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FFIV > SEC Filings for FFIV > Form 10-Q on 6-Feb-2014All Recent SEC Filings

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Form 10-Q for F5 NETWORKS INC


6-Feb-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial condition and results of operations contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 and Section 27A of the Securities Act of 1933. These statements include, but are not limited to, statements about our plans, objectives, expectations, strategies, intentions or other characterizations of future events or circumstances and are generally identified by the words "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates," and similar expressions. These forward-looking statements are based on current information and expectations and are subject to a number of risks and uncertainties. Our actual results could differ materially from those expressed or implied by these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed under "Item 1A. Risk Factors" herein and in other documents we file from time to time with the Securities and Exchange Commission. We assume no obligation to revise or update any such forward-looking statements. Overview
We are a global provider of software and hardware solutions and services within an intelligent services framework that help companies efficiently and securely manage the delivery, optimization and security of application and data traffic on networks, and to optimize the performance and utilization of data storage infrastructure and other network resources for their customers, partners, and employees. We market and sell our products primarily through multiple indirect sales channels in the Americas (primarily the United States); Europe, the Middle East, and Africa (EMEA); Japan; and the Asia Pacific region (APAC). Enterprise customers (Fortune 1000 or Business Week Global 1000 companies) in the technology, telecommunications, financial services, transportation, education, manufacturing and health care industries, along with government customers, continue to make up the largest percentage of our customer base.


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Our management team monitors and analyzes a number of key performance indicators in order to manage our business and evaluate our financial and operating performance on a consolidated basis. Those indicators include:
Revenues. The majority of our revenues are derived from sales of our application delivery networking (ADN) products including our high end VIPRION chassis and related software modules; BIG-IP Local Traffic Manager, BIG-IP Global Traffic Manager, BIG-IP Link Controller, BIG-IP Application Security Manager, BIG-IP Edge Gateway, BIG-IP WAN Optimization module, BIG-IP Access Policy Manager, WebAccelerator; FirePass SSL VPN appliance; diameter routing agents and signaling delivery controller products; and ARX file virtualization products. We also derive revenues from the sales of services including annual maintenance contracts, training and consulting services. We carefully monitor the sales mix of our revenues within each reporting period. We believe customer acceptance rates of our new products and feature enhancements are indicators of future trends. We also consider overall revenue concentration by customer and by geographic region as additional indicators of current and future trends.

Cost of revenues and gross margins. We strive to control our cost of revenues and thereby maintain our gross margins. Significant items impacting cost of revenues are hardware costs paid to our contract manufacturers, third-party software license fees, amortization of developed technology and personnel and overhead expenses. Our margins have remained relatively stable; however, factors such as sales price, product mix, inventory obsolescence, returns, component price increases and warranty costs could significantly impact our gross margins from quarter to quarter and represent significant indicators we monitor on a regular basis.

Operating expenses. Operating expenses are substantially driven by personnel and related overhead expenses. Existing headcount and future hiring plans are the predominant factors in analyzing and forecasting future operating expense trends. Other significant operating expenses that we monitor include marketing and promotions, travel, professional fees, computer costs related to the development of new products, facilities and depreciation expenses.

Liquidity and cash flows. Our financial condition remains strong with significant cash and investments and no long term debt. The decrease in cash and investments for the first three months of fiscal year 2014 was primarily due to $200.0 million of cash used to repurchase outstanding common stock under our stock repurchase program, partially offset by cash provided by operating activities of $158.9 million. Going forward, we believe the primary driver of cash flows will be net income from operations. Capital expenditures of $5.0 million for the first three months of fiscal year 2014 were comprised primarily of information technology infrastructure and equipment purchases to support the growth of our core business activities. We will continue to evaluate possible acquisitions of, or investments in businesses, products, or technologies that we believe are strategic, which may require the use of cash.

Balance sheet. We view cash, short-term and long-term investments, deferred revenue, accounts receivable balances and days sales outstanding as important indicators of our financial health. Deferred revenues increased in the first quarter of fiscal year 2014 due to growth in the amount of annual maintenance contracts purchased on new products and maintenance renewal contracts related to our existing product installation base. Our days sales outstanding for the first quarter of fiscal year 2014 was 49.

Summary of Critical Accounting Policies and Estimates The preparation of our financial condition and results of operations requires us to make judgments and estimates that may have a significant impact upon our financial results. We believe that, of our significant accounting policies, the following require estimates and assumptions that require complex, subjective judgments by management, which can materially impact reported results: revenue recognition; reserve for doubtful accounts; reserve for product returns; accounting for income taxes; stock-based compensation; goodwill and intangible assets; and investments. None of these accounting policies and estimates have significantly changed since our annual report on Form 10-K for the year ended September 30, 2013 (Form 10-K). Critical accounting policies and estimates are more fully described in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Form 10-K. Actual results may differ from these estimates under different assumptions or conditions. Results of Operations
The following discussion and analysis should be read in conjunction with our consolidated financial statements, related notes and risk factors included elsewhere in this Quarterly Report on Form 10-Q.


