F5 Inc (FFIV) 2011 Q2 法說會逐字稿

Good afternoon and welcome to the F5 second-quarter financial results conference call.

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

Also, today's conference is being recorded.

If anyone has any objections, please disconnect at this time.

I'd now like to turn the call over to Mr.

John Eldridge, Director of Investor Relations.

Sir, you may begin.

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Hello.

Hello, Ashley.

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You are online.

Thank you, Ashley.

Welcome all of you and I'm sorry for the rough start to our second-quarter fiscal 2011 conference call.

This is John Eldridge.

Speakers with me today on the call are John McAdam, President and CEO, Andy Reinland, Senior Vice President and Chief Financial Officer.

Other members of the Exec team are also with us to answer your questions following our prepared comments.

If you have questions following the call, please direct them to me at 206-272-6571.

If you don't have a copy of today's press release, it's available on our website at F5.com.

In addition, you can access an archive version of today's live webcast from the events calendar page of our website through July 20 4.30 PM today until midnight Pacific time April 21.

You can also listen to a telephone replay at 800-294-2480 or 203-369-3227.

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 from those impressed-- expressed or implied by these statements.

Factors that may affect our results are summarized in our quarterly release, described in detail in our SEC filings.

Please note that F5 has no duty to update any information presented in today's call.

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

Thank you, John.

During the second quarter of fiscal 2011, F5 achieved solid revenue growth and operating results.

Revenue of $277.6 million, which increased 35% year-over-year and 3% sequentially, was within our guided range of $275 million to $280 million.

GAAP EPS of $0.68 per diluted share was above our guided range of $0.65 to $0.67.

Excluding stock-based compensation expense, non-GAAP EPS of $0.88 per diluted share was also above our guidance of $0.84 to $0.86.

Product revenue of $173.7 million grew 34% year-over-year and represented 63% of total revenue.

Service revenue of $103.9 million grew 36% year-over-year and accounted for 37% of total revenue.

Book-to-bill for the quarter was equal to 1.

Revenue growth during the quarter was driven by strong performance in the Americas and APAC.

The Americas grew 38% year-over-year and 4% from Q1 and accounted for 59% of total revenue.

APAC grew 68% year-over-year, 10% sequentially and accounted for 14% of total revenue.

EMEA revenue, which was essentially flat with the prior quarter, grew 22% year-over-year and accounted for 22% of revenue.

Japan accounted for 6% of total revenue, was down 6% sequentially and flat with the second quarter a year ago.

Revenue from our core Application Delivery Networking business was $270.5 million, up from $261.7 million in Q1.

Revenue from our ARX file virtualization products was essentially flat with the prior quarter at $7.1 million.

During Q2, the financial vertical accounted for 20% of revenue, Telco was 19% and technology was 24%.

Total government revenue was 10%, including 6% from US Federal.

In Q2, we had one greater than 10% distributor, Avnet, which represented 19.6% of total revenue.

Moving down the income statement, GAAP gross margin in Q2 was 81.7%.

Excluding approximately $2.2 million of stock-based compensation expense, non-GAAP gross margin was 82.5%.

GAAP operating expenses of $143.7 million were within our target range of $142 million to $146 million.

Excluding $19.6 million of stock-based compensation expense, non-GAAP operating expenses were $124.1 million.

GAAP operating margin was 30%.

Non-GAAP operating margin, which excludes stock-based compensation expense, was 37.8%.

Our GAAP effective tax rate was 34.4%.

Excluding stock-based compensation, our non-GAAP effective tax rate was 32.9%.

On the balance sheet, cash flow from operations was $91.2 million contributing to total cash and investments of $997.2 million at quarter end.

Free cash flow for the quarter was $85 million.

DSO at the end of Q2 was 46 days.

Inventories at quarter end were $18.2 million.

Deferred revenue increased 9% sequentially to $313.3 million.

Capital expenditures for the quarter were $6.2 million, and depreciation and amortization expense was $5.3 million.

We ended the quarter with approximately 2,255 employees, an increase of 125 from the prior quarter.

