Rafael Nadal is still in contention, rebounding from his five-set, second-round win to beat No. 106-ranked Dudi Sella 6-1, 6-0, 7-5 in a third-round match lasting a little over two hours to reach the fourth round.
In women's play, Eugenie Bouchard of Westmount, Que., struggled through a scrappy opening set before earning a 7-5, 6-0 third-round win over Caroline Garcia that featured 10 breaks of serve.
"Yeah, I don't think it was the prettiest tennis out there," said Bouchard, who reached the semifinals in her first trip to Melbourne Park last year and went on to make the semifinals or better at two of the other three majors in a breakthrough season.
No. 2-ranked Federer came into the season's first major in form, winning the warmup tournament at the Brisbane International and aiming for an 18th Grand Slam title. Nadal was coming off a lengthy stint on the sidelines, and hadn't given himself much chance of collecting a 15th major.
Federer had never lost to No. 46-ranked Seppi in 10 previous meetings, but made some uncharacteristic errors including nine double-faults — one to surrender a mini break in the last tiebreaker — in the 6-4, 7-6 (5), 4-6, 7-6 (5) defeat.
Seppi, a 30-year-old Italian who had only advanced beyond the second round once at his nine previous trips to the Australian Open, held his nerve despite some withering winners from Federer, who registered his 1,000th career match win earlier this month in Brisbane.
Federer also had a 4-1 lead in the second-set tiebreaker and let it slide.
"I knew how important that second-set tiebreaker was — clearly that hurt, losing that one," Federer said. "It just broke me to lose that second set. And actually the fourth, I should win it, too. Just a brutal couple of sets to lose there. The end wasn't pretty."
Federer has won the Australian title four times, and had reached the semifinals or better at Melbourne Park every year since winning the championship for the first time in 2004. This was his earliest exit since 2001, when he also lost in the third round.
"I had to believe that I could win," said Seppi, who said he stuck out his racket and hoped for the best on match point — a forehand that sailed past Federer and landed in the corner. "I was just trying to stay relaxed and just focusing on every shot and to breathe calm and don't get nervous.
"I think I did pretty well. Very well. I'm very happy I could manage the emotions."
The 33-year-old Federer walked over to Seppi's side of the net to shake his hand after the match, and applauded the crowd before he left the arena with his head lowered. It was only the second time in his last 43 Grand Slam tournaments that the Swiss star failed to at least reach the fourth round.
Seppi will almost certainly get another match on Rod Laver Arena for his fourth-round meeting with Australian teenager Nick Kyrgios, who shrugged off concern over a nosebleed to beat Malek Jaziri of Tunisia 6-3, 7-6 (6), 6-1. Kyrgios has form in the fourth round, beating then No. 1-ranked Nadal at that stage at Wimbledon last year.
Nadal faces a fourth-rounder against No. 14 Kevin Anderson, who beat No. 24 Richard Gasquet 6-4, 7-6 (3), 7-6 (6).
Three-time Australian Open finalist Andy Murray beat Joao Sousa 6-1, 6-1, 7-5 to set up a fourth-round clash with No. 10 Grigor Dimitrov, who had a tough third-rounder against 2006 Australian Open finalist Marcos Baghdatis before winning 4-6, 6-3, 3-6, 6-3, 6-3.
Seventh-seeded Tomas Berdych needed eight match points before beating Viktor Troicki 6-4, 6-3, 6-4 and will next play Bernard Tomic, who beat fellow Australian Sam Groth 6-4, 7-6 (8), 6-3.
On the women's side, No. 2-ranked Maria Sharapova needed just 61 minutes for her 6-1, 6-1 win over No. 31 Zarina Diyas and will next meet No. 21 Peng Shuai.
Third-seeded Simona Halep advanced with a 6-4, 7-5 win over Bethanie Mattek-Sands, missing twice when she served for the match in the eighth and 10th games before finally serving out.
Halep, who opened the season by winning the Shenzhen Open in China, will next play Yanina Wickmayer, who beat No. 14-seeded Sara Errani 4-6, 6-4, 6-3.