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F5 Networks, Inc. (NASDAQ:FFIV)

Q2 2007 Earnings Call

April 25, 2007 4:30 pm ET

Executives

John Eldridge - Director of IR

John McAdam - President & CEO

Andy Reinland - SVP & CFO

John Rodriguez - SVP & CAO

Julian Eames - SVP of Business Operations and Global Services

Tom Hull - SVP of Worldwide Sales

Dan Matte - SVP of Marketing

Karl Triebes - SVP of Product Development & CTO

Analysts

Troy Jensen - Piper Jaffray

Paul Mansky - Citigroup

Matt Robinson - Baker Watts

Ryan Hutchison - WR Hambrecht

Kim Martin - J.P. Morgan

Joanna Makris - Cannacord Adams

Mujal Shah - Jefferies & Co.

Jeff Lubert - Banc of America Securities

Mark Sue - RBC Capital Markets

Rohit Chopra - Wedbush Morgan

Manny Recarey - Kaufman Brothers

Samuel Wilson - JMP Securities

Gabe Larry - Unterberg

Cameron Cooke - Janco Partners

Brent Bracelin - Pacific Crest Securities

Ken Muth - Robert W. Baird & Co.

Presentation

Operator

Good afternoon. Welcome to F5 Second Quarter Financial Results. All parties will be on a listen-only mode until the question-and-answer session. Today's call is being recorded. If you have any objections, please disconnect.

I would now like to turn the call over to Mr. John Eldridge, Director of Investor Relations. Thank you, sir. You may begin.

John Eldridge

Thank you, Angie (ph). Welcome to our second quarter 2007 conference call. Speakers on today's call are John McAdam, President and CEO; Andy Reinland, Senior VP and Chief Finance Officer; John Rodriguez, Senior VP and Chief Accounting Officer; Julian Eames, Senior VP of Business Operations and Global Services; Tom Hull, Senior VP of Worldwide Sales; Dan Matte, Senior VP of Marketing; and Karl Triebes, Senior VP of Product Development and CTO are also with us to answer questions following our prepared comments.

You don't have a copy of today's press release, it is available on our website www.f5.com. In addition, you can access an archived version of today's live webcast, the event calendar page of our website through July 25th, 4:30 pm today until 7:00 pm Pacific Time tomorrow you can also listen to a telephone replay at 800-876-5573 or 402-220-5329.

During today's call, our discussion will contain forward-looking statements, which include words such as belief, anticipate, expect, and target. These forward-looking statements involve risks and uncertainties, 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 press release described in detail on our SEC filings. Please note that F5 has no duty to update any information presented on this call. If you have any questions regarding today’s call, please direct them to me at 206-272-6571.

Now, I’d like to turn the call over to Andy Reinland.

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Andy Reinland

Thank you John. Revenue in EPS for the second quarter of fiscal 2007 were above the guidance we provided in our release and conference call on January 24th. Driven by sales of our core application delivery networking products we achieved revenue of $127.6 million, above our target range of $124 to $126 million.

GAAP EPS of $0.47 per diluted share was also above our guidance of $0.44 to $0.46 per share. Overall, revenue grew $7.6 million just over 6% from the prior quarter. Year-over-year revenue was up $33.5 million or 36%.

The Americas represented 58% of revenue, EMEA accounted for 17%, Japan 12% and APAC 13%. Product revenue of $96.1 million represented 75% of total revenue. Service revenue of $31.5 million was 25%.

Revenue from our core business was $117.1 million or 92% of total revenue, representing 8% growth over the prior quarter. Security revenue was $8.6 million, which was below our expectations. This included $2.1 million from our Application Security Manager products and $6.5 million from our SSL, VPN products.

WAN optimization and acceleration revenue was $1.9 million. The Telco Vertical increased sequentially to 23% of our business. Sales within the financial sector was 19%. U.S. Federal Government generated 5% and total government was 10%.

During Q2 we had two greater then 10% distributors, Ingram Micro, which accounted for 12.9% of total revenue and that net technologies, which accounted for 13.3%. Our book-to-bill ratio for the quarter was less than one.

As a reminder from my remarks on margins expenses and earnings our results in guidance discussed are GAAP base unless specifically define otherwise. We have provided a breakout of stock-based compensation expense by function in today's earning release.

Gross margin in Q2 was77.4%, operating expenses of $73.1 million were within our target range of $70.5 million to $73.5 million. Our operating margin was 20.1%. Our non-GAAP operating margin, which excludes stock-based compensation expenses, was 29.3%. Our effective tax rate was 39.3% excluding stock-based compensation expense; our non-GAAP effective tax rate would have been 34.5%.

On the balance sheet, account receivable DSO end of the period at 52 days. Inventories at quarter end were $7.9 million reflecting continued strength in our services business. Deferred revenue increase 10% sequentially to $75.2 million.

