NetApp cuts costs as economic clouds gather

NetApp set a record for second quarter revenues but is cutting costs in anticipation of lower customer spending and economic headwinds.

Revenues for the period ended October 28 were $1.66 billion, up 6 percent year-on-year. Profits were $750 million, compared to $224 million a year ago. This was partially due to a $445 million income tax benefit.

George Kurian, NetApp
George Kurian

CEO George Kurian said: ”We delivered a solid quarter in a dynamic environment, with all-time highs for Q2 revenue, billings, gross profit dollars, operating income, and EPS… In a challenging macro environment, we remain focused on innovation, execution, and operational discipline.”

There was a caveat in his prepared remarks: “We are disappointed with the deceleration of growth in our cloud services. Our conviction in the cloud opportunity and our ability to execute against it is unwavering.” 

NetApp revenues

There are signs of customers reducing their spending. In the light of this, NetApp has implemented a broad-based hiring freeze and is lowering operating expenses, reducing discretionary spending, and optimizing its real estate footprint. It is also shifting resources away from lower yield activities to bigger opportunities. 

CFO Mike Berry said: “We will continue to pause Cloud Operations acquisitions for the remainder of fiscal ’23.”

NetApp is intent on better integrating its various CloudOps buys, with Berry saying NetApp will “sharpen our portfolio focus by refining the Cloud Insight value proposition and sales motion, accelerating the integration of Spot and CloudCheckr into a single finops suite, and driving the successful integration of InstaClustr.”

Cloud Insights cross-selling will start to become significant in 2024, he added.

In NetApp’s hybrid cloud business, revenue was $1.52 billion, compared to $1.48 billion a year ago. Public cloud revenue was $142 million, compared to $87 million the year before. Public cloud ARR was $603 million, up 55 percent year-on-year, but short of NetApp’s expectations. 

NetApp cloud revenues

Kurian said: “Growth has slowed as customers look to optimize cloud spending [and] caused some slowing of growth in our cloud storage services, as well. ” He singled out “a few customers with very large project-based workloads, like chip design, that came to their natural conclusion.” 

However, Spot, NetApp’s cloud cost optimization tools, did well: “Q2 saw an acceleration of new Spot customer additions from Q1.” In Kurian’s view: “Our Public Cloud Services are highly differentiated and create customer preference for NetApp. We have a multiyear advantage over our traditional competitors in this critical market, positioning us well to deliver sustained growth.” 

In particular: “We are the only certified and supported third-party cloud storage solution for VMware Cloud, which creates significant new opportunity for us. As those VMware environments move to the cloud, we can capture the data that resides on competitors’ on-premises systems.” 

All-flash array revenues grew 2 percent, with an annual run rate $3.1 billion, the same as a year ago. All-flash penetration of the installed base is now 33 percent.

Financial summary

  • Gross margin: 66.3 percent (68.3 percent a year ago).
  • Cash, cash equivalents and investments: $3.03 billion at quarter end.
  • Operating cash flow: $214 million, compared to $298 million a year ago.
  • Free cash flow: $137 million. 
  • Share repurchase and dividends: Repurchased $150 million in stock and paid out $108 million in cash dividends, returning  $258 million to shareholders overall.
  • EPS: $3.41, compared to the year-ago $0.98

The outlook reflects slowing customer spending. Kurian said: “We believe strongly in the opportunity ahead but have slightly tempered our revenue outlook for the remainder of the fiscal year due to near-term macro headwinds… As we moved through the quarter, we saw increased budget scrutiny, requiring higher level approvals, which resulted in smaller deal sizes, longer selling cycles, and some deals moving out of the quarter. In Q2, we felt this most acutely in the Americas hi-tech and service provider sectors.” 

Unprecedented foreign exchange headwinds were also mentioned.

Next quarter’s outlook is for revenues between $1.525 billion to $1.675 billion, $1.6 billion at the mid-point and $10 million down on the year-ago $1.61 billion. 

Kurian said: “Current economic realities and unprecedented Fx headwinds are and will continue to impact IT spending, causing us to temper our revenue expectations for the second half.”  That means the full 2023 revenue outlook is now for 2 to 4 percent growth to $6.5 billion.

This is nowhere near as bad as the recessionary situation affecting NAND and disk drive media suppliers such as Seagate, Western Digital, Micron, SK hynix and others. NetApp is tempering its growth forecasts.