F5 2002 Annual Stockholder's meeting 2/13/03
Just like last year they had the event at their headquarters. About the only change was that the pool table was moved out of the room. It hasn't gone away. It just sat in the hallway for the morning. Attendance was equally distributed between real people, institutional types, industry folks, and folks who work there. There were about a dozen of each. Was there some census for that? Of course not, but that's my best guess from overheard conversations, company nametags, and the kind of questions people asked. They did go upscale in one regard; this year they had pastries to go with the tea and coffee. Unfortunately for me I remembered last year so I ate a big breakfast before the event.
THE OFFICIAL MEETING
The f5 CEO did his usual and efficient job of running the official part of the meeting. I forgot to bring my stopwatch to see if he managed to get it done in less than 60 seconds. While some might think that is too quick, I am in favor of such a performance when no tight votes or significant shareholder proposals are involved. Too often I have seen CEOs use the onus of the OFFICIAL part of the meeting to control the entire event. That is their legal choice but it does not encourage me to invest more with their companies. I've never seen management's desires fail so the official part is very largely moot. At least this is one CEO that treats it legally without wasting anyone's time. As usual everything passed.
BUSINESS OVERVIEW
The CEO switched to the main topic of describing the company's business, past performance and possible future; or as he put it: "Where we are and where we are going". This lasted about twenty minutes.
From a company that was created in 1996 and went public in 1999 they have grown to a company of 470 employees, though it was higher at one time, with lots of Fortune 1000 customers. The dotcoms were mentioned but not emphasized because they are not the key customers: big enterprises are. F5's products are sold based on the notion of increasing security while reducing costs for the customer.
The revenue breakdown is dominated by the hardware side at 70% with 25% from services. The remaining 5% is from software sales that provide the best hope for increasing profit margins. That is impressive considering that the profit margins are already in the high 70's.
The good news from 2002 included the entry level BigIP 1000 machine, the flagship 5100, the Universal Inspection Engine, Dynamic Security Infrastructure, Blade server software, iControl, Value added resellers, More sales accounts, better financials, and improved market share. He went into more detail later in the talk. The next slide very honestly talked about the bad news. The economy didn't help, though he didn't hide behind that much, flat revenue growth which was related to less than expected revenue from Nokia products, and the elimination of the cache business. That last one is a good news bad news item though. F5 got out of a stagnant market where they weren't making money and that was a small part of the revenue picture. But if it ain't there it can't grow either.
With today's economy they are pushing more towards maximizing sales to existing customers. The top nine customers accounted for $3M in revenue in 2001 and $12M in 2002. The benefit of encouraging that trend is that it does not require larger sales staffs while simultaneously improving visibility with large enterprise customers. He gave about five specific examples including, Citigroup, GE, and Sprint.
Specific product areas
The Layer 7 products (which is the end of the Internet traffic management closest to the user) are mostly portable items like the Universal Inspection Engine (UIE) and other software. The UIE sounds very interesting for its ability to notice and respond to Denial of Service attacks. To me that sounds very saleable.
Their free iControl software continues to be seen as a sales driver even though it doesn't generate revenue on its own. It helps establish a standard that f5 products are designed for. They feel that this is a competitive edge. It is key to Microsoft's .NET initiative and is already included throughout that system. A recent Oracle presentation also mentioned f5 products several times in a positive light. It is nice when other companies make your sales presentations.
Integrated SSL is a place where they consider themselves to be the market leader. This is one of those places where f5's philosophy of integrated solutions makes them more attractive than the competition. If I heard it right, one f5 SSL item replaces eleven steps of the competitor's products.
Level 2/4 hardware from f5 is integrated with f5 software though I don't recall anything more specific about any additional distinguishing characteristics. Maybe the competition is fractured between hardware and software.
Product development is expected to cover the field from Level 1 through Level 7 and I got the impression that could happen this year. I hesitate there though because this was not emphasized.
The blade server software market is expected to have modest growth but eventually turn into something much more significant.
The BigIP is the defacto standard for blade servers. I think the topic is the software, not the hardware.
One success story I liked was that the L4/7 market share is 29% while Cisco and Nortel each have 19%. F5's portion increased by 14% from 15% in 2001.
