NetApp (NASDAQ:NTAP) is set to announce its Q4 FY 2013 results on May 21, and we expect overall revenues to register mid-single digit growth. While the storage hardware business may continue to witness a decline, this should be negated by the growth in software and services businesses. Gross margins are expected to improve with more revenues coming in from the high margin software and services businesses.
Last quarter, NetApp clocked $1.63 billion in revenues, up slightly on a year-over-year (y-o-y) basis. GAAP net income came in at $158 million, or $0.430 per share, compared with $120 million, or $0.32 per share, in the same period last year. Below we discuss some key business trends influencing the company’s performance.
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Services And Software Growth Will Outpace Hardware Decline, Margins To Improve
We expect overall hardware revenues to continue to decline due to cautious IT spending and a weak macroeconomic environment. The OEM part of this business, which constitutes a significant chunk of total revenues, continues to face a slowdown. The branded business, however, is expected to register strong growth with new products including FAS 3220 and 3250 seeing strong traction as more midsized businesses are consolidating operations onto a shared storage platform.
Further, NetApp’s comprehensive flash portfolio also continues to witness strong growth. Flash provides high speed data performance and despite the costs associated with it companies are willing to pay for the enhanced performance. In Q3, bookings for systems with Flash pools, a hybrid disk and SSD solution, grew 67% sequentially. We can see the hybrid solutions becoming a major driver going forward.
In the services business, hardware maintenance contracts are expected to continue to show robust growth. Growth in the software business is being driven by continued adoption of Data ONTAP, the top storage operating system (OS). In Q3, ONTAP 8 saw strong customer adoption as almost 50% of the global installed base moved to the OS, with a majority already shifting to version 8.1 which was launched in mid-2012.  Further, its StorageGRID software should also continue to add to revenue growth after the addition of the Cloud Data Management Interface (CDMI) standard (Read our article NetApp Looks Cheap With 40% Of Its Stock Price In Cash) for more details.
Product gross margins are estimated to be in the low 50% range while services margins are slightly higher nearing 60% and software margins are much higher nearing the 90% mark. With increasing revenue share of services and software businesses, we expect overall margins to improve.
What Are We Watching?
We will watch for updates on the ongoing uncertainty in U.S. federal spending due to budget sequestration that could limit spending and if it poses challenges for the company in any way. The U.S. federal and public sector has been one of the big growth drivers for the company.
Further, on Thursday, news of Elliott Management Corp. picking up close to 5% stake in NetApp surfaced. NetApp’s stock soared as the activist hedge fund is known for picking up stakes in high potential but poorly performing businesses, and pushing the managements to make changes to increase shareholder value. The fund is said to be quietly campaigning to revamp NetApp’s board. The fund is reviewing potential strategic options, which may include a possible stake sale or strategic partnerships with other companies. We will be closely watching for any comments from the management on this development.
We currently have a $38 Trefis price estimate for NetApp, which is in line with the current market price.Notes: