Network Engines: Worth a Second Look?

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May 22, 2006 | Stocks | | Author Asif

Towards the beginning of April, a SINLetter subscriber asked me about Network Engines, Inc. (NENG) and I posted my thoughts about why it was prudent to stay away from Network Engines here. Since then Network Engines has lost close to half of its value falling from $3 per share to $1.65 after releasing disappointing quarterly results. Most of this steep loss in Network Engines occured before the recent worldwide carnage in the stock markets.

At its current market cap of $62.65 million, Network Engines just might be worth a second look. The company currently holds $33.7 million in cash and short-term investments on its balance sheet and the new management team headed by CEO Gregory A. Shortell (an ex-Nokia executive) looks promising. At its current cash burn rate of under $3 million a quarter, there is a good chance that the company will reach profitability over the next few quarters as its NS series product gathers steam. Network Engines still remains a speculative investment and there is a chance that the stock could head lower but at this point I feel that the potential rewards far outweigh the risks.

Voluntary Disclosure: I currently do not hold any positions in Network Engines but may start a long position soon.




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  1. yehuda fruchter
    May 29th, 2006

    As an investor in Network Engines, I did not think their second quarter report was at all dissappointing. It was exactly as expected and forward guidance was good. The stock fell for no other reason than that it was up almost 100% in a short period of time, on expectations that will take at least another year to pan out. Unfortunately, the market in micro caps is very volatile. Reading anything into the short term price movements is dangerous, IMHO. I encourage you to listen to the JPM investor conference where the CEO of Websense (WBSN) specifically mentioned the NS Series and expected good sales starting in July. With all the readily publicly available information pointing to a successful product in the NS, with $10 million a year in operating profits already from the OEM business, and with $30 million in cash, I do not think Network Engines at the market cap is at all speculative, unless paying 4X EV/cash flow is risky. I have been long NENG since $1.88. Rode up, rode it down and keep buying.

  2. Asif
    May 30th, 2006

    Yehuda, as someone who used to be a part of Value Line’s equity analyst team, I respect your opinion. I have read all your posts about Network Engines and referenced two of them in my first post about Network Engines. Revenue growth of 2.56% when compared to the first quarter of 2006 and a widening loss both on a GAAP and non-GAAP basis in indeed disappointing for a stock that shot up more than 100% in less than three months. The reasons I classified Network Engines as a speculative investment were the volatility you mentioned along with uncertainty about when Network Engines would reach profitability. However at these levels I agree with you that the stock does look attractive. I recently started a long position in Network Engines and I wish you luck.

  3. Yehuda Fruchter
    June 21st, 2006

    Hi Asif,
    Good points. I believe it will still take another six months or so, until we see some decent revenue growth from NS. So the jury is out on NS until 2007. But it is important to remember that the company has a profitable OEM business, which provides some degree of protection for investors in the event that the higher margin NS Series does not catch on.

  4. Former Perfect Guy
    June 21st, 2006

    The problem with investing in Network Engines (NENG) as this point is the big question about where we are in the economic cycle.

    How soft or hard a landing is the economy going to go through over the next year as interest rates keep getting raised?

    Right now businesses are going great guns but the money maker for Network Engines NS series will be ISA Server 2006 software which is not due to be released until the end of this year or in the first half of 2007.

    If the economy holds together reasonably well and companies don’t starting cutting IT budgets then Network Engines worth buying as a speculative investment even at these prices. However with the economic outlook for 2007 very hazy at this point I think that at this time that there are far safer investments with good returns available than Network Engines.

  5. Asif
    June 21st, 2006

    If the only market Network Engines (NENG) was serving at this point was the North American market then a slowdown in the economy could be a concern. On May 10th, Network Engines signed a distribution agreement with NOXS to distribute its products in Europe (mainly France and Italy) and in early April it signed an agreement with Unipalm to distribute its products in UK and Ireland.

    This should come as no surprise as the new CEO Greg Shortell has a strong background in international operations and sales. With the release of the new Motorola Q phone that runs Windows Mobile 5.0 and the continued popularity of the Blackberry, I see increased deployment of Microsoft Exchange Servers. This could be very beneficial to Network Engines as it makes security appliances specifically tailored to protecting Exchange Servers.

    It does remain a speculative investment as the company is currently unprofitable and the path to profitability is not very clear. This is why I have not yet featured it in my investment newsletter. Given its current management team, cash burn rate and strong balance sheet, I am willing to allocate a small portion of my personal portfolio to Network Engines.

  6. Mike
    July 27th, 2006

    Yahuda

    Any thought (negative or positive) about today’s earnings report and the CC, especially regarding the “Getronics” deal. Your input is greatly apreciated.

  7. Rob Saikaley
    December 24th, 2006

    Shortell has reinvisioned what Network Engines will look like in the future. Hes our unstoppable man of progression. Bringing many oem products to our manufacturing table with high quality products will only ensure the success of the many divisions he is creating at Network Engines. The NS series of firewall appliances will be just one of our offered products through the channel products being manufactured.

