NetApp Earnings Preview: Hardware Weakness Offset By Software And Services
NetApp (NASDAQ:NTAP) is set to announce its Q1 fiscal 2014 results on August 14, and we expect overall revenues to register mid-single digit growth. The storage hardware business may continue reel under pressure from weakness in the OEM business amid cautious IT spending. However, this should be negated by growth in branded hardware products. The continued growth in software and services businesses is expected to lend support as its Data ONTAP storage operating system continues to do well. Gross margins are expected to improve due to a favorable product mix and more revenues coming in from the high margin software and services businesses.
Last quarter NetApp clocked $1.72 billion in revenues, up 1% on a yearly basis. GAAP net income came in at $158 million, or $0.43 per share, compared with $120 million, or $0.32 per share, in the same period last year. For Q1 fiscal 2014, NetApp estimates revenues in the range of $1.47-$1.57 billion, about 5% year-over-year growth and non-GAAP EPS between $0.45 and $0.50. Below we take a detailed look at the trends observed and key business developments.
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See our full analysis on NetApp
Hardware Business To Decline
Due to weak IT spending and a sluggish macroeconomic environment that EMC’s earnings helped to confirm (Read EMC Registers Steady Growth In Q2 Though Momentum Should Pick Up), we expect NetApp’s overall hardware business to continue to decline. Its OEM business should decline at a high-teen rate as clients like IBM and Fujitsu continue to reduce their purchases of NetApp-sourced kit. Under its OEM business, NetApp sells its products to other companies which then market the same under their own brands. Since revenues from the OEM business constitute a significant chunk of overall product revenues, this will weigh on revenue growth even as the branded business will remain in the positive growth territory. Growth in the branded business will be driven by the mid-end array including FAS 3220 and 3250 as more mid-sized businesses are seen consolidating operations onto a shared storage platform. High-end array FAS 6000 and entry-level array FAS 2000 could, however, see some pressure. Branded E-Series products have picked up growth as witnessed in the last quarter.
NetApp’s comprehensive flash portfolio should also continue to post strong growth. Flash provides high speed data performance, and despite the costs associated with it, companies are willing to pay for enhanced performance. The EF 540, an all-flash array built on E-Series, has seen strong traction. In Q4, bookings for systems with flash pools, a hybrid disk and SSD solution, grew 32% sequentially.
Software And Services Business, Gross Margins To Improve
Growth in the software business will be driven by the continued adoption of Data ONTAP, the top storage operating system (OS). ONTAP 8 has been seeing strong customer adoption. However, we will look for updates on the performance of version 8.2 of ONTAP, which was launched in this quarter. NetApp has simplified the upgrade to the latest version through a reduction in the required downtime, which had been a key barrier for many clients. It has also introduced new features that are expected to lead to higher adoption for the operating system (Read NetApp Eyes Market Share Gains With New Version Of Flagship Storage Operating System). The services business through which NetApp provides support solutions and customer education and training will continue to grow at a high single digit growth rate due to a growing installed base. Hardware maintenance contracts provide a recurring revenue stream for the company.
Overall, gross margins are expected to benefit from a favorable mix in the hardware segment with growing sales of high margin branded products. The higher revenue share of high margin software will also lift margins. Operating margins, however, could remain under pressure due to an expected increase in R&D and SG&A costs. The company is investing heavily in marketing and branding to gain back growth momentum through new contracts and strategic partnerships. It has also intensified its efforts to develop new products to fend off increasing competition from EMC and its own partners. While NetApp announced 900 job cuts in the last earnings, this may not be enough to boost operating margins.
We will update our $38 Trefis price estimate for NetApp following results.
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