NetApp Shares Tumble but CEO Insists Flash Storage, Cloud Momentum Remain Good

A slowdown in flash storage revenue growth is just the law of large numbers at work, insists NetApp  (NTAP) CEO George Kurian following his company’s latest sales and earnings beat. Though NetApp beat expectations, investors were punishing its stock, with shares down almost 13% to $68.05 on Thursday morning.

Results and Guidance

After the close on Wednesday, NetApp, the world’s second-biggest provider of standalone enterprise storage systems after Dell EMC, reported October quarter (fiscal second quarter) revenue of $1.52 billion (up 7% annually) and non-GAAP EPS of $1.06 (up 29%), topping consensus analyst estimates of $1.51 billion and $0.99. NetApp’s closely-watched product (hardware and software) revenue grew 11% to $913 million, beating a $905 million consensus.

NetApp also guided for revenue of $1.55 billion to $1.65 billion (up 2% to 8%) and EPS of $1.12 to $1.18. Revenue guidance is in line with a $1.6 billion consensus; EPS guidance is largely above a $1.12 consensus.

For now, NetApp is maintaining its fiscal 2019 (ends in April 2019) guidance. This includes a forecast for EPS, which is benefiting from margin growth and stock buybacks, to grow by a mid-20s percentage, and for revenue to grow by a mid-single digit percentage before accounting for the benefit provided by enterprise license agreements (ELAs) for NetApp’s software. ELAs are expected to account for 2% of revenue in fiscal 2019, and also future years.

Flash Storage Growth

Possibly weighing on NetApp’s shares: The annual revenue run rate for NetApp’s all-flash storage array (AFA) sales was up 29% annually at the end of the October quarter, down from the 50% increase that existed at the end of the July quarter. And in dollars, the AFA run rate was flat sequentially at $2.2 billion, after having risen by $200 million to $1.7 billion a year ago.

Kurian insists the slowdown in the annualized AFA growth rate is nothing to be concerned about, and indicated deal timings played a role. “Last quarter, we had some large one-time customer deployments of AFAs, so it’s really the law of large numbers,” he said.

Likewise, CFO Ron Pasek insisted on NetApp’s earnings call that the company’s hasn’t seen “any fundamental change in [its] competitive landscape.” He also stated only a mid-teens percentage of NetApp’s installed base has adopted AFAs, leaving plenty of room to grow.

IT Spending Trends

In May and August, Kurian sounded upbeat about global IT spending. Today, he’s still generally positive about spending conditions, but notes there are some pockets of weakness, such as in certain emerging markets.

“[IT spending] is still good in several parts of the world. There are some modest changes in some parts of the world, correlated to economic outlook…I think the macroeconomic environment is a little more mixed than it was three months ago,” he said. Kurian added that he hasn’t seen any “direct correlation” between trade concerns and IT spending trends.

Cloud Software and Services

NetApp has invested heavily over the last few years in developing software that allows the storage on locally-deployed NetApp storage systems to be jointly managed with storage residing on public cloud infrastructures from the likes of (AMZN) , Microsoft (MSFT) and Alphabet/Google (GOOGL) . It has also worked with cloud giants to launch storage management offerings that leverage NetApp’s ONTAP storage OS and run directly on cloud infrastructures.

NetApp officially launched several new cloud offerings in October, including a subscription-based cloud monitoring tool and a file storage service for Microsoft Azure that was jointly developed by NetApp and Microsoft. Kurian says monthly recurring revenue for NetApp’s cloud data services offerings grew 35% sequentially last quarter to about $27 million, and argues the ability of its software to play nicely with a variety of environments has been a big selling point.

“Most customers are clearly looking at deploying a hybrid, multi-cloud, IT architecture,” he said. “And the ability to manage applications, infrastructure and data consistently across all of those clouds, as well as in their own data center, is something that they’ve really wanted.”

The Lenovo Partnership

In September, NetApp announced an alliance with PC and enterprise hardware giant Lenovo through which Lenovo will resell NetApp’s hardware, and the companies will co-develop a new line of Lenovo-branded storage products. They also plan to launch a Chinese storage JV that’s expected to become operational next spring.

“What we have with Lenovo is a provider that has skills in computing, in geographic markets that NetApp is not strong in,” said Kurian, who added NetApp is starting to see customer wins as a result of Lenovo’s efforts to resell its products. However, he cautioned it will take some time for Lenovo’s distribution channels to be trained to sell NetApp’s offerings. “I think the majority of the upside [from the partnership] will be in fiscal 2020 and the years subsequent to that,” he said.

Hyperconverged Infrastructure (HCI) Growth

Kurian says sales of NetApp’s hyperconverged infrastructure (HCI) offerings — they combine server (compute) and storage functions, with buyers able to independently scale compute and storage nodes as their needs grow — rose strongly again in the October quarter. Last month, NetApp launched a pair of new HCI compute nodes, including one that supports server GPUs.

“We had several large customer wins and expanded the total number of customers as well as our revenue trajectory substantially,” said Kurian about last quarter’s HCI performance, while declaring his company’s offerings to be differentiated in terms of performance, efficiency and cloud integration. Major players in the HCI market include Nutanix (NTNX) , HP Enterprise (HPE) and Dell.

Services Growth

While NetApp’s product revenue rose 11% to $913 million last quarter, its software maintenance revenue rose a more modest 5% to $236 million, and its “hardware maintenance and other services” revenue fell 1% to $368 million.

Much as he did in August, Kurian said NetApp’s services growth will soon pick up, since maintenance revenue is tied to past product sales and NetApp’s product growth has improved meaningfully in recent quarters. However, he added that while the growth rate for services sold at the time of product sales is “starting to reflect” improved product growth, NetApp “[needs] to do more to further accelerate” services sales that stem from renewals.

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