F5 Networks (NASDAQ:FFIV) recorded 22% year-over-year revenue growth in the second quarter. It also exceeded revenue and earnings guidance for the third quarter in a row, thanks to strong demand for its underlying application delivery controller, or ADC, platform, as well as to newer offerings such as security and diameter signalling. Can F5 continue to improve its performance and to exceed expectations?
Good, better, best
In the first quarter, F5 introduced a new pricing strategy called good-better-best. Basically, this means that F5 offers three bundled solutions, which increase in value as well as in price. For the customer, buying one of the three bundles is cheaper than paying for components individually and simpler than choosing among dozens of different products and services. For F5, it's clearly an opportunity to extract more value from each customer.
F5 management has stated that the performance of the good-better-best program has exceeded their expectations. In the second quarter, there was an 82% increase in sales through the program, with over 70% of customers buying the "best" bundle. Importantly, the high-end bundle contains more high-margin software solutions, so the good-better-best program has the potential to independently increase both the top and the bottom line.
Security is the main driver
When asked previously about the best prospects for growth, F5 CEO John McAdam stated unequivocally, "Security, across the board." This continued to be the case in the second quarter, with F5's security offerings replacing competitors' solutions and winning two new multimillion dollar contracts.
Besides fighting for security customers directly, F5 has also formed a partnership with VMware (NYSE:VMW) that might prove to be lucrative down the line. VMware has been aggressively expanding its end-user computing portfolio as it tries to catch up to competitor Citrix Systems in such areas as virtual desktops and mobile device management. With the partnership, F5 will provide security for VMware's virtual desktop deployments, and as VMware works to ramp up its end-user computing sales, F5 should benefit nicely.
Traffix is competitive
As telecoms around the world roll out the new 4G LTE standard, a core piece of these new networks, called a Diameter signaling controller (DSC), is gaining in importance. Basically, a DSC allows network providers to better manage the huge amounts of traffic that are being generated by smartphones and tablets, a trend that will only increase in the coming years.
The number one player in the DSC market is currently Oracle (NYSE:ORCL), thanks to its acquisition of Tekelec in 2013. However, according to management, F5's DSC solution, Traffix, continues to win customers, including some from Oracle's Tekelec product. The DSC market is set to expand drastically in the next several years, as only a third of service providers worldwide have so far made the switch to the Diameter protocol, but in time, all will do so. The current success of Traffix is great news for investors in F5, since it means that the company will be able to fight for a lot of this new business down the line.
F5's management, whose guidance for revenue and earnings has been lower than performance for the last several quarters, is predicting continued growth for the rest of the year. In particular, they are forecasting third quarter revenue of $428 million-$438 million, a 17% increase year-over-year at the midpoint, and EPS of $1.35-$1.36, a 21% year-over-year increase.
The company is also expecting an increase in operating expenses. This is actually good news, since it is due to stepped-up hiring to cope with all the new opportunities. F5 has done very well over the last year, and thanks to its new pricing strategy and to continued demand for its core and extended offerings, it seems likely that F5 will continue to grow and to exceed expectations.
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Srdjan Bejakovic has no position in any stocks mentioned. The Motley Fool recommends VMware. The Motley Fool owns shares of F5 Networks, Oracle, and VMware. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.