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F5 Networks, Inc. (NASDAQ:FFIV)

Preliminary Second Quarter Fiscal 2013 Results Conference

April 04, 2013 5:00 pm ET

Executives

John Eldridge

Andy Reinland - Chief Finance Officer and Executive Vice President

John McAdam - Chief Executive Officer, President and Executive Director

Analysts

Mark Sue - RBC Capital Markets, LLC, Research Division

Ashwin Kesireddy - JP Morgan Chase & Co, Research Division

Timothy Long - BMO Capital Markets U.S.

Alexander B. Henderson - Needham & Company, LLC, Research Division

Brian T. Modoff - Deutsche Bank AG, Research Division

Operator

Good afternoon, and welcome to the F5 Networks Conference Call. [Operator Instructions] Also, today's conference is being recorded. If anyone has any objections, please disconnect at this time. I'd now like to turn the call over to Mr. John Eldridge, Director of Investor Relations. Sir, you may begin.

John Eldridge

Thank you, Sharon. Good afternoon, everyone. Today, as you know, we announced preliminary results for the second quarter of fiscal 2013. The purpose of today's call is to provide some additional perspective on those results. Following prepared remarks by John McAdam, President and CEO; and Andy Reinland, Executive VP and CFO, we will open the call up for questions.

An archived version of today's live webcast will be available until noon on April 24. You can access the webcast and information about our regularly scheduled second quarter conference call from the Events Calendar page of our website from 4:30 p.m. Pacific time today, until midnight Pacific, April 5. You can also listen to a telephone replay at (866) 444-9032 or (203) 369-1130.

During today's call, our discussion will contain forward-looking statements, which include words such as believe, anticipate, expect and target. These forward-looking statements involve risks and uncertainties that may cause our actual results to differ materially from those expressed or implied by these statements. Factors that may affect our results are summarized in our quarterly release, described in detail in our SEC filings. Please note that F5 has no duty to update any information presented in this call.

Now I'll turn the call over to Andy Reinland.

Andy Reinland

Thank you, John. As we announced in today's press release, preliminary results for the second quarter of fiscal 2013 came in below our expectations. Revenues for the quarter are expected to be $350.2 million, up 3% year-over-year, down 4% sequentially and below our guidance of $370 million to $380 million. Product revenue in the quarter was $185.1 million. Services revenue was $165.1 million. Book-to-bill for the quarter was equal to 1. We estimate GAAP gross margin for Q2 will be in line with our 83% target, with non-GAAP gross margin at approximately 84%. We expect our non-GAAP operating margin to be approximately 34.5%. During the quarter, we added approximately 30 new employees. Currently, we anticipate GAAP EPS to be in a range of $0.79 to $0.80 per share, below our guided range of $0.93 to $0.96. We anticipate non-GAAP EPS in a range of $1.06 to $1.07 per share, below our guidance of $1.21 to $1.24.

We will provide further details on Q2 results along with details about our outlook for Q3 during our regularly scheduled conference call on April 24.

With that, I will turn the call over to John McAdam.

John McAdam

Thanks, Andy, and good afternoon, everyone. Clearly, Q2 results are well below our expectations and our internal forecast. During the quarter, we experienced difficulties in closing certain forecasted deals as customers hesitated to release purchase orders, causing us to adjust our internal forecast in the last month of the quarter. The slowdown in orders was pronounced in North America and to a lesser extent, EMEA, while Asia Pacific and Japan came in roughly at plan.

While we plan to go into more depth on sales results by vertical on our quarterly earnings call, far and away the largest area of weakness was in the telco space, where sales were down significantly on both a year-over-year and sequential basis as funding for several projects were delayed. While we are very optimistic regarding our industry-leading solutions for the telco space and the opportunity to grow our revenues within this customer base, telco sales tend to be very lumpy, and we saw this in our Q2 result. Government sales were also down year-over-year and were likely impacted to some degree by the U.S. government sequester. Outside of telco and the U.S. federal government, we saw okay results on sales to enterprise customers with reasonable year-over-year bookings growth.

