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Executives

John McAdam - President and CEO

Andrew Reinland - Senior Vice President and Chief Financial Officer

Mark Anderson – Senior Vice President, Worldwide Sales

Dan Matte - Senior Vice President, Marketing

Julian Eames – Senior Vice President Business Operations

Analysts

Ittai Kidron - Oppenheimer & Co.

Sanjiv Wadhwani – Stifel Nicolaus

Troy Jensen - Piper Jaffray

Ryan Hutchinson - Lazard Capital Markets, LLC

Erik Suppiger - Signal Hill Group, LLC

Jeff Kvaal - Barclays Capital

Mark Sue - RBC Capital Markets

Rohit Chopra - Wedbush Morgan Securities

Jeff Evans - Sanford Bernstein

Richard Sherman – MKM Partners

Kenneth Muth – Robert W. Baird & Co.

Ehud Gelblum - JP Morgan

F5 Networks, Inc. (FFIV) F1Q09 Earnings Call January 21, 2008 4:30 PM ET

Operator

Good afternoon and welcome to the F5 first quarter financial results conference call. (Operator Instructions) I would now like to turn the call over to Mr. Andy Reinland, Senior Vice President and Chief Financial Officer. Sir you may begin.

Andrew Reinland

Welcome to our conference call for the first quarter of fiscal year 2009. Joining me on today’s call is John McAdam, President and CEO. Members of the senior management team are also with us today to respond to any questions following our prepared comments. John Eldridge, our Director of Investor Relations has been in Washington, D.C. for the inauguration and will be back in the office tomorrow. If you have any questions after the call please direct them to John at (206) 272-6571.

If you don’t have a copy of today’s press release it is available on our website www.F5.com. You can access an archived version of today’s live web cast from the Events Calendar page of our website through April 22. From 4:30 p.m. today until midnight Pacific time on January 22, you can listen to a telephone replay at (866) 439-3725 or (203) 369-1044.

During today's call, our discussion will contain forward-looking statements that include words such as believe, anticipate, expect and target. These forward-looking statements involve risks and uncertainties that may cause our actual results to differ materially from those expressed or implied by these statements. Factors that may affect our results are summarized in our quarterly release and described in detail in our SEC filings. Please note that note that F5 has no duty to update any information presented in this call.

Now, for the Q1 results.

As stated in our conference call on January 6, revenue for the first quarter of fiscal 2009 was $165.6 million, below our guided range of $172-174 million. Despite the revenue shortfall, GAAP EPS of $0.27 per diluted share was at the high end of our guided range. Excluding stock based compensation expense, non-GAAP EPS was $0.40 per diluted share, just under our target of $0.41 to $0.42 per share. Product revenue of $107.9 million represented 65% of total revenue. Service revenue of $57.7 million accounted for 35%. Book to bill for the quarter was below one as the result of timing issues related to a large shipment at quarter end.

North America accounted for 54% of total revenue; EMEA contributed 24%, APAC 13% and Japan 9%. Revenue from our core application delivery networking business was $155.6 million and accounted for 94% of total revenue. ARX revenue was $3.7 million representing just over 2% of total revenue and revenue from FirePass was $6.3 million, slightly under 4% of total.

During Q1, Telco revenue represented 23% of total revenue, the financial sector represented 20% and technology accounted for 17%. U.S. federal government was 4% of revenue and total government accounted for 9%. Avnet Technologies was our only greater than 10% distributor at 17.1% of total revenue.

Moving down the income statement, GAAP gross margin of 78.2% was above our guidance of 77-78%. Excluding approximately $1.2 million of stock based compensation expense, non-GAAP gross margin was 79%. GAAP operating expenses of $102.3 million were below our guided range of $104-107 million. Our non-GAAP operating expenses which exclude $13.7 million in stock based compensation expense were $88.7 million.

Our GAAP operating margin was 16.4%. Non-GAAP operating margin was 25.4%. Reflecting the retroactive effect of the reinstated R&D tax credit our GAAP effective tax rate was 28.8%. Excluding stock based compensation expense, our non-GAAP effective tax rate was 28.1%.

