NTAP

NetApp, Inc. (NTAP)

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NetApp (NTAP)

Q3 2012 Earnings Call

February 15, 2012 5:00 pm ET

Executives

Nicholas R. Noviello - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Thomas Georgens - Chief Executive officer, President and Director

Analysts

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

Maynard J. Um - UBS Investment Bank, Research Division

Shebly Seyrafi - FBN Securities, Inc., Research Division

Deepak Sitaraman - Crédit Suisse AG, Research Division

Brian G. Alexander - Raymond James & Associates, Inc., Research Division

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

Benjamin A. Reitzes - Barclays Capital, Research Division

Amit Daryanani - RBC Capital Markets, LLC, Research Division

Rajesh Ghai - ThinkEquity LLC, Research Division

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

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

Andrew J. Nowinski - Piper Jaffray Companies, Research Division

Jason Ader - William Blair & Company L.L.C., Research Division

Ananda Baruah - Brean Murray, Carret & Co., LLC, Research Division

Brian Marshall - ISI Group Inc., Research Division

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

Glenn Hanus - Needham & Company, LLC, Research Division

Chris Whitmore - Deutsche Bank AG, Research Division

Presentation

Operator

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

Nicholas R. Noviello

Thank you, Tara. Good afternoon, everyone. NetApp delivered a solid quarter with revenue and non-GAAP earnings per share at the midpoint of our guidance range. Our Americas, European and Asia Pacific geographies all showed healthy growth trends, as did most of our major accounts, both on a sequential and year-over-year basis. The only outlier was our U.S. Public Sector, where the typical sequential decline in revenues we see from Q2 to Q3 was exacerbated by lower spending by customers in the defense and intelligence sectors.

Hard disk drive constraints did have a modest dampening impact on revenue in Q3 although within the balance of what we forecasted. We expect constraints and unpredictability of supply for certain types of drives to continue for a few more quarters, so we will maintain a conservative stance with respect to the impact of hard disk drive supply on both our revenue and gross margin forecast for Q4.

Our total OEM revenues grew 6% sequentially, while our NetApp branded revenues grew just under 4% sequentially from Q2. Overall performance was on plan with our expectations despite the dynamics around hard disk drive supply and softer U.S. Public Sector performance. Both software entitlements and maintenance revenue and services revenue resumed their typical growth patterns in the quarter.

Turning now to margin. On our earnings call last quarter, we said we expected to finish Q3 with non-GAAP gross margins around 60% and non-GAAP operating margins around 17%. Actual impact of customer mix, OEM mix and Thailand flooding were all consistent with our forecast. That said, non-GAAP product margins, which reflected these factors came in about $5 million lower than we ultimately expected, in part due to new customer acquisition-related costs. Non-GAAP service gross margins declined 40 basis points sequentially rather than rebounding as we had expected, primarily due to several million dollars in costs we absorbed for replacement parts associated with hardware component supplier quality issues. Our non-GAAP operating expenses increased about 2.7% sequentially in Q3, in line with our expectations. The Q3 non-GAAP tax rate was 17.4%, returning very close to the 17.5% rate we expect to average for FY '12.

Our balance sheet remains strong with approximately $4.9 billion in cash and investments. Total deferred revenue increased by $107 million, almost double the net increase in deferred revenue in Q2. Our accounts receivable days sales outstanding increased modestly to 40 days from 38 days in Q2. Inventory improved to 16.5 turns this quarter. Cash from operations of approximately $269 million declined 24% from the same period last year, in part due to the change in DSO but also a decrease in payables of over $30 million associated with one-time integration activities and transition from legacy E-Series contract manufacturers to our own. Free cash flow finished the quarter at $178 million.

Our diluted share count decreased by about 2 million shares sequentially to about 374 million shares, primarily due to a lower average quarterly share price in Q3. The accounting for the shares associated with our convertible notes and warrants had a modest impact with about 6 million shares associated with the convertible notes included in diluted share count. You may recall that 80% of the convertible notes are hedged. If we were to adjust the share count to reflect the hedge, then non-GAAP EPS would have been about $0.01 higher. You can find the table on our website, which shows the impact on diluted share count for a range of stock prices.

Now looking forward. Our target revenue range for Q4 is $1.645 billion to $1.725 billion, which at the midpoint implies just under 8% sequential growth and 18% year-over-year growth. We expect consolidated non-GAAP gross margins of approximately 59% and non-GAAP operating margins of approximately 17%. We expect our blended consolidated non-GAAP effective tax rate to be approximately 17.5%, bringing our earnings per share estimate to approximately $0.60 to $0.65 per share.

Diluted share count is projected to increase to about 378 million shares in Q4 based on our average stock price of $39.43 for the first 10 days of the quarter. This will include about 8 million shares from the convertible notes. Recall that the favorable impact of the note hedges is not included as an offset. If we were to adjust the share count for the convertible note hedge, that would add about $0.01 to the EPS guidance.

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