F5 Networks Inc. (FFIV) delivered third quarter 2012 adjusted earnings per share (EPS) of 92 cents, inching past the Zacks Consensus Estimate of 91 cents. The quarter’s earnings also grew 20.5% from the year ago level. The outperformance was attributable to solid revenues arising from the growing demand for the company’s products, as well as market share gains. The company also witnessed strong demand from financial and Telco verticals.

However, shares slumped 1.09% in after hours reflecting low investor confidence. F5 Networks delivered a cautious outlook citing a tough spending environment, and the same did not meet the Street’s expectation.

Revenues

F5 Networks reported revenues of $352.6 million in the reported quarter, up 21.3% from $290.7 million in the year-ago period. The book-to-bill ratio was less than one.

Revenue was within the company’s guidance of $350.0-$355.0 million and roughly flat with the Zacks Consensus Estimate of $353.0 million. Revenue growth was driven by strong product demand across all geographic regions and strength in Service Provider biz.

Continuous enhancement of product suites and strong demand for its VIPRION, BIG-IP suites during the quarter led to a year-over-year growth of 15.5% in the Product segment. Revenues from the Services segment climbed 30.6% year over year, fueled by growth in new and renewed service maintenance contracts booked during the quarter.

Geographically, on a year-over-year basis, Americas grew 22.0% year over year and represented 57.0% of revenues. EMEA grew 27.0% year over year, accounting for 21.0% of revenues. Asia-Pacific and Japan grew a respective 17.0% and 9.0%, representing 15.0% and 7.0% of revenue.

By vertical, Financial was the strongest, accounting for 23.0% of the total revenue. Telco slid a position from the prior quarter and accounted for 22.0% of revenues, followed by Technology, which represented about 16%. Government accounted for 12% (including 6% from U.S. federal). Of the verticals, Telco performed better-than-expected, amidst a stringent spending environment.

Operating Results

Gross profit in the reported quarter surged 22.7% from the year-ago quarter to $292.3 million. Gross margin escalated 90 basis points year over year to 82.9%. The increase was supported by an improved product mix.

F5 Networks’ operating expenses increased 21.6% year over year, mainly due to a 33.3% rise in research and development expenses and 19.7% rise in sales and marketing expenses. Expenses hiked due to continuous hirings. Despite the substantial rise in expenses, operating income came in at $110.0 million, up 24.6% from $88.3 million reported in the year-ago quarter. Operating margin in the quarter was 31.2%, up from 30.4% in the year-ago quarter. The margin improvement could be attributed to higher revenues.

Reported net income was $72.3 million or 91 cents per share compared with $62.5 million or 77 cents a year ago. The company’s earnings marginally surpassed its own guided range of 88-90 cents.

Excluding the effect of stock-based compensation, amortization of intangibles and acquisition-related expenses, non-GAAP EPS was $1.14 versus 97 cents in the prior year quarter. But including the stock-based compensation and related tax adjustments, EPS was 93 cents, compared to 77 cents in the year ago quarter.

Balance Sheet, Cash Flow & Share Repurchase

Cash, cash equivalents and short-term investments totaled approximately $519.7 million in the third quarter, up from $489.6 million in the prior quarter. Receivables grew $9.7 million sequentially to $193.7 million. Inventories remained sequentially unchanged at $17.0 million.

Total deferred revenue was $433.9 million, compared to $412.8 million in the previous quarter. F5 Networks’ balance sheet does not comprise any long-term debt. Cash flow from operations was $113.4 million, up from $101.6 million in the prior quarter. Capital expenditure was $5.7 million versus $6.9 million in the prior quarter. F5 Networks repurchased 425,088 outstanding shares for $50.0 million during the quarter.

Guidance

Management expects favorable growth trajectory in mobile traffic, data center consolidation, virtual environments and data security. Management believes that solid revenue could be generated out of it, going forward. But, at the same, management expressed its concern about the macro uncertainties that could affect the near-term fundamentals.

Management also remained concerned about an expected budget cut from the telecom customers.

For the fourth quarter of fiscal 2012, F5 Networks expects revenues of $360.0 million to $370.0 million representing a sequential growth excluding any material contribution from the Traffix acquisition. On a GAAP basis, earnings per share are expected in the range of 90-93 cents. Excluding stock-based compensation expense, amortization of purchased intangible assets and related tax effects, the company estimates non-GAAP earnings per share between $1.16 and $1.19. The Zacks Consensus Estimate for the fourth quarter is pegged at $1.11.

Our Take

F5 Networks delivered impressive third quarter results, beating the Zacks Consensus Estimate on the bottom line and matching the same on the top line. Better execution and focus on enterprise and service providers have placed F5 Networks well in the application delivery controller (ADC) market and helped it grab share from Cisco Systems Inc. (CSCO) and Juniper Networks Inc. (JNPR). F5 Networks is also keen on expanding its cloud exposure.

With the rollout of TMOS ver.11, F5 Networks is witnessing strong demand for its VIPRION products. On the other hand, the company remains optimistic regarding a rebound in its Financial and Enterprise verticals. This could help the company in trouncing its own estimates, in our belief.

Though steady geographic contributions, margin expansion and continuous share repurchases are positives for the quarter, tight spending environment, book-to-bill ratio of less than 1 and stiff competitive atmosphere keep us concerned.

Currently, F5 Networks has a Zacks #4 Rank, implying a short-term “Sell” rating.

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