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STEC Inc. reported second quarter 2012 adjusted loss per share of 36 cents, wider than the Zacks Consensus Estimate of 32 cents loss per share. The adjusted or non-GAAP loss per share excludes employee severance fees, litigation costs and deferred tax valuation allowance, but includes stock-based compensation expense. The quarter’s earnings dropped 294.0% from the year-ago level. The miss was due to higher costs, lower pricing and market share loss.

Revenue

Total revenue for the second quarter was $40.7 million, down 50.6% on a year-over-year basis. The lackluster performance was primarily due to a 50% decline in Flash-based product sales. The sales decline was due to market share loss.

Operating Results

Reported gross margin in the quarter was 36.6%, down from 44.7% in the year-ago quarter. Higher percentage of fixed production overhead and labor costs on revenue and competitive pricing pulled down the gross margin. This was partially offset by favorable flash-component costs.

Operating margin was (56.0%) versus 12.0% in the year-ago quarter. The company’s total operating expenses increased 39.8% on a year-over-year basis. Higher operating expenses were mainly due to 68.4%, 34.5% and 13.7% year-over-year increases in general and administrative expenses, research and development expenses, and selling and marketing expenses, respectively.

Net loss on a GAAP basis was $49.6 million or $1.07 per diluted share compared with net income of $9.7 million or 18 cents in the year-ago quarter.

After excluding non-recurring items associated with cost of sales and operating expenses after taxes but including stock-based compensation expense, adjusted net loss for the second quarter was $16.6 million or 36 cents per diluted share. There were no such one- time items recorded in the year-ago quarter.

Balance Sheet & Cash Flow

Cash and cash equivalents were $207.2 million versus $205.7 million in the previous quarter. Inventories were at $34.6 million compared with $37.5 million in the prior quarter. Receivables were $19.4 million versus $21.4 million in the prior quarter. Cash from operating activities was $4.0 million, down from $26.2 million in the prior quarter. Capital expenditure was $4.7 million compared with $1.8 million in the prior quarter.

Outlook

Earlier, STEC marketed its products through OEMS (original equipment manufacturers). However, since the past few months, it has been marketing its products directly to enterprises and end-users. The management believes that the transition will likely take place during the third quarter and expects solid contributions from enterprise verticals. With this diversification strategy, the company believes that customer concentration risks will be mitigated.

For the third quarter, management expects revenue in the range of $40.0–$142.0 million, Non-GAAP loss per share is expected between 31 cents and 27 cents.

The Zacks Consensus Estimates for third quarter and fiscal 2012 are pegged at a loss of 27 cents and $1.00 per share, respectively.

Our Take

STEC’s second quarter loss per share was wider than the Zacks Consensus Estimate. The third quarter guidance announced by the company is disappointing, despite the encouraging and diversified marketing strategy adopted by the company.  

We are also bearish due to intense competitive pressures from SanDisk Corporation (SNDK - Analyst Report), Micron Technology Inc. (MU - Analyst Report) and OCZ Technology Group .

Currently, STEC has a Zacks #4 Rank, implying a short-term Sell rating.

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