NetApp Inc (NTAP) 2012 Q1 法說會逐字稿

Welcome to the NetApp First Quarter Fiscal Year 2012 Conference Call.

My name is Michelle and I will be your Operator for today's call.

At this time, all participants are in a listen-only mode.

We will conduct a question and answer session at the end of the conference.

(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.

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 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'll make forward-looking statements and projections, including our financial outlook for Q2 and future operating metrics, our expectations regarding our future market share, competitive position and new product innovations, the benefits we expect from our partnerships and strategic alliances, our plans for our stock repurchase program and our expectations regarding our recent acquisition of Engenio, all of which involve risk and uncertainty.

Actual results may differ materially from statements and projections.

Factors that could cause actual results to differ include, among others, customer demand for our products and services, our ability to compete effectively, general economic and market conditions, particularly US budget and debt considerations and the continuing fiscal challenges in the Euro zone, and other equally important factors that 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 which of 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 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?

Thank you, Tara.

Good afternoon, everyone.

NetApp achieved mixed results this quarter, after getting off to an extremely strong start during the first 2 months.

Unfortunately, business softened dramatically during the last few weeks of July under the weight of the debt ceiling crisis and macroeconomic uncertainty.

Our growth rate in July ended up at about half of our growth rate in May.

As a result, our revenue came in at the bottom end of our targeted range.

However, non-GAAP EPS was at the midpoint of our target, helped by stronger margins.

As I mentioned at our Analyst Day in June, moving forward we will focus our color commentary on the performance of our total OEM revenues, our total NetApp branded revenues, and our total consolidated revenues.

In some markets, the distinctions between the branded E-Series and branded FAS may blur.

As a result, we will be focusing on optimizing the total branded revenues.

In the case of OEM revenue, a large account, such as IBM, may see a shift in the mix between our FAS offerings and E-Series OEM offerings and some OEM customers may even carry both product families in the future.

Bottom line; we feel that understanding revenues from a branded, OEM, and total perspective is the most useful way to assess our performance.

Our E-Series OEM revenue performance was a bright spot this quarter, coming in well above planned at $157 million in revenue with better than expected product cost performance.

Our consolidated non-GAAP gross margins were also a bright spot, coming in about 0.5 point higher than our expectations, despite slightly softer revenue.

Moreover, non-GAAP product margins were in line with the model we presented at our Analyst Day, despite the larger than forecasted amount of E-Series OEM revenue in the mix.

Remember, E-Series OEM revenue carries a significantly lower gross margin profile than our NetApp branded products.

The strength of our product margins is indicative of the strength of our competitive position.

In addition, the improving product costs and the positive implications it has for the margin synergies we discussed at Analyst Day are beginning to make their way to the earnings statement.

Non-GAAP operating expenses declined more than we had forecast in Q1.

Expenses benefited from better than anticipated operating efficiencies, as well as lower than anticipated costs in several areas of the Engenio integration.

The combination of favorable gross margin performance and operating expense performance drove our operating margins slightly above our expectation.

Our balance sheet remains strong with approximately $4.7 billion in cash and short-term investments as the highlight.

Our accounts receivable day sales outstanding decreased to 37 days from the 47 days reported in Q4, with 90% of the accounts receivable balance in the current category.

The deferred revenue balance increased $68 million sequentially and grew 23% year-over-year.

The effect of the Engenio acquisition is minor for most balance sheet categories, but the largest impacts can be observed on goodwill and other intangibles net and, of course, our cash balance.

As a reminder, we spent $480 million to acquire LSI's Engenio assets.

Relative to typical Q1s, cash generation was very solid this quarter.

Remember, in Q1 the Company always makes the annual payout for our incentive compensation program and the payout for the Q4 commissions.

These 2 large payouts always depress Q1 cash flow performance and this year they drove a $200 million reduction in accrued compensation.

Despite this, cash from operations, at $241 million, increased 36% from the same period last year.

Free cash flow finished the quarter at $142.3 million.

Our diluted share count increased 1.9 million shares sequentially to about 406 million shares.

The average closing price of NetApp shares in Q1 was very similar to Q4, thus the accounting for our convertible notes and warrants had minimal sequential impact.

Approximately 15 million shares are included in the dilutive share count to account for the impact of the notes and another 8 million shares account for the warrants sold as part of the original transaction.

You may recall that 80% of the convertible notes are hedged, while the warrants were not hedged.

If we were to adjust the share count to reflect the bond hedge, then non-GAAP EPS would have been about $0.02 higher.

You can find a table on our website which shows the impact on the diluted share count for a range of stock prices.

Looking forward, our target revenue range for Q2 is $1.5 billion to $1.6 billion, which implies approximately 3% to 10% sequential growth and 20% to 28% year-over-year growth.

Consolidated non-GAAP gross margins are expected to finish at around 63.5%.

We anticipate that non-GAAP operating margins will finish in a tight band around 18.5%, bringing our earnings per share estimate to approximately $0.58 to $0.62 per share.

Dilutive share count is forecasted to decline to about 392 million shares in Q2, based on our average stock price of $43.04 for the first 10 days of the quarter.

This will include about 10 million shares from the convertible notes and 2 million shares from the warrants.

Remember 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.

We do plan to continue our stock repurchase program this quarter.

However, the details of the repurchase have not been finalized.

Therefore, the potential impact is not included in the share count guidance.

We expect our blended consolidated non-GAAP effective tax rate to remain at approximately 18.7% in FY '12, up slightly from our Analyst Day guidance.

