F5 Networks, Inc. — Q1 FY2020 Form 10-Q
Reporting period: Three months ended December 31, 2019; comparisons are with the three months ended December 31, 2018 unless noted. Amounts are in U.S. dollars.
Business context and financial performance
F5 provides multi-cloud application services, including hardware, software, subscription offerings, and related services. It reports one operating segment and sells primarily through indirect channels.
| Metric | Q1 FY2020 | Q1 FY2019 | Change / context |
|---|---|---|---|
| Revenue | $569.3 million | $543.8 million | Up 4.7% |
| Product revenue | $234.5 million | $233.9 million | Up 0.3% |
| Services revenue | $334.8 million | $309.9 million | Up 8.0% |
| Gross profit / gross margin | $480.7 million / 84.4% | $457.1 million / 84.1% | Margin up 0.3 percentage points |
| Operating expenses | $358.3 million | $298.8 million | Up 19.9%; includes $7.8 million restructuring charge |
| Operating income / margin | $122.3 million / 21.5% | $158.2 million / 29.1% | Income down 22.7% |
| Net income | $98.5 million | $130.9 million | Down 24.7% |
| Diluted EPS | $1.62 | $2.16 | Down 25.0% |
| Effective tax rate | 22.8% | 20.8% | Increase attributed primarily to stock-based compensation tax effects |
Cash flow, liquidity, and debt
- Operating cash flow was $144.0 million, compared with $197.9 million a year earlier. Investing activities used $29.4 million; financing activities provided $21.0 million. No shares were repurchased during the quarter.
- Cash and cash equivalents were $735.5 million at December 31, 2019. Cash, short-term investments, and long-term investments totaled $1.474 billion, up from $1.331 billion at September 30, 2019.
- Current assets were $1.737 billion and current liabilities were $1.151 billion. Deferred revenue totaled $1.238 billion, including current and long-term balances; it increased primarily with maintenance contracts and renewals.
- The balance sheet reported no borrowings at December 31. After quarter-end, F5 borrowed $400 million under a three-year term loan to help fund the Shape Security acquisition; it also established a $350 million revolving facility, with no borrowings outstanding as of February 5, 2020. Both facilities include leverage-ratio covenants.
- Management said existing cash and investments, together with operating cash generation, should be sufficient for operating requirements for at least the next 12 months, based on current forecasts.
Material changes and notable items
- Revenue growth came mainly from software, subscription products, and services; product revenue was nearly unchanged. International revenue represented 51.6% of total revenue versus 51.3% a year earlier.
- Operating expenses rose faster than revenue. Sales and marketing increased 19.0%, and general and administrative increased 38.7%; management cited higher personnel, facilities, and outside professional-services costs. Headcount increased across sales and marketing, R&D, and G&A.
- F5 recorded $7.8 million of restructuring expense for a reduction in force affecting approximately 75 employees. It said no significant additional charges were expected.
- F5 adopted the lease accounting standard on October 1, 2019, recognizing operating lease right-of-use assets and liabilities. At quarter-end, operating lease liabilities totaled $384.8 million; the principal facility lease is for its Seattle headquarters and runs through 2033.
- Shape Security, a fraud- and abuse-prevention company, was acquired on January 24, 2020 for approximately $1.0 billion in cash, subject to adjustments. The initial purchase accounting and pro forma combined results were not available in this filing. F5 also reported approximately $4.0 million of Shape acquisition and integration expenses in the quarter.
- F5’s 2019 acquisition of NGINX was completed before this period; its results are included from the acquisition date. The filing describes integration work and $509.4 million of goodwill recorded in the purchase-price allocation.
Outlook, risks, and contingencies
- The filing provides no specific revenue, earnings, or margin guidance. Management identified operating income as a key source of future cash flow and said it would continue to consider strategic acquisitions and investments.
- Remaining non-cancelable performance obligations were approximately $1.2 billion; F5 expected to recognize about 68.5% within 12 months. This is a contracted-obligations measure, not revenue guidance.
- Risks discussed include sensitivity of fixed-income investment values and interest income to interest rates, execution of acquisitions and integration, and operating cost and margin pressures. Three distributors each accounted for more than 10% of quarterly revenue; distributor concentration also appears in receivables.
- F5 reported no pending legal proceeding it believed was reasonably likely to have a material adverse effect, while noting ordinary-course claims and inherent uncertainty. It had $44.1 million of unrecognized tax benefits and was subject to tax audits; management did not expect near-term changes to be material.
- Management reported disclosure controls and procedures were effective as of December 31, 2019. It reported no material changes to risk factors from its prior annual report.
Important facts for investors to verify
- Shape’s final purchase-price allocation, acquired assets and liabilities, goodwill, and pro forma results in subsequent filings.
- Post-acquisition cash, debt, interest expense, leverage, and compliance with the term-loan and revolver covenants.
- Whether revenue and recurring maintenance/subscription growth can offset the higher operating expense base and restore operating margins.
- Cash conversion and deferred-revenue trends, including the timing of collections and recognition of remaining performance obligations.
- Lease commitments and any effects of the headquarters move, subleases, and future facility costs.