NetApp Earnings Preview: Services To Drive Earnings

NetApp (NASDAQ:NTAP) is scheduled to announce its Q4 fiscal 2015 earnings on Wednesday, May 20. The company reported a 4% year-over-year decline in net revenues to $1.54 billion in fiscal Q3, which was slightly lower than the guided revenue range of $1.56-$1.66 billion. NetApp’s storage product revenues (hardware and software combined) declined by over 8% y-o-y to $929 million. The decline in product revenues was a result of currency fluctuation – particularly in Europe – during the quarter, complemented by certain sales execution issues. On the other hand, 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. ^[1]

The company’s full year revenues for the calendar year 2014 were about 2.5% lower than the previous year at $6.2 billion. Much of the decline was attributable to weak storage product sales, corresponding to the industry-wide decline in storage system factory revenues. NetApp’s storage product revenues fell by over 6% for the full year to $3.8 billion. As a result of low product revenues, the related SEM revenues were also down by about 2% on a year-over-year basis to $900 million for the full year. 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 in Q3’15 stood at 64.6%, 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.

We have a $40 price estimate for NetApp’s stock, which is about 10% higher than the current market price. The stock price has fallen by about 15% since the start of this year.

See Full Analysis For NetApp Here

How Low Global Storage Hardware Spending Affected NetApp

Global spending on storage systems has witnessed a slowdown in recent years, with total factory revenues growing by 18% in 2010, 10.9% in 2011, 4.8% in 2012 and declining by about 0.5% in 2013 and 2014. According to IDC, low product sales in the first half of 2014 were attributable to a 25% y-o-y decline in high-end storage spending. As a result of weakness in the storage hardware market, many large storage systems providers such as EMC’s (NYSE:EMC), IBM (NYSE:IBM), NetApp and Hitachi Data Systems lost share in market through the year. NetApp was one of the few large storage system vendors to have maintained its market share through the first half of 2014 at over 14%  in the storage systems market. The company witnessed strong demand for its all-flash arrays and storage units with attached clustered nodes in that period. Subsequently, the company’s product sales suffered in the December quarter and managed a mere 10% share in global external storage system sales. As a result, its share for the full year stood at 12.8%, which was about 25 basis points lower than 2013 levels.

SEM revenues, which include software upgrades, bug fixes and patch releases, for the full year were down by about 2% on a year-over-year basis 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. Since the company had major product launches in Q2’15, SEM revenues could pick up in the coming quarters. The new products included the all-flash storage array FlashRay, the Data ONTAP 8.3 operating system, Cloud ONTAP software for usage in public clouds and the new range of products from the SteelStore acquisition. 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.

Services Division Likely To Sustain Growth

NetApp’s hardware maintenance revenues have witnessed double digit annual growth in nine consecutive quarters. In the most recent quarter, the company witnessed a 10% y-o-y rise in hardware maintenance support contracts revenue to $316 million. Similarly, full year hardware maintenance contracts revenues for 2014 were up by 10% y-o-y $1.2 billion. NetApp’s services revenues are likely to be boosted in the coming quarters due to strong demand for enterprise service agreements from its larger clients. Furthermore, the company has 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 about 3% y-o-y to $80 million for the quarter, partially offsetting the growth in revenues from maintenance contracts. Comparatively, professional services revenues for the full year were flat over the previous year at $332 million. These revenues could rise in the long run due to strong demand for enterprise service agreements from its larger clients.

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1. NetApp Q3 FY 2015 Earnings Call Transcript, Seeking Alpha, February 2015 [↩]