This is based upon the distribution of our pre-tax profits between the US and overseas, as well as the expiration of the R&D tax credit in the US.

To summarize, the fundamentals of our business remain solid.

The E-Series OEM program got off to a great start in its first quarter demonstrating the resiliency of this OEM revenue.

Our business model showed its underlying strength as we achieved our operating margin and EPS targets, despite some revenue softness.

In terms of the full year, it's just too early to tell whether we will need to modify the revenue targets we laid out at our Analyst Day.

Our European and Asia-Pac business levels were robust in Q1, so it remains to be seen whether the US levels recover.

It will depend upon whether broader economic stability occurs in the coming months.

Before I turn the call over to Tom, I'd like to take a moment to comment on my upcoming retirement.

It's been a goal of mine to retire by the time I'm 60 and that milestone is just around the corner.

I look forward to spending more time with my family and pursuing a number of personal interests which always took second priority while working full time.

Over the next 4.5 months, my CFO responsibilities will remain the same and I will be working with Nick to ensure a smooth transition as part of our planned succession.

Nick has made tremendous contributions to the organization during his tenure and I have the utmost confidence in his abilities.

You will be in great hands come the first of 2012.

At this point, I'll turn the call over to Tom for his thoughts.

Tom?

Thanks, Steve.

Good afternoon, everyone.

Before I begin, I'd like to take a moment to recognize Steve for his tremendous contributions and strategic counsel over the past 9 years and also, to congratulate Nick on his promotion.

Both are well-deserved.

But Steve has not retired yet and I do not expect improvements in his golf game until next year.

Turning now to the business, as Steve described, we exited Q4 with strong momentum and it continued into Q1.

Even without the new E-Series products, the combination of April and May were the strongest consecutive bookings growth quarters in a year.

We entered the month of July with forecasts and results well ahead of our expectations, despite the geographical balance being uneven.

APAC and EMEA bookings were especially strong.

America's commercial was on track, but US Federal was behind.

Over the course of July, the international business remained strong, but the federal business struggled to catch up with the backdrop of the debt ceiling dispute.

However, July also brought some weakness in our business in the US, particularly in the financial services sector.

We have 23 US firms in our major accounts program.

6 of them are in financial services.

All 6 of them saw bookings declines from Q1 of last year.

Despite the weakness in US Federal and financial services, we did see strength in other parts of the Americas with very strong growth in our state, local and higher education group, our telco and service provider group and in the channel.

We also had our second highest ever storage 5,000 new customer acquisition quarter.

Although anti-climactic, Q1 actually ended up as the third consecutive quarter of increasing year-over-year bookings growth in the organic NetApp business.

However, the trajectory weakened as the last month was roughly half the growth rate of the first, causing us to come in lower than where we had anticipated.

Economic conditions remain uncertain, but they are clearly different than they were 90 days ago.

It is in the context of the July and early August business climate that we base our Q2 guidance.

Despite some sector weakness in our core business, we are pleased with the initial quarter of our new E-Series.

Operationally, we booked and shipped product on the day the deal closed and transition costs were lower than expected, while product cost performance was better than expected.

We closed our first full-motion video deal, a deal we did not win quest our FAS product, and last week, we closed a nearly $14 million branded E-Series deal in the high performance computing space.

We are still learning the monthly cadence of the OEM side of the business, but it finished ahead of our overall expectations.

It also included a new product release from one of our larger partners and a commitment from Oracle to continue the OEM relationship.

Overall, with our first quarter of business behind us, the internal execution, as well as the health of both the OEM and branded E-Series businesses, are positive.

Our channels to market continue to serve as a source of strength and a differentiator for NetApp in both FAS and E-Series.

We believe we have the most diversified go-to-market motion in the industry and the best relationships with our partners of all the major storage vendors.

Our indirect channels grew to 76% of revenue, assisted by the inclusion of the E-Series OEM.

Keep in mind that the addition of E-Series does change the mix analysis somewhat for several facets of the business including channels, geographies and disc drive capacity trends.

Arrow and Avnet contributed 26% of our total revenue, up 21% year-over-year.

Total OEM contribution was 15% of total revenue in Q1.

This includes E-Series OEM and the prior OEM sales with IBM and Fujitsu.

In addition to our channel development, our partnerships and alliances continue to grow and deepen.

We now have active co-development programs going on with Microsoft, VMware and Oracle.

This quarter, we nearly doubled the number of our FlexPod customers to over 300.

FlexPod is a suite of tightly integrated modular and validated solutions, often in collaboration with Cisco, VMware, Microsoft, Citrix and SAP.

We are seeing a notable up trend in FlexPod average deal sizes in the Americas accounts and a number of installations around the world continues to grow.

We believe the innovation stacks built around NetApp's offerings provides customers the largest portfolio of best-of-breed solutions of any of our server or storage competitors.

On the product side, gross margins remain strong in all areas; an indication that, despite market headwinds, our competitive position and the value proposition remain intact.

The growth of our new product platforms continues to be incredibly robust and has contributed to the margin strength.

Our 6000 series delivered record high revenues and a record number of units shipped this quarter.

Our 3000 series was also very strong, contributing over half of all FAS platform revenue with volume of units shipped second only to last quarter's record level.

Our 2000 series saw a decline from both last quarter and the year-ago quarter.

We believe this is due in part to migration to the low end of the newer 3000 family, as well as a drop in the public sector business this quarter, with units of the 2000 series shipped to the Federal Government down over 30% from a year ago.