Cash flow from operations was $37 million. This result was a net of $18 million in estimated tax payment, which we began paying in Q2. We ended the quarter with $586 million in cash and investments. Capital expenditures for the quarter were $4.5 million and depreciation and amortization expenses was $3.8 million. During Q2 we added approximately 125 employees ending the quarter with 1280 full time employees.

Moving on to the third quarter outlook. We are targeting revenue in the range of $131 million to $133 million. We expect gross margin in the 77% to 78% range including approximately $500,000 in stock-based compensation expense.

We expect operating expenses between $73 million and $76 million including approximately $10 million of stock-based compensation expense. Our effective tax rate going forward is estimated to be 39%. Excluding stock-based compensation we expect our non-GAAP effective tax rate to be 34.5%.

Our earnings per share is expected to be within in the range of 48 to 50 cents per share. We are continuing to invest in the growth of the business and plan to add 60 to 80 employees this quarter. We estimate DSO’s will be at or around 50 days. We expect inventory levels within the range of $7 million to $9 million and we believe our cash flow from operations will be in excess of $35 million.

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

John McAdam

Thanks Andy, and good afternoon everyone. Q2 marks seventeenth consecutive quarter of sequential growth. Overall, I was pleased with our performance especially in our core application delivery controller market, where we continue to see solid sequential growth.

From a geography perspective, the performance was balanced across the major geographies with revenue up sequentially across all the major regions. Our service business yet again produced solid growth with another large increase in deferred revenue.

We also continue to see growing demand for our services consulting business, which we expect will continue in the second half of this year and into fiscal 2008.

After a couple of quarters of sequential growth with FirePass, we saw a sequential decline last quarter, which was pretty much across most of the main geographies. Historically, the FirePass business has been somewhat lumpy and last quarter result’s again demonstrated that characteristics.

We do not believe the competitive landscape has change in any material way and we do see some large opportunities for FirePass in this current quarter.

Our WAN optimization business was also down sequentially in quarter two and we remain very focused on our product roadmap funds to move the WANJet Solution on to a TMOS platform with a target delivery date during summer this year.

We continue to believe that TMOS along with iControl and iRules gives a significant competitive advantage as demonstrated by our clear leadership in the application delivery controller market. And we intend to leverage that advantage in adjacent of WAN optimization and remote access market.

We launched a number of very exciting marketing and product initiatives last quarter, including the introduction of a new high-end slide ship 8800 platform. We believe the 8800 has no viable direct competitor in the market today, and we have already seen high interest for the product from the large enterprises, large service provider and the very large Internet companies.

Internet traffic continues to grow dramatically in both volume and complexity, a trend that will no doubt continue for the foreseeable feature. We also launch two very significant initiatives with Microsoft during the quarter.

A joint F5 Microsoft announcement regarding our OEM relationship for Microsoft’s system center Operation Manager 2007 will enable F5 to deliver an appliance named Control Point to monitor and report an overall health of that customer’s application delivery infrastructure.

We also announced to IF5 application ready network from Microsoft. This is the fast application delivery network campaign specifically designed for Microsoft. It contains prescript of architectures, designs, applications and deployment gates, all of which utilized entire F5 product portfolio.

These solutions optimize Exchange 2007, SharePoint 2007 and Vista applications. The benefits of utilizing the F5 application ready network architecture include up to 2.5 times faster application performance. The 33% shorter deployment cycles, up to 70% reduction on I Test and Tools cost, up to 70% reduction bandwidth utilization and five 9s availability for critical network and application resources.

We have plans and pleased to run rate towards to introduce to F5 applications ready network in various cities in North America this quarter. And then follow-up with similar events in EMEA, Japan, and APAC through out the year. We also intend to expand this approach through major application partners in the future.

Our product roadmap remains in very good shape. We remain in target for introducing a WANJet on TMOS this summer and we continue to work on a similar project with FirePass. Also Montreal chassis-based solution is progressing well and remains on track for the end of this calendar year.

We believe our current leadership with TMOS under current platform portfolio gives us a strong competitive of advantage and combined with our roadmap. We believe we will maintain an increase set advantage going into fiscal 2008.

Regarding outlook as far as Q3 is concerned Andy indicated that we continues to target sequential growth in our overall business. Our prospect pipeline remains strong and all our major regions with exception of Japan are forecasting solid sequential growth in Q3. Of course Japan tends to be during this quarter as they enter the new financial year and we expect our Japan business to be up strongly again in Q4.

We remain committed to our growth strategy. We added a 125 people to the F5 team last quarter, bringing the total number of new hires to 210 in the first half of fiscal 2007. This includes an increased to our sales infrastructure headcount bringing that for to 125 in total at quarter end. We anticipate that the majority of new sales hires in the first half will start to ramp this quarter accelerate in quarter four and achieve full productivity in the first half of fiscal 2008.

