F5 Networks (FFIV) is trading lower today (-3%) despite reporting good upside to 1Q18 (Dec) results last night as it appears product revenue was not quite as good as expected. A lot of people have heard of F5 Networks but may not really understand what they do. So let's take a minute to explain. The company sells application delivery controllers (ADC). Its software defined application services are designed to ensure that applications delivered over IP networks are faster, smarter and safer. F5 serves mid-to-large enterprises, the public sector, and top service providers around the globe.
Its core technology is a software platform called TMOS (Traffic Management Operating System). The TMOS platform supports an array of application services, including traffic management, network and application security, access management, web acceleration and a number of services. These services are available as software modules that can run individually or as part of an integrated system on F5's BIG-IP appliances and chassis-based VIPRION systems or as software-only Virtual Editions that run on major hypervisors in public and private clouds.
The majority of F5's revenue is derived from sales of BIG-IP and VIPRION products. The architecture of these systems is designed to accelerate and optimize the performance of F5's software by offloading repetitive, compute-intensive functions such as encryption and compression to specific components, and enabling complex application-layer processing at network speed. Deployed throughout the IT infrastructure, its hardware enables customers to consolidate multiple application services.
As IT architecture continues to evolve, there is growing demand for cloud-based and software-only application services that can be deployed in virtual environments next to each instance of an application. F5 offers its Virtual Edition (VE) products are software-only versions of the same application delivery services it sells as modules on its purpose-built hardware.
F5 has been struggling over the past year as the company has struggled to adapt its hardware-intensive offering to the cloud computing era of today. F5 has been focused on moving away from hardware and toward subscription software services with varied results. Keep in mind that F5 launched TMOS in 2004, before the cloud computing environment took off, so the company, like other tech companies of a certain age, has been having to adapt.
While not the same business, it does remind us of how Oracle has been struggling to adapt to the cloud world. On-premise enterprise systems had been its bread-and-butter for years and they have been criticized for being slow to transition to the cloud. ORCL has been trying to catch up with companies like Amazon and Microsoft. F5 is in a somewhat similar boat.
Turning to the Q1 (Dec) results, non-GAAP EPS rose 14% YoY to $2.26, which was well above prior guidance of $2.02-2.05. Revenue rose 1.4% year/year to $523.2 mln, which was at the higher end of prior guidance of $515-525 mln. Based on the Q&A from the call last night, it appears that analysts were a bit disappointed in product revenue in DecQ. It came in at $227.3 mln, down 5% YoY.
In terms of guidance for Q2 (Mar), F5 expects non-GAAP EPS of $2.24-2.27 and revenue of $525-535 mln. The EPS guidance is well above market expectations while the mid-point of the revenue guidance is slightly above market expectations.
F5 says it's seeing continued momentum with its software offerings, driven by customers deploying its system on-premises and in the public cloud. The company sees a number of emerging trends across the global application landscape: It's clear that applications and related services are taking an increasingly important role as digital transformation reshapes the modern enterprise. F5 says it's well positioned to benefit from these broader industry trends as customers require more multi-cloud support, IT automation, and application security.
In sum, based on the Q&A on the call, it seems product revenue in DecQ is being viewed as a bit of a disappointment, down 5%. The good news is that F5 expects there to be some sequential improvement in MarQ. Analysts are hoping that DecQ was the trough in terms of product revenue, but time will tell. Investors are seeming to adopt a wait-and-see approach.