During the quarter, we repurchased approximately 405,000 shares of our common stock at an average price of $114.85 per share for a total of $46.5 million.

Approximately $166 million remains authorized under the current share repurchase program.

Looking ahead to Q3, we are encouraged by the continued momentum we see in our key drivers, with large projects, data center consolidation and virtualization continuing to push our business.

This, combined with our strong product offerings and our operational strength and efficiency, give us confidence we will grow sequentially and sustain our current level of profitability through the remainder of fiscal year 2011.

Nevertheless, the uncertain impact of Japan has inclined us to be somewhat cautious in assessing our near-term prospects.

With that in mind, we are targeting Q3 revenue in the range of $287 million to $292 million.

We expect GAAP gross margin in the 81% to 82% range, including approximately $2 million of stock-based compensation expense.

We anticipate GAAP operating expenses in the range of $147 million to $151 million.

This includes approximately $20 million of stock-based compensation expense.

Our GAAP EPS target is $0.69 to $0.71 per diluted share.

Excluding stock compensation, our non-GAAP EPS target is $0.89 to $0.91 per diluted share.

We are forecasting an effective tax rate of 35.5%.

Excluding stock-based compensation, we expect a non-GAAP effective tax rate of 33.5%.

We plan to increase our head count by more than 125 employees in the current quarter.

We estimate our DSO will be in the mid 40-day range.

We expect inventory levels within a range of $18 million to $20 million.

And we believe our cash flow from operations will be in excess of $95 million.

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

Thanks, Andy, and good afternoon, everyone.

Overall, I was very pleased with the F5 team's performance in Q2.

In the Americas, revenue grew 78% year-over-year and Asia-Pacific revenue increased 68% year-over-year.

Helped by a strong linearity in the early part of the quarter, Japan revenue was essentially flat year-over-year, a tremendous achievement considering the enormous difficulty they faced in the later stages of the quarter.

Revenue from EMEA grew 22% year-over-year, below our internal expectations.

Once again, we improved our balance sheet significantly with cash flow from operations at approximately $91 million, and closed the quarter with $997 million in cash and investments and no debt.

Our services business achieved a significant milestone, with revenue above $100 million in the quarter and continues to be a key growth driver and a strong profit contributor to our business model.

Most important, we have been able to achieve these outstanding financial results while maintaining customer satisfaction at world class levels.

From a product perspective, our ADC business continues to be the fundamental driver of our overall growth.

The application fluency we provide with our unique full proxy TMOS architecture and the flexibility of iRules has given our customers and partners the ability to rapidly optimize and secure our applications with minimum disruption and cost.

Our online user community, DevCentral, continues to grow in popularity with both membership and activity hitting all-time highs.

This highlights how customers are integrating our products more deeply with their architectures and their applications.

The application fluency capabilities of our products continue to be critical to the important partnerships we have built with global applications solution providers like Microsoft and Oracle.

In addition, the module of architecture of TMOS has enabled the continued expansion of our solution modules and a significant increase in our addressable market.

More than 30% of our sales last quarter were heavily influenced by solution modules such as ASM, our Application Security Module, Edge and APM, our optimized secure access and policy modules, as well as our WAN acceleration and optimization module solutions.

Nearly all of these solution modules were derived from the technology acquisitions we have made over the last few years.

During the quarter, our virtual appliance strategy continued to have a positive impact on sales.

In just a year since we introduced our virtual edition of BIG-IP for local traffic management, we will have added six new virtual appliances.

These virtual appliances have been instrumental in driving trial and broader adoption of F5 solutions within new parts of enterprise organizations, service providers and different geographies.

During Q2, we also introduced our virtual addition of our ARX product.

In addition, we launched ARX Cloud Extender and we are seeing growing interest from customers and channel partners in both these solutions.

Within the next six months, we plan to introduce two new ARX platforms which will significantly enhance the [price] performance of ARX solutions.

We are confident that our recent and future product introductions will continue to enhance our competitive position, which is the strongest it has ever been.

