NTAP

NetApp, Inc. (NTAP)

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NetApp Inc. (NTAP)

F2Q2011 Earnings Call Transcript

November 17, 2010 5:00 pm ET

Executives

Tara Dhillon – VP, IR

Steve Gomo – CFO and EVP, Finance

Tom Georgens – President and CEO

Analysts

Maynard Um – UBS

Aaron Rakers – Stifel Nicolaus

Ittai Kidron – Oppenheimer

Keith Bachman – Bank of Montreal

Alex Kurtz – Merriman Capital

Chris Whitmore – Deutsche Bank

Kevin Hunt – Hapoalim Securities

Brian Marshall – Gleacher

Richard Gardner – Citigroup

Mark Moskowitz – JP Morgan

Paul Mansky – Canaccord Capital

Jayson Noland – Robert W. Baird

Jason Maynard – Wells Fargo

Brent Bracelin – Pacific Crest

Katy Huberty – Morgan Stanley

Kaushik Roy – Wedbush Securities

Ben Reitzes – Barclays Capital

Presentation

Operator

Good day, ladies and gentlemen. And welcome to the NetApp second quarter fiscal year 2011 earnings conference call. My name is Katie, and I will be your coordinator for today. At this time, all participants will be in a listen-only mode. We will be conducting a question-and-answer session towards the end of this call. (Operator Instructions)

I would like to now hand the call over to Ms. Tara Dhillon. Ms. Dhillon, over to you please.

Tara Dhillon

Thank you. Before we began, I would like to acknowledge that approximately 3 p.m. Eastern Time today, it appears that someone improperly accessed a restricted website, a link to our financial tables, without the accompanying press release and supplemental commentary was been disseminated by someone approximately one hour prior to the press release. We are investigating how it happened and we will do our best to ensure that it does not happen again. With that, let me begin our prepared remarks.

Good afternoon, everyone. Thank you for joining us. With me on today's call are our CEO, Tom Georgens and our CFO, Steve Gomo. This call is being webcast live and will be available for replay on our website at netapp.com, along with the earnings release, the supplemental commentary, our financial tables, and the non-GAAP to GAAP reconciliation.

Concurrent with today's press release, the supplemental commentary we published contains many of the metrics and analysis we previously provided during our live call, in order to provide additional time for review of the data prior to the call and allow us to focus on more strategic commentary and perspective from our CEO and CFO.

As a reminder, during today's call, we will make forward-looking statements and projections, including our financial outlook for Q3, our expectations regarding our future market share and our expectations regarding the benefits of our new product introductions, all of which involve risk and uncertainty.

Actual results may differ materially from our statements or projections. Factors that could cause actual results to differ from our projections are detailed in our accompanying press release, which we have filed on Form 8-K with the SEC, as well as our 10-K and 10-Q reports also on file with the SEC and available on our website, all of which are incorporated by reference in today's discussion.

These factors include, among others, customer demand for our products and services, including our recently announced new product introductions, our ability to compete effectively and general economic and market conditions. All numbers mentioned today are GAAP, unless stated otherwise. To see the reconciling items between non-GAAP and GAAP, please refer to the table in our press release, on our supplemental commentary and our website.

I'll now turn the call over to Steve for his thoughts. Steve?

Steve Gomo

Thanks, Tara. Good afternoon, everyone. The NetApp team delivered another quarter of outstanding financial performance in Q2, by offering customers the more flexible and efficient alternative to traditional storage, NetApp grew total revenue by 33% and product revenue by 49% year-over-year. Our total gross margins are near their high watermark and non-GAAP operating margins were the highest in over a decade at 19.8%.

Non-GAAP net income jumped 56% over Q2 last year. Our cash balance increased over $460 million, sequentially, to $4.4 billion, with free cash flow contributing $321 million. Non-GAAP product gross margins were also near record high levels this quarter, improving by 4.5 percentage points from Q1 level, several favorable forces drove this improvement.

First, a tiny gap between some material cost reductions and the associated price reductions added about 2 percentage points to the sequential product margin increase. Second, the mix of richly configured systems was high contributing about 1 percentage point to the sequential product margin increase. Finally, volume and all other factors drove the remaining improvement during the quarter.

Non-GAAP operating expenses increased 10% sequentially from Q1. The primary drivers of this increase were the full quarter impact of the net 640 people we added in the first quarter, annual merit increases which went into effect in August and higher than expected variable and incentive compensation, associated with our strong financial performance. We added 370 new people in Q2 and expect to continue hiring primarily sales and engineering resources at similar levels next quarter.

As I mentioned earlier, our cash balance increased by over $460 million in Q2. Some of the big contributors to our cash balance increase were high level of net profit, an increase in deferred revenue and a high level of stock option exercises, which added about $96 million of U.S. cash to the balance sheet. Free cash flow was $321 million in Q2, a very strong 27% of revenue. Well above our annual target of 17% to 22%.

Before turning to our projections for Q3, there is an important phenomenon I would like to point out to you about our share count this quarter. As you know, NetApp issued convertible notes in June of 2008, at a conversion price of $31.85. When our stock price was $23.59.

At the time of the issue, we also purchased note hedges and sold warrants with the goal of reducing future economic dilution associated with the conversion of the notes. While the notes are outstanding, our dilutive share count will be increased to the extent the average closing price of our stock for any quarter is above $31.85.

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