NetApp, Inc. — Q3 FY2011 Form 10-Q
Business and period. NetApp supplies enterprise storage and data-management hardware, software, and services. This unaudited quarterly report covers the three and nine months ended January 28, 2011; comparisons are with periods ended January 29, 2010. The nine-month comparison is not exactly like-for-like: FY2011 included 39 weeks versus 40 weeks in FY2010.
Financial performance
Amounts are in millions of dollars, except per-share data and percentages.
| Metric | Q3 FY2011 | Q3 FY2010 | Nine months FY2011 | Nine months FY2010 |
|---|---|---|---|---|
| Net revenue | $1,268.1 | $1,011.7 | $3,613.3 | $2,759.6 |
| Gross profit / margin | $823.8 / 64.9% | $641.5 / 63.4% | $2,349.3 / 65.0% | $1,770.7 / 64.2% |
| Operating income / margin | $198.6 / 15.7% | $129.3 / 12.8% | $560.2 / 15.5% | $315.5 / 11.4% |
| Net income | $172.5 | $107.9 | $478.9 | $255.2 |
| Diluted EPS | $0.42 | $0.30 | $1.23 | $0.73 |
- Revenue mix and growth: Q3 revenue rose 25%; nine-month revenue rose 31%. Product revenue increased 32% and 43%, respectively; software entitlements and maintenance increased 8% and 6%; service revenue increased 20% in both periods. Product sales represented 65% of quarterly revenue versus 61% a year ago.
- Cash flow: Nine-month operating cash flow was $905.5, versus $500.4 a year earlier. Investing used $1,059.4, including $149.8 of capital expenditures and $74.9 net cash paid for Bycast. Financing provided $357.7, principally from employee equity plans and related tax benefits. Cash and cash equivalents increased $214.4 to $1,919.4.
- Liquidity: Cash, cash equivalents, and short-term investments totaled $4,755.6, up from $3,724.0 at April 30, 2010. Working capital was approximately $3.7 billion. Management said available resources and expected operating cash flow should meet requirements for at least 12 months.
- Debt: NetApp had $1,265.0 principal amount of 1.75% convertible senior notes due June 2013, with a balance-sheet carrying amount of $1,137.7. Other long-term financing arrangements totaled $12.9. The notes were convertible at holders’ option through March 31, 2011; at the January 28 share price of $54.03, the disclosed if-converted value exceeded principal by about $911.6.
Changes, outlook, and notable items
- Management attributed revenue growth to strong demand for storage-efficiency and data-management solutions and a November 2010 product launch. Gross margin improved, which management linked to a higher product-sales mix and improved margins.
- Sales, marketing, R&D, and G&A expenses rose overall as headcount, incentive compensation, and commissions increased. Operating income and margins nevertheless improved. The prior-year nine-month comparison included $41.1 of net income from the terminated Data Domain merger, including its $57.0 termination fee less $15.9 of related costs.
- No specific revenue or earnings guidance is provided in the supplied filing text. NetApp expected approximately $60 of capital-project spending in the remaining three months of FY2011.
- NetApp completed the Bycast acquisition in May 2010 for an initial purchase price of $83.8, primarily to add object-based storage software. It completed the approximately $60 cash acquisition of Akorri Networks on January 31, 2011, after quarter-end.
- Convertible-note dilution is a significant near-term consideration. Note hedges were expected to offset about 80% of dilution, but the hedge for 20% was terminated following the counterparty’s bankruptcy and was not replaced; warrants may also create dilution above their exercise price.
- Investment risks include auction-rate securities with $71.8 par value and $65.1 estimated fair value, classified as long-term due to uncertain liquidity. The filing reports cumulative temporary losses of $4.5 and a separate $2.2 other-than-temporary impairment. Management said it intended and was able to hold these securities, but further losses could arise if markets deteriorate.
- Tax matters include $142.5 of unrecognized tax benefits and ongoing U.S. and foreign audits. NetApp said a final settlement of its IRS 2003–2004 audit was reasonably possible within three months. It also appealed a Danish withholding-tax assessment. Outcomes could adversely affect tax expense and cash flow.
- A shareholder derivative action alleges fiduciary-duty breaches and waste related to controls over government contracting. The amended complaint seeks compensation disgorgement and unspecified damages; NetApp recorded no accrual because outcomes were not determinable.
- Other exposures include $165.0 of non-cancelable contract-manufacturer purchase commitments, $317.1 of other purchase obligations, $75.6 of maximum financing-guarantee contingencies, and synthetic-lease residual guarantees. The estimated fair value of properties under the synthetic leases was $36.9 below aggregate residual guarantees.
Key facts for investors to verify
- Whether product demand and the recent launch sustain revenue growth, and whether gross margins hold as product mix, pricing, and component costs change.
- How much operating cash flow is supported by deferred-revenue growth ($222.5 in the nine-month period) and how receivables and working capital develop.
- The timing and economic effects of convertible-note conversion, including dilution from the unhedged portion and warrants.
- Developments in IRS and Danish tax matters, the derivative lawsuit, auction-rate security valuations, and synthetic-lease guarantees.
- Distributor concentration: Arrow Electronics represented 18% of Q3 revenue and Avnet 12%; together they were also significant receivables and sales channels.
- Whether the post-quarter Akorri acquisition and the Bycast integration deliver expected benefits, and whether the authorized but unused repurchase capacity is deployed. No shares were repurchased under the program during the nine months.