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Network Appliance Shares Swim Upstream

The storage company's stock offers a lone Nasdaq bright spot.

SAN FRANCISCO -- Shares of

Network Appliance

(NTAP) - Get NetApp, Inc. (NTAP) Report

tacked on new gains as investors overlooked rocky first-quarter financial results and cheered the company's outlook and its expanded stock buyback plan.

Late Wednesday, the data-storage gear maker

reported first-quarter net income that fell 38% from a year earlier but was in line with reduced guidance that management issued earlier in the month. Excluding nonoperating costs and stock-based compensation, the company earned 20 cents a share, a penny better than analysts' revised expectations.

The company's problems stemmed largely from a difficult sales environment. Contracts worth $1 million or more fell 27% from the previous quarter. Chief Executive Dan Warmenhoven said several large clients, mostly financial services, manufacturing, telecommunications and life sciences customers, put off purchases. This exacerbated pressure on the bottom line, which was already ailing under the prior year's excessive hiring.

But investors focused on Network Appliance's rosy second-quarter sales and earnings forecasts and its plans to improve profitability. Shares were recently trading up $1.76, more than 7%, to $25.92, offering investors a bright spot amid another severe selloff in U.S. and foreign stock markets.

Network Appliance's bookings rose 27% compared with the same quarter a year earlier, giving the company a beefy backlog that can boost revenue in the coming quarter. Warmenhoven expects a pickup in orders in the second half of the year, according to normal patterns of seasonal spending. He forecast second-quarter sales between $752 million and $768 million, a rise 15% to 18%, which would reverse the sequential decline it experienced in the first quarter.

"We've just picked ourselves off the mat," said Warmenhoven in a conference call Wednesday after announcing the earnings. "We believe the underlying market forces driving demand for our solutions remain intact."

The company also is taking measures to hold up past profit levels. A greater contribution of sales from software helped hold gross margins above 60% despite lackluster sales and pricing pressure on the company's core hardware products. And management is scaling back hiring plans to return its operating margin to its target rate of 16%.

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What's more, management said it will buy back an additional $1 billion in stock on top of the $200 million remaining for share repurchases. This could help stem the fall in earnings per share as the company works through an uncertain sales environment and tightens its cost structure.

Despite its profitability problems, Network Appliance has steadily generated cash, which could be used for the buybacks if problems roiling the credit markets make debt unaffordable.

Over the past few years, Network Appliance's cash flow has grown at a 38% compounded annually. First-quarter cash flow from operations rose 22% to $200 million, helped by faster collection of accounts receivable.

Free cash flow, which subtracts big-ticket investments such as machinery, rose 18%.

"I think the market has been inordinately harsh on Network Appliance," said Jay Hingorani, a Standard and Poor's analyst. "Based on our outlook, expected share repurchases, our view of a strong balance sheet and continued free cash flow generation, we see Network Appliance shares attractively valued."

He expects tech spending to pick up as IT managers place orders that they've been putting off.

Standard and Poor's has no business relationship with Network Appliance, and Hingorani doesn't own the company's shares.

Stephen Jue of mutual fund manager RCM, a long-term Network Appliance investor, says that company's prospects look promising because data storage remains high on the list of priorities cited by corporate information technology managers. He too says the shares are attractively valued, given the recent selloff.

Network Appliance's outlook did little for other data storage companies. Shares of its chief rival,

EMC

(EMC)

, were recently trading down 67 cents, nearly 4%, to $17.47.