A reader wrote to ask for the StorageMojo take on NetApp now, as opposed to the assessment in How doomed is NetApp? two years ago.
Q3 had some good news for NetApp. In their latest 10Q filing, they noted that while revenues for the first 9 months of the year were down 3%, for the latest quarter they were up 1% year over year. Why?
The increase in the third quarter of fiscal 2017 compared to the third quarter of fiscal 2016 was primarily due to higher product revenue, driven by the increase in revenues from strategic products more than offsetting the decrease in mature products. The increase in product revenues was partially offset by lower hardware maintenance and other services revenue. The decrease in the first nine months of fiscal 2017 compared to the first nine months of fiscal 2016 was primarily due to lower product revenue and lower hardware maintenance and other services revenue.
In other words, SolidFire and Clustered ONTAP systems are making a difference, but now NetApp is being dragged down by non-renewed maintenance contracts and other service revenue shortfalls – especially for high end systems – as well as the continued erosion of the FAS line. Gross margins dropped a percentage point, which I suspect was do to more aggressive discounting to win competitive business. Without that, Q3 may not have eked out even 1% product growth.
The people problem
People are the most expensive part of NetApp’s cost structure – as it is for most businesses – and NetApp has laid off about 2500 people – ≈20% – in the last couple of years. The cuts have been strongest in sales and marketing, but R&D has also taken a significant hit dropping from 16% of net revenues in the 9 months ending January 2016, to 13% for the three months ending January 2017.
If you assume that the laid off people were somewhat productive, you’d expect to see a hit somewhere, and indeed we do.
In sales and marketing expenses, NetApp reports that
Compensation costs for the third quarter and the first nine months of fiscal 2017 compared to the corresponding periods in the prior year were favorably impacted by lower salary and stock-based compensation expenses due to a 12% decrease in average headcount, but were unfavorably impacted by higher incentive compensation expense.
Translation: the remaining people wanted more money to do the extra work we thrust on them.
Same story with R&D, which took a 19% headcount cut:
Compensation costs for the third quarter and first nine months of fiscal 2017 . . . were unfavorably impacted by higher incentive compensation expense.
R&D was also “favorably” impacted by
. . . lower spending on materials and services associated with engineering activities to develop new product lines and enhancements to existing products due to the completion of certain key development projects.
Reduced spending on new product development? What could possibly go wrong?
The StorageMojo take
NetApp’s strategic products – i.e. the ones customers want – are growing at a healthy rate and constitute a majority of their product revenues. So they’ve come back from the dead, right?
Not really. Slowed the decline is more accurate. The fundamentals haven’t changed, even with SolidFire and Clustered ONTAP.
NetApp has a good sized installed base, and can be profitable for years to come servicing them. But it doesn’t look like that installed base is expanding, and in a growing industry, that means decline.
Cutting sales and marketing and R&D are easy ways to pump up short term results. But they won’t build the company for the long term or reverse secular decline.
What NetApp has excelled at is the financial engineering required to keep the stock price high. Throughout all the turmoil of the last few years, their gross margins have remained in the low 60’s. So Wall Street is happy. In fact, the stock is trading close to its highest value of the last 5 years.
Would they have been wiser to trade margin dollars for protecting the installed base and growing new accounts? Probably. But the stock price wouldn’t be where it is today. And for execs with big options packages, that’s the bottom line.
Courteous comments welcome, of course.