NetApp, Inc. — Form 10-Q Summary
Business context and reporting period. NetApp supplies enterprise storage and data-management hardware, software, and services. This filing covers the 13-week first quarter of fiscal 2013, ended July 27, 2012; comparisons are with the quarter ended July 29, 2011, except balance-sheet comparisons, which are with April 27, 2012. Figures are in U.S. dollars; financial statement amounts are in millions unless noted.
Financial results and liquidity
| Metric | Quarter ended July 27, 2012 | Prior-year quarter | Change |
|---|---|---|---|
| Net revenue | $1,444.6 | $1,458.2 | Down 1% |
| Gross profit / gross margin | $850.1 / 58.8% | $896.9 / 61.5% | Margin down 2.7 percentage points |
| Operating income / margin | $80.2 / 5.6% | $176.2 / 12.1% | Down 55% |
| Net income / net margin | $63.8 / 4.4% | $139.5 / 9.6% | Down 54% |
| Diluted EPS | $0.17 | $0.34 | Down 50% |
| Operating cash flow | $229.2 | $240.6 | Down $11.4 |
| Capital expenditures | $61.9 | $98.3 | Down $36.4 |
- Revenue mix: Product revenue was $898.0 million, down 7%; software entitlements and maintenance revenue was $218.5 million, up 10%; and service revenue was $328.1 million, up 11%.
- Cash and liquidity: Cash and cash equivalents were $1,529.4 million and short-term investments were $3,911.7 million, totaling $5,441.1 million. Working capital was approximately $3.3 billion. Cash, cash equivalents, and short- and long-term investments increased by $37.9 million from April 27.
- Debt: The 1.75% convertible senior notes have $1,265 million principal and mature June 1, 2013. Their balance-sheet carrying amount was $1,215.8 million; they were not holder-convertible as of July 27. Other long-term financing arrangements totaled $10.6 million.
- Balance sheet: Total assets were $9,406.0 million and total liabilities were $5,030.3 million. Deferred revenue totaled $2,767.5 million.
Material changes versus the prior-year quarter
- Product revenue fell $67.7 million, while software entitlements and maintenance and service revenue rose by $20.3 million and $33.8 million, respectively. Management attributed the product decline primarily to product and customer mix and unfavorable foreign exchange, partly offset by higher volume.
- Configured-system revenue decreased 9% even as unit volume rose 10%, reflecting a shift from higher-priced 3000-series systems toward lower-priced 2000-series systems and lower average selling prices. Gross margin also faced pressure from product mix, OEM mix, and foreign exchange.
- Operating expenses rose 7% to $769.9 million, with higher average headcount and stock-based compensation contributing. Research and development expense increased 11% and sales and marketing expense increased 6%.
- Product costs included higher hardware warranty expense and inventory write-downs. The warranty reserve rose to $96.5 million from $59.5 million a year earlier.
- Stock-based compensation increased to $79.2 million from $58.1 million, including a $12.8 million charge related to the employee stock purchase plan’s purchase-price adjustment provision.
- Net income included $3.1 million of net foreign-exchange gains in other income. The effective tax rate was 14.0%, compared with 16.5%.
Outlook, commentary, risks, and contingencies
- Management stated that available liquidity and expected operating cash flows should meet working-capital, capital-expenditure, investment, repurchase, debt-service, and other requirements for at least the next 12 months. The filing does not provide a clear revenue or earnings forecast.
- Capital expenditures for the remainder of fiscal 2013 were expected to be $200 million to $250 million, including an anticipated $69.6 million buyout of properties under synthetic leases. NetApp expected to exercise its buyout option as those leases expire between December 2012 and January 2013.
- NetApp repurchased 4.9 million shares for $150 million during the quarter, at an average $30.31 per share. Approximately $346 million remained authorized under the repurchase program at quarter-end.
- Key stated risks include uncertain IT spending and macroeconomic conditions, product and customer mix and pricing, competition, reliance on channel partners and suppliers, product quality and warranty costs, foreign-exchange exposure, and investment-market and interest-rate risks. Two distributors, Arrow Electronics and Avnet, generated 16% and 14% of quarterly revenue, respectively; indirect channels represented 78% of revenue.
- Approximately $2.9 billion of cash, cash equivalents, and short-term investments were held internationally. Management intended to keep foreign funds permanently reinvested; repatriation could incur U.S. federal and state taxes.
- The $1.265 billion notes become unconditionally convertible at holders’ option on March 1, 2013 and mature in June 2013. The filing identifies potential cash repayment needs and possible dilution from conversion and related warrants.
- Commitments included $281.0 million in non-cancelable contract-manufacturer purchase commitments and $50.3 million in capital purchase commitments. Financing guarantees had maximum potential payments of $161.4 million, offset by $151.3 million of associated deferred revenue.
- Tax matters include U.S. federal and state examinations, a transfer-pricing protest, and an appeal by Danish tax authorities following a favorable ruling for NetApp’s Danish subsidiary. Unrecognized tax benefits were $162.8 million; the timing and amount of potential changes were uncertain.
- NetApp reported discussions with the DOJ and GSA regarding contract-compliance matters involving sales through a channel partner. It also disclosed a review and cooperation with U.S. authorities concerning media allegations that products may have reached Syria through a third party. The filing says no material accrual was recorded for ordinary-course legal proceedings; Part II lists no legal proceedings.
- NetApp held auction-rate securities with a $50.6 million par value and $46.3 million estimated fair value, classified as non-current. A 100-basis-point increase in interest rates was estimated to reduce the fair value of fixed-income securities by approximately $44 million.
Important facts for investors to verify
- Whether the sharp year-over-year decline in operating income and margins reverses, and how product mix, pricing, foreign exchange, warranty costs, and inventory write-downs affect future gross margins.
- Whether recurring software-maintenance and service growth continues to offset weaker product revenue, and how concentrated distributor and indirect-channel exposure affects sales.
- The company’s cash generation and capital allocation, including the planned synthetic-lease property buyout, remaining repurchase authorization, and the June 2013 note maturity and conversion terms.
- Developments in IRS, California, and Danish tax matters, the DOJ/GSA contract-compliance discussions, and the export-control review concerning Syria.
- Potential investment valuation changes, including auction-rate securities, and the impact of interest-rate and foreign-exchange movements.