While we did not -- while we did see a slight increase in the number of competitive engagements, our win rates remain consistent with prior quarters. We believe the slowdown in orders is not caused by competitive losses but by customers committed to F5 who were reluctant to sign off on purchase orders toward the end of the quarter. Our view is that most of this reluctance was due to either budget constraints or delays in decisions as customers transition to F5's new range of products we are introducing into the market over the course of this year. We also experienced a fairly sizable drop in year-over-year orders greater than $1 million in size, a trend that has been ongoing since Q3 of last year.

We did see several positive trends in Q2, led by sales of our security solutions, which were up substantially during the quarter. We had a number of excellent sales wins with our Application Delivery Firewall solution especially in the financial vertical. We also continue to see strong traction with our new BIG-IP 4200 platform, which we introduced in Q1. This should bode well for future sales of the new entry level BIG-IP 2000 series, which started shipping during last quarter. We also achieved some excellent sales wins by replacing Cisco ACE products on large customer accounts. And the pipeline of similar opportunities continues to grow rapidly.

In spite of the Q2 results, I remain very excited about the future prospects for F5. I believe that our current solutions and future product deliverables continue to position us well in our key markets of security, service provider, cloud-based architecture and new generation data centers.

At this time, there is little additional information or color we can provide. We will discuss our Q2 results in more detail and provide a look ahead at Q3 on our regularly quarterly conference call on the 24th of this month.

And with that, we'll hand over for a brief Q&A. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Mark Sue of RBC Capital Markets.

Mark Sue - RBC Capital Markets, LLC, Research Division

The indications were that the federal and the profit technology verticals would be weak due to sequestration and some of your customers spending in things in-house, as I look at the telco decline year-over-year, it seems to suggest there might be a broader trend as it relates to maturation of the ADC market and if we look at product cycles having an impact, products often have product cycles but what I'm wondering why the magnitude this time around, there's some other things that you're picking up from your customer base for the delay.

John McAdam

No. We don't see a broader trend. And certainly, we don't see anything right now. What happened, Mark, was that actual forecast of the telco business was down quite significantly. That was up obviously at the beginning of the quarter because we knew about projects. So it's not like where there's a dearth of pipeline in telco because of broader trends. Those pipelines are there. We just couldn't get them closed this quarter.

Mark Sue - RBC Capital Markets, LLC, Research Division

Okay. John, do you feel that maybe the market is just a little bit short now and it's not growing at the rate it used to? A lot of people who have deployed ADC are not digesting it. So it's going to be some time before things rebound or is there just really a timing issue from your part?

John McAdam

I think it's a timing issue. That's what we think. I mean, we obviously -- we're looking at a number of things and we'll have much more detail on 24th. But obviously, we mentioned, we made some reference to the product transition as well and has that caused any delays. And I guess that's possible. But the 4200 which came out in Q1 was actually quite strong. So we're hoping that will bode well for the other new products.

Operator

Our next question comes from Rod Hall of JPMorgan Chase.

Ashwin Kesireddy - JP Morgan Chase & Co, Research Division

This is Ashwin Kesireddy on behalf of Rod Hall. On your telco business, is the weakness limited to any specific trade-off customers? Or did you find the weakness across both?

John McAdam

Well, the weakness was actually pretty global but more pronounced in North America and again -- so obviously, the bigger customers.

Operator

Our next question comes from Tim Long of BMO Capital Markets.

Timothy Long - BMO Capital Markets U.S.

Two quick ones if I could. First, John, you guys talked a little bit about some ACE replacement wins last quarter. Did you get any major impact from that in March? And were there more large Fortune 500 wins replacing Cisco ACE? And then secondly, did you pick up any of the delays due to maybe a little bit more of going to virtual products across the customer base?