    The manufacturing divisions are for Covax, Newbury Networks, SurfControl, Emc, and others but the most important of all is the dbx small business appliance manufactured for Getronics.

    The revenues alone for this manufactured product over the next 5 years already guarantees a doubling of sales each quarter for the next 5 years. At 2.70 nobody is saying where is the money!

    Its already here and im not selling any shares till this stock reaches full evaluation on the new profit cycle that is beginning to commence for the second quarter(jan-mar) of 2007.

    Its a no brainer really. Buy to accumulate till full value is reached on a forward looking PE multiple ratio.

  8. Asif
    December 26th, 2006

    Thanks for your comments Rob. Did they explicitly mention reaching profitability in the second quarter of 2007 in the conference call? From the fourth quarter earnings release it appears that they expect to make another loss of $(1.1) million to $(1.4) million in the fiscal first quarter of 2007 and revenue is expected to drop for the second sequential quarter.

    The small business appliances are still under testing by Getronics and a whopping 99% of revenue still comes from the OEM business. Unless I am mistaken, it has now been over two years since they launched the NS Series Security Appliances.

    While the loss in fiscal 2006 narrowed considerably when compared to 2005, it should be noted that half the loss in 2006 can be attributed to stock based compensation. I am still long Network Engines but am considering taking profits off the table if revenue growth continues to remain anemic.

  9. Rob Saikaley
    December 26th, 2006

    As always the conservative expectations of each quarters projections are always beat by management. It ensures the success of management regaining confidence of the current long term shareholders including myself. Revenue growth being anemic? I certainly do not think this will be the case for 2007. A doubling in revenues for just one large contract with Getronics will insure growth in revenues and profits. As for the NS SERIES SECURITY appliances. A new integration of these devices will be installed with many other corporations as integration devices.

    Its a new formula that balances the synergies of the Network Engines output. Other corporations now see the value added using Network Engines new protocol. Balancing new contracts will meet in the channel devices to every corporation interested in saving themselves their own start up manufacturing costs.

    Network Engines will profit from each contract received. Just some input thoughts for the day. Taking profits? The loss by the way will be very small this quarter. I expect an upgrade in their earnings forecast in January for the January to March period.

    The sales are going to climb exponentially as Network Engies fullfills their contract with Getronics in 2007!!!

  10. Envoy Global Research
    December 26th, 2006

    Hi Asif,

    Thanks for starting this thread again.

    Readers should check out Envoy’s latest post about NENG at:

    http://www.envoyglobalresearch.com/2006/12/notes_from_netw.html

    As Rob rightly pointed the NS Series is no longer a standalone product line. It’s been morphed into the OEM business. See the link above for details.

    Best of luck.

  11. Rob Saikaley
    December 26th, 2006

    I will post here where common sense prevails. I see nothing on the yahoo site this evening. I have put many aliases on ignore. I was right that over the last two years my list of wantabee bashers&bulls are all but the same person trying his best to derail the long players. What a joke for all to see. We cannot police the thread at yahoo anymore but talking amongst sain minds is better from time to time. Im actually happy to post here. I find it more annoying lately to see Mr Trader/basher/slash whoever he is bashing nonstop. Its really hard to have a conversation with someone so bashful. Its the deceit and lies we have to hear. Why arent there any laws to protect the Corporation from being ramsacked by such fraudalent postings.

    I will be married to my stock for quite some time Asif why do you think profits will be anemic in the second quarter of 2007? Im expecting a breakeven quarter for the first but Getronics has orders to fill for 17 of the 20 largest banks in the world. Thats 12 weeks of continued nonstop delivery of the dbx small business appliance manufactured by Network Engines. They are selling these devices through Getronics at 3700 dollars a pop to each banking branch. Of course that is the smallest branch by the way.

    Why would you sell and take profits if you knew profits will move the stock in the second quarter? I just dont get why you would even trade it for such a small run. Why shoot your winning horse before she even crosses the finish line. The horse hasnt even left the gate yet Asif. Just from a market maven like myself. I have learned over the years never shoot your winning horse till it runs runs runs and crosses the finish line!!! I am accumulating stock each day. Hopefully we attract more and more posters here and sinletter edits out the bashers. I have no need to promote this stock because the fundamentals in the short and long term will take care of themselves. We will go up as more deals and the pipeline of products manufactured go out the company door.

    A much more peaceful thread without the trash of bash. Thanks

  12. Rob Saikaley
    January 1st, 2007

    I have seen so much from the Conference Call wil be posting it soon from the yahoo message board

  13. Asif
    January 3rd, 2007

    Rob, it took me a while to respond to your comments as I was caught up with writing the January investment newsletter.

    I guess I was looking at the drop in revenue from Q3 2006 to Q4 2006 and was considering that as anemic revenue growth. The Year-Over-Year revenue growth at Network Engines in indeed impressive. I have tabulated the YOY and sequential revenue growth for the last four quarters below.

