Network Appliances Options are Bustling with Activity

Yesterday, there was some notable trading action in Network Appliance Inc. (NTAP). The stock closed the day higher by $0.78, or 3.53% to $22.88, and was up an additional 1.31% in the after hours session. Volume was remarkably heavy, with 10.3 million shares changing hands as compared to a daily average volume of just 6.7 million shares. But it wasn't simply the common stock that was active, Network Appliance options were bustling with activity.

While the trading of options expiring in March was mixed, the contract volume for puts with a strike price of $22.50; 3,389 $25.00; 5,242 $27.50; 3,223 with the volume for calls with a strike price of $22.50; 4,179 and $25.00; 11,222, like the reaction in the stock, the activity for options expiring in April was decidedly bullish. Of particular note, were the 21,298 contracts traded for the April call with a strike price of $22.50. Network Appliance shares have come off its January low of $19.58 by 16.8%, but the bullish activity is really hard to justify.

In an environment where tech spending is weakening, Network Appliance shares just recently forecasted lower fourth quarter earnings in the range of $0.35 to $0.37 per share on revenue of between $915 and $945 million, which is below the previous analyst consensus of earnings per share of $0.38 on revenue of $963 million. The projected estimates mean that the company would post its lowest sequential growth rate for the April quarter since 2003.

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[fAT]

$884 million, slightly above company guidance of $872-$883
million and ahead of our projection of $879 million. The top line
grew by 21% year-over-year and 12% sequentially. Non-GAAP
gross margins deteriorated slightly from the prior quarter, to
62.0% from 62.2%, but remained flat with the year-ago level. We
note that the sequential decline reflects an increase in business with
IBM, which accounted for about 5% of revenues in the latest;
NetApp supplies IBM with some storage products for resale, which
carry lower gross margins but favorable operating margins.
M oving further down the income statement, we note that the
company's cost controls were quite impressive, enabling non-GAAP
operating margins to exceed company guidance of 15.0%-15.5%,
coming in at 16.6% for the quarter. This is also ahead of the
company's long-term goal of 15.8%-16.4%.
At the bottom line, non-GAAP EPS were $0.37, compared with
$0.29 in the year-ago quarter, exceeding company guidance of
$0.33-$0.34 as well as our estimate of $0.34. Including all items,
GAAP EPS were $0.29, compared with $0.17 one year ago.
EARNINGS & GROWTH ANALYSIS
For the final quarter of FY08, management projects revenues of
$915-$945 million and non-GAAP EPS of $0.35-$0.37. While this
guidance is less than what Wall Street had been forecasting, it is in
line with our estimates. Accordingly, we are maintaining our 4Q08
non-GAAP EPS estimate of $0.36, but for the full year we are
increasing our estimate to $1.25 from $1.22 to reflect the success of
the third quarter.
A s we said in our last note on this company, we anticipate a
slowdown in IT spending, particularly at companies in the financial
services space. Indeed, NTAP's guidance for the current quarter
reflects this. Note, however, that the portion of sales that NTAP
derives from the financial services sector dipped to 13% of total
revenues in 3Q08 compared to the company's average of
14%-15%. In our view, this implies that NetApp has been able to
offset the slowdown in IT spending in the financial services sector,
and we expect this to remain the case moving into FY09.
Accordingly, we are increasing our non-GAAP EPS estimate for
FY09 by a penny, to $1.55. Our long-term growth rate forecast for
NetApp remains 16%.