In particular, we believe that Victoria, our mid-range chassis platform, and TMOS version 11 will be well accepted by the market.

Victoria will provide significant price performance advantages, increase solution flexibility and enhance the availability capabilities with the chassis-based architecture.

TMOS version 11 includes over 150 new sophisticated management and scalability features to enhance data center consolidation and cloud architectures.

Version 11 also includes new application visibility and management features, specific solutions for the Telco market, and significant software and firmware performance enhancements to many of our software modules.

As far as the overall business outlook is concerned, I feel very confident about our prospects for the second half of the fiscal year.

The key drivers for our business, including data center consolidation, virtualization, cloud-based services, the growth of mobile applications and data and the increasing requirement for sophisticated application security solutions, all continue to produce a strong and expanding market opportunity for F5 products.

In the context of several global macro economic issues, we delivered solid sequential and year-over-year revenue growth in Q2.

Until those issues are resolved, however, we believe it is prudent to remain cautious in the short term.

We are anticipating a sequential decline in Japan and I believe we have included an appropriately conservative assumption for the Japan business in our Q3 guidance.

Nevertheless, as our guidance indicates, we expect to continue to grow revenues sequentially in Q3.

During the remainder of fiscal year 2011, we are confident in our market opportunities, our competitive position, our technology leadership and our ability to maintain and expand that leadership position will enable us to achieve solid sequential and year-over-year revenue gains.

As a result, we plan to continue hiring to follow strength in our sales and marketing, service and development organization and enhance our prospects for future growth.

In conclusion, I would like to thank the F5 team, our partners and our customers for the support last quarter.

I will now pass the call over for Q&A.

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

(Operator Instructions)

Hello?

Your first question comes from Brian Marshall.

Your line is open.

Great.

Thanks, guys.

Nice quarter.

I had a question with regards to, if you could just update us with respect to your share as well as penetration gains across your various geographies.

I think in the past you've given some metrics with regards to Fortune 500, FT 500 et cetera, and was wondering if you could just update us on those quickly?

Yes, we're in the-- just above 60% of the Fortune 500.

As we've said many times it's not just about selling our products into these companies, it's about becoming the preferred supplier, making sure that we get multi-million dollar accounts.

But that obviously gives us still a good, a good in road to penetrate more accounts.

Last quarter, we had 2 very big wins last quarter into Fortune 50-type companies where they were pretty sizable in value, but more importantly, we expect to see increased business over the next few years.

So very much that's a big focus in what we're doing.

And John if you look at FT 500 I mean is that basically about half of where you are with the Fortune 500 here in the states?

Yes, probably a little higher is what I'm thinking.

A little higher than half?

Yes.

Okay, great.

And then the final question is with respect to sizing the opportunity for Victoria, I mean, can you help us think about how many SMB clients actually required a chassis-based architecture, if you can give some granularity, that'd be great.

Thanks.

Yes, well I mean first of all, I personally believe that Victoria is going to be a pretty hot product.

We are looking to release that in the coming quarter.

We'll actually be releasing, maybe Karl could give details about it in a second.

It's not into the SMB market, I mean it's into our existing market which is larger enterprises and the verticals that we talk about.

But the beauty about it is that the price of it is now in the mid-range of our pricing range and it's got all the benefits of increased performance.

On the chassis architecture it allows you to add more modules and sort of a lot higher availability in CMP type facilities.

Karl do you want to add--?

Yes, I'll just add to that.

We'll be releasing Victoria, as John mentioned, this quarter.

We're releasing it actually initially on version 10 in front of our V 11 release.

And one of the reasons we're doing that is to help facilitate adoption by our current customer base, which largely is now qualified on V 10 in an environment moving forward.

However, when V 11 shows up, it'll support all of the new modularity with VCMP as well as our new centralized management infrastructure so that customers can now better manage resources, they could support multi-tenancy, it just gives them more granular control and better scalability for their environments.

Great.

Thanks, guys.

Nice quarter.

Your next question comes from Jess Lubert.

