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Xyratex Gored as Outlook Disappoints

Shares of Xyratex were slammed on Thursday as Wall Street registered its displeasure with the company's outlook for the fourth quarter.



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shares fell sharply on Thursday after the U.K.-based data storage company's fourth-quarter outlook apparently disappointed Wall Street by offering less upside to the current consensus view than expected.

"XRTX results for the August quarter demonstrate the challenges of being a small-cap company, with a lumpy business model and limited sell-side coverage," said BMO Capital Markets in a note to clients, adding later: "If the 'upside'

in the August quarter in revenue had come in the November quarter, and August had been more in line, we believe the stock's reaction would have at least been muted, and potentially even positive."

The reaction was anything but muted, however, as the stock ended the day as the Nasdaq's biggest percentage decliner with volume running at more than 7 times its usual churn.

The shares finished down $2.51, or 14.5%, at $14.84 on volume of 4.3 million. Year-to-date, they are still up more than 30%, but have fallen more than 27% since hitting a 52-week high of $20.45 on April 26.

After Wednesday's closing bell, Xyratex reported a non-GAAP profit of $37.6 million, or $1.20 a share, on revenue of $430.2 million for the three months ended in August. The performance was well ahead of the average estimates of analysts polled by

Thomson Reuters

for earnings of $1 a share on revenue of $408.4 million in the quarter.

For its fiscal fourth quarter ending in November, the company forecast non-GAAP earnings of 60 to 86 cents a share on revenue ranging from $395 million to $445 million. Those projections surrounded consensus views for a profit of 76 cents a share on revenue of $419.5 million, showing enough room on the downside to spook the Street.

Another factor may be that the last time Xyratex fell short of analyst expectations was in last year's fiscal fourth quarter, when its EPS of 26 cents came in more than 30% below the estimate of 35 cents. The company has topped views by an average of 18% in the past three quarters.

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BMO Capital remains positive on the stock, sticking with its outperform rating but trimming its 12-month price target to $22 from $23. The firm also cut its earnings estimate for fiscal 2011 slightly, going to $2.47 a share from $2.55, but said it "like

s the risk return at current levels." For fiscal 2010, the firm cut its EPS estimate to $4.22 from a prior view of $4.38.

In order to get back the stock back above $20, BMO Capital believes Xyratex will need to "demonstrate earnings power in the $2.50 range" and it believes a slow shift in investor sentiment on the company's disk drive business towards bullishness may provide a catalyst.

"Keys for the stock: 1) ability to effectively ramp new drive customers and maintain gross margins above 30%, and 2) manage the transition of lower NTAP


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while ramping other storage customers, and not allowing gross margins to move lower than 12%," the firm said in its note.

As BMO Capital pointed out, the harshness of the sell-off in the stock isn't entirely surprising considering how bullish Wall Street was headed into the report. Of the seven analysts covering the company, five were at buy and two at strong buy.


Written by Michael Baron in New York.

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