F5 does deserve credit for growing service revenue 28%. This means that the company is doing well and is outperforming Juniper and Cisco in the service category. It's also outperforming Check Point, which is considered the best in the business. But F5 managed to offset its strong service performance with a dismal 4% growth in product revenue. Plus, it was down 2% sequentially. And this was supposed to be F5's strength.
Can profitability silence the alarms? On the bright side, the company made significant improvements in profitability. Gross margin advanced year over year by almost one percentage point and improved sequentially by forty basis points. And, despite the uninspiring performance in product revenue, F5 made them count. As evident by the improved margins, the company got the most from the product it was able to move. But operating income shed 2% sequentially, which was caused by an uptick in sales and marketing expenses.
This is not so much of a concern, however. As an investor, I would have been angered if the company opted instead to sit on its hands and did nothing while bleeding market share. This is precisely what Juniper has done. Plus Cisco has exited the application delivery control market altogether. Essentially F5 does not have to compete with two of its biggest rivals and is still unable to fully dominate this market. Something's wrong.
F5 has to get back to its strengths, which lies in its products. And investors should feel encouraged that there are some catalysts on the horizon, including a new product cycle. From that standpoint, the company deserves a little more time to fix its underlying operational issues. Product revenue can't stay in the single-digits. Either the market has become saturated or F5 is not executing up to par and neither scenario is good for the stock.
But all in all, compared to Juniper and Check Point, this wasn't a terrible performance for F5. Unfortunately, this first quarter followed a horrendous fourth quarter which made things look worse. That the stock didn't tank following the report means the company is getting a pass for now. But for how long? Eventually, investors will realize that the potential they are paying for in these shares today is not being met in execution.
Plus, with Cisco and Fortinet performing so well, explanations such as macro and sector problems no longer carry weight. In the meantime, valuation matters for F5. And for this stock to make sense again, the P/E needs to come down commensurate to the company's reduced guidance. Astute investors should be hearing alarm bells.
The article Why It's Time to Sound the Alarms at F5 Networks originally appeared on Fool.com and is written by Richard Saintvilus.
Fool contributor Richard Saintvilus has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Check Point Software Technologies, Cisco Systems, and F5 Networks. The Motley Fool owns shares of Amazon.com, Check Point Software Technologies, and F5 Networks.
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