Your line is open.

Thank you for taking my question, and congratulations on a nice quarter.

Can you maybe start off by quantifying the impact of Japan in the March quarter?

Really it's what we said.

I mean we-- they had tremendous linearity, which I think helped dramatically.

I think it was outstanding the resilience that our F5 Japan team showed and the resilience that they showed throughout the quarter.

We think we're in very good shape there.

We have taken a conservative view in terms of this current quarter and we feel good about that.

We actually had a conference call on Monday evening with the Japan team, so I think it's very much in control.

And then, John, can you maybe comment on the pipeline and the close rates embedded in the outlook?

Last quarter you mentioned that the pipeline was bigger than the previous quarter and that you had embedded close rates below those they experienced the previous 3 quarters, I believe.

Can you maybe talk about how you're thinking about those metrics heading into--

We're taking a similar approach.

We think we're taking a conservative view of close rates for this coming quarter as well.

And then just the last question on the service provider business, it looks like revenue there declined sequentially, can you help us understand what drove the sequential decline and how you're thinking about that business going forward?

Was this a surprise?

I mean a little bit of a surprise, but let me pass it over to Mark and he'll go through the service providers.

Yes, hi, this is Mark Anderson.

So I think if we look at the drop in Telco, especially as a percentage, it was primarily in the US.

We had-- there was a couple-- specifically a couple of US providers are focusing on building out LPE.

And of course we kind of come in after the radio access network and the core network deployments for new network builds like this.

So we're expecting a lot of benefit from these particular customers that have built out these networks.

I think the other thing you have to recognize is our sales growth in -- for cloud infrastructure providers was really triple digits year over year.

Companies like Rackspace, Salesforce.com, Microsoft Azure, the growth was pretty impressive there, deals much bigger.

So we see them building out.

We actually don't call these guys Telco in this percentage.

And then finally, our managed service providers, many of whom are Telco customers, our penetration into the sell-through business to them was pretty dramatically up as well.

So they're acting as a very efficient and productive channel.

Would the expectation be for sequential growth through the second half of the year in Telco?

For the second half of the year, most likely.

All right, thanks, guys.

Thank you.

Your next question comes from John Slack.

Your line is open.

Yes, kind of following up on the first question on Victoria, is there any -- I think we hit on it last quarter as well, is there any concern about potential Osborne effect?

And then maybe if it's a mid-range pricing cannibalization of higher end platforms and 8900s that are going out?

Yes, no, we don't -- we feel we've really got the whole Osborne effect very much in control.

We actually, for example, we did the American operations quarterly business review on Monday and it was -- we spent a number of hours on this and we're very comfortable that forecasting information that they're giving us won't be affected by any slowdown because of Victoria.

Having said that, I did say earlier we're-- our plan is to ship this quarter during Victoria-- Victoria this quarter, so we do expect to see revenue as well.

And what was the second part?

Oh, just potential cannibalization given the price performance.

I mean it's a classic case of you increase the price performance, but as you're doing that, your traffic is increasing, your complexity is increasing, don't see any major issues there at all.

Great.

Thanks a lot.

Your next question comes from Brent Bracelin.

Your line is open.

Thank you.

I guess first question for John, Karl perhaps, you talked about Victoria adding some Telco-specific features, could you maybe talk a little bit about how that's being received in the Telco space?

And as a follow on, the Centaur platform that you guys referenced at the analyst day, does that also help improve your positioning in the Telco space?

And then one follow-up on product gross margins.

Right, so all the Telco features we're talking about in V 11, most are driven by the customer base themselves.

And a lot of these were initially iRules that our SEs implemented on site.

I mean hundreds of iRules, in some cases that we've gone and productized.

And there's some other things that we've done, say an IPv6, to do some hardening and qualification, things like DNS [Explorer].

So it was a bunch of areas on the network side that were making it easier for the Telco guys to adopt the platforms.

But there's a lot of work also going on in iRules, I mean it's a broad attack and it's not just one, any one feature we're talking about for Telco for the release.

