NetApp, Inc. Q1 Fiscal 2009 Filing Summary
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended July 25, 2008 (First Quarter of Fiscal 2009). NetApp, Inc., based in Sunnyvale, California, is a supplier of enterprise storage and data management software and hardware. The company changed its name from Network Appliance, Inc. to NetApp, Inc. in March 2008. The filing reflects strong revenue growth driven by demand for storage solutions, new product introductions (FAS6000 and FAS2000 series), and increased service revenues, despite a constrained macroeconomic environment.
Key Financial Metrics
| Metric | Q1 FY2009 (Ended July 25, 2008) |
Q1 FY2008 (Ended July 27, 2007) |
|---|---|---|
| Total Revenues | $868.8 million | $689.2 million |
| Gross Margin | $516.6 million (59.5%) | $417.2 million (60.5%) |
| Operating Income | $38.7 million (4.5%) | $24.5 million (3.6%) |
| Net Income | $37.7 million | $34.3 million |
| Diluted EPS | $0.11 | $0.09 |
| Cash from Operations | $250.2 million | $200.9 million |
| Cash & Equivalents (End of Period) | $1.70 billion | $0.62 billion |
| Total Debt (Notes + Credit Facilities) | $1.40 billion | $0.17 billion |
Material Changes vs. Prior Period
- Revenue Growth: Total revenue increased 26.0% year-over-year. Product revenue grew 18.2%, Software entitlements and maintenance grew 33.8%, and Service revenue surged 49.6%.
- Debt Issuance: In June 2008, the company issued $1.265 billion of 1.75% Convertible Senior Notes due 2013. Concurrently, it entered into note hedge transactions ($254.9 million cost) and sold warrants ($163.1 million proceeds).
- Stock Repurchases: The company repurchased 16.96 million shares for $400.0 million during the quarter, compared to 6.52 million shares for $200.0 million in the prior year period.
- Investment Impairments: Recorded a net loss on investments of $2.6 million due to write-downs of privately-held company investments. Additionally, recorded a temporary impairment charge of $0.6 million on auction rate securities (ARS).
- Interest Expense: Increased significantly to $4.6 million (from $1.1 million) due to the new convertible notes and amortization of debt issuance costs.
Guidance, Outlook, and Risks
- Outlook: Management expects continued revenue growth driven by server virtualization, storage efficiency, and green initiatives. However, they caution that macroeconomic conditions and reduced IT spending could impact growth rates.
- Capital Allocation: On August 13, 2008 (subsequent to period end), the Board approved an additional $1.0 billion stock repurchase program. The company expects capital expenditures to increase to support infrastructure growth.
- Legal Contingencies:
- Patent Litigation: Ongoing multi-lawsuit dispute with Sun Microsystems regarding patent infringement. No accrual recorded as outcome is undeterminable.
- Government Investigation: Under investigation by the GSA and Department of Justice regarding potential False Claims Act violations related to GSA contracting (1995-2005). DOJ believes liability exists regarding price reduction clauses. No provision recorded.
- Market Risks: Significant exposure to credit market volatility affecting the liquidity and valuation of Auction Rate Securities ($71.9 million fair value). The company has reclassified ARS to long-term investments due to uncertainty in liquidation within 12 months.
Investor Verification Checklist
- Debt Structure: Verify the terms of the $1.265 billion convertible notes, specifically the conversion price ($31.85) and the mechanics of the note hedges and warrants.
- Auction Rate Securities: Assess the liquidity risk and potential for further impairment charges on the $76.0 million par value of ARS held.
- Legal Exposure: Monitor the status of the GSA/DOJ investigation and the Sun Microsystems patent litigation for potential material financial impact.
- Margin Pressure: Review product mix shifts and pricing strategies, as product gross margin declined to 54.4% from 58.5% year-over-year.
- Accounting Changes: Note the upcoming adoption of FSP APB 14-1 (effective Q1 FY2010) which will require retrospective adjustment of convertible debt accounting, potentially lowering reported net income and EPS.