NetApp: 'We're Winning'

Network Appliance says its financial results from last quarter show its strategy to become more of a SAN and enterprise vendor is working. (See NetApp Reports Earnings.) And they attributed a successful quarter to larger deals involving systems rolled out in the past 15 months -- the FAS3000 the FAS6000.

"I would just keep it simple -- we are winning," NetApp president Tom Mendoza said Wednesday night on a conference call with analysts. "We are winning big deals, big opportunities we were not even in before. We are getting invited into big deals that we were not invited to before."

As evidence of this, NetApp execs say they landed their biggest deal ever last quarter -- a $12 million contract with a federal agency. They also reported another deal worth over $10 million and several between $5 million and $10 million. Overall, NetApp reported 70 percent of its income from "enterprise-class" customers -- up from 58 percent the previous year. When asked by analysts last night, NetApp officials would not divulge names of any of the new customers.

NetApp reported revenues of $621.3 million for the quarter, up 39 percent from last year. This compares to flat systems revenue for its major competitor EMC last quarter and five percent year-over-year growth by its next largest competitor Hewlett-Packard. (See Tucci: EMC's Problems 'Self-Induced' and HP Announces Earnings.)

NetApp CEO Dan Warmenhoven has made it clear in recent months that he expects to transition from a pure NAS play to more of a SAN and enterprise vendor. (See NetApp Solid On SANs.) Warmenhoven says the average capacity of systems shipped increased sharply last quarter, up nearly 60 percent on the midrange FAS3000 and nearly 27 percent on the new enterprise FAS6000 from the previous quarter. He says NetApp shipped more than 100 FAS6000 systems in its first full quarter of availability. (See NetApp Scales Up.)Warmenhoven also said 35 percent of NetApp's bookings last quarter included SAN capability -- 25 percent with Fibre Channel, 14 percent with iSCSI and four percent with both. "We are now considered a serious SAN vendor," Warmenhovens says.

NetApp's revenue numbers were no surprise, falling within the guidance it gave last May and repeated in July. (See NetApp: We're OK.) Still, they underscore that NetApp is gaining ground against EMC.

"We believe NetApp is clearly putting some increased competitive pressure on EMC," A.G. Edwards analyst Aaron Rakers wrote in a research note today, in which he upgraded NetApp's stock.

But NetApp also faces increased competition as it moves deeper into the SAN space, cautions analyst Paul Mansky of CitiGroup.

"The company's primary market, NAS, is highly concentrated between it and EMC," Mansky wrote in a research note. "However, in order to support future growth the company must now begin to penetrate the SAN market. The SAN market, while approximately three times larger than NAS, is characterized by more intense competition among well-established companies including EMC, IBM and HP."Whether IBM is a NetApp competitor is open to debate. IBM has a deal to OEM NetApp systems and offers most of the NetApp FAS line. However, there have been rumblings of competition between channel partners of the two vendors. Warmenhoven says any conflict should be cleared up when IBM begins shipping the FAS6000 next month.

"There have been lots of rumor and innuendo about the channel conflict, particularly through the indirect channel. What the conflict there was, first of all, it was very small," Warmenhoven says. "When they introduce their version of the FAS6000, we will have product line parity, and so the indirect channels really are no longer going to have a reason to try to come to NetApp directly."

Warmenhoven is also concerned about inventory buildup being overblown. In a proxy filing in July, NetApp reported inventory levels for finished goods were up 36.5 percent during the last quarter, suggesting it might have expected sales to slow this quarter. (See NetApp Filing Prompts Concern.) On the earnings call, Warmenhoven said finished goods inventory dropped by more than $6 million last quarter mostly because of the FAS6000 ramp and inventory "is approximately zero."

He did not address another touchy issue from that proxy filing: 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. (See Reyes Charged With Fraud and Vendor Options Draw SEC Scrutiny.) None of the analysts asked Warmenhoven about the letter or the stock options issue, although the NetApp CEO was quoted in a BusinessWeek story this week calling the options scandal a "witch hunt" by the SEC that penalizes shareholders and "creates real issues of investor confidence."

— Dave Raffo, News Editor, Byte and Switch