Mellanox Technology (MLNX.O) makes products that facilitate data transfers between servers, storage devices and communications infrastructure equipment. Over the long term, the need for data transmission is growing tremendously. But right now, server manufacturers are waiting for the next generation of servers to be released before investing. Mellanox has seen an increase in the inventory levels of its products in client warehouses – and a simultaneous revenue decline. That doesn’t bode well for earnings and the Thomson Reuters StarMine Predicted Surprise of negative 4% means Mellanox may miss earnings estimates when it reports second-quarter results on July 24.
As seen in the chart below, the I/B/E/S consensus (blue line) estimate has declined by more than half, to 20 cents per share from 44 cents. Although the differential between the StarMine SmartEstimate and the consensus has decreased, the SmartEstimate is still one cent below the consensus. Just a week ago that differential was 3 cents. Analysts have reduced EPS estimates for the quarter by 56% in the last 90 days, and they’ve reduced estimates for the whole year and next year by 29% and 16%, respectively. That indicates that they do not think issues are restricted to just the current quarter. What are some of these issues?
Source: Thomson Reuters Eikon
Higher inventory, lower revenue
The chart below on top shows that average inventory days for Mellanox have increased to 140. At a technology company, products are under constant threat of obsolescence and high inventory days could be a troubling sign. That is compounded by the fact that some of Mellanox’s biggest clients have built up inventory on their end too. Their end clients are likely to first try and deplete their own inventory before putting in new orders. On the first quarter conference call, Eyal Waldman, President and CEO, noted that as customers deplete more of their inventory, Mellanox will see higher growth in revenue later in the year. The revenue drop off in the last two quarters is quite evident in the chart on the bottom. In fact, in the first quarter of 2013 revenues of $83 million were lower than revenues from the same year-ago quarter of $89 million.
Mellanox Inventory Days (Top) and Revenues (Bottom)
Source: Thomson Reuters Eikon
Large customers face uncertainty
Mellanox’s two largest customers are facing some uncertainty. Hewlett Packard and IBM represent 20% and 19% of revenues. Hewlett Packard was one of the customers that saw a huge buildup of inventory and has seen a slowdown in its server business. IBM is facing uncertainly around the sale of its server business to Lenovo. That uncertainty is driving down their purchases from Mellanox. While those customers may pick up spending again, that does not seem to be the case for this quarter at least, based on analysts’ expectations.
SMARTESTIMATES AND THE PREDICTED SURPRISE %
SmartEstimates: Thomson Reuters StarMine Professional quantitatively analyzes the earnings estimate accuracy of sell-side analysts and uses this information to create proprietary
SmartEstimates®.SmartEstimates help you better predict future earnings and analyst revisions with estimates that place more weight on recent forecasts by top-rated analysts.
Predicted Surprise %: The Predicted Surprise% is the percentage difference between the SmartEstimate and the I/B/E/S consensus estimate. When SmartEstimates diverge significantly from consensus, it serves as a leading indicator of the direction of future revisions and/or surprises. In aggregate, this indicator gets earnings surprises directionally correct 70% of the time.
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