After NetApp (NTAP) reported its second quarter last week, the stock flew higher as a wave of optimism washed over the shares. Short-sellers covered their positions as tech investors backed up the truck. (Tech investors can't help themselves.) Once the stock popped higher, the analyst community jumped on board, upgrading the shares and slapping target prices on it as high as $40. But, while it can be exciting to choose a big turning point, I remain unconvinced.
Last week NetApp reported fiscal second-quarter earnings of $0.37, or $0.03 ahead of the consensus estimate. Revenue came to $1.54 billion, up 2.3% year over year. Management attributed the stronger-than-expected performance to the software and services business. Software and maintenance revenue was up 10.8% to $219.4 million, and service revenue rose 11.3% to $326.0 million.
While that's great, software and service represents only 35% of the top line. The rest of the numbers were a total mess. Product revenue, which comprises the vast majority of sales, declined 2% to $995.8 million. Gross margins dropped 130 basis points to 59.3%. Total operating expenses jumped 8%. Operating income declined 29.7% to $135 million. Further, operating margin was 8.8%, down from 12.8% in the year-ago quarter.
Even with fourth-quarter guidance of 4% revenue growth, NetApp is still set to end fiscal 2013 with sales growth of just 2%. Net income, moreover, will probably end the year down 14.5%. How is that an exciting buy? Because of a few new products and some product refreshes, analysts are looking for 8% revenue growth next year. With revenue growth and a stock buybacks, the Street thinks NetApp can growth earnings per share at 15%.
One of the strongest parts of NetApp's business has been European government spending. But one has to wonder how long that will last. For the company to hit Street estimates, business-technology spending has to pick up dramatically if European spending heads south.
Despite the NetApp mania among investors, I remain unconvinced that the rally is backed by solid fundamentals. If I'm right, the NetApp fever will break and the shares will fall back to pre-mania levels.