NTAP

NetApp, Inc. (NTAP)

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NetApp Inc. (NTAP)

F1Q2011 Earnings Call Transcript

August 18, 2010 4:00 pm ET

Executives

Tara Dhillon – VP, IR

Steve Gomo – EVP & CFO

Tom Georgens – President & CEO

Analysts

Keith Bachman – Bank of Montreal

Jayson Noland – Robert W. Baird

Richard Gardner – Citigroup

Aaron Rakers – Stifel Nicolaus

Brian Marshall – Gleacher & Company

Louis Miscioscia – Collins Stewart

Amit Daryanani – RBC Capital Markets

Ben Reitzes – Barclays Capital

Jason Ader – William Blair

Katy Huberty – Morgan Stanley

Chris Whitmore – Deutsche Bank

Mark Moskowitz – JPMorgan

Brent Bracelin – Pacific Crest Securities

Jason Maynard – Wells Fargo

Brian Freed – Morgan Keegan

Kevin Hunt – Hapoalim Securities

Alex Kurtz – Merriman & Co.

Paul Mansky – Canaccord

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the NetApp first quarter fiscal year 2011 earnings conference call. My name is Crystal, and I will be your operator for today. At this time, all lines are in listen-only mode. Later, we will conduct a question-and-answer session. (Operator instructions) As a reminder, today’s conference is being recorded for replay purposes.

I would now like to turn the conference over to Ms. Tara Dhillon, Vice President, Investor Relations. Please proceed.

Tara Dhillon

Good afternoon, everyone. Thank you for joining us. With me on today’s call are CEO, Tom Georgens, and our CFO, Steve Gomo. This call is being webcast live and will be available for replay on our Web site 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’ve previously provided during our live call. Our goal is to provide additional time for review of the data prior to beginning the call. This allows us to focus on more strategic commentary and perspectives from our CEO and CFO as well as a longer Q&A period.

As a reminder, during today’s call we’ll make forward-looking statements and projections, including our financial outlook, our expectations regarding future market share, and our beliefs regarding the benefits that our customers will realize from using our products, 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 an 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 Web site, all of which are incorporated by reference into today’s discussion.

These factors include among others that our quarterly operating results may fluctuate for a number of reasons; that competition may increase in our target markets and that our results may be adversely affected by general economic and market conditions, some of which are beyond our control. All numbers mentioned are GAAP unless stated otherwise. To see the reconciling items between non-GAAP and GAAP, refer to the table in our press release, our supplemental commentary, and our Web site.

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

Steve Gomo

Thanks, Tara. Good afternoon everyone. The NetApp team produced the strongest Q1 in our history with non-GAAP operating margins well above our target and with revenue near the high end of our targeted range despite a seven-tenths percentage point sequential currency headwind.

The strength of our business is apparent with revenue growing nicely, robust gross margins, and strong cash performance. For the second quarter in a row NetApp generated product revenue growth of over 50% and despite the decline from Q4, product margins remained strong relative to our historical levels. The rapid growth in product revenues combined with strong product gross margins is a very good indicator of our current competitive position in the market and is very consistent with our market share gain.

The 51% product revenue growth is also a leading indicator for the strength of our business over time because of the maintenance streams that are attached to our product sales. The same product growth eventually drives the growth of the deferred revenue elements on our P&L.

While the overall gross margin remained strong this quarter, non-GAAP product gross margins did decline by just over a point and a half from Q4 level. This was due to the foreign exchange impact of a weaker euro, sales of less originally configured systems and some volume effects on our manufacturing operations.

On the other hand, non-GAAP service gross margin was up by more than 3.5 points as support contract revenues continued to grow faster than support cost. Our non-GAAP operating expenses declined 4% from Q4 as the abnormally high levels of variable and incentive compensation associated with FY’10’s outperformance were reset with the start of the new fiscal year.

That said, expense levels will rise in Q2 as we realize the full quarter effect of the hiring we did in Q1 along with the impact of our annual merit increase, which went into effect at the beginning of Q2. We also plan to continue hiring primarily sales and engineering resources, albeit at a more moderate pace.

Turning to the balance sheet, I would like to point out that our cash and investments increased by nearly $200 million in Q1 despite the cash payment for the Bycast acquisition and the record payout of variable compensation.

The big contributors to the cash balance were the high level of net profit, the reduction in our receivables balance highlighted by our 30-day DSO and an unusually high level of employee stock purchases and stock option exercises.

The combination of stock option exercises and employee stock purchases added $140 million of U.S. cash to the balance sheet this quarter. Those stock option exercises did have the negative results of increasing our share count by approximately 4 million more shares than expected. We don’t expect this level of additional dilution going forward.

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