NetApp, Inc. 10-Q Summary: Quarter Ended January 23, 2009
Business Context and Reporting Period
This filing covers the third quarter and first nine months of fiscal year 2009, ended January 23, 2009. NetApp, Inc. is a supplier of enterprise storage and data management software and hardware. The reporting period was significantly impacted by the global financial crisis, which led to a contraction in customer budgets and a severe slowdown in IT spending. The company also faced specific legal and investment headwinds, including a major accrual related to a General Services Administration (GSA) investigation and impairment charges related to Lehman Brothers securities.
Key Financial Metrics
| Metric | Three Months Ended Jan 23, 2009 | Nine Months Ended Jan 23, 2009 | Three Months Ended Jan 25, 2008 | Nine Months Ended Jan 25, 2008 |
|---|---|---|---|---|
| Net Revenues | $746.3 million | $2,526.8 million | $884.0 million | $2,365.4 million |
| Gross Margin | $393.2 million (52.7%) | $1,456.0 million (57.6%) | $539.3 million (61.0%) | $1,440.5 million (60.9%) |
| Operating Income (Loss) | $(91.1) million | $13.2 million | $105.7 million | $210.4 million |
| Net Income (Loss) | $(75.4) million | $11.5 million | $101.8 million | $219.9 million |
| Diluted EPS | $(0.23) | $0.03 | $0.29 | $0.60 |
| Cash and Cash Equivalents | $1,708.2 million (as of Jan 23, 2009) | |||
| Short-term Investments | $752.7 million (as of Jan 23, 2009) | |||
| Long-term Debt | $1,265.0 million (Convertible Notes) | |||
| Operating Cash Flow (9mo) | $693.6 million |
Material Changes vs. Prior Period
- Revenue Decline (QoQ): Net revenues for the quarter decreased 15.6% year-over-year. This decline was driven by a $128.0 million non-cash accrual for a GSA contingency and a decrease in product revenues due to lower unit volumes and pricing pressures. Without the GSA accrual, revenue would have been higher.
- Operating Loss: The company reported an operating loss of $91.1 million for the quarter, compared to an operating income of $105.7 million in the prior year. This was primarily due to the GSA accrual, a $19.0 million restructuring charge, and increased operating expenses.
- Restructuring Charges: NetApp recorded $19.0 million in restructuring and other charges in the quarter. This included $14.9 million in impairment of intangible assets related to the discontinuation of the SnapMirror for Open Systems (SMOS) product and the closure of an engineering facility in Haifa, Israel.
- Investment Impairments: The company recorded $23.2 million in other-than-temporary impairment charges related to investments in Lehman Brothers securities and auction rate securities (ARS) during the nine-month period.
- Debt Issuance: In June 2008, the company issued $1.265 billion in 1.75% Convertible Senior Notes due 2013, increasing long-term debt significantly compared to the prior year.
Guidance, Outlook, and Risks
- Outlook: Management noted that business levels softened in January 2009 as customer budgets contracted. While the company gained a record number of new customers, revenue was impacted by a decrease in large system shipments. The company is focusing on expense management and optimizing resource allocation to improve operating leverage in fiscal 2010.
- Subsequent Restructuring: On February 11, 2009 (subsequent to the period end), NetApp announced a worldwide restructuring in response to worsening economic conditions. The company expects to incur cash restructuring charges of approximately $30.0 to $35.0 million in the next 12 months.
- GSA Contingency: The company recorded a $128.0 million accrual related to a potential False Claims Act violation regarding GSA contracts. The actual loss could be larger or smaller, and the outcome remains uncertain.
- Investment Liquidity: The company holds investments in the Reserve Primary Fund (which suspended redemptions) and auction rate securities. While management believes it has the ability to hold these until maturity, there is a risk of additional impairment charges if market conditions deteriorate.
- Convertible Notes: The company has $1.265 billion in convertible notes. If the stock price exceeds the conversion price ($31.85), the notes may be converted, potentially causing dilution, though note hedges are in place to mitigate this.
Key Facts for Investor Verification
- GSA Accrual Impact: Verify the status of the GSA investigation and the likelihood of the $128.0 million accrual being the final settlement amount, as this significantly distorted Q3 revenue and operating income.
- Investment Portfolio Health: Monitor the recovery of the Reserve Primary Fund and the liquidity of auction rate securities, as further impairments could impact future earnings.
- Restructuring Execution: Track the execution of the February 2009 restructuring plan and the associated $30-$35 million cash outflow to assess its impact on future operating margins.
- Product Mix Shift: Analyze the shift in revenue mix from high-end systems to lower-end systems and the impact on gross margins, which declined from 61.0% to 52.7% in the quarter.
- Debt Covenants: Confirm continued compliance with financial covenants on the $250 million unsecured and $250 million secured credit facilities, particularly given the operating loss in the quarter.