NetApp Rallies on Restructuring

Investors warm to the storage company's strategy to cost cuts and boost its margins.
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NetApp's

(STX) - Get Report

shares rallied in early trading Thursday as investors overcame the initial shock of the firm's

third-quarter results

.

Despite suffering the ill effects of the tech-spending slowdown, investors warmed to NetApp's long-term plan to cut costs and stabilize its business.

The storage specialist, which has been perceived as one of the more recession-resistant tech firms, had a tough third quarter, missing Wall Street's revenue forecasts as it swung to a $75 million loss.

After plummeting during extended trading Wednesday, NetApp's shares surged Thursday, rising 80 cents, or 5.26%, to reach $16 Thursday. Despite its worse-than-expected third quarter, NetApp still outpaced the broader decline in tech stocks, which saw the

Nasdaq

slip 0.24%.

By touting technologies such as de-duplication, which eliminates users' redundant data, NetApp positions its products as a way for firms to cut costs, although the third-quarter

spending climate

was tougher than it anticipated.

"While our results in November and December were close to plan, close rates became even more unpredictable than we had expected in January and January performance was lower than planned," explained Steve Gomo, the NetApp CFO, during a conference call.

NetApp's top enterprise accounts were the main reason for the firm's third-quarter revenue shortfall, cutting their spending by 20% year over year. New accounts, however, partly made up for this by growing 16%, according to NetApp CEO Dan Warmenhoven.

"It was very concentrated in those

top enterprise accounts," he said. "They just basically stopped spending."

Like

other

tech firms, NetApp is now

streamlining

its business, which is clearly resonating with investors. The company, for example, announced plans to reduce its reliance on contractors and outside services in an attempt to get its arms around its costs, as well as examining its real estate portfolio.

"Looking further out into our next fiscal year the restructuring actions we are taking now will enable us to achieve our targeted 16% operating margin and revenues in the low-$900 million range," added Warmenhoven. "This sets our foundation for future growth."

In something of a cruel irony, however, NetApp also outlined plans to

cut

540 jobs, or 6% of its workforce earlier this week, just three weeks after

Fortune

named the firm the best place to work in the U.S.

In the fourth quarter, NetApp expects to incur severance and other charges of between $30 million and $35 million as a result of its restructuring strategy.

"Management is quickly reacting and taking actions to protect margins," wrote William Choi, an analyst at Jefferies & Co., in a note released Thursday. "But we remain on the sidelines given falling IT spend, unfavorable mix shift, and increased competition."

Citing lack of visibility, NetApp has not issued fourth-quarter revenue guidance, although analysts estimate that this will be around $925.5 million.

Choi, however, warns that NetApp's actual revenue could be much lower. "Our checks suggest current business remains weak, and a lot depends on the month of April -- as a result, we are modeling fiscal Q4 revenues to decline 4% sequentially to $837 million."

Min Park, an analyst at Goldman Sachs, also warned that NetApp's future looks cloudy.

"An uncertain revenue outlook and several negative trends take away the urgency to buy NetApp shares now and our rating remains neutral," he wrote, in a note released Thursday.

Park explained that NetApp's results and its comments on the recent drop-off in demand will likely cause the shares to give back much of their 9% year-to-date gain. "Moreover, without a catalyst, the shares should trade with market following the reset," he added.

NetApp reported third-quarter revenue of $746 million, down from $884 million in the same period last year, although the third quarter was impacted by a $128 million accrual related to a dispute with the General Services Administration (GSA). Without this item, NetApp would have reported revenue of $874 million, still below analysts' estimate of $912 million.

The Sunnyvale, Calif.-based firm posted a loss of 23 cents a share on a net loss of $75 million during its third quarter, compared to a profit of $102 million or 29 cents a share, in the same period last year.

Despite its lack of revenue guidance, the storage specialist was somewhat more forthcoming on the subject of margins during its conference call, estimating a fourth-quarter non-GAAP gross margin of around 60%.

NetApp, which competes with

EMC

(EMC)

,

Hewlett-Packard

(HPQ) - Get Report

and

Isilon

(ISLN)

, also promised to launch "another high end platform" in 2009, referring to the next version of its Data ONTAP storage pooling software.

Choi, however, was largely unmoved by this news.

"We see several longer-term growth opportunities (including software upgrade), butnear-term fundamentals remain weak," he said, maintaining his 'hold' rating and $13 NetApp price target.