NetApp Earnings Preview: Can Sub-$25K All-Flash Array Boost Performance?

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Storage giant NetApp (NASDAQ:NTAP) is scheduled to announce its Q1 fiscal 2016 earnings on Wednesday, August 19. [1] NetApp had an eventful quarter, with the company announcing changes to its executive leadership and board in June. Dismal performance in the core storage business and weakness in the company’s U.S. commercial channel prompted changes to leadership. NetApp’s management appointed George Kurian as the new CEO and board member Mike Nevens as the chairman of the board, both replacing outgoing CEO and chairman Tom Georgens. One of the first major decisions under new management was the introduction of AFF8000 all-flash arrays with a starting price of as low as $25,000. This could help the company compete with flash startups and small vendors that have gained share in the storage systems market over the last few quarters (read more on: NetApp To Take On Big Vendors, Flash Storage Startups With Sub-$25K All-Flash Array).

Another key area of focus for the company in the coming quarters is to cut down on operating expenses. The company has reduced its global workforce by around 4% this year; correspondingly, NetApp could incur about $30 million in employee termination expenses in Q1 FY 2016. [2]

We have a $39 price estimate for NetApp’s stock, which is significantly higher than the current market price. The stock price has fallen by over 25% since the beginning of 2015.

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See Full Analysis For NetApp Here

Outlook For Q1’16

NetApp had a disappointing Q4 fiscal 2015, which management attributed to a shift in customer preference towards a combination of on-premise solution deployment and cloud-based storage solutions. As a result of the ongoing transition, there was low demand for existing NetApp offerings. Although the transition phase was expected by the company, management mentioned that it underestimated the extent of the disruption it would cause.

Weakness is expected to continue through Q1’16, with revenues likely to fall by over 10% year-over-year to $1.32 million. Moreover, the company expects margins to be about a percentage point lower than FY 2015 levels through the coming fiscal year, primarily attributable to the clustered ONTAP transition. [3] On a positive note, the company plans to continue to repurchase stock through fiscal 2016. Management highlighted the company’s plans to reduce its share count by about 5% or return almost $500 million to shareholders by stock repurchases through fiscal 2016.

Product Sales And SEM Revenues Stay Low

NetApp’s product revenues fell by over 12% y-o-y to $913 million in the previous quarter, which – adjusted for FX fluctuation – was still an 8% annual decline. Similarly, product revenues for the fiscal year ended April were over 7% lower than the previous year at $3.6 billion. With the company expanding its product offerings to include cheaper storage arrays, it could lead to a wider customer base to cater to. However, this is more likely to boost sales in the long run than have an immediate impact on storage hardware sales.

Moreover, the gross margin (GAAP) for the products division in Q4’15 was about 5 percentage points lower than the comparable prior year period at 51.7%. A similar trend was observed by competing storage provider EMC (NYSE:EMC), which reported a 6% annual decline in product sales to under $2.2 billion in the March quarter. EMC’s gross margin (GAAP) for its information storage division (storage product and services combined) was about 3 percentage points lower than the year-ago period at 50.5%. Much of the decline in NetApp’s product revenues (and loss in market share through 2014) was attributable to a 19% y-o-y decline in OEM revenues due to the termination of the IBM-NetApp deal in May last year. Going forward, the elimination of IBM as a channel partner will not impact year-over-year comparisons. We currently forecast NetApp’s share in the external storage systems market to stay flat over 2014 levels at about 12.8%.

SEM revenues, which include software upgrades, bug fixes and patch releases, witnessed limited growth through fiscal 2015, mainly due to the sale of new products. In the fiscal fourth quarter, SEM revenues were 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 are likely to pick up starting Q1’16. 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 To Sustain Growth

NetApp’s hardware maintenance revenues have grown at double digit percentages (y-o-y) in each of the last ten quarters. Services revenues have risen due to an increased installed base and aggregate contract values under service contracts. The company witnessed a 10% y-o-y rise in hardware maintenance support contracts revenue to $323 million in the most recent quarter. 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.

Professional and other services revenues declined by 10% y-o-y to $77 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. The newly introduced AFF8000 series of all-flash arrays this quarter is the first range of all-flash arrays that can be procured on a software-only basis and be accessed via Amazon Web Services, Amazon’s (NASDAQ:AMZN) cloud environment. Moreover, the company has extended software support to AFF8000 customers for seven years, significantly more than the typical 3-5 year support offered by the company, which could help drive the company’s services revenues further.

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Notes:
  1. NetApp Hosts First Quarter Fiscal Year 2016 Financial Results Webcast, NetApp Press Release, August 2015 []
  2. NetApp to cut 500 jobs, Reuters, May 2015 []
  3. NetApp Q4 FY 2015 Earnings Call Transcript, Seeking Alpha, May 2015 []