    Quarter Year-Over-Year Growth Sequential Growth
     Q1 2006  1.15%  17.88%
     Q2 2006   18.43%  2.81%
     Q3 2006  31.86%  14.3%
     Q4 2006  35.49%  (2.20%)

     

    I look forward to your post about the conference call.

  14. Rob Saikaley
    January 4th, 2007

    Network Engines Conference Call Transcript.

    Part 5 and once  you get there just scroll down to part 4 3 2 1

    I tried posting the whole letter here and i was not allowed something about it being truncated. I split it in parts on yahoo.

    Shortell has got this company on overdrive!!!

  15. Envoy Global Research
    January 4th, 2007

    Q4 is almost always down sequentially from Q3. It’s a seasonal thing. Q1 is also usually much stronger than Q4. Since they were profitable in Q4 2006, it therefore stands to reason that they will show impressive profits in Q1 2007. The strange thing was the conservative guidance given by management in Q4 2006, but given their continued conservative estimates it’s probably a very low-ball number and it’s a good bet these guys will surprise nicely to the upside in the coming quarter.

  16. Asif
    January 4th, 2007

    Rob, the truncation issue will hopefully be taken care of when we move to a new server this weekend. Thanks for posting a link to the transcript.

    Yehuda, I looked at the income statement for the last three years and you are right about the seasonal weakness in Q4. I read through the earnings guidance part of the conference call and I wish they had been clearer about what we can expect in 2007.

  17. Envoy Global Research
    January 5th, 2007

    Hi Asif,

    I wish they were clearer also, but I think Shortell learned his lesson. When he first came on board almost a year ago, he was putting out fluff PR almost every day and the stock subsequently doubled to over $3. But then results did not live up to the hype and the stock cratered again. I think he realized that you can’t run a public company like you run a sales department, i.e. on just hype. So my guess is that they are now being very conservative with estimates. But if history is any guide Q1 should be better than Q4, which means we’ll see a nice profit. That’s my bet anyhow.

    In sum, I’ve been with this stock for about a year now. Bought in at $1.88 and hung thru all the nonsense and volatility just waiting for the cash profits which we just had. So I’m very pleased with the return thus far (30%) and the improved financial results at the business. Most people in this stock and other  tech stocks have completely unrealistic expectations.

    If anyone is interested I suggest they re-read my initial coverage of this stock back in February 2006. I was calling for a double in two years. A double will be about $3.60. I expect we’ll reach that price in 2007, if the company reports another profit this quarter.

    Link to my first report can be found here:

    http://hardware.seekingalpha.com/article/8381

    Best of luck.

  18. Mike
    January 10th, 2007

    Yahuda

    You quoted in your earlier posts that you originally purchased NENG at $1.88 about a year ago, and that

    <

    If anyone is interested I suggest they re-read my initial coverage of this stock back in February 2006. I was calling for a double in two years. A double will be about $3.60. I expect we'll reach that price in 2007, if the company reports another profit this quarter.>>

    This means that you are NOT giving any enhanced value to the pps with Shortell being the new CEO, nor to any of the recent joint agreements that NENG has signed since then under Shortell’s management (specifically Getronics and a few others)… What gives ???

  19. Rob Saikaley
    January 14th, 2007

    The corporate web site has been updated to show the new strategy they are taking from within the new applications being offered and hardware approaches. This includes Getronics, Surf Control, and other makers. We are moving ahead and this stock will move higher with or without the market makers.&nbsp; New buyers will step in once they deliver on more growth potentials on revenues and profits. I can feel the naked short sellers squirming. You cannot price a stock that is profitable into the negative column. The corporation is running on all cylinders. Good luck to all but no luck is required here….just accumulation of more and more shares. This is a long term play and it will unfold each quarter. Thank you

  20. Rob Saikaley
    January 19th, 2007

    The Yahoo message board is dead. Go figure that one out fellows. Maybe management complained about the abuse of the one only ISP number putting in so many bullshit aliases of both positive and negative aliases. Well it looks like we have a new message board here for now as Shortell cleans up the message board. I am speculating but perhaps the MR TRADER is getting set up for a lawsuit. Yesterday i noticed there were only 4 posts all day. Did Mr Trader with 1000 aliases take a vacation for a week?

    Good day everyone. Observations on a weary corrupt trader but Network Engines will outshine its own fundamentals soon.The growth parameters are set and the employee notices are few which means full work force are working on all cylinders. At 2.35 a share a bargain nonetheless from the recent highs. I thought this stock would have been over 3 bucks by now. I do think it will surpass its 52 week high.

  21. Rob Saikaley
    January 19th, 2007

    It seems every message board is down so ignore my last post. Its very interesting to note perhaps Yahoo has finally decided to only allow one message poster per each IP address. Then the abuses we see today will stop and we can certainly thereafterwards identify with each other as real legitimate posters. The theory goes there is one big trader with 100’s of aliases. Yahoo needs to clean its image up for the message boards to be taken seriously. Good day everyone

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