NetApp Inc (NTAP) 2012 Q4 法說會逐字稿

Welcome to the NetApp fourth quarter and fiscal year 2012 earnings conference call.

My name is Larissa, and I will be your operator for today's call.

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

Later, we will conduct a question and answer session.

Please note that this conference is being recorded.

I will now turn the call over to Ms. Shauna O'Boyle.

Ms. O'Boyle, you may begin.

Good afternoon, everyone.

Thank you for joining us.

With me on today's call are our CEO, Tom Georgens and our CFO, 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 Q1, future product offerings, expected benefits of partnerships, alliances and product introductions, our ability to procure sufficient inventories, and our expectations regarding future competitive positions, all of which involve risk and uncertainty.

Actual results may differ materially from our statements and projections for a variety of reasons, including general economic and market conditions, such as the macroeconomic environment and the flooding in Thailand, and matters specific to our business such as customer demand for and acceptance of our products and services.

We describe these factors in our accompanying press release, which we have filed in an 8-K with the SEC, as well as in 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 in today's discussion.

All numbers discussed today are GAAP, unless stated otherwise.

To see the reconciling items between the non-GAAP and GAAP, you may refer to the table in our press release, our supplemental commentary or on our website.

In a moment, Nick will walk you through some additional color on our financial results.

And then Tom will walk you through his perspective on the business this quarter.

I will now turn the call over to Nick.

Thank you, Shauna.

Good afternoon, everyone.

I realize many of you just joined us from HP's call, and wanted to thank HP for coordinating the timing with us today.

Q4 marked another quarter of solid financial performance by NetApp.

Revenue of $1.7 billion was above the midpoint of our previous guidance, and non-GAAP EPS of $0.66 was just over the high end of our Q4 guidance.

We closed our ninth consecutive quarter of over 20% year-over-year product revenue growth and, with full-year revenues of $6.23 billion, a year of 22% total revenue growth.

Our Americas, EMEA and Asia Pacific geographies all showed healthy revenue growth trends on a Q4 year-over-year and full-year basis.

NetApp branded revenue grew 14% sequentially in Q4 and 9% for the full-year, and revenue growth trends for both SEM and service revenue remained stable.

Total OEM customer revenue declined 17% sequentially in the quarter, which corresponds to a seasonally slow first quarter for many of our OEM customers.

Full-year E-Series revenue was just under $700 million, and coincident with our one-year anniversary of the E-series transaction, we completed the last of the integration activities.

Going forward, we expect to talk about E-Series revenue as part of total NetApp branded, or total NetApp OEM revenue, as appropriate.

So overall revenue performance was in line with our expectations, despite the continued dynamics around hard disk drives.

We exceeded both our gross and operating margin targets for Q4, achieving non-GAAP gross margin of 59.6%, and non-GAAP operating margin of 17.9%.

For the full-year, non-GAAP gross margins were just under 61% and non-GAAP operating margins were just under 18%, reflecting stronger margins in the first half of the fiscal year before the impact of the Thailand flooding on disk drive supply and costs.

In Q4, our non-GAAP operating expenses were 42% of revenue, reflecting lower levels of spending and hiring.

While hiring was slow in Q4, net new headcount grew by almost 2,000 in fiscal 2012, an increase of 19% over last year-end.

For Q1, we expect to closely monitor our operating expenses during our seasonally slow first quarter.

Our Q4 effective tax rate was 19%, reflecting some year-end one-time true-ups which increased our full-year effective tax rate to 17.9%, slightly higher than our forecast of 17.5%.

Non-GAAP EPS grew 14% sequentially and 12% year-over-year in Q4, and for the full year non-GAAP EPS was $2.41, up 10% from fiscal year 2011.

Turning to the balance sheet, we closed the year with a record $5.4 billion of cash and investments.

Our deferred revenue balance increased by $270 million, up 22% year-over-year consistent with each of Q1, Q2 and Q3 of fiscal year 2012.

Our ability to generate cash remains robust, as we just closed our best-ever quarter in cash from operations.

Cash from operations was $583 million in Q4, an increase of 27% from the same period last year.

Free cash flow was $459 million for the quarter and over $1 billion for the fiscal year, marking our second year of over a $1 billion dollars in free cash flow, and coming in at 17% of total revenue.

Our diluted share count increased by about 8 million shares sequentially to about 382 million shares, primarily due to a higher average quarterly share price in Q4.

The accounting for the shares associated with our convertible notes and warrants had a modest impact, with about 10 million shares related to the convertible notes, and just under 1 million shares associated with the warrants 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 a $0.01 higher.

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

Turning to guidance, as always there are many factors that influence our numbers.

Currently, the increasing uncertainty about the broader macroenvironment plays a prominent role.

This lack of clarity about the global economy limits our visibility at this time to accurately forecast our customer buying patterns going forward.

For this reason, we are not planning to give full-year fiscal 2013 guidance now or at our upcoming Analyst Day.

For Q1, our target revenue range is $1.4 billion to $1.5 billion, which at the mid point implies a 15% sequential decline, and 1% year-over-year decline in revenue.

This decline is a combination of our typical Q4 to Q1 ongoing revenue dynamics, as well as conservatism with respect to the overall macroenvironment.

We expect consolidated non-GAAP gross margins of approximately 60% to 61%, up from Q4 and consistent with our strong competitive position and cost discipline.

Due to the impact of the conservatism we are building in on revenue, we expect non-GAAP operating margins of approximately 11% to 12%.