However, the volume-oriented demand remained strong as evidenced by the growth of our distribution partners and our general territory business.

Lastly, our V-Series continues to be solid, especially as a vehicle to enter new accounts, with growth of over 30% year-over-year.

We remain confident in our competitive products and our positioning in the market.

We see strong differentiation and customer interest in our storage efficiency offerings, our ability to enable end users to re-architect their data centers to maximum the use of virtualization in the private cloud.

And our ability to allow them to optimize their environments using our unique tiering approach that offers superior price performance, reduced complexity and limited administration overhead.

The new E-Series platforms open new workloads in big bandwidth and analytics and we'll continue to see new innovation brought to market including Data ONTAP 8.1 as the year progresses.

Overall, the July slowdown notwithstanding, the business performance has been strong.

The June IDC numbers showed us gaining 2.7 points of share in the first calendar quarter of 2011; the biggest gain in our history.

We have had 9 months of accelerating bookings performance in the organic NetApp business.

We had our second highest level of new Storage 5000 customer acquisitions in Q1 and the number $1 million deals was up substantially over Q1 of last year.

Despite the very positive indicators of our market momentum, the sector weaknesses of July made the internal goals we set for ourselves unattainable.

Looking ahead, the environment remains unsettled and macroeconomic forecasting is beyond our scope.

Internally, our approach is essentially unchanged and our focus remains on continued market share gains.

In the last downturn, following the financial crisis, we found economic pressures forcing customers to consider new options.

With our competitors' incumbency weakened and with our compelling innovation to help customers, we achieved record new customer acquisitions creating a more diversified customer set and positioned us for best in class growth when the market improved.

While due caution is influencing our guidance, we are still innovating on our road map, doubling down on our areas of strength to enable us to continue to gain share and position the Company for continued growth in the future.

At this point, I will open up the floor to questions.

As always, we ask that you please limit yourself to 1 so we may address as many people as possible during our remaining time.

Thank you.

Operator?

(Operator Instructions) Aaron Rakers, Stifel Nicolaus.

Yes.

Thanks for taking the question, guys.

Just to dig in a little bit of what you saw in July, and maybe what you're seeing at this point in August, can you update us there?

Just so I understand, are you pulling the full year guidance off the table given, Tom, your comment there at the end?

The answer is no to your second part of the question.

I think, at this point in time, that the trajectory of the full-year guidance is going to be a function of the macro and I don't think that's what we're going to predict.

When I think about the guidance we gave, the EPS was already in line, so we're certainly not off our EPS trajectory, certainly not after one quarter.

The revenue is certainly a little bit behind, but if we have some reasonable health in the market, I'm more of the belief that we can close the gap.

The July thing was obviously surprising, as you could well imagine.

We just came off Analyst Day.

So the last thing we'd have done is if we didn't believe what we were saying, it would be hard to pull off Analyst Day.

But we were in good shape.

We exploded out.

April, we closed last quarter exceptionally strong.

I think we were very pleased with how last quarter ended.

May was very strong so we came out of the chute.

So there was no evidence that we had drained the swamp or we had no business to carry into this year and June was strong, so we were rolling.

We were ahead on the results.

We were ahead on the forecast and we felt really, really good about where we were.

But the combination of April and May was the best 60 day period we had in the whole year.

For us, I think we felt pretty good.

Now what we did know at the time was that we were a little uneven.

The Federal business was clearly lagging and we saw that.

But we were overpowering it on the strength of basically the Asia-Pac and the EMEA business.

The feeling was that, we didn't necessarily have to hit on all 4 cylinders to get there and we have a lot of confidence in the federal team.

We thought that they might be able to close the gap in the quarter as the quarter progressed, but it turned out to be more of a struggle.

I don't know whether debt ceiling was a factor or not.

Probably safe to assume it didn't help us any, but what we didn't expect is the US side of the house weakened as the quarter wore on as well and financial services, in particular.

I wouldn't go so far as to say they were the only one.

But I'd say if you look at our other businesses, we have accounts that were up, accounts that were down, but financial services, the fact that all 6 of them in our major accounts program was down is an indication that something is going on there that I don't think is specific to NetApp.

It's probably the big wrinkle is the federal team, which as you follow our performance, is dramatically outperforming the industry, they thought they could close the gap.

It turned out they couldn't, but I think the US surprise was the other one.

While, on the other hand, the international business remained strong and the other thing I'd say is across the US, it wasn't all weak.

Our state and local was strong.

Our telcoms were strong.

Our channel was strong.

Our new customer acquisition was strong.

It was really, really around large accounts that are specifically financial services.

Richard Gardner, Citigroup.

Great.

Thank you.

Just to follow up on that question, Tom, you spent a lot of time on competitive metrics.

Can you just give us your sense of whether your win rates in the marketplace have changed at all since EMC started ramping up VNX in the mid-range?

Do you feel like this is 100% a market issue or do you have any reservations at all that this might be partly a competitive issue?

Thank you.

Clearly that's a fair question on your behalf and also internally to the Company, particularly when we come up a little bit short on revenue.

I think it's fair and I think the answer to that we'd probably ask is, first and foremost, we need to look inside first.

The numbers certainly correspond to weakness that certainly other people are reporting, so it's very plausible that would make sense, but I think we need to investigate ourselves.

