F5 Networks, Inc. — Q1 FY2017 10-Q
Reporting period: Three months ended December 31, 2016; comparisons are with the three months ended December 31, 2015. F5 provides application delivery, security, and related services through hardware, software, and cloud subscriptions.
Financial performance
| Metric | Q1 FY2017 | Prior-year quarter | Change |
|---|---|---|---|
| Revenue | $516.0 million | $489.5 million | +5.4% |
| Product revenue | $239.5 million | $234.7 million | +2.0% |
| Services revenue | $276.5 million | $254.8 million | +8.5% |
| Gross profit / margin | $430.7 million / 83.5% | $403.8 million / 82.5% | Margin +1.0 percentage point |
| Operating income / margin | $137.5 million / 26.7% | $130.9 million / 26.8% | Income +5.0% |
| Net income | $94.2 million | $89.7 million | +5.0% |
| Diluted EPS | $1.44 | $1.28 | +12.5% |
| Operating cash flow | $189.3 million | $203.9 million | Down $14.6 million |
Product and services gross margins were 82.6% and 84.2%, respectively, based on the reported revenue and cost figures. Cost of services fell as a share of services revenue, which management attributed to support-infrastructure scalability and maintenance-contract growth. Net income per diluted share rose faster than net income as weighted-average diluted shares declined to 65.6 million from 69.9 million, reflecting share repurchases.
Liquidity, debt, and capital allocation
- Cash, cash equivalents, and short- and long-term investments totaled $1.197 billion at December 31, 2016, up $38.1 million from September 30, 2016. Cash and cash equivalents were $572.9 million.
- Management reported no long-term debt and said cash and investments plus expected operating cash flows should cover operating requirements for at least the next 12 months.
- Operating cash flow was $189.3 million; capital expenditures were $14.1 million. Cash used in financing was $128.2 million, principally due to $150.0 million of share repurchases, partly offset by $18.8 million from employee stock plans.
- F5 repurchased and retired 1,055,640 shares during the quarter at an average $142.11 per share. Repurchase authorization remaining at quarter-end was $623.7 million.
- Current deferred revenue was $669.9 million, with another $244.3 million classified as long-term. Management linked the increase in deferred revenue to maintenance contracts on new products and renewals.
Material changes and management commentary
- Revenue growth was driven mainly by services, reflecting a larger installed base and maintenance-contract purchases and renewals. Product revenue growth was modest; management cited a $6.8 million increase in application delivery networking product sales.
- Operating expenses increased 7.5% to $293.2 million, faster than revenue. General and administrative expense rose 21.7%, primarily due to personnel costs; research and development rose 7.3% and sales and marketing rose 4.5%.
- Stock-based compensation expense increased to $46.6 million from $38.2 million; $230.2 million of unrecognized compensation cost remained, mostly expected to be recognized over the next two years.
- Four distributors each represented at least 10% of quarterly revenue: Westcon 18.8%, Ingram Micro 16.0%, Avnet 12.3%, and Arrow ECS 10.1%. International sales were 50.3% of revenue.
Outlook, risks, and contingencies
- No specific revenue or earnings guidance was provided. Management expected research and development expense to remain consistent as a percentage of revenue and stated that liquidity was sufficient for at least the next 12 months.
- F5 disclosed a pending CEO transition: John McAdam was expected to retire on April 3, 2017, with a successor selected. The filing warns that management changes could disrupt operations.
- In the Radware patent litigation, a 2016 judgment awarded Radware approximately $6.9 million, including prejudgment interest, and included an injunction. F5 and Radware appealed different aspects of the case; Radware’s $192,000 cost request remained pending. F5 had accrued $7.0 million in fiscal 2016 and said other litigation outcomes and potential losses could not be determined.
- Other disclosed exposures include operating leases through 2025, component-purchase obligations tied to rolling forecasts, tax audits and uncertain tax positions, and interest-rate and credit risks in the investment portfolio. The filing reported $16.0 million of unrecognized tax benefits.
- Management identified competition for qualified personnel and retention of key employees as risks, including potential effects from the CEO transition and the company’s ability to grant equity compensation.
Important facts for investors to verify
- Whether service-led growth and maintenance renewals can continue, and whether product growth improves.
- How operating expenses, particularly general and administrative costs and stock-based compensation, affect margins and earnings.
- Distributor concentration and the effect of any channel or international-sales changes on revenue and receivables.
- Developments in the Radware litigation, including appeals, the injunction, and the pending costs request.
- Execution of the CEO transition and F5’s ability to retain and recruit key personnel.
- Share-repurchase pace and remaining authorization relative to cash generation and investment needs.