Using our expected blended consolidated non-GAAP effective tax rate of approximately 17.5%, our non-GAAP earnings per share for Q1 should range from approximately $0.34 to $0.39 per share.

Diluted share count is projected to decrease slightly to approximately 380 million shares in Q1, based on our average stock price of $38.11 for the first 10 days of the quarter.

This will include about 7 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 a $0.01 to the EPS guidance.

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

Tom?

Thanks, Nick, and good afternoon, everyone.

Our performance this quarter demonstrated strong execution in many areas of the business.

We had year-over-year revenue growth of 19%, strong cash generation, and improved gross margins and operating margins.

Our robust product revenue growth stands out in the industry and demonstrates the continued expansion of our channels and market presence.

In Q4, we generated a record number of transactions over [$5 million], and had the highest Storage 5000 new customer acquisition quarter in over three years.

Our Americas commercial and Asia Pacific geographies had solid performance, in both the fourth quarter and the year.

Americas commercial revenue grew 30% year-over-year for both the quarter and the fiscal year, and the Asia Pacific geography grew 55% in the quarter, and just under that for the year.

The stronger geos were partially offset by softness in EMEA and the US public sector.

Our Q4 EMEA revenue growth of 8% year-over-year was the weakest fourth quarter for EMEA since April 2009, and we are seeing longer sales cycles, smaller transactions, and slow downs even in the countries where we have traditionally been strong.

Also, lower defense-related spending continues to affect our US public sector, with revenue down for the quarter and flat for the year.

In addition, our major account growth lagged the rest of the business, as it has for most of the fiscal year.

Our relationship with our partners continues to grow and deepen, as our business fulfilled through the channel finished the year at 79% of Q4 revenue.

Our two largest partners, Arrow and Avnet grew to 31% of Q4 revenue, up from 26% last quarter.

Arrow hit a new milestone, surpassing $1 billion in revenue for the fiscal year.

Reflecting the strength of our product offerings and partner ecosystem, we shipped a record number of 2000 Series systems in Q4, with units up 43% sequentially and 23% year-over-year.

As expected, units of the 3000 were down slightly in Q4, as a result of the transition to the newly refreshed 2000 Series.

The momentum of the 6000 Series continued, as we had another very strong quarter.

After increasing year-over-year unit counts by 2.5 times last quarter, our 6000 Series units in Q4 were up again sequentially, up 58% year-over-year and just about double for the full-year.

The ongoing growth of our 6000 Series shows our increasing participation in high end deployments, especially large-scale NAS, and deeper penetration into business critical data center workloads.

Data ONTAP currently has the largest market share of any operating system in the storage industry.

ONTAP 8 continues this innovation leadership by merging the richest and most sophisticated data management platform with the architectural capability of clustering to provide unlimited performance, availability and scale.

As the innovation leader in the industry, and the only Company offering a unified scale-out platform, we are the clear choice for enterprises, as they re-architect their data centers to build private clouds.

Since it's release in November, we have been encouraged with the progress of ONTAP 8.1.

And with over 6,000 systems installed, we are pleased with this rapid adoption.

Last quarter, we announced it's general availability.

Using ONTAP 8.1 in cluster mode, our customers are now running an ever-increasing variety of workloads including VMware, Oracle and Microsoft applications, using both SAN and NAS protocols.

While others offer disparate architectures for different workloads, we focus on minimizing the number of architectures our customers need, thereby enabling to build homogeneous, multi-tenant storage infrastructures that dramatically reduce complexity and cost.

Fiscal year 2012 marked the launch of the E-Series family of products, the result of our biggest acquisition to date.

With continued product leadership and significant execution, we exceeded our full-year E-Series OEM revenue expectations and closed the year close to our overall revenue goal.

We are pleased that many of our OEM partners have embedded the newest E-Series technology into their future product offerings, and we continue to make progress in the market with our E-Series branded solutions, including high performance computing, seismic processing, full motion video, media management and Hadoop workloads.

This quarter, we introduced our first new major release of the E-Series software since the acquisition.

It is the largest release the team has ever produced, demonstrating our ongoing commitment to the development and evolution of this platform.

The new release provides our OEMs with features like thin provisioning and asynchronous replication.

It also includes an industry first, Dynamic Disk Pooling, which dramatically decreases risk by significantly reducing the rebuild times of very large disk drives.

In addition to our achievements with E-Series, we've had continuous success in each of our three prior acquisitions, both in terms of revenue and integration into our technology road map.

Combined, revenue from these three acquisitions grew 30% in fiscal year 2012 from the previous year.

On the Big Data front, enterprises are grappling with both the management of the growth, scale, and diversity of the data their businesses generate, as well as deriving value from all the information in their possession.

Dealing with these massive data issues starts with selecting the right enterprise storage infrastructure.

Even before introducing clustering, NetApp was the leader in managing data at scale, as we have over 100 customers with more than 10 petabytes of data, and some with over 100 petabytes of data.

However, managing very large amounts of data is just the first phase of Big Data.

The next step is to leverage the information inside those data sets.

Our unique ability to unify the storage of both structured and unstructured data with a single architecture, enables our customers to simplify access to their data, transform it into high quality information, and provide deeper business insights to produce better business decisions.

We have consistently said that flash will be deployed throughout the hardware stack, and our flash offerings will be aggressive and multi-faceted.

