CRITICAL ANALYSIS OF NIMBLE STORAGE
Critical Analysis of Nimble Storage
On November 19, 2015, the stock for Nimble Storage (Nimble) dropped 50% after missing analysts expected revenue targets by seven million dollars and a loss per share by six cents (Bort, 2015, paras. 3–4). My organization had struck a significant deal with Nimble two days before their third quarterly earnings were posted. Nimble, a niche digital storage company whose mission is “to engineer and deliver the industry’s most efficient flash storage platform” (Vasudevan, Singh, & Mehta, 2016, p. 1) had successfully convinced my team of architects of their innovation value in this space. Following the news of their stock’s tumble, we began to worry about their solvency; would they survive long enough to provide us the service and support we required for the next four years? Today, they still have failed to revive their ailing stock. However, with high satisfaction in their products, we are faced with a different decision: do we purchase more from them, or select another storage vendor?
The Computer Storage Devices industry is undergoing rapid technological transformation. IDC (2015) estimated the entire external disk storage market made $5.7 billion dollars in the third quarter of 2015 alone (para. 4). The demand for storage is expected to continue growing. Marr (2015) predicted unprecedented global data growth between 2015 and 2020 from 4.4 zettabytes to 44 zettabytes (para. 3) which is equivalent to 12 trillion full resolution digital photos. This mass of information is known as “Big Data”. For organizations to extract value from this data, it must be quickly analyzed necessitating high-speed data retrieval. Agrawal and Nyamful (2016) observed that combining the traditional hard disk drive for storage volume with the emerging solid state drives for speed would provide the most cost-effective and performant option (p. 8). The combination of these two storage technologies is known as hybrid storage; a key strength of Nimble and positioning them well in this market. This made Nimble’s stock devaluation even more surprising. Bort (2015) stated that competition was the primary reason Nimble missed their revenue targets (para. 6). Per Nimble’s annual report, Vasudevan et al. (2016) named NetApp, Pure Storage, the large systems providers (HP and Dell), and cloud storage-as-a-service as their competitors (p. 15).
This paper will make use of financial ratios to examine Nimble’s potential for: going bankrupt (Z Score), covering short-term debts (liquidity), covering long-term debts (solvency), and covering their operational costs (profitability). To aid in this examination, this paper will compare Nimble’s ratios against three other niche digital storage vendors in the same industry as Nimble: NetApp, Pure Storage and Quantum (referred to in this paper as the “triumvirate”, or including Nimble, the “quadrumvirate”). The market for digital storage is also heavily supplied by large diversified technical companies (for example: Dell, EMC, Hewlett Packard, Hitachi, and IBM) but this paper only compares niche vendors like Nimble who specialize in digital storage. All financial data will come from the latest annual reports of each company using a combination of Mergent Online, Investing.com and YCHARTS (“Mergent Online,” 2016, “Stock – NetApp Inc,” 2016, “Stock – Nimble Storage,” 2016, “Stock – Pure Storage Inc,” 2016, “Stock – Quantum Corporation,” 2016, “YCHARTS,” 2016).
Altman Z Score
Altman (1968) claimed his mixture and weighting of ratios could predict with 94% accuracy a firm’s bankruptcy. He also noted that his study was conducted with mostly public manufacturing firms (p. 609). Even though Vasudevan et al. (2016) confirmed that Nimble outsources its manufacturing to Flextronics (p. 14) this paper will analyze Nimble using the original Altman Z Score (Z Score). Nimble’s resulting Z Score for 2016 was 0.92 indicating that Nimble is in a distressed state.
Figure 1: Altman Z Score for the quadrumvirate over 5 years.
Narayanan (2010) claimed the Z Score was “not useful for new companies with little or no earnings” (p. 13) but did not provide a substantive definition for “new”. As Nimble was incorporated in 2007 and went public in late-2013, it is possible that it meets the definition of “new” and the score may be inaccurate. However, Altman (1968) stated that even though new companies need time to build up their retained earnings, 50% of them fail in the first five years (p. 595). This indicates that Nimble is at risk of bankruptcy.
