F5’s Q1’15 Earnings Hit By Lower Million Dollar Deals, Though Pipeline Remains Strong For Q2

F5 Networks (NASDAQ:FFIV) reported its Q1 2015 earnings on January 21st, delivering results and guidance a bit below consensus.   (Fiscal years end with September.) This sent the stock down 15% in after hours trading, though is has recovered some ground since.  December quarters for the company normally display seasonality, which was reflected in consensus. Yet there was also a marked decrease in million-dollar-plus deals (compared to previous quarters), which led to a slight sequential decline in the company’s revenue.  That said, revenues of $463 million were up 14% year to year, even if it was only within the lower half of its guided range. The company experienced a larger than expected drop in million dollar plus deals in both large enterprise and Federal opportunities in the U.S. However, it firmly believes that this is more of a seasonal issue and claims to have a strong pipeline of such deals for the current quarter.

F5 reported half a percentage point sequential growth in its gross margin. Even though it witnessed a 10% sequential decline in its operating income, the retroactive reinstatement of the R&D tax credit helped the company beat its GAAP EPS guidance. GAAP EPS was $1.21, considerable above the guided range of $1.10 to $1.13. The R&D tax credit benefited the EPS by approximately $0.08 per share on a GAAP basis and $0.07 per share on a non-GAAP basis.

Based on the strength of its current pipeline, including the return in the number of large deal opportunities and continued momentum from key drivers, F5 anticipates sequential and year-over-year growth in the current quarter. The company is confident that the growth drivers of its business remain robust, and expects the momentum to build in this current quarter and continue into the second half of the year. It claims that its business pipeline create rate was very strong in Q1, up significantly over the previous year, and the pipeline of business in Q2 2015 looks very strong.

We are in the process of updating our price estimate of $127 for F5 Networks for the Q1 2015 earnings release.

See our complete analysis for F5 Networks here

Security Business Remains The Largest Growth Driver

F5 continued to see strong growth in its security business in Q1 2015, with strong sales across the security solutions portfolio including ASM (Application Security Manager), APM (Application Performance Manager) and AFM (Application Firewall Manager). The company claims to have gained some very strategic sales wins in the service provider market, as its consolidation strategy and focus on security NFC, Gi 1 services and LTE applications is resonating well with the service providers. F5 is starting to see some real momentum globally with its Gi firewall solutions and believes it can be a strong growth driver in fiscal 2015 and beyond.

The company got a very positive reaction to the launch of its Silverline hybrid application services strategy from its sales force, partners and customers. The initial launch included F5’s subscription based DDoS service and anti-malware and fishing protection service. It has already seen some excellent orders for both the solutions and is planning to increase the portfolio of cloud-based subscription services starting with the vast AFM solution in the new few months.

Additionally, F5 added significant functionality to its orchestration and management product ( BIG-IQ), which was key to getting the strategic security wins.  It is also another component of the hybrid applications services strategy. During the quarter, F5 also continued to make great progress with its SDN partnerships, both in its technology and in its go-to-market initiatives.

F5 has a host of new functionality and new products in its pipeline. It recently released a new high-end 2U platform – BIG-IP 12000, and plans to enhance its management and orchestration capabilities with BIG-IQ release 4.5 in the near future. The release will include significant enhancements to F5’s datacenter security product, AFM, and ASM as well as comprehensive support for the SDN ecosystem.

The ‘Good, Better, Best’ pricing model, introduced in November 2013 to help customers maximize their value of enterprise application delivery, continued to gain momentum in the quarter with customer adoption continuing to be very strong in the Best category.

Cisco ACE Replacement Opportunity To Continue in 2015

F5 continued to see strong sales of Cisco ACE replacements in Q1 2015, as customers continue to take the opportunity to add additional functionality, such as the AFM and AFM security modules.

In 2012, rival firm Cisco announced its decision to exit the ADC market after losing more than 50% of its market share to F5 and Citrix. F5 has scored big product wins by replacing some of Cisco ACE products in large customer accounts since then. F5 expects  the opportunity to continue throughout 2015 and beyond. The ACE installed base is over $1 billion of potential business, but F5′s target market is much larger. In addition to replacing Cisco’s existing solutions, F5 has the added opportunity of providing customers additional functionality including security, access control and application acceleration.

F5 has created a sales service web portal for ACE Migration which complements a significant experience and consulting expertise. It also intends to step up its market initiatives on the ACE opportunities starting this quarter to take advantage of its current growth momentum and experience in transitioning ACE customers to F5 ADC solutions.

Q2 2015 Outlook

– Revenue in the range of $465 million to $475 million.

– GAAP and non-GAAP gross margin in the range of 82% to 82.5% and 83.5% to 84%, respectively.

– GAAP operating expense in the range of $255 million to $264 million.

– GAAP and non-GAAP effective tax rate of 38.5% and 35.5%, respectively.

– GAAP and non-GAAP EPS between $1.07 to $1.10 and $1.48 to $1.51, respectively.

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