F5, INC. Q1 FY2021 earnings

F5 closed the December 2020 quarter with revenue of $624.6 million, up 9.7% from $569.3 million in the prior-year quarter. The top line was not the problem. Profitability was. Operating income fell 3.7% to $117.7 million, net income dropped 11.0% to $87.7 million, and diluted EPS came in at $1.41, down 13.0% from $1.62 a year earlier. Gross margin slipped to 81.6% from 84.4%, a decline of 2.8 percentage points. The operating margin narrowed to 18.9% from 21.5%. Costs tied to the software and subscription push are showing up faster than the revenue they bring.

The quarter's release was as much about strategy as about numbers. F5 agreed to acquire privately held Volterra for about $440 million in cash plus roughly $60 million in deferred consideration and assumed unvested incentive compensation for founders and employees. Management frames the deal as the foundation of an Edge 2.0 platform that is security-first, app-driven, and hardware-independent. Volterra brings about 125 employees, 75% of them engineers, more than 50 enterprise customers, and three of the world's top 15 telcos. F5 sizes its 2023 total addressable market at $28 billion and the edge security slice of that at $5 billion. The transaction needs regulatory approval and is expected to close in the first quarter of calendar 2021. Management said it will avoid further large acquisitions for at least 12 to 18 months while Volterra is integrated.

Guidance moved up. F5 raised its Horizon 2 revenue growth CAGR for fiscal years 2021 and 2022 to 7% to 8% from 6% to 7%, and lifted the long-term revenue growth target to double digits from 8% to 9%. Non-GAAP operating margin and EPS growth targets for Horizon 2 were left unchanged, keeping the pledge of double-digit non-GAAP EPS growth. The company also reiterated a commitment to return $1 billion of capital over the next two years.

Because the accounting close was not finished, the 8-K carried only a preview. F5 put GAAP and non-GAAP revenue at $623 million to $626 million, well above the $595 million to $615 million range it gave on October 26, 2020, and lifted its non-GAAP EPS outlook above the prior $2.26 to $2.38 range. Preliminary non-GAAP software revenue growth was roughly 70%. Chief Executive Francois Locoh-Donou described the period as the company's best quarter since the transformation began, pointing to strong software demand and a resilient systems business. GAAP EPS was not yet available, and full results were expected on January 26, 2021.

Cash generation held up but slipped. Operating cash flow was $137.4 million, down 4.6% from $144.0 million a year earlier, while capital expenditures fell 78.9% to $4.7 million from $22.3 million. Deferred revenue rose 9.8% to $1.36 billion, and remaining performance obligations grew 16.7% to $1.40 billion, both signs of the shift toward subscriptions and SaaS. Cash, cash equivalents, and investments totaled $1,462.1 million at December 31, 2020, up from $1,312.8 million at September 30, 2020. The term loan balance stood at $385.0 million, and the $350.0 million revolving credit facility was undrawn. On February 3, 2021, the company paid $500 million into accelerated share repurchase agreements with two financial institutions.

Risks are a familiar mix. Integrating Volterra and selling its products through F5's channel carries execution risk, and the deal still needs regulatory clearance. COVID-19 remains an unknown for demand and the supply chain. Distributor concentration stayed high, with Ingram Micro at 18.1% of net revenue and Synnex at 10.0%. Revenue outside the United States was 48.7% of the total, down from 51.6%. Days sales outstanding stood at 50. Management also flagged competitive pricing pressure, industry consolidation, and the unpredictability of the sales cycle in its forward-looking language.