Our belief is that offering flash primarily in the form of a cache is the most efficient and effective way to deploy this technology in storage arrays, and most of the industry is now following this approach.

With an over 50% attach rate in our 3240 and 3270 systems, and half a terabyte of flash embedded in every 6000 system, NetApp is on the forefront of flash integration.

In addition, our R&D pipeline contains projects to further exploit the use of flash on other layers of the stack, and our next release of ONTAP will contain additional flash-related offerings.

FlexPod growth continues to be robust, as we now have over 850 worldwide customers using this solution.

This quarter we expanded the platform portfolio by releasing a new entry level version for smaller workloads.

This provides greater flexibility, scalability, and customer choice by supporting multiple hypervisors at business applications, as customers build out their multi-tenant private clouds.

We have also added new FlexPod design architecture for Microsoft, the first validated data center infrastructure to support Microsoft Systems Center 2012.

One workload where we are seeing significant activity is desktop virtualization, a technology whose viability is substantially enhanced by our storage efficiency leadership.

The consumerization of IT and workforce mobility initiatives continue to drive demand for this technology.

We see strong activity in financial services where we have implemented solutions in eight of the top ten global banks, and we are seeing momentum in the healthcare and education sectors.

This past year, we saw approximately 75% growth in revenue from systems used for desktop virtualization.

And it has helped us deepen the Cisco partnership, as it is the most popular workload deployed on a FlexPod.

In Q4, the impact of drive pricing and supply constraints on our revenue and gross margin played out essentially as we expected.

We see drive availability returning to normal, although spot shortages will likely occur around individual drive types, since buffer inventories have not yet been rebuilt.

Pricing remains elevated relative to pre-flood levels, and some of this has been passed along to end users.

As drive supply continues to normalize, we expect over time to once again see price erosion from the drive vendors.

While we remain confident in our product differentiation, and this quarter we once again proved our ability to compete and win, there are increasing macroeconomic concerns that are hard to predict and beyond our control.

With the deteriorating macroenvironment affecting many European countries and a slow growing US economy, many are calling for low growth in IT budgets through the remainder of 2012.

Historically, storage has taken a larger share of IT budgets, and we believe this will still be the case.

However, given the increasing uncertainty in the macroenvironment and the fact that Q1 is almost always our most challenging quarter, we are being particularly cautious about our Q1 guidance.

Given the multitude of factors influencing enterprise spending, we have limited visibility into our full fiscal year 2013.

And as Nick indicated, we are not planning to provide full-year guidance at this time.

As we look back over the fiscal year, we have many accomplishments to be proud of, another year of over 20% revenue growth, the successful integration of our largest acquisition and our strong cash generation.

In addition, we recently earned a place on the Fortune 500 list and celebrated our twentieth anniversary as a Company.

All these accomplishments would not have been possible without the ongoing dedication and support of our employees, partners, and customers.

Thank you for joining us today, and I hope you'll attend our Analyst Day on June 26 in New York, where we will talk further about our innovation, our strong competitive positioning, and how by focusing on customer success we have built and will continue to build a growth company of scale.

At this point, I will open up the call for Q&A.

As always, I will ask you to be respectful of your peers on the call, and limit yourself to one question so we can try to address everyone in our allotted time today.

Thank you.

Operator?

(Operator Instructions).

Our first question comes from Jayson Noland from Robert Baird.

Okay, thank you.

Tom, it sounds like your channel SMB business is fairly healthy.

The other categories are not.

Just trying to understand with the guide, how much of that is macroeconomic concern versus your actual pipeline right now?

Well, certainly, the momentum of the 2000 has been very, very strong, and you can see the Arrow and Avnet performance.

On the other hand, the 6000 was spectacularly strong, and basically units in that space have doubled year-over-year.

So I don't know if I would separate those two.

As I look about the guidance, I think a couple of things that are in play.

Clearly, Q1 is our most challenging quarter, and even if you look over the last decade, not just the last couple years, it has always been a situation where we've had some shortfalls.

If you look at the normal seasonality of NetApp, typically you'll see, particularly in this growth range, probably a negative 10%, Q4 to Q1 transition, is roughly what we saw coming into this year.

You got the bellwethers out there, people with broader coverage than we do talking -- basically taking their guidance down by another 2% to 5%.

NetApp is probably a little bit more over-weighted, from a EMEA and US public sector point of view.

You throw an FX on top of that, on and on and on.

But I think you'd just add those factors together, it's pretty easy to come to a 15% reversal from Q4.

So maybe the market is different, and maybe we're being too pessimistic on the macro.

But I don't think anybody knows what the future holds.

But given that it's our Q1, which is always a challenge, I think we wanted to be careful.

The one thing we do know, is the quarter we just put up, and where we came in ahead of the guidance, and we came in over the top of the range on EPS.

And I think we had momentum at the very, very low end, and also at the high end.

So while we are cautious about the future, I think the one thing we do know is the number we just produced, and I think we're pretty strong this quarter across-the-board.

Thank you.

Our next question comes from Kulbinder Garcha from Credit Suisse.

Hi, thanks.

Just with the guidance you've given, it just seems that, unless you have a very strong recovery, especially earnings in the back half of the year, the earnings this year actually could be down.

I know you don't want to give guidance.

I'm just wondering, apart from the macro concerns in the near term, what's the confidence on a strong snapback that could happen in the second half of the fiscal year?

What kind of fundamentals should we be thinking about?

Many thanks.

Well, I think -- in our gross margin, any reversal on the revenue has a big impact on EPS, in both directions.

