Friday, May 10, 2013

Citrix Systems Returning to Growth?

The difficult earnings season for technology continues, and Citrix Systems $CTXS didn't disappoint to disappoint. The market is in no mood to take prisoners right now with any kind of tech company that misses revenue and earnings forecasts. Consequently, the stock took a battering after it missed and guided earnings lower for Q2. On the other hand, I think there are some mitigating circumstances and this drop is a good opportunity to pick some up. So I did.

Citrix's citric Q1 results

A quick summary of the earnings and guidance relative to analyst forecasts

  • Q1 Revenue of $672.9 million vs. analyst estimates of $676.9 million

  • Q1 Non-GAAP EPS of $0. 62 vs. analyst estimates of $0.63

  • Q2 Revenue guidance of $705 million-$715 million vs. analyst estimates of $711.5 million

  • Q2 EPS guidance of $0.62-$0.63 vs. analyst estimates of $0.70

  • Full Year Revenue guidance of $2.95 billion-$2.98 billion vs. analyst estimates of $2.97 billion

  •  Full Year EPS guidance of $3.08-$3.11 vs. analyst estimates of $3.14

So, its Q2 EPS guidance is way below consensus estimates but the full year revenue guidance is in line with the market and Citrix’s previous guidance. However the full year EPS forecast is now 1.4% below estimates. Is that really a reason to panic?

I think the answer to this question is ‘no’, but then again, I can appreciate how some investors wouldn’t want to spend a summer waiting for the market to wake up and come around to its point of view. As for the maintenance of full year revenue guidance and the decent looking earnings guidance, well, what usually happens is that the market chooses to ignore them and focus on the near-term trends. They appear to be negative. Or do they?

Short-term loss aversion

I have a few points to make over these results which should add more color.

Firstly, there was a combination of temporary macro weakness and a new product issue which appears to be rectifying. IBM, Oracle, TIBCO, Fortinet, F5 Networks $FFIV have all missed estimates this earnings season. There is no doubt in my mind that corporations are in a ‘cost-cutting’ first mode right now, and fears over the sequester haven’t helped. In fact, they appear to be using any excuse to delay purchases, particularly with discretionary items.

IBM and Oracle saw general weakness (although they blamed sales execution), but I note that F5 is undergoing some product refreshes while the story with Citrix was largely over disappointing mobile & desktop virtualization revenue.

Citrix argued that this was partly due to the Q1 launch of its enterprise mobility XenMobile solution. In other words, customers may well have delayed orders. In a cautious spending environment, it’s reasonable to expect CIOs to ‘prioritize their caution’ towards any solution that wasn’t mission critical or required consideration. Is this what also happened with F5’s product refresh?

The good news is that Citrix forecast low double-digit growth in mobile & desktop license, and that its full year plans were ‘on track’.

Secondly, the Q2 earnings estimate is disappointing, but this is the first time that the company has actually given Q2 guidance. I suspect it did so because management knew the earnings number was coming in way below market estimates. I think that this is a consequence of the way analysts were modeling the numbers.

Moreover, the product mix (with Netscaler sales increasing strongly but virtualization growth weaker) is contributing to lower margins. Indeed, Citrix did lower full year margin and earnings guidance, but it was hardly a dramatic downgrade.

Thirdly, Netscaler saw strong growth in the quarter. Interestingly, this is in contrast with F5 Networks’s recent results. It’s hard not to conclude that the relationship with Cisco $CSCO hasn’t helped. After Cisco decided to stop investing in its application delivery controller (ACE), it shifted to recommending that its installed base should purchase Citrix’s Netscaler.

While the market was also made open to F5, it appears that Citrix has taken the opportunity to broaden the number of verticals it sells into. If there was some good news for F5 investors, it is that Citrix is not seeing any competitive changes in the sectors where it competes with F5. As for Cisco, these results are a good sign that its intelligent networks have real relevance with its customers.

Where next for Citrix?

In conclusion, if Citrix hits its full year guidance then the stock will be higher from here, although, I doubt many will believe that right now. In my view, there were enough positives in this report to justify topping up. Netscaler sales were excellent and XenMobile was cited as being on track for the full year. The weakness in desktop & mobile virtualization license sales is understandable in the context of a weak tech spending environment for Q1, and the launch of XenMobile seems to have caused some delays.

As ever, investors need to focus on valuation. This stock generated nearly $700 million in free cash flow and despite the weaker Q1, it is guiding towards over 14% revenue growth in 2013. If the tech slowdown proves to be temporary and customers get acquainted with the XenMobile offering, then the stock could recover nicely from here. I bought some more in anticipation.

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