NetApp's CEO: IT Spending Conditions Still Look Good
George Kurian has been NetApp's CEO since 2015.

Though NetApp's (NTAP) stock is slumping post-earnings following a strong 2018 run-up, its CEO insists both IT spending conditions and his company's sales outlook remain good.

On Wednesday afternoon, NetApp reported July quarter (fiscal first quarter) revenue of $1.47 billion (up 12% annually) and non-GAAP EPS of $1.05, beating consensus estimates of $1.42 billion and $0.80. The company's October quarter guidance is in-line with estimates: Revenue of $1.45 billion to $1.55 billion and EPS of $0.94 to $1.00 versus a consensus of $1.51 billion and $0.97.

It's worth noting that NetApp's July quarter sales and EPS got a boost from ASC 606 accounting rules. ASC 606 requires NetApp to fully recognize the revenue from the software portion of enterprise licensing agreements (ELAs) up-front, rather than over the deals' lifetime (typically three years). On the earnings call, CFO Ron Pasek said NetApp recorded about $60 million in ELA-related revenue last quarter that wasn't baked into its original guidance. That, along with strong all-flash storage array (AFA) demand, helped its total product revenue rise 20% annually to $875 million.

Notably, NetApp's October quarter guidance doesn't assume any ELA revenue, nor will any future fiscal 2019 guidance; the company attributes this to the unpredictability of ELA deal timing. And though NetApp spent $500 million on stock buybacks last quarter, its guidance also doesn't account for any potential EPS boost from future stock repurchases. All of that could lead guidance to be conservative.

Shares fell 6.5% in after-hours trading to $7.15, after having gone into earnings just $1.13 below a 52-week high of $83.60. They remain up over 40% on the year.

As was the case in May following NetApp's April quarter report, TheStreet had a chance to talk with CEO George Kurian on Wednesday about his company's results. Here's a recap of some of the topics that were discussed:

IT Spending Trends

Just as he did in May, Kurian struck an upbeat tone about IT spending conditions. "IT spending is correlated with economic growth," he said. "[To] the extent that we have a pretty good economic growth outlook over large parts of the globe, we see correlated IT spending intentions being good."

Here, it's worth noting that NetApp's report coincides with upbeat results, guidance and product order figures from networking giant Cisco Systems (CSCO) . And though the dollar's recent strengthening might lead growth to come in a little below this level, research firm Gartner forecast in April that global IT spending would rise 6.2% this year to $3.52 trillion.

Margin Expansion

Officially, NetApp's non-GAAP gross margin (GM) rose 2.9 percentage points sequentially and annually to 66.2%, and its product GM grew 3 points sequentially and 6.2 points annually to 55.7%. ASC 606 adoption played a major role here, but Kurian indicated product GM still rose by 1.5 points annually if one backs out ASC 606's impact.

An ongoing product revenue mix shift from hardware to software is aiding NetApp's margin expansion. And for now, lower NAND flash memory prices are also helping. However, Kurian downplayed the latter's long-term impact, declaring NetApp's strategy is to pass on flash cost savings to customers.

Flash Storage Growth

After having reported in May that AFA annual revenue run-rate was up 43% from a year earlier, Kurian says its AFA run-rate was up 50% as of the July quarter to $2.2 billion. The technology assets that NetApp obtained from its early-2016 acquisition of AFA vendor SolidFire continue to help out, as do software solutions for integrating on-premise NetApp storage with public cloud storage that often relies on white-box hardware.

"We are increasingly gaining share in a broad and diverse set of workloads," Kurian said about NetApp's AFA momentum. He also suggested the company is seeing good traction for the hyperconverged infrastructure (HCI) offerings it launched last fall; on the call, he mentioned a win with a European financial services firm in which Netapp beat out fast-growing HCI leader Nutanix (NTNX) .

Nvidia and Intel

Two weeks ago, NetApp announced a partnership with Nvidia (NVDA) to create solutions for AI/deep learning workloads that pair Nvidia's DGX servers -- they pack high-end Nvidia GPUs used for AI training -- with NetApp's AFF A800 flash array. When asked about the tie-up, Kurian asserted the deal expands NetApp's addressable market; he noted IDC expects the total market for AI storage solutions to be worth $5 billion next year, and to grow at a 39% compound annual rate over the next few years.

And with Intel (INTC) having announced last week that it has begun shipping main memory modules (DIMMs) that use its 3D XPoint next-gen memory -- it aims to strike a middle ground between DRAM (very fast, but expensive and not dense) and flash memory (cheap and dense, but relatively slow) -- I asked if NetApp has plans to support Optane DIMMs. Kurian noted the high-performance file system NetApp obtained last year through its acquisition of startup Plexistor will help it support next-gen memory technologies, and suggested the company will have more to share at its annual Insight conference (it's set for October).

Services Growth

While NetApp's product revenue has been growing at a healthy clip, its services revenue, which accounted for 40% of last quarter's sales, has been seeing muted growth. A major reason for this: Services revenue is closely linked to past product sales, and NetApp's product revenue fell from $4.21 billion in fiscal 2012 to $2.99 billion in fiscal 2016, before starting to rebound.

Kurian sounded optimistic that NetApp's product revenue pickup will help drive future services growth. He noted total services revenue grew slightly last quarter (it was down in many prior quarters), and that the company's deferred revenue and financed unearned services revenue grew 4% "You should see [services revenue] start to grow going forward," he said.


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