F5 Networks, Inc. — Q1 Fiscal 2018 Form 10-Q
Reporting period: Three months ended December 31, 2017; comparative period is the three months ended December 31, 2016. F5 provides application delivery, security, and related services through hardware, software, and cloud-based offerings.
Financial results
| Metric | Q1 FY2018 | Q1 FY2017 | Change |
|---|---|---|---|
| Revenue | $523.2 million | $516.0 million | Up 1.4% |
| Product revenue | $227.3 million | $239.5 million | Down 5.1% |
| Services revenue | $295.9 million | $276.5 million | Up 7.0% |
| Gross profit / gross margin | $435.8 million / 83.3% | $430.7 million / 83.5% | Margin down 0.2 percentage points |
| Operating income / margin | $142.0 million / 27.1% | $137.5 million / 26.7% | Income up 3.3% |
| Net income | $88.4 million | $94.2 million | Down 6.1% |
| Diluted EPS | $1.41 | $1.44 | Down 2.1% |
| Operating cash flow | $190.0 million | $189.3 million | Nearly flat |
- Services represented 56.6% of revenue, versus 53.6% a year earlier. Management attributed the increase to maintenance purchases and renewals associated with a larger installed base. Product revenue fell primarily because ADN product sales declined by $11.0 million.
- Cash, cash equivalents, and short- and long-term investments totaled $1.353 billion at quarter-end, up from $1.302 billion at September 30, 2017. Cash and cash equivalents alone were $612.0 million. The company reported no long-term debt.
- Cash flow from investing was negative $121.1 million, primarily reflecting net investment purchases and $6.5 million of capital expenditures. Financing cash flow was negative $130.1 million, including $150.0 million of share repurchases, partly offset by $19.9 million from employee stock plans.
- Current liabilities were $945.3 million, including $722.0 million of current deferred revenue. Deferred revenue increased from September 30, which management attributed to growth in maintenance contracts. Days sales outstanding was 50.
Material changes, outlook, and risks
- Profit declined despite higher revenue and operating income, primarily reflecting the rise in the effective tax rate to 38.7% from 32.7%. The rate included Tax Cuts and Jobs Act impacts: a $7.0 million provisional deemed-repatriation tax expense and an $11.6 million expense from remeasuring deferred tax assets. The company said the repatriation calculation was provisional and expected to be finalized by fiscal year-end 2018. The federal rate for fiscal 2018 was stated as 24.5%, declining to 21% in fiscal 2019.
- Higher product costs reflected global memory shortages and investment in subscription-based services. Overall gross margin was 83.3%, versus 83.5% a year earlier; service cost efficiency improved, with service cost of revenue declining to 14.9% of service revenue from 15.8%.
- F5 said existing cash and investments, together with operating cash generation, should be sufficient for operating requirements for at least the next 12 months. It provided no specific revenue or earnings guidance in the supplied filing text. Management expected R&D expense to remain consistent as a percentage of revenue in the foreseeable future.
- The board authorized an additional $1.0 billion for repurchases in October 2017. F5 repurchased 1.24 million shares at an average $120.73 per share during the quarter; approximately $1.024 billion remained available at December 31.
- Distributor concentration is notable: four distributors each accounted for at least 10% of quarterly revenue, led by Ingram Micro at 15.3%. F5 also identified reliance on key personnel as a risk; CEO François Locoh-Donou had taken office in April 2017, and CFO Andy Reinland had announced plans to retire during Q3 FY2018.
- F5 disclosed ongoing patent litigation with Radware, including its own infringement claims and a Radware counterclaim. No loss contingency accrual was recorded; management said the outcome and potential exposure could not be determined. The company also cited possible litigation costs and exposure to tax audits and adjustments.
- Other risks include interest-rate effects on the investment portfolio, operating lease and supplier commitments, and potential disruption from hiring or retaining qualified staff. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
- F5 planned to adopt the new revenue standard in Q1 FY2019 using the modified retrospective method. It expected contract-acquisition costs, primarily commissions, to be deferred and amortized, and some term-license revenue to be recognized upfront; it did not expect a material income-statement impact but was still assessing balance-sheet and disclosure effects. Lease-standard adoption and its financial-statement impact were also under assessment.
Important facts for investors to verify
- Whether service growth can offset continued weakness in product and ADN sales, and how distributor concentration affects reported revenue.
- How memory shortages and subscription-service investment affect product costs and margins.
- The final tax accounting under the Tax Cuts and Jobs Act, including the provisional repatriation charge and deferred-tax remeasurement.
- Future repurchase pace, remaining authorization, and the effect of buybacks on cash and share count.
- Developments in the Radware litigation and any changes to potential legal or tax exposures.
- The eventual balance-sheet and disclosure effects of adopting the revenue and lease accounting standards.