NetApp’s Strategic Product Line Continues To Drive Growth

NetApp (NASDAQ:NTAP) announced its fiscal Q2 earnings on November 15, reporting a 6% increase in net revenues to just over $1.4 billion. Reported net revenue, gross margin, operating margin and EPS were higher than the mid point of the guidance provided by the company at the end of the previous quarter. This strong performance was driven largely by strength in product sales combined with a higher mix of flash products (which have typically higher margins) sold during the quarter.

Additionally, improved operational efficiency during the quarter led to a healthy operating profit margin of over 19%, as shown above. In recent quarters, NetApp has reported an improvement in its adjusted operating profit margin, attributable to cost reduction measures primarily by reducing headcount. This trend has resulted in NetApp’s operating margin improving by 3-4 percentage points through the year. Resulting earnings per share stood at 81 cents per share, which was 35% higher on a y-o-y basis.

Key Segment Trends

Higher revenues and healthier margins were largely due to strength in the company’s strategic solutions, which make up roughly 70% of product sales. Over the last three quarters, revenue growth has come from product sales rather than the software maintenance or services business. Storage product sales were up by 14% year-over-year to $807 million for the quarter. Within the product division, strategic product sales (including sales for products such as the all-flash array) were up 23% y-o-y to $557 million, while mature product sales were down 3% to $250 million. With product revenues rising significantly, both hardware and software maintenance revenues suffered – a trend likely to accompany the increase in product sales in future quarters as well. Correspondingly, revenues from hardware maintenance were down 3% to $375 million. Software maintenance revenues were roughly flat over the comparable prior year period – a trend consistent in recent quarters.

An increasing mix of strategic products, which include certain high-margin flash storage products, led to an improvement in product gross margins. NetApp’s non-GAAP gross margin for the quarter stood at 64.3%, which was 160 basis points higher than the year-ago period. The reported gross margin was well above the mid-point of the guided range of around 63.3%. In addition to the product division, both maintenance divisions reported an improvement in gross margins, as shown below. The company attributed the increase in product gross margin to “improved leverage from ongoing transformation” towards a refreshed product line during the quarter.

Strong Guidance For Q3’18

Netapp’s management has given positive guidance for the current quarter. Net revenues are forecast to increase by around 7% over the prior year quarter to $1.5 billion, while the gross margin is forecast to improve by 150 basis points over the comparable previous year quarter. The operating margin is expected to remain at the 20% range in the coming quarters, leading to robust growth in diluted earnings per share, as shown below.

We are in the process of revising our $39 price estimate for NetApp, which is over 15% lower than the current market price. NetApp’s stock price has risen by over 25% this year, following a strong set of recent quarterly results in each of the three quarters.

See our complete analysis for NetApp

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