On the balance sheet, cash flow from operations was $57.9 million. We ended the quarter with $487 million in cash and investments after repurchasing 873,000 shares of our common stock for a total of approximately $20 million. DSO was 55 days. Inventories at quarter end were $15.6 million. Deferred revenue ended the quarter at $155.9 million, an increase of 7.5% from the prior quarter.

Capital expenditures for the quarter were $3.9 million and depreciation and amortization expense was $6.5 million. We increased headcount by 15 in Q1, ending the quarter with approximately 1,710 employees.

Moving on to the outlook, clearly the continuing economic uncertainty has reduced visibility into our end markets. Taking this into account and based on review of the pipeline and in-depth discussions with our sales management team, we are targeting Q2 revenue in the range of $157-164 million. We expect product revenue to be down from the quarter just ended. We expect service revenue to continue growing though we are seeing that growth slow somewhat due to the decline in product sales.

We expect GAAP gross margin in the 77-78% range including approximately $1 million of stock based compensation expense. To maintain our operating margin targets we have reduced discretionary spending throughout the organization. In addition we are restructuring and consolidating areas of our business which will result in a 5-7% reduction in total headcount by the end of the quarter and a reduction in certain office space. These actions will result in a restructuring charge during the quarter in a range of $4.5-5.5 million. We will exclude this charge from our non-GAAP results for Q2.

Q2 GAAP operating expense are expected to be in the range of $100-105 million including approximately $13 million of stock based compensation expense and the restructuring charge of $4.5-5.5 million. Our GAAP EPS target is $0.19 to $0.21 per diluted share. Excluding stock compensation expense and the restructuring charge, our non-GAAP EPS target is $0.36 to $0.38 per diluted share.

We are forecasting an effective tax rate of 35%. We expect a non-GAAP effective tax rate of 32%. We estimate DSO’s will be in the mid 50’s. We expect inventory levels within a range of $14-16 million and we believe our cash flow from operations will be approximately $35 million. This reflects an anticipated decrease over the prior quarter due to seasonality in our U.S. Federal Tax payment schedule and costs related to the reorganization.

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

John McAdam

Thanks Andy and good afternoon everyone. Since our pre-release conference call on January 6, we have focused on analyzing the reasons for the business shortfall we experienced last quarter as well as closely examining our future business prospects and pipeline of opportunities.

As we stated in the pre-release call, the overall Q1 forecast appeared to be on track as we approached the final week of the quarter. I also mentioned from a revenue perspective that Q1 revenue was tracking ahead of the previous quarter’s revenue by several million dollars through late December. In the last week of December we experienced a significant slow down in expected orders at levels we had never seen before, especially in North America. The slow down occurred across all major regions in North America as budgets were frozen or withdrawn completely.

Our analysis of the revenue from opportunities that dropped out in Q1 indicates approximately 60% of the revenue is forecast to close this coming quarter while 20% has moved out beyond this coming quarter or has been postponed indefinitely. We are still qualifying the remaining 20%.

Clearly this scenario may change as customers continue to review their individual budget plans. Given the trends in capital spending delays that we saw last quarter we expect to see continued postponement of projects and reductions in spending during this quarter as well.

Apart from North America the other major geographies were pretty close to our internal expectations. Both the EMEA and Asia Pacific regions delivered year-over-year sales growth and Japan was up sequentially over the previous quarter. In North America we did see some weakness in our technology vertical especially in business from large dot com and e-commerce customers.

As expected, our U.S. federal business was down sequentially which is usual for the first new quarter in the year of federal. On a positive note, the other financial metrics in the quarter remained quite strong. We maintained solid gross margins in both our product and services business, managed our expenses towards the low end of our guided range and generated a healthy cash flow from operations of $57.9 million.

Once again our services business delivered sequential growth over the previous quarter with another increase in deferred revenue. As we have already stated we believe the shortfall in revenue last quarter was directly associated with the slow down in the economy which resulted in IT budgets being reduced or expenditures being postponed.