Altman and Fleur (1981) used the Z Score as a management tool to successfully restore GTI, a company on the verge of failure, back to financial health (p. 37). Therefore, the components of Nimble’s Z Score might provide clues into how they can achieve financial health. Breaking down the Z Score provides the following components:
Figure 2: Components of the Altman Z Score for Nimble.
The values for X1, X4 and X5 represent liquidity, solvency and sales efficiency respectively whereas X2 and X3 represent equity leverage and profitability respectively. The latter two components represent the priority areas that Nimble should focus on. Components X1 through X4 will be examined in greater detail.
Nimble’s short-term debts consisted of 51% deferred revenues and 49% accounts payable, accrued compensation and benefits (Vasudevan et al., 2016, p. 66), and product warranties (p. 74). This section will analyze Nimble’s ability to pay these liabilities.
Current and Quick Ratios
As of January 31, 2016, Nimble had $2.65 of liquid assets to pay for every $1 of short-term debt if needed. This Current Ratio of 2.65:1 is higher than the industry average of 1.7:1 and the quadrumvirate average, but lower than Pure Storage. The Current Ratio includes inventories that Nimble uses for sales, service and evaluation. Should Nimble become insolvent or have an urgent need for cash, the amount they could get for this inventory will likely be less than the book value. By conservatively excluding this inventory, over 98% of Nimble’s current assets are cash and accounts receivable (Vasudevan et al., 2016, p. 66). Their resulting Acid Test Ratio of 2.37:1 is also higher than both the industry average of 1.52:1 and the quadrumvirate average. Consequently, Nimble will likely not have issues covering their short-term debts.
Nimble kept their inventories for approximately 45 days. Stated differently, Nimble sold their inventories 8.05 times in a calendar year.
Figure 3: Inventory Turnover for the quadrumvirate over five years.
This is almost exactly at par with the industry average of 8.07 and slightly below the quadrumvirate average. However, in addition to selling storage products, Nimble also sells service and support contracts. Vasudevan et al. (2016) disclosed that an average $4.85 million worth of service inventory was stored at service depots between 2015 and 2016 (p. 73) representing 35% of the total inventories. While having a high inventory turnover in sales is positive, a high inventory turnover in service could imply defective products. This suggests a weakness in the Inventory Turnover ratio which uses all inventories. In separating sales from service, Nimble’s inventories for sales were kept for only 38 days, where their inventories for service were kept for 68 days. Additionally, Vasudevan et al. (2016) noted that the write-down for excess or obsolete products is captured in Nimble’s cost of revenues (p. 73). This suggests another weakness in the Inventory Turnover ratio; if Nimble wrote-down a large portion of their inventories as excess, this would artificially inflate this ratio (increase the cost of revenues and decrease the inventories). In comparison to the industry and the triumvirate, Nimble’s ability to sell their inventory is not a concern.
Cash Current Debt Coverage
Nimble has generated a positive cash flow from operating activities in the past two years only. Vasudevan et al. (2016) reported $5.8 million and $5.4 million in 2016 and 2015 respectively (p. 70). Today, this cash only covers six percent of their short-term debts. They are slightly below the quadrumvirate average of 6.4%, but well below NetApp’s 31%. In contrast, Nimble was burning 144% of their cash to run operations in 2012. Their improvement since then is evident in the following graph:
Figure 4: Cash Current Debt Coverage for the quadrumvirate over five years.
As mentioned, deferred revenues make up roughly half of Nimble’s short-term debts. Looking closer at this, Vasudevan et al. (2016) stated that it “consists of the unrecognized portion of revenue from sales of its support and service contracts” (p. 75) and these liabilities will be recognized as revenue when the services are rendered (p. 46). Unlike other debts where cash leaves the company, these debts automatically become revenues when they meet Nimble’s revenue recognition criteria. As these are current debts, they will become revenue within one year. Excluding them, Nimble is still only able to cover 11.3% of their short-term debts with the cash generated from operations. Ideally, they should be able to cover 100%. While they can sell their product, they are reliant on their assets to cover their short-term debt, not the cash from operations; this is a concern.
