F5 Networks, Inc. — Q3 FY2016 Form 10-Q
Reporting period: Quarter and nine months ended June 30, 2016. Financial amounts below are in U.S. dollars; income and cash flow figures are compared with the same periods in 2015. F5 develops application delivery and security products and services, including BIG-IP hardware and software, virtual editions, cloud subscriptions, and support services.
Key financial results
| Metric | Q3 FY2016 | Q3 FY2015 | Nine months FY2016 | Nine months FY2015 |
|---|---|---|---|---|
| Revenue | $496.5m | $483.6m | $1,469.7m | $1,418.5m |
| Gross profit / margin | $412.2m / 83.0% | $397.9m / 82.3% | $1,217.4m / 82.8% | $1,170.9m / 82.5% |
| Operating income / margin | $138.9m / 28.0% | $140.1m / 29.0% | $384.7m / 26.2% | $405.3m / 28.5% |
| Net income | $91.8m | $93.2m | $256.9m | $268.0m |
| Diluted EPS | $1.37 | $1.29 | $3.75 | $3.67 |
| Operating cash flow | Not separately stated | Not separately stated | $507.5m | $501.2m |
- Q3 revenue grew 2.7%; nine-month revenue grew 3.6%. Product revenue declined 7.0% in Q3 and 5.8% for the nine months, while services revenue rose 12.9% and 13.7%, respectively. Management attributed service growth primarily to a larger installed base and maintenance purchases and renewals.
- Q3 net income fell 1.5% year over year and nine-month net income fell 4.1%; diluted EPS rose in both comparisons as weighted-average diluted shares declined. Operating income fell 0.9% for the quarter and 5.1% for the nine months.
- At June 30, cash and cash equivalents were $429.6m; short- and long-term investments totaled $694.6m. Combined cash and investments were $1,124.2m, versus $1,172.0m at September 30, 2015. F5 reported no long-term debt.
- Cash from investing activities was $33.4m for the nine months; financing activities used $503.7m, primarily reflecting $550.1m of share repurchases. Cash and cash equivalents ended the period at $429.6m, up from $390.5m at fiscal year-end.
- Total deferred revenue was approximately $856.2m ($626.8m current and $229.3m long-term), up from $783.3m at September 30, 2015. Management cited growth in maintenance contracts and renewals. Q3 days sales outstanding were 48.
Material changes, outlook, and risks
- Operating expenses rose 6.0% in Q3 and 8.8% for the nine months, led by higher sales and marketing and research and development personnel costs. Research and development expense increased 11.7% for Q3 and 14.4% for the nine months.
- Gross margin improved year over year. F5 attributed better service cost ratios to support-infrastructure scalability and maintenance revenue growth.
- F5 recorded $8.9m of Radware-related litigation expense in Q2, including a $6.4m jury verdict and $2.5m of legal costs; it recorded a $0.5m credit in Q3. The jury had found willful infringement of one patent. Radware sought an injunction, additional accounting, treble damages, and fees; F5’s post-trial motion remained pending. The ultimate outcome and potential exposure were uncertain.
- Management said cash and investments plus expected operating cash generation should meet operating requirements for at least the next 12 months. It expected R&D expense to remain consistent as a percentage of revenue; the filing provides no specific revenue or earnings guidance.
- The board authorized an additional $1.0bn for the repurchase program in April. Through June 30, F5 had repurchased 5.4m shares during FY2016 at an average $101.83 per share, with $923.8m remaining authorized.
- Material risks highlighted include dependence on ADN products and channel distributors, competition and technology shifts (including cloud delivery models), product/security defects, reliance on a primary contract manufacturer and constrained component sources, unpredictable quarter-end sales timing, and international, tax, and intellectual-property risks. The filing also noted uncertainty following the U.K. referendum and the potential disruption of the CEO succession process after the board began a search for John McAdam’s replacement.
- Disclosure controls were reported effective as of June 30, 2016, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether service growth and maintenance renewals can continue to offset declining product revenue.
- Progress and final cost or remedies in the Radware litigation, including the pending post-trial motions.
- Distributor concentration: three distributors represented 47.4% of Q3 revenue; four represented 57.4% for the nine months.
- Repurchase pace, remaining authorization, and the effect of buybacks on cash, share count, and per-share results.
- Execution on cloud and subscription offerings, and any effect on revenue mix, costs, or margins.
- Potential effects of CEO succession, supply-chain concentration, and changing international market conditions.