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.
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.
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. 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.
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 (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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