Worrisome Comments From Network Appliance By Ben Thomas RealMoney Contributor 11/15/2007 8:07 AM EST

Updated from 7:16 a.m. on Nov. 14.

Network Appliance (NTP) reported a very solid number and provided guidance above the Street estimates. For the quarter just ended, the company reported adjusted EPS of 32 cents on revenue of $792 million. Product revenue came in at $541 million, with software revenue of $117 million and service revenue of $134 million. The company cited strength in the U.S. federal and Europe and Asia as primary drivers of the solid revenue numbers. The company also suggested that the sluggishness in U.S. economy continued.

The company expects revenue for the current quarter to come in between $872 million and $883 million and adjusted EPS between 33 cents and 34 cents. Consensus was for EPS of 32 cents on revenue of $855 million.

Management comments:

• The company continues to gain market share in the software storage industry (grew twice the industry growth rate according to IDC) .
• Network Appliance will start to compete a little more on pricing.
• Financial services are "squeezing down" on capex.
• The backlog is in a healthy position.
• Management will not cut expenses from the sales force unless it sees a collapse in the general economy.

Overall, the company reported very decent number and provided guidance that shouldn't be too disappointing. The problem is the company did talk about a slowdown in financials services, it did talk about the possibility of Europe weakening, and it did say that it would compete on pricing somewhat. So despite the positive numbers, these are worrisome comments. Is management just being conservative? Perhaps, but considering that the company has lowered guidance twice over the past nine months, it's enough to make you stop and think. Tough call right here. I may choose to stand back and watch for a bit and then perhaps trade it with a long bias.

Network Appliance Preview: Outlook Is Key

Network Appliance (NTAP) is slated to report earnings after the close Wednesday with a conference call scheduled for 5:00 p.m. EST. Current projections call for the company to make 26 cents in EPS on total revenue of $759 million. Originally, management guided the quarter to an EPS range of 24 cents to 26 cents on revenue of $752 million to $768 million. I think most on the Street are expecting the company to report solid numbers for the quarter but aren't quite sure what to expect for the guidance.

On the call, I'll be listening for any signs of management losing enthusiasm about the current macro picture. Generally speaking, even if the weakness is company specific, management will blame the economy first. If management plays up the weakness in financial services capex projections or IT spending levels at all, I would be very worried.

I suppose this is pretty obvious, so also look for smaller details, such as hits to the income statement. For example, I expect gross margins to come in around 62%, which would still be down year over year but still very respectable. Any pricing pressure or slowing IT demand will show up in the gross margins.

Lately, it seems that any tech company that talks about earnings, sees its stock sell off the next day. Given the weakening sentiment and the fear that management could talk cautiously about the quarter, I'm a little gun shy going into the quarter. Despite fair valuation at about 17x to 18x forward estimates, I plan to sit on the sidelines right here since I don't necessarily believe that strength at EMC Corporation (EMC) translates to strength at Network Appliance.

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At the time of publication, Thomas had no positions in the stocks mentioned, although holdings can change at any time without notice.

Ben Thomas, CFA, is the founder and managing principal of Waycross Partners. Waycross Partners is a long/short hedge fund that focuses on the technology and health care sectors. Before Waycross, Ben was a portfolio manager and senior equity analyst at INVESCO, where he was part of a team that managed over $20 billion in assets. While at INVESCO, he was the lead manager for the INVESCO Midcap Growth fund as well as the firm?s senior equity analyst covering technology stocks.

Prior to INVESCO, Ben worked for Banc One Securities and Prudential Securities. He graduated from the University of Kentucky with a bachelor?s degree in finance and went on to earn his MBA from Indiana University. Ben is a member of the CFA Institute and serves on the board of directors for the CFA Society of Louisville.

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