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                                        Three months ended
                                           December 31,
                                    2013                   2012
                                (in thousands, except percentages)
Net Revenues
Products                     $        218,601       $        204,712
Services                              187,851                160,739
Total                        $        406,452       $        365,451
Percentage of net revenues
Products                                 53.8 %                 56.0 %
Services                                 46.2                   44.0
Total                                   100.0 %                100.0 %

Net revenues. Total net revenues increased 11.2% for the three months ended December 31, 2013, from the same period in the prior year. Overall revenue growth for the three months ended December 31, 2013 was primarily due to increased service and product revenues as a result of our increased installed base of products and increased demand for our core ADN products. International revenues represented 49.4% of total net revenues for the three months ended December 31, 2013, compared to 46.7% for the same period in the prior year. We expect international sales will continue to represent a significant portion of net revenues, although we cannot provide assurance that international revenues as a percentage of net revenues will remain at current levels.
Net product revenues increased 6.8% for the three months ended December 31, 2013, from the same period in the prior year. The increase in net product revenues for the three months ended December 31, 2013 was due to an increase of $16.0 million in sales of our ADN products from the same period in the prior year. Sales of our ADN products represented 99.8% of product revenues for the three months ended December 31, 2013, compared to 98.8% of product revenues for the three months ended December 31, 2012.
Net service revenues increased 16.9% for the three months ended December 31, 2013, from the same period in the prior year. The increase in net service revenues was primarily due to increases in the purchase or renewal of maintenance contracts driven by additions to our installed base of products. Avnet Technology Solutions, Ingram Micro, and Westcon, three of our worldwide distributors, accounted for 14.3%, 17.9%, and 13.5% of our total net revenue for the three months ended December 31, 2013, respectively. Avnet Technology Solutions, Ingram Micro, and Westcon accounted for 16.9%, 15.2%, and 11.0% of our total net revenue for the three months ended December 31, 2012, respectively. Ingram Micro, Westcon, and Arrow ECS, another worldwide distributor, accounted for 11.0%, 16.1%, and 12.0% of our accounts receivable as of December 31, 2013, respectively. Avnet Technology Solutions and Ingram Micro accounted for 11.2% and 10.3% of our accounts receivable as of December 31, 2012, respectively. No other distributors accounted for more than 10% of total net revenue or receivables.

                                                                        Three months ended
                                                                           December 31,
                                                                    2013                   2012
                                                                (in thousands, except percentages)
Cost of net revenues and Gross Margin
Products                                                     $         37,244       $         31,792
Services                                                               35,639                 29,093
Total                                                                  72,883                 60,885
Gross profit                                                 $        333,569       $        304,566
Percentage of net revenues and Gross Margin (as a
percentage of related net revenue)
Products                                                                 17.0 %                 15.5 %
Services                                                                 19.0                   18.1
Total                                                                    17.9                   16.7
Gross profit                                                             82.1 %                 83.3 %

Cost of net product revenues. Cost of net product revenues consist of finished products purchased from our contract manufacturers, manufacturing overhead, freight, warranty, provisions for excess and obsolete inventory and amortization expenses in connection with developed technology from acquisitions. Cost of net product revenues increased 17.1% for the


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three months ended December 31, 2013, as compared to the same period in the prior year. The increase in cost of net product revenues is primarily due to a higher volume of units shipped.
Cost of net service revenues. Cost of net service revenues consist of the salaries and related benefits of our professional services staff, travel, facilities and depreciation expenses. For the three months ended December 31, 2013, cost of net service revenues as a percentage of net service revenues was 19.0%, compared to 18.1% for the three months ended December 31, 2012. Professional services headcount at the end of December 2013 increased to 824 from 701 at the end of December 2012. In addition, cost of net service revenues included stock-based compensation expense of $3.4 million for the three months ended December 31, 2013, compared to $2.6 million for the same period in the prior year.

