NetApp Posts Top Line Growth From Strategic Product Line, Robust Outlook For Coming Quarter

NetApp (NASDAQ:NTAP) announced its fiscal Q3 earnings on February 15, reporting a 1% increase in net revenues to $1.4 billion. ^[1] Revenues were in line with the guidance provided by the company at the end of the previous quarter, while gross margins were slightly lower than expected. NetApp’s non-GAAP gross margin for the quarter stood at 61.5%, which was 160 basis points lower than the year-ago period while the operating profit margin (non-GAAP) was almost 3 percentage points higher than the comparable prior year period at 20.2% (the guidance was 18.3%). Resulting earnings per share stood at 82 cents per share, which was also slightly higher than the guided range of 72-77 cents a share. A significant improvement in operating margin led the non-GAAP diluted EPS to be 17% higher on a y-o-y basis, as shown below.

Among the various revenue streams, storage product sales were up by 5% year-over-year to $784 million, a trend that has been consistent all year. NetApp’s mature product sales were down 18% y-o-y to $272 million, in line with our expectations. Comparatively, revenues from “strategic” product lines were up 22% y-o-y to $512 million, driving much of the combined product revenues. High product sales also presumably impacted hardware maintenance revenues, with customers purchasing new hardware spending less on maintenance of existing hardware. Given that the company has a high installed base and a healthy attach rate, hardware maintenance revenues could pick up in subsequent quarters.
NetApp’s Software Entitlements and Maintenance revenues were up 3% y-o-y to $240 million. This trend has been consistent through 2016, with revenues growing by low single digits in each of the last few quarters. 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.

Despite slight growth in revenues, falling hardware prices also led to lower gross profit margins for the product division. As a result, product gross margin (non-GAAP) was 5.4 percentage points lower on a y-o-y basis to 45.7% for the quarter. Comparatively, the services and software maintenance businesses reported a 1 percentage point improvement in gross margins for the quarter. Hardware maintenance & services non-GAAP gross margin was over 5 percentage points higher than the year ago period at 71.6%.

To offset the decline in revenues and low gross margins, NetApp’s management indicated early last year that it would cut 1,200 jobs to enhance profitability. ^[2] This led to an improvement in the operating margin through the year. The company further initiated cost reduction measures starting November to reduce around 6% of its global workforce. This could 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) stood at 20.2%, which is almost 3 percentage points higher than the previous year quarter. Consequently, its net income per share could improve by around 17% y-o-y to 82 cents per share. ^[3]

Going forward NetApp’s net revenues could increase by 4% to $1.44 billion in the fourth fiscal quarter. Gross margin could continue to be low due to pricing pressure on product sales while operating margin could improve by over 5 percentage points to 19%. As a result, diluted EPS (non-GAAP) could be almost 50% higher to 82 cents a share.

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1. NetApp Reports Third Quarter Fiscal Year 2017 Results, NetApp Press Release, February 2017 [↩]
2. NetApp To Slash 12 Percent Of Workforce, Fortune, February 2016 [↩]
3. NetApp Q3 FY 2017 Earnings Call Transcript, Seeking Alpha, February 2016 [↩]