The enterprise storage market is changing at a rapid pace. New technology inflection points such as flash-based arrays and software-defined storage have emerged to address the changing needs of today’s data-intensive workloads. In addition, public cloud-based storage offerings from vendors like Amazon.com, Microsoft and Google are making a permanent impact on enterprise storage economics and consumption models.
Big market shifts like these pose serious threats to the incumbent enterprise storage providers like Dell EMC, Hewlett Packard Enterprise (HPE), IBM and NetApp who must innovate quickly to keep up. These vendors are responding with new products and services in an effort to keep their businesses on track and remain relevant with both existing and new customers.
NetApp has struggled over the last several years to keep pace with market change. For example, the company was late to the all-flash array party, missing much of the initial wave of testing and acceptance by early adopters. In February of this year, the company announced a transformation initiative to get back on track with a focus on growth in new technologies along with a cost structure realignment. The latest effort as a part of this transformation was a 6% workforce reduction, announced earlier this month.
In NetApp’s earnings call this week, the company appeared to be doing a good job of managing expectations with the investment community on the transformation, with at least four or five congratulatory comments on their execution for the quarter. The company’s gross margin was up slightly over the prior quarter and operating expenses were down as a result of the company’s transformation efforts. However, product gross margins (non-GAAP) remain stubbornly low, in the 48% zone, which is 2 points lower than 2016 and 8 points lower than 2015.
One of the key highlights promoted this quarter was the achievement of a $1 billion annual run rate in all-flash arrays (~$250M in revenue for the quarter). This translates to a healthy growth rate of ~40% over the previous quarter. Strangely, if this is true, it means the rest of their “strategic revenue” sources are actually declining quarter-on-quarter. It will be critical for NetApp to ensure they have multiple sources of revenue from new products to have the right bets in place as the market experiences transitions.
The company appears to be checking all the right boxes to please the market on their near-term execution to their business transformation promises. However, is NetApp transitioning fast enough to win in the long haul?
In no particular order, here are six key factors that NetApp must count on to continue their positive trajectory:
- Holding or gaining share vs. Dell EMC and other competitors. NetApp is catching up to its peers in new products. However, it is unclear from the comments on the earnings call what NetApp’s specific strategies are to thwart off competitive threats from both traditional competitors and new entrants.
- A steady global demand for enterprise solutions. Uncertain macroeconomic conditions and comments about market softening from other vendors may signal a larger threat to the growth of the enterprise infrastructure market. For example, Cisco Systems alluded a ‘challenging global business environment’ in its call this quarter.
- Continued leveling out in the company’s mature product revenue. NetApp held revenue flat in mature products quarter on quarter but saw declines year on year. However, NetApp executives stated that they believe prominent declines in mature products revenue are behind them.
- Continued strong sales partnership with Cisco Systems. Cisco Systems appears to be enhancing its own roadmap to compete in enterprise storage. NetApp must continue to show unique value to Cisco Systems to ensure their joint business remains a growth engine.
- Growing as fast or faster than the market in all-flash arrays. NetApp does have a strong and loyal customer base and is viewed as one of the storage market leaders for mainstream IT customers. Catching up to its competitors in all-flash means that NetApp has an opportunity to target these mainstream IT customers as they transition to flash-based storage.
- Keeping up with new technology transitions. Other new technologies like storage-class memory are on the horizon for enterprise storage. NetApp needs to make sure they have a product roadmap that is line with future market shifts.
The jury is still out on whether or not NetApp can turn its business around quickly enough to remain a leader in enterprise storage. The competitive landscape looks drastically different that it did a few years ago, as new competitors have entered the fold like the public cloud providers and new enterprise storage-focused vendors like Pure Storage, Nimble Storage and Nutanix. In addition, big shifts are happening with incumbent storage providers like Dell and EMC, who have combined forces to broaden their portfolio and customer reach.
It does appear that NetApp has recognized their past missteps and now has its cost structure under control. However, customers and investors will be paying close attention over the coming quarters to make sure that NetApp remains a viable competitor and is able to innovate quickly enough to keep pace with the rapidly changing market.