F5 Networks Earnings: What Went Wrong?

By Billy Duberstein Markets Fool.com

This was not the way that Francois Locoh-Donou wanted to start out his tenure as CEO of F5 Networks (NASDAQ: FFIV). The company missed analysts' expectations on both the top and bottom lines, leading to a 7% fall in the stock price. But could this drop be an opportunity, or a sign of things to come?

Continue Reading Below

Image source: Getty Images.

The quarter

F5 reported $518.2 million in revenue, which fell short of analyst expectations of $538 million. Adjusted earnings of $127 million also fell short at $1.95 per share versus expectations of $2.09. Excluding stock-based compensation and other intangibles, net income was only $93.1 million, or $1.43 per share.

The figures marked a decent 7.1% revenue growth year over year, and 14% growth in net income. The launch of new products contributed 6.9% growth, making up 47% of revenue, while services grew 7.3% and made up 53% of revenue.

Guidance for the June quarter also came in below expectations, with revenue between $520 and $530 million and non-GAAP (generally accepted accounting principles) earnings coming in between $2.01 and $2.04 per share.

Continue Reading Below

With the stock trading at 24 times earnings heading into the quarter, that modest growth was not good enough for Wall Street, and the stock sold off.

The company blames Europe

The company pointed to macroeconomic issues in Europe as one of the main pockets of softness. With anxiety about the now-passed French elections, as well as question marks about data residency on the Continent after Brexit, the company's EVP of sales John DiLullo said customers in Europe paused their purchases in the quarter.

DiLullo also said the company was putting in new leadership in the U.K. and Germany, with new training in the region to focus on businesses that are looking to deploy in the public cloud.

Positive light

The company pointed to some positives, however. One is that the company is in the midst of a product refresh: New products only made up roughly 25% of product revenue, which should ramp up to 80% three quarters later, and continue over the next two years. This was the first quarter that the new products were available for the entire period, so analysts and investors are looking for product-revenue growth.

On that note, the company stated that the average deal size also went up, from $110,000 to $125,000, and that the number of $1 million-and-up deals was steady. This should point to better product growth over the next year or two.

The big concern

The quarter wasn't a disaster by any means, even if it came in a little light. However, any growth letup is bound to feed fears that F5's load-balancing and application security products are coming under fire from the competition.

In a recent note, Deutsche Bank analyst Vijay Bhagavath downgraded F5 due to rising competition from the well-funded cloud behemoths Amazon and Microsoft in its core load-balancing products. Moreover, Bhagavath also said its security products, which the company says is growing by double digits, could come under attack from Cisco and Akamai.

On the topic of competition, new CEO Locoh-Donou said:

Within the growth of the virtual ADC [application delivery controller] market, there are use cases that potentially are best addressed by a simple implementation with the AWS [Amazon Web Services] solution. So if a small enterprise has a single use case that doesn't require a lot of application services, but just simple load-balancing, then that's a scenario where there's a good fit for a WAF-type [Web application firewall] solution.

But there are a large number of use cases in the virtual ADC space that are well addressed by our Virtual Edition, and we're seeing, actually, very significant revenue growth on our Virtual Edition, and generally in software, as a percentage of our revenues in general.

F5 is certainly the leader in this type of product, and for advanced uses, continues to be the leader today; however, we all know that Amazon does not stand still, and is a vigorous competitor in any field it enters. It is not unthinkable that Amazon, Microsoft, and Cisco will improve their offerings in time.

Looking ahead

F5 continues to earn very high returns on capital, which is great in the sense that it seems to have had a competitive advantage and is embedded in its customers' data centers; however, a high return on capital means that competitors will look to get a share of those big profits.

I wouldn't count F5 out just yet, as it has been a leader in application management and security for two decades and F5 is very embedded in large customer deployments. Only time will tell which of these companies continues to have the better product, sales execution, and pricing in the fast-moving world of enterprise tech.

10 stocks we like better than F5 Networks
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now and F5 Networks wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of May 1, 2017

Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Billy Duberstein owns shares of Amazon and Microsoft. The Motley Fool owns shares of and recommends Amazon. The Motley Fool recommends Cisco Systems. The Motley Fool has a disclosure policy.