NetApp’s Q1 was a happy surprise for Wall Street: earnings blew past estimates and the stock spiked over 16%. But the quarterly 8k report was more downbeat.

Product revenues
Net revenue was down $41 million year over year. Products the company calls Strategic – presumably hybrid cloud and flash, but not defined in the 8k – were up $77m YOY, but the Mature products were down $81 leaving the product segment down slightly YOY.

Flat product sales don’t sound too bad, given the wrenching turnaround CEO George Kurian is trying to execute. But gross margins have dropped to the mid-40s, down over 300 basis points YOY, evidence that NetApp is buying business to keep product revenues up.

Maintenance warning
The bigger problem was hardware maintenance contracts, down $23m – over 7% – YOY. Maintenance revenues are tied to annual contracts, and thus highly predictable.

Given that total product sales were relatively flat, this says that either old kit is coming off contract and not being replaced, OR, that new kit isn’t going on lucrative 24/7 contracts. Since gross margins are up almost 400 basis points – from 64.1% Q1/15 to 67.9% Q1/16, this also suggests that NetApp is milking the base – and they don’t like it.

Cash bonfire
Over the last quarter NetApp has burned through more than $1.2 billion in total assets. Presumably much of that – $850m – went to pay back a short term loan used to buy SolidFire.

But that leaves another $350 million, of which $228m was spent on stock buybacks and dividends – which is more than they put into R&D. Propping up the stock price more important than new products?

The StorageMojo take
All NetApp has to do is build products that customers want to buy and that have good margins. The growth in strategic product sales – whatever those are – says they are having some luck with customers, but the gross margins suggests they are buying the business rather than winning it.

That’s not a good long-term strategy.

While the company has some good news to share – they won the Flash Memory Summit Best of Show for Customer Implementation, and all-flash NAS and unified SAN/NAS arrays in the 2016 IT Brand Leader Survey – the brand has been badly damaged.

Missing the flash transition – which was obvious from the first Fusion-io demo – was beyond clueless.

The movement of storage to inside servers is a fundamental threat to network storage on the high-end.

Object storage threatens the NAS market from the active archive side, whether cloud or on-premise.

Finally, bringing in a new Marketing VP from IBM during the SolidFire integration is a risky move. Clearly, NetApp’s culture needs a good shaking, but whatever caused multiple flash projects to fail is at the core of the problem, with training sales to sell multiple product lines next.

The only strategy I see for NetApp going forward is to be acquired for their world-wide sales and service organization. Perhaps one of the cloud vendors that they are courting will take the plunge.

Courteous comments welcome, of course.