growth versus maybe recovery mode.

Then also address the share gains which means entering into next year do you expect share gains to continue, or you think you've got the market share which is sustainable going forward, and do you think the underlying market itself to grow at such a high rate as we've seen through 2010, or was it just recovery?

Yes, Tal, this is John, I'll pass to Dan as well.

But just to give you some comments before I do that, we're pretty convinced internally that our market is an expanding market, in nature in the sense that we continue to add more jewels that increase our market opportunity.

We'll talk a lot about that in November because we think that with a lot of the trends that are going, plus the platform base that we have with TMOS, as well as ARX, but with TMOS mainly, we can increase the market opportunity.

In terms of share gains, yes I think we'll continue to gain share.

Obviously we have to execute on our product roadmap.

But I think we will do that.

We will continue to gain shares.

In terms of the market growth I think we're a big driver of it.

Maybe Dan can comment on that.

Yes, absolutely Tal.

When you look at some of the market analyst projections and just thinking about sort of a pure ADC market as they measure it, the advanced portion of the marketplace, which is the one that we dominate, looking over the next couple years, sort of from the low 20's percent annual growth there.

When you look at that piece, but also what John raised, and that is we do a whole lot more than just address the -- that ADC segment of the market, we're pushing into increasingly into security, increasingly into the mobile space and to storage optimization, so on and so forth.

So we'll talk a lot about that during the investor day.

But people have asked us previously, is market constraint something that keeps us up at night, and it certainly is not.

And then also in terms of market share gains in the ADC market, in the past years John highlighted we picked up just under 8% in the market as measured by the analysts out there.

About half of that, or just under half of that came from Cisco.

Some of the smaller players in the marketplace also gave up significant share over the course of the year, and then some of the other Tier 2 players were basically flat over the course of the year.

So we took some from the bigs and some from the smaller guys, and the other ones were steady state.

Tal, another variable that we think is a driver for us here is improved sales productivity.

We think we have the opportunity to drive that up, and is another reason that we're focused on investing in sales people, because we think it in itself can have an impact on the overall market.

So you will see us doing that as well.

Excellent, thank you.

Thank you.

Your next question comes from Jeff Evanson.

Your line is open.

Thanks.

I'm wondering if you could give us some metrics of insight into the growth of some of your new product introductions and in particular talk about the uptake that you've seen in the virtual version of your ADC.

Sure.

This is Dan.

In terms of actual numbers, I don't think we've disclosed the actual sales of the particular modules or particular products, but things that I am very happy with are progress that we've seen on APM, our Access Policy Manager, in particular has been great.

Our Global Traffic Manager, as well has seen really, really good growth over the past several quarters driven by things like the adoption of DNSSEC in the Internet for enhanced security in the DNS system, some of the other things are WAN optimization module.

I've seen some really, really nice gains there.

So it's really across the board, as well as our Edge piece on the SSL VPN and access.

We've seen that taking the over from the traditional FirePass.

The other thing, without disclosing the numbers, on our virtual edition of BIG-IP on LTM, we introduced that.

I think we released it in February, and I don't have the number right in front of me, but I want to say we've had about 14,000 downloads of that since then.

So it's a pretty good follow-up in terms of our goal of increasing our reach with that product out in the marketplace.

So that's been really, really good.

We've also introduced a virtual version of FirePass, so we've seen activity on that as well.

So, overall, I think with the new products in the portfolio, sort of the emerging products, if you will, I'm very happy with how things are going.

Do you have any sense for what share of the downloads of your virtual systems are used in production environments versus back rooms to develop and test new ways to use TMOS and iRules?

I think the majority of them today are mostly tests.

We have seen definitely deployment in production as well.

But I think the majority is making it easier for people to try the stuff out.

Test their [applications] against it.

Develop iRules so they can go ahead and roll out their full system later on.

So that's definitely the majority today.

Thank you.

You're welcome.

Your next question comes from Rod Hall.

Your line is open.

Hi, guys, thanks for taking my question.

Just a couple quick ones.

One, I wondered.

You guys have been quoted in some recent conferences talking about new products coming up.

I think wireless products, Victoria, other high-end products.

I wonder if you could talk about whether new product assumptions are in your guidance, or if your guidance excludes any new products that might come down the pike in Q1?

Obviously we'll go through them in November.

Maybe Karl could give a very brief summary of some of this stuff in a second, but in terms our guidance, not really.

These are -- Victoria, for example, we expect to see our next calendar year, and obviously we haven't given any specific guidance, we've only given specific guidance for the quarter.

So, no, I don't think the new products have any significant material effect on the guidance for the current quarter we're in.

This is Karl.

We will be talking about Victoria and other platforms and our new features that are coming at the upcoming analyst day here in a few weeks.

Okay.

And then I had a -- I just wanted to follow up on, now that you guys have the benefit of the July data under your belt, I wonder if you could talk about, Cisco talked about this end of June, early July downturn in enterprise spending.

