An Overview of NetApp’s Robust 2017 Performance

NetApp (NASDAQ:NTAP) has had a solid year thus far, with strong results through the first three quarters of the year. NetApp’s all-flash storage product line has witnessed robust demand, leading to significant revenue growth through the year. At the end of the previous quarter, NetApp’s management provided solid guidance for the current quarter.

Through the year, NetApp’s net revenue was up 5%, after three consecutive years of revenue declines. The company has observed strong demand for its Strategic Products, which largely drove top line growth this year. Its non-GAAP gross margin was up 130 basis points to 63.5% due to a better product mix, particularly from flash storage solutions.

Furthermore, improved operational efficiency this year led NetApp’s operating income to increase 44% on a y-o-y basis to almost $790 million. This was attributable to cost reduction measures, primarily by reducing headcount. As a result, NetApp’s operating margin improving by 5 percentage points through the year. The company’s diluted earnings per share has also risen by over 40% this year, beating analyst estimates.

Performance By Segment

This strong performance was driven largely by strength in product sales combined with a higher mix of flash products (which have typically higher margins) in recent quarters. NetApp’s strategic product sales make up around 70% of total product sales. Strategic product sales (including sales for products such as the all-flash array) rose 23% on a y-o-y basis to over $1.6 billion through the year. Comparatively, mature product sales were down 7% to $730 million, due to which total storage product sales were up by 12% year-over-year to $2.4 billion. 

As a result of increased product sales, NetApp’s share in the storage systems market has risen this year. According to data compiled by IDC, NetApp’s market share has improved from 11.2% in the first half of 2016 to 13.5% through the first two quarters of 2017. We forecast NetApp’s market share to eventually increase to over 15% through the end of our forecast period.

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. Hardware support contracts revenue were down 4% to $917 million this year. Professional services revenues were roughly flat over the comparable prior year period, as shown in the table above. As a result, consolidated hardware maintenance and services revenues were also down 4% to $1.1 billion.

An increasing mix of strategic products, which include certain high-margin flash storage products, has driven product gross margins higher. NetApp’s non-GAAP product gross margin has improved by almost 3 percentage points this year. This is the first time since 2014 that product gross margins have improved. We forecast margins to improve through 2018 and stabilize going forward.

Gross margins improved across segments as shown below. Hardware maintenance and software maintenance gross margins (non-GAAP) also improved by 220 basis points and 50 basis points to 70.1% and 97.3%, respectively.

We maintain our $44 price estimate for NetApp, which is around 20% lower than the current market price. NetApp’s stock price jumped from $46 to $54 after the company announced strong Q2 FY’18 results in November. NetApp’s revenue growth and margin improvement is expected to continue in the near term, but we remain conservative in our estimates since we expect the impact of a product refresh to normalize by the end of next year. You can modify the interactive charts in this note to gauge how a change in individual drivers can have on our price estimate for NetApp.

See our complete analysis for NetApp

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