Industry pundits place f5 as the best combination of vision and ability to execute. I noticed their nearest competitor was Cisco so it is not like f5 can just drift along.
2003 Plan
They hope to maintain their technical leadership, reach revenue profitability, continue to grow market share, and emphasize their existing accounts. Growing those accounts and expanding the customers into other products is their preferred growth option. He also mentioned the possible market expansions of mobile IT, web services, and security.
FINANCIALS
The CEO gave up the podium so Steve (CFO?) could give a quick presentation with lots of numbers in it. Most of what he showed was in the Annual Report and the 10-K but I'll quickly cover the bit I cold write down.
Market share improved from 16% in FY01 to 29% in FY02.
Gross profit increased from 60% to 72%.
They've been cash flow positive for seven consecutive quarters and have $82,000,000 in cash with little debt.
Revenue growth was flat which is normally bad but relative to the competition looks good.
They see a return to profitability and I believe the last quarter was the start of that trend.
Inventories had diminished significantly but will increase as new products are introduced.
Day Sales Outstanding stands at 64 which is much better than a year or so ago but I got the impression that it might be flatter for a while.
The 2Q03 numbers looked so much like the 1Q03 numbers that it all looked okay though not stellar to my eyes.
That concluded the formal presentations. The management team got up to field questions.
Q&A
I tend to paraphrase these so don't be surprised if you don't see the exact question or answer. The precise interchange is probably out there somewhere digitally or available through Investor Relations.
> The large increases in sales to large firms is seen as an indication of further growth, not as a dead end. Last quarter's customer satisfaction metric was the highest ever.
> The only readily identifiable large customer that has been lost has been the dotcom industry in general.
> The Sun blade server is seen as a partner in terms of software availability and as a competitor in terms of L4/7 hardware. F5 supports Sun's N1 initiative that is striving for high availability and scalability of a company's computers via its networks.
> Cisco definitely acknowledges f5's competitive challenges and this is evidenced through the copy cat offerings from Cisco. The competition is being played out in one of Cisco's smaller markets so it not like the gorilla is diverting all of its resources to crushing f5. F5 tends to win sales on technical grounds, but if internal company politics get involved Cisco might win. To me this sounds like folks that have to compete against IBM. Microsoft's early history comes to mind.
> The request for a two to five year revenue projection wasn't answered in great detail and that wasn't a surprise. The point was made though that in some markets the entire industry sees $500M revenue so it would be hard to make more than that. Adding revenue streams will help.
> The UIE product (Universal Inspection Engine is seen as having a lot of potential in the security market because it can act as an enforcement point against denial of service attacks and some viruses. Evidently last year's largest sales success was to the federal government so I guess there is an implied connection. Microsoft is involved here too but I missed the link.
> Revenue for FY03 won't be projected out because the economy is too large a variable. Hardware was down a bit for the first quarter. Slight growth is expected from Europe and Asia.
> Intellectual properties is being beefed up with a dedicated patent attorney. There have been three new patents awarded. They emphasized the "cookie persistence" patents though of course they aren't generating revenue yet but are more of a strategic positioning. Luckily no one is suing f5 and f5 is not suing anyone else, though this may only be in the patent infringement area.
MY CONCLUSION
The management team seems to be as good as ever. They seem to be a nice combination of conservative and optimistic. Large growth might be gone for a while but I like the possibility that the new customers are large and can buy lots of f5 products. The security products would seem to be good products but I don't know how the competition compares. Financially they are sound and I don't worry about them going under. They have no debt and are cash flow positive which is a nice combination. It does seem though that buying more now is only prudent if I am willing to have the money sit there for a few quarters waiting for the revenue to rise. Of course, such safe havens aren't to be scoffed at considering recent stock market trends. I'll continue to hold and might buy more later this year but I suspect there are some speculative plays that will prove too enticing. I'll leave my FFIV shares long as a nice diversification.
DISCLAIMER
LTBH and owner of FFIV shares for a couple of years. It has become a significant portion of our portfolio so it might not be added too for that reason.
Keep in mind I am not an expert in the field so feel free to correct me and fill in details and insights that I missed. When in doubt, call Investor Relations. |