We continue to enjoy a very strong competitive position in our core application delivery networking market. We introduced our new mid-range BIG-IP 6900 which has been very well received in the market and continues to add to our technology leadership position across our product range.

Our new entry level products, the BIG-IP 1600 and 3600 continue to be well accepted by our customers and our high-end flagship VITRION product continues to enjoy a significant performance leadership position with no viable competition. Although our ARX virtualization product sales were down sequentially from last quarter, we are seeing a gradual increase in the sales pipeline. The ROI customers receive from this solution is very strong and we expect to see some modest growth with ARX in Q2 and the second half of the year.

We also plan to announce a new comprehensive version of our ADC operating system TMOS. Version 10, referred to internally as [part] city is scheduled to be delivered in the next few months. Version 10 comes with a vast array of new and improved functionality, a lot of which has originated from customer requests. This new TMOS version should further increase our leadership position in the ADC market as well as raising the value to entry in our market.

We also plan to introduce a new BIG-IP 8900 product at the same time as version 10. The BIG-IP 8900 will replace the current high-end 8800 system and deliver significantly improved throughput at a very attractive price point.

As far as the current outlook is concerned, Andy indicated that we are targeting Q2 revenue in the range of $157-164 million. As Andy also mentioned, the increasing weakness in the global economy is clearly making it difficult to forecast business even in the near-term. Our current Q2 revenue target includes flat to sequential declines in all the major regions. We expect to see continued sequential increase in our services business along with a healthy year-over-year growth although we do expect to see the percentages of sequential growth decrease as our product growth continues to slow.

We remain committed to delivering strong operating margins during fiscal 2009. We have plans in place to implement several cost saving initiatives that should produce non-GAAP operating margins in the 25% range and our goal remains to deliver operating margins above 25% as we move into the second half of the fiscal year.

In spite of the formidable challenges we expect to see with the global economic problems during fiscal 2009, I continue to remain very positive about F5’s future. Our balance sheet continues to improve and our cash balance continues to increase. We have no debt. We enjoy competitive advantage and technology leadership in our market and our customer satisfaction levels are at an all time high.

As I mentioned earlier, the F5 management team is committed to taking appropriate actions to maintain our profitability during this period of economic uncertainty. Having said that we will continue to make appropriate investments in our business to ensure our technology and market leadership positions remain intact and indeed get stronger as the economic environment improves.

I would like to thank the entire F5 team and our partners for their contribution in Q1 and with that we will hand the call over for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Ittai Kidron - Oppenheimer & Co.

Ittai Kidron - Oppenheimer & Co.

First on your services slow down comments, through fiscal 2008 on a quarterly basis you have seen sequential growth of low to very high single digit quarter-over-quarter in services. Do you still expect those services? Although it will slow down do you still expect it to remain positive growth from quarter-to-quarter through year-end?

John McAdam

Absolutely we do. The reason we were raising that is there has been a lot of discussion on our services business and clearly from a market perspective if your product growth is slowing over time that is going to affect the overall growth of your services business. As we look at fiscal 2009 it is certainly still going to be a sequential growth driver as well as a healthy year-over-year growth driver.

Ittai Kidron - Oppenheimer & Co.

Can you explain the increase in gross margin in the services business? It seems like you have had a record quarter this time around. What was different this quarter and how sustainable is that?

Andrew Reinland

Primarily the gross margin on the services side is driven by headcount. A lot of it is just timing of hiring. We had a pretty light hiring quarter as we talked about with the 15. We have also said many times that our target is more in the 73-74% range for service but I do think we are going to see a higher service margin over the next couple of quarters just related to headcount.

Ittai Kidron - Oppenheimer & Co.

Going back touching on the headcount comment is the 5-7% reduction in headcount will that help the gross margin as well and Andy can you put dollars on this? What is the quarterly opEx savings run rate you hope to achieve and will that be fully reflected in the June quarter?

Andrew Reinland

To answer the first part of the question we expect that to be a part of it. In terms of the exact dollars on opEx I don’t have that at hand but more from an operating margin perspective is really our focus. We do believe that will allow us to be at that 25% level and above as we go through the year.

