F5 Networks, Inc. — Q2 FY2013 Form 10-Q
Business context and reporting period. F5 sells application delivery networking hardware and software, related maintenance and professional services, and other networking and storage products. This unaudited report covers the quarter and six months ended March 31, 2013; comparisons are with the corresponding 2012 periods. Amounts below are in millions of dollars except per-share data.
Financial performance and position
| Metric | Q2 FY2013 | Q2 FY2012 | Six months FY2013 | Six months FY2012 |
|---|---|---|---|---|
| Product revenue | $185.1 | $205.2 | $389.8 | $401.7 |
| Services revenue | $165.1 | $134.5 | $325.9 | $260.3 |
| Total revenue | $350.2 | $339.6 | $715.7 | $662.1 |
| Gross profit / gross margin | $289.9 / 82.8% | $282.0 / 83.0% | $594.5 / 83.1% | $548.9 / 82.9% |
| Operating income / margin | $92.5 / 26.4% | $104.7 / 30.8% | $201.6 / 28.2% | $204.5 / 30.9% |
| Net income | $63.4 | $68.6 | $132.9 | $135.1 |
| Diluted EPS | $0.80 | $0.86 | $1.68 | $1.69 |
| Operating cash flow | Not separately stated for the quarter | $225.5 | $233.5 |
Balance sheet and liquidity at March 31, 2013: Cash and cash equivalents were $229.7; short- and long-term investments were $293.2 and $662.8, respectively. Cash plus investments totaled $1,185.7, compared with $1,195.0 at September 30, 2012. Total assets were $2,065.9; current assets $804.4; current liabilities $520.7; and shareholders’ equity $1,428.2. F5 reported no long-term debt. Current and long-term deferred revenue totaled $490.7.
Cash flows for the first six months: Operating activities provided $225.5; investing activities used $120.1, including $124.9 for the LineRate acquisition; and financing activities used $85.6, primarily reflecting $100.0 of share repurchases. Cash and cash equivalents ended at $229.7.
Material changes versus the prior comparable period
- Q2 revenue increased 3.1%, but product revenue declined 9.8%; services revenue rose 22.8%, mainly from maintenance contracts on the expanding installed base. For the six-month period, revenue increased 8.1%, with products down 3.0% and services up 25.2%.
- Q2 operating income fell 11.7% and net income fell 7.6% year over year, despite higher revenue. Operating expenses rose 11.3% in the quarter, including increases in sales and marketing, research and development, and general and administrative costs. Six-month operating income declined 1.4% and net income 1.6%.
- F5 acquired LineRate Systems in February 2013 for approximately $125.3 million; $124.9 million was reported as cash paid, net of cash acquired. The allocation included $99.6 million of goodwill and $29.9 million of in-process research and development. F5 expected to complete that development project in 2014, then begin amortization over an estimated ten-year useful life.
- Goodwill increased to $447.8 million from $348.2 million at September 30, 2012, primarily reflecting LineRate. F5’s March qualitative impairment assessment concluded that impairment was not more likely than not; no impairment charge was recorded in the quarter.
Outlook, commentary, risks and unusual items
- Management said cash and investments, excluding auction rate securities, together with operating cash generation should cover operating requirements for at least the next 12 months. It identified operating income as the expected primary driver of future cash flow.
- F5 expected research and development expense to remain consistent as a percentage of revenue in the foreseeable future, and expected international sales to remain a significant part of revenue. The filing gives no specific revenue or earnings guidance.
- Key stated risks include dependence on application delivery networking products, unpredictable and quarter-end-weighted sales, competition and pricing pressure, reliance on a single contract manufacturer for ADN hardware, component availability, distributor concentration, product/security defects, and acquisition integration. Three distributors represented 40.8% of Q2 revenue and 42.0% of six-month revenue.
- F5 held $4.0 million of illiquid auction rate securities classified as Level 3; management said it did not intend or expect to be required to sell them before recovery. The filing also identifies $7.9 million of unrecognized tax benefits and $18.1 million of component inventory commitments for the next 30 days.
- On April 24, 2013, the board authorized an additional $200 million for share repurchases, after quarter-end. As of May 3, F5 reported $277.2 million remaining under its repurchase programs and 10.3 million shares repurchased and retired at an average $70.13 per share.
- Management reported effective disclosure controls as of March 31, 2013 and no material adverse effect from changes in internal control over financial reporting. F5 reported no pending legal proceeding expected to have a material adverse effect.
Important facts for investors to verify
- Whether product revenue stabilizes and service growth continues to offset weaker product sales.
- Whether rising operating expenses and lower operating margin reflect sustained investment or begin to constrain earnings growth.
- How LineRate’s technology and acquired development project progress, and whether expected strategic benefits justify acquisition costs and goodwill.
- Exposure to the three major distributors and the single contract manufacturer, including any changes in customer demand or supply continuity.
- Liquidity and valuation developments for the illiquid auction rate securities, and the use and pace of the expanded repurchase authorization.