NetApp Earnings: Weakness In Product Sales Offset By Services

-7.88%
Downside
105
Market
96.70
Trefis
NTAP: NetApp logo
NTAP
NetApp

Storage giant NetApp (NASDAQ:NTAP) announced its Q3 fiscal 2015 earnings on Wednesday, February 11. The company reported a 4% year-on-year decline in net revenues to $1.54 billion for the quarter, slightly lower than the guided revenue range of $1.56-$1.66 billion. NetApp’s net revenues declined mainly due to weakness in product revenues, which declined by over 8% y-o-y to $929 million in Q3. However, revenues generated by hardware maintenance and support contracts rose by over 7% y-o-y to $395 million while software entitlements and maintenance revenues stayed flat over the prior year quarter at $227 million. According to NetApp management, product revenues were negatively impacted by currency fluctuation – particularly in Europe – complemented by certain sales execution issues. The company’s net revenues adjusted for FX fluctuations were roughly flat over the prior year period. [1]

See Full Analysis For NetApp Here

Services Division Drives Growth

Relevant Articles
  1. Up 27% Over The Past Year, Will Higher Margins And Cloud Sales Drive NetApp Stock Higher Post Q3 Earnings?
  2. Up 28% Since The Beginning Of 2023, What’s Next For NetApp Stock?
  3. What To Expect From NetApp’s Q4 Results?
  4. NetApp Stock Looks Attractive Despite Easing IT Spending
  5. Despite A Rise In Sales, Here’s Why NetApp Stock Has Underperformed The S&P
  6. After Strong Outperformance, Can NetApp Stock Maintain Its Streak?

NetApp’s hardware maintenance revenues saw double digit year-on-year growth in eight quarters prior to the most recent quarter, owing to an increased installed base and aggregate contract values under service contracts. The growth continued in third fiscal quarter, albeit at slower pace than previous quarters. The company witnessed a 10% y-o-y rise in hardware maintenance support contracts revenue to $316 million. Management mentioned that the company intends to enhance its focus on large enterprise customers and cloud providers in the coming quarters, which could result in improved margins for the services division. The company has already worked on its data fabric vision for hybrid cloud adoption by opening NetApp private stores for IBM’s software (NYSE:IBM), SteelStore appliances and Cloud ONTAP for Amazon (NASDAQ:AMZN) web services.

Professional and other services revenues declined by 3% y-o-y to $80 million for the quarter, partially offsetting the growth in revenues from maintenance contracts. Professional services revenues could rise in the long run due to strong demand for enterprise service agreements from its larger clients.

Product Revenues Decline, Software Sales Remain Suppressed

After a sustained period of declining global spending on storage hardware through the first two quarters of 2014, demand picked up in the September quarter as storage companies witnessed an increase in shipments of storage arrays costing less than $100,000. Industry-wide external storage factory revenue declined by about 3% y-o-y to $11.6 billion in the first half of the year. Comparatively, global factory revenues for external storage systems were up by 1% y-o-y to $5.8 billion in the quarter ended September. [2] This was evident in competing storage provider EMC’s (NYSE:EMC) recent quarterly earnings report. EMC witnessed a 7% y-o-y rise in product revenues to $2.59 billion in the December quarter. On the other hand, NetApp’s product revenues failed to post similar growth figures. NetApp’s product revenues declined by over 8% y-o-y to $929 million. Management partially attributed the decline to foreign exchange, which impacted branded product sales.

Software entitlements and maintenance (SEM) revenues, which include software upgrades, bug fixes and patch releases, have been flat since the beginning of the fiscal year, mainly due to the sale of new products. The trend continued in the fiscal third quarter, with revenues staying flat relative to the prior year quarter at $227 million. Management mentioned that customers typically test or evaluate new products for about six months before upgrading software and listing requirements for patch fixes. Since the company had major product launches in Q2, SEM revenues could pick up in the coming quarters. Additionally, the company also intends to independently sell unbundled software from full systems to large customers and sell pure-software solutions to clients using third-party storage arrays, which could further drive SEM revenues.

Conservative Forecast For Q4’15

NetApp’s branded product and services revenues fell by 2% over the year-ago period to $1.42 billion, while products sold via the original equipment manufacturer (OEM) channel declined by 22% y-o-y to $124 million. Weakness in NetApp’s OEM channel, complemented by the termination of the IBM-NetApp deal in May, led the company to expect a 30-40% y-o-y decline in OEM revenues through fiscal 2015. However, these revenues have declined by just over 20% y-o-y through the first three quarters of the current fiscal year. Branded revenues could pick up through the end of the fiscal year, owing to the revamped range of products on offer and strength from product sales and corresponding services revenues. However, weakness in the OEM channel is likely to continue, due to which the company expects its Q4’15 revenues to be $1.55-$1.65 billion, which at the midpoint of the guided range implies a 3% y-o-y decline.

NetApp’s non-GAAP gross margin stood at 64.6% for the quarter, slightly higher than the guidance given by the company at the end of the previous quarter. The company-wide gross margin improved by almost a percentage point over the year-ago period, owing to a favorable product mix and strong growth in the services division. The services gross margin rose by almost 4 percentage points over the prior year quarter to 64.5%, which the company attributed to lower expenditures on support infrastructure complemented by higher support contract revenues. Going forward, the company expects its non-GAAP gross margin to be around 63.5% for Q4’15, which is slightly higher than the prior year quarter.

View Interactive Institutional Research (Powered by Trefis):
Global Large CapU.S. Mid & Small CapEuropean Large & Mid Cap
More Trefis Research

Notes:
  1. NetApp Q3 FY 2015 Earnings Call Transcript, Seeking Alpha, February 2015 []
  2. Worldwide Quarterly Disk Storage Systems Tracker Q3 2014, IDC Press Release, December 2014 []