How Has NetApp Managed Operational Efficiency With Significant Revenue Declines?

Storage systems manufacturer NetApp (NASDAQ:NTAP) has reported a consistent drop in net revenues over the last few years driven by a fall in net spend on IT hardware across the globe. NetApp’s core storage products form a significant chunk of its net revenues, which have been negatively impacted by low demand, consequent price falls and competition from flash-storage startups. Competing storage systems manufacturers such as EMC (now owned by Dell), HPE (NYSE:HPE), Hitachi Data Systems and IBM (NYSE:IBM) have also witnessed declining storage product revenues, but a diversified portfolio of products and services have kept their business largely immune from weakness in the storage hardware market.

Although NetApp has expanded its product lines to include software-based storage solutions, flash storage and post-sales services to cater to the transitioning customer preferences, yet its main source of revenue remains selling storage hardware. Last year alone, NetApp generated $3.1 billion from storage product sales, which was 55% of net revenues. In the wake of this trend, it has become important for the company to improve gross margins and manage its operating expenses to diminish the impact of falling revenues on net cash profits. Since services and software maintenance are higher margin businesses, a higher proportion of these revenues has helped offset the revenue decline and lower gross margin from the product business. The second area can be more challenging to quantify and improve. To analyze operating efficiency, the revenue generated per dollar spent on sales, general and administrative (SG&A) expenses can be regarded as a key indicator. Below we take a look at this indicator for NetApp.

NetApp generated roughly $3.70 per dollar spent on SG&A expenses in 2013, which went down to around $3.30 in 2015 as shown below. Similarly, the company’s adjusted gross profit per dollar of SG&A expenses stood at $2.20 in 2013, which dropped to around $2 in 2015. While revenues (and subsequent gross profits) fell significantly in this period, NetApp’s SG&A expenses fell only slightly from around $1.75 billion in 2013 to $1.72 billion in 2015. It should be noted that the gross profit and SG&A figures used by Trefis are adjusted for depreciation, amortization, share-based compensation and other non-GAAP reconciliation measures reported by the company. Moreover, the reported figures mentioned below are calendar year figures while NetApp’s fiscal year ends in April.

Expectation For Future

In terms of operating efficiency, the company has made efforts to reduce its cash operating expenses over the last few quarters. This has resulted in lower sales & marketing and research & development costs through fiscal 2016. Additionally, NetApp’s management indicated that it will cut 1,200 jobs by July, which is roughly 12% of the company’s total workforce. ^[1] This should help reduce operating expenses in future quarters. The company further expects an operating margin of around 13.5% in fiscal 2017, an improvement from around 11-12% in previous quarters. ^[2]

As the company aims to control its operating expenses, its operational efficiency should improve in the short term. As a result, the revenue generated per dollar spent on SG&A could stabilize at around $3.20 from 2016 through 2018, according to our estimates. In the long run, we expect the rate of decline in revenue per unit SG&A and gross profit per unit SG&A expenses to taper down, as shown below. It would take more than just controlling operating expenses (i.e. strong revenue growth) to improve this metric.

We have a $31 price estimate for NetApp, which is around 15% lower than the current market price. NetApp’s stock price has surged from $21 at the beginning of the year to $36 now. A positive set of Q1’17 results and robust guidance for future quarters led NetApp’s stock to jump by 15% the day after its earnings release. ^[3] A similar trend was observed after NetApp’s Q2’17 results and positive guidance for future quarters. ^[4]

See our complete analysis for NetApp

1. NetApp To Slash 12 Percent Of Workforce, Fortune, February 2016 [↩]
2. NetApp Q1’17 Earnings Call Transcript, Seeking Alpha, August 2016 [↩]
3. NetApp shares surge after easily topping earnings expectations, CNBC, August 2016 [↩]
4. NetApp Jumped To A New High After Q2 Profit Topped Expectations, RTT News, November 2016 [↩]