NetApp (NTAP 78.98, -3.49, -4.23%) is trading lower today after reporting
earnings for Q1 (Jul) last night and guiding for Q2 (Oct).
NTAP is a supplier of data storage systems used by businesses for archiving and backup. NTAP provides a full range of hybrid cloud data services that simplify management of applications and data across cloud and on-premises environments. Its FAS storage platform uses the NetApp Data ONTAP storage operating system to deliver integrated data protection, data management, and built-in efficiency software for virtualized, shared infrastructures, cloud computing, and mixed workload business applications.
NTAP supplies both hardware and software for data storage and management. Basically, NTAP helps customers extend their IT infrastructure to the cloud. Its total addressable market is comprised of three segments: 1) the networked storage market (NTAP's traditional market), which is large but expected to decline at a rate of 4% CAGR over the next three years 2) hyper-converged, which is expected to grow at a rate of 29% over the next three years; and 3) cloud storage, which is a large market growing at a rate of 13%.
Just a word on NTAP's legacy networked storage segment: although declining in aggregate, certain sub-segments of this market are growing very quickly. The hard disk drive-based segment is shrinking, but the all-flash array segment is growing substantially at about 21% CAGR. More than 50% of NTAP’s revenue from configured systems now comes from all-flash arrays. Moreover, NetApp’s market share in flash is substantially greater than it had been with the disk-based business segment. The company reports that it is clearly outpacing competitors in all-flash arrays. Not only has the flash segment come to dominate revenue contributions to the company’s own configured systems business, but as the flash market has grown to be a bigger part of the overall storage market, NetApp’s progress in the segment has positioned the company to capture aggregate market share gains in the overall market.
Furthermore, as new workloads get created, like artificial intelligence and machine learning, these workloads will need to run on high-performance NFS systems, and NTAP‘s solid position in all-flash arrays and NFS give it an opportunity to capture those new workloads, whether they run on-premises or in the public cloud. Overall, networked storage still represents an opportunity for NTAP. NTAP says the market transition to flash is still in the early stages, and it is likely to create enormous new opportunities for NTAP as they consolidate and displace competitors' legacy equipment and as they upgrade their installed base with cloud connected all-flash systems.
Turning to the Q1 (Jul) results, non-GAAP EPS rose 73% year/year to $1.04, which was above prior guidance of $0.76-0.82. Revenue rose 11.6% year/year to $1.47 bln, above prior guidance of $1.365-1.465 bln. Looking ahead, the guidance for Q2 (Oct) was basically in-line with market expectations: non-GAAP EPS of $0.94-1.00 and revenue of $1.45-1.55 bln.
So why the big upside? A couple of reasons. First, product revenue came in higher than expected, reflecting the continued strength of NTAP's all-flash array business. Second, and probably more relevantly for the upside, NTAP received roughly $60 mln from strategic enterprise agreements, which they did not include in prior guidance. Enterprise License Agreements, or ELAs, are enterprise-wide deals in which NetApp is a key strategic partner in implementing the customers' broader digital transformation.
From a revenue recognition perspective, the new ASC 606 standard requires the software product component of ELAs to be recognized upfront. Under the old ASC 605 standard, these software licensing agreements were recognized ratably across the life of the deal (typically three years). The structure of these ELAs coupled with the upfront revenue recognition makes their financial impact lumpy and difficult to predict. Moving forward, NTAP will continue to take a conservative approach in predicting the timing and size of these strategic deals. As such, NTAP will not be including ELAs in its guidance for Q2 nor the remainder of fiscal 2019.
In sum, JulQ was a good quarter. Normally you would expect to see a stock higher on such big upside, but it appears that it comes mostly due to an accounting change in terms of the timing of revenue recognition. If you're an investor in NTAP, you'll need to get used to this. The timing of ELAs are very difficult to predict. Certain quarters could see zero of them, which is why NTAP will not guide for them. Plus, they are so large that if NTAP were to include it in guidance and not get it, a big miss would result. Anyway, expect some lumpy quarters with NTAP and back out the ELA impact when evaluating the numbers.
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