You Are Expected To Select A Company And Three Competitors From The Same Industry And Prepare An Analytical Report In Which You Will Critically Evaluate, Analyse, Discuss And Comment On The Key Issues In The Financial Appraisal.

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.

Liquidity

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.

Inventory Turnover

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:

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.

Solvency

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:

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 profitable.

Profitability

Nimble has not made a profit since it was incorporated. Vasudevan et al. (2016) stated that Nimble will continue to operate at a loss as they enhance their product, properly size their employee base and adjust to changing market conditions. This trend will continue for the foreseeable future (p. 17). Consequently, Nimble’s profitability ratios yield the greatest concerns and opportunities for improvement.

Z Score – X2

This ratio measures how much of the retained earnings are being used to acquire assets. Altman (1968) stated that this ratio is a measure over time; a new company will accumulate its earnings the longer it operates. Consequently, newer companies who haven’t built up their retained earnings may be negatively reflected by this ratio (p. 595).

Figure 9: cumulative earnings invested in assets for the quadrumvirate over five years.

Nimble, who has been publicly traded since 2013, may be considered new. Nimble hasn’t retained any earnings, in fact, it has an accumulated deficit worth over $320 million or 10 times its losses in 2012 as represented by the following table:

This table also shows that their accumulated deficit growth rate is slower in 2016. However, in comparing the Z Score X2 ratio to the triumvirate, Nimble’s losses are the second worst; this is a concern.

Return on Assets

In 2016, due to Nimble’s continued negative profitability, their return on assets of -37% was well below the industry average of 4.18% and the quadrumvirate average. Stated differently, instead of helping the company generate a profit, Nimble’s assets cost the company $120 million dollars. In looking at Nimble’s five-year trend, their ratio improved in 2014 because of their IPO.

Figure 10: Return on assets (ROA) for the quadrumvirate over five years.

Nimble was operating at a loss, so the large increase in assets improved this ratio (from -51% to -26%). This presents a weakness in this ratio; when operating at a loss, increasing cash (by iassuing stock or financing) will temporarily improve the results even though no long-term assets were purchased to improve productivity. Additionally, Vasudevan et al. (2016) disclosed a meager interest income of $240 thousand dollars on their cash and cash equivalents by investing in money market funds (p. 48). To improve this ratio and profitability, Nimble executives should evaluate investing a portion of these cash assets in higher risk / higher return funds.

Z Score – X3

This ratio is like the ROA, except that it evaluates earnings before interest and taxes. Altman (1968) preferred this ratio as it is a better measure of the company’s raison d’être (p. 595). Considering Nimble’s low interest earned on cash, it will be very close to ROA:

The recommendation to improve the ROA by investing a portion of the cash in higher yield funds will not influence this ratio. As Nimble’s raison d’être is producing storage devices, the only ways this ratio can be improved are for Nimble to earn more on the sale of their product, or to reduce operating costs.

Profit Margin

In 2016, Nimble sold $322 million dollars’ worth of product and service with a gross profit margin (GPM) of 65%, the highest of the quadrumvirate. Despite this, they posted a net loss of $120 million resulting in a profit margin of -37%; their operational costs are too high for the revenues they are making. The margin was below the quadrumvirate average and second lowest next to Pure Storage.

Figure 11: Profit margin for the quadrumvirate over five years.

Upon examining Nimble’s operating expenses, approximately 60% were in sales and marketing. This is slightly higher than the quadrumvirate average 52% but very close to NetApp. However, unlike Nimble, NetApp enjoyed a positive profit margin of 4.1%. The IDC (2015) reported that NetApp held approximately 11% of the external storage market in the third quarter of 2015 measured by revenue (para. 5). Being incorporated since 1992, NetApp not only has a well-established brand, they had a 15-year lead on Nimble and today holds a notable portion of the market. To make their product better known, Nimble would need to increase their sales and marketing, a strategy confirmed by Vasudevan et al. (2016, p. 43). To confirm if this is a good strategy, the following chart analyzes the change in sales and marketing expense over the past 5 years:

The following table show the change in revenue over the past 5 years:

This horizontal analysis shows diminishing returns; in 2016, one additional dollar invested in sales and marketing created $0.30 of additional revenue. If this trend holds, this strategy will likely worsen profit margins. To improve, Nimble should look at their GPM. If they lower their product prices to align their GPM with the triumvirate, they might increase their sales without having to increase their sales and marketing teams. Additionally, Nimble needs to reconsider their customer base. For example, rather than compete with cloud storage-as-a-service, Kurian, Pasek, and Nevens (2016) stated that NetApp supplies these “hyperscaler providers” (p. 11). Doing a combination of both could correct Nimble’s ailing profitability.

General limitations of analysis

In addition to the limitations stated in each section above, the following limitations apply generally.

Each company uses a different amortization schedule for property and equipment:

(Dietzen & Riitters, 2016, p. 69; Gacek & Ahmad, 2016, p. 58; Kurian et al., 2016, p. 58; Vasudevan et al., 2016, p. 75). This will result in a different mixture of expenses vs long-term assets. When using these ratios to compare multiple vendors, these variations could produce incongruent results.

Despite all being categorized in the Computer Storage Devices industry, each company has different types of products and different levels of diversification:

(Dietzen & Riitters, 2016, pp. 7–10; Gacek & Ahmad, 2016, pp. 4–6; Kurian et al., 2016, pp. 6–10; Vasudevan et al., 2016, pp. 7–12). The ratios, like profit margin, gross profit margin, Altman Z Score X5, return on assets, return on sales, etc all use the overall totals recorded on the income statement. Because the different mix of products per vendor, using the ratios to compare between them could produce incongruent results.

Meaningful horizontal analysis could not be performed on some of Nimble’s line items because of the change from loss to profit, as demonstrated with their net-cash from operations:

Instead, this information was plotted on a graph to perform the analysis.

Conclusion

The future of Nimble is uncertain. A recurring theme in this analysis is that Nimble must become profitable. From the analysis performed, the recommendations include: suspending their plans to increase sales and marketing, lowering the price on their products to align with the triumvirate, supplying cloud storage-as-a-service, and better investing some of their cash. Until this happens, Nimble will be reliant on financial leverage which today is achieved through the issuance of stock. Nimble is selling their inventory, they can meet their short-term debt obligations, and their total market capitalization is 300% higher than their total debts. With their current Altman Z score, they are at risk of becoming insolvent in 1-year and will rely on customers like us to purchase their quality products to survive.

References

Agrawal, R., & Nyamful, C. (2016). Challenges of big data storage and management. Global Journal of Information Technology, 6(61), 1–10.

Altman, E. I. (1968). Financial Ratios, Discriminant Analysis and the Prediction of Corporate Bankruptcy. The Journal of Finance, 23(4), 589–609.