Blount/LE on XRTX
XRTX Q306; HDD Capex Pull Forward
Sector View:
New: 2-Neutral
Old: 2-Neutral
Xyratex (XRTX, not rated), a major NTAP system supplier and Seagate capital equipment provider, posted better than expected 3Q06
(August) revenues and eps due to pull forward of storage infrastructure revenues originally forecast for Q4 (likely due to STX speeding up
transition of MXO lines to STX lines - 1x rip and replace). XRTX gave 4Q06 (November) guidance below consensus primarily due to the
pull forward of Q4 revenues in Q3 on the storage infrastructure (hard drive capital equipment) side. This pull-ahead is consistent with our
data points, suggesting that STX will have completed the migration from MXO's desktop platform by early October and its enterprise
platform by early December. XRTX left its full year guidance intact. XRTX's wide range of storage systems (primarily NTAP) guidance
growth of 8% to 13% q/q has a midpoint of 10% which is higher than NTAP's October quarter guidance of 3%-4%; however, we would
note that the companies have different quarter ends (November versus October) and XRTX's non-NTAP business is expected to grow
faster than its NTAP business. We continue to believe that NTAP offers the best long-term growth prospect in our IT Hardware universe
due to leadership in the fast growing iSCSI SAN and NAS market (and share gains in Fibre Channel) while we believe investors continue
to underestimate the EPS accretion potential of STX post merger. STX remains the top rated drive company in our universe (1-OW).
XRTX noted solid demand for the storage infrastructure side and hard drive industry in general which is consistent with the data points
we recently picked up from industry checks. Mgmt noted that it had observed some aggressive pricing in HDD industry in a bid by
vendors to gain market share in light of STX/MXO acquisition and our checks suggest that HDD pricing remains competitive but the rate
of erosion has slowed. We reiterate our 1-OW ratings on NTAP and STX.
Summary XRTX 3Q06 revs of $263.1M (60.5% y/y and down 9% q/q) were better than consensus estimates of $242.1M and guidance for revenues
of $233-248M (nearly all of the upside came from storage infrastructure). Non-gaap EPS was $0.68 compared to guidance of $0.44-
$0.54 and $0.51 consensus. Gross margins increased y/y to 21.1% from 20.2% due to increased storage infrastructure revenue
contribution, customer and product mix. XRTX shipped 102 PB compared to 97 PB last quarter (125% y/y, 6% q/q) of which we estimate
NTAP was approximately 73 PB. Storage systems revenues of $148.6M declined 3% q/q and 41.8% y/y (vs. NTAP July qtr revs 4% q/q) versus guidance of $146.5-
$154.5M (down 5% to up 1% q/q). NTAP contributed to approximately 75% of revenues in storage systems in the third quarter compared
to ~80% in Q2, suggesting an approximate mid-single digit quarter decline in NTAP revenue q/q. Mgmt continues to expect to diversify its
storage customer revenue base and decrease NTAP's contribution. XRTX guided for storage networking systems revenues of $160-$168M (8% to 13% q/q growth). This range of growth guidance has a
midpoint of 10% q/q which is higher than NTAP's October guidance of 3%-4% q/q growth. However, taking into account XRTX's move
towards revenue diversification and goal of 60-75% y/y growth in non-NTAP revenue, we estimate that XRTX guidance implies that
NTAP related revenue will grow between down 2% and up 5% q/q which encompasses NTAP October guidance of 3-4% q/q. We note
that NTAP’s quarter ends in October while Xyratex’s ends in November (off by one month). The balance of XRTX's revenue comes from storage infrastructure products ($114.6M for 93.7% y/y growth, down 15.2% q/q), principally
testing equipment for Seagate and Western Digital (2-EW). This result was $24M higher than the midpoint of original guidance for $86.5-
$94M (down 30-36% q/q). The better than expected performance resulted from pull forward of revenues from Q4 to Q3 (FY06 revenue
estimates roughly the same). Management stated that Xyratex sped up order production and installation at the request of one of its large
OEM customers (likely STX as Seagate works to move up the transition from MXO product lines to Seagate). Mgmt observed some price aggressiveness in the HDD industry as companies worked to take market share given the STX/MXO acquisition. As HDD
companies move towards higher area density, higher capacity, as well as toward perpendicular drives, more testing time and equipment
will be required as testing times lengthen.
XRTX guided for storage infrastructure revenues to range from $57M to $63M (down 45 to down 50% q/q growth). Xyratex likely
benefited in the August quarter from a 1x replacement of equipment in existing factories related to the MXO acquisition and a pull forward
in revenues from Q4, which explains the lower SI guidance for the November quarter. We believe STX and WDC need to continue
ramping capital spending to accommodate higher volumes, and to prepare for lower throughput related to perpendicular recording.
XRTX maintains close relationships with STX, WDC, and KOMG (not covered) and continues to explore new opportunities. Recently,
XRTX announced that Hitachi GST has started testing Xyratex’s storage infrastructure product.
We would note that overall company guidance (storage networking systems plus storage infrastructure) for the November quarter was for
revenues of $215-$230M and non-gaap EPS of $0.24-0.34 which is significantly lower than consensus estimates for $251M/$0.56 due to
the pull-forward of SI revenues (which was reflected in the much better than expected August quarter results).
Management continues to believe that Komag will become a material customer in CY06 in the storage infrastructure products business.
Komag recently made comments about lowering expectations for the current quarter (we believe this is due to higher build of finished
goods inventory at HDDs, thereby lowering production needs relative to actual shipments rather than a reflection of market demand for
HDDs).
Network Appliance is set to dual source its storage subsystems sometime in the second half. Network Appliance currently sources all of
its storage subsystems from Xyratex and will source a new low end product from Dot Hill. |
