F5 Networks Continues To Rely On Services To Drive Top Line Growth, Profits

F5 Networks (NYSE:FFIV) announced its fiscal Q3 earnings on Wednesday, July 26, reporting a 4% annual increase in revenues to $518 million. Similar to previous quarters, most revenue growth (7%) came from the company’s services segment, while product revenues were up by around 2% on a y-o-y basis. Two key drivers of growth for the company during the quarter were a strong rate of adoption for iSeries products and robust demand for security products, including the Gi/SGi firewall and application security in both on-premise and cloud environments.  The company’s stock fell by over 7% in after market trading following the announcement, primarily due to a weaker than expected outlook going forward.

We have a $141 price estimate for F5’s stock, which is around 10% higher than the current market price.

See our complete analysis for F5 Networks

Q3 Highlights & Key Trends

F5 has increasingly facing competition from new entrants in the application delivery controller (ADC) market as well as from native cloud-based service providers in the ADN market. The growth rate in F5’s combined product sales slowed down to low single digits in 2015 before showing a negative trend in 2016. Although revenue growth has improved this year, revenues were up by only 2% y-o-y to $235 million this quarter, as shown below. The company is also facing some uncertainty in demand for its core ADC solutions over the cloud as some of its customers are reevaluating their application architectures and deployment options. As the adoption rate remains relatively low, it can continue to put pricing pressure on hardware products.

F5’s services business reported 7% annual growth in revenues to $283 million. Moreover, the company’s services gross margin (GAAP) improved by 20 basis points to 83.7% for the June ended quarter. Over the years, F5’s services revenues have become more meaningful due to the significant customer base acquired by the company.

Despite revenue growth, low margins for the products segment led F5’s consolidated gross margin (non-GAAP) to fall by around 40 basis points over the comparable prior year period to 84.1%. However, a limited increase in operating expenses led to positive 5% growth in non-GAAP operating income to $250 million. In addition, F5 repurchased roughly 3 million shares over the last year, due to which net income per share jumped 12% on a y-o-y basis to $2.03 for the quarter.

Guidance For September Quarter

F5’s management expects a modest 2% annual increase in revenues to $535 million in fiscal Q4. Its gross margin will likely remain lower than previous year levels at around 84.5% for the September quarter. F5 expects its non-GAAP diluted EPS for the September quarter to be around $2.22.

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