NetApp Filing Prompts Concern

Any celebrations at Network Appliance headquarters over rival EMC's admission of a poor quarter have ended abruptly.

When EMC revealed sales for last quarter did not measure up to its previous forecast three days ago, the price of its shares tumbled 6.89 percent. (See EMC Slips on Symmetrix Transition.) Yet NetApp's shares took a steeper dive yesterday -- closing at $28.60, falling $2.13 (6.93%) from its opening price.

What's the problem? NetApp released its 10K disclosure for last quarter, and it included a couple of possible red flags. One was a cryptic reference to a comment letter from the SEC dated April 28 relating to a routine review of company filings. That caused concern because of the recent flurry of investigations into companies' stock option grants.

Another potential red flag was that inventory levels for finished goods were up 36.5 percent during the last quarter, suggesting NetApp might have expected sales to slow this quarter.

Wall Street analyst Shebly Seyrafi of Kaufman Bros. said he was concerned about the company "for a variety of reasons" in a note to clients. He pointed to product inventories and potentially disappointing sales in Europe and to the U.S. federal government.Other analysts paint a less dire picture. Dan Renouard of R.W. Baird and Co. wrote to clients calling the concerns "overblown." Of the SEC letter, he wrote "We believe this letter is a standard general inquiry concerning accounting practices typically received every few years." As for inventory, Renouard suspects the rise in finished product could reflect "new product launch build versus an indication of softening demand."

Aaron Rakers of A.G. Edwards wrote a note speculating the SEC letter could have an adverse effect on shares. He put out another note later yesterday saying a conversation with the company said the letter was unrelated to options.

On NetApp's May earnings call, CEO Dan Warmenhoven said, "First, I'd like to make it very clear that we have not received any inquiry from any regulatory body." Warmenhoven added that an independent review of NetApp's options grants from 1994-2005 as part of its Sarbanes-Oxley certification process last year confirmed the company was compliant with SEC requirements on options.

NetApp refused comment on the developments.

Dave Raffo, News Editor, Byte and Switch