Operator

The next question comes from Sanjiv Wadhwani – Stifel Nicolaus.

Sanjiv Wadhwani – Stifel Nicolaus

John can you comment on the first three weeks of January? What has been your experience with deal closures, etc.?

John McAdam

First of all typically January is down versus the last quarter. That is a seasonal certainty we see and we have seen every year. The next two weeks frankly are the important ones for us. Actually it is like one fiscal week. That is really important in terms of January overall but we have taken the run rate of January business very much into account in terms of range. In fact that has been a factor. I’m not going to be that specific but pretty close to seasonal.

Sanjiv Wadhwani – Stifel Nicolaus

Nothing dramatically unusual compared to last year for example?

John McAdam

No, as I said we have taken that into account in our guidance.

Sanjiv Wadhwani – Stifel Nicolaus

A couple of questions on the balance sheet. Accounts payable popped up quite a bit and so did inventories. Any specific reason for that?

Andrew Reinland

The inventory was within the range that we guided and that is just with the product transition we are going through, making sure we have some specific parts on hand that we want to carry is why that increased. Nothing out of the ordinary there. Then on the AP side really with the federal tax payments and just gearing up preparation to make those payments it drove up the AP side.

Operator

The next question comes from Troy Jensen - Piper Jaffray.

Troy Jensen - Piper Jaffray

Andy, just a little chatter today on your filing last night. It sounds like you are looking to get authority for up to 7 million more shares for stock based compensation. I was wondering if you could just touch on that a bit. Are you planning to incentivize the workforce more with equity here or is that just kind of eligible shares? How should we think about stock based compensation here in 2009?

Andrew Reinland

As part of our proxy statement I think is where you saw that and part of it is going to be for ESPP but in terms of how we look at the stock compensation I think as a percentage we have been less than 2% annually in what we have awarded out there. As of now I don’t know that our thinking has really changed that much at what we are looking at for annual grants.

John McAdam

We don’t see any significant change in the sense of quality at all.

Troy Jensen - Piper Jaffray

So the authorization is potentially there but no change.

John McAdam

For future years yes.

Andrew Reinland

And it is multi-years.

Troy Jensen - Piper Jaffray

John, could you talk about specifically Cisco? I know Citrix is probably the best number two player in the market but do you see Cisco more or less? Are they active? Anything on new products coming out of Cisco?

John McAdam

No, we were discussing that this morning actually. We have seen Cisco less in the marketplace. We have actually seen Citrix less as well. We are very confident the issues we have seen are absolutely linked to the economy compared to otherwise we are in really strong shape. We have actually seen Cisco less.

Operator

The next question comes from Ryan Hutchinson - Lazard Capital Markets, LLC.

Ryan Hutchinson - Lazard Capital Markets, LLC

On the workforce reduction it looks like it is around 84-120 heads if I have that right. Can you break that out in terms of the parts of the organization? John, I don’t want to put words in your mouth but assuming things do get worse before they get better are you going to take further action there?

John McAdam

First of all we wouldn’t break it out across the organization but just about every function is involved as is I think probably to some degree every location. It is pretty general in its tone. I will just repeat what we said in the summary in the conference call we are absolutely committed to maintaining those 20-25% margins and we continue to take action to do that. Obviously you balance that with the fact this economy will get better one of these days and we will have a market leadership when that happens but we are pretty committed. We think we can do that with cuts. That is why we took the actions we did.

Ryan Hutchinson - Lazard Capital Markets, LLC

There has been some channel feedback there has been some departures in the EMEA region at a fairly high level. Can you maybe address if one that is the case specifically as it relates to EMEA and the U.K. and why that took place if indeed it did on the sales side?

Mark Anderson

We did change the sales leadership in EMEA. John Williams decided to leave F5 for personal reasons. We were able to quickly replace him with a gentleman that I have known for a long time that has a great background, a long time at Cisco and Siemens as well. We are very confident in the leadership there and I think the reaction from the team has been very, very strong.

