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Network Appliance Taken Apart

Daniel Del'Re

Shares of Network Appliance (NTAP Quote) sank late Thursday after the data-storage device maker lowered its revenue and profit estimates for the quarter that ended last month.

In a statement released after the markets closed, Network Appliance said first-quarter revenue would fall in the range of $684 million to $688 million. In May, the company had estimated it would have $745 million to $753 million.

The company blamed soft tech spending in the U.S. and U. K., namely from customers in financial services, manufacturing, telecommunications and life sciences.

Network Appliance also said it expects earnings to be 19 cents to 20 cents a share, excluding one-time items, down from its previous range of 24 cents to 25 cents and below analysts' average estimate of 25 cents.

The company's shares were recently diving $5.32, or 18.5%, to $23.39 in extended trading.

"We are disappointed with our [fiscal first-quarter] results. We believe our performance was impacted by some continued softness in enterprise storage spending, most notably in our existing customer accounts in the U.S. and parts of Europe," said Chief Executive Dan Warmenhoven in a statement.

In a conference call after the announcement, Warmenhoven said that some customers have curbed spending because past purchases left them with excess storage capacity. Others, he said, have become "very conservative" because of fears that the weak real estate sector would dampen economic growth.

"We're seeing a definite reduction in spending on capital improvements from most of our major accounts," Warmenhoven said.

The trouble is limited to the U.S. and U.K., as some of the largest economies in Europe and Asia continue to lead generally strong demand on those continents.

The giant legacy telecom carriers France Telecom(FTE Quote) and Deutsche Telecom (DT Quote), for example, have increased spending, said Warmenhoven. And Japan continues to lead growth in Asia.

Warmenhoven tried to ease the pain by saying that the customers causing the weakness are not switching to competitors like EMC (EMC Quote) or Hewlett-Packard (HPQ Quote). He said the company has maintained the same "win rate," or the pace at which it wins new business over alternative providers.

Network Appliance's troubles aren't completely unexpected. The company ended the fourth quarter on a sour note. Then, Warmenhoven said that the company hit an "air pocket" at the end of the quarter as prospective customers delayed purchases and the number of new contacts slowed to a trickle.

He said the company entered the first quarter with a smaller backlog than usual, which could dent the quarter's revenue and profit. The company took a hit for issuing guidance sharply below analysts' estimates.

At the time, Warmenhoven conveyed a similar message to his statement on Thursday, saying that the slowdown in purchases was systemic and that Network Appliance's competitors were suffering as well. He took pains to emphasize that his company was not losing market share.

It's uncertain how much the "air pocket" is responsible for Network Appliance's troubles. During the last quarter, the company hired new employees at a torrid pace. Analysts and investors faulted the company for aggressively expanding its workforce.

The company responded by ratcheting down its hiring from the nearly 490 new hires in the fourth quarter to a range of 200 to 250 for the first.

Even still, the company is clearly signaling to investors that its efforts to scale back expenses weren't sufficient to offset the slowdown that it continues to experience.

Chief Financial Officer Steve Gomo tried to end the conference call on a positive note, saying that he expects "absolutely expects sequential growth" from the first quarter to the second quarter, reversing the sequential decline forecast for the first quarter.

Gomo said that first-quarter bookings rose 27% from the same quarter a year ago and that the company has a significant backlog taking it into the second quarter, said Gomo.

He stressed that this differs from the fourth quarter in which Network Appliance had no backlog.

Gomo told analysts that they could expect the company to reach its target operating margin of 16% in the fourth quarter. At the end of the last quarter, he pegged the first-quarter margin at 12.5%.

The company plans to release its final first-quarter numbers Aug. 15.