In the mean time we intend to continue hiring across the board to take advantage of the gross opportunities we see in our key markets.

I would like to thank the entire F5 team and partners for their efforts in Q2. And with that I’ll hand the call over for Q&A.

Question-and-Answer Session

Operator

(Operator Instruction) Our first question comes from Troy Jensen. Your line is open. Please state your company name and you may ask your question.

Troy Jensen - Piper Jaffray

Piper Jaffray, congrats on the next quarter John.

John Eldridge

Thank you.

Troy Jensen - Piper Jaffray

Hey, quick question on BIG-IP 8800 was that, could you share whether or not that was a generating revenues for you in the during the March quarter?

John Eldridge

Yes it did generated, you know, we won’t as we’ve done in the past nicely indicated specific revenues by product. But we absolutely shift and took revenue on a last quarter.

Troy Jensen - Piper Jaffray

Okay, it was a primarily just to beta sides that converted?

John Eldridge

No, it was combination of some base have also you know some of the larger customers I would kept in my script.

Troy Jensen - Piper Jaffray

Okay, understood got it, two questions quickly for Andy, Andy you mentioned book-to-bill is below one in the quarter, is that correct?

Andy Reinland

Yep.

Troy Jensen - Piper Jaffray

Anyway you guys can maybe quantify how close to it was?

John Eldridge

Yeah, let me do that Troy. And don’t, we can tell, we report at the end of the year, but just to give you a few for it. As to book-to-bill was equal to one we would have been within our range of guidance of a 124 to 126.

Troy Jensen - Piper Jaffray

Got you, okay that’s very clear. And then a last question, I guess talked about you know operating margins in the high 20% range looks like right now if my math is correct pro forma is 29.3 given that the headcount higher it sounds like it is going to decelerate a little bit. Do you think we are kind of roughly at the low point of the margins or...

John Eldridge

I think if you look at the guidance that has sized up for Q3, you will kind of see that we expected to stay in that range for Q3 and now wouldn’t look to headcount number is anything other than looking at our expectations today given the hiring we have to date immigrating them into the organization that’s the number that we can see fitting in nicely for Q3 and as we always say we’ll revaluate and reassess and adjust those as the numbers play out.

Troy Jensen - Piper Jaffray

Understood. Keep up the good work guys.

John Eldridge

Thank you.

Operator

Thank you. Paul Mansky your line is open. Please state your company name and you may ask your question.

Paul Mansky - Citigroup

Yes. It’s Citigroup. On the win optimization front obviously, you know from one of your major competitor there recently putting up some pretty decent growth numbers. On that sub sequential growth number, how much of that should bit to just market conditions, competitive conditions and then you own product cycle upcoming?

John Eldridge

I recall hugely on our own product cycle. We’ve been very open about the one-optimization market actually since the beginning of the fiscal. We think first of all the market is pretty down vibrant is the good news.

The bad news from our perspective in the short term is that we do believe we have some competitors functionally missing that we are aggressively putting into the product namely some management features and some discussion in particularly. That gets fix with our release, which is the one, which schedules for summer activities on track and we expected to be a bigger player in that market.

Paul Mansky - Citigroup

Great. Thank you. Congratulations again on the quarter.

Operator

Thank you. Matt Robinson your line is open. Please state your company name and you may ask your question.

Matt Robinson - Baker Watts

That’s Baker Watts. My usual question about central users, how that’s going?

Dan Matte

Sure Matt. This is Dan. That’s about 15,300.

Matt Robinson - Baker Watts

That’s about 2,000 adds. Right.

Dan Matte

That’s correct.

Matt Robinson - Baker Watts

So, it sounds like that’s the most you ever had in time.

Dan Matte

So that’s all time high in terms of adds and the other metrics that we look at as well. They are all very, very positive. During the quarter we actually lost that central version for where we leveraged a lot of 2.8 type of technologies before that central and we have see the very, very positively received.

Matt Robinson - Baker Watts

Okay. Thanks. That’s it for me.

Operator

Thank you (inaudible) your line is open. Please state your company name and you may ask your question.

Unidentified Analyst

Hi, thanks. This is (inaudible) Merrill Lynch is the company name. Just a question on again towards the end of the quarter and looking at the book to bill just wondering if there is anything that you care to clarify there is a lot of chatter and noise in the market about similar things going on. Potentially I am wondering where you think that comes from and have a good follow up after that?

John McAdam

Sure about things going on we don’t normally here that, but just to ask some feel for it we did about 50% when we allocate. So that was pretty normal from a quarter basis. So not much difference there. We did see some seasonality. We did some of that but again that wasn’t entirely unexpected, but I am not quite sure what the question means.

