NetApp, Inc. 10-Q Filing Summary
Business Context and Reporting Period
Company: NetApp, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: October 24, 2008 (Second Quarter of Fiscal 2009)
Business Overview: NetApp is a supplier of enterprise storage and data management software and hardware products and services. The company operates on a 52-week or 53-week fiscal year ending on the last Friday in April.
Key Financial Metrics
| Metric | Three Months Ended Oct 24, 2008 | Six Months Ended Oct 24, 2008 | Three Months Ended Oct 26, 2007 | Six Months Ended Oct 26, 2007 |
|---|---|---|---|---|
| Total Revenues | $911.6 million | $1,780.4 million | $792.2 million | $1,481.4 million |
| Gross Margin | $546.2 million (59.9%) | $1,062.8 million (59.7%) | $484.0 million (61.1%) | $901.2 million (60.8%) |
| Income from Operations | $65.6 million (7.2%) | $104.3 million (5.9%) | $80.2 million (10.1%) | $104.7 million (7.1%) |
| Net Income | $49.2 million | $86.9 million | $83.8 million | $118.1 million |
| Diluted EPS | $0.15 | $0.26 | $0.23 | $0.32 |
| Cash & Equivalents | $1,171.0 million (as of Oct 24, 2008) | |||
| Short-term Investments | ||||
| Total Debt (Notes + Credit Facilities) | $1,330.3 million ($1,265M Notes + $65.3M Credit Facility) |
Material Changes vs. Prior Period
- Revenue Growth: Total revenues increased 15.1% year-over-year for the quarter and 20.2% for the six-month period. Growth was driven by increased product, software entitlements, and service revenues, partially offset by declines in older generation products.
- Profitability Decline: Net income decreased 41.3% for the quarter and 26.5% for the six-month period compared to the prior year. Operating margins compressed due to increased operating expenses and investment impairments.
- Investment Impairments: The company recorded a significant other-than-temporary impairment charge of $23.2 million in the quarter. This included $21.1 million related to direct and indirect investments in Lehman Brothers securities and $2.1 million related to auction rate securities (ARS).
- Debt Issuance: In June 2008, NetApp issued $1.265 billion of 1.75% Convertible Senior Notes due 2013. Proceeds were used for general corporate purposes, stock repurchases, and entering into note hedge transactions.
- Stock Repurchases: The company repurchased 17.0 million shares for $400.0 million during the six-month period ended October 24, 2008. No repurchases were made in the quarter ended October 24, 2008.
Guidance, Outlook, Risks, and Unusual Items
- Management Commentary: Management highlighted a challenging economic environment and tightened credit markets. In response, the company is curtailing headcount growth, reducing capital purchases, and reducing discretionary spending to return to targeted operating profit margins.
- Unusual Items:
- Lehman Brothers Exposure: Significant impairment charges were taken on Lehman Brothers corporate bonds and the Reserve Primary Fund (which held Lehman securities).
- Auction Rate Securities (ARS): Liquidity issues in the credit markets caused ARS auctions to fail. NetApp reclassified these assets to long-term investments and recorded impairment charges.
- Conference Cancellation: A $3.9 million charge was recorded in sales and marketing expenses due to the cancellation of the NetApp Accelerate user conference.
- Risks and Contingencies:
- Legal Proceedings: An ongoing investigation by the GSA and Department of Justice regarding potential False Claims Act violations could result in liabilities up to $131.2 million. No provision has been recorded as the outcome is uncertain.
- Patent Litigation: Ongoing patent infringement lawsuits with Sun Microsystems; no accrual recorded as the outcome is indeterminable.
- Counterparty Risk: Lehman Brothers OTC Derivatives, Inc. is the counterparty to 20% of NetApp's note hedges. While an "event of default" occurred, NetApp has not terminated the transaction but is monitoring the situation.
- Subsequent Event: On December 1, 2008, NetApp terminated a synthetic lease agreement for a building in Sunnyvale, California, reducing future lease obligations by $52.8 million.
Key Facts for Investor Verification
- Investment Portfolio Health: Verify the current status and fair value of the remaining auction rate securities and any further impairments related to the Reserve Primary Fund or other Lehman Brothers exposures.
- Legal Exposure: Monitor the status of the GSA/Department of Justice investigation regarding the False Claims Act, as potential liabilities could be material.
- Debt Covenants: Confirm continued compliance with financial covenants in the Secured Credit Agreement and Convertible Notes, particularly regarding Total Debt to EBITDA ratios and unencumbered cash levels.
- Revenue Mix: Assess the sustainability of revenue growth given the decline in older generation products and the impact of the economic downturn on enterprise IT spending.
- Counterparty Risk: Evaluate the potential financial impact if the note hedge transaction with Lehman Brothers OTC is terminated or if replacement costs are incurred.