NetApp Inc. (NTAP) reported second quarter fiscal 2012 adjusted earnings per share (EPS) of 51 cents, surpassing the Zacks Consensus Estimate of 49 cents. Adjusted EPS excludes amortization of intangible assets, acquisition-related expenses, non-cash interest expense as well as investments and tax gains, but includes stock-based compensation expenses.
After the closing bell, NetApp's share price plunged 7.00%. The decline was mostly due to lackluster sequential guidance for revenue, non-GAAP margin and EPS.
Revenue
NetApp reported second quarter revenues of $1.51 billion, up 20.5% from $1.25 billion in the year-ago quarter. The revenue was roughly in line with the lower end of the company’s guidance. While product revenues grew the most, other segments also improved year over year. Customer wins were at its peak during the quarter. But revenue growth was badly affected by the slowing demand from its major customer and the U.S. federal government, reflecting budget constraints due to the European crisis.
Product revenues were $1.02 billion in the quarter, up a whopping 23.2% from $824.8 million reported in the year-ago quarter and accounted for about 67.4% of the total revenue. The improvement was attributable to successful product launches during the quarter.
Software Entitlement & Maintenance revenues were $198.0 million, up 12.1% from $176.7 million in the year-ago quarter. The segment’s revenues represented around 13.1% of the total revenue.
Service revenues were $292.8 million, up 17.4% from $249.5 million reported in the year-ago quarter. The segment accounted for 19.4% of the total revenue.
Operating Results
NetApp reported gross profit of $913.0 million, representing an 11.8% year-over-year increase. Gross margin dropped 470 basis points (bps) year over year to 60.6%. The favorable effects of increased volumes and configuration mix were more than offset by a greater mix of E-Series OEM business, warranty costs and some pricing discounts.
Total operating expenses surged 19.4% from the year-ago quarter to $720.6 million. This was mostly driven by steeper expenses on research and development as well as sales and marketing. Operating income dropped 9.6% from the year-ago quarter to $192.4 million. Operating margin fell 420 bps year over year to 12.8%.
Net income on a GAAP basis was $165.6 million, or 44 cents per share, compared with $175.4 million, or 45 cents per share in the prior-year quarter. The quarter’s result came above the company’s guided range.
Excluding the above-mentioned special items, but including stock-based compensation, adjusted net income was $190.5 million or 51 cents per share, compared to $187.1 million or 48 cents a year ago.
Balance Sheet & Cash Flow
NetApp exited the quarter with cash, cash equivalents and investments of $4.6 billion, down from $4.7 billion in the previous quarter. Receivables were $625.2 million, up from $597.0 million a quarter ago. Inventories increased $25.1 million from the prior quarter to $163.3 million. The company bears no long-term debt.
Cash generated from operations in the quarter was $370.2 million, up from $240.6 million in the prior quarter. Capital expenditure in the quarter was $93.3 million, down from $98.3 million in the year-ago quarter.
Guidance
The company is still unsure about the extent of damage that the Thailand flood has caused to its fundamentals or results for the second half of fiscal 2012. Disk drives are the prime elements of its hardware suites. Thailand is the biggest manufacturer of hard disk drives (HDD) and this flood forced most of the producers to shut down their facilities. This will cause a major supply cut and price rise for raise prices in the HDD sector. But, as NetApp mostly uses enterprise class drives, the manufacturers of which have not been affected very badly. Hence, there is a possibility that NetApp will not be affected much. But NetApp should not suffer much as it mostly uses enterprise class drives, manufacturers of which have not been affected severely.
For the third quarter of 2012, NetApp expects revenues in the range of $1.52 billion and $1.61 billion, representing 1.0% to 7.0% sequential and approximately 18.0% to 25.0% year-over-year growth.
Non-GAAP gross margins are expected to be roughly 60.0%, while non-GAAP operating margins are projected at roughly 17.0%. GAAP EPS is expected to range between 36 cents and 40 cents, while non-GAAP EPS is expected between 56 cents and 60 cents. The company estimates shares outstanding of approximately 380 million.
Our Take
The quarter’s results were modest, with the bottom line marginally beating the Zacks Consensus Estimate. However, the result was not very encouraging compared to the year-ago period. Moreover, management guided its next quarter cautiously, keeping in mind the ongoing macro uncertainty caused by European debt crisis, federal budget cuts and Thailand flood.
But we believe 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.
NetApp is performing impressively, despite macro concerns and stiff competition from industrial heavyweights like International Business Machines Inc. (IBM) and EMC Corporation (EMC).
NetApp currently carries a Zacks #3 Rank (short-term Hold recommendation).
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