Unidentified Analyst

Okay. No I will ask this related to seasonality and if I look at the guidance number it seems like the outlook in terms of what folks in general were assuming in terms of the dollar level of growth, you sort of at the mid point keeping that maybe $5 million or so growth rate.

I am just wondering where some of the reservations are in terms of maybe the range that you are giving is fairly right 131 to 133, what could lead maybe to the lower end of that and the higher end maybe you can talk about these factors?

Andy Reinland

We normally get the remaining at $2 million that’s a norm how we do that. So, isn’t any case that we’d normally do? In terms of the guidance we do that same system as we’ve done for the last more than four years, so we look at the pipeline, we look at bottoms up forecast etcetera, etcetera. And that’s the number we come up.

In terms of some of the things that’s ongoing that’s related to that, we do expect as I said on the call in Japan to be done in this quarter that’s nothing unexpected but that is beginning of the financial year.

The other thing that’s worth mentioning is that given our book-to-bill was less than one in last quarter. The bookings this quarter into the revenue range will actually to be greater than the actual revenue. So, from that perspective that booking, the sales booking is slightly more aggressive than our revenue range.

Unidentified Analyst

That’s very helpful. Thank you very much.

Operator

Thank you. Ryan Hutchison your line is open please state your company name and you may ask your questions.

Ryan Hutchison - WR Hambrecht

WR Hambrecht. Just a couple of questions here, just in terms of the distribution strategy in place. Were there any changes in the quarter specifically with that matter on GEX or should we expect anything moving forward and then maybe touch on the Westcon relationship as well?

Tom Hull

This is Tom Hull. There weren’t any major changes other than Westcon coming on board. So, we are proceeding with our strategy continuing to invest in our existing partners and looking for opportunities to expand. But from a distribution standpoint no major changes.

Ryan Hutchison - WR Hambrecht

Okay. Great. And then in terms of Montreal the end of the calendar year, was that up slightly from prior targets?

Karl Triebes

Hi, this is Karl here. In terms delivery no, it’s pretty much the same as what we communicated in February. So, it’s on track after that.

Ryan Hutchison - WR Hambrecht

Okay. Then and finally, just in terms of the acquisition strategy for the company how should we look at that, has there been any changes there?

John McAdam

No. I wouldn’t consider any changes from our continuing strategy.

Ryan Hutchison - WR Hambrecht

Would you look for more technology tucking or you guys pretty content on where we sit today?

John McAdam

I think where we sit today we have a lot in our plate organically. So as we always seen never seen never to these types of questions, because we continue to look at what’s available in another adjacent markets. But from in terms of where we sit today, we have a lot in our plate.

Ryan Hutchison - WR Hambrecht

Great. That’s it for me. Thanks guys.

John McAdam

Yes.

Operator

Thank you. Ehud Gelblum, your line is open. Please state your company name and you may ask your questions.

Kim Martin - J.P. Morgan

Thanks, it’s Kim Martin in for Ehud at J.P. Morgan. Just a question on starting off on security, you mentioned no change to competitive outlook. Did you see any changes to the pricing environment or other is due to seasonality or if you could just touch on that a little bit further?

John McAdam

No. We didn’t we basically I think seasonality definitely plays a part. We’ve seen a number of times in previous calls. We think that secure access market is a great market, but from mission critical perspective as mission critical typically is core big IP market so, it’s easier to delay decision, which would lead to some seasonality.

Also, I noticed in one of our competitor’s conference calls recently that they talked of SSL VPN not being so whole last quarter as well, which would be in a line with, I'd say to that no, we haven’t seen any major material change in the competitiveness.

Kim Martin - J.P. Morgan

Okay. Okay. And then your silicon business definitely seems to be growing quite a bit faster than the product business. How, do you expect that to continue indefinitely and how much of that at this point is on consulting services at the first imminent contract?

John McAdam

Yes, it has being growing strongly and the business really as it evolved on top of layering of the installed base, we’ve seen our differed revenue grow very well. So we are happy to see that. In terms of consulting which, you know we’ve talked a lot about is investing back in the business.

So consulting was an area that a lot of our customer base has been asking for. We’ve been adding consultants probably 4 to 8 a quarter and our customers are very happy about that and we see the revenues growing up from that.

We are not going to break it out for you, but we did see a pretty significant ramp up. And also training is done very well, that also contributed to the increase that we saw this quarter. And from our prospective seeing that training going at, that’s investing back in the business and establishing ourselves for long-term growth. So we are very happy with it.

Kim Martin - J.P. Morgan

So do you expect the services business to continue to grow little bit faster? Case and products?

John McAdam

Definitely that consulting we expect will continue to grow as well as the training.

Kim Martin - J.P. Morgan

Okay. And my last question is on hiring. It sounds like next quarter again a pretty robust hiring albeit down from the last quarter obviously. What’s the end goal here? Where, do you guys have magic number in your head in terms of where you want to get to, and should we you know, its not a number. Should we expect to continue to hire for the remainder of the year.

