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F5 Networks, Inc. (FFIV - Snapshot Report) delivered second quarter 2013 adjusted earnings per share (EPS) of 81 cents, which missed the Zacks Consensus Estimate by a penny. The miss could well be attributed to higher expenses and tax rate. The quarter’s results were lower than 88 cents reported in the year-ago quarter.

The miss was not surprising as F5 negatively preannounced its second quarter in early April and lowered its forecasts for the quarter.

Revenues

F5 Networks reported revenues of $350.2 million in the reported quarter, up 3.1% from $339.6 million in the year-ago period but down 4.2% sequentially. Revenues were in line with the company’s revised guidance provided in its mid-quarter update. Previously, the company expected revenues to be in the range of $370.0–$380.0 million. Management blamed slowing sales in North America and Europe, Middle East and Africa for the dismal performance. From end market viewpoint, soft Telco and U.S. Federal bookings hampered revenue growth.

Product revenues dropped 9.8% year over year to $185.1 million, while Services revenues climbed 22.8% year over year to $165.1 million.

Geographically, on a year-over-year basis, Americas declined 4.0% and represented 54.0% of revenues. Europe, the Middle East and Africa (EMEA) grew 13.0%, accounting for 23.0% of total revenue. Asia-Pacific grew 21.0%, representing 16.0% of total revenue, while Japan declined 5.0% and represented 6.0% of revenues.

By vertical, Financial was the strongest, accounting for 23.0% of total revenue. Technology accounted for 18.0% of revenues, followed by Telco, which represented about 17.0%. Government accounted for 13.0% of total revenue (including 5.0% 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 plans to launch BIG-IP 5000 and BIG-IP 7000 series during the second half of 2013.

Operating Results

Gross profit in the reported quarter inched up 2.8% from the year-ago quarter to $289.9 million. Gross margin dropped 20 basis points (bps) year over year to 82.8%.

F5 Networks’ operating expenses increased 11.3% year over year, mainly due to a 20.6% rise in research and development expenses and 13.6% rise in general and administrative expenses. Expenses increased due to continuous hiring. Operating income came in at $92.5 million, down 11.7% from $104.7 million reported in the year-ago quarter. Operating margin in the quarter was 26.4%, down from 30.8% in the year-ago quarter.

Reported net income was $63.4 million or 80 cents per share compared with $68.6 million or 86 cents a year ago. GAAP earnings per share were at the higher end of revised guidance. Excluding amortization of intangibles and acquisition-related expenses but including stock-based compensation and related tax adjustments, non-GAAP EPS was 81 cents compared with 88 cents in the year-ago quarter.

Balance Sheet & Cash Flow

Cash, cash equivalents and short-term investments totaled approximately $522.8 million in the second quarter, up from $517.8 million in the prior quarter. Receivables were $192.8 million versus $209.1 million in the prior quarter. Inventories were $18.0 million, down from $18.7 million in the prior quarter.

F5 Networks’ balance sheet does not comprise any long-term debt. Cash flow from operations was $80.7 million, down from $144.8 million in the prior quarter. Capital expenditure was $7.0 million versus $7.8 million in the prior quarter.

Share Repurchase

F5 Networks repurchased 508,000 million outstanding shares for $50.0 million during the second quarter. Currently, there are $81.3 million worth shares outstanding under the existing authorization.

Concurrent with the earnings release, F5’ board also declared an additional share buyback authorization of $200.0 million.

Guidance

For the third quarter of fiscal 2013, F5 Networks expects revenues of $355.0 million to $365.0 million, up 2.8% sequentially at the mid-point. On a GAAP basis, earnings per share are expected in the range of 80–83 cents. Excluding stock-based compensation expense, amortization of purchased intangible assets and related tax effects, the company estimates non-GAAP earnings per share between $1.06 and $1.09.

Amid macro concerns and tight federal budget, management remains positive on the company’s upcoming product launches and growing demand for its security solutions. But the company remains somewhat concerned about bill slippage and longer sales cycles, particularly in the telco vertical, as well as U.S. federal sales.

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

F5’s view for fiscal 2013 seemed pretty good. For fiscal 2013, F5 aims to reaccelerate product revenue growth through Big-IP appliance refresh and the introduction of new products such as Application Delivery Firewall (layer 3-7), DPI, and the next version of TMOS.

F5 also expects Traffix (acquired on February 2012) to start contributing materially toward revenues in 2014 as it sees good traction from customers for its diameter routing technology.

Our Take

F5 Networks missed the Zacks Consensus Estimate by a penny in the second quarter of fiscal 2013. We have been noticing that over the past few quarters, despite consistent product launches, revenue generation is gradually slowing down. This could prove hazardous to the company’s fundamentals if the new product lineups fail to ramp up demand in 2013.

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 #4 (Sell).

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