NetApp Nets a Bundle

Network Appliance Inc. (Nasdaq: NTAP) received high marks from analysts this quarter, not so much because of how much money it made but because of how it earned it.

NetApp reported third-quarter earnings of $40.1 million or $0.11 per share, up from $22.7 million or $0.06 per share in the same quarter last year. Revenues of $297.3 million for the quarter increased 30 percent from last year and 8 percent over the previous quarter.

Not surprisingly, reaction was positive, although that wasnt the case last quarter when NetApp’s stock dived after it posted $48.4 million in earnings (see NetApp Keeps Pedal to Metal).

There were a few differences about this quarter. One is the way the company increased earnings. While maintaining strong sales in its core NAS business, NetApp also made gains in software sales and in the nascent low-end SAN market. Its guidance is also stronger: NetApp forecasts sequential growth of 7 percent to 9 percent and EPS of $0.11 to $0.12 next quarter, up on both counts from the guidance it gave (and beat) for the just-completed quarter.

“We believe the company is executing on every phase of its growth strategy,” ThinkEquity Partners analyst Paul Mansky writes in a research note.NetApp reported that add-on software and software services -- in other words, software not bundled with systems -- accounted for 31 percent of total revenues, up 2 percent from last quarter. Software enabling remote replication and disk-to-disk backup drove the uptick. NetApp says initial sales of backup systems using ATA disks were solid. NetApp also reported selling 300 units of its new low-end SAN systems, which analysts see as a high-growth area.

“We think NetApp is beginning to enter what we believe could be a surprisingly strong growth phase in its SAN business, which may come as quite a surprise to any investors still categorizing NetApp as a predominantly NAS-centric storage company,” Legg Mason Inc.'s Clay Sumner wrote in a research note today. “Small and medium-size businesses (SMBs) represent a largely untapped opportunity for SANs and we believe NetApp has the most compelling offering for this segment.”

Despite early success, don’t think NetApp is becoming predominantly a low-end SAN player, however. In a call with analysts yesterday, CEO Dan Warmenhoven stressed the bulk of NetApp’s growth will be in the enterprise. He also pointed out that NetApp’s SANs sell in the $20,000 to $40,000 range, which he characterizes as “not low-low end” but “kind of low-middle.”

Other execs stress that NetApp sees low-end SANs as a way to take advantage of iSCSI connectivity between NAS filers and heterogenous storage pools. “Our view of the low end is the edge of the enterprise,” NetApp president Tom Mendoza says. “It’s not just standalone systems and small companies.”

Still, addressing the low-end SAN market gives NetApp room to grow and provides a hedge if it does lose ground in NAS sales. That's not in the cards, execs say, despite inroads by EMC Corp. (NYSE: EMC) or IBM Corp. (NYSE: IBM)with its new NAS filer (see IBM Swings New NAS Gateway and EMC: Everything's 'Better').“We could not be in a stronger position on the NAS front than we are now,” Mendoza says. “The other guys have missed so many times -- there’s only so many times you come back to the same movie expecting a different ending.” So far, this isn't whistling in the dark: NetApp was the market leader among NAS sales in the third quarter 2003, according to IDC and Gartner Inc.

What about the beast from Redmond? Microsoft Corp. has thrown its considerable weight into the NAS fray, and low-end systems from Dell Computer Corp. (Nasdaq: DELL) and Hewlett-Packard Co. (NYSE: HPQ) are built on the Windows 2003 Storage Server. But Warmenhoven says he hasn't seen much success at all from Windows-based NAS competitors. “We rarely see the Windows Storage Server positioned as an alternative to our solutions."

Although Dell is making inroads in storage, it's uncertain how much of that is in the NAS market (see Dell's Storage Sales Jump). And Microsoft's support hasn't helped Iomega Corp. (NYSE: IOM), which suffered heavy losses on its NAS products (see Iomega Gets Its NAS Kicked).

Still, NetApp likes Windows. Warmenhoven says revenues of pure Windows NetApp systems accounted for 20 percent of overall sales. “If you look at multiprotocol and everything else, you could argue total Windows business is 45 to 50 percent."

As of press time today, NetApp's stock was up $1.70 to $23.97, a 7.63 percent jump.— Dave Raffo, Senior Editor, Byte and Switch