John McAdam

Yes. And we don’t have and end goal, you know, specific end goals. Basically what we are looking at, is what we believe is a market opportunity is. Sales productivity, we spend a lot of time in that, we can get as we simulate sales, the sales organization into the field.

Obviously we hire aggressively in product development to maintain technology leadership and then in service to provide customer satisfaction and quality. But the key thing we are looking at is, is gross potential. That will be, when I want to get numbers for what we expect to do in quarter four, what we would absolutely expect to continue to be do the hiring as we move in to the fiscal.

Kim Martin - J.P. Morgan

Okay. Great. Thank you.

John McAdam

Yes.

Operator

Thank you Joanna Makris, pleas state your company name and you may ask your question.

Joanna Makris - Cannacord Adams

Hi, Cannacord Adams. I am wondering if you could talk about a little bit about kind of a general outlook for the 8800, It's newly out of the box if you can comment perhaps on, what you are seeing in terms of order activity and any, how we should think about applications on that product line for the year?

John McAdam

Yes, I will mention quickly and Karl or Dan can also add. But we are very excited about the 8800 and I am probably more excited about the trends, I mean that, when we talked to the large service providers, the larger customers, the large Internet companies, the statistics on web complexity and traffic growth is really pretty amazing.

So we go in to the market where functionality was everything, you know functionality is everything as long as you got tremendous performance. And I said in the script there is no competitor at these performance levels.

So we think we can absolutely break into the, it’s a real big opportunities here with this product. And we are already doing that, but we think that’s going to continue. And of course that bodes well once have this as well. Now do you want to add anything?

Operator

Thank you. Bill Choi, your line is open. And please state your company name and you may ask your question.

Mujal Shah - Jefferies & Co.

Yes. This is Mujal Shah for Bill Choi with Jefferies & Company. Couple of questions, one average deal size in the quarter?

John McAdam

Yeah it was pretty consistent with last quarter, so around 160,000.

Mujal Shah - Jefferies & Co.

Okay. And could you just comment on the sales cycles in terms of you know what you are seeing out there, are people taking longer time to evaluate the products or just ever that shortening or lengthening?

John McAdam

We are not seeing any change in sale cycles. So, we basically have -- our sale cycles probably average in the three months type figure. We do see sales in a quarter that start and end in the quarter. And then we see some longer ones that tend to be the bigger ones as well, but no major change whatsoever.

Mujal Shah - Jefferies & Co.

Okay. Thanks a lot.

John McAdam

Yeah.

Operator

Thank you. Tim Long, please state your company name and you may ask your questions.

Jeff Lubert - Banc of America Securities

And this is Jeff Lubert dialing in for Tim Long. A couple of questions, first it looks like you are hiring at slightly lower pace, is that due to diminishing returns on new hires, and should we expect that pace to declining going forward?

John McAdam

No its absolutely and undefeated and that really is linked to the stimulation. We have hired lot of people in the last couple of quarters. And, we’re going to keep that going as we move into this quarter maybe slightly less, as we indicated in the previous quarter, but when you look at percentage of hire, that is pretty significant. I don’t see it slowing as we move into quarter four, but we haven’t given specifics on that.

Jeff Lubert - Banc of America Securities

So, in terms of the opportunity things still look just as good as they did three months ago and maybe six months ago?

John McAdam

I think we are going to see some aggressive hiring continuing.

Jeff Lubert - Banc of America Securities

And then on the service provider business pretty strong this quarter, can you talk about what drove the strength there; was it a result of new hires? Was that availability of 8400 and now the 8800? And then the final question is on legal expense due to options, how much was for this quarter and should that be going away in the next quarter?

John McAdam

Yeah, I’ll answer that. First, there was about 300,000 in legal fees related to options. Next quarter it could be as much as the same, we’re really in an uncertain stage with that, but I wouldn’t expect it to be anymore.

Jeff Lubert - Banc of America Securities

Okay.

Dan Matte

Jeff, this is Dan. As far as the service provider category and what constrain really was again quite balance across the number of different areas implementations and fixed environments, mobile environments, hosting ISPs.

Everything was really, really strong. I don’t know, if we could link it directly to a particular platform and it was more general than that. I think it was more people exploiting the capabilities of our platform helping with the web mail implementation, the Voice-over-IP, ZIP video, just a number of different things.

And then finally, I think as well we are seeing the results of the team that we have focusing on the service provider vertical and result of their operating technologies.

Jeff Lubert - Banc of America Securities

So should we expect this business to trend up as a percentage of sales through the remainder of the year? And I guess what’s the target level?

John McAdam

Really tough one, I mean I think you will see by the nature of that market, there is going to be some big deals. Make it slightly lumpy and we’ve seen that over the last couple of quarter. But we expected that delays as a big opportunity for us, and so as the enterprise. And so I wouldn’t describe that either, so we expect to see growth in both, I would like to call it as a definitive in terms of percentage.

