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NetApp Inc. (NTAP - Snapshot Report) reported second-quarter fiscal 2014 earnings (excluding amortization and other one-time items but including stock-based compensation) of 52 cents per share, which beat the Zacks Consensus Estimate by 4 cents. On a year-over-year basis, earnings improved 36.8%.

Revenues

NetApp’s revenues for the quarter increased 0.6% year over year to $1.55 billion but failed to beat the Zacks Consensus Estimate of $1.61 billion. The modest year-over-year growth was primarily driven by higher branded revenues, which increased 5.1% from the year-ago quarter to $1.39 billion and fully offset the 27.9% decline in OEM revenues which came in at $151.1 million.

On operating segment basis, Product revenues (61.6% of total revenue) decreased 4.1% from the year-ago quarter to $955.3 million. Software Entitlement & Maintenance revenues (15.0% of total revenue) increased 5.7% year over year to $231.8 million in the quarter. Service revenues, which comprised 23.4% of total revenue, surged 11.3% year over year to $362.8 million.

During the quarter, NetApp entered into partnerships to provide cloud-based services. The company collaborated with Oracle (ORCL - Analyst Report) and Verizon (VZ - Analyst Report) to provide enhanced data management services across private and public clouds. The company witnessed strong demand for its storage operating system – Data ONTAP – and flash solutions.

Geographically, the Americas Commercial revenues and revenues from EMEA region increased 3.0% and 2.0%, respectively, on a year-over-year basis. Revenues from the Asia-Pacific region, however, remained flat.

Operating Results

Adjusted gross margins (including stock-based compensation but excluding amortization and other one-time items) expanded 300 basis points (bps) from the year-ago quarter to 63.2% primarily due to favorable mix and strength in product margins.

Operating expenses (including stock-based compensation but excluding amortization and other one-time items) as percentage of revenues marginally increased 10 bps to 50.1%, primarily due to lower sales and marketing expense.

Higher revenue base and lower-than-expected increase in operating expenses helped operating margins (including stock-based compensation but excluding amortization and other one-time items) to expand 292 bps to 13.1% from the year-ago quarter.

Net income (including stock-based compensation but excluding one-time items and related tax effect) margin increased 262 bps from the year-ago quarter.

Balance Sheet & Cash Flow

NetApp exited the quarter with cash, cash equivalents and investments of $5.27 billion, up from $5.08 billion in the previous quarter. Receivables were $590.4 million, up from $533.3 million in the previous quarter. The company has a long-term debt balance of $995.0 million.

The company generated cash from operations of $362.5 million compared with $285.8 million in the previous quarter NetApp repurchased stocks worth $150.5 million and paid dividends amounting to $51.3 million for the quarter.

Guidance

For the third quarter of 2014, NetApp expects revenues in the range of $1.575 billion to $1.675 billion, up 5.0% sequentially but flat year over year. Branded revenues are expected to be slightly down from the second quarter. However, revenue decline in the OEM segment is expected to normalize in the upcoming quarter.

For the third quarter, non-GAAP gross margins are expected in the range of 61.5% to 62%, while non-GAAP operating margin is expected at 18%. Non-GAAP earnings per share are expected in the range of 68 cents to 73 cents per share, up from 67 cents reported in the year-ago quarter.

Our Take

We believe that NetApp’s innovative product line-up, frequent updates and shareholder-friendly activities will boost profitability, going forward. Moreover, its partnerships with Oracle, Verizon and Amazon (AMZN - Analyst Report) and rapid adoption of its ONTAP system are positives.

Nonetheless, we believe that uncertain IT spending outlook and stiff competition from EMC remain the primary headwinds, going forward. 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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