NTAP

NetApp, Inc. 10-K Summary (Fiscal Year Ended April 30, 2010)

Business Context and Reporting Period

This Annual Report on Form 10-K covers NetApp, Inc. for the fiscal year ended April 30, 2010 (a 53-week year). NetApp is a leading provider of storage and data management solutions, offering hardware, software, and services designed to lower the cost of managing data while increasing agility. The company operates globally with over 8,300 employees and sells through direct and indirect channels, with indirect channels representing 69% of total revenues in fiscal 2010.

Key Financial Metrics

Note: Fiscal 2009 results were negatively impacted by a $128.7 million settlement with the General Services Administration (GSA).

Material Changes vs. Prior Period

• Revenue Growth: Net revenues increased 15% to $3.9 billion, driven by growth in product, software entitlements and maintenance (SEM), and service revenues. This contrasts with fiscal 2009, which was depressed by the GSA settlement.
• Profitability Surge: Operating income jumped from $47.2 million to $488.4 million, and net income increased from $64.6 million to $400.4 million. This significant improvement is largely attributable to the absence of the GSA settlement charge in the current year and improved gross margins.
• Gross Margin Expansion: Gross margins improved to 64.1% from 58.4%, aided by reductions in product material costs and a favorable revenue mix, partially offset by lower average selling prices.
• Operating Expenses: Total operating expenses rose 10% to $2.0 billion, primarily due to increased incentive compensation and commissions linked to stronger performance, as well as the 53-week fiscal year.
• Acquisition Income: The company recorded $41.1 million in net proceeds from the termination of a proposed merger with Data Domain, Inc., recognized as acquisition-related income.

Guidance, Outlook, Risks, and Unusual Items

• Outlook: Management expects to continue investing in R&D and sales to support growth. The company maintains a strong liquidity position with over $3.7 billion in cash and investments, sufficient to fund operations and strategic initiatives for at least the next 12 months.
• Convertible Notes: NetApp has $1.265 billion in 1.75% Convertible Senior Notes due in 2013. A portion of the hedge associated with these notes (20%) was terminated following the Lehman Brothers bankruptcy, exposing the company to potential dilution if the stock price exceeds the conversion price of $31.85.
• Investment Portfolio Risks: The company holds auction rate securities (ARS) with a par value of $73.8 million. Due to market liquidity issues, these are classified as long-term assets. While no further other-than-temporary impairments were recorded in fiscal 2010, future market deterioration could necessitate additional charges.
• Legal Contingencies: NetApp is engaged in ongoing patent litigation with Oracle Corporation (formerly Sun Microsystems). No accrual has been recorded as the outcome and potential settlement amounts cannot be reasonably estimated.
• Tax Matters: The company is undergoing federal and state tax audits. A favorable tax ruling in the Netherlands was secured, extending the expiration date to 2015. However, changes in tax laws or audit outcomes could adversely affect the effective tax rate.
• Synthetic Leases: The company utilizes synthetic lease arrangements for its headquarters. As of April 30, 2010, the estimated fair value of these properties was $36.9 million below the guaranteed residual value, a deficiency being accrued over the lease term.

Key Facts for Investor Verification

• GSA Settlement Impact: Verify the extent to which fiscal 2009 comparisons are skewed by the $128.7 million GSA revenue reduction, which is not present in fiscal 2010.
• Convertible Note Dilution: Assess the risk of dilution from the $1.265 billion convertible notes, particularly the 20% unhedged portion following the Lehman Brothers default.
• Auction Rate Securities Liquidity: Monitor the liquidity status of the $73.8 million ARS portfolio and the potential for future impairment charges if market conditions worsen.
• Customer Concentration: Note that two distributors, Arrow and Avnet, accounted for 14% and 11% of net revenues, respectively, in fiscal 2010.
• Stock Repurchase Program: Confirm the remaining authorization of $1.1 billion for stock repurchases, as no shares were repurchased in fiscal 2010.
• Patent Litigation: Track the status of the patent infringement lawsuits with Oracle, as an unfavorable resolution could materially impact operations.