F5 Networks, Inc. — Q2 FY2016 Form 10-Q
Business and period: F5 provides application delivery, networking and security products and related support services. This unaudited quarterly report covers the three and six months ended March 31, 2016; comparisons are with the corresponding 2015 periods. Amounts below are in millions except per-share data.
Financial performance
| Metric | Q2 FY2016 | Q2 FY2015 | Six months FY2016 | Six months FY2015 |
|---|---|---|---|---|
| Revenue | $483.7 | $472.1 | $973.2 | $934.9 |
| Product revenue | $225.4 | $244.1 | $460.1 | $485.1 |
| Services revenue | $258.2 | $228.0 | $513.0 | $449.9 |
| Gross profit / margin | $401.4 / 83.0% | $389.5 / 82.5% | $805.3 / 82.7% | $773.0 / 82.7% |
| Operating income / margin | $114.9 / 23.8% | $132.9 / 28.1% | $245.9 / 25.3% | $265.2 / 28.4% |
| Net income | $75.4 | $85.7 | $165.1 | $174.8 |
| Diluted EPS | $1.11 | $1.18 | $2.40 | $2.38 |
Cash flow: For the six months, operating cash flow was $337.0 million, investing cash flow was $48.9 million, and financing cash flow was negative $380.1 million. Capital expenditures were $29.8 million. Cash and cash equivalents ended at $398.3 million.
Liquidity and debt: Cash and short- and long-term investments totaled $1.094 billion at March 31, versus $1.172 billion at September 30, 2015. Current assets were $1.194 billion and current liabilities $800.4 million. Management reported no long-term debt. Current and long-term deferred revenue together were $842.7 million.
Material changes and management commentary
- Revenue grew 2.4% in the quarter and 4.1% for the half-year. Services revenue rose 13.2% and 14.0%, respectively, primarily from maintenance contracts associated with a larger installed base. Product revenue fell 7.7% and 5.1%, respectively, reflecting lower application delivery networking product sales.
- Quarterly operating income declined 13.5% year over year despite higher revenue. Operating expenses increased 11.6%, including $8.9 million of litigation expense; R&D expense rose 15.8%. Quarterly net income fell 12.0%, while diluted EPS declined from $1.18 to $1.11. For the six months, diluted EPS increased from $2.38 to $2.40 despite lower net income, alongside a lower weighted-average share count.
- Share repurchases used $400.1 million of cash in the first half. The company reported 66.981 million shares outstanding on April 22, 2016, compared with 70.138 million at September 30, 2015.
- Management said existing cash and investments plus operating cash generation should cover operating requirements for at least 12 months. It expected R&D expense to remain consistent as a percentage of revenue in the foreseeable future. No numerical revenue or earnings guidance is provided in the supplied filing text.
Risks, contingencies and unusual items
- Radware patent litigation: A March 2016 jury verdict found willful infringement of one patent and awarded Radware $6.4 million. F5 accrued $8.9 million in total, including $2.5 million for legal fees and other costs. A hearing on F5’s motion challenging the willfulness finding was scheduled for May 13, 2016; Radware might seek enhanced damages and attorneys’ fees. Related counterclaims and a separate F5 patent complaint remained pending.
- Sales and channel concentration: Three distributors accounted for 46.5% of quarterly revenue; four accounted for 57.7% for the half-year. Westcon and Ingram Micro represented 18.8% and 12.6% of receivables, respectively.
- Business risks: The filing highlights competition and changing cloud/subscription models, dependence on ADN products, product development and security risks, reliance on a single primary hardware assembler and constrained component sources, international and foreign-exchange exposure, and quarter-end sales variability.
- Leadership transition: John McAdam became CEO in December 2015 following Manual Rivelo’s resignation and was serving until a successor could be found.
- Subsequent event: On April 20, 2016, the board authorized an additional $1.0 billion for repurchases. As of April 22, the filing reported $1.1 billion remaining under the program and 26,976,896 shares repurchased and retired at an average $91.79 per share.
- Management reported effective disclosure controls as of March 31, 2016, with no material change in internal control over financial reporting during the quarter.
Key facts for investors to verify
- Whether service growth can offset continuing product-revenue declines, and how revenue mix affects margins.
- The outcome and potential additional exposure from the Radware litigation, including the willfulness motion and any post-trial claims.
- The durability of operating cash generation after substantial repurchases and the pace of future buybacks.
- Distributor concentration, especially the impact of any disruption at major channel partners.
- Execution of the CEO succession and cloud/subscription strategy, including any margin effects.