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F5 Networks Inc. (FFIV - Snapshot Report) delivered third quarter 2013 adjusted earnings per share (EPS) of 87 cents, which beat the Zacks Consensus Estimate of 85 cents. The beat could well be attributed to better-than-expected revenue growth. The quarter’s results were lower than 93 cents reported in the year-ago quarter. Shares surged 8.08% in the after-hours.

Revenues

F5 Networks reported revenues of $370.3 million in the reported quarter, up 5.0% from $352.6 million in the year-ago period. Revenues were above the company’s guidance and the Zacks Consensus Estimate of $362.0 million. Improvement in revenues was mainly due to broad-based strength in end markets and geographical regions.

Product revenues dropped 5.0% year over year to $196.7 million, while Services revenues climbed 19.3% year over year to $173.6 million.

Geographically, on a year-over-year basis, Americas grew 6.0% and represented 58.0% of revenues. Europe, the Middle East and Africa (EMEA) grew 4.0%, accounting for 21.0% of total revenue. Asia-Pacific grew 7.0%, representing 15.0% of total revenue, while Japan declined 7.0% and represented 6.0% of revenues.

By vertical, Financial was the strongest, accounting for 22.0% of total revenue. Telco accounted for 21.0% of revenues, followed by Technology, which represented about 16.0%. Government accounted for 13.0% of total revenue (including 4.0% from U.S. federal).

The company noticed increasing demand for its security products (Application Security Module, Advanced Firewall Manager and BIG-IP 4200 platform). Considering the popularity of BIG-IP solutions, F5 expects demand for its newly-released BIG-IP 5000 and BIG-IP 7000 series, going forward.

Operating Results

Gross profit in the reported quarter grew 4.5% from the year-ago quarter to $305.4 million. Gross margin dropped 40 basis points (bps) year over year to 82.5%.

F5 Networks’ operating expenses increased 10.4% year over year, mainly due to a 15.1% rise in research and development expenses, 8.7% rise in general and administrative expenses and 8.6% rise in selling and marketing expenses. Expenses increased due to continuous hiring. Operating margin in the quarter was 28.1%, down from 31.2% in the year-ago quarter.

Reported net income was $68.2 million or 86 cents per share compared with $72.3 million or 91 cents a year ago. Excluding amortization of intangibles and acquisition-related expenses but including stock-based compensation and related tax adjustments, adjusted earnings per share were 87 cents compared with 93 cents in the year-ago quarter.

Balance Sheet & Cash Flow

Cash, cash equivalents and short-term investments totaled approximately $551.3 million in the third quarter, up from $522.8 million in the prior quarter. Receivables were $205.1 million versus $192.8 million in the prior quarter. Inventories were $18.3 million versus $18.0 million in the prior quarter.

F5 Networks’ balance sheet does not comprise any long-term debt. Cash flow from operations was $126.2 million, up from $80.7 million in the prior quarter.

F5 Networks repurchased 633,000 million outstanding shares for $50.0 million during the third quarter.

Guidance

For the fourth quarter of fiscal 2013, F5 Networks expects revenues of $378.0 million to $388.0 million, up 3.4% sequentially at the mid-point. GAAP gross margin is expected to be roughly 83.0%. On a GAAP basis, earnings per share are expected in the range of 93–96 cents. Excluding stock-based compensation expense, amortization of purchased intangible assets and related tax effects, the company estimates non-GAAP earnings per share between $1.17 and $1.20.

Amid macro concerns and tight federal budget, management remains positive on the company’s upcoming product launches and growing demand for its security solutions.

F5 also mentioned that it will continue investing in technology and headcount to keep pace with changing market trends.

Our Take

We are encouraged by F5 Networks’ third quarter results, which surpassed the Zacks Consensus Estimate on both counts. Revenue growth seems to be steady but the continuous slowdown in Product revenues will remain an overhang. But F5 is positive on its product launches and growing demand for its products, particularly the security products.

Better execution and focus on enterprise and service providers have placed F5 Networks well in the application delivery controller (ADC) market. F5 Networks is also keen on expanding its cloud exposure. But the volatile spending atmosphere and stiff competition from Cisco Systems Inc. (CSCO - Analyst Report), Juniper Networks Inc. (JNPR - Analyst Report) and Brocade (BRCD - Snapshot Report) remain concerns.

Currently, F5 Networks has a Zacks Rank #3 (Hold).

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