So if you just look at the quarter that we just produced, we saw solid operating margin, we saw increased gross margins.

I think we -- the drive situation is opportunity for increased margins going forward, so that part we are forecasting.

But the big lever for us is going to be the top-line number.

I think we're clearly, we're prudent this quarter, in terms of headcount.

I think we are going to watch expenses very closely as the year goes on.

So I don't think we'll be very aggressive on that front.

But that said, if the revenue stays depressed, it will be hard to get the numbers back.

But on the other hand, if the revenue does rebound, I think the business model is still absolutely intact.

And I think there is opportunity for tremendous amounts of expansion of EPS.

It's all going to hinge on the top line, and that's going to hinge on the macro, and that's why we are going to stay away from full-year guidance at this time.

I guess, Tom (inaudible) like given how you expect to start this first quarter, with IT purchase growing let's say, low digits, you would at least track that for the full year, do you think?

Or is it hard to say?

I think it depends on -- it certainly depends on the mix of storage, it depends on the mix of a number of things.

One of the things that's a little bit different where we sit this year, than last year, is APAC had a big year for us, up 50%.

Americas had a big year for us, up 30%.

But I think we also have the counter balance of US public sector and EMEA.

And I think how that balance plays out over time, are those sectors going to pull down the US?

Will Asia slow?

That will lead us in one direction.

Or will they rebound?

And time will tell.

So I think for us, when there is this type of uncertainty our focus is on market share, 19% product growth I think clearly is an industry leading number.

And that would be our focus going forward.

So I admit it will be tough to model.

That's why we aren't given full-year guidance.

But I do see gross margin expansion.

And I think the bottom line will be purely a function of how the top line performs over the course of the next nine months.

Thank you.

The next question comes from Aaron Rakers from Stifel Nicolaus.

Yes, thanks for taking the question.

In terms of your reported results, and also looking forward, first, can you give the configured versus non-configured business of revenue from a product perspective?

And can you talk about within that, the E-Series contribution for both?

And then also you had mentioned Data ONTAP 8, a next-gen operating system.

Can you give us, as your closest competitor continues to talk about Isilon and Mavericks et cetera, can you give us any sense of timing, or how we should think about that launch?

Thank you.

Yes.

So I think there's a few questions.

I'm not sure I understand the configured and non-configured.

So maybe I'll let Nick answer that.

But let me take the 8.1 question.

As we think about Isilon -- but I think the broader thing to understand about 8.x and where that's heading, is when I say there is a combination of Data ONTAP, which is the world's richest data management suite, and on its own is the number one market share as any individual operating system.

So taking that functionality, and marrying it with the capability of clustering.

And from that point of view it allows us to take that data management capability, and add effectively what clustering can bring, which is really unlimited scale and unlimited performance and non-disruptive operation.

And that's really the vision of ONTAP 8.

So while certainly, scale-out NAS and the Isilon is clearly a place where that technology can play, I think just as relevant is the evolution of that data -- of that technology, is basically to go deeper into the data center, and basically marry this data management capability with scale, and open up a much broader set of applications to us.

So Data ONTAP 8.1 is not necessarily a head-on-head with Isilon.

It's in fact, the way we are going to attack the business apps in the data center to fundamentally change the way the data is being done.

When I look at where 8.1 is going, certainly we see deployments with Isilon and some of the other scale-out products.

But still the predominant use of 8.1 is actually business applications deep in the data center at larger and larger scale.

I'd say that the 8.1 adoption falls into a few categories right now.

There are some that just want the latest functionality right away, to fill very large clusters right out of the shoot.

There are others that are evaluating it, and trying to understand a little bit more.

But the other ones understand that what this really is, is an infrastructure decision.

It's basically an infrastructure choice that they are going to make, about how they are going to deploy storage in the future, regardless of the applications they run.

So the customers that are actually making that decision is really where the future momentum is just going to come from.

And that is, they are going to standardize on this, to run their business applications, to run their scale-out NAS, to run their Big Data deployments, all around a single architecture.

So when I think about 8.1, I don't think about it at all in the Isilon range.

Certainly we complete there with them, and that will be the case.

But the bulk of our engagement with EMC is around their traditional offerings and their core product offerings in the data center.

And that's where I expect this technology to have it's greatest roots.

If I can follow on that, you alluded to a next-gen operating system in the pipeline.

Is that something we expect to see over the next couple quarters?

I don't think I alluded to a next-gen operating system.

I think I alluded to more functionality coming from 8.1, but certainly didn't allude to any 8, 9 dot something, or anything along those lines.

Okay.

And configured versus non?

Aaron, just with respect to your question on configured versus non-configured, we put some of those numbers which are subcomponents of product revenue into our Qs.

I don't have some of those numbers available to me right now.

What I would say, on an organic basis, on the product side of the fence, if I pull out the E-Series OEM, we've got a sequential growth of 15%, and a year-over-year of 6%.

So those are probably numbers that help you, in terms of understanding what's going on, in terms of the product outside of the acquired E-Series OEM.

Perfect, thank you.

I think on the broader question of configured and non-configured -- I don't know if that's getting into are we upgrading systems or selling new ones?

What I can tell you is the unit count numbers were up big this quarter, both on the 2000 and the 6000.

So clearly, we're landing new footprints.

Great.

Thanks.

Our next question comes from Amit Daryanani from RBC Capital Markets.

Hi, Tom.

