Despite Global Macroeconomic Issues, F5 Reports A Strong Q1’16, Instilling Confidence About Future Prospects

Leading application delivery networks provider F5 Networks (NASDAQ:FFIV) reported its Q1 2016 earnings on January 20th. (Fiscal Years end with September.) Although the company’s topline declined by 5% sequentially due to the seasonal softness, it reported revenues at the higher end of its guidance. F5’s service revenue constituted 52% of the overall revenues for the quarter and grew by 15%, offsetting the decline in product revenue. While the quarter was not too good for the company’s product business, it expects to re-accelerate the growth in product revenue on the back of product additions and upgrades. Also, F5 is expanding its footprint in security solutions to gain from the rising need for securing applications against sophisticated cyber crimes.

Our price estimate of $127 for F5 Networks is approximately 40% above the current market price. We are in the process of updating our price estimate in light of the recent earnings announcement.

Quick Snapshot of the Q1 2016 Earnings

At $489.5 million, F5’s Q1 2016 revenue increased 6% year over year, coming in at the higher end of the guided range. While the product revenue at $243.7 million declined by 2.6% year over year and accounted for 48% of overall sales, service revenue increased by 14.9% year over year to $254.8 million, or 52% of total revenues. On a regional basis, revenue in the Americas, EMEA and APAC grew 3.8%, 9.3%, and 7.5%, respectively. On the bottomline front, the company’s GAAP and non-GAAP EPS  ($1.28 and $1.73, respectively) came in well above its guidance and consensus ($1.16 for GAAP and $1.61 for non-GAAP).

Product Upgrades And New Product Additions To Boost Sales In The Second Half Of FY2016

F5 is planning a series of product additions and software upgrades to increase its addressable market. The product upgrades and additions pipelined by the company over the next two quarters are: 1) the addition of a high performance 100 gig blade for the Vipron series platform in the application delivery hardware segment; 2) the release of the next generation of iRules, called iRulesX; 3) the introduction of iAppsLX; 4) the release of an application firewall for Azure service catalog; 5) the upgrade of BIG-IQ to version 5.0; and, 6) a product refresh that provides seamless connectivity between data centers, private clouds and F5-supported public clouds. F5 underwent the most significant product refresh in several years in 2014, with the aim to boost demand and create new revenue growth opportunities for the future. We believe that the upcoming product refresh will boost the revenue for the company in the coming quarters as the gains from previous versions start to taper off.

Security Continues To Be The Key Growth Driver For F5

F5 claims to have won several contracts during the first quarter for deploying the security module,  BIG IP APM (Access Policy Manager). As enterprises increasingly migrate to the public cloud, which is more economical and convenient for data storage and computation, there is a rising need for them to deal with security issues in the new environment. F5’s BIG IP APM ensures security for enterprises by providing a centralized control feature for applications that are migrated over cloud. By having a centralized control feature, enterprises can control who should get access to the application on the cloud, and the devices and locations from where those applications can be accessed.

Additionally, with a record quarter of security sales in EMEA, F5 saw a double digit growth in the volume of deals for the Silverline security solution that defends cloud, network and application layers from the modern day denial of service attacks. Although the Silverline product is in its early stages of adoption, F5 is seeing business opportunities for its services globally. Furthermore, the company plans to add malware detection capabilities to WebSafe product, which protects financial institution against sophisticated fraud threats.

Reducing security risk is an important criterion for enterprises with an ever increasing network complexity. Going ahead, F5 can see a strong demand for its portfolio of security solutions as customers look to secure their applications from sophisticated cyber crimes.

Q2 2016 Outlook

– Revenue in the range of $480 to $490 million.

– GAAP and non-GAAP gross margin of 82.5% and 84%, respectively.

– GAAP operating expense of $272 million to $281 million.

– GAAP and non-GAAP effective tax rate of 36.5% and 34%, respectively.

– GAAP and non-GAAP EPS of $1.13 to $1.16 and $1.61 to $1.64, respectively.

– Cash flow from operations in excess of $125 million.

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