NetApp Beats Estimates On Revenues, Profits; Long-Term Cost Cutting Measures Implemented

NetApp (NASDAQ:NTAP) announced its fiscal Q2 earnings on November 16, reporting a 7% decline in revenues to $1.34 billion. ^[1] Revenues were in line with the guidance provided by the company at the end of the previous quarter, while the margins were better than expected. NetApp’s non-GAAP gross margin for the quarter stood at 62.7%, which was an improvement of 20 basis points over the year-ago period while the operating profit margin (non-GAAP) was flat over the comparable prior year period at 15.2% (the guidance was under 14%). Resulting earnings per share stood at 60 cents per share, which was also slightly higher than the guided range of 51-56 cents a share.

Among the various revenue streams, storage product sales were down by 13% year-over-year to $710 million, a trend that has been consistent all year. Combined product sales for the three quarters of the year thus far have fallen by 11% to $2.1 billion, as shown below. Most large storage vendors have witnessed a decline in hardware product sales over the last two years. This trend is likely to continue in over the next couple of years due to lower selling prices and increasing competition from smaller storage systems vendors in this market space. Low product sales have also impacted hardware maintenance revenues, with revenues falling by 2% to $388 million for the quarter. Management mentioned that the company observed an increase in the installed base and attach rate but revenues still fell on a y-o-y basis, presumably due to falling prices. ^[2]

NetApp’s Software Entitlements and Maintenance division has been the only segment which has not faced a revenue decline this year. This trend continued through the company’s fiscal second quarter ended October, with software maintenance revenues increasing by 4% y-o-y to $242 million. We forecast software maintenance revenues as a percentage of product sales to increase from around 30% in 2015 to over 35% by the end of our forecast period.

In addition to revenue declines, falling hardware prices also led to lower gross profit margins for the product division. As a result, product gross margin (non-GAAP) was 3.6 percentage points lower on a y-o-y basis to 48.2% for the quarter. Comparatively, the services and software maintenance businesses reported an improvement in gross margins for the quarter. Hardware maintenance & services non-GAAP gross margin was over 3 percentage points higher than the year ago period at 67.8% while software maintenance non-GAAP gross margin was up by a percentage point to 97.1%.

To offset the decline in revenues, NetApp’s management indicated earlier this year that it would cut 1,200 jobs to enhance profitability. ^[3] This led to an improvement in the operating margin in the first half of the year. The company further initiated cost reduction measures starting November to reduce around 6% of its global workforce, which would result in a onetime charge of $50-60 million in the third fiscal quarter. This should help NetApp save around $130 million a year on operating expenses going forward. For the third fiscal quarter, NetApp’s operating profit margin (non-GAAP) could be around 13.5%, which is almost a percentage point higher than the previous year quarter. Consequently, its net income per share could improve by around 6% y-o-y to 75 cents per share.

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1. NetApp Reports Second Quarter Fiscal Year 2017 Results, NetApp Press Release, November 2016 [↩]
2. NetApp Q2 FY 2017 Earnings Call Transcript, Seeking Alpha, November 2016 [↩]
3. NetApp To Slash 12 Percent Of Workforce, Fortune, February 2016 [↩]