Thanks a lot.

Just a question, everyone has a concern, and maybe you can help us understand why the conviction that you may not be losing share to some of your competitors?

So if I look at EMC's product growth, at least margins and pipelines ahead of what you just reported.

And then just beyond that, if demand is going to get constrained throughout the year, do you expect pricing to get more severe, and that may negate some of the drive savings you get going forward?

Thank you.

I'm not quite sure where you are come -- I am not quite sure of the comparable numbers, but if I just look at the storage industry, you've had Dell just report two consecutive quarters of negative growth.

You've had IBM report two consecutive quarters of negative growth.

I don't know what HP reported today, but their prior quarter was negative growth.

And on a product growth perspective, you have EMC report four consecutive quarters of declining product -- year-over-year product growth, and it was 3% this past quarter.

So we were 19% -- or I'm sorry, we were above that.

Or I'm -- say on the product growth, we're 19%, and even if you back out the OEM we're above that.

So the idea that the rest of the industry is outgrowing us, I guess I don't see it.

So from that perspective, from a product growth perspective, certainly, EMC of three is the best of the lot, I'll give you that.

But on the other hand, the numbers we just reported are better than that.

(Inaudible) I guess the organic numbers, and I had -- and I'll check mine, but I had you as a plus 2.5% ex Engenio, and EMC at 7%-plus, and I can take that off line.

But maybe broadly, as we just talk about -- (Multiple Speakers).

No, no, let's stop on that.

So EMC is -- I'm talking about product growth here, so they were 7%-plus overall, but product growth was 3%.

And the NetApp number from a product growth perspective year-over-year was 21%, and even if you back out Engenio, it's still well above 3%.

So those are the numbers that we're looking at.

Our next question comes from Katy Huberty from Morgan Stanley.

Yes, thanks.

Just to broaden the discussion, over the last couple of questions.

Over the last quarter or two, you talked about a more competitive landscape and aggressive pricing.

Would you describe the situation today as worse, same, or better than it was in the January quarter?

Hi, Katy, it's Nick.

Let me address that.

Last quarter we talked about some specific numbers in terms of the gross margins, and the gross margin guidance we gave.

So in the last quarter, when we gave guidance for the fourth quarter, we said gross margins would be approximately 59%, and we came in higher than that.

We have come in higher on the product gross margin side as well.

When I look at the quarter, with respect to discounting, with respect to mix, with respect to supply and drive constraints, all of those things were consistent, or we did better than our forecast on all of those.

In addition, we're talking about gross margins of 60% to 61% go forward.

So we have continued to say that it's a dynamic environment out there.

However, I think we're doing pretty well in terms of what we did in Q4, in terms of gross margin guidance and the go forward.

So one point -- to your point Katy is, if I remember right in the last quarter, as we did the bridge on gross margin, we had some costs associated with new customer acquisition.

And actually the new customer acquisition this quarter was actually better than last quarter.

But last quarter, we had big identifiable deals that I could really point out and attribute that to.

So I'm guessing is that some of those new deals will probably costly again, but they weren't as identifiable in the pack.

But overall, as Nick indicated, usually Q4 is where we see gross margin decline even further historically.

So we forecasted I believe on this call, 90 days ago was 59%, and we actually came in a bit higher than that.

So fair to say that the conservative guidance is almost entirely macro-related, and nothing that you are seeing on the competitive environment is driving the conservatism?

Yes, in fact, we're actually continuing to see an improvement in the gross margin.

So we've actually gone that far out on a limb.

Okay.

Clearly, I see this more as a macro dynamic.

I think this quarter was solid, last quarter was solid.

It isn't to say that competition isn't intense.

I just don't see it any different.

But I would say, that the macro climate -- even look at the guidance of the other bellwethers, and even look at the relative storage performance and growth rates of the other players in this industry, I still think it's a bit challenging, and I think we need to be careful.

And the other factor that we have at this point in time is our Q1.

And I would like to say in Q2, we have got the end of the government fiscal year to help us.

At the end of Q3, in Q3, we have the end of the calendar year.

In Q4, we have the end of our fiscal year.

But in Q1, we've got nothing going for us.

Makes sense, thank you.

Our next question comes from Brian Marshall from ISI Group.

Great.

Thanks.

The quarter was good, but the guidance, frankly, is a real head scratcher to me.

I think my financial model on NetApp goes back 16 years.

And I just went and looked back 16 years, and I couldn't find a period where revenues were down 15% for Q1, which is your mid-point of your guidance.

So it seems to me like the situation in EMEA is not new.

So questioning that level of decline in Q1.

And then point number two, would be OpEx.

So the guidance roughly implies that OpEx is going to be flat on an absolute dollar basis sequentially.

And the last time we did have a material decline in revenue was back in July of 2007.

And so when I looked at that period, revenues were down 14% sequentially.

The OpEx was down about 6% sequentially, so down about $22 million on an absolute dollar basis.

So I guess the question is, in light of revenues being down so much sequentially, couldn't we get OpEx down more as well?

Thanks.

On the broader question of the sequential, yes, I don't think we've had a 15% sequential Q4 to Q1 transfer.

I think as we look at it, it's not uncommon for us, particularly with this forward growth projection, even if you go back to the consensus estimates for the full-year, we're in that range, in the mid teens, where you are forecasting.

It's not uncommon for us to see 10%, from Q4 to Q1.

And so, I'm not saying that's suddenly 15%.

