F5, Inc. — Q1 FY2016 Form 10-Q
Reporting period: Three months ended December 31, 2015. F5 develops and sells application-delivery, networking and security products, software and cloud subscriptions, and related services. Comparisons below are with the three months ended December 31, 2014 unless otherwise noted.
Financial performance and liquidity
| Metric | Q1 FY2016 | Prior-year quarter | Change / context |
|---|---|---|---|
| Net revenue | $489.5 million | $462.8 million | +5.8% |
| Product revenue | $234.7 million | $240.9 million | -2.6% |
| Services revenue | $254.8 million | $221.9 million | +14.9%; growth primarily from maintenance contracts and renewals |
| Gross profit / margin | $403.8 million / 82.5% | $383.4 million / 82.9% | Margin down 0.4 percentage points |
| Operating income / margin | $130.9 million / 26.8% | $132.3 million / 28.6% | Income down 1.0%; margin compressed |
| Net income | $89.7 million | $89.1 million | +0.7% |
| Diluted EPS | $1.28 | $1.21 | Up 5.8%; weighted-average diluted shares fell to 69.9 million from 73.9 million |
| Operating cash flow | $203.9 million | $186.4 million | Higher year over year |
| Cash and investments | $1.175 billion | $1.172 billion at September 30, 2015 | Includes cash, short-term and long-term investments |
At December 31, 2015, current assets were $1.208 billion and current liabilities were $802.6 million. F5 reported no long-term debt. Deferred revenue totaled $837.5 million, including $619.6 million current, and increased from September 30, 2015, primarily reflecting maintenance contracts and renewals. Days sales outstanding was 51. The company generated $19.5 million from investing activities and used $180.4 million in financing activities; capital expenditures were $13.3 million.
Material changes and management commentary
- Service revenue growth more than offset declining product revenue. ADN products accounted for 98.6% of product revenue and approximately 47.3% of total revenue in the quarter.
- Operating expenses increased 8.7% to $272.9 million, faster than revenue growth. Research and development expense rose 15.8%, primarily due to personnel costs; management expected R&D expense to remain consistent as a percentage of revenue in the foreseeable future.
- Cash generated from operations was largely offset by $200.0 million of share repurchases. F5 said cash and investments, together with operating cash generation, should be sufficient for operating requirements for at least the next 12 months.
- F5 had repurchased and retired 24.9 million shares under its current program at an average $91.55 per share; $273.8 million of authorization remained as of January 22, 2016.
- CEO John McAdam became interim CEO effective December 13, 2015, following Manual Rivelo’s resignation, while the company searches for a successor.
Outlook, risks and contingencies
- The filing provides no specific revenue or earnings guidance. Management highlighted ongoing uncertainty from changing IT spending, cloud adoption, evolving subscription models and competitive conditions. Cloud-service development and infrastructure investment could pressure historical operating margins.
- Four distributors each contributed more than 10% of quarterly revenue and together represented approximately 59.2%, creating channel concentration risk. International revenue was 51.1% of total revenue.
- A patent-infringement case brought by Radware was scheduled for trial on February 22, 2016. F5 acknowledged infringement of certain asserted claims before a January 2016 redesign for purposes of trial; the company had no recorded accrual for legal loss contingencies and said the ultimate outcome and potential exposure could not be determined.
- Other key risks include reliance on a single primary hardware contract manufacturer, component availability, product defects or security vulnerabilities, sales timing and quarter-end shipments, competition, international and foreign-exchange exposure, and tax uncertainty.
- F5 reported $10.8 million of unrecognized tax benefits and ongoing state tax audits. The effective tax rate was 32.1%, down from 34.0%, primarily due to the permanent extension of the federal research credit.
- Management reported effective disclosure controls as of December 31, 2015, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether service and maintenance growth can continue to offset declining product revenue, and how product mix affects margins.
- Whether operating expense growth and stock-based compensation—$38.2 million for the quarter—affect future operating leverage and per-share results.
- Progress and financial impact of the CEO succession process and cloud-service strategy.
- Developments and potential exposure in the Radware litigation, including the effects of the product redesign.
- Distributor concentration, the single-source manufacturing arrangement, and the remaining share-repurchase authorization.