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NetApp Inc. (NTAP - Free Report) reported second-quarter fiscal 2017 non-GAAP earnings (including stock based compensation) of 42 cents, which beat the Zacks Consensus Estimate by 4 cents. Excluding stock-based compensation, earnings declined 1.6% year over year but jumped 30.4% to 60 cents. The sequential growth was driven by margin expansion.

Shares jumped more than 10% in after-hours trading.

Revenues declined 7.3% from the year-ago quarter but increased 3.6% from the previous quarter to $1.34 billion, which missed the Zacks Consensus Estimate of $1.36 billion. However, the figure was within management’s guided range of $1.265 billion to $1.415 billion.

Segment Revenue Details

Product revenues (53% of total revenue) fell almost 13% year over year but increased 7.6% sequentially to $700 million. Strategic solutions comprised 62% of net product revenues and increased 1.2% on a year-over-year basis. Sequentially, strategic solutions grew almost 10%, reflecting strong adoption among customers.
 

 

However, mature solutions revenues plunged 29% from the year-ago quarter but increased 4.2% sequentially. NetApp anticipates headwinds impacting mature solutions revenues to decrease over rest of the fiscal year.

Software Maintenance revenues (18.1%) increased nearly 4% from the year-ago quarter and 0.4% from the previous quarter to $242 million.

Revenues from Hardware Maintenance & Other Services (29%) dropped 2.3% year over year and 1.3% quarter over quarter to $388 million. The revenue decline was primarily attributed to lower hardware maintenance support contract revenues.

Clustered ONTAP, Flash Driving Growth
 

NETAPP INC Price, Consensus and EPS Surprise

 

NETAPP INC Price, Consensus and EPS Surprise | NETAPP INC Quote

NetApp noted strong demand for Clustered ONTAP, which was deployed on 86% of FAS system shipped in the second quarter, up from roughly 70% in the year-ago quarter. Clustered ONTAP enables seamless enterprise data management across flash, disk as well as public and private cloud environments.

With Clustered ONTAP, enterprises can consolidate multiple workloads into a single repository, dramatically improving the efficiency of their enterprise storage infrastructure. The strong demand is validated by growing unit shipments, which grew 14% year over year.

The installed base of FAS systems continues to grow and Clustered ONTAP is now running on approximately 36% of systems in this large and growing installed base.

NetApp’s latest ONTAP 9 has gained strong adoption since it release four months ago. During second-quarter, the company expanded ONTAP 9’s features with built-in multichannel capable inscription for improve data security, support for massively scalable high performance NAS containers and greatly simplified provision in operations for enterprise applications.

In the reported quarter, NetApp’s all flash array business tripled year over year to an annualized net revenue run rate of over $1 billion. The business includes all flash FAS, EF and SolidFire product and services. During the quarter, the company shipped more than 200 petabytes of flash.

During the quarter, NetApp refreshed portfolio of ONTAP powered hybrid in all flash arrays and also enhanced ONTAP Select to support flash in commodity servers. The new hybrid array systems address the needs of large enterprise data centers as well as small enterprises and mid-size businesses.

The new product offers increased speed and responsiveness compared to the company’s previous hybrid arrays. They can scale up to 14 petabytes in a single system and out to a 172 petabytes in a Cluster.

NetApp has expanded ONTAP cloud features to include Microsoft (MSFT - Free Report) Azure and has announced cloud control for Microsoft Office 365. The solution supports data retention in cloud services such as Amazon’s (AMZN - Free Report) S3 and Azure as well as on premises storage.

Further, NetApp launched private storage as a service, an OpEx based consumption model available to a growing partner delivery ecosystem.

Operating Details

Non-GAAP gross margin expanded 30 basis points (bps) both from the year-ago quarter and on a sequential basis to 62.4%, primarily due to higher hardware maintenance and other services gross margin.

Non-GAAP operating expenses as a percentage of revenues declined 10 bps from the year-ago quarter and 300 bps sequentially reflecting benefits from the company’s ongoing cost reduction initiatives.

On Nov 3, NetApp announced that it will reduce approximately 6% of worldwide headcount that will result in a onetime charge of $50–$60 million, primarily in third-quarter fiscal 2017. This action will yield an annual run rate savings of approximately $130 million.

Notably, in fiscal 2016, NetApp announced plans to lower costs by $400 million annually by the end of fiscal 2017. Some of these savings will be reinvested into strategic opportunities such as SolidFire and is likely to yield a net run rate savings of almost $130 million annually.

Stringent cost control over indirect spending, improvements in supply chain efficiency, streamlining of product portfolio and reducing headcount lowered operating expenses in the quarter.

Consequently, non-GAAP operating margin expanded 30 bps on a year-over-year basis and 340 bps on a sequential basis to 11.4% in the reported quarter.

Balance Sheet & Cash Flow

NetApp exited the quarter with cash, cash equivalents and investments of $4.36 billion, compared with $4.42 billion at the end of previous quarter. The company has a long-term debt balance of $1.49 billion.

NetApp generated cash from operations of $158 million during the quarter, compared with $228 million in the previous quarter. Additionally, free cash flow decreased from $192 million to $102 million at the end of the quarter.

Further, NetApp repurchased shares worth $117 million and paid $52 million as dividends in the reported quarter.

Guidance

For third-quarter fiscal 2017, NetApp expects non-GAAP earnings in the range of 72–77 cents per share.

Net revenues are anticipated to be in the range of $1.325 to $1.475 billion. At the midpoint, the guidance implies a sequential increase of approximately 4% and 1% increase on a year-over-year basis.

NetApp expect gross margin in the range of 61.5% to 62.5% and operating margin between 18% and 18.5% for the third-quarter.

NetApp anticipates strong strategic solutions growth will improve product revenue growth trajectory in the rest of fiscal 2017.

Zacks Rank & Key Picks

NetApp carries a Zacks Rank #3 (Hold). Seagate Technologies (STX - Free Report) sporting a Zacks Rank #1 (Strong Buy) is a better-ranked stock in the sector. You can see the complete list of today’s Zacks #1 Rank stocks here.

Seagate’s long-term earnings growth is currently pegged at 4.1%.

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