I would say one of the things that is different is that, even if you look at the guidance of the other players, you look at the guidance of the guys that just reported in the last couple days, Cisco, and other bellwethers who have a bigger, broader footprint than we do, clearly, they are taking guidance down from future consensus.

So I think if you compound those factors, and if you further go that the areas that are weakening or potentially weak, EMEA and US public sector, we're probably a little bit more over-weighted than some of the other guys.

And then, FX and whatever.

So I guess what I'd say is, I would start with normal Q4 to Q1 seasonality, in the 9% or 10% range.

And then you can decide what type of factors you want to add on top of that.

But if you look at the rate at which people have taken down their consensus, that's another three points or four points or whatever.

It doesn't take much to get to 15, without even talking about anything that is specific to NetApp.

So and Brian, it's Nick.

Let me add one thing.

If you take out the inorganic OEM revenue from Q1 last year, you'll see from Q4 to Q1, a 9% revenue decline.

Sequentially, just one year ago.

So that's something to keep in mind as well.

And then on the OpEx side of the fence, you're talking about a virtually flat, there's a variety of things going on.

Also, if you think back to this prior year, we took guidance off the table.

We had obviously had planned for a year higher.

Some of the variable compensation types of items were a tail wind for us last year, earlier in the year.

Those things we have to reset back up to 100%.

So those types of plans will be headwind as we go into Q1.

And we're offsetting it with spending conservative in a variety -- conservatism in a variety of other areas.

So that's how you're getting to the flattish on the OpEx for Q1.

Operator, next question, please?

Our next question comes from Andrew Nowinski from Piper Jaffray.

Hi, thanks.

I guess I just wanted to real quick sort of expand on that OpEx question from Brian, on the last question.

So historically, you've said that if the macro environments deteriorate, you would take action to protect your 16% operating margins.

Now the macro has clearly deteriorated, and you noted that you have limited visibility beyond Q1.

So is it fair to assume you are still thinking you can get the 16% for FY '13, given that you are not reining in spending yet?

Well, I think the year has just begun.

I think from our point of view, it's really hard to modulate expenses, in direct proportion to the seasonality of the business.

And yes, we've got the macro overhang, which is basically adding to the seasonality, the sum of two factors.

So I think at this point in time, the real question is how long is this going to last?

And I think if we felt that this was a protracted situation and we weren't going to be able to get back to the model any time soon, then clearly we would have to take some action.

But on the other hand, if we believe that this is something, a storm we can weather -- remember in Q4, we were very much on the model.

And now we're into Q1, and what has really changed since then I think is really the macro concern.

And the question is, is it going reverse?

But as long as we believe we can gain share, and we can continue to grow this business, and we want to position ourselves when this bounces back, then I don't think we'll over react to the near term.

And on the other hand if this is protracted, then just as we did the last time we went through this, back in 2008, 2009 when the sense is this is going to be a relatively long-duration thing, that we are not going to bounce back right away, then we take action.

So I think you certainly have our commitment to basically take action that we see necessary.

But on the other hand, we don't want to basically whipsaw the operating expense around a single quarter, or even a six-month phenomenon.

If we think this thing is coming back in the second half -- second half of our fiscal year, as others may have predicted, then I think we would ride the storm out.

But if we think it's going to persist, then clearly we're going to take action, similar to what we have done in the past.

All right, thanks.

Our next question comes from Brent Bracelin from Pacific Crest.

Thank you.

Also wanted to follow-up on the theme here, relative to this disconnect between the April quarter and your July guide.

If I look at the April quarter, you have a nice recovery in the NetApp branded business, offset by an OEM decline.

Your July guidance obviously, implies a meaningful step down, in fact, a 20% sequential decline in product revenue, if you just assume that services and software like they historically have been in Q1 are flat, does imply a change in -- I guess the question I have is, one, do you expect another big step down in OEM?

And if you do, why are you seeing a step down in OEM?

Two, on the NetApp core business, why aren't you seeing a bigger recovery there, and is there something in the pipeline that makes you concerned?

And then three, you are guiding to the biggest sequential drop in operating margins that we've seen in the history of the Company.

Is there something you're doing different here?

And again, I know you're going to adjust OpEx, relative to a protracted environment where you don't see the growth.

But the organic growth of the business has been in a single digit protracted 6% growth rate, by our calculation for fiscal 2012.

And you're guiding to a 1% organic growth rate for Q1, which would make what, five quarters in a row now, of single-digit growth?

So trying to balance all of these things, a good quarter, a nice recovery in the core NetApp business, but again, this outlook that does imply something else is wrong.

Is there something, Company-specific here, that we need to be worried about?

Well, I think if you look at the OEM business, it's going to be a function of the storage business of the OEMs themselves.

And certainly, their outlook has not been great.

So I think that's one factor.

I think if you go forward, clearly, I don't know if I'd agree on the 20%.

I would have to do that calculation myself, but it's still a big number, and it's the sum of those two factors.

So as Nick indicated, the 9% was typical of us going into this year, where we actually had a decent growth quarter in Q1.

And the other thing is -- I would be a little bit careful of the year-over-year compares, in the quote-unquote core business, because a couple things come into play there.

One of which is, now with IBM, now that we own the DS and the N-Series, we are ambivalent about which way that business goes, while obviously a year ago, we had a preference.

And likewise, to some extent in the channel, where there is opportunity to sell either product.

So to assume that the NetApp branded business is the same as it would have been, had we not done the acquisition is probably not entirely accurate.