Jeff Lubert - Banc of America Securities

Thanks guys. Congratulations.

John McAdam

Thank you.

Operator

Mark Sue your line is open. Please state your….

Jeff Lubert - Banc of America Securities

I did. I am sorry.

Mark Sue - RBC Capital Markets

Hi, RBC Capital Markets. Just knock on the service provider strategies that go to replace competitors. So you feel there is enough business around in the service provider, still in the early phases of that?

Dan Matte

Mark, this is Dan. I think, there is definitely replacement business going on, although it's driving some of the revenue that we're seeing. The majority of that is just new implementation that we're running into. So I think the bottom line is that there is plenty of business to go around there.

Mark Sue - RBC Capital Markets

Okay. Got it. And John is the business becoming more seasonal in North America or was it just as current March quarter and will it back to normal in term of seasonality now that we are into June quarter.

John McAdam

I don't if it is the kind of more seasonable but that is definitely an element of seasonality, so typically in North America enterprise. There is some seasonality in the first quarter and that tends to build figure much stronger in this current quarter. But the big seasonality for us is usually Japan, that's most obvious one along with the sum degree a year of course in summer.

Mark Sue - RBC Capital Markets

Got it. As we go to returns of the bill greater than the one at the end of this quarter.

John McAdam

The current guidance that we have given is equal to one.

Mark Sue - RBC Capital Markets

I see. Okay. Thank you, gentlemen.

John McAdam

Okay.

Operator

Rohit Chopra. Your line is open. Please state your company name and you may ask your question.

Rohit Chopra - Wedbush Morgan

Wedbush Morgan. Good afternoon. I had couple of questions, one I just want to come back to the government vertical. I just want to ask you question there. Are you working with anyone on any large contracts with the military or possibly like the networks contract, which was announced toward the upcoming enterprise contract, which will be announced soon.

And the second question comes back to WANJet. So given that there is a number of players out there and people already sort of out there with the decent product. Are you guys in any way worried that sort of a low hanging fruit is captured even though we all understand that there is a big market out there.

Does it make it difficult for you or are there are different plans put in place to try and capture an opportunity, which may be a longer ramp or something like that?

John McAdam

Yes. On the first question we are working on a number of sales of large federal contract, but we wouldn't be specific about what are, but we do, we're seeing that the fruits of focus on federal for a number of years -- and it was a reasonable quarter on federal this quarter.

And a lot of that was linked to some of the big contracts and yes number of non-military, but that's the only comments we'll make in. Regarding WANJet we quickly ask to question in the sense that if we can have it tomorrow.

I begin with Karl Treibes but it seems to have already, but it looks like it's going to be summer. We still think there'll be an opportunity there, no question about it, it's seems to be a pretty whole market. And I think with teamwork we can add some real differentiation. So, yeah, we would like to get it as soon as possible, but it is what it is.

Rohit Chopra - Wedbush Morgan

Okay. Thanks guys.

Operator

Thank you. Manny Recarey, your line is open. Please state your company name and you may ask your question.

Manny Recarey - Kaufman Brothers

Thanks. Kaufman Brothers. The follow-up on the question is the U.S. Government. Can you guys having a concerned about the funding aspect of the ended with its formula of defense with the things going on in DC about budgeting at all?

John McAdam

You mean in the short-term and the quarterly basis is a long perhaps.

Manny Recarey - Kaufman Brothers

No, in the short-term basis at June quarter we will see a battle over the budget. And do you have any concern about funding being delayed, as quarter is so out.

John McAdam

Yes. I understand. We are not specific by vertical in terms of our forecast but it is pretty reasonable forecast for federal this quarter. So I guess that you never see nor concerned about potential budget issues, but that’s not come up as a major issue from the field.

Andy Reinland

Tom, could you believe that talk?

Thomas Hull

Yes. We are involved in civilian opportunities as well as in the federal, so it's not just the defense that were engage in at ones

Manny Recarey - Kaufman Brothers

Okay. As far as your hiring goes would -- if you expected it to be more on the sales and marketing or R&D or both?

Andy Reinland

I think it will continue pretty evenly as sales and marketing will be the lead, but then services and R&D.

Manny Recarey - Kaufman Brothers

Okay. And then the last question, just see the share account, seem to be flat quarter-over-quarter is that a fair expectation. You expect that to or where that’s flat, just curious?

Andy Reinland

You know, really I think it was primarily driven by share pricing and the calculation for full dilution there. When we model out, we usually model in increase of about a 0.5 million shares a quarter that, overtime we’ve seen that to be about the average rise.

Manny Recarey - Kaufman Brothers

Okay. Thanks.

Operator

Samuel Wilson your line is open. Please state your company name and you may ask your question.

