Network Appliances Inc. (NTAP) reported first quarter fiscal 2011 adjusted earnings per share (EPS) of 41 cents, exceeding the Zacks Consensus Estimate of 36 cents. The adjusted earnings per share excludes amortization of intangible assets, acquisition related expenses, non-cash interest expense as well as investments and tax gains, but includes stock-based compensation expenses.

Revenue

NetApp reported first quarter fiscal 2011 revenue of $1.14 billion, up 35.8% from $837.9 million reported in the year-ago quarter. The quarter’s revenues also exceeded the Zacks Consensus Estimate of $1.13 billion. Revenue growth could be attributed to the significant increase in product revenues, while other revenue segments also improved on a year-over-year basis. Additionally, a rebound in technology spending may also have supported the quarter’s results.

Product revenue was $720.8 million in the quarter, up 50.7% from $478.2 million reported in the year-ago quarter and accounted for about 63.4% of total revenue.

Software Entitlement & Maintenance revenues in the quarter were $174.7 million, up 5.7% from $165.3 million reported in the year-ago quarter. The segment’s revenues represented around 15.4% of total revenue.

Service revenues were $242.3 million in the first quarter, up 24.6% from $194.4 million reported in the year-ago quarter. The segment accounted for 21.2% of total revenue.

Operating Results

The GAAP gross margin in the quarter was 63.7%, up from 62.4% in the year-ago quarter. Gross margin benefited from a better mix of business in the quarter.

Operating income on a GAAP basis was $164.2 million (14.4% of revenue), compared to $70.8 million (8.4% of revenue) in the year-earlier quarter. Substantial increase in the company’s sales, as well as a tight control on cost and expenses led to the increase in operating profits. Operating expenses as a percentage of total revenue was lower than in the year-ago period.

GAAP net income in the first quarter of fiscal 2011 was $142.0 million, or 38 cents per share, compared to $52.0 million, or 15 cents per share in the comparable period last year. GAAP net income in the quarter includes amortization of intangible assets, stock-based compensation expenses, acquisition related expenses, non-cash interest expense as well as investments and tax gains.

Excluding the above-mentioned special items, net income, on a non-GAAP basis, was $182.6 million, or 49 cents per share, compared to $75.9 million, or 22 cents per share in the year-earlier period. However Incorporatedluding stock-based compensation, the adjusted EPS in the quarter was 41 cents.

Balance Sheet & Cash Flow

NetApp exited the quarter with cash, cash equivalents and investments of $3.92 billion, or an increase of around $196.9 million over the prior quarter. Receivables were $372.5 million, a decrease of $99.0 million from the prior quarter. Inventories decreased $22.5 million from the prior quarter to $90.4 million.

Long-term deferred revenue was $821.0 million, reflecting a sequential increase of approximately $41.5 million. Long-term debt grew $36.1 million from the preceding quarter to $1.3 billion.

Cash from operations in the quarter was $177.3 million, down from $474.6 million in the previous quarter. Capital expenditure in the quarter was $40.2 million, down from $38.4 million in the prior quarter.

Guidance

NetApp expects second quarter 2011 revenue in the range of $1.16 billion to $1.21 billion. GAAP earnings per share are expected to range between 35 cents and 38 cents, while non-GAAP earnings per share are expected to be in the range of 47 cents to 50 cents.

Our Take

During the first quarter, NetApp strengthened its strategic relationships with Microsoft and other partners to facilitate customers’ and service providers’ transition to cloud computing. NetApp, VMware Inc. (VMW), and Cisco Systems Inc. (CSCO) also took their trilateral venture a step ahead by introducing new solutions to increase data center efficiencies. Nevertheless, the ongoing weakness in Europe remains a concern as is indicated by the company’s conservative guidance.

We remain encouraged by improved results in the quarter and believe that the momentum will continue based on strong partnership programs and increasing IT spending. Moreover, we are optimistic about NetApp’s M&A strategy.

NetApp is doing well, despite stiff competition from technical behemoths like International Business Machines Inc. (IBM) and EMC Corporation (EMC) in the data storage and management software space. Consequently, the shares have a Zacks #2 Rank, implying a short-term Buy recommendation.

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