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STEC Inc. reported third quarter 2012 adjusted loss per share of 33 cents, narrower than the Zacks Consensus Estimate of 36 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 451.0% from the year-ago level. The disappointing result was due to higher costs, lower pricing and market share loss.

Revenue

Total revenue for the third quarter was $42.1 million, down 42.0% on a year-over-year basis. The sales decline was due to market share loss.

Operating Results

Reported gross margin in the quarter was 37.0%, down from 45.8% 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 (50.9%) versus 7.6% in the year-ago quarter. The company’s total operating expenses increased 33.5% on a year-over-year basis. Higher operating expenses were mainly due to 73.9%, 16.5% and 25.2% year-over-year increases in general and administrative, research and development, and selling and marketing expenses, respectively.

Net loss on a GAAP basis was $19.8 million or 42 cents per diluted share compared to a net income of $4.8 million or 9 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 third quarter was $15.5 million or 33 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 $186.2 million versus $207.2 million in the previous quarter. Inventories were at $44.5 million compared with $34.6 million in the prior quarter. Receivables were $13.2 million versus $19.4 million in the prior quarter. Cash from operating activities was $18.1 million, up from $4.0 million in the prior quarter. Capital expenditure was $2.5 million compared with $4.7 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 could lead to solid contributions from enterprise verticals. With this diversification strategy, the company believes that customer concentration risks will be mitigated.

For the fourth quarter, management expects revenue in the range of $36.0–$40.0 million. Non-GAAP loss per share is expected between 31 cents and 35 cents.

The Zacks Consensus Estimates for fourth quarter and fiscal 2012 are pegged at a loss of 27 cents and $1.23 per share, respectively.

Our Take

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

Also, intense competitive pressures from SanDisk Corporation (SNDK - Analyst Report), Micron Technology Inc. (MU - Analyst Report) and OCZ Technology Group are concerns.

Currently, STEC has a Zacks #3 Rank, implying a short-term Hold rating.

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