NetApp Earnings: Services Drive Revenue Growth, New Products Lined Up

Storage giant NetApp (NASDAQ:NTAP) announced its Q2 FY 2015 earnings on Wednesday, November 12. The company reported a 4% sequential rise in net revenues to $1.54 billion for the quarter, which was roughly flat over the prior year quarter. Seasonal demand from the U.S. government (one of NetApp’s major clients) at the end of its fiscal year drove NetApp’s net revenues to increase sequentially during the quarter. However, continuing the trend from the first fiscal quarter, both product revenues and software entitlements and maintenance revenues declined by 3% y-o-y to $929 million and $224 million, respectively. The decline in hardware and software revenue streams was partially offset by robust sales of hardware maintenance and support contracts, which drove an increase in services revenues of 7% y-o-y to $389 million for the quarter. ^[1] In its recent quarterly earnings report, EMC witnessed a 7% rise in product revenues to $2.59 billion over the prior year quarter. On the other hand, NetApp’s hardware and software revenues failed to post similar growth figures, with both revenue streams declining by 3% y-o-y. Management partially attributed the decline to foreign exchange, which impacted branded product sales.

However, in its second fiscal quarter, NetApp introduced a significant number of new products including all-flash storage array FlashRay, the Data ONTAP 8.3 operating system, Cloud ONTAP software for usage in public clouds and the new range of products from the SteelStore acquisition. Moreover, the rate of NetApp’s Clustered ONTAP system attached with hardware increased across its storage products. The attach rate for high-performance storage platforms was close to 65% during the quarter, while it stood at 50% for mid-range storage products. NetApp’s converged storage architecture solution FlexPod had a solid quarter, with a 50% rise in shipments compared to the prior year quarter.

Margins Improve, Conservative Forecast

NetApp’s non-GAAP gross margin stood at 65% for the quarter, slightly higher than the guidance given by the company at the end of the previous quarter. The company-wide gross margin improved by 140 basis points over the year-ago period, owing to a favorable product mix and strong growth in the services division. The services gross margin rose by almost 4 percentage points over the prior year quarter, which the company attributed to lower expenditures on support infrastructure complemented by higher support contract revenues. Product revenues also improved by over a percentage point due to improved supply chain efficiency, a favorable product mix and lower warranty costs – a trend similar to the first fiscal quarter. Management mentioned that unfavorable foreign exchange fluctuations and higher expenses due to the SteelStore acquisition could restrict margin improvement in the coming quarters. As a result, the company expects its non-GAAP gross margin to be around 64% for fiscal 2015, despite posting healthy figures for the first two fiscal quarters.

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1. NetApp Q2 FY 2015 Earnings Call Transcript, Seeking Alpha, November 2014)

   NetApp’s branded product and services revenues grew by 2% over the year-ago period to $1.42 billion, while products sold via the original equipment manufacturer (OEM) channel declined by 22% y-o-y to $119 million. Weakness in NetApp’s OEM channel, complemented by the termination of the IBM-NetApp deal in May, led the company to expect a 30-40% y-o-y decline in OEM revenues through fiscal 2015. However, these revenues have declined by just over 20% y-o-y in the first half of the current fiscal year. However, management mentioned that despite a lower decline in the first half, OEM revenues for the full fiscal year could fall by up to 40%. Branded revenues are expected to rise through the end of the calendar year, owing to the revamped range of products on offer and strength from product sales and corresponding services revenues. The company expects its Q3’15 revenues to be $1.56-$1.66 billion, which at the midpoint of the guided range implies roughly flat revenues over the year-ago period.

   See Full Analysis For NetApp Here

   Services Division Drives Growth
   

   NetApp’s hardware maintenance revenues have witnessed a double digit year-on-year increase in each of the previous eight quarters due to an increased installed base and aggregate contract values under service contracts. The growth continued during the second fiscal quarter, with a 12% y-o-y rise in hardware maintenance support contracts revenue to $311 million. Professional and other services revenues declined by 10% y-o-y to $78 million for the quarter, partially offsetting the growth in revenues by maintenance contracts. The company expects services revenues to be boosted in the coming quarters due to strong demand for enterprise service agreements from its larger clients.

   Software entitlements and maintenance (SEM) revenues, which include software upgrades, bug fixes and patch releases, have been flat since the beginning of the year, mainly due to the sale of new products. Management mentioned that customers typically test or evaluate new products for about six months before upgrading software and listing requirements for patch fixes. Consequently, the company should generate higher SEM revenues in the coming quarters. Additionally, the company also intends to independently sell unbundled software from full systems to large customers and sell pure-software solutions to clients using third-party storage arrays, which could further drive SEM revenues.

   Core Product Revenues Decline, New Product Range Lined Up
   

   A recent IDC report mentioned that  external storage system product sales declined by 1.4% y-o-y to $5.87 billion in the quarter ending June. Two of the biggest players in the storage hardware market – EMC (NYSE:EMC) and NetApp – witnessed declines higher than the industry average at 5.0% and 3.2%, respectively. Much of the decline was driven by weakness in high-end storage spending, coupled with a decline in mid-range product sales. ((Worldwide Quarterly Disk Storage Systems Tracker Q2 2014, IDC Press Release, September 2014 [↩]