First and foremost the high level bet is, whether it be EMC or HP or IBM or Dell with new offerings, I think it was too sudden and too concentrated to think it was suddenly a competitive issue.

On top of that, on the Federal side, that's an area where we're very, very strong and none of those guys were reporting competitive losses.

If you go beyond that, I think that the margins were strong.

So there wasn't any indication that we're seeing margin degradation.

I think the proximate cause of the shortfall in revenue, relative to our plan, I don't believe was competitive.

I think the question that we are evaluating is, while it might not have been the proximate cause of the revenue shortfall, are these various different products nibbling at us around the edges?

Where that becomes relevant is we need to make an assessment as to whether we think Federal and the Americas are going to bounce back quickly.

If we're going to double down in some other area, then clearly understanding the dynamics of those other sectors of the market matter to us.

But I think from a purely competitive perspective, I'd say just the nature of it, the timing, the specificity of it, the fact that it's a handful of accounts, we have a lot of intelligence into those accounts.

I don't think it's competitive.

Could there be nibbling around the edges for the rest of the business that chopped off a little of our upside?

Perhaps and that's what we're looking at.

Jason Ader, William Blair.

Thank you.

I want to just delve into the Federal, because you guys are certainly not alone there.

Pretty much every Company is talking about it.

My question to you is why wouldn't -- September is coming up, end of the fiscal year.

If these agencies have the budget, which I think it's already been allocated, because of the budget process, why wouldn't they spend it?

Why wouldn't you be more confident that the October quarter will see a significant change in terms of your Federal trajectory?

To some extent that is baked into part of our guidance.

I think the question that nobody's going to know the answer to until October 1 is where are they?

Federal spending is reportedly behind.

We hear different schools of thought.

One of them is that austerity is coming and they're going to spend every cent they possibly have now and there's another school of thought that says austerity is coming and they want to conserve cash now.

So, we'll see what happens.

I think the debt ceiling dynamic was a little bit different because they were facing this arbitrary deadline of August 2 and cash hoarding to extend that deadline, I think might have been in play.

But I don't want to dwell too much on that and speculate.

The bottom line here is I think there's a few moving parts on the government.

I think we took our best shot.

Certainly, we're anticipating that our US public sector will be up significantly from this quarter, as it typically is.

But the dynamic of that business, and this year is no different, is that a substantial amount of the budget is still not allocated to individual projects until the end.

A fair amount of the activity in that business has positioned themselves in the event money becomes available.

So there's really 2 questions.

One of them is how much money will be available and what projects will it fund?

Correlated to that, in what agencies?

And that will determine whether we're successful or not.

So, what do I think?

I think the government being the government, they'll find a way to spend all their money.

It will probably be a last minute thing, but I can't predict which agencies will get what funding.

Brian Marshall, Gleacher & Company.

Thanks, guys.

A follow-up on that question, with respect to what's implied for the guidance for the quarter, you talked about US public being up significantly.

Can you talk about your expectations for both EMEA, as well as financial services?

EMEA, obviously, being that it's kind of mixed out there globally, it seems like you guys are doing well, roughly 30% of sales.

Can you talk about what you're embedded in your guidance for that in addition to financial services, obviously, perhaps 10% to 15% of total revenue?

Thanks.

Yes.

From our guidance point of view, our financial services is kind of buried into a broader Americas number.

As the team rolls up from the field and we're looking at bookings forecasts and things of the like, that's kind of buried in there and factored in.

We don't do specific vertical forecasts, certainly, I don't.

As far as EMEA, we'll see.

I think EMEA was remarkably strong.

One of the things about -- we didn't go through it in the script is, sometimes there's a little bit of a spread between the bookings performance and the reported revenue performance and the revenue is kind of mixed up now between the 2 businesses, but the EMEA booking performance was really strong.

Even if you adjust out the currency effects, we're very, very pleased with what happened in EMEA and really across all the territories, including the mature ones, the UK, France and Germany.

I think we're anticipating continued strength.

We just did that in a quarter where certainly the German GDP growth was not that impressive, yet we still had a pretty good quarter.

My general sense of the business is, yes, we have these backdrops, but I expect to overachieve against the backdrops.

We've been doing it for the last year and if Europe's weak, obviously, that's not going to make it easier for us, but I expect us to do better than most.

Shebly Seyrafi, FBN Securities.

Yes.

Thank you.

If you could crack the $157 million in E-Series OEM revenue, then looks like your core NetApp business grew no more than 13% year-to-year.

I'm wondering why you're not cutting back your projection for like -- I think it was 18% core growth this year?

What kind of catalysts do you see ahead?

Is it simply a rebound in the Federal segment?

Is it ONTAP 8.1?

Is it a low end refresh?

What do you see that causes you not to pull in your forecast right now?

We're talking about roughly a $6.7 billion number and we're talking about being $50 million behind after 1 quarter.

It doesn't take much of a move in a favorable direction to get us in pretty good shape.

So I think we're a long way away from that.

Now I think, right now, trying to extrapolate $50 million, the macro is going to have a bigger lever on driving that one way or the other.

The other part of it is the deferred revenue coming off the balance sheet that we built in prior years is going to get stronger as the year goes on, so I think we have that buffeting the business.

Our business doesn't hinge quarter-to-quarter purely on bookings.

We also have some underlying -- it's roughly one-third to 40% of our overall revenue is actually coming off the balance sheet.

That gives us some stability, both on the revenue side and on the margin side, frankly.

But I think going forward, one thing that was -- we were in really good shape midway through the quarter and one of our geographies we're behind.

