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Summary

  • The company reported an 8% year-over-year decline in its storage product revenues to just over $1 billion.
  • However, revenues generated by NetApp's services division grew by almost 8% over the year ago period to $378 million.
  • We expect NetApp to gradually gain market share in the storage hardware market.

NetApp (NASDAQ:NTAP) announced its Q4 FY 2014 earnings on May 21. The company reported an 8% year-over-year decline in its storage product revenues to just over $1 billion, while software entitlements and maintenance (NYSE:SEM) revenues remained flat at $227 million over the prior year quarter. On the other hand, revenues generated by NetApp's services division grew by almost 8% over the year ago period to $378 million. [1]

NetApp's overall non-GAAP gross margins for the quarter improved over 3 percentage points over the prior year quarter to 63.2%. This is the third consecutive quarter where NetApp's margins rose by 3 percentage points, partially due to a more favorable product mix, an efficient supply chain and a decline in the cost of materials. Additionally, the services margins improved by about 7 percentage points compared to the year ago period, which contributed favorably to overall gross margins. The company has revised its margin guidance range for the year to 63-64% for FY 2015, which is 3-4 percentage points higher than the fiscal 2014. We have revised our price estimate for NetApp to $41.19, which is around 20% higher than the current market price.

Storage Product Sales Remain Subdued

NetApp's mix of products sold via the original equipment manufacturer (OEM) channel, which include products sold by partner companies such as IBM (NYSE:IBM) and Fujitsu, declined from about 18% in 2011 to just over 11% in 2013. The company's OEM product sales plummeted to under 7% for the quarter, which was significantly lower than what the company had previously anticipated. NetApp management mentioned that IBM's storage business had witnessed a ~20% decline in the last few quarters, which contributed significantly to NetApp's OEM revenues.

Although the company's branded product revenues remained flat over the prior year quarter at about $1.5 billion, the products sold via the OEM channel declined by over 30% year-over-year to $105 million. Consequently, overall product sales were down by 4% compared to Q4 FY 2013. [2] In line with our expectations, NetApp's storage products faced a difficult quarter mainly due to weakness in its OEM channel and a slow IT spend across the industry. Going forward, the company expects its branded revenues to grow at mid-single-digit percentages over the next few quarters, while the OEM products are likely to continue decline at similar rates. As a result, overall product sales could be annually down by 4-5% in fiscal 2015. Despite generating comparatively lower storage product revenues in the coming quarters, we expect NetApp to gradually gain market share in the storage hardware market. [3]

Hardware Maintenance Revenues Continue To Grow

NetApp's hardware maintenance revenues grew by almost 12% year on year to $294 million. Hardware maintenance revenues have consistently grown in the last eight quarters owing to an increased installed base and aggregate contract values under service contracts. Given the continued growth in maintenance contracts, NetApp's hardware maintenance revenues are likely to continue that growth in the coming quarters.

However, the increase in maintenance contracts has weighed on the revenues generated by NetApp's professional and corporate services segment. An increase in the number of maintenance and software entitlements contracts, coupled with customers opting for services on a when-and-if basis rather than training services offered by NetApp's professional services division, has led its revenues to consistently decline in the last few quarters. Unsurprisingly, the company's corporate and professional services revenues decreased by over 4% year-over-year to $85 million in the last quarter. Going forward, we expect these revenues to continue to decline at a similar rate.

Disclosure: No positions.

Source: NetApp Earnings: Storage Slump Continues, Services Drive Growth