NetApp Earnings Preview: Weakness In Product Sales To Continue To Impact Revenues, Margins

NetApp (NASDAQ:NTAP) is scheduled to report its fiscal Q2 earnings on November 16. ^[1] Over the last couple of years, storage systems vendors including EMC, NetApp, Hewlett-Packard Enterprise (NYSE:HPE), Hitachi Data Systems and IBM (NYSE:IBM) have faced a tough selling environment for hardware product sales due to falling prices and increased competition from smaller original design manufacturer (ODM) vendors. The trend was evident in the first half of the year as well, with storage product revenues falling by around 10% y-o-y to $2.7 billion for the first half of the year. Revenues generated from the Software Entitlements and Maintenance division has been the only segment which has not faced a revenue decline this year.

In addition to revenue declines, falling hardware prices have also led to lower gross profit margins, as shown below. Despite lower revenues and gross margins through the first half of the year, the company successfully reduced its operating expenses, leading to a healthier operating margin (non-GAAP) and a 7% increase in net income.

While the weakness in the storage hardware division is expected to continue through the end of the year, a higher mix of software and services revenues could help improve gross margins. According to management, NetApp’s Q2 FY’17 revenues could be around 7% lower on a year-over-year basis with storage product sales likely to remain low. After the Dell-EMC deal closed in September this year, NetApp is now the only large vendor that is solely a storage systems manufacturer. NetApp’s largest competitors – EMC (with Dell), HPE and IBM – are all IT giants, with product expertise beyond storage. It is left to compete with larger competitors with deeper pockets and the opportunity to integrate product offerings across multiple domains. NetApp’s share in the storage systems market has fallen due to weak demand for hardware over the last couple of years. We expect the trend to continue in the near term, and forecast NetApp’s share to decline to around 10% over the next few years from a peak of over 13% in 2013.

To offset the decline in revenues, NetApp’s management indicated earlier this year that it would cut 1,200 jobs to enhance profitability. ^[2] This led to an improvement in the operating margin in the first half of the year, as shown in the table above. In the coming quarters, it is imperative for the company to reduce operating expenses further. For the second fiscal quarter, NetApp’s operating profit margin (non-GAAP) could be around 13.5%, which is almost 2 percentage points lower than the previous year quarter. Consequently, its net income per share could fall by over 10% to just over 50 cents per share.

We have a $28 price estimate for NetApp’s stock, which is around 15-20% lower than the current market price.  This should help the company sustain its operating profit margin through the end of the year. (Read: Why NetApp’s Stock Is Worth $28)

See our complete analysis for NetApp

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1. NetApp Hosts Second Quarter Fiscal Year 2017 Financial Results Webcast, NetApp Press Release, November 2016 [↩]
2. NetApp To Slash 12 Percent Of Workforce, Fortune, February 2016 [↩]