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Morningstar | NTAP Updated Forecasts and Estimates from 31 May 2019

No-moat NetApp's revenue, operating margin, and earnings missed our expectations for its fourth quarter and next quarter revenue is expected to decline year over year. Sales declined by 3% year over year while GAAP gross margin expanded by 190 basis points to 64.4% and GAAP operating margin grew by 426 basis points to 23.2%. NetApp was hindered by sales and marketing execution issues, a poor job of capturing renewals, and the OEM business declining significantly. We decreased our growth expectations for NetApp, and lower our fair value estimate to $51 per share from $54. Shares are down by 6% after hours to $63 per share, and we remain cautious about NetApp's ability to sustainably win hyperscale cloud storage business and its position after the wave of all-flash array adoption.

Compared with the prior year, product-based revenue declined by 3%, software maintenance grew by 3%, and hardware maintenance shrank by 9%. Management stated that although it struggled with renewals in the quarter and customers were putting off product orders, its total asset base grew and deferred revenue increased by 9% year over year. Bright spots in the quarter were 25% year-over-year growth in all-flash arrays alongside private cloud services (including hyperconverged infrastructure) growing to a $150 million quarterly run rate. In our view, NetApp's margins are benefiting from NAND pricing declines and its shift to software. We see the growth in these embryonic areas as positive news for NetApp, but we expect the return to growth to be challenging as it faces larger competitors like Dell Technologies alongside the trend of customers choosing native hyperscale cloud storage over branded options.

While the growth decline was unexpected, we were pleased with NetApp announcing that its dividend will increase by 20% to $0.48 next quarter from $0.40. NetApp repurchased $500 million worth of shares in the quarter and has $1.9 billion remaining that is authorized for buybacks.

Guidance for next quarter includes a 6% year-over-year decline at the midpoint, and NetApp expects low-single-digit growth in fiscal 2020 coming from all-flash sales accelerating and increases in revenue associated with private and public cloud offerings. The company will be undergoing a strategic sales and marketing reorganization to focus on higher growth opportunities. NetApp expects OEM to remain a drag in fiscal 2020 although it is a relatively small portion of NetApp's consolidated revenue. The company commented that it does not expect any material impact from tariffs after managing its supply chain to minimize any potential disruptions.