Over the past three months, shares of NetApp Inc. (NASDAQ:NTAP) are up almost 40% since reaching a low of $26.26. Ordinarily, this would imply that new investors are late to the party. However, despite this gain, the stock is down 13% over the past 12 months. While NetApp is still a dominant force in the realm of data storage — aka big data — there are increasing concerns that the company can’t ever overtake rival EMC Corporation (NYSE:EMC). But it doesn’t have to. The market has proven that it can support more than one leader. And after a solid Q3 report, there are signs that NetApp is poised for more gains.
Netting out a solid third quarter
Considering what has been a broadly soft earnings season for tech, NetApp investors weren’t expecting much, especially given International Business Machines Corp. (NYSE:IBM)‘s roughly 1% revenue decline. But NetApp delivered the goods. Revenue arrived 4% higher year over year and 6% sequentially. These are not breathtaking numbers, but sales showed good acceleration from Q2’s 2% growth. Product revenue was down slightly by 18 basis points, but advanced 6.5% from the prior quarter.
As expected, U.S. public sector revenue was down from the prior quarter, but was up 14% year over year. Likewise, branded revenue advanced 8%. Although this was not stated by management, it looks as if the growth in branded revenue inhibited the progress of product revenue. Regardless, the net effect is still the same; no reason to raise eyebrows. But it will nonetheless be encouraging if NetApp can reverse the trend in the fourth quarter.
There were some mixed results on the operating side. Although non-GAAP gross margin of 60.4% was consistent with management’s prior guidance, 53.1% posted in product gross margin was softer sequentially. Management attributed this to a shift in customer mix. Meanwhile, service gross margin advanced 1% sequentially, helped by lower costs. Operating income was impressive, up 8% year over year and 25% sequentially.
Need more “attack” and less “preserve”
It was clear that the company showed a focus on profitability and, in particular, cost management. To that end, operating margins of 17.1% arrived better than management expected, helped by a drop in operating expenses. While NetApp deserves credit for this, I do wonder how long can it keep costs down and still work to grow market share. While IBM is showing some signs of struggle, there will be a point when enterprise spending recovers. And NetApp needs to prepare for attack mode.
The company will need to distinguish itself — if not from EMC, certainly from IBM. I think management understands the opportunities that lie ahead. However, NetApp guided a bit conservatively. Fourth-quarter revenue is expected to arrive between $1.7 billion to $1.8 billion. This presumes roughly 7% sequential growth and 3% year-over-year growth. Although competition plays a major role in this outlook, investors should expect NetApp to be an outperformer going forward.