Market Share and Profits of NetApp Predicted to Rise

NetApp, the leader in enterprise storage, witnessed an 7% decline in storage product revenues in the last quarter, while storage software entitlements and maintenance revenues remained at $225 million on a year-over-year basis. NetApp ’s services division grew by almost 7% y-o-y to $380 million. As a result, the company’s net revenues for the quarter declined by 4% to $1.65 billion. Management anticipates the y-o-y decline in revenues to continue through its first fiscal quarter due to a slowdown in storage hardware sales. NetApp’s top line could fall to around $1.47 billion (the mid-point of its revenue guidance) for the quarter, from $1.52 billion last year.

The company did report a higher profit last quarter despite low product revenues due to a favorable product offering, transition towards services and maintenance-based revenues and lower input and operational costs.
However, NetApp’s external storage systems revenues dropped less than2.9% y-o-y to $845 million during the quarter. The company outperformed the market – a trend that continued from the December quarter last year when NetApp and rival EMC were the only players in the market to witness growth in storage hardware in a period when the industry faced a decline. As a result, NetApp gained share in the external storage systems market. We forecast NetApp to continue to gain share in the market on the back of a solid customer base, a high number of client maintenance contracts and a revamped product line, including the clustered ONTAP storage system and the EF flash-array series.

Its weakness in items sold via the original equipment manufacturer channel, which included products sold by partner companies such as IBM and Fujitsu , is likely to continue as IBM killed its deal with NetApp to sell the latter’s storage products. The contribution of revenues from the OEM channel has decreased significantly in the last few years from about 18% of its product sales to just over 11% in 2013. Comparatively, NetApp’s branded sales have grown consistently in each of the previous seven quarters. Although termination of the IBM deal may hinder NetApp’s top line growth in the near term, it is likely to push margins up since OEM sales typically have lower margins for the manufacturer.

The combination of storage products (hardware and software) to overall revenues declined from 65% of net revenues in 2012 to 63% in 2013. Consequently, NetApp’s non-GAAP gross margins improved from 59.3% to 61.5% in that duration. The trend continued in the previous quarter with a reduced contribution of product revenues over the year-ago period. The revenue mix is expected to continue to shift towards services and SEM revenues through 2014 owing to a slowdown in storage systems sales, which is likely to enhance NetApp’s overall profitability.

The second factor to contribute to margin improvement was relatively high-margin product sales such as flash-arrays and converged storage systems. Non-GAAP gross margin for storage products rose from 51.8% in 2012 to 54.8% in 2013. This figure further improved to 58% in the previous quarter due to an increasing mix of high-margin products. The company expects to continue to sell products with high margins in the coming quarters.

Management expects Q1’15 margins to be 2-3 percentage points higher than that prior year period owing to an expected shift towards a favorable product mix, lower hardware warranty costs and an increasing revenue contribution of software and services. Additionally, the company is likely to continue to lower its expenses by reducing headcount and other realignment measures leading to enhanced overall profitability. See NetApp’s complete hardware offerings.