Samuel Wilson - JMP Securities

Sure. This is Jonathan Curtis for Sam from JMP Securities. Quick question on, in your core market are you seeing more or less of Citrix, Juniper and Foundry within the big IP space.

John McAdam

I’ll talk maybe Dan you will add. Yes, we basically, we see Cisco all the time because we selling into the their kind. So if you let me hear that changing actually and so they are obviously a number one.

Citrix we see, we believe competitive differentiation had got stronger against Citrix as the courses have been folded here. And then frankly we don’t believe in our core market that we have another viable competitor.

Samuel Wilson - JMP Securities

Got it. And then, just quickly CapEx for the quarter, what was it?

Andy Reinland

That was 4.5 in Q2.

Samuel Wilson - JMP Securities

4.5. And then on, back on WAN optimization step, are you guys actually even competing for new opportunities in that market or you are just taking in down calls and sort of selling if people come asking. But you are actually out in the market pushing all WANJet solution?

John McAdam

Yes, I mean we are pushing WANJet solution button in focused areas, So data center to data center we believe there will be some strength there in some of the customer base. But the sales force have got a pretty strong focused on our bit IP products where we have leadership. So most of the energy is focused there. As we will get more competitive that will change, but that’s the way we’ve placed it today.

Samuel Wilson - JMP Securities

Got it. Good. Thank you guys

Operator

Gabe Larry, you line is open. Please state your company name and you may ask your question.

Gabe Larry - Unterberg

Gabe Larry with Unterberg Congratulation again gentlemen. Quick question concerning WANJet, once that gets integrated in to CMOS are you positioning it to extend the platform in to the storage market?

Dan Matte

Good question. Yes, so initially get this is Dan. When you look at what we can do and I think you are sort of alluding to WANJet distributing storage sold different places and use the WAN optimization to be able to speed the access to those resources spread around. I think certainly over the long-term, you can see things going in that direction when we come out of the gate, with the product I don’t think that will be a sort of headline that we will be waiting with.

Gabe Larry - Unterberg

Thank you.

Operator

Cameron Cooke, your line is open, please state your company name and you may ask your questions.

Cameron Cooke - Janco Partners

Janco Partners. I was wondering if you could a talk little bit about how WebAccelerator picked up after you guys put it on TMOS TrafficShield and then how that relates to WANJet and FirePass, a balanced against the release of Montreal

Dan Matte

Cameron, this is Dan. We’ve seen actually a great uptick with WebAccelerator now, it’s become a module on TMOS over the past quarter. Lost of the additional activity on it, good solid pipeline so we have seen good results from that.

Also as people are evaluating when optimization for their different applications, if it’s a web based opt, there are many scenarios we’re doing something simply at the head end, makes a common sense and doesn’t require any additional device out of the far end to have to administered and incur cost there.

In terms of balancing that against FirePass and other things, you know obviously different market segment and this things are moving in different directions at their own paces there.

Again Montreal, I think is, you had again a different pieces once it’s available then we’ll be making WebAccelerator module available on F as well. And we’ll be able to provide with extremely high capacity deployments of our technology.

Cameron Cooke - Janco Partners

All right.

Karl Triebes

Let me clarify, this is Carl. On Montreal, Montreal, supports all of our Version 9 software so if the function is available as part of Version 9, on Montreal to be no different, exciting scalability resilience turning as Montreal provides. So customers that are using WebAccelerator can then buy a Montreal and experience the scalability that Montreal gives them with WebAccelerator.

Cameron Cooke - Janco Partners

So you won’t expect there to be at lag, but when you release WANJet, FirePass and TMOS waiting for the Montreal to released? In terms of the sales growth?

Julian Eames

We don’t think so. We think Montreal, its ability 80, 100 introduction and that is right to the high end we have not seen take away was born, take effect and over the last five years so we really don’t believe that’s going to be a material issue.

Cameron Cooke - Janco Partners

Thank you.

Operator

Brent Bracelin, your line is open. Please state your company name and you may ask your question.

Brent Bracelin - Pacific Crest Securities

Two questions if I may. First of one in the internet vertical, have you guys seen any kind of go slow movement particularly with a 8800and then the new 8400. And then John if you could I know at early days Rutherford (ph) but could you kind of compare contrast the Rutherford product cycle what you’re seeing with that and what you kind of saw with Buffalo Jump kind of three years ago or so?

John McAdam

Yeah, well, first of all we definitely see an opportunity with large Internet companies. We actually had some success in last quarter and I think you will hear some more successes this quarter. So I am pretty existed about that, because they definitely need functionality and it really need performances there. The numbers are ramping up astronomically. So, 8800 I think is an ideal vehicle for that.

And what was the, I missed the second?