It then snapped right back.

I wonder -- I think as of last quarter you guys really didn't see that.

Can you say, now with the benefit of July data, was there anything in your numbers that would suggest that was going on, or just saw absolutely nothing?

No, we didn't see anything that reflected those comments.

Okay.

And the last question I've got for you is on the hiring.

Can you give us any idea of regionally where you're hiring?

Are you doing more in Asia PAC, more in Europe?

Is it mostly US?

Can you just talk us through that?

Yes, actually, I think it's pretty broad in reality.

I think you'll see North America lead the way.

But it's almost, from our perspective, on the sales front in particular, which tends to make up over 40%, it will be pretty broad.

But by broad do you mean proportionate, or do you mean just everywhere but not -- (multiple speakers).

Yes, I think that's fair way to put it, proportionate to what, if you look at the break down of our business worldwide.

Yes.

[All year it would] go up -- percentage or something like that.

Okay.

Great, guys, thanks a lot.

Thank you.

Next question comes from Catharine Trebnick.

Your line is open.

Good afternoon, gentlemen.

My question has to do around the Policy Manager that you discussed.

Could you give us some more color as to the type of applications for wins for this product?

Was it more mobile?

Was it more data center specific?

Absolutely, this is Dan.

It was pretty broad based, actually, Catharine.

Some of the things that I would highlight in terms of wins that we've had and solutions that we put forward during the quarter would be some of the stuff that we've done with Oracle, for example, integration with their Oracle Access Manager System, and using APM specifically to off-load some of the functions that otherwise would have required a whole tier of proxies to be deployed.

So having that happen in one place with us is a good example of that.

We've also seen, in the wireless space as well, some of the integration with the directory services going on.

Another example would be in the federal space where, security is critical, and Access Policy Manager was something that drove some great business for us there.

So it's pretty widespread.

When we look at what that product really does, we're combining optimization, security, offload of functions that otherwise have to be built into a multitude of individual applications.

So people find it very, very convenient and productive to deploy this.

Thank you.

You're welcome.

Your next question comes from John Slack.

Your line is open.

Great, thanks, guys.

I was wondering if you could give some color around maybe on the platform, on the product platform strength what particular products are seeing more strength than others versus VIPRION versus some of the mid-range products.

Would love to hear that.

Again, maybe pass it to the Karl in terms of the details, but what we are seeing and we saw again this quarter is a jump in the average order size.

In fact, it was fairly significant this quarter.

We're also seeing jumps in the number of deals above $200,000, etc.

So we're seeing bigger transaction with bigger products in the mix within those transactions so the 8900 and above range has been very hot.

VIPRION has been very hot.

But across the board we still have a pretty good mix, but definitely trending towards the high end.

This is Karl again.

We introduced some new platforms too, with our 11050.

So that's still fairly nascent.

That just went out about a quarter ago.

We'll see that, I think start to engage with some opportunities.

Victoria, when it comes out, also slots in nicely between our appliances and our high end VIPRION at a better cost point, a much better cost point.

So we see a lot of opportunities there.

But in general consolidation, virtualization has really been driving a lot of adoption, especially the high-end platforms, but I think also the low end, too.

It's been doing quite well, as well.

Just maybe one comment.

This is Mark Anderson.

What we've done in the last year is we've really worked hard to train the sales team to sell bigger configurations and train our partners to sell bigger configurations.

The amazing thing is, our customers deploy these bigger boxes, the VIPRIONs, the 8900s, and they go through them.

It allows them to deploy modules in a much more scalable way.

It's obviously the platform that we're pushing.

Great.

Maybe a follow-up.

On the bigger order, or jump in order size, are you seeing not only bigger configurations, but also more units on an average order, too?

I don't know if we know the answer to that question actually.

That's something we need to check.

Just a reminder that Version 10, because it's quite often forgotten, Version 10 is the version that come out with the ability to have multiply modules.

I think that's been pretty profound in terms of end of product side, because as you increase the modules you typically go higher up the product range.

I think that's one of the big drivers, that, and of course the fact that all our traffic is obviously exploding.

Great, thanks a lot.

Your next question comes from Troy Jensen.

Your line is open.

That's a nice quarter, gentlemen.

Thanks, Troy.

A quick ARX.

Any new thoughts on revenue targets there and a time frame?

Then I'm also curious to know if at the current revenue level, if the operating margins are positive or negative on it.

Yes so this is John.

I'm not going to put a stake in the ground like I did last fiscal.

I'm not going to do that.

I will say but, and I said in my introduction, is that we do think it could be a good growth driver for us in fiscal 2011.

I think it will grow sequentially when we look at the pipeline and we look at the way we're doing well with our go to market and our sales activity.

Our operating margin is a different story.

Our deal with ARX right now is to focus on revenue growth momentum.