So we think it makes it easier.

With Centaur, that's on track with our internal project schedules.

The performance is looking where we expected to be with that and we're continuing to roll forward with that.

It doubles up the performance of the existing TB 200 blades on the chassis, and our customers are looking for that.

Yes, the big verticals for that will be Telco, they'll be sort of like dot coms, social networking, the large Internet traffic site.

Perfect, and then last question for me on the product gross margin side, just looking back, looks like over the last I think 5 quarters you've had sequential improvement, consecutive sequential improvement in the product gross margin.

You talked about kind of increasing attach rates on ASM and APM and the WAN Op side of things, how should we think about kind of product gross margins going forward, Andy?

Could we have kind of an upward bias here even going forward above the 83% level because of the loading factor on these modules?

Yes, you're right on.

Its software attach rates were strong and helped in particular this quarter, as well as some cost efficiencies on the box side.

Going forward, what I'd say is probably what you normally hear us say, is we're constantly going to be looking at how we can improve overall gross margin, pushing software attach rates, supply chain, design issues, et cetera.

And we'll continue to do that with the goal of having flexibility in the business model to reinvest in the business and drive the top line.

But as we look at it, obviously we're at pretty high levels right now and it gets harder, but we'll continue to pound at it and work to improve those rates.

Great, thank you.

Your next question comes from Mark Sue.

Your line is open.

Thank you.

John, are there some customers where you've reached saturation who may be saying I have more than I need?

And a second part of that question would be, do you feel that since you are now the dominant player, your rate of market share gain starts to slow?

And I'm asking because having done 35% growth in a tough environment and an unexpected uptick by the Telcos later on, should we kind of still think of 35% growth for the next several quarters?

I knew you would sneak the last bit in (inaudible) we only did a quarterly guidance.

But in terms of the first 2 questions, I feel very strongly about our ability, that once we penetrate a Fortune 500 account that we can see increased business, we can see an increase in the application of those solutions as well.

And all the data we've got shows that we start off and we continually increase.

So I don't see a current saturation anywhere within our customer base.

I think it's the opposite.

For example, we had a very large transaction last year that was pretty significant in size that we talked about publicly.

We've done a lot of business in that account since, so it's quite difficult.

And the second part of the question--

Do you think your market share--

Yes.

Well, I think we make the market significantly.

I think that's why we're hiring aggressively.

We talk a lot about something we felt strongly about for a number of years that we've got great market opportunity; at the geography level, a vertical level and an account level, we think it is pretty underpenetrated and that's how I see the growth coming.

That may come at the cost of removing incumbents and it is that, we do that every quarter, but the real thing for me is execution by good hiring and maintaining technology leadership.

Okay, so, John, qualitatively with the Telcos still pushed back, which points to a strong uptick in the second part of the year and what your customers are telling you, does it feel like you're reaching a reacceleration in the business?

Yes, I'm not going to say that.

You heard this Mark saying that I think we're being reasonably cautious given the macro environment--

Right.

And we really are.

And we're looking at a quarter at a time quite frankly from a business perspective.

Obviously we have a view on what we think we can do next year and we'll talk about that at the appropriate time.

But no, I think we're in good shape, I think we're (inaudible).

I'm very excited about Victoria and I'm very excited about version 11 and some of the other products are coming.

So if we can hire properly, we will continue to grow.

Okay.

That's helpful.

Thank you, and good luck, gentlemen.

Thank you.

Your next question comes from Alex Henderson.

Your line is open.

Thanks.

I wanted to go back and look at the Telco segment a little bit more.

I mean normally you would expect it to be down sequentially from 4Q to-- or calendar 4Q to fiscal 2Q here, or calendar 1Q.

So to the extent that that is the normal pattern, and it actually didn't decline very much, we're still going back and looking at that drop off of the 25% that you did in the fiscal fourth quarter, calendar third quarter.

So can you give us a little bit more granularity on what's going on there, particularly in the US market?

There's obviously a lot of discussion about issues within Verizon, in particular, that have been out on the tape.