Brent Bracelin - Pacific Crest Securities

Yeah, just comparing the two different product cycle if you could, obviously it were so very days with are so very early days with Rutherford and we seen kind of Montreal yet, but as you kind of looking at your current kind of product cycle and product roadmap and compare contrast that with Buffalo Jump that’s been very successful, you know, enabling you to gain share, how do you look at kind of the early days of Rutherford?

John McAdam

It’s a tough question in the sense, it’s not quite apples-to- apple, in the sense that Buffalo Jump was a complete change of product line, 8800 is really the extension to the top of the range. But you are right in the sense as it’s giving its capability from a competitor point of view, I think it’s much stronger than we ever had. And I think that please over the next couple of quarters, and I think it does clear in the service providers begin to make companies.

Brent Bracelin - Pacific Crest Securities

Okay, great. And as you look it kind of Rutherford and as you look the existing kind of 1 gig, Buffalo Jump products, how long do you think the market will continue to kind of buy the 1 gig products and those kind of 10 gig kind of Redford platforms.

Dan Matte

Brent, this is Dan. I think we're still see quite a long life cycle to the 1 gig products, that entering into the 10 gig marketplace, the 8400 now the 8800. We don't really see a whole bunch of people doing the either odd choice between the 1 gig or the 10 gig platforms, so they are somewhat separate. So I don't think, there is a product replacement 0.45 going on there and the existent for the 8800 will not shorten the life cycle of the 1-gig products.

Brent Bracelin - Pacific Crest Securities

Great. My last question really has to do with SSL, you guys used to talk a lot about kind of the SSL, kind of offload functionality, I think in the past you guys kind of talked about some clusters moving to this SSL everywhere kind of environment, what is kind of SSL role as far as driving growth and then what is the interest level relative to some of customers out there on the SSL side?

Dan Matte

Brent, this is Dan again. So we continue to see a great strong interest in offloading SSL launch in the network, that continues to drive a good healthy portion of our sales and we see people have demanded ever increasing performance capabilities from us to make that happen.

Now take that data point melded with people continuing to rollout the SSL VPN and stressing that us to sale traffic out to the end point and then also we are getting questions from people saying, if within my infrastructure I have my wired, my wireless and my remote people and I like very much to be able to treat them all in the same way using the same system authenticate in the same way secure by communications in a similar fashion.

So one of the things and reasons that's strengths those three data points together that were driving toward bringing our FirePass released on top of TMOS is that we believe for people to be able to really deploy this in and SSL everywhere type of deployment they’re going to need a lot of performance to make that possible on the LAN as well as the wireless LAN and so on and so forth.

So I think that we are consistent and are continuing to execute against that vision of being able to provide people the right products to address that problem.

Brent Bracelin - Pacific Crest Securities

Okay, great. Thank you.

John Eldridge

Angie, lets take one more question and then we’ll end the call.

Operator

Thank you. Our final question comes from Ken Muth. Your line is open. Please state your company name and you may ask your question.

Ken Muth - Robert W. Baird & Co.

Hi, Robert Baird. On the international front, can you just give us any highlights of kind of what regions were good, what regions may not been so good?

John Eldridge

Yes, so Asia-Pacific you had a pretty solid quarter, Japan was up maybe not clear up as much as it normally but it was up and feel good about that. Europe was a slightly mixed we strong in most of the regions but we did see a little bit of softness in Southern Europe and some softness in Germany.

Ken Muth - Robert W. Baird & Co.

Okay, and then on the service side of vertical, could you just give us a sense of that U.S. versus international what is the breakdown of that vertical?

John Eldridge

Now -- on service only?

Ken Muth - Robert W. Baird & Co.

No, sorry service provider exact. You had great growth in the quarter.

John Eldridge

It would be fair to say, it was pretty broad.

John McAdam

Exactly.

John Eldridge

Spread that we just don’t have the breakup for.

Ken Muth - Robert W. Baird & Co.

Okay, and then last question may for, Tom. Obviously it’s a very hot deal market. Right with -- seeing a lot of hiring going across the lot of verticals. Are you seeing a lot of people trying to pick up F5 sales force? You’ve had any turnover there?

Tom Hull

Yes, now more than normal. So, I’d say we’re kind of right in there. We’re hiring and have in fairly great opportunities to hire great people in the industries. So, as we step up, we think we are keeping our best and hiring great people.

John McAdam

And the numbers we’ve been getting your member on net numbers, so they do take into the consideration. When we check of attrition, we think we’re pretty much below the industry average.

Ken Muth - Robert W. Baird & Co.

Okay. Great. Thank you very much.

John Eldridge

Okay. So, that’s about the end of the call and thanks for coming, and we’ll talk to you next quarter. Thank you.

Operator

Thank you. That concludes today’s conference. You may now disconnect from the audio portion.

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Source: F5 Networks F2Q07 (Qtr End 3/31/07) Earnings Call Transcript
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