That's probably a little bit of a pessimistic assumption.

But overall, I think in the grand scheme of things, if we did not have this broader concern about the macro, and watching what other companies are doing with their guidance, I think we would have been absolutely normal.

And what you should expect from us is a nominal 9% or 10%, just like we did last year in the core business.

And so if you use that as a baseline, what we are really debating is the rest of it macro or is it us?

And you can debate whether we are being overly pessimistic or not.

But the only point I'd come back to is, the only thing we do know, is the quarter we just had, and I think the quarter was strong.

We saw increasing gross margins.

We see that going forward.

And as far as the OpEx and EPS margin drop, that's effectively a top-line discussion, right?

OpEx is flat.

Gross margins are actually improving.

So what we are really talking about is the top line.

And I think that's the thing that we need to monitor.

As that goes, so will go the EPS.

Fair enough.

Our next question comes from Mark Moskowitz from JPMorgan.

Thank you.

Hi, Tom.

If I could follow-up on your commentary there, in terms of the only thing you know is the quarter you just had.

Does the 2240 now being fully available, does that maybe have an outsized contribution to the April quarter, and that's why you're also maybe a little cautious?

And then my bigger question here is just, I really appreciate your comments around Flash during the prepared remarks, in terms of your strategy.

But if we think about Extreme IO, I think NetApp was trying to make a bid for that asset.

(Inaudible) a few years ago, NetApp lost that asset.

Are we getting to a point now, especially with the stock, where it's indicated in after hours, where NetApp needs to consider maybe locking up, or partnering up with a bigger, deeper-pocketed partner to really go up against EMC going forward?

Well, okay.

So those are a couple -- I presume you don't mean that -- in order to compete for winning these deals.

As far as individual transactions, we're not going to comment on any deal.

Obviously, we spend time with a lot of people, and visit a lot of people, and talk to a lot of people, and talk about potential engagements.

We do that constantly.

As far as Flash goes, I see that as a vehicle innovation, and a way to promulgate our data management capability, and that's going to be a key part of our strategy.

So I think you should expect to see us do things organically, and you will see some of those, I indicated, in our upcoming release of 8.1.

You will see it inorganically, and you'll see it through partnership.

So I think you'll see NetApp participating on Flash on multiple dimensions, and primarily it's to basically expand our data management footprint.

Kind of lost sight of the other question.

Do we need to partner up with a bigger --

Do we need to partner off with a bigger person?

I'd say, let's just go down that list again, right?

IBM had two consecutive down quarters in storage.

Dell had two consecutive down quarters in storage.

I don't know the latest on HP, but they were down a quarter ago.

You had Hitachi, which had a good year last year, and then guided basically flat for this fiscal year starting in April.

EMC has had four consecutive quarters of declining product growth.

So if we had a bigger sales force, could we sell more?

If that's the question, I think the answer is yes.

On the other hand, I don't see who the player is that we would connect to, that would suddenly give us anymore leverage than we currently have.

Okay.

And then just to follow-up on the 2240, did that have an outsized contribution to your fourth quarter results, and that's why you're maybe being conservative as well?

No, I think it's great to have the momentum there.

And it's great to see the 2000 be strong again.

We clearly went through a slow patch roughly a year ago.

We have been accelerating with a good quarter last quarter, and even a better quarter this quarter, obviously, over 10,000 units, an all-time high.

But let's not lose sight of the high end, of what the 6000 did.

The 6000 doubled year-over-year, was up 58% this quarter, was up 200%-something last quarter.

So I think we have momentum on a number of fronts.

I think the 2240 is probably carving out part of the 3000, simply because it's new, and the 3000 is an older product line.

But I think both the large systems and the small systems have a tremendous amount of momentum right now.

So I wouldn't say that it's just one segment.

Clearly, those two products are serving two different segments in the market, and they both seem to be doing well.

Thank you.

The next question comes from Brian Freed from Wunderlich Securities.

Thank you.

If we try to predict your growth going forward -- I know you don't want to give specific guidance, but if you think of your business relative to the storage industry, what multiple of the industry growth rate for storage do you think you can grow on an organic basis moving forward?

I hate to have that bring up the question, if the growth -- if there's a decline in the industry, do we decline at twice the rate?

If you just go through those numbers that we just put out there -- from a product revenue which is the thing that drives market share, I should think we have the highest product revenue growth of anybody this past quarter.

So I still see us as a share gainer.

Our focus is on a point of share, and depending on the growth of the market, that will vary.

So do I still think we can double the growth of the market, double the growth of the business?

Yes, I do, particularly if it's a small number.

So I still feel good about where we are.

I still feel good about this quarter.

But if you can predict the future better than I can, then have at it.

You can adjust our numbers accordingly.

But I think for now, given that it's our Q1, which is never our strength, and given the question, really the question said, nothing has really changed about Europe, I suggest that it has.

Perhaps nothing has really changed about US public sector spending.

And that's probably not going to change any time soon, perhaps the election later in the year.

But overall, I feel good about the momentum.

I just wish I had more visibility.

Okay.

So your goal is to grow by -- gain a point of market share in the coming year?

Yes.

That's right.

And NetApp, in it's history, has only gained a point of share twice, once was last year, and the other is the year before, and that doesn't count the acquisition.

Okay, thank you.

The next question comes from Ryan Bergan from Craig-Hallum Capital.

Just wondering what your long term free cash flow growth rate ranges are going forward?

