NetApp Inc. (NTAP) reported fourth quarter fiscal 2012 adjusted earnings per share (EPS) of 55 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. The quarter’s beat was aided by better-than-expected revenue growth and favorable tax rate.

However, after the closing bell, NetApp's share price slid a massive 16.59% only due to a dismal guidance for the next quarter that was below the Street expectation. The guidance reflected uncertainty in the macroeconomic environment and levels of tech spending.

Revenue

NetApp reported fourth quarter revenues of $1.70 billion, up 19.2% from $1.43 billion in the year-ago quarter. The revenue was within the company’s guidance range of $1.645–$1.725 billion and slightly above the Zacks Consensus Estimate of $1.68 billion. While product revenues grew the most, other segments also improved year over year. The company is enjoying a strong demand for its storage products thanks to mobile devices with  remote computing and Internet access like Apple Inc’s (AAPL) iPhone that are so in vogue.

Customer wins during the quarter were healthy as they were keen on leveraging storage virtualization to re-architect their data centers in order to gain efficiency, flexibility and cost savings. Moreover, the quarter witnessed solid geographical contributions from America and Asia-Pacific. But revenue growth was adversely affected by the slowing demand from the U.S. federal government and constrained European spending.

Product revenues were $1.17 billion in the quarter, up 21.3% from $960.5 million reported in the year-ago quarter and accounted for about 68.4% of the total revenue. The double-digit improvement has been consistent since the past nine quarters and the reason can be attributed to the successful launch of new products and a well-knitted distribution system. The recent launch of FlexPod, in association with networking giant Cisco Systems Inc. (CSCO) was quick to attract customers.

Software Entitlement & Maintenance revenues were $212.5 million, up 13.6% from $187.0 million in the year-ago quarter. The segment’s revenues represented around 12.5% of the total revenue.

Service revenues were $324.9 million, up 19.1% from $262.6 million reported in the year-ago quarter. The segment accounted for 19.1% of the total revenue.

Operating Results

NetApp reported gross profit of $995.0 million, representing a 7.2% year-over-year increase. Gross margin dropped 660 basis points (bps) year over year to 58.4%. The gross margin was affected by higher costs of drives due to supply shortages post the Thailand flood.

Total operating expenses increased 8.2% from the year-ago quarter to $773.6 million. This was mostly due to a steep rise (25.6%) in research and development expenses. Operating income grew 4.0% from the year-ago quarter to $221.4 million. Operating margin fell 190 bps year over year to 13.0%.

Net income on a GAAP basis was $180.7 million, or 47 cents per share, compared with $160.6 million, or 40 cents in the prior-year quarter. The quarter’s result was on the lower end of the company’s guided range of 38-43 cents.

Excluding the above-mentioned special items, but including stock-based compensation, adjusted net income was $208.3 million or 55 cents per share, compared to $186.2 million or 46 cents a year ago.

Balance Sheet & Cash Flow

NetApp exited the quarter with cash, cash equivalents and investments of $5.4 billion, up from $4.9 billion in the previous quarter. Receivables were $830.9 million, up from $685.4 million a quarter ago. Inventories increased $7.7 million from the prior quarter to $161.5 million. The company bears no long-term debt, a 1.75% convertible senior notes amounting $62.6 million is due in 2013.

Cash generated from operations of $582.6 million, nearly doubled from $269.2 million in the prior quarter. The improvement was backed by higher profit generation and a favorable working capital. Capital expenditure in the quarter was $124.2 million, up from $91.3 million in the year-ago quarter.

Guidance

NetApp provided a feeble first quarter 2013 outlook reflecting normal seasonality (which is typical of first quarters) and increasing macro uncertainty. Additionally, management stated that operating expenses will be closely monitored to neutralize the lackluster revenue.

For the first quarter of 2013, NetApp expects revenues in the range of $1.4 billion to $1.5 billion, representing a decline of 12.0% to 18.0% sequentially. However, the year-over-year comparison indicates a range of 4.0% decline to 3.0% growth.

Non-GAAP gross margins are expected in the range of 60.0–61.0%, while non-GAAP operating margins are projected at roughly 11.5% (+/- 5.0%). GAAP EPS is expected to range between 10 cents and 15 cents, while non-GAAP EPS is expected between 34 cents and 39 cents. The company estimates shares outstanding of approximately 380 million and a tax rate of 17.5%.

Our Take

The quarter’s results were encouraging, with the top and bottom lines beating the Zacks Consensus Estimates. Product strength was the driving force, but margin contraction remained the main challenge. Moreover, management guided a lackluster first quarter, keeping in mind the ongoing macro uncertainty caused by the European debt crisis, federal budget cuts and Thailand flood (which is limiting component availability).

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. Considering this, we think that the first quarter guidance is a bit conservative.

However, we are cautious regarding the impact of new product launches from EMC Corp. (EMC) on NetApp’s fundamentals, going forward.

NetApp currently carries a Zacks #3 Rank (short-term Hold recommendation).


 
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