NetApp Pounds Out Profits

Network Appliance Inc. (Nasdaq: NTAP) posted a strong increase in sales for its most recent quarter and delivered an unambiguously sunny outlook for its current one (see NetApp's Q1 Profits Soar).

The Sunnyvale, Calif., company had revenues of $260.5 million for its first fiscal 2004 quarter, which ended August 1, 2003. That's up 26 percent from revenues of $206.8 million for the same period a year ago and represents an 8 percent increase over the prior quarter. Its net income for the period was $27.1 million, or $0.08 per share, an increase of 67 percent over the $16.2 million, or $0.05 per share, it reported in the year-ago quarter.

NetApp shares were up $2.30 in after-hours trading, or around 13 percent, to $20.35.

Laura Conigliaro, an analyst with Goldman Sachs & Co., says a strong surge in NetApp's products revenues were the driver behind its winning quarter [ed. note: well... sure]. "With or without the July quarter's extra week of sales, NetApp still delivered its best quarter in years," she writes in a research note.

During the quarter, NetApp shipped more than 2.7 petabytes of its NearStore ATA-based disk storage system for nearline data, a 40 percent sequential increase. Analysts noted, however, that revenues from NearStore grew no more than 10 percent from the previous quarter.For the current quarter, NetApp executives said they expect revenues to increase 3 to 7 percent sequentially and 25 to 30 percent year over year. Gross margins will remain about flat, and earnings per share will be 9 to 10 cents per share, the company said.

The only area of concern for the company is in its grossmargins, according to Kevin Hunt, an analyst with Thomas Weisel Partners. NetApp's gross margins of 59.9 percent for the quarter was below Hunt's 60.8 percent estimate. "While management has indicated in the past that long-term gross margin is likely to be in the high 50s, we have been concerned regarding potential pricing pressure in the NAS space (and that at some point NetApp will be unable to offset through mix, etc.) and would continue to monitor pricing environment more closely," Hunt writes in a research note issued today.

NetApp CEO Dan Warmenhoven told analysts on a conference call today that the company still doesn't see much competition from the EMC Corp. (NYSE: EMC) NS600, the Clariion-based NAS system that was designed to compete head-on with NetApp (see EMC Darts Into Midtier NA$).

"We have not seen them much in the field," he said.

Warmenhoven also noted that the company has already driven prices down substantially, especially with its NearStore ATA offering. "We're not looking to get much more aggressive on pricing," he said. "Price is not the obstacle to us gaining additional share."Warmenhoven touted NetApp's "leadership position" in iSCSI, noting that more than 500 users have downloaded its iSCSI stack to test in their enterprise environments since it introduced free software in February 2003. "ISCSI is clearly something our customers are interested in using."

NetApp recently instituted a certification test to verify third-party iSCSI adapters with its IP SAN storage, in conjunction with Medusa Labs, Finisar Corp.'s (Nasdaq: FNSR) testing division (see NetApp Pokes & Prods iSCSI).

Meanwhile, Warmenhoven said the company's business is up in most of Europe, and also in Australia, where broader IT spending is flat. And he said the company's business grew 1 to 2 percent in North America. "This is mostly share gain. I don't sense that there's a buying spree going on." He added that the company's federal business was down a bit last quarter compared to the quarter before, when NetApp saw a surge prior to the war in Iraq.

Also during the quarter, NetApp stepped up its push into the midrange market by inking distribution agreements with Arrow Electronics Inc.'s (NYSE: ARW) North American Computer Products group and Avnet Hall-Mark (see NetApp Tiers Up).

Warmenhoven said it fully expects to increase its product revenues with its new distribution deals: "The faster we grow, the more the mix is going to shift towards product."At the same time, NetApp says it won't need to increase its sales force. "At the moment, we don't have to invest in sales capacity," said Warmenhoven. "If anything, we will invest in services capacity." The company has increased its professional services headcount by 27 percent over the past year, he said.

The company did not, however, discuss its pending patent infringement litigation against NAS vendor BlueArc Corp. In its complaint, filed on July 15, NetApp alleged that BlueArc infringes on certain patents that NetApp acquired for about $9 million in bankruptcy court proceedings for Auspex Systems Inc. (Nasdaq: ASPX) (see NetApp Zaps BlueArc With Lawsuit).

Todd Spangler, US Editor, and Eugénie Larson, Senior Editor, Byte and Switch