I don't think that we need to execute the perfection to get to that number.

I just think that we need to see some rebound either a little bit in both of the 2 that under-performed or one of them coming completely back.

As far as the full year, it's way too early to tell.

Even if the climate got no better than it is today, that $50 million plus the guidance that we built in this quarter is recoverable as the year wears on.

(multiple speakers)

Amit Daryanani, RBC Capital Markets.

It just makes me want to understand, given the concerns of a softer macro going forward, is there any plan to look to constrain OpEx and probably freeze hiring for the rest of the year?

How should we think about head count in OpEx numbers over the next few quarters?

The answer is no.

We're executing our strategy.

Last quarter, since it was so late at the end of the quarter there was no time to do that, but we substantially haven't changed things any this quarter either.

We are still hiring.

We're still pushing ahead and the gross margins are ahead of plan.

Some of the efficiencies and some in the transaction we just did is ahead of plan.

If EPS is still on plan, I don't see any reason to change anything and our guidance reflects that.

So, I see no reason to panic.

Yes, we had a couple slow downs in a couple sectors.

It deteriorates from here, clearly we'll change direction.

I think if there's one thing we proved in the last downturn, where we actually got back to our operating plan in one quarter, is that if we put the brakes on, we can put the brakes on hard, but we're not doing that now.

There's way too many pockets where we are outperforming and gaining share and as long as that's the case, we're going to invest in them.

Now, if it looks like the government and financial services or even some other sectors of the US is protracted, we may realign resources, but we are in no means constraining OpEx.

Clearly, we're trying to protect our guidance and we're trying to protect the guidance we gave for the year as well on the EPS side, but we're certainly not in panic mode.

I don't see any business distress here.

We're going through some tough sector weaknesses and we're going to ride through it and we're going to monitor it closely.

Brian Freed, Wunderlich Securities.

Thank you.

Good afternoon.

As you look back at the past, you guys were somewhat of a canary in the coal mine going into the 2008/2009 recession, one of the first storage vendors to really see a lot of weakness.

Can you kind of compare and contrast what you saw then versus what you're seeing right now?

I'm trying to envision whether we want to be the canary in the coal mine or not.

I'd love to think that this is just a flash in the pan and we're back to normal soon.

I would say what was different last time was that the symptom that we saw then was lots of deals that were being struck that we'd win technical evaluations and then it was difficult to get transactions signed.

And while we're starting to see some of that, it's not as widespread as it was last time.

That's what I would say is the biggest difference is that we still did a fair number of large transactions.

They were just harder to close in some industries than others and then you have this big government overhang, which is completely different.

So if you took the fed piece out, I think the story would look a lot different.

I don't feel like we're on the trajectory that we were in a couple years back.

It may feel that way 90 days from now, but it doesn't yet feel that way today.

In fact, this government thing, I don't know how much the political overhang is a factor here and we'll just see what happens, but right now, I think we're just going to assume that the current environment's going to stay roughly at this level going forward and we'll see where it goes from there.

But right now, it still seems to be a little bit localized and it'll either heal itself or it'll get worse and right now we're just going to assume steady state.

Deepak Sitaraman, Credit Suisse.

Great, thanks.

Tom, if I could just ask one more on the guidance.

To the extent your full year guidance is still valid, the implied half over half revenue growth rate is quite a bit higher than what we've seen over the last several years.

My question is, what level of visibility or confidence do you have beyond the second quarter?

Are you expecting strength in Asia-Pacific and EMEA to offset any potential weakness on the Federal or the US public side or do you just not know at this point?

One of the things that we have in our favor is the deferreds again.

Last year we went through a whole year where the deferreds were basically flat all year, so we had roughly 0.33 to 40% of our revenue generating no growth and we just overpowered that with extremely strong product growth.

This year, those deferreds that we put on the balance sheet during those growth periods are actually going to start to create growth for us, so we'll actually see roughly 20% growth in the deferreds as the year wears on.

So from that perspective, I think we have that base to build on.

If you think about it in terms of what's the incremental year-over-year product growth its going to achieve in numbers, it's not quite as intimidating.

Maynard Um, UBS.

Hi.

Thanks.

I just wanted to get a question on your comment that you'd focus on continued market share gains.

I'm just wondering how we should think about that comment?

In fiscal '09 you had revenues up on a year-over-year basis, but that was pretty much offset by gross margin declines and OpEx increases.

Obviously, you said it was harder to close deals back then in the last downturn because of technical evaluations, et cetera.

But I'm just wondering if we were to go into another downturn, which seems to be the fear, how we should think about that comment in particular relative to the business model?

And where you would put the brakes on the spend?

Is it geographical expansion, R&D and sales?

What part of your costs are variable?

Thanks.

I think we have a number of variable costs, not the least of which is our hiring plan.

But right now, that's kind of a hypothetical conversation.

That's not really what's dominating our thought process at this point in time.

As I think about market share gains, clearly that's going to be in the context of an overall adequate P&L performance and we're certainly not going to chase market share gains all the way into a loss position.

And frankly, several years ago, we didn't do that.

In fact, once it was clear that market share gains weren't there to be had and the industry was in distress, we actually reduced OpEx and did one of the few painful layoffs in our history.

It's market share at any price.

I just think that we're in a situation where the revenue is a little weak.

On the other hand, our earnings were right there.

Our gross margins are strong.

It doesn't appear that we're losing competitive position.

There were certain geographies where we were exceptionally strong.

