NetApp Earnings Preview: Software And All-Flash Array Key To Drive Growth

Storage giant NetApp (NASDAQ:NTAP) is scheduled to announce its Q3 FY 2013 results on February 12. In the previous quarter, NetApp recorded revenues of $1.55 billion, which were marginally below the company’s guidance. NetApp attributed the shortfall to lower-than-expected sales through its original equipment manufacturer (OEM) channel coupled with the federal shutdown, resulting in reduced product sales. However, an increased mix of high-margin branded products, in lieu of OEM products, resulted in healthier margins than the prior-year period. While gross margins on products in Q2 improved by almost 400 basis points both sequentially and annually, to 57%, its software and services margins were nearly flat. ^[1]

Looking ahead, the company has given a net revenue guidance for Q3 of $1.625 billion, which is a 5% sequential increase, but around the same as the prior year period. NetApp’s current market price is about in line with our $43 price estimate.

See our full analysis of NetApp’s stock.

Software And Software-Defined Storage Revenues Growing

NetApp’s software division is the most profitable segment within the company, with gross margins of around 97%. On the back of increased adoption of NetApp’s flagship Data ONTAP storage operating system, revenues generated by the software division grew by 5% in the first two quarters of the fiscal year, compared to the same period in 2012. Going forward, NetApp’s management believes that with the storage industry witnessing a shift towards cloud and software-defined storage, the company’s strong partnership with major cloud storage providers such as Verizon (NYSE:VZ) and Amazon’s (NASDAQ:AMZN) Web Services is likely to benefit NetApp. ^[2] Additionally, the company’s investment in integrating its Data ONTAP clustered platform with emerging cloud solutions such as OpenStack and CloudStack signals NetApp’s clear intention to cater to the growing software-defined storage market. ^[3]

All-Flash Array To Drive Branded Hardware Sales

NetApp’s highlight of the quarter was the recently launched EF550 all-flash array. The EF550 can perform 400,000 inputs/outputs per second (IOPS) and can store up to 96 terabytes (TB) of data. This is a 33% increase in IOPS and a 100% increase in data storage from its predecessor, the EF540. Owing to increasing demand for Big Data storage and a requirement for frequent data access, traditional hard drive-based storage arrays are struggling to meet high IOPS requirements. All-flash arrays are a good solution for data center storage, and are increasingly being adopted by enterprises. This trend was also evident in competitor EMC’s (NYSE:EMC) recent earnings.

With a growing number of flash-based storage solutions, the company’s hardware storage margins could improve further. However, if OEM product sales recover from the slight decline in the previous quarter, then the rise in low-margin OEM product sales could offset the overall improvement in margins. In addition, we expect the increasing number of software-based solutions and Data ONTAP operating system adoption to lead to healthier overall margins.

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1. NetApp Historical Supplemental Data, NetApp Investor Relations, November 2013 [↩]
2. NetApp Q2 FY 2013 Earnings Call Transcript, Seeking Alpha, November 2013 [↩]
3. NetApp Looks To Universalize Cloud Management, ARN Net, September 2013 [↩]