Operator

The next question comes from Erik Suppiger - Signal Hill Group, LLC.

Erik Suppiger - Signal Hill Group, LLC

Just from a product perspective you have had a chance to evaluate where the shortfall came from. If you look at your product line mid to low end, mid range and high end, were there any areas that were weaker than you had expected?

John McAdam

We did see a shortfall mostly in the mid range. So the low end was pretty good. We probably saw some degree of cannibalization, not a lot of it, but some degree between the 3600 and the 3400. However, the game is not played out yet because the 6900 really only started shipping at the end of the quarter and that has been received extremely well. So I think that is going to be a major factor when we look at this quarter.

Erik Suppiger - Signal Hill Group, LLC

In the low end, did your business in aggregate grow in the low end where I’m sure you had cannibalization of the new product replacing the old products and you said the 36 and 1600 were good but in aggregate did the low end products grow?

John McAdam

Yes. I’m not 100% sure. We think it was maybe slight to flat but nothing significant.

Erik Suppiger - Signal Hill Group, LLC

Just to be clear, I think you said the operating margins would be greater than 25% in the second half of the year. Does that suggest they will be less than 25% in the June quarter here?

Andrew Reinland

No. We are definitely planning we want to be at a comparable level with last quarter or better.

Erik Suppiger - Signal Hill Group, LLC

Lastly, are you expecting seasonal strength in Japan? Typically they have a good fiscal year end. What do you see there?

John McAdam

We are currently assuming flat to maybe slightly down in just about every geography and that includes Japan.

Erik Suppiger - Signal Hill Group, LLC

So not much seasonal strength there?

John McAdam

Not much, no.

Operator

The next question comes from Jeff Kvaal - Barclays Capital.

Jeff Kvaal - Barclays Capital

John I was wondering if you could comment on the competitive landscape on two metrics; one, could you suggest why Cisco and Citrix seem to be showing up less often for you and then secondly I noticed you mentioned Nortel earlier this week. How big is that of an opportunity for you?

John McAdam

Regarding Cisco, I think the main way to view our market is to look at our competition which is mainly Citrix and Cisco and then look at the product launches, the new products that have been introduced over say the last 18 months. We haven’t seen much at all from our competition. We have seen a significant amount from us including an almost complete product refresh as well as VITRION. I also mentioned TMOS by the way and Version 10 which is another big leap that we will take there. We have had much more focus in this market than any of those players by a long, long way. They are involved in a lot of other bigger markets and I think that is very, very good for us.

What was the second question?

Jeff Kvaal - Barclays Capital

Alteon?

John McAdam

Yes.

Dan Matte

Our best estimate in the Nortel Alteon isn’t broken out specifically by most of the industry analysts right now but best estimate would be a single digit market share. Probably a mid single digit.

Jeff Kvaal - Barclays Capital

Andy would you mind commenting on the book to bill push out and if we should be expecting book to bill to better than one this quarter or what it might have been had that [inaudible] come in?

Andrew Reinland

Relative to the book to bill we were actually tracking that we would be better than one and then just right near the end of the quarter having emergency must ship that took us below. I wouldn’t look at it as an indicator of what is going to happen next quarter or not.

Operator

The next question comes from Mark Sue - RBC Capital Markets.

Mark Sue - RBC Capital Markets

John do you feel $157 million is the base revenue base or is it possible to dip below that or is that really not in your planning assumptions considering where you are with some of your products? I’m also not sure what product revenues would be down sequentially if you recovered a number of deals that actually slipped from December?

John McAdam

You ask some good questions Mark. Obviously when we give our guidance we expect that the bottom of the range is going to be the bottom of the range. We have normally been right in that. We weren’t correct last quarter. Here is the way we look at the guidance. We look very closely at the pipeline. We have talked about this actually before externally. We also look at what we call the factored pipeline. That is the forecasted run of business. We look at the percentages of close and actually we have talked about during the last year actually about our factor close dropping. Actually it dropped pretty materially last quarter. If you take another drop in that factor pipeline that takes us to the bottom of the range. If basically we maintain the Q4 factored pipeline percentage of rate closed that will take it towards the top of the range. That is the metrics we use.