Z Score, component X1
This ratio measures the proportion of working capital to total capital in a company. Altman (1968) stated that “a firm experiencing consistent operating losses will have shrinking current assets in relation to total assets” and is one of the most valuable liquidity ratios and a strong indicator of eventual failure (pp. 594-595). The following table horizontally analyzes Nimble’s ratio over time:
|Working Assets / Total Assets||53.2%||58.8%||75.6%||67.3%||79.6%|
|% of base-year (2012)||66.8%||73.9%||94.9%||84.5%||100.0%|
|% change for the year||-9.6%||-22.2%||12.3%||-15.5%||–|
Nimble’s current assets have been shrinking year-over-year except for 2014.
Figure 5: Working capital reflected in total assets for the quadrumvirate over five years.
Vasudevan and Singh (2014) disclosed that their initial public offering (IPO) in December 2013 generated $176 million in cash assets (p. 54). Considering their continued decline following their IPO and their low current cash debt coverage ratio, Nimble will continue to be reliant on financial leverage to operate until they can turn a profit; this is a concern.
Nimble’s long-term debts consist of 65% deferred revenues and 35% accounts payable, accrued compensation and benefits (Vasudevan et al., 2016, p. 66), and vested stock options (p. 84). This section will analyze Nimble’s ability to pay these liabilities.
Cash Total Debt Coverage
In 2016, Nimble successfully generated positive cash flow for two straight years but could cover 3.7% of their total debt with cash. This is higher than the quadrumvirate average of 2.9% but much lower than NetApp at 14.8%. Despite this being low, Nimble had doubled its average debt just to run operations in 2012:
Figure 6: Cash Total Debt Coverage for the quadrumvirate over five years.
In late-2013, Nimble’s IPO generated a strong cash injection and they became cash positive in 2015. Vasudevan et al. (2016) stated that their long-term deferred revenue is comprised of service contracts with an average 2.2 years remaining (p. 75). As these deferred revenues are prepayments, the liability will disappear when the service is rendered without affecting cash flows. Excluding them, Nimble is still only able to cover 9.6% of their total debts with the cash generated from operations. Ideally, they should be able to cover 100%.
Debt to Asset
In 2016, over half of Nimble’s total assets were financed by debt. This is lower than the quadrumvirate’s average of 78.7% but higher than Pure Storage’s ratio of 35%.
Figure 7: Debt to Total Asset for the quadrumvirate over five years.
Reflecting on Nimble’s deferred revenues, this also means over one-third (35%) of their total assets were financed by customers who prepaid for long-term service contracts. Unlike the triumvirate, Nimble’s balance sheet does not contain any good will or intangible assets. Lhaopadchan (2010) surmised that management could manipulate or delay recognizing impairments against intangible assets (pp. 125-127) calling into question the true value of the intangible assets. This ratio can therefore be manipulated if the value of total assets is not reasonably revalued. Because Nimble’s balance sheet does not contain intangible assets, their result is more conservative than the triumvirate. This ratio doesn’t yield any concerns for Nimble.
Z Score, component X4
Altman (1968) stated that this ratio measures how much a company’s market capitalization can decline before it becomes insolvent (p. 595). Nimble’s stock price has fallen sharply since its IPO. At the end of January 2014, Nimble’s stock was worth $43.23 per share, and at the same time in 2016, it was worth $6.57 per share. This ratio had the single largest impact on Nimble’s overall Z Score:
Figure 8: Liabilities covered by market value of equity for the quadrumvirate over five years.
Despite the large fall, this also shows that Nimble (as of January 2016) was still in a comfortable position:
|Outstanding shares at Jan 31||82,120,000|
|Price per share as of Jan 31||$6.57|
|Market value of equity (equity)||$539,528,400|
|Total liabilities (debt)||$176,141,000|
|% Equity (equity / debt + equity)||75.3%|
This suggest the stock can devalue by three quarters before Nimble would become insolvent (Altman, 1968, p. 595). In summary, the key solvency issue Nimble needs to focus on is increasing the cash generated from operating activities thus becoming pr