3 Reasons Why NetApp CEO George Kurian Expects A Revenue Shortfall (And 5 Ways He’ll Turn It Around)

Macroeconomic factors probably accounted for two-thirds of the expected shortfall, Kurian says, and pricing or competitive pressures were not a factor.

NetApp CEO George Kurian said a worsening macroeconomic environment was a large contributor to its expected first fiscal quarter 2019 revenue and income shortfall, but also said that big part of the blame is on the company itself.

NetApp last week surprised Wall Street by releasing its preliminary first fiscal quarter 2019 financials about two weeks before their official Aug. 14 release. Executives told analysts in a last-minute conference call that the company expects a 17 percent drop in revenue and a 50-plus percent drop in GAAP income compared with its previously announced expectations.

[Related: NetApp CEO Kurian On HCI, Cloud, And Growth Prospects]

NetApp's results were disappointing, Kurian told financial analysts during the conference call.

NetApp saw a softening of the IT hardware buying environment in the second half of the quarter, but it was not across the board, he said. Public sector spending for the most was part on track, but there were a couple of weaknesses, he added.

1. Global accounts have taken a more cautious view of macroeconomic environments. "These large accounts are spending considerably less in total Capex this year compared to calendar year '18," Kurian said. "In the past several years, we've had a focus on growing in our top global customers. We've made great progress in some but need to do more to expand our share in a broader set of these customers."

Kurian also said that NetApp's reliance on large global accounts may make the company more susceptible to global macroeconomic spending changes.

2. NetApp continues to have issues in the Americas selling private cloud and cloud data services offerings. "We know we need to be in more transactions in more customers selling our full portfolio to achieve our desired growth rate," he said.

However, Kurian said, this weakness was actually focused around NetApp's storage business, as private cloud and cloud data services sales grew year over year in the first fiscal quarter. "But they're still a small part of our business and not yet able to offset the slowdown in storage," he said.

The large global accounts, however, indicate that NetApp's shortfall is not related to changes in the competitive environment, Kurian said. "We did not see a decline in win rates, and our product gross margins remain strong," he said.

3. Some deals were delayed or downsized. NetApp was actually on track to meet guidance in the first half of the second fiscal quarter but then saw a deterioration in its pipeline growth rate as some deals got pushed out or downsized, especially in its largest global customers and in the Americas, Kurian said. "As the quarter progressed, the close rate started to deteriorate substantially as deals were pushed out or downsized," he said. "So far, we have seen a small percentage of the deals get canceled, which is a reflection of budgets potentially getting downsized. But we've also seen deals getting pushed out quite substantially, which is why we've been more cautious in our perspective for the full year."

When asked whether NetApp was impacted by tariffs on China-made products, Kurian said that the impact was more pronounced in larger customers.

For example, Kurian said, two of NetApp's largest customers that were impacted by the U.S.-China dispute shrank their capital spending by 30 percent year over year. "And that has meaningful consequences even to IT hardware spending," he said.

Kurian’s Plan For Growth

1. Land and expand. Looking forward, NetApp needs to improve its execution to gain share by selling the value of its portfolio and more aggressively attacking the private cloud and cloud data services opportunities, Kurian said. The company, he added, needs to continue to focus on new account acquisitions while expanding business with existing customers.

"We remain confident that we have the right strategy and technologies to gain share even in a down market," he said. "We consistently hear from customers and partners that our hybrid multi-cloud portfolio is the right one, as we are seeing good results by those teams who are acquiring new customers and are selling our full portfolio. These facts reinforce our belief that we can return to growth over time."

2. Add more sales reps. To return to growth, NetApp is investing in expanding sales coverage by adding dedicated reps to acquire new accounts without increasing overall expenses, Kurian said.

"We will continue to make investment trade-offs to reallocate resources towards those activities with high returns, like increasing sales coverage and accelerating our private cloud and cloud data services businesses," he said.

3. Stay focused on high-growth areas. Customer priorities remain public cloud services, which reflects customers' digital transformation activities, Kurian said. NetApp is also seeing continued growth in private cloud and in converged and hyper-converged infrastructure, while changes in the storage business are more on a case-by-case basis, he said.

"Typically, customers are prioritizing their most business-critical applications, which are higher-performance ones, or analytics environments where they're building big data lakes," he said.

4. Stay the course on pricing. Pricing pressure was not an issue, as evidenced by NetApp's strong preliminary gross margins for the quarter, Kurian said in response to an analyst's question. Furthermore, he said, the company does not believe pricing provides elasticity in an environment where there is macro uncertainty, which means NetApp can remain disciplined in its pricing approach.

There was “some more work that needed to be done better in the Americas,” he said. "I think that is the place where I feel we can gain share by competing in more transactions. We have a really competitive portfolio, our product gross margins are strong, and I don't think pricing provided elasticity in an uncertain environment."

5. Take share from rivals. When asked about the potential impact from the large Dell EMC midrange storage refresh coming later this year, Kurian said NetApp has an opportunity to make market-share gains.

"We have plenty of opportunity to take share from them," he said. "I think what they have done effectively is grow their VxRail [hyper-converged infrastructure] business," he said. "And we have beaten VxRail in a bunch of transactions. But we haven't competed in as many transactions as we need to. And that is where the emphasis on better execution and better coverage of the market with some folks who know how to sell our private cloud is something that's a focus for us."

The Channel Response

Some NetApp solution providers said NetApp’s expected shortfall has not had an impact on their business with the company to date.

The issues seem focused primarily on large global accounts where many solution providers are not as exposed, said John Woodall, vice president of engineering at Integrated Archive Systems, a Palo Alto, Calif.-based solution provider and longtime NetApp channel partner.

"In general, and this is not specific to NetApp, we are in a bit of a recession," Woodall told CRN. "Even Amazon's results are down. NetApp seems to be mainly impacted by things it can't control."

Sales are a bit soft now, primarily because sales are usually soft in the summer, Woodall said. "Sometimes we'll be in the middle of a discussion and the customer takes off for a week or two, and then the discussion picks up again," he said.

The big indicator of how the business is doing will come as other vendors report their financials, Woodall said.

"From what I've seen in this earnings season, there's a mix of good and not-so-good reports," he said. "The next few quarters at NetApp might be bumpy."

NetApp continues to do well in terms of moving its technology focus to stay in front of customer trends, Woodall said.

"In the trends that are emerging, NetApp is doubling down on them," he said. "I didn't hear NetApp say they are doing anything wrong. I see them focused on what's coming."

It is also encouraging that NetApp is not seeing competitive pressures, Woodall said.

"If there are macro and tariff issues, along with competitive issues, that's not good," he said. "As a partner, however, I'm curious about what NetApp intends to do about the one-third of its issues it says were caused by its own business. That's a question. I don't like questions."

An executive with another NetApp solution provider, who preferred to remain anonymous when talking about a vendor partner's fiscal results, told CRN that the solution provider has a lot of NetApp business in its pipeline, particularly new business with NetApp's Data Fabric platform for managing and migrating data across edge, on-premises and cloud environments.

"Deals that start as cloud-only are dragging 5X to 10X in on-prem deals once customers see what NetApp is capable of," the solution provider said. "I'm thinking this is more macroeconomic in nature. People keep talking about a impending slowdown. I'm sure the new China tariffs aren't helping either."