                                                                        Three months ended
                                                                           December 31,
                                                                    2013                   2012
                                                                (in thousands, except percentages)
Operating expenses
Sales and marketing                                          $        134,803       $        122,268
Research and development                                               64,133                 48,541
General and administrative                                             25,500                 24,673
Total                                                        $        224,436       $        195,482
Operating expenses (as a percentage of net revenue)
Sales and marketing                                                      33.1 %                 33.5 %
Research and development                                                 15.8                   13.3
General and administrative                                                6.3                    6.7
Total                                                                    55.2 %                 53.5 %

Sales and marketing. Sales and marketing expenses consist of salaries, commissions and related benefits of our sales and marketing staff, the costs of our marketing programs, including public relations, advertising and trade shows, travel, facilities, and depreciation expenses. Sales and marketing expenses increased 10.3% for the three months ended December 31, 2013, from the comparable period in the prior year. The increase in sales and marketing expense was primarily due to an increase of $5.9 million in commissions and personnel costs for the three months ended December 31, 2013, from the comparable period in the prior year. The increased commissions and personnel costs were driven primarily by growth in sales and marketing employee headcount for the corresponding period. Sales and marketing headcount at the end of December 2013 increased to 1,365 from 1,296 at the end of December 2012. Sales and marketing expense included stock-based compensation expense of $14.0 million for the three months ended December 31, 2013, compared to $10.6 million for the same period in the prior year.
Research and development. Research and development expenses consist of the salaries and related benefits of our product development personnel, prototype materials and other expenses related to the development of new and improved products, facilities and depreciation expenses. Research and development expenses increased 32.1% for the three months ended December 31, 2013, from the comparable period in the prior year. The increase in research and development expense was primarily due to an increase of $7.2 million in personnel costs for the three months ended December 31, 2013, from the comparable period in the prior year. Research and development headcount at the end of December 2013 increased to 968 from 802 at the end of December 2012. Research and development expense included stock-based compensation expense of $11.6 million for the three months ended December 31, 2013, compared to $7.8 million for the same period in the prior year. We expect research and development expenses to remain consistent as a percentage of net revenue in the foreseeable future.
General and administrative. General and administrative expenses consist of the salaries, benefits and related costs of our executive, finance, information technology, human resource and legal personnel, third-party professional service fees, bad debt charges, facilities and depreciation expenses. General and administrative expenses increased 3.4% for the three months ended December 31, 2013, from the comparable period in the prior year. The increase in general and administrative expense was primarily due to an increase of $0.8 million in personnel costs for the three months ended December 31, 2013, from the comparable period in the prior year. Stock-based compensation expense was $5.0 million for the three months ended December 31, 2013, compared to $5.4 million for the same period in the prior year. The decrease in stock-based compensation expense from the prior year is primarily due to the departure of certain executive officers and the cancellation of their stock-based awards. General and administrative headcount at the end of December 2013 increased to 363 from 328 at the end of December 2012.


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                                                                          Three months ended
                                                                             December 31,
                                                                      2013                   2012
                                                                  (in thousands, except percentages)
Other income and income taxes
Income from operations                                         $        109,133       $        109,084
Other income, net                                                           246                  1,550
Income before income taxes                                              109,379                110,634
Provision for income taxes                                               41,331                 41,141
Net income                                                     $         68,048       $         69,493
Other income and income taxes (as percentage of net revenue)
Income from operations                                                     26.8 %                 29.9 %
Other income, net                                                           0.1                    0.4
Income before income taxes                                                 26.9                   30.3
Provision for income taxes                                                 10.2                   11.3
Net income                                                                 16.7 %                 19.0 %

Other income, net. Other income, net consists primarily of interest income and foreign currency transaction gains and losses. The decrease in other income, net for the three months ended December 31, 2013, from the comparable period in the prior year was primarily due to a $1.0 million charge for a legal settlement. Provision for income taxes. The effective tax rate was 37.8% and 37.2% for the three months ended December 31, 2013 and 2012, respectively. The increase in the effective tax rate is primarily due to state income taxes and non-deductible stock-based compensation expense.
We record a valuation allowance to reduce our deferred tax assets to the amount we believe is more likely than not to be realized. In making these determinations we consider historical and projected taxable income, and ongoing prudent and feasible tax planning strategies in assessing the appropriateness of a valuation allowance. Our net deferred tax assets at December 31, 2013 and December 31, 2012 were $41.2 million and $46.6 million, respectively. The net deferred tax assets include valuation allowances of $9.6 million and $0.4 million as of December 31, 2013 and December 31, 2012, respectively, which are primarily related to tax net operating losses incurred in certain foreign jurisdictions.
Our worldwide effective tax rate may fluctuate based on a number of factors, including variations in projected taxable income in the various geographic locations in which we operate, changes in the valuation of our net deferred tax assets, resolution of potential exposures, tax positions taken on tax returns filed in the various geographic locations in which we operate, and the introduction of new accounting standards or changes in tax laws or interpretations thereof in the various geographic locations in which we operate. We have recorded liabilities to address potential tax exposures related to business and income tax positions we have taken that could be challenged by taxing authorities. The ultimate resolution of these potential exposures may be greater or less than the liabilities recorded which could result in an adjustment to our future tax expense.
Liquidity and Capital Resources
Cash and cash equivalents, short-term investments and long-term investments totaled $1,235.2 million as of December 31, 2013, compared to $1,271.1 million as of September 30, 2013, representing a decrease of $35.9 million. The decrease was primarily due to $200.0 million of cash required for the repurchase of outstanding common stock under our stock repurchase program for the three months ended December 31, 2013, which was partially offset by cash provided by operating activities of $158.9 million for the three months ended December 31, 2013. Cash provided by operating activities for the first three months of fiscal year 2014 resulted from net income of $68.0 million combined with changes in operating assets and liabilities, as adjusted for various non-cash items including stock-based compensation, depreciation and amortization charges. Based on our current operating and capital expenditure forecasts, we believe that our existing cash and investment balances, together with cash generated from operations should be sufficient to meet our operating requirements for at least the next twelve months.
Cash provided by investing activities was $70.2 million for the three months ended December 31, 2013, compared to cash used in investing activities of $133.4 million for the same period in the prior year. Investing activities include purchases, sales and maturities of available-for-sale securities, business acquisitions, capital expenditures and changes in restricted cash requirements. The amount of cash provided by investing activities for the three months ended December 31, 2013 was


