F5 Networks (NASDAQ:FFIV) is definitely looking good following its first-quarter earnings. It exceeded estimates for the second quarter in a row and gave positive guidance for the coming quarter. This is good news after a troubled 2013 season.
F5 has previously claimed that its quarterly results in different markets are often flukes and not indicators of trends, due to the large size of its contracts and the subsequent lumpy income. The management was probably trying to explain occasional unfavorable numbers, but the same reasoning might also explain last quarter's great performance. What are the reasons to hope F5 can continue growing in the future?
F5 is back on track
It's important to put the recent numbers into perspective.
The first half of fiscal 2013 was clearly not a good time for F5. However, F5's most recent revenue figure was $406.5 million, up 11% from the first quarter of 2013. Its earnings guidance for the second quarter is $408 million-$418 million (the green section on the graph, estimated at $413 million), which equates to 18% growth year-over-year.
While this rate of growth isn't as impressive as the explosive expansion F5 experienced prior to 2012, the numbers themselves are solid and outpace much of the tech sector. So, what's the story behind this turnaround?
The product refresh delivers
In 2013, F5 completed its largest product refresh in years. F5's management believes that this has been one of the drivers of the improved growth in the second half of 2013, as well as a possible explanation for the stagnation in the first half of that year (customers were delaying orders and waiting for the new product release). Indeed, product revenue was up 7% year-over-year in the first quarter.
How long can the product refresh continue to drive sales? On the conference call, CEO John McAdam stated, "If you look historically, there certainly have been two to three years of growth that we could assign directly to [the product refresh]." Two to three years can be a long time in the technology market, but there seems to be no reason to doubt that F5's updated product line will be attractive to customers for at least the next few quarters.
The core is strong
The application delivery controller, or ADC, business has always been at the center of F5's strategy, since it forms the platform to which the company's other products can be added. F5 has dominated this market with a share of about 40%-50%, though the company has started to see increased competition in the last several years from big names like Citrix and Brocade, as well as from smaller competitors like Radware.
The ADC market is maturing, but, according to F5, it's still a large opportunity. In particular, since Cisco (NASDAQ:CSCO) withdrew from the ADC market with its ACE product, there have been replacement opportunities that both Citrix and F5 have been fighting for head-to-head. Even though Citrix is Cisco's recommended ACE replacement, F5 has been winning a large number of these contracts and continues to see ACE replacement as an opportunity for at least the next two years.
Expanding into new markets
F5 has traditionally entered markets related to its core ADC business. Two such new efforts seem like they could grow into significant sources of profit in the coming years.
First is security, which is already becoming a major driver of business for F5 -- in 2013, 30% of F5's product sales involved some security component. When questioned about the best prospect for growth, McAdam responded unequivocally, "Security, across the board." Besides developing its own products in this arena, F5 recently acquired security company Versafe. It will be releasing Versafe's products as subscription-based services that could provide increasing revenue over time.
The second exciting growth prospect for F5 is Diameter signaling, which is a solution to help service providers cope with ever-increasing amounts of traffic coming from smartphones and tablets. Current sales of F5's Diameter product, Traffix, are still modest, but they are picking up. The exciting part is that, since only one-third of service providers worldwide have made the switch to the Diameter protocol, eventually they all will be forced to do so. Due to its large customer base among service providers and its investment in developing Traffix, F5 is well-placed to be a front-runner in this market.
F5's stock has traditionally been volatile. The company has grown impressively, but its customer base -- often very large enterprises and organizations -- means that its income can be lumpy and its quarterly performance variable. Nonetheless, F5's current portfolio of successful products, as well as its expanding businesses in security and Diameter signaling, suggest that the company is well-placed to continue growing in the future.
Srdjan Bejakovic has no position in any stocks mentioned. The Motley Fool recommends Cisco Systems. The Motley Fool owns shares of F5 Networks. 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.