NTAP

NetApp, Inc. (NTAP)

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NetApp (NTAP)

F3Q11 Earnings Call

February 16, 2011 5:00 pm ET

Executives

Thomas Georgens - Chief Executive Officer, President, Principal Operating Officer and Director

Steve Gomo - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance

Tara Dhillon - Senior Director of Investor Relations

Analysts

Louis Miscioscia - Collins Stewart LLC

Brian Marshall - Gleacher & Company, Inc.

Maynard Um - UBS Investment Bank

Keith Bachman - BMO Capital Markets U.S.

Benjamin Reitzes - Barclays Capital

Richard Gardner - Citigroup Inc

Amit Daryanani - RBC Capital Markets, LLC

Aaron Rakers - Stifel, Nicolaus & Co., Inc.

Jayson Noland - Robert W. Baird & Co. Incorporated

Shebly Seyrafi - Capstone Investments

Kaushik Roy - Wedbush Securities Inc.

Eric Martinuzzi - Craig-Hallum Capital Group LLC

Chris Whitmore - Deutsche Bank AG

Kathryn Huberty - Morgan Stanley

Mark Moskowitz - JP Morgan Chase & Co

Alex Kurtz - Merriman Curhan Ford & Co.

William Fearnley - Janney Montgomery Scott LLC

Jason Ader - William Blair & Company L.L.C.

Jason Maynard - Wells Fargo Securities, LLC

Bill Shope - Goldman Sachs Group Inc.

Presentation

Operator

Welcome to the NetApp's Third Quarter Fiscal Year 2011 Conference Call. My name is Monica and I'll be your operator for today's call. [Operator Instructions] I will now turn the call over to Tara Dhillon, Vice President, Investor Relations. Ms. Dhillon, you may begin.

Tara Dhillon

Good afternoon, everyone. Thank you for joining us today. 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 earnings release, the supplemental commentary, our financial tables and the non-GAAP to GAAP reconciliation. As a reminder, during today's call, we will make forward-looking statements on projections, including our financial outlook for Q4, our expectations regarding our future market share and the benefits of our recent product introduction, as well as our expectations regarding future hiring, all of which involve risk and uncertainty. Actual results may differ materially from our statements and 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 website, all of which are incorporated by reference into 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, refer to the table in our press release, our supplemental commentary and on our website.

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

Steve Gomo

Thanks, Tara. Good afternoon, everyone. Continuing the trend of recent quarters, NetApp generated very strong business results in Q3, driven primarily by our successful new product launch in November.

Total revenue grew by 25% and product revenue grew by 32% year-over-year. Our total non-GAAP gross margins remain quite strong at 65.5%, demonstrating the competitive strength of our products and non-GAAP operating margins continued new record highs.

Non-GAAP net income grew 46% year-over-year and made a large contribution to free cash flow, which registered a robust 23% of revenue. This quarter, we experienced the fastest uptake of a new product line in our history. Customers converted over to the new FAS3200 platform at a far faster rate than we had projected, significantly exceeding our expectations for the mix between the new and the previous FAS3000 product line. As a result, we are experiencing some material constraints, which we believe delayed the shipment of approximately $10 million to $15 million of revenue.

We have increased our forecast with suppliers several times over the past few months and we are managing the situation closely. Given the steep ramp in demand, certain materials may remain supply constrained in Q4. Despite this operational challenge, product revenue growth was still above 30%.

We are very pleased with our overall growth margins, which ended up slightly stronger than expected. Non-GAAP product gross margins behaved as we have anticipated, finishing just slightly above 60%. The timing of cost reduction and price reduction that we discussed last quarter is now back in balance. Non-GAAP service gross margins finished about one percentage point stronger than anticipated as support renewals were a bit higher than expected.

Non-GAAP operating expenses increased 3% sequentially from Q2 as lower marketing and administrative expenses partially offset the salaries associated with increased headcount and increased variable compensation. We added 415 net new people in Q3 and expect to continue hiring, primarily sales and engineering resources, at slightly higher levels this next quarter.

Cash generation was another highlight this quarter. Despite a slight increase in accounts receivable, DSOs, our strong net profit combined with a large uptick in the growth of deferred revenue on the balance sheet yielded $364 million in cash from operations and $297 million in free cash flow.

As I mentioned earlier, free cash flow finished at a very solid 23% of revenue. This was the primary contributor to the $374 million sequential increase in our cash and investments balance. Cash and investments now stand at $4.8 billion.

Our diluted share count increased 14.5 million shares sequentially to 406 million shares, roughly in line with what we had projected on last quarter's earnings call. The increase was driven primarily by the impact of a higher average quarterly stock price and the accounting for our convertible notes and warrants.

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