NetApp Earnings Preview: Services To Continue Growth, Storage Flash Arrays To Drive Product Sales

NetApp (NASDAQ:NTAP) is scheduled to announce its Q2 FY 2015 earnings on Wednesday, November 12. The company reported a 2% year-over-year decline in net revenues to $1.49 billion in its first fiscal quarter. The decline was attributable to weakness in product sales, which declined by 5% over the prior year quarter to $883 million. Moreover, add-on storage software sales, which are categorized software entitlements and maintenance (SEM), also fell by 3% y-o-y to $221 million. However, the decline in hardware and software revenue streams was partially offset by robust sales of hardware maintenance and support contracts, which drove an increase in services revenues of 8% y-o-y to $385 million for the quarter. ^[1]

However, NetApp had a strong quarter in terms of new-product sales including all-flash arrays and integrated storage systems. Shipments of all-flash array units rose by 48% y-o-y during the quarter ending June. Additionally, shipments of units with attached clustered nodes grew by 177% over the prior year quarter. Management mentioned that the rate of NetApp’s Clustered ONTAP system attached with hardware increased across its storage products, and that the attach rate for high-performance storage platforms was close to 50% during the quarter. Competing storage provider EMC posted solid quarterly figures in its recently reported earnings release, with 7% y-o-y growth in storage product revenues.

Services Division To Drive Growth, Improve Margins

NetApp’s hardware maintenance revenues have witnessed a 15-20% year-on-year increase in each of the previous seven quarters due to an increased installed base and aggregate contract values under service contracts. The growth continued during its first fiscal quarter, albeit at a slower rate than the previous quarters. Services revenues generated by hardware maintenance contracts grew at 11% y-o-y to $303 million, with year-to-date revenues up by 11% to $596 million. The company expects services revenues to be boosted in the coming quarters due to a strong demand for enterprise service agreements from its larger clients.

Software entitlements and maintenance (SEM) revenues, which include software upgrades, bug fixes and patch releases, grew at a CAGR of 9% from 2010 to 2013. However, SEM revenues have been flat since the beginning of the year, mainly due to the sale of new products. Management mentioned that customers typically test or evaluate new products for about six months before upgrading software and listing requirements for patch fixes. Consequently, the company should generate higher SEM revenues in the latter half of the year. Additionally, the company also intends to independently sell unbundled software from full systems to large customers, which could further drive SEM revenues.

In the quarter ending June, NetApp’s non-GAAP gross margin was higher than the upper end of its guided range and 3 percentage points higher than the year-ago period at 64.3%. The improvement in margins was attributable to a favorable product mix, higher supply chain efficiency and comparatively lower warranty costs during the quarter. Product margins were up by almost 4 percentage points over the prior year quarter to 57.1%, while the non-GAAP gross margin of the services division rose by over 3 percentage points to 62.7%. SEM gross margin was stable at previous year levels of over 96%. Going forward, a solid rise in services revenues could directly impact margins owing to the fixed nature of expenses in NetApp’s services business. The company expects its non-GAAP gross margin to be around 64% in the second fiscal quarter and at similar levels through fiscal 2015.

View Interactive Institutional Research (Powered by Trefis):

Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap
More Trefis Research

1. NetApp Q1 FY 2015 Earnings Call Transcript, Seeking Alpha, August 2014)

   NetApp’s branded product and services revenues remained nearly flat over the year-ago period at $1.36 billion, while products sold via the original equipment manufacturer (OEM) channel declined by over 22% y-o-y to $129 million. These revenues suffered largely because of weakness in the OEM channel complemented by the termination of the IBM-NetApp deal in May. Furthermore, the company expects OEM revenues to decline at 30-40% through fiscal 2015. On the other hand, NetApp’s branded revenues are expected to continue to grow through the end of the calendar year, owing to the seasonal rise in product demand from the U.S. government, one of NetApp’s major clients. The company expects its Q2’15 revenues to be around $1.54 billion, which is roughly flat over the prior year quarter revenues.

   See Full Analysis For NetApp Here

   Decline In Core Product Revenues

   In a recently published report on storage systems, IDC reported that the external storage system product sales declined by 1.4% y-o-y to $5.87 billion in the quarter ending June. Two of the largest storage systems manufacturers – EMC (NYSE:EMC) and NetApp – witnessed a decline higher than the industry average at 5.0% and 3.2%, respectively. Much of the decline was driven by weakness in high-end storage spend, coupled with a decline in mid-range product sales. ((Worldwide Quarterly Disk Storage Systems Tracker Q2 2014, IDC Press Release, September 2014 [↩]