Mark Sue - RBC Capital Markets

From your customer discussions do you feel the products are becoming more discretionary? I ask since you have a lot of new products and are gaining market share yet revenues are contracting. Do you feel you are moving lower in the ladder of IT budgets or is it more the pie?

John McAdam

Clearly we have discussed that a lot internally. That is a really hard question to judge and let me tell you why. First of all, just to remind everybody we really had a very strong October and November. So we are coming into December where we really hadn’t seen any, in fact we were tracking above the previous quarter so that puts it in perspective. Most of the shortfall happened right at the end with effectively days to go in the last week of the quarter. So there is not much trend there to make that type of assumption. Our products produce great ROI across the board. If somebody is building a data center we add tremendous value and I don’t see that changing. The other area that is worth thinking about that we talked about is we did see in the financial vertical, and we didn’t see this in the pre-release because we hadn’t analyzed it enough, but sorry in the technology vertical, the large dot com a few small large customers definitely reduced spending. So that is more specific than the overall market.

Operator

The next question comes from Rohit Chopra - Wedbush Morgan Securities.

Rohit Chopra - Wedbush Morgan Securities

First I had a question from Matt Robison, who is now part of our team, and he wanted to know exactly how many desk central users there were.

Dan Matte

The answer is 36,942.

Rohit Chopra - Wedbush Morgan Securities

I knew you would have that at your fingertips and I know he is listening.

John McAdam

We thought we wouldn’t be asked the question today.

Rohit Chopra - Wedbush Morgan Securities

I have three questions. Am I looking at this correctly that the allowance for [dabble] accounts went up fairly significantly if you look at it year-over-year or even sequentially?

Andrew Reinland

Yes it did go up. Really that was targeted to a specific situation we had in one of our emerging markets. I wouldn’t look at it as anything systemic there. It was just something we wanted to get covered.

Rohit Chopra - Wedbush Morgan Securities

John, can you comment on and I think a lot of people have sort of figured this out but are services actually going to be going direct? Is that plan underway and is there some revenue threshold that you are forcing on some of your channel partners and maybe talk about how you are managing the channel feedback there?

Julian Eames

Yes to the services plan. We have changed the model a piece. We are not really going direct but we have changed the discounts given to some of the resellers and cut them out in terms of some of the distributors. It is really looking at where they are adding value and where they are not. The major resellers we have worked with and have lots of discussions with and there are some changes and those were effective the first of January.

Rohit Chopra - Wedbush Morgan Securities

Is that causing any strange feedback or some consternation with the channel? Is there any problem?

Julian Eames

We have had some discussions recently with some and we have adjusted the program a little bit and there will be more changes but related to the whole program coming out.

Andrew Reinland

If I can just add to that. What we are trying to do here is we are trying to adapt to what our customers need and to what is best for F5 and our shareholders. I think we have a responsibility to do that every year and we have made changes in our channel program pretty much every year. So this is really along the lines of that. It is really just adapting to the market and adapting to what our customers are asking us to do.

Rohit Chopra - Wedbush Morgan Securities

This wouldn’t contribute to the services slow down at all? Is there any component of this factored in?

John McAdam

I’m looking forward to a little bit more of a speed up going forward with them if we make it right.

Rohit Chopra - Wedbush Morgan Securities

At the low end, I remember when the products were being introduced, I think one of the positives was you would be able to penetrate the Japanese market a little bit more because they aren’t looking for highly technical products because of the two-tiered distribution model. Can you talk about the penetration there? Is it being well received? Is there anything we can look to in the future or positive change there?

John McAdam

The short answer is yes. First of all we are still in the very early days with the entry level products in Japan. I mentioned a couple of times we are very conservative. We are starting to ship entry level products now but it is early days. We do see upside. Japan in general, this was sequential growth last quarter which was very important because they had sequential decline for a number of quarters previously so we are happy with that. When you look forward to this coming quarter and moving forward actually the year-over-year growth should look better mainly because it is easier comparisons but it should start to move into year-over-year growth. The entry level is going to help that.