Right now I think what we're probably spending a little bit more time on is, which of these areas are going to come back, which ones do we think are going to come back or do we let those go for a little while, maintain investment and reinvest in other areas where we have some strength?

I think our aspiration, is unless the market deteriorates substantially from where we are today, our goal is to get back to our guidance and even if we have to make it up in other areas.

So, that's really where we are.

Make no mistake, if the market deteriorates and we're dropping and there just isn't business to be had, we're going to protect the P&L and at the very least, try and protect the EPS guidance we gave.

But beyond that, as long as we're in the range, we're going to try find ways to eke out growth out of this environment wherever the opportunity lies.

Jason Maynard, Wells Fargo.

Good afternoon, guys.

I just wanted to follow up, maybe on that last comment then about protecting the P&L, is there a hypothetical operating margin target that you have in mind that you feel like you have to hit?

One of the things that I believe differentiated you in the last downturn is that you did still make ongoing investments in light of the economic challenges.

How do you balance that out as you think about the various scenarios that could play out over the next 6 months?

I have no magic number.

I think that the first thing that we would probably try and do is protect the EPS guidance we gave and I think that's where we want to be and I think we have a fair amount of investment leverage and still be able to do that even if the market doesn't materially improve from here.

A couple years ago, we did a few things, some of which I think were probably obvious to the outside world looking at the P&L, but some of them were very specific internally.

That is, we had a very clear message to the team and that is, there's a lot of initiatives we want to pursue, but the spending levels are flat.

So in context of a flat investment environment, how are we going to fund these initiatives.

We put a pretty big effort on what are the low-yield activities that we have underway that we're going to shed so we can move the stuff to things that matter going forward?

I think we did that and out of that, we shed some product lines and it was painful.

I think we [crisped] up our marketing message.

I think we did a bunch of things that served us well.

I think that, even under the covers, of an investment is that realigning the investments, whether it's realigning them geographically to take advantage of market opportunities, whether it's product side, but as far as an ultimate threshold, I would say it depends on what we see happening.

If we think it's competitive, we might do one thing.

If we think it's a regional slowdown, we might do something else, but I don't really want to commit to that number.

Our focus is going to be on EPS and clearly, we want to protect the EPS guidance that we just gave.

The other thing that I think is somewhat in our back pocket, which will play out a little at a time, I think is synergies from the acquisition we just did.

I think we're seeing probably the near term supply line synergy of just basically our buying power coming into play.

I think as time goes on, we'll basically bring them into our manufacturing fold and get leverage there, as opposed to having split manufacturing like we do today.

I think in the longer run there's obviously some engineering synergies around common components.

I think that there's Engenio leverage, over time, that will play out and we also have some transition services underway with them.

We did not buy an operating business.

We just bought assets, so there's still some dependency on our side that we'll try and wind down over time.

I think there's a number of sources of synergies and reprioritization even before we think about increasing the OpEx envelope.

Bill Shope, Goldman Sachs.

I have a question on pricing and I recognize that when this question's been asked in the past, the answer is that it's always competitive and the dynamic hasn't changed that dramatically over the past several years.

But did you see any signs that pricing seemed to get more competitive as demand came under pressure in July?

Do you think that's a risk, particularly since it seems like you believe this weakness is impacting all vendors in the industry?

And how should we think about that risk going forward in light of your margin goals and whatnot?

I think that's a question of how widespread this becomes.

In the Federal accounts, I don't think they were standing across the table saying you guys are too expensive, if you guys were cheaper, we would buy.

I think they were saying we don't have any money and we're not going to buy anything.

If it becomes more widespread, then you have the inevitable issue of too much worldwide sales capacity chasing too many deals and limited opportunities and people can't afford to lose any and as a result, pricing becomes very competitive.

I wouldn't rule that we'll see some of that on the financial services side if this continues, but I'd say that in general, we're not in that state on a worldwide basis yet.

I'm not anticipating any significant pressure from the margin side other than what we normally see.

Bill, this is Steve, here.

It's interesting that -- I took a look at that myself and we actually saw lower discounting this past quarter than we did in the prior quarter and it's noticeable and it had a slight impact on the product gross margins.

That's one of the reasons why the product gross margins are stronger.

If it is getting more competitive, we haven't seen it yet.

I would characterize it the same way I have over the past several years, Bill, is that it is a tough market out there.

It is very competitive all the time and people will do something to get a footprint in a particular installation or customer site.

But at the end of the day, I don't think this quarter we saw anything to give us any indication the competitive situation has changed.

Ben Reitzes, Barclays.

Yes, Thanks a lot.

With Engenio doing better than expected in the quarter, can you talk about your expectations for the year?

Are they still the same at [$750 million] and $150 million for NetApp branded and for the accretion as well?

What is the expectation for accretion for the year?

Also, your expectations in the 2Q for Engenio, that would be great to hear that, too.

At this point, we're just trying to develop an intuition for the business.

Even the question of, did we see the same July effect in the Engenio business as we saw in the rest of the business, is still something that we're trying to sort out.

One of the things that's a little bit different dynamic is the big customers in that business have quarter ends that don't line up with ours.

At this point, I think we're just trying to build up our own intelligence around the business and what the seasonality is going to be.

So I don't think we want to tip the numbers up or down.

I think we're very pleased how we came out of the chute.

I'd say probably from a pure accretion perspective, I think we're ahead of where we are.

There's still opportunities on the cost side as time goes on, as well.

