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Network Appliance Beats Earnings Estimates on Soft Sales

It wasn't a blowup. But receivables and inventory leaped while the company tried to nudge analysts' growth expectations lower.

Updated from 4:29 p.m. ET

Network storage systems company

Network Appliance


reported fiscal third-quarter earnings surpassing Wall Street's expectations Thursday after the close of regular trading. But the company's sales came in a hair lower than forecast, an uncharacteristic shortfall for a company well-positioned in one of the fastest growing technology markets, and yet another sign that corporations aren't spending as freely on tech gear as they once were.

The Sunnyvale, Calif.-based firm said that income excluding certain items totaled $38.9 million, or 11 cents a share, in the period ended Jan. 26. That figure bests the 10 cents a share that analysts polled by

First Call/Thomson Financial

were looking for, and is up 95% from the $20 million, or 6 cents a share, the company earned in the same period last year. Actual earnings were $34.1 million, or 9 cents a share, compared with last year's $19.8 million, or 6 cents a share.

Revenue, meanwhile, came in at $288.4 million. That's up 91% from the prior year's $151.3 million, but about $5 million below the number analysts had been expecting.

You can blame the recent convulsions and contractions in the capital-expenditure budgets of some of NetApp's large customers. "We lost a certain amount of business from some of our largest installed base accounts because of their reassessments of their capital spending plans," CEO Dan Warmenhoven told

. "During those reassessment periods, they just chose not to spend anything." He cited the example of

Texas Instruments


, a large NetApp customer reviewing its capex plans. "They ordered nothing from us in January. It doesn't take many of those to take $10 million off the top line."

The Big Story

NetApp makes server appliances -- mainly filers and caching devices -- for network-attached storage, of NAS, systems. Unlike the traditional server-attached storage, or SAS, model, NAS detaches data-storage devices from the servers that run applications for a network's workstations. Putting storage devices directly on a network helps alleviate bottlenecks and allows technology managers to add new storage capacity easily by attaching additional appliances to the existing network.

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NetApp's single-minded focus on NAS has turned it into the prime beneficiary of the recent explosion of networked storage. The company holds more than 60% of the NAS market and has turned in 21 consecutive quarters of more than 70% revenue growth. But competition has been heating up as the immense opportunities have become clear. New initiatives by large, established hardware companies like

Sun Microsystems


and storage giant



, which has vowed to be the dominant company in networked storage, have led a number of brokerages to adopt more cautious stances on NetApp in recent weeks.

Accordingly, NetApp has lost more than 40% of its value in 2001, amid fears of declining profit margins and a general slowdown in corporations' spending on technology infrastructure.


With NetApp's stock having tumbled more than 20% in the two sessions prior to its earnings release, a $5 million revenue shortfall was certainly not the disaster that many had been fearing. But there were negative signposts that bear watching.

First, there was a big jump in accounts receivable, often a sign that a company is letting its customers take longer to pay. Receivables grew to $222.6 million, up 37% from the previous quarter and easily outstripping sales growth on both a sequential and year-over-year basis. According to the company, the largest single cause of the jump in receivables was a slowdown in early January that pushed bookings and shipments out toward the end of the month. NetApp says it was simply unable to collect payment on those sales before the end of the quarter.

Whatever the cause, the jump in receivables caused a correspondingly large leap in days sales outstanding, a measure of accounts receivable that counts the number of days between the time a product is shipped and when payment is received. In the third quarter, DSOs rose to 70 from 57. The highest point DSOs had reached in the prior 12 quarters was 62.

On top of all this, inventories posted a massive 67% sequential increase, reaching $37.1 million. Inventory turns, or the number of times on average that a company is able to sell its inventory each quarter, fell to 12, a 29% decline from the prior quarter's 17.

NetApp hardly dodged these issues. On a conference call following the earnings release, CFO Jeffry Allen said that measures had been taken to get inventory turns back to the company's target of 15. He also pledged to get DSOs back down to the company's targeted range of 50 to 60 in the next two quarters, though Warmenhoven later told


that a range of 55 to 65 would be more realistic in the current environment. These numbers will be closely watched in coming quarters.

Spinning It Forward

NetApp maintained its normally positive tone concerning the competitive landscape. Warmenhoven touted his sales force's customer-win rate, which he puts at above 80% in competitive situations. He said that the company wasn't feeling any extreme pressure to cut prices, though CFO Allen did tell analysts to expect gross profit margins to decline "moderately" over the next several quarters. As for the EMC juggernaut, NetApp management boasted that recent NAS product introductions had done nothing to disrupt its ability to compete, since EMC's salespeople are reluctant to lead with a product that threatens that company's main SAS business.

However, at the same time, guidance was considerably more sober. Allen told analysts to expect sales growth to come in at the low-end of the company's targeted range of 10% to 15%. Growth of 11% would put NetApp's fiscal fourth-quarter revenue at $320.1 million, about $11 million below current estimates.

The rest of the company's guidance was similarly conservative. Allen predicted 2001 sales of $1.1 billion -- about $15 million below estimates. For 2002, he forecast sales growth of 55% to 60%, the low end of which equates to sales of $1.7 billion, about $50 million below estimates. (The company's guidance for fiscal 2001 and fiscal 2002 earnings was squarely in line with estimates: 41 cents a share for 2001, which ends in April, and a range of 55 cents to 60 cents a share for 2002.)

All this considered, investors shouldn't be surprised to see analysts do some trimming Friday morning. In the current cautious climate, it would be more surprising if they didn't.

"We were basically suggesting that some of the analysts need to lower their numbers," Warmenhoven bluntly put it. "Some are sitting at the high end of that range, sort of like this quarter. They'll have to look at their models. I can't do it for them."