Business Context and Reporting Period
Company: Network Appliance, Inc. (NetApp)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: October 27, 2006 (Second Quarter of Fiscal 2007)
Business Overview: NetApp is a leading supplier of enterprise storage and data management software and hardware. The company reported strong revenue growth driven by the adoption of new product lines (FAS 3000, FAS 6000, NearStore VTL, and Decru security solutions) and increased software subscriptions. The quarter included the divestiture of certain NetCache assets to Blue Coat Systems.
Key Financial Metrics
| Metric | Three Months Ended Oct 27, 2006 | Six Months Ended Oct 27, 2006 | Three Months Ended Oct 28, 2005 | Six Months Ended Oct 28, 2005 |
|---|---|---|---|---|
| Total Revenue | $652.5 million | $1,273.8 million | $483.1 million | $931.5 million |
| Gross Margin | 61.5% | 60.8% | 61.9% | 61.5% |
| Net Income | $86.9 million | $141.6 million | $70.7 million | $130.8 million |
| Diluted EPS | $0.22 | $0.36 | $0.18 | $0.34 |
| Operating Cash Flow (6mo) | $403.4 million | $241.4 million | ||
| Cash & Short-Term Investments | $1,379.4 million (as of Oct 27, 2006) | $1,322.9 million (as of Apr 30, 2006) | ||
| Total Debt | $193.4 million (Current + Long-Term) | Minimal |
Material Changes vs. Prior Period
- Revenue Growth: Total revenue increased 35.1% year-over-year for the quarter and 36.8% for the six-month period. Growth was driven by new product introductions, increased software subscriptions, and service revenue.
- Product Mix Shift: Revenue from older FAS 900 series systems declined significantly, offset by strong growth in FAS 3000 and FAS 6000 series units. ATA drives accounted for 52.1% of total petabytes shipped in the quarter.
- Accounting Change (SFAS 123R): The company adopted SFAS No. 123R effective May 1, 2006. This resulted in a significant increase in stock-based compensation expense ($42.4 million for the quarter vs. $3.3 million in the prior year), reducing operating income and net income compared to what they would have been under the previous standard (APB 25).
- Divestiture: Completed the sale of NetCache assets to Blue Coat Systems, recording a pre-tax gain of $25.3 million.
- Debt: The company incurred a $300 million term loan in March 2006 to finance a foreign dividend repatriation. As of October 27, 2006, total debt outstanding was approximately $193.4 million.
Guidance, Outlook, and Risks
- Outlook: Management expects revenue from FAS 3000 and FAS 6000 series to increase, while revenue from FAS 900 and NearStore R200 will decline. They anticipate further price declines per petabyte for products, which may negatively impact gross margins if not offset by software mix.
- Acquisition: On November 8, 2006, NetApp entered into an agreement to acquire Topio, Inc. for approximately $160 million in cash, expected to close in December 2006.
- Stock Repurchase: On November 15, 2006, the Board approved a new $800 million stock repurchase program. As of October 27, 2006, $41.7 million remained available under the prior program.
- Risks:
- Competition: Intense competition from EMC, HDS, HP, IBM, and Sun/StorageTek could lead to price reductions and margin compression.
- Supply Chain: Reliance on a limited number of suppliers for disk drives and microprocessors creates risks regarding supply constraints and pricing.
- Tax Audits: The company is undergoing federal and foreign tax audits; unfavorable resolutions could adversely impact the effective tax rate.
- Legal: Two shareholder derivative lawsuits were filed regarding stock option granting timing; management intends to defend vigorously.
Investor Verification Checklist
- SFAS 123R Impact: Verify the sustainability of earnings growth given the significant non-cash stock-based compensation expense introduced in the current fiscal year.
- Gross Margin Pressure: Monitor the impact of declining average selling prices per petabyte and higher disk content on future gross margins.
- Debt Servicing: Confirm the company's ability to service the $193.4 million term loan, which matures in March 2008, using operating cash flows.
- Product Transition: Assess the success of the transition from legacy FAS 900 systems to the new FAS 3000/6000 platforms and the Topio acquisition integration.
- Deferred Revenue: Review the $818.6 million deferred revenue balance as an indicator of future recurring revenue from software subscriptions and services.