John McAdam

Yes, I understand the question. Yes, first of all with the second part, no, we're not seeing -- I know there's been a lot of talk about this, but we're not seeing delays caused by virtual products and software, SDN, et cetera. We're not seeing anything significant there. This was projects that were in the forecast, were in the pipeline, the factor pipeline. And we expected them to come in and they didn't. Regarding ACE, I don't know if there was any Fortune 500. Now that doesn't mean there -- there may have been. Don't read that as a negative. I don't know. What I do know about is that the actual rate of closure of the ACE pipeline has actually been better than the rest of the factor pipeline. So we feel good about that. And the pipeline of ACE opportunities has been increasing and our win rate is quite high. So we -- that's why I called it out. We feel quite good about that, specifically, Fortune 500. We'll probably have a look at that for the 24th call.

Operator

Our next question comes from Alex Henderson of Needham & Company.

Alexander B. Henderson - Needham & Company, LLC, Research Division

So I guess I'm a little confused about your commentary here. I mean, if I look at the year-ago period, you had 27% of your revenues coming from service provider in the first quarter. Normally, seasonally, it's a seasonally weak quarter for service provider. I would think that, that would come down sharply, given you were 22% in 4Q. And so you would have had to have been making this up with very robust demand in the enterprise piece. If your service provider came down from over 27% to under 22%, which is where it was in CY 4Q, is that what you're saying is the weakness? Or is it even steeper than that and you're down under 20% and it's down even sharper than that? How do we read that comparison?

John McAdam

Yes, Alex, you'll get that -- we won't give you that until the 24th. However, one of the things I did say was that it was pretty global. It's specific in North America as well. That was where we saw most of it, but it was pretty global. So you are going to see a fairly low-ish percentage when we announce those results.

Alexander B. Henderson - Needham & Company, LLC, Research Division

So is it that you just simply couldn't get enough enterprise acceleration in the new product portfolio to offset that steep decline?

John McAdam

No.

Alexander B. Henderson - Needham & Company, LLC, Research Division

It sounds more company-specific, to be honest with you.

John McAdam

Obviously, we would have liked more enterprise. But what we're saying is -- I talked with enterprise being okay. I mean, that doesn't mean it was perfect, but it was okay and it was up year-over-year. What we did say, and this is important, is that the forecast of the telco business missed not just from a comparison year-over-year but the actual forecast this quarter.

Operator

Our next question comes from Brian Modoff of Deutsche Bank.

Brian T. Modoff - Deutsche Bank AG, Research Division

John, continuing along that line, can you talk a little bit about what you think were the delays specifically? What are these customers evaluating in terms of -- in other words, what do you expect to occur in Q2 with that vertical? And you mentioned earlier about strength as you already get [indiscernible].

John McAdam

Until we do a deep dive with the sales force, we're not going to get into that detail. I mean, we -- there's no question that when we were talking to the salespeople during the quarter, there were budgets not being released was announced, et cetera, but I don't want to make that grand statement yet until the 24th.

Brian T. Modoff - Deutsche Bank AG, Research Division

All right. I wasn't done with the question. So the other part of it was around security. Can you talk a little bit about what -- you mentioned earlier that security was stronger. Can you give us a little granularity about what's driving that? Can you talk about general [ph] application?

John McAdam

What was strong there was -- first of all, we continue to see good sales of the ASM product but more importantly, the Application Delivery Firewall that we announced. And really, we were only effectively shipping that in the last month of the quarter. And we saw some really nice wins there. And from a year-over-year growth in security, it was pretty substantial. Again, we're not going to give any more detail than that, but it was pretty substantial.

John Eldridge

Okay, thank you for -- Brian, you have another question?

Brian T. Modoff - Deutsche Bank AG, Research Division

Last question was, any view on telco in Q2?

John McAdam

Not yet. No, no. We will talk about the forecast and -- I know you want to know, but we really need to do our homework after seeing what we just saw in March there before we do that.

John Eldridge

Thank you all for joining us, but it's obvious that there are so many questions you have that we are not in a position to provide answers to until our 24th call. So we will do our best to get them by then. And thank you again for joining us.

John McAdam

Thank you.

Operator

This concludes today's conference. Thank you for your participation. You may now disconnect.

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