Shares of NetApp Inc. (NTAP) were down 3.1% during after-hours trade on Nov 12, 2014 after the company reported lower-than-expected second-quarter fiscal 2015 adjusted earnings (including stock-based compensation but excluding amortization and other one-time items) of 52 cents per share. The Zacks Consensus Estimate was pegged at 53 cents.
Quarter Details
NetApp’s revenues for the quarter decreased 0.5% year over year to $1.54 billion and missed the Zacks Consensus Estimate of $1.55 billion. The year-over-year decline was primarily due to a 21.5% drop in original equipment manufacturer (OEM) revenues. However, Branded revenues increased 1.8% from the year-ago quarter and came in at $1.42 billion.
On an operating segment basis, Product revenues (60% of total revenue) decreased 2.7% from the year-ago quarter to $929.1 million. Software Entitlement & Maintenance revenues (15%) decreased 3.3% year over year to $224.2 million.
Nonetheless, Service revenues (25%) increased 7.3% year over year to $389.2 million. Within Service revenues, hardware maintenance support contracts revenues increased 12.5% on a year-over-year basis, which more than offset the decline in revenues from Professional & Other Services (down 9.5% year over year).
The company witnessed strong demand for its storage operating system — Data ONTAP — and flash solutions. Arrow Electronics (ARW) and Avnet (AVT) contributed approximately 24% and 17%, respectively, to net revenue.
Adjusted gross margins (including stock-based compensation but excluding amortization and other one-time items) expanded 142 basis points (bps) from the year-ago quarter to 64.6%. The improvement came primarily on the back of higher product gross margins and service gross margins.
Operating expenses (including stock-based compensation but excluding amortization and other one-time items) as a percentage of revenues increased 107 bps to 51.2%, primarily due to an increase in sales and marketing expenses and general and administrative expenses. In dollar terms, operating expenses increased 1.6% year over year.
Operating margins (including stock-based compensation but excluding amortization and other one-time items) expanded 33 bps to 13.4% from the year-ago quarter, primarily due to strong demand for its storage operating system and better-than-expected growth in Branded revenues. Net income (including stock-based compensation but excluding one-time items and related tax effect) came in at $171.5 million compared with $179.2 million reported in the year-ago quarter.
Balance Sheet & Cash Flow
NetApp exited the quarter with cash, cash equivalents and investments of $5.27 billion, compared with $5.56 billion in the previous quarter. Receivables were $632.7 million versus $585.4 million in the last quarter. The company has a long-term debt balance of $1.49 billion.
NetApp generated cash from operations of $381.4 million compared with $215.5 million in the earlier quarter. The company repurchased stocks worth $600 million and paid $52 million as dividend.
Guidance
For the third quarter of fiscal 2015, NetApp expects revenues in the range of $1.56 to $1.66 billion (mid-point $1.61 billion), up approximately 4% sequentially but flat on a year-over-year basis at the mid-point. The Zacks Consensus Estimate is pegged at $1.63 billion.
Management expects non-GAAP gross margin in the range of 64–64.5% and non-GAAP operating margin in the range of 18% to 18.5%. Non-GAAP earnings per share are expected within 74 to 79 cents per share. The Zacks Consensus Estimate is pegged at 63 cents.
Our Take
NetApp reported tepid second-quarter results and provided lower-than-expected revenue guidance for the next quarter.
Nevertheless, the company is gaining momentum in flash-based solutions with the newly introduced all-flash array, which will help it to gain traction in the storage market. The recent product launches and product refreshes will drive revenues and stringent cost controls will ensure margin expansion.
However, we believe that an uncertain IT spending outlook and competition from EMC Corp. (EMC) remain headwinds. Continuous decline in OEM revenues further add to the woes.
NetApp currently carries a Zacks Rank #3 (Hold).
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