NetApp Earnings Preview: Revived Storage Segment To Drive Revenues, Profits

NetApp (NASDAQ:NTAP) is scheduled to report its fiscal Q1 earnings on Wednesday, August 16. Through the course of the previous year, NetApp witnessed a decline in net revenues driven by low product sales. Moreover, low demand for storage hardware coupled with falling prices led the company-wide gross margin to compress slightly. Comparatively, NetApp’s services and software maintenance revenues have improved to offset the decline from product sales. However, this trend was reversed in NetApp’s fourth fiscal quarter 2017 ended April, with the company’s “Strategic Product” sales driving much of the growth in revenues as well as gross margins.

We have a $38 price estimate for NetApp, which is around 10% lower than the current market price. NetApp’s stock price has risen by over 15% this year, following a strong set of results in Q3 and Q4 of fiscal 2017.

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Guidance For Q1 FY’18

NetApp’s management expects a mild 2% growth in net revenues to around $1.32 billion in the first fiscal quarter. In addition to revenue growth, its gross margin (non-GAAP) is expected to be slightly higher than the comparable prior year period at around 62.5%. Subsequently, the company anticipates long-term margins of around 62-64% through the end of the decade. In addition, NetApp’s operating margin is expected to improve by almost 7 percentage points to 19% due to sustained efforts by the company to reduce operating expenses, largely by reducing headcount. As a result, the company’s net income per share is expected to be around 15% higher on a y-o-y basis to 53 cents per share, as shown above.

Key Trends & Highlights

In recent years, global spending on conventional external storage arrays has declined, due to which most large vendors such as Dell-EMC, NetApp, IBM (NYSE:IBM) and HP Enterprise (NYSE:HPE) have had a tough period in terms of storage hardware product sales. However, the trend reversed for NetApp in Q4 FY’17, with product sales driving significant revenue growth. Storage product sales were up by 13% year-over-year to $852 million. Within the product division, strategic product sales were up 24% y-o-y to $596 million, while mature product sales were down 6% to $256 million. A significant portion of strategic products included NetApp’s all-flash array, which accounted for over $400 million in sales for the quarter.

While industry-wide revenues from sales of external storage systems were down by 3% in the March quarter, NetApp’s product sales rose 13%. NetApp was the only large vendor to witness growth in revenues during the quarter, according to data compiled by IDC. As a result, its market share in the external storage systems market was by two percentage points to 14%.

In terms of profits, NetApp has reported an improvement in gross margins for both software maintenance and hardware maintenance segments in recent years. This trend was evident through calendar year 2016, with product gross margin falling by almost 5 percentage points while hardware maintenance gross margin was up by 5 percentage points, as shown below.

This trend also reversed in the previous quarter (ended April) with the growth in new and strategic product sales leading to healthier gross margins for the product division. As a result, the product gross margin (non-GAAP) was over two percentage points higher on a y-o-y basis to 48.9% for the quarter. Similarly, NetApp’s services and software maintenance businesses both continued to report healthy gross margins, as shown below.

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