Earnings Preview: NetApp Inc. (EMC) (IBM) (LSI) (NTAP)

Zacks

NetApp Inc. (NTAP) is scheduled to announce its second quarter 2012 results on November 16. We find limited movement in the analyst estimates so far.

First Quarter Overview

NetApp reported modest first quarter 2012 numbers, with earnings per share (EPS) missing the Zacks Consensus Estimate by 2 cents.

Revenue grew 26.4% from the year-ago quarter to $1.46 billion and was roughly in line with the lower end of the company’s guided year-over-year growth rate. The improvement was driven by a surge in demand for its storage products, as well as a change in the revenue recognition policy. Growth across the other segments was also encouraging.

But revenue growth was badly affected by the slowing demand from its biggest customer and budget constraints at the U.S. federal government. The U.S. federal government's budget crisis and financial problems across Europe are hurting technology spending.

For further details on the quarter’s performance please see: NetApp Misses, Guides Cautiously.

Second Quarter Outlook

Management has guided cautiously for the next quarter, keeping in mind the ongoing macro uncertainty caused by the European debt crisis and federal budget cuts. NetApp expects second quarter 2012 revenues in the range of $1.5 billion and $1.6 billion, representing 3% to 10% sequential and approximately 20% to 28% year-over-year growth.

On a non-GAAP basis, the gross margin projection is roughly 63.5% and operating margin is roughly 18.5%. The GAAP EPS is expected to range between 38 cents and 42 cents, while non-GAAP EPS is expected to be between 58 cents and 62 cents. The share count is expected to be approximately 392 million.

Agreement of Analysts

Prior to the earnings release, let’s see what the analysts are saying about NetApp’s performance.

On the whole, analysts believe that NetApp’s core competencies in Network Attached Storage and Internet-based storage networking protocol will position the company well to benefit from further adoption of server virtualization, unified storage and the shift toward 10G Ethernet infrastructure. Moreover, increasing storage spending, strong exposure to midrange systems and overall share gains would help NetApp drive revenue upside.

Some analysts are also positive about the new low-range FAS product line. They believe that these products, being more aggressively priced than competing products, should generate additional demand for NetApp.

But NetApp is in a vulnerable position due to its high exposure to Europe (roughly 33% contribution) and the U.S. public sector (~15%). These two sectors are fighting with debt issues and constrained budgets, respectively, putting a lid on NetApp’s revenue growth trajectory.

This exposure, the lackluster revenue growth and expected deterioration of margins on account of proposed R&D and headcount increases have made some analysts cautious. The integration of LSI Corp.’s (LSI) Engenio business could also be challenging according to some, as the OEM business model is very different from the company’s core operating model.

Though we witnessed a mixed sentiment from the analysts, movements in their estimates were limited. Out of the 13 analysts providing estimates for the second quarter, just one raised estimates, while another lowered in the last thirty days. A similar movement was noticed among the 14 analysts tracking the stock for fiscal 2012. There was no movement noticed in the past 7 days.

Magnitude of Estimate Revisions

The magnitude of revisions has been huge since the company reported its first quarter results. Overall, estimates for the upcoming quarter and fiscal 2012 were lowered over the last ninety days.

For the second quarter and fiscal year 2012, the Zacks Consensus Estimates decreased 2 cents and 13 cents, respectively, to 49 cents and $2.02 over the past ninety days. For 2013, the estimate went down from $2.50 ninety days ago to $2.34.

Recommendation

Though we are confident about NetApp’s strong business momentum, the company’s cautious guidance based on the ongoing macro uncertainty caused by European debt crisis and federal budget cuts keeps us on the sidelines. Moreover, we fear that NetApp may face some storage supply disruptions due to the recent flood in Thailand.

But we believe that NetApp will be able to sustain its growth story and remain a key player in the virtualization and network storage market based on product launches and strategic acquisitions. With its latest Engenio takeover, NetApp will now be able to address the video storage market as well as high performance computing applications like genomics sequencing. Hence, we expect NetApp to beat our estimates.

NetApp is performing impressively, despite stiff competition from technical behemoths such as International Business Machines Inc. (IBM) and EMC Corporation (EMC) in the data storage and management software segments.

The Zacks rank on NetApp shares is currently #3, or a Hold rating in the short-term (1-3 months).

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