So, so far, so good.

Even if the core business was strong, I don't think that we'd be changing our expectations for the new E-Series business just yet.

In terms of in the market, the OEMs continue.

Terra data was very, very strong, IBM is continuing.

We had good conversations with Oracle this quarter amid all the noise and we have commitments from them that this business will continue unchanged.

On the branded side, the enthusiasm is very high.

There's nothing like a $14 million deal to get people's attention.

But even beyond that, the amount of activity, the ability to getting all that stuff through our systems and parts numbers because we're shipping the branded stuff out of our systems, not through LSI's, has been a little slow.

That's probably the only execution issue concern I'd have.

But the enthusiasm for the field, the amount of bids that are out there, the amount of opportunities being pursued, the OEM business appears to be on track.

It's not on spectacular, but the branded side has a lot of activity and I'm still very optimistic about that.

Lou Miscioscia, Collins Stewart.

Maybe if you could talk about Europe a little bit more, give us maybe the constant currency growth number that you had there, what kind of demand trends that you're seeing?

Obviously, the number looks good, but does it seem like that's going to continue as we finish out the year given some of the problems they've had over there?

Okay, Lou, this is Steve.

I'll start the answer.

Yes, we were very, very pleased with Europe in terms of the demand we saw over there.

As Tom mentioned earlier, it was spread across the larger geographies, which was also good news from our perspective.

If you look at the constant currency type of demand growth we saw, it was probably on the order of 25% and, in fact, currency adjustment was much higher than that.

Europe had a very, very good first quarter, that's all there is to it.

We read the papers every day like everybody else and it looks like there's storm clouds brewing over there, but nonetheless, right now they're still bullish on their opportunities and they're winning their fair share of business.

Yes.

I think we said before that Southern Europe is not material to our European number at this point.

From a risk perspective, I think it's small.

The other message that I'm always quick to point out to the team is that when you have no market share, the macro economy doesn't matter.

I think in a lot of those geographies, we don't really have a strong presence that we're building up.

We grew in all of those, in fact, but even if they disappeared tomorrow it wouldn't be material, although we're clearly getting bigger and bigger as each quarter goes by.

But the general European trend -- the German GDP numbers that were reported this week were a bit of a surprise to me because in general, I kind of felt over the last year, the Germans in particular, were remarkably bullish.

In light of everything else that was going on, they were enormously confident.

And I'm not just talking about our sales guys, I'm talking about the customers themselves.

We'll see if that confidence is shaken, but in the midst of this relatively low GDP quarter, they still bought a lot of stuff and they still showed a lot of confidence.

It's just like anything else.

As long as we're winning and gaining share, we're going to continue to invest.

The papers are interesting, but until they affect our business, we're not going to do anything different.

Katy Huberty, Morgan Stanley.

Steve, congrats on the retirement.

Last quarter, you mentioned that the Company's APAC exposure needs to increase and that did happen in the July quarter.

Can you talk about whether that's a function of a formal initiative you've put in place and we should continue to see that percentage of revenues coming from APAC grow or were there some big deals impacting the quarter?

In terms of the growth numbers and the percentage of revenue associated with APAC, part of that is related to the new business that we acquired.

So that adds to the APAC number because a number of them have manufacturing facilities out there on the OEM side.

But, that said, on the core business side it was very, very strong and even Japan had double-digit growth and all the other geographies did better.

The key thing there, not surprisingly, is really leadership.

We've replaced a lot of our leaders in a lot of these geographies.

A lot of them have been in place now for a year to a year and a half and we're seeing the impact.

Asia-Pac had a very, very good booking year last year.

They had a very, very good first quarter.

So I think we're just plain executing better.

Now, that said, as a percentage of our revenue, it still needs to be higher.

That means, by definition, we're underpenetrated in a number of geographies, so we need to keep doing better.

But overall I think that, as a Company, I've got more confidence in the Asia-Pac team than at any time in my tenure at NetApp.

Ananda Baruah, Brean Murray.

Steve, congrats as well.

Just a question about the buyback that you alluded to in your earlier comments.

To what extent might that be response to what the stock did today and seemingly doing in the aftermarket and philosophically, how opportunistic might you be willing to be?

Any context you can give us there would be great.

Thanks.

Sure.

Those are fair questions.

For what it's worth, that part of the script was written before today's performance.

Basically, we told you that we had the authorization from the Board last quarter when we did the buyback, how much the authorization is and how much is left.

We told you we would probably continue it at that point.

Now we're affirming that we're going to continue it.

We haven't decided on an amount, the timing.

We obviously don't know the share price yet, but there's not a lot of other details I can give you.

But indeed, it's better to buy stock when it's down as opposed to up.

So, it looks like it could be a good opportunity right now.

Mark Moskowitz, JPMorgan.

More of a technology question, Tom, I just want to get a sense what you're seeing from customer interest in term of ONTAP [E.1].

What type of benefits can you maybe characterize for us that could attract customers or retain customer interest if the macro issues worsen?

Are there certain [goodies] or cost savings with ONTAP 8.1 that could really preserve your relevance in data center optimization?

Yes.

I think the essence of 8.1 is it's the first time we're going to broadly marry our enterprise data management software suite with clustering to basically bring that in scale.

And that has got implications in many dimensions including, obviously, the obvious ones on the purely performance side and the scalability side and content repository side.

