F5 Networks, Inc. — Q1 FY2013 Form 10-Q
Reporting period: Three months ended December 31, 2012; comparisons are with the three months ended December 31, 2011 unless stated otherwise. Financial amounts below are in U.S. dollars, generally millions.
Business context
F5 sells application delivery networking hardware and software, related services, and file virtualization products. It also offers Diameter signaling products acquired with Traffix Systems in 2012. Sales are made primarily through indirect channels. Application delivery networking products accounted for 98.8% of product revenue in the quarter.
Financial performance
| Metric | Q1 FY2013 | Prior period | Change / context |
|---|---|---|---|
| Revenue | $365.5 | $322.4 | Up 13.3% |
| Product revenue | $204.7 | $196.6 | Up 4.2% |
| Service revenue | $160.7 | $125.9 | Up 27.7%; maintenance sales and renewals drove growth |
| Gross profit / margin | $304.6 / 83.3% | $266.8 / 82.8% | Margin up 0.5 percentage points |
| Operating income / margin | $109.1 / 29.9% | $99.8 / 30.9% | Income up 9.3%; margin down 1.0 point |
| Net income / margin | $69.5 / 19.0% | $66.5 / 20.6% | Income up 4.5%; margin down 1.6 points |
| Diluted EPS | $0.88 | $0.83 | Up from prior period |
| Operating cash flow | $144.8 | $131.9 | Higher year over year |
Operating expenses rose 17.0% to $195.5 million, faster than revenue. Sales and marketing expense increased 15.1%, research and development 24.1%, and general and administrative 13.8%; increased headcount and personnel costs were major drivers. The effective tax rate rose to 37.2% from 34.6%, primarily due to expiration of the federal research credit at year-end 2011 and nondeductible stock compensation attributable to foreign employees.
Liquidity, balance sheet and capital allocation
- Cash, cash equivalents and short- and long-term investments totaled $1.289 billion at December 31, 2012, versus $1.195 billion at September 30, 2012. The company reported no long-term debt.
- Current assets were $791.8 million and current liabilities $529.6 million. Deferred revenue totaled $480.6 million, including $379.9 million current.
- Cash and cash equivalents declined to $184.6 million from $211.2 million at fiscal year-end; operating cash flow was offset by investment purchases, share repurchases and capital spending. Investing activities used $133.4 million; financing activities used $37.9 million.
- The company repurchased $50.0 million of shares during the quarter. As of February 1, 2013, $128.5 million remained authorized, and cumulative repurchases under the programs were 9.76 million shares at an average $68.73 per share.
- Capital expenditures were $7.8 million. The company was committed to approximately $16.6 million of contract-manufacturer component inventory purchases over the next 30 days.
Changes, outlook, risks and unusual items
- Service revenue grew substantially faster than product revenue, increasing its share of total revenue to 44.0% from 39.0%. International revenue was 46.7% of total revenue, versus 47.0% a year earlier.
- Management said existing cash and investments, excluding auction rate securities (ARS), together with expected operating cash flows should fund requirements for at least the next 12 months. It expects research and development expense to remain consistent as a percentage of revenue. The filing provides no specific revenue or earnings guidance.
- On January 2, 2013, legislation retroactively extended the federal research activities tax credit through 2013. F5 said it would account for the credit’s tax effects in fiscal Q2 2013.
- ARS had a fair value of $4.6 million and remained illiquid following auction-market failures; management said it did not intend to sell and did not expect to be required to sell them before recovery. The company reported no material impairment charges.
- Three distributors represented 16.9%, 15.2% and 11.0% of quarterly revenue, respectively—43.1% combined—creating channel concentration exposure. Key risks also include competition, dependence on ADN products, unpredictable sales timing and quarter-end shipments, reliance on a single primary hardware assembler, component supply constraints, product/security defects, international operations and tax uncertainty.
- No pending legal proceeding was identified as likely to have a material adverse effect. The filing describes potential ordinary-course litigation, including intellectual-property claims. Disclosure controls were assessed as effective, with no material change in internal control over financial reporting.
Most important facts for investors to verify
- Whether service growth and maintenance renewals continue, and whether product revenue growth accelerates or remains modest.
- Whether operating expense growth, particularly R&D and sales staffing, can be absorbed without further pressure on operating and net margins.
- The effect and timing of the reinstated research tax credit on the effective tax rate and reported earnings.
- Distributor concentration and the company’s ability to maintain supply from its primary contract manufacturer and key component sources.
- Liquidity and valuation developments for the illiquid ARS, alongside ongoing share repurchases and cash deployment.