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NetApp, Inc. (NTAP)

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NetApp (NTAP)

Q2 2012 Earnings Call

November 16, 2011 5:00 pm ET

Executives

Tara Dhillon - Senior Director of Investor Relations

Steven J. Gomo - Chief Financial Officer, Principal Accounting Officer And Executive Vice President Of Finance

Thomas Georgens - Chief Executive officer, President and Director

Nicholas R. Noviello - Senior Vice President of Finance and Global Controller

Analysts

Richard Gardner - Citigroup Inc, Research Division

Brian Freed - Wunderlich Securities Inc., Research Division

Keith F. Bachman - BMO Capital Markets U.S.

Brent A. Bracelin - Pacific Crest Securities, Inc., Research Division

Kaushik Roy - Merriman Capital, Inc., Research Division

Andrew J. Nowinski - Piper Jaffray Companies, Research Division

Brian Marshall - ISI Group Inc., Research Division

Mark A Moskowitz - JP Morgan Chase & Co, Research Division

Katy Huberty - Morgan Stanley, Research Division

Maynard J. Um - UBS Investment Bank, Research Division

Jayson Noland - Robert W. Baird & Co. Incorporated, Research Division

Aaron C. Rakers - Stifel, Nicolaus & Co., Inc., Research Division

Glenn Hanus - Needham & Company, LLC, Research Division

Bill C. Shope - Goldman Sachs Group Inc., Research Division

Presentation

Operator

Welcome to the NetApp Second Quarter Fiscal Year 2012 Conference Call. My name is John, and I'll be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Ms. Tara Dhillon. Ms. Dhillon, you may begin.

Tara Dhillon

Good afternoon, everyone. Thank you for joining us. With me on today's call are our CEO, Tom Georgens; our CFO, Steve Gomo; and our SVP and Global Controller, Nick Noviello. 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.

As a reminder, during today's call, we will make forward-looking statements and projections, including our financial outlook for Q3 and future operating metrics, the benefits to us and the customers of new product introductions, the adequacy of our future inventory supply, our expectations regarding our future competitive position and the benefits we expect from our partnerships and strategic alliances, 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 include, among others, general macroeconomic and market conditions, particularly the continuing fiscal challenges in the U.S. and Europe; the effects of the flooding in Thailand; customer demand for our products and services, including our recently announced new product introductions; and other equally important factors, which 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 report also on file with the SEC and available on our website, all of which are incorporated by reference into today's discussion.

All numbers discussed today are GAAP unless stated otherwise. To see the reconciling items between non-GAAP and GAAP, you may refer to the table in our press release, our supplemental commentary or on our website.

In a moment, Steve will provide you with some additional color on our financial results. Nick will walk you through our guidance for Q3 of FY '12. And then Tom will walk you through his perspective on the business this quarter.

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

Steven J. Gomo

Thank you, Tara, and good afternoon, everyone. This quarter's financial performance can be characterized by its contrast. In terms of business demand, we continue to see strength across most of our business with the normal puts and takes. For instance, our European enterprise and our Asia/Pac geographies were robust and our E-Series OEM had another stellar quarter. Similarly, our volume channel businesses were very strong and our largest channel partners demonstrated solid growth, where we saw underperformance to our revenue forecast within our major account program.

Our Q2 guidance included an analysis of the business dynamics associated with these large accounts, their seasonality as well as relatively modest expectations for sequential revenue growth from them. Of the 46 accounts in the program, just 9 of the U.S. accounts produced the entire shortfall from the midpoint of our revenue guidance. Nevertheless, despite lower-than-expected revenue, with our non-GAAP operating margin and non-GAAP earnings per share, we're quite strong with non-GAAP EPS above our targeted range and at record level.

Our total OEM revenues were strong this quarter at $230 million, growing 8% sequentially from Q1. NetApp-branded revenues grew 3% sequentially, impacted primarily by softness in those 9 major accounts I just mentioned.

Software entitlements and maintenance revenue and services revenue showed a sequential decline this quarter. In the case of SEM, the revenue decline was a function of a minor perturbation in our deferred revenue schedule. For the services revenue, the sequential decline was due to a Q2 drop in professional services revenue, which tends to be lumpy. The underlying revenue growth trends for both SEM and service maintenance contracts remain intact. Moreover, our deferred revenue balance increased by $56 million sequentially and grew 25% year-over-year. We expect that the absolute revenue level will increase for both of these revenue categories next quarter.

Our non-GAAP product gross margins declined 0.6 percentage points from Q1 levels as the favorable effects of increased volume and configuration mix were more than offset by increased mix of E-Series OEM business, warranty costs and some pricing discounts. Normalizing for mix, these product margins remain within the range of our expectation.

Non-GAAP service gross margin declined 3.2 percentage points sequentially primarily as a result of a loss on a single transaction. We expect the services margin to bounce back next quarter. The underlying service maintenance contract gross margin remains very healthy.

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