Any willingness to address whether your relationships with any of the top Tier 1s have altered over the course of the last couple of quarters?

Yes, I mean on that last part, definitely not.

I mean we feel really good about opportunities with the existing large US customer, US Telcos, and I'm including everybody in that, obviously Verizon, AT&T, we think we're in a good position there and we'll continue to be in a good position.

One of the things that we have talked about internally is that remember we tend to lag infrastructure-type spending.

So if you're building a big LTE, until it gets ready to actually go into operation, it's really, we tend to lag that in terms of our spending and I think there are some issues there.

There are some big projects out there, not getting (inaudible) scales in those that are out there, and you're going to see some lumpiness.

Maybe, Dan, do you want to talk about some of the solutions that we see?

Yes, absolutely, Alex.

So this is Dan.

You might remember back in November actually, we put an announcement out really targeted at the service provider segment, introducing the notion of service delivery networking.

And there are really sort of 4 big things that were part of it.

One, we're talking about how we're doing policy-based traffic steering with our products.

So just based on the knowledge of the traffic that we have, how service providers can use information on who the users are, where they're coming from, what they're up to, and use that to create and apply policies against it to either create new services, new lines of business for themselves or drive costs down.

That was sort of 1 big thing we're seeing a lot of that around.

The second one is scaling IP services, and Karl touched on this a little bit earlier.

But as these guys are basically just monstrous amounts of traffic growing and growing every quarter, they're looking for more efficient ways to deal with it.

So a great example is something simple like network address translation, where our systems are able to do them at about a third of the cost of doing it in a firewall, which is traditionally how some of the service providers have been doing it.

Third place would be IPv6 being able to support that easily in conjunction with an IPv4 infrastructure, so our gear let's them do both simultaneously and easily.

And then the last area I guess would be sort of improving user experience and improving security as well.

So an example there would be people using us to secure the DNS infrastructure and DNS is the front door for applications and services that they provide out there and it's massively important.

Not all that sexy sometimes, but it's very susceptible to things like denial and service attacks and now with people starting to roll out support for DNSSEC to better secure their DNS infrastructure, we give them ways to do that very, very easily.

So we're seeing a lot of activity across all those fronts, not only in the US, but around the world.

So I'm pretty amped up about it.

And Alex, this is Mark, so the other thing to remember, we've increased the size of the team pretty nicely in the last year all around the world and we're getting a lot more traction into other Telco verticals like fixed wireline as well as cable.

And last quarter was a particularly good quarter for cable.

So just, just so I can get my hands around this LTE issue, so do you have comments from the service providers that are in the process of deploying the LTE, that are indicating to you that as they get that LTE deployment in place, that that would result in a measured pickup in the business through to F5, or is this speculation that's more soft in nature?

No, no, no.

We feel pretty strongly that's a big opportunity for us.

As advanced technologies like that, like LTE get installed, traffic increases, the need to do complex work in that traffic, that's what our products do.

So that's-- we feel pretty good about that being a big opportunity.

So the Tier 1s are telling you once they get the radios in place that they'll be doing this very quickly afterwards then?

Yes, you used the word very quickly, that is a big opportunity for us.

Okay.

Then last question, can you give us some sense of what the percentage of pull-through associated with VMware and some of the other partners like VMware in the quarter, or what-- how did that translate into demand this quarter?

Yes, Alex, this is Dan again.

Alex, it continues to be very, very strong for us.

So we said historically it was sort of more than half our business has been influenced by that.

If we look, the end market continues to be very, very strong.

Microsoft continues to be very, very strong as well, things like the Exchange 2010 rollouts, they're still just in their infancy for people, and Oracle as well had a great pull-through for us last quarter as well.

So we continue to be very, very pleased on that front.

I'll cede the floor.

Thank you very much.

Thank you.

Your next question comes from Kent Schofield.

Your line is open.

Thank you.

Can you talk a little bit about operating margins going forward, especially in light of some of the head count additions that you're talking about making?