So it's -- it is the one area that we don't invest behind revenue.

So is it safe to say they are negative margins now?

Any color on where they are?

Yes, we haven't broken it out, but that's safe to say.

Okay.

Andy, just to challenge you a little bit, you guys have said invest behind the revenues here a couple of times.

You just did almost 38% operating margins this quarter, but you're giving a target range of 36 to 38.

For me to get to 36 kind of implies deleveraging and investing ahead of the revenues, so is 36 realistic or is that just kind of a cushion for you guys?

We want to invest, and I see this as kind of a catch-up quarter for that.

So if you're looking quarter-by-quarter, it doesn't quite hold, but if you're looking over the scope of the year, I think we'll be able to do 36 to 38 which is investing behind revenue for the year.

All right, keep up the good work, guys.

Thank you.

Your next question comes from Theodore Nikos.

Your line is open.

Okay, that was an interesting -- okay, hey, it's Nikos here.

I had a couple of questions.

On the verticals, if I did the math right, and let me know if this is wrong.

I think your two strongest growth verticals in fiscal 2010 were US federal government and financial services.

And as people look out to next year, people kind of look at US federal government and financial services as being two areas where fundamentally there are challenges for the government in terms of budget, and financial services, there's still issues with mortgages, et cetera.

What's your view on those two businesses remaining strong for you next year?

This is John.

I feel very good about those verticals.

If you look at those verticals, they're very dependent for their existence on growing the competitiveness through Internet and that's why they're strong for us.

Obviously with -- where last year we had a very big transaction at financial.

Their vertical that did obviously help the growth of the financial, but I still think it's going to be very healthy.

The area we feel very good about is also telco.

You didn't mention that.

But that was 25% this quarter.

We're going to be talking quite a bit about telco in November as well.

Where we see possibilities to expand the telco space, but I don't want to steal any thunder before November by talking about that in detail.

But, yes, if you look at fiscal 2011 with the ROI story that we have, I think financial's going to be really, really strong.

I think federal, we're going to continue to invest in.

Technology with the big dot-com type companies, and telco are going to be the top ones.

Okay, yes.

Good.

I didn't ask you about telco because I thought that was more clear in terms of prospects.

Okay, so it sounds like for government financial you still feel pretty good about the growth next year.

Yes.

On gross margin, specifically on product gross margin, it continues to tick up quarter-to-quarter.

You're going more towards the high end mix.

You're doing more virtualized product.

Why wouldn't that continue to trend up next year quarter-to-quarter as it did this year?

Yes, it goes back to what we've pretty continuously said, which is we would like to invest that back in the business.

And I think that's still our position.

That being said, you're right, it has trended up strongly when we look at the drivers to that, software modules, the offshoring that we've done, supply-chain management, we feel good about it.

We're going to continue to try to invest it back in the business, so we'll see how it plays out.

Okay.

But when you say invest back in the business that would imply hiring, more OpEx and so forth.

But in terms of the actual --

No, it could be the channel.

It could be --

Services, investing higher in the services side of the organization.

It could be discounting, a myriad of things.

Got it.

Okay, great, all right thank you.

Ashley, this is John Eldridge.

We're going take one more caller then we're going to wrap it up.

Your last question comes from Mark Sue.

Your line is open.

Hi, it's Justin Bieber for Mark Sue.

Just kidding.

Are you going to sing?

Just a question on data centers.

It's early in the cycle.

Yet there's some concern that there's a little bit of overbuild in data centers, and some are actually losing some pricing power, whether it's colo or hosting or managed services.

Are you seeing any of that, and is that creating some pause, or do you still think we're very early as it relates to new data centers and hybrid clouds?

We had an internal conversation on this a couple days ago.

Given some of the notes that we've seen out there from analysts, et cetera.

We think it's at the very early stages.

I know, I personally when I've met with CIOs, I don't hear any messages that they're fully penetrated in terms of the virtualization roadmap or the data center consolidation that's going on is anywhere near done yet so we think that's something that continues.

Okay, lastly, application service providers, John, they seem to be pulling you into more and large deals.

Any thoughts on the trends with these partners?

Like Microsoft and Oracle?

Is that what you are talking about, Mark?

Yes.

Yes definitely.

Yes, in fact, I deliberately put that into my review of the year because sometimes when we talk about mobile data and we talk about data center consolidation and virtualization, we sometimes miss the obvious part of our business where we're really in a very strong position, which is optimizing our mission critical applications.

That gets stronger, especially with Microsoft and Oracle in particular.

We have great relationships there -- a lot with the stuff we're doing with application templates.

There's going to be more information on that in November about our new release of software and what that does to the templates scene.

But yes.

No, that's going to continue to be a driver.

Okay.

Thank you and Justin Bieber says thank you.

Thank you.

Okay, thank you very much for joining us today, and if you have any follow-up questions, please don't hesitate to give me a call.

Talk to you next quarter.

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