NetApp Lags on Q4 Earnings, Revs - Analyst Blog

NetApp Inc. NTAP reported fourth-quarter fiscal 2014 adjusted earnings of 70 cents per share, which lagged the Zacks Consensus Estimate of 79 cents. On a year-over-year basis, earnings improved 27.2%.

Adjusted earnings include stock-based compensation but exclude amortization, restructuring and other one-time items.

Quarter Details

NetApp's revenues for the quarter not only decreased 3.9% year over year to $1.65 billion but also lagged the Zacks Consensus Estimate of $1.67 billion. The year-over-year decline was primarily due to a 33.7% drop in original equipment manufacturer (OEM) revenues and 0.8% decrease in Branded revenues.

On an operating segment basis, Product revenues (63.0% of total revenue) decreased 8.4% from the year-ago quarter to $1.04 billion. Nonetheless, Software Entitlement & Maintenance revenues (14.0% of total revenue) increased 0.2% year over year to $227.5 million and Service revenues (23.0%) increased 7.7% year over year to $378.7 million.

The company witnessed strong demand for its storage operating system — Data ONTAP — and flash solutions. Arrow Electronics' ARW and Avnet's AVT contribution in net revenues were 24% and 17%, respectively.

Adjusted gross margins (including stock-based compensation but excluding amortization and other one-time items) expanded 310 basis points (bps) from the year-ago quarter to 64.1%. 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 decreased 54 bps to 47.3%, primarily due to decrease in sales and marketing expenses, research and development, and general and administrative expenses. In dollar terms, operating expenses decreased 5.0% year over year.

Operating margins (including stock-based compensation but excluding amortization and other one-time items) expanded 365 bps to 16.8% from the year-ago quarter primarily due to lower-than-expected operating expenses. Net income (including stock-based compensation but excluding one-time items and related tax effect) came in at $235.6 million or 70 cents, up from $202.7 million or 55 cents driven by efficient cost management and share repurchase initiatives.

Balance Sheet & Cash Flow

NetApp exited the quarter with cash, cash equivalents and investments of $5.00 billion, compared with $5.07 billion in the previous quarter. Receivables were $855.9 million versus $584.3 million in the previous quarter. The company has a long-term debt balance of $995.5 million.

NetApp generated cash from operations of $369.5 million compared with $331.8 million in the previous quarter. The company repurchased stocks worth $374.0 million and paid dividends amounting to $49.2 million for the reported quarter. The company also increased the dividend by 10% to be payable on Jul 22, 2014.

Guidance

For the first quarter of 2015, NetApp expects revenues in the range of $1.420 to $1.520 billion (mid-point $1.47 billion), down approximately 10.9% sequentially and approximately 3% from the year-ago quarter at the mid-point. The Zacks Consensus Estimate is pegged at $1.52 billion. The tepid guidance was due to seasonality and continued underperformance of the OEM business.

Management expects non-GAAP gross margins in the range of 63.5–64%, and non-GAAP operating margin to be 15%. Non-GAAP earnings per share are expected within the 53 to 58 cents range, significantly up from 37 cents reported in the year-ago quarter. The Zacks Consensus is pegged at 43 cents.

The company expects demand for its scale-out enterprise storage systems and converged solutions to increase with the adoption of hybrid cloud strategies by its customers in fiscal 2015. Thus, leveraging this demand, the company expects branded revenues to be up in mid single-digits in 2015. Nonetheless, management expects approximately 40% revenue decline from its OEM customers during fiscal 2015.   

For fiscal 2015, NetApp expects gross margins to be between 63% and 64%, consistent with its first-quarter estimates (+/-50 bps) while operating margins are expected at 18%.    

Our Take

NetApp reported dismal fourth-quarter results and also provided tepid first-quarter revenue guidance. However, the earnings guidance was encouraging, reflecting the company's stringent cost control measures and continuing share buyback initiatives. Management's positive commentary on the company's scale-out enterprise storage systems and converged solutions bode well. Moreover, rapid adoption of ONTAP system remains the growth catalyst, going forward.

Nonetheless, we believe that uncertain IT spending outlook and stiff competition from EMC Corp. EMC remain the primary headwinds. Continuous decline in OEM revenues also remains a cause of concern. Moreover, tepid revenue guidance for the coming quarter will remain an overhang on the stock.

NetApp currently carries a Zacks Rank #4 (Sell).

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