But the thing that's especially unique about it is that we bring the data management suite that we're bringing to enterprise customers in traditional business apps and we're marrying that with true scale and true clustering and it's really going to be the only platform of its type that's targeted at the enterprise customer.

So it's really a modernization of storage for the enterprise customer.

Most of the enterprise applications are still running on architectures that are 15 or 20 years old, so that is really the big push on this.

It will spill over into high performance computing.

It will spill over into technical computing and a lot of the scalability boundary limits and things like that will be relaxed, so it will make these easier to manage.

A value proposition, I think, is clearly the ability to bring our broader value proposition to a greater set of customers and a greater set of applications.

For existing customers, obviously the manageability and the scalability and the performance and the ability to manage storage as a pool as opposed to an individual box.

I think it will have tremendous advantages from a complexity perspective, a performance perspective and really the ability to build a virtualized infrastructure, the ability to build a broad storage pool to serve a big server forum that's capable of running multiple apps at the same time and manage security, manage performance, manage capacity, manage cost.

From that perspective, I think that's a generic value proposition whether the industry is up or the industry is down.

I think what it will do is it'll broaden the applicability of our storage efficiency technologies, our de-duplication for primary, which we're still the only player to do that broadly, the thin provisioning, the use of ATA drives.

What we'll be able to do is bring that storage value proposition, which I think will be particularly relevant in a downturn, it certainly was last time.

The storage efficiency messaging really helped us a lot as economically (multiple speakers) were depressed.

So, overall, my view is what it'll do is it'll broaden the applicability of those things that do have value in a downturn, which is primarily storage efficiency, but it will also open up new sets of customers and new sets of apps to us that perhaps were somewhat concerned about our scalability in the past.

Is there anything specific about a downturn that would make this particularly applicable?

No.

Just the ability to deploy storage efficiency more broadly.

But absent that, I think this is a fundamentally different approach to enterprise storage and it's going to be a big departure from what customers have and really deliver what I think is unquestionably the biggest software feature set in the industry and bring that to enterprise apps in scale.

Keith Bachman, Bank of Montreal.

Hi, thank you.

Tom, I wanted to get the customer sets that have slowed, which is Federal government and financial services, is the characterization that they've shelved the deals or are they still in discussion or don't know?

I'm just trying to understand if they pulled or tabled.

And then related to that, when I look at your guidance for this upcoming quarter it's a fairly wide range of say 3% to 10%, but if you pick the midpoint, in the last 2 years you've grown 8% and 9% sequentially, so it's in that same neighborhood.

My question is have you left yourself enough room here, because it seems like implicitly you're assuming that the weak areas of Federal and financial grow at normal seasonal trends and I'm just trying to reconcile that with your comments on uncertainty surrounding their current demand trends.

The other thing that we didn't have last year is that we have the deferreds growing at a reasonable date that we didn't have a year ago and that will clearly help us on this particular dimension.

As far as deals being shelved or whatever, I'd say more so on the Federal side than on the commercial side, including financial services.

I don't think that any of them have suddenly sat down and re-architected and recrafted their budgets for the entire year and everybody has new budgets.

I think people are operating under the old rules and basically spending is being modulated at high levels when these things have to be signed off.

I'd say on the Federal side, clearly projects have been deferred.

I'd say on the US side and particularly the financial services sector, I think those are still in the delayed and if things look a little better, we'll approve them type of mode.

Chris Whitmore, Deutsche Bank.

Thanks very much.

To follow up on Keith's question, wanted to ask about impacts of product cycles on customer spends.

In other words, do you think you're seeing a pause in front of [Romley] or a pause for evaluation of ONTAP 8.1, et cetera, that's contributing to the pullback or do you think this is purely macro?

On the server side, I don't think that the Intel refreshes have that big of an impact on our business.

In some ways, you could argue it would be the opposite.

If they think they have a big server spend coming up, they might spend less on storage, I don't really know.

But I've never really seen a correlation there.

ONTAP 8 -- what's interesting about our business is that the customer behavior is actually more driven by platform refreshes than they are software refreshes.

The thing about 8.1 is it's going to run on the platforms that we currently ship.

So if they make an investment in the platform today and then make an upgrade to 8.1, it isn't like the equipment is obsolete.

So from that perspective, I'm not expecting that there's a big waiting for 8.1 to come along.

I just don't see that.

If 8.1 only ran on a new platform that only ran 8.1, then it would be a little different, but I just don't think that's the case.

The server thing I think is somewhat irrelevant, but what I do think though, is that the demand tends to flow towards the newer platforms and I think we see that with the 3000.

We see that with the 6000.

The 6000 just blew it out and I think that some of that is people might be buying a new 6000 instead of a couple of 3000s to get in on the new technology at the high end and I think some of that's happened with the 2000.

They'll buy a 3000 instead of a couple of 2000s.

And then the public sector business hit.

If you look at our 2000 family, it kind of goes into a few categories.

There's some that goes into the big accounts for like branch office type of things and that was kind of mediocre.

There's the channel business, which mostly goes to mid-size enterprise and small businesses, state and local governments, that was actually strong, and then there was the public sector use which could be anything from ships to cars to boats to planes to whatever and that was very weak and that was the big mover on the platforms this quarter.

I will now turn the call over to the host for any final remarks.

Thank you all for joining us today.

We will announce our next quarter's earnings results on November 16.

In the meantime, we look forward to talking to you -- to many of you between now and then.

Have a good day.

Thank you, ladies and gentlemen.

This concludes today's conference.

Thank you for participating.

You may now disconnect.