What we are really focused on is to get them to sell more added value, not just load balancing, so their first modules and then take us up the chain, not just low end.

Operator

The next question comes from Jeff Evans - Sanford Bernstein.

Jeff Evans - Sanford Bernstein

A couple of questions related to the Nortel rebate that you announced earlier this week. One is the rebate is up to $9,000. What is your targeted percentage of your product cost that would typically be? Second, where do you account for that on your income statement? Is that going to be sales and marketing expense or did you put it as the price and reflect it in cogs?

Andrew Reinland

In terms of where it would get reflected it would bring down the revenue on the deal. It is just part of a discount with the deal. Then less than 5% just off the top of my head on the cost.

Jeff Evans - Sanford Bernstein

Lastly, when it was mentioned that Nortel’s market share is only single digits today I think that is certainly true in the current market but if we look back 4-5 years they were in the mid teens. Are you also giving rebates on those older products?

Andrew Reinland

Absolutely. The focus on Nortel really isn’t just something we woke up last quarter and decided to do. This is something we have systematically been doing over the last several years and I think the market share numbers reflect that. So, we are looking at legacy Nortel customers as we have for the last couple of years and we are just going after them a little bit more aggressively now.

Operator

The next question comes from Richard Sherman – MKM Partners.

Richard Sherman – MKM Partners

My question is about the LAN product. Will that be shut down as part of the right sizing, cost control efforts?

John McAdam

No it won’t. That is very much linked to Version 10 that I talked about. As I said, Version 10 is due to come out in a few months and that is where we have effectively the module on top of TMOS and that is still very, very much part of the plan.

Operator

The next question comes from Kenneth Muth – Robert W. Baird & Co.

Kenneth Muth – Robert W. Baird & Co.

Can you maybe share with us the total number of customers you have in the VIPRION product portfolio and kind of how many you are adding a quarter?

John McAdam

No, we don’t give those numbers out actually but we still remain very happy with VIPRION. The pipeline for this coming quarter is looking very good as well but we don’t give those specific numbers out.

Kenneth Muth – Robert W. Baird & Co.

I imagine that the dot com’s you talked about in the tech and that was down meaningfully sequentially and I would assume is that the same kind of pause in the cloud computing area?

John McAdam

This is specific customers and data center roll outs. I won’t get into it in any more detail but it is a few customers and it was a fairly big difference quarter-over-quarter and we thought it was appropriate to highlight that.

Kenneth Muth – Robert W. Baird & Co.

Can we continue to see kind of a downturn in the Acopia product? What are the thoughts on trying to maybe get that around?

John McAdam

In fact I mentioned that. It was a pretty slight downturn. What we are seeing is we are finally seeing some of the integration happening better. We are seeing a stronger pipeline. We think we are going to see some small but growth quarter-over-quarter and that is going to get healthier as we get into the second half.

Kenneth Muth – Robert W. Baird & Co.

What about the number of customers for that product portfolio? Anything you can share with us there?

John McAdam

Not really. It was over 100 when we did the acquisition. I don’t actually know the numbers I’m afraid.

Operator

The next question comes from Ehud Gelblum - JP Morgan.

Ehud Gelblum - JP Morgan

John you mentioned you weren’t giving out numbers for VIPRION. You did give out the ARX at $3.4 million I think you said. Should we assume that the VIPRION has not quite hit that level yet or you would let us know that it is starting to hit stride?

John McAdam

I’m not going to give the numbers of VIPRION. It is typically above that number by the way but the reason we don’t do that is we have historically given out numbers when we have done an acquisition for a period of about a year and that is really what we are doing with ARX.

Ehud Gelblum - JP Morgan

So VIPRION is above that?

John McAdam

We see VIPRION as very much a part of the ADC BIG-IP family.

Ehud Gelblum - JP Morgan

Andy on the operating margin in the last conference call you said you were looking for 26-27% operating margin, non-GAAP operating margin throughout the year ending at the high end, now you are saying 25% plus. Is that just the change in revenue level? That is what is bringing down your level of confidence in the operating margin expansion?

