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F5 Networks (NASDAQ:FFIV), a leading provider of technology that optimizes the delivery of network-based applications, reported its Q2 2014 earnings on April 23. At $420 million, the company’s revenue came in above its target range, driven by rising customer adoption of its new product portfolio, the "Good, Better, Best" pricing model, and the growing sales momentum of F5′s security and service provider business. Though F5 registered a marginal decline in its gross margin (82%), its GAAP earnings per share ($0.91) beat the company estimate. Non-GAAP earnings per share, at $1.27, were two cents over consensus.

F5 experienced strong annual growth across most of its business segments, with the enterprise customers accounting for 65% of the total sales. It recorded double-digit growth in sales bookings across the Americas, EMEA and Japan; however, sales in Asia Pacific were flat year over year, mainly on account of lower sales in China (which is in line with industry trend).

Based on the rising demand for its new products, growing strength in its security offerings, and the building growth momentum with its Traffix Diameter solutions, F5 feels confident of building on the growth momentum gained in the first two quarters of fiscal 2014 (ends with September). In 2014, the company claims that it will continue to introduce significant enhancements and world-leading technology in key growth areas—namely security, service providers and mobility, the cloud, orchestration, and software-defined application services.

Our price estimate of $108 for F5 Networks is in line with its current market price. We are in the process or updating our valuation to incorporate the Q1 2014 earnings.

Good, Better, Best Offerings Spurs Software Sales

F5 introduced the "Good, Better, Best" pricing model in November 2013 to help customers maximize their value of enterprise application delivery. The program helps customers select a platform that best fits the organizations’ needs, offering advanced traffic management, optimization, and security services. The company claims that the model makes it easier to package its solutions together for the customer, giving them some incentive to add more modules.

F5 saw its revenue from the sale of software modules increase in Q2 2014, as a higher percentage of its customers purchased the "Better" and "Best" offerings. This was the first full quarter of the "Good, Better, Best" market model and sales were up 83% compared to Q1 2014. 78% of the customers bought the "Best" offering.

Expanding Security Market Remains A Key Growth Driver

With its BIG-IP 11.1 software passing the ISCA Labs test for network firewalls, F5 entered the Internet firewall market in February 2012, and since then has expanded its security solution portfolio with the addition of new products. Security solutions continue to be a major growth driver for the company.

With the explosion of data and processing required online, security has become a major concern for most enterprises, and thus, this is one segment bound to witness tremendous growth in the coming years. IDC estimates that companies around the world will spend $491 billion in 2014 for fixes and recovery from data breaches and malware, $127 billion in dealing with security issues and $364 billion dealing with data breaches.

In Q2 2014, F5 saw strong sales across its securities solutions portfolio including ASM, APM and AFM. It had two multimillion-dollar sales wins in the quarter as F5 solutions replaced existing competitors’ solutions. Also, a Tier 1 service provider purchased F5′s AFM firewalls to replace their existing traditional data center firewalls.

F5 acquired Israel-based Versafe Ltd., a provider of web anti-fraud, anti-phishing, and anti-malware solutions in September 2013. Offering advanced web and mobile protection solutions, Versafe provides a comprehensive real-time detection and protection for every user, device and browser. The acquisition will help make the company’s security, access, and mobile solutions (including its Application Delivery Firewall solution) stronger. The world-class security operations centers in Seattle and Tel Aviv are now live and operational, and will help support the new online security service from the Versafe acquisition. F5 claims that is has started to see sales wins of the Versafe services.

With growing awareness of its security solutions in the market, F5 believes that this segment offers huge growth opportunity and expects the strong sales momentum to continue in fiscal 2014.

Q3 2014 Outlook

- Revenue in the range of $428 million to $438 million.

- GAAP gross margin to remain flat, at 82%.

- GAAP operating expenses in the range of $228 million to $236 million.

- GAAP effective tax rate of 38.5%.

- GAAP and non-GAAP EPS target of $0.99 – $1.02 and $1.33 to $1.36, respectively.

Disclosure: No positions.

Source: Rising Customer Adoption Of Its New Products Drove F5′s Growth In Q2 '14