Yes, so we-- last quarter I believe we affirmed that we sought between 37% and 38% pretty much for the rest of the year and we continue to believe we'll be in those ranges.

So I see no reason to change that.

Yes, I mean our challenge is hiring.

I mean it's -- we had a pretty good quarter last quarter with every intention of pushing it forward this quarter.

But especially in development, I mean it's a tough hiring year.

We're doing very well in service, we're doing very well in sales, but development is a tough environment.

So that's more of our focus actually on a weekly basis than looking at the overall expansion.

I think with that we feel very good about.

We've got that in great shape.

It's really getting the hires in the door.

Sure.

Any change in the trend in terms of versus sales and marketing or versus R&D as you look at head count?

Yes, no it's panned out to be pretty consistent with how we've said, roughly 40% sales and marketing and then 30%-ish for R&D and services, and our hiring patterns continue to follow in line with that.

Okay, thank you.

The next question comes from Jason Ader.

Your line is open.

This is 2 quarters in a row now where you've just met the revenue guidance after many quarters in a row of beating pretty handily.

So just have 2 questions on that.

Number one, do you feel like you're going through some digestion?

I know you talked about seasonality last quarter, but any comments on this quarter, whether there was some, maybe some digestion of purchases, US things really snapped back after the recession.

And secondly, do you feel more confident that you'll be able to beat guidance in Q3, and if so, what drives that?

Yes, I'm not going to answer this directly, Jason, but I'll give you some feelings as to how we're viewing things.

If you look at last quarter, I mean, clearly I did see -- I mean yes, it was below internal expectations and obviously we had the issues in Japan.

I don't want to hide behind those, but they did happen and both obviously a surprise, one a very big one of course with the disaster in Japan.

If-- we as a Company have exceeded many more times than we've been in the range, and sometimes we've been below the range, but we've exceeded more than we have.

We like to think we have a realistic forecast, but our forecast is realistic but beatable.

And we'll see, we'll see where -- how we take it from here.

And what drives it for Q3, if you end up exceeding, what would be the key variables there?

We'd beat the forecast that was taken for guidance, sorry to be flippant.

But it's sales, it's sales execution.

Is there a specific product or geography that you could point to--

No, I'm not going to get any more granular than that.

I mean we've given our guidance and that's a guidance that we think is realistic.

Okay and then last question for me, on the federal, it sounded like it was pretty much in line with your expectations, is that fair?

And what do you see out of federal budgets going forward?

Is that an area of concern for you or do you feel pretty good about where things are?

Yes, no and first of all, I think it is a fair statement that federal, federal is what we consider a very good quarter this quarter and delivered.

And we've got a great team there, we've been talking about this for a couple of years now, and some new Management building up the team.

We've been investing in federal.

We feel that we've got very good visibility on the projects and the project wins.

Clearly, there's always some issues on timing and you have to manage through that, but I think we're in good shape.

And Jason, remember, a lot of our deals, excuse me, are being sold into the programs, right, so we're selling to big systems integrators that have contracts with the Department of Defense and civilian agencies.

So it's -- there's still risk with continuing resolution, but I think a little bit less risk because we're selling into programs.

Okay, very good.

Thank you.

Thank you.

Your next question comes from Brian Modoff.

Your line is open.

Yes, hello, Andy, John.

This is Vijay on behalf of Brian.

Yes, hi.

Just a quick question and a follow up.

The question is around the several time expansion use cases you mentioned, IPv6, the Web 2.0 guys, SSL offload, Web application security, et cetera.

What's your view in terms of how does TAM expansion in opportunities drive growth both this year and next?

And then the follow up is on TMOS 11, any thoughts on timing of that and would TMOS 11 also have an accompanying platform refresh cycle in addition to the software upgrades?

Yes, and just on the last part of the question, and maybe Dan can address the initial stages of the question, on TMOS version 11, the current plan is for next quarter.

So if you remember what we said, what Karl said was that Victoria we-- our plan is to ship it this current quarter but running version 10, that's a-- that I think is a very good move because typically the reason that you'll see delays in uptakes of platforms is because customers are very wary of taking new operating systems-- and in the past with version 10 and version 9, is really about a year plus the build up for the operating system.

