Editor’s note: NetApp’s latest earnings report Wednesday clearly shows the challenges facing the company remain despite the ouster of its previous CEO and job cuts, says Technology Business Research analyst Stephen Belanger.

HAMPTON, N.H. – In 2Q15 NetApp’s revenue declined 10.4% year-to-year to $1.3 billion due primarily to product revenue declines of 24.8% over the same period to $664 million.

TBR attributes the vendor’s revenue decline to weak sales of its traditional ONTAP 7-Mode offering, as many customers that are deploying cloud and analytics solutions are opting instead for emerging storage technologies including scale-out, software-defined, converged and flash storage.

NetApp continues to focus on driving operational efficiency by streamlining its workforce and business structure. However, these actions did not offset NetApp’s revenue decline in 2Q15, as gross margin declined 190 basis points year-to-year to 61.1%.

Additionally, operating margin declined from 10.7% in 2Q14 to a loss of 1.9% in 2Q15 due to increased product investments to realign its portfolio for changes in global storage demand, as well as expenses related to recent layoffs.

TBR believes NetApp’s 2H15 revenue will decline year-to-year due to lower product revenue resulting from weak demand for its traditional storage products. The vendor will focus on streamlining its expense structure through employee layoffs and cost takeout initiatives to support profitability despite continued revenue challenges. Further, NetApp is working to evolve from its legacy in traditional storage systems to become a strategic advisor to customers that are transforming their infrastructure and adopting cloud, analytics and mobile technologies.

However, it will be difficult for NetApp to reposition its business due to spending constraints stemming from its ongoing revenue challenges. Stabilizing its revenue performance will be critical for NetApp to improve its long-term position by freeing up resources that can be redirected back to sales and R&D in high-demand areas such as cloud, flash, SDS and analytics.

NetApp replaces CEO Tom Georgens following several quarters of revenue contraction in its core storage hardware business

In June, NetApp ousted CEO and chairman of the board Tom Georgens following its sixth consecutive quarterly year-to-year revenue decline in 1Q15. Georgens’ vacant board role is filled by current board member Mike Nevens, while George Kurian took over as temporary CEO. Previously, Kurian was in charge of strategy and development for NetApp’s Product and Solutions portfolio. NetApp will search for a new, permanent CEO, who will be tasked with directing NetApp’s investments and strategy to achieve revenue growth within two years.

NetApp’s new CEO will inherit the challenging task of evolving NetApp’s portfolio and sales efforts away from its legacy ONTAP-led approach to better accommodate growing demand in areas such as flash, hybrid cloud, hyperconverged platforms and analytics.

In addition to its executive changes, NetApp is also making changes to its workforce. Specifically, in May NetApp announced a workforce realignment initiative to improve efficiency, reduce costs and realign its workforce to high-demand areas such as cloud and analytics. Job cuts of approximately 500 employees will be completed by the end of 2015.

TBR believes job cuts will help NetApp drive long-term margin improvement and realign around strategic growth areas such as flash; however, they have the potential to cause short-term execution issues and threaten employee morale.

NetApp launches aggressively priced flash arrays to boost hardware revenue

In 2Q15, NetApp incurred its eighth consecutive year-to-year product revenue decline due in part to competition in the flash storage market from major OEMs such as EMC, HP and Dell, as well as smaller-scale vendors such as Pure Storage and Nimbus Data.

TBR believes competitors’ use of aggressive pricing to win customers has hindered adoption of NetApp’s flash offerings. In response, NetApp launched its All Flash FAS 8000 (AFF8000) series in June with starting prices as low as $25,000. TBR believes the launch will help NetApp drive continued AFF unit sales triple-digit growth for the remainder of 2015.

In June, NetApp launched four AFF8000 models, which can be ordered as either standalone systems or as part of FlexPod converged infrastructure solutions. Additionally, NetApp or its partners are providing professional services to help users identify the key workloads areas that are best served by all-flash systems, which TBR believes will help NetApp accommodate changes in the storage hardware purchase process due to the growing influence of line-of-business buyers.

Global demand for flash storage will steadily rise and TBR believes NetApp is well positioned to attract customers with lower-priced all-flash arrays. However, the vendor will continue to face significant competition as rival storage OEMs also release lower-priced flash solutions.

For example, in 2Q15 HP and Dell launched new all-flash arrays with very low prices per gigabyte with the launch of new all-flash 3PAR arrays and SC4020 all-flash arrays, respectively. NetApp’s AFF8000 product launch will help the company address customer demand for low-priced flash solutions and drive storage hardware revenue from rising flash sales.

However, TBR believes continued pricing wars will hinder the potential margin benefits of increased flash sales.

(C) TBR