Andrew Reinland

Definitely the results for Q1 weren’t expected. In fact, as John said not only in bookings but as we came into the December quarter we thought we were going to exceed that guidance on operating margin and then just the end result in revenue put us at that 25.4%. I think our comments on the call on January 6 around operating margin were acknowledging that situation and saying at this revenue level yes the 25% range is kind of what we are targeted into but we have every expectation in the latter half of the year to get back up in that 26-27% range we talked about.

Ehud Gelblum - JP Morgan

That would be a function purely of revenue or headcount reduction as well?

Andrew Reinland

I think the comments on the cost cutting that we are making and we are doing is meant to impact that and of course revenue going up we hope will help drive it there too.

John McAdam

In case I’m understanding it, just to be specific, we haven’t got any plans to do any more headcount reductions than announced today.

Ehud Gelblum - JP Morgan

But that will help you back into the 26-27% range on possibly a lower revenue total than you were looking at earlier?

John McAdam

Absolutely.

Ehud Gelblum - JP Morgan

If I can put two together that were mentioned earlier, the shortfall this quarter because of what happened at the end of December was roughly around $7 million versus your previous guidance. 60% of that or roughly $4 million plus seemed to have gotten pushed into this March quarter so your guidance now should we be looking at $4 million of that sort of padded a little bit by $4 million so sort of a run rate as we look further into June, etc. should be $4 million below? Then on the converse side…

John McAdam

That’s not really the way to look at it. As I was saying earlier we take total pipeline, which includes stuff that has moved in, but the total pipeline which is a pretty significant number and that number has moved in from the quarter a small portion of that. We look at that. We look at the close rates and the fact the forecasted deals and that is the key for us and that is where we get our range from.

Ehud Gelblum - JP Morgan

On converse side the fact the doubtful went up by $2.7 million that is still about 103 basis points of margin this quarter, give or take. That is only a one-time occurrence. So then we should be looking, that is the source of margin expansion. You could have done a 26.7% or 27% right now if you hadn’t taken the doubtful [inaudible]?

Andrew Reinland

Definitely the increase there impacted our overall outcome.

Ehud Gelblum - JP Morgan

Unless your revenue from those emerging markets expands in future quarters that is a one time issue?

Andrew Reinland

Yes, I would say that is one-time.

Ehud Gelblum - JP Morgan

Finally, your cash flow which has been consistently very strong, $59 million last quarter and $57 million this quarter. Your guidance I think you said $35 million next quarter. So that is a drop of $12-14 million where you could have been or otherwise would have been?

Andrew Reinland

The factors that are going to hit us this quarter we have approaching $20 million of U.S. federal tax payments greater than we had last quarter and then also as part of the restructuring I talked about there is going to be costs related to that. So those are factored into that outcome.

Ehud Gelblum - JP Morgan

That is where I was going. What is the cash cost of those…you said you had a $4.5-5.5 million charge for the restructuring. What is the cash component of that in the quarter?

Andrew Reinland

I don’t have the exact number and I know what you are getting at because a big component of this is going to be related to the offices and the cash doesn’t go out right away but the estimate is going to be at least a couple million dollars.

Ehud Gelblum - JP Morgan

So the tax part is the majority of the drop?

Andrew Reinland

On par, yes.

Ehud Gelblum - JP Morgan

What should it look like if we go into June assuming for nothing else but just a flat to up revenue number? Should it bounce back into the 55+ range?

Andrew Reinland

We haven’t look at that yet but obviously that would be our expectation.

John McAdam

We had a very similar profile last year by the way. A very similar profile.

Ehud Gelblum - JP Morgan

So the cash tax part is really kind of eats into you in the beginning of the calendar year?

John McAdam

Correct.

Andrew Reinland

With that we will wrap up the conference call. Thank you very much for calling in. We will see you next quarter.

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Source: F5 Networks, Inc. F1Q09 (Qtr End 12/31/08) Earnings Call Transcript
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