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NetApp Inc. (NTAP - Snapshot Report) reported first quarter fiscal 2014 earnings of 37 cents per share, which beat the Zacks Consensus Estimate by 3 cents. Earnings per share excludes amortization of intangible assets, acquisition-related expenses, non-cash interest expense as well as investments and tax gains, but includes stock-based compensation expenses.

Revenues

Revenues climbed 5.0% year over year, but declined 11.7% sequentially to $1.52 billion and lagged the Zacks Consensus Estimate of $1.54 billion. Revenues were within management’s guided range of $1.475 billion to $1.575 billion.

The year-over-year growth was primarily driven by higher branded revenues, which jumped 9.0% to $1.35 billion and fully offset the 20.0% decline in OEM revenues.

Product revenues increased 3.7% from the year-ago quarter, but declined 18.2% from the previous quarter to $930.8 million. Software Entitlement & Maintenance revenues increased 4.6% year over year and edged up 0.7% sequentially to $228.5 million in the quarter. Service revenues surged 8.8% year over year and increased 1.5% sequentially to $356.9 million.

Indirect revenues contributed 80.0% of the revenues in the quarter. Regionally, Americas grew 7%, Europe, Middle-East and Africa grew 2%, and Asia Pacific grew 3% from the year-ago quarter.

Operating Results

Gross margin expanded 110 basis points (“bps) from the year-ago quarter, but contracted 30 bps from the previous quarter to 59.0%. Gross margin includes stock based compensation expenses but excludes amortization expense.

Operating expenses as percentage of revenues decreased 240 bps to 50.4%, driven by lower sales & marketing (down 210 bps) and research & development (down 30 bps) expenses.

Sequentially, operating expenses jumped 260 bps, primarily attributed to higher sales & marketing (up 150 bps), research & development (up 80 bps) and general & administrative (up 20 bps) expenses.

Lower year-over-year increase in operating expenses and higher gross margin base helped operating margin to expand 360 bps to 10.6% from the year-ago quarter. However, operating margin decreased 240 bps from the previous quarter.

Net income (including stock based compensation but excluding one-time items and related tax effect) margin increased 280 bps from the year-ago quarter, but decreased 260 bps from the previous quarter.

Balance Sheet & Cash Flow

NetApp exited the quarter with cash, cash equivalents and investments of $5.08 billion, up from $6.95 billion in the previous quarter. Receivables were $533.3 million, up from $800.9 million a quarter ago. The company bears a long-term debt balance of $994.8 million.

Cash generated from operations was $285.8 million compared with $455.6 million generated in the prior quarter. Capital expenditure in the quarter was $65.3 million, up from $63.6 million in the prior quarter.

NetApp paid back approximately $900.0 million to shareholders through buyback ($850.0 million) and dividend payment ($51.0 million) during the quarter.

Guidance

For the second quarter of 2014, NetApp expects revenues in the range of $1.560 billion to $1.660 billion, representing approximately 6.0% sequential growth and 5.0% year-over-year growth at the mid-point. Branded revenues are expected to be approximately similar to first quarter. However, OEM revenues are expected to decline in the upcoming quarter.

For the second quarter, gross margin is expected to be approximately 61.0%, while non-GAAP operating margin is projected in the range of 16.0%–16.5%. Earnings are expected to be in the range of 60 cents to 65 cents per share, up 18.0% to 27.0% from the year-ago second quarter.

For fiscal 2014, gross margin is expected to be approximately 61.0% and operating margin is forecasted at 17.0%. Earnings are expected to grow in the mid-teens and the company expects to complete the $2.0 billion share repurchase by the end of this fiscal.

Our Take

We believe that NetApp’s innovative product line-up, frequent updates and shareholder-friendly activities will boost profitability going forward.

Though new product refreshes, partnerships with Cisco Systems Corp. (CSCO - Analyst Report) and Microsoft (MSFT - Analyst Report), and ramp of ONTAP 8.2 are positives, we believe that uncertain IT spending outlook and stiff competition from EMC Corp. (EMC - Analyst Report) are the primary headwinds going forward.

NetApp currently carries a Zacks Rank #2 (Buy).

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