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NetApp Inc. (NTAP - Snapshot Report) is scheduled to announce its second quarter 2013 results on November 14, 2012 and movements in analyst estimates indicate some negative sentiment.

First Quarter Overview

NetApp reported unimpressive first quarter 2013 numbers, with earnings per share (EPS) of 23 cents missing the Zacks Consensus Estimate by 2 cents.

Revenue fell 0.9% from the year-ago quarter to $1.44 billion. However, reported revenue was within the company’s guidance range. The year-over-year decrease was due to a decline in Product revenue, which was a bit surprising given its solid performances in the past quarters.

Both the Americas and the Asia-Pacific grew in the last quarter. But this was offset by slowing demand from the U.S. federal government and constrained European spending.

Weak revenues coupled with cost increases resulted in margin contraction.

Second Quarter Outlook

Keeping in mind the ongoing macro uncertainty caused by the European debt crisis and federal budget cuts, management guided a cautious yet positive second quarter.

NetApp expects revenues in the range of $1.5 billion to $1.6 billion, representing a 7.0% sequential growth and 3.0% year-over-year growth. Non-GAAP gross margins are expected to be in the range of 60.0–61.0%, while non-GAAP operating margins are projected at roughly 13.5% (+/- 5.0%). GAAP EPS is expected to be between 23 cents and 28 cents, while non-GAAP EPS is expected to be between 45 cents and 50 cents.

Agreement of Analysts

Notwithstanding the prospects and importance of storage in today’s IT systems, most of the analysts expect NetApp to miss its own revenue guidance.

This is supported by the fact that there has been no significant improvement in the demand situation since the last reported quarter. Weak U.S. enterprise and SMB (small and medium business) demand and ongoing Euro concerns are taking a toll on NetApp fundamentals.

Though budget flush from the U.S. federal government could provide some support, a few analysts contend that NetApp’s archrival EMC Corp. (EMC - Analyst Report) is better positioned to capitalize on the opportunity.

On the other hand, some analysts believe that the positive trend in accepting the latest iteration of ONTAP 8.1 (NetApp’s operating system) and close association with Cisco Systems Inc. (CSCO - Analyst Report) and VMware Inc. (VMW - Snapshot Report) could act as catalysts. NetApp is collaborating with the two to develop converged datacenter solutions. They are also positive about the product refreshes, which could help demand for its product to rise in the coming quarters.

Given the opposing arguments, it is not surprising that estimate revisions were limited. The majority of analysts preferred to maintain their estimates. Of the 13 and 14 estimates available for the second quarter and fiscal 2013, respectively, none were revised in the last 7 days. However, 1 and 2 estimates for the second quarter and fiscal 2013, respectively were lowered in the past 30 days to reflect analyst concern.

Magnitude of Estimate Revisions

The magnitude of revisions has been minimal since the company reported its first quarter results but reflected analyst sentiment. The Zacks Consensus Estimate for the upcoming quarter and fiscal 2013 slipped a penny to 33 cents and $1.45, respectively over the last 7 days. However, we noticed a huge decline of 8 cents and 9 cents, respectively in the estimates for fiscal 2013 and 2014 over the last 90 days.

Recommendation

Though we are confident about NetApp’s long-term growth prospects, the company’s lackluster second quarter guidance, ongoing macro uncertainty caused by the European debt crisis and overall IT spending patterns keep us on the sidelines.

We believe that NetApp will be able to hold its own in the difficult operating environment 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 and also target high performance computing applications like genomics sequencing.

NetApp shares carry a Zacks #4 Rank, implying a Sell rating in the short-term (1-3 months).

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