For all of the pessimism that seemed to be building about the outlook for tech in 2011, January's earnings reporting season seems to be swinging the market back to some degree of optimism. With a decent quarter in the books and management seeming pretty confident about the pipeline of new business, F5 Networks (Nasdaq:FFIV) looks as though it will enjoy yet another post-earnings run.

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A Decent Start to the Fiscal Year
F5 Networks reported fiscal first quarter earnings after the close on Wednesday and the results (and more importantly, the guidance) pleased the Street. Revenue rose 2% on a sequential basis (and 20% on an annual comparison). Product revenue was a little soft (down 0.5% sequentially), while software revenue climbed 7% and deferred revenue rose about 11%.

Profitability was more mixed. Gross margin did improve nicely - up 60 basis points (BPS) sequentially and a full point annually - due in part to higher sales of the software-intensive (and higher margin) Viprion systems. Operating income was less impressive; earnings grew less than 1% from last year as sales and marketing spending growth outpaced revenue growth. This isn't a cause for panic, but it bears watching as it will ultimately distill down to free cash flow. (For related reading, see Free Cash Flow: Free, But Not Always Easy.)

Mixed Markets
F5 reported some curious data on its end-user markets. Overall book-to-bill was above 1 and management seems confident about its near-term order pipeline. The company's telecom business did alright - down 9% sequentially in what is often a tough quarter. That's interesting giving the comments from Alcatel-Lucent (NYSE:ALU), Juniper (NYSE:JNPR) and Adtran (Nasdaq:ADTN) about carrier spending. Sales to financial customers were quite strong (up 13% sequentially), while government was very weak (down 23%).

For better or worse, investors should get used to this - both government and financial markets are likely to stay volatile.

Old Faces in New Places?
F5 really came into its own while Cisco (Nasdaq:CSCO) was churning through its midlife crisis, and F5's gains in the ADC market came significantly at Cisco's expense. Now Cisco is trying to strengthen around its core and rebuild what it has lost. F5 has a big lead in the still-growing ADC market, but no company should rest too easy when Cisco targets them. At the same time, companies like Citrix (Nasdaq:CTXS) and Brocade (Nasdaq:BRCD) would certainly like to grow their shares of ADC, though Citrix is quite a bit further along in that regard.

F5 management also realizes that the company must move beyond its core in ADC to expand its addressable market opportunities. So far, that has meant expansion into security and WAN optimization. That brings the company into even more conflict with Cisco (in security) and also into competition with Riverbed (Nasdaq:RVBD) (in WAN optimization), which also happens to be looking to get into the ADC market. If this all wasn't enough on its own, Check Point (Nasdaq:CHKP) wants to be a bigger player in the hardware and appliance side of security and could be a wildcard in this market.

The Bottom Line
On the surface, there is little cause to worry about F5's growth thesis - F5 doesn't make the Internet or network, but it makes them work better (and faster) and that's still very much a growth market. Still, those rich margins are tempting and F5 may eventually have to choose between growth (and market share) and profits.

F5 is a frustrating stock; I love the growth prospects and I think that momentum could easily come back into these shares and take it beyond its fair value in the $130's. Maybe value investors need to just accept that they'll never get large discounts to fair value in growth tech names and make their peace with it. While I would prefer to let the post-earnings enthusiasm burn itself out before buying, I admit that the risk of doing so is that I never get to buy these shares at a reasonable price.

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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

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