Okay, Ryan.

It's Nick.

Look, we obviously did in the 17% range for the year, 17% of revenue for the year, second year over $1 billion dollars in free cash flow.

So we feel very good about that.

We've shown some charts in the past that have some revenue associated with them as well.

You've got to look at what revenue growth is going to be, to be able to back in what free cash flow as a percentage of revenue is going to be.

But we've talked about numbers in the 20s, in the low 20 range.

And we have been able to do that, multiple quarters and years in a row.

So this year is a little lighter, this past year I should say, behind us, a little lighter.

This coming quarter, I'd caution you that we generally have not a great first-quarter free cash flow.

But those types of ranges we've talked about in the past, assuming the revenue growth, I think are still reasonable.

Could we have the next question?

The next question comes from Ananda Baruah from Brean Murray.

Hi.

Thanks for taking the question.

Hi, Tom, I just wanted to make sure I was clear on which areas that you have, I guess the lack of visibility, around the greatest lack of visibility?

And which areas specifically you see as having changed since last quarter?

And then I was also just wondering about how the linearity for this quarter was?

Thanks.

Okay.

So I would say public sector is largely the same, and I think the dynamics are there, and they are not great.

Obviously, we're facing an election, and that may change things.

But I think it may change emphasis, but not the overall macro picture.

Asia Pacific was strong all year and remains that way.

And I would say that in general, our concerns about Europe are clearly increasing, and it's not so much Greece, and it's not so much Italy.

Those are relatively small markets for us.

It's a spill-over effect into the -- into basically the big enterprise countries, Germany, France, UK.

So from our perspective, I think the spill-over effect of this, and what it means for the other countries is a concern.

Obviously, there has just been an election in France, so we will see what that yields.

Beyond that, I think if you look at the US, I think it's still uneven, and some sectors are clearly doing better than others.

I'd say a sector that would worry us is financial services.

And I think that's one thing that is also subject to probably a declining sentiment, from where we were 90 days ago.

Other sectors in the US are doing just fine, media, entertainment, consumer healthcare.

But I'd say that financial services, which is a big sector for us, is probably worse than it was.

And I think EMEA -- I don't know if it's worse.

It probably is a little worse.

But I would say that the bands -- or the range of the potential outcomes in the near term in EMEA is probably much greater today than it was 90 days ago.

I think that we could -- all sorts of things could happen, depending on the Greek elections and what happens there, what happens to the euro.

So I think from my perspective, I think EMEA, the mid-point is probably a bit worse than it was 90 days ago, but I would say the range of outcomes is probably much wider than it was 90 days ago.

To answer your question on linearity, the linearity in the fourth quarter of '12 was actually better than that in the fourth quarter of '11.

You can also see the DSO declined, if you look at it year-over-year.

Great.

Thanks a lot.

Next question comes from Bill Shope from Goldman Sachs.

Great, thanks.

And I apologize if this question was already asked.

But digging into the guidance once again, I think we all understand the lack of visibility and conservatism, given the environment.

But did you see anything quantitatively in the quarter that pushed you towards this aggressive down-tick in guidance?

I remember back in 2007 you had a similar type of guide, not as bad, but a similar surprise.

And you'd drained backlog in the fourth quarter, and that depleted backlog ended up compressing the July quarter.

Did you see anything like that in backlog this time around?

And then so far in May, are you seeing weakness that would support this type of outlook as well?

It's a little bit complicated in Q4, because it has a dynamic of being our fiscal year-end, and things of that nature.

But from a backlog perspective, our backlog measure is effectively the same going into Q1 as it was going into Q1 last year.

So I don't see that as a different data point.

I think overall, I would say that business was a challenge across the board, getting deals approved, getting large deals approved, and fighting through that.

I think we won more than our fair share of them, but I would say that activity was very selective.

And I think we had to battle for it, and I'm actually quite proud of the team, that not only we win our fair share of it, we actually increased margins in the process of doing so.

So I think the execution is good, but I think that the aggregate demand, certainly is not where it was, certainly a year ago.

Okay, thank you.

The final question comes from Brian White from Topeka Capital -- Mortgage.

Yes, Tom, could you talk a little bit about when the last time that you saw visibility was this low, number one.

And number two, what does the financial vertical represent as a percentage of business?

Thank you.

Okay.

I'll have to look up.

Financial is about 10% of our business.

And as far as visibility, I would say it's a little bit different this time is, that there is -- it's not only an economic concern, there is also a political concern involved, whether it be a US election, whether it be the role of the European Union.

And I think there is a level of complexity, that as a businessman that is a little bit harder to sort out here, in terms of what could happen.

And I think the other factor simply is, just to make it a NetApp story, is Q1 has hardly been our strength.

And if there's going to be a quarter where we are going to be cautious, and not want to get too far ahead of ourselves, particularly when there's a lot of unknowns out there, this is going to be it.

So I think from that perspective, we're just going to basically play this one safe.

I think you see the guidance of the other guys.

I don't see them talking about any different dynamics than we are.

And then you layer in our normal seasonality on top of that, and perhaps a little bit of our concentration in those two sectors, and likewise even FX, I think it's pretty easy to come up with a mid-teens sequential decline.

And that's where we are.

Thanks.

Thank you, ladies and gentlemen, for participating in the NetApp fourth-quarter and fiscal-year 2012 earnings conference call.

This concludes today's conference.

Thank you for participating.

You may now disconnect.