Juniper Beats Guidance On Strong Switching And Edge Routing Gains

Juniper (NYSE:JNPR) announced a strong set of Q1 2014 results on Tuesday, as revenues beat the high end of guidance and operating margins improved solidly on healthy cost controls and revenue gains. While the service provider market continued to recover well from the macroeconomic overhang of the Euro debt crisis, enterprise spending sustained its newfound momentum in the first quarter. Coming off a record Q4 in which enterprise revenues grew by 11% over the same period last year, Juniper was able to better it with 12% year-over-year growth in the first quarter. The enterprise outperformance was led by gains in switching, as strong adoption of EX and QFabric saw switching revenues jump by a huge 46% over the same period last year. On the service provider side, Juniper’s newly launched MX line of edge routers continued to do well, offsetting weakness in the core due to usual lumpiness in order bookings.

Along with revenue gains, Juniper continued to benefit from its restructuring efforts, which drove efficiency in operations and helped margins grow by 150 basis points over the year-ago quarter. The company’s restructuring plans received a boost from a recently announced “integrated operating plan”, which promises to streamline R&D costs and drive long-term shareholder value. The headcount reduction and rationalization of expenses across verticals is expected to save Juniper about $160 million annualized operating expenses by the end of Q1 2015. Going forward, restructuring charges are expected to impact profitability in the near term but recurring cash savings should drive long-term value in the stock. Our $28 price estimate for Juniper is about 10% ahead of the current market price.

See our full analysis of Juniper Networks

Macroeconomic concerns recede further into the background

With macroeconomic uncertainty subsiding, service providers have started investing more heavily in their network infrastructure. The recent macroeconomic concerns had caused project cycles to lengthen and extended the delivery timelines from customers. However, the sustained high demand for data due to the proliferation of mobile devices and high-quality video content on the web means that carrier networks have been running hot without additional capacity additions. With economic conditions stabilizing, capital spending on networks has returned and with it, Juniper’s top-line growth. As compared to a 2.6% y-o-y growth in overall revenues in Q1 last year, Juniper’s revenues registered a 10.5% increase last quarter.

Service providers account for more than two-thirds of Juniper’s revenues. In the U.S., where service provider demand is on the rise, Verizon and AT&T have been big Juniper customers, with each accounting for about 10% of Juniper’s revenues in recent years. The performance of Juniper’s new MX series of edge routers in recent quarters is perhaps the most encouraging, given that the edge router market is by far the biggest among all router markets. By our estimates, edge routers account for more than 50% of the overall market and about 70% of the service provider router market. There is still some lumpiness being seen in the order build-up for core routers, but Juniper managed to more than offset that with MX’s continued strength at the edge last quarter. Routers account for over 40% of Juniper’s overall valuation by our estimates, and market share gains in edge routers should be the most accretive to Juniper’s value going forward.

Intense competition causes margins to take a hit

However, the impressive revenue gains have come at the expense of Juniper’s gross margins. The company’s non-GAAP product gross margins fell by 70 basis points from a year ago to 63.5% last quarter, primarily due to competitive pricing and unfavorable mix. Its service margins also declined by 240 basis points to below 60% last quarter, due to higher support costs and increased bearing. Juniper typically incurs such costs at the beginning of a new product cycle or the initiation of a new customer contract. Going forward, we expect service margins to improve from current levels and offset some of the impact of growing competition on product margins in the coming quarters.

With product margins taking a hit due to rising competition, the company is working on improving its operational efficiency and driving bottom-line growth. The restructuring initiative, called the “Integrated Operating Plan”, aims to cut $160 million in operating costs by Q1 2015 and return $3 billion to shareholders over three years. To achieve this goal, the company will reduce its worldwide headcount by 6% and dispose of around 300,000 square feet of leased facilities. It has discontinued the development of the application delivery controller (ADC) technology licensed from Riverbed, taking a non-cash asset write-down charge of $85 million in Q1. With a majority of the headcount-related cuts already executed, Juniper will focus the rest of the year on consolidating facilities and expects to incur about $70 million in restructuring charges. The mix of cash savings that the company hopes to achieve from these moves is about 60% from job cuts, 20% from program and project reductions and the rest from facilities restructuring (see Juniper Begins Restructuring, Aims To Save $160 Million In Operating Expenses).

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