We'll see now with version 11.

So that's basically the plan is to get that in Q4.

And Vijay, as far as the TAM goes, think back at our investor day, we laid out how we're sort of pushing into other market opportunities and whether it's just by way of new modules and functionality that we're driving into our products, or some new markets that we're just starting to penetrate.

So I think as John said before in addressing the saturation question out there, that is not something that keeps us up at night.

We're seeing interesting uses come through in things like with our virtual editions of our products, seeing them getting deployed in both places within the enterprises and geographies that we probably wouldn't touch or up to simply feet on the street.

So all in all, I think we're in pretty good shape there.

Perfect.

Yes, I think my question was more in terms of how you would relate the TAM expansion use cases to meaningful growth for this fiscal year and next?

Are these TAM expansion opportunities meaningful enough that it can drive growth or not yet?

Well, just to give you an example, Vijay, this is Karl.

On the security side of the product, we've been doing a lot of work to focus on that.

ASM has been driving a lot of our module revenue, but it's also driving a lot of the awareness in security features in the products.

So we're having a lot of customers now that suffered through the denial-of-service attack that happened with the WikiLeaks looking at our security features in a different light and deploying these in lieu of the traditional firewalls, and so we see a major opportunity there.

We have another new module that John talked about in his script, AVR, Application Visibility Reporting module, that gives visibility now into the performance of applications, not only at the data center side, but also as they're rendered on the client.

So we have new opportunities both in visibility security as well as the Telco features and everything else we talked about that we have a lot of confidence that expands that total addressable market for us.

Yes, thank you, very helpful.

Your next question comes from Troy Jensen.

Your line is open.

Congrats on the nice quarter, gentlemen.

So end of the quarter, there's a lot of chatter about aggressive sales tactics, it did not show up in your DSOs.

So I was just wondering if you can make some comments on linearity in the quarter?

I'm looking over here at Mark, first of all.

But we-- I'd like to think we've always got aggressive sales tactics.

That's what we're supposed to do.

But I don't think it was anything different this quarter from previous.

What about linearity, then?

Yes, the linearity was a little higher than our 50% third month normal, but if you go back a year ago, it's very consistent with March a year ago.

So we didn't see anything abnormal to us.

And also on the aggressiveness, I'd highlight our discounting was right in line with what we've historically seen.

So I-- for the most part, deal by deal, it was business as usual.

And how about another one for Andy here, service gross margins actually declined looks like 90 basis points here sequentially, kind of the first time we've seen a big drop.

Was that just hiring related?

It was to some extent hiring, but more so payroll taxes kicking in in the first quarter took our overall expenses up there.

Okay.

And we knew we had the offset on the product side for consistent overall margins, so--.

And then last one and I'll jump off here, you said you're modeling conservative for Japan here into the June quarter, is conservative down 5% sequentially, is it down 20% sequentially?

Could you kind of give us a range on where you think--

Yes, I don't want to be specific.

I mean it's down sequentially and it's down year over year.

Okay, that's helpful.

Keep up the good work, guys.

Ashley, this is John Eldridge.

We're going to take one more question and then end the call.

Your last question comes from Ryan Hutchinson.

Your line is open.

Okay, great.

Thanks for squeezing me in.

I just had a question on the product and services split.

It looks like it's actually come in on the product side below consensus estimates for a couple quarters.

So I'm just -- I know you don't like to give specifics for the out quarter, but maybe if you could provide a little more color on the split between product and service for the next quarter, specifically if services should grow faster than product on a sequential basis?

Yes, we don't break it out on a go-forward basis, Ryan, but I will say to you our focus is all about driving product growth and that's the key to our business and what our focus is on.

So we'll be pushing for that as we execute through the rest of the year.

Okay, great.

Thank you.

Thank you all for joining us on the call.

We'll look forward to catching up with you throughout the quarter and talking to you again next quarter.

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