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Why NetApp Inc. (NASDAQ:NTAP) Busted Under Support Levels on the Beat-and-Raise

NetApp Inc. (NASDAQ:NTAP) reported second quarter EPS, beating market expectations at $1.06 on revenues of $1.52 bln, which also beat, coming in above the midpoint of the company’s guidance.

However, like a number of other cloud and data plays, the company missed the spiritual target on next-Q guidance, underwhelming hopes and undermining the stock. NTAP shares plunged in response, taking out several key levels. And the big question now is about whether this was a nice shakeout or has larger trend and cycle implications.

NetApp Inc. (NASDAQ:NTAP) gross margins were 65%, aided by product gross margins that increased one and a half points yr/yr to 54.5%, reflecting continued salesforce discipline, benefit from Enterprise License Agreements (ELAs), and some one-time items.

Sales strength was driven by product revenue growth 11% to $913 mln as strength in the all-flash array business, an expanding traction in NetApp’s HCI platform as well as roughly $20 mln benefit from ELAs.

The big problem that we see with this picture is that it represents a second-derivative deceleration in the product sales growth curve. It’s a “peak before the peak” kind of dynamic that doesn’t foster support in a nervous tech tape like this.

In addition, the company’s cloud position was likely under scrutiny. Based on Q2 results, the company’s annualized monthly recurring cloud data services revenue is approximately $27 mln, up 35% from Q1. However, in Q2, NetApp’s all-flash array business inclusive of All Flash FAS, EF, and SolidFire products and services grew 29% compared to last year to an annualized net revenue run rate of $2.2 bln, essentially flat compared to last quarter.

Finally, NetApp’s revenue guidance wasn’t as bullish as the market had expected, either. The company’s third quarter EPS forecast of $1.12-1.18 did come in ahead of where the market thought NetApp would be next quarter, but third quarter sales guidance of $1.55-1.65 bln wasn’t as robust as the market had anticipated.

The revenue outlook perhaps suggests that product revenue may decelerate a little from the nearly 11.5% growth seen in the second quarter. Additionally, the company guided gross margins in-line at 62.5-63.5% for the third quarter.


Sell-Side Sour Grapes

  • Target adjustments: Maxim Group lowers their NTAP tgt to $89 from $91; Morgan Stanley raises their NTAP tgt to $72 from $70; Citigroup lowers their NTAP tgt to $77 from $83.
  • Maxim Group: “Excluding Enterprise License Agreements (ELAs), product revenue decelerates again to 9% y/y growth rate, which is still well above long-term guidance of mid-single digit growth. Midpoint guidance in-line with consensus, which embeds product revenue will decelerate to 5% y/y growth, but still post a seasonal 10% q/q increase. On in-line to consensus guidance, but below our more bullish F2H19 estimates, we are slightly lowering estimates & thus 12-month price target to $89, from $91. Our extensive technology channel checks gives us confidence NTAP’s Hybrid Cloud will be a driver of sustained share gains, reiterating Buy rating.”
  • DA Davidson: “Over the last two years NTAP has executed a significant realignment as it moved aggressively into the Flash storage system market. The company has a rejuvenated product line that now spans many new markets (including Cloud and HCI); it has strong cash flow, a commitment to its stock buyback program, and pays a dividend. We believe the stock is undervalued, and reiterate our BUY recommendation.”
  • Oppenheimer: “NetApp reported solid FY2Q19 results, reflecting steady overall execution and more share gains. Longer-term product positioning is also encouraging with mgmt. highlighting an accelerating HCI pipeline and expanding cloud efforts (CDS, StackPointCloud acquisition, hyperscale exposure, various product enhancements, etc.). While we’re positive on NetApp’s longer-term growth strategy and developing TAM (HCI, CDS), we note that ELAs again contributed to some of the upside and that its strategic product YoY growth is showing QtQ moderation. We believe this could weigh on investor sentiment near-term. Our thesis is unchanged—we’re positive on NetApp’s cloud initiatives, though view this as a multi-quarter evolution that will take time before it becomes a bigger growth catalyst. Maintain Perform.”

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