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primarily due to the sales and maturity of investments partially offset by purchases of investments and capital expenditures related to maintaining our operations worldwide.
Cash used in financing activities was $186.6 million for the three months ended December 31, 2013, compared to cash used in financing activities of $37.9 million for the same period in the prior year. Our financing activities for the three months ended December 31, 2013 consisted primarily of cash required for the repurchase of outstanding common stock under our stock repurchase program of $200.0 million, partially offset by cash received from the exercise of employee stock options and stock purchases under our employee stock purchase plan of $13.2 million.
Obligations and Commitments
As of December 31, 2013, our principal commitments consisted of obligations outstanding under operating leases. We lease our facilities under operating leases that expire at various dates through 2023. There have been no material changes in our principal lease commitments compared to those discussed in Note 8 to our annual financial statements.
We outsource the manufacturing of our pre-configured hardware platforms to contract manufacturers who assemble each product to our specifications. Our agreement with our largest contract manufacturer allows them to procure component inventory on our behalf based upon a rolling production forecast. We are contractually obligated to purchase the component inventory in accordance with the forecast, unless we give notice of order cancellation in advance of applicable lead times. There have been no material changes in our inventory purchase obligations compared to those discussed in Note 8 to our annual financial statements.
Recent Accounting Pronouncements
The anticipated impact of recent accounting pronouncements is discussed in Note 1 to the accompanying Notes to Consolidated Financial Statements of this Quarterly Report on Form 10-Q.
Risk Factors that May Affect Future Results This Quarterly Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties. Our business, operating results, financial performance and share price may be materially adversely affected by a number of factors, including but not limited to the following risk factors, any one of which could cause actual results to vary materially from anticipated results or from those expressed in any forward-looking statements made by us in this Quarterly Report on Form 10-Q or in other reports, press releases or other statements issued from time to time. Additional factors that may cause such a difference are set forth elsewhere in this Quarterly Report on Form 10-Q. Our quarterly and annual operating results may fluctuate in future periods, which may cause our stock price to fluctuate Our quarterly and annual operating results have varied significantly in the past and could vary significantly in the future, which makes it difficult for us to predict our future operating results. Our operating results may fluctuate due to a variety of factors, many of which are outside of our control, including the changing and recently volatile U.S. and global economic environment, which may cause our stock price to fluctuate. In particular, we anticipate that the size of customer orders may increase as we continue to focus on larger business accounts. A delay in the recognition of revenue, even from just one account, may have a significant negative impact on our results of operations for a given period. In the past, a majority of our sales have been realized near the end of a quarter. Accordingly, a delay in an anticipated sale past the end of a particular quarter may negatively impact our results of operations for that quarter, or in some cases, that fiscal year. Additionally, we have exposure to the credit risks of some of our customers and sub-tenants. Although we have programs in place that are designed to monitor and mitigate the associated risk, there can be no assurance that such programs will be effective in reducing our credit risks adequately. We monitor individual payment capability in granting credit arrangements, seek to limit the total credit to amounts we believe our customers can pay and maintain reserves we believe are adequate to cover exposure for potential losses. If there is a deterioration of a sub-tenant's or a major customer's creditworthiness or actual defaults are higher than expected, future losses, if incurred, could harm our business and have a material adverse effect on our operating results. Further, our operating results may be below the expectations of securities analysts and investors in future quarters or years. Our failure to meet these expectations will likely harm the market price of our common stock. Such a decline could occur, and has occurred in the past, even when we have met our publicly stated revenue and/or earnings guidance.


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Our stock price could be volatile, particularly during times of economic . . .

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