F5 Inc. NYSE: FFIV is struggling along with most of its peers in the EDP services industry. The semiconductor chip shortage and supply chain constraints are inhibiting industry growth with many companies reporting a contraction in their revenues and cash flows. F5 Inc. is somewhat shielded from the brunt of these disruptions due to its pivot toward becoming primarily a subscription-based business offering cloud software and security packages. The rest of the company's operating segments, however, are experiencing a contraction in growth, and investors have paid attention to this. The company's stock is currently down 7% YTD and there is room for greater losses.
The company is set to underperform the market for the rest of the year despite seeing strong growth in its enterprise cloud and security software subscriptions. Although software sales for the company are expected to grow near the top of its 35% to 40% guidance range in FY2022, its systems, product, and global services segments will experience only an anemic growth rate in the range of 1% to 1.5%. Due to these problems, F5 Inc. is set to increase its non-GAAP EPS only by 5.2% in Q3 FY2022 to $2.30. By comparison, companies in the S&P 500 are expected to increase their earnings by 11.7% in the same quarter. The bottom line is that investors are aware that the company is struggling, as it currently trades 27% below the MarketBeat consensus and the semiconductor shortages are expected to continue throughout FY2022.
F5 Inc. Struggles In Q2 FY2022
F5 Inc. experienced a contraction in all of its market segments except for software in Q2 this year. The company experienced a 27% contraction in its systems growth and 4% in products which reflected how reliant its business remains on precious semiconductors. Revenue also contracted overall by 2% from the previous quarter.
It should be noted that the underlying demand for F5 Inc's products remains strong, but only a handful of suppliers are able to ship the required semiconductors used in the assembly of its hardware. Suppliers of these chips are expected to add capacity in Q4 this year, which will translate to improvements in the company's earnings in Q2 FY2023.
In the company's earnings call, it was stated that executives believed the semiconductor shortages are a temporary disruption, so no adjustments were made to the firm’s cost structure. This adversely affected F5 Inc's margins which in turn reduced its net income. The operating margin shrank to 26.5%, down from 30.3%, and its non-GAAP net income was reduced to $130.8 million, down from $155.1 million.
F5’s Upside in Software Sales Growth
On the software and subscription side of the business, things looked more positive. A saving grace for the company's earnings is the fact that an increasing percentage of its software revenues are recurring month-to-month. 69% of the company's revenues were recurring in Q2, up from 64% in the previous quarter. Total revenue from software also increased 25% to $152 million.
F5 Inc. also saw some wins from its infrastructure-agnostic approach to cloud application and security. Its flexibility in its offerings allowed it to land several marquee clients during Q2 including an American multinational beverage company and the Ministry of Health for a nation in the APAC region. The company's solutions allow its customers to unite both traditional and modern cloud architectures while not locking them into a single cloud, which is one of the firm's key competitive advantages.
Looking ahead, the company is positioning itself to help companies manage multi-cloud environments with its distributed cloud services offering. The new platform will unify an array of services used to manage cloud platforms into a single Software-as-a-Service offering. It also represents the first integration between F5 Inc. and its recently acquired company Volterra, which was completed early in 2021.
Share Repurchases Are Returning Value to Investors
To help offset the damage the global chip shortage and supply chain constraints is doing to the business, F5 Inc will continue to repurchase shares to drive up their value. The company repurchased $250 million in shares YTD FY22 and has committed to repurchase another $500 million in shares by the end of this year. The company’s ultimate intention is to return 50% of FCF to shareholders via share repurchases by FY23.
The Technical Outlook: Oversold and Unlikely to Recover Soon
F5 Inc. has been in a descending channel since the 21st of December last year. It’s clear to see that the overall trend is to the downside and is presently oversold on the stochastics. A cross-over is imminent on the MACD which suggests that momentum is gradually shifting to the upside. However, considering that the channel has been in place since the end of last year and the state of the market as a whole, it seems more likely that this will be a short-lived recovery before continuing its course toward the bottom.
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