NetApp, Inc. — Form 10-Q Summary
Business context and reporting period
NetApp supplies enterprise storage and data-management hardware, software, and services. The filing covers the 13-week fiscal third quarter ended January 27, 2012, and the nine months then ended, compared with the corresponding 2011 periods. Although the request metadata says “2011 Q3,” the filing itself reports fiscal 2012 Q3.
Financial performance and liquidity
Amounts are in millions of U.S. dollars except per-share data.
| Metric | Q3 FY2012 | Q3 FY2011 | Nine months FY2012 | Nine months FY2011 |
|---|---|---|---|---|
| Revenue | $1,565.5 | $1,289.6 | $4,530.7 | $3,694.3 |
| Gross profit | $908.5 | $846.2 | $2,718.4 | $2,400.5 |
| Operating income | $156.5 | $221.0 | $525.1 | $611.4 |
| Net income | $119.6 | $186.4 | $424.7 | $512.5 |
| Diluted EPS | $0.32 | $0.46 | $1.10 | $1.31 |
| Operating cash flow | Not provided for quarter | $880.0 | $887.5 |
- Revenue grew 21% in Q3 and 23% over nine months. Product revenue rose 26% and 27%, respectively; software entitlements and maintenance rose 11% and 12%, and service revenue rose 14% and 18%.
- Gross margin declined to 58.0% from 65.6% in Q3 and to 60.0% from 65.0% for the nine-month period. Operating margin fell to 10.0% from 17.2% and to 11.5% from 16.6%, respectively. Management attributed gross-margin pressure mainly to lower-margin Engenio E-Series OEM sales and higher discounting, partly offset by manufacturing cost reductions.
- Cash, cash equivalents, and short-term investments totaled $4,866.1 at January 27, 2012. Working capital was $4.0 billion. Cash and cash equivalents alone were $2,420.9.
- Operating cash flow was $880.0 for nine months. Investing activities used $784.1, including the $480.0 Engenio acquisition and $282.9 of capital expenditures; financing activities used $415.2, principally reflecting $600.0 of share repurchases. Cash and cash equivalents declined $336.4 from the fiscal-year opening balance.
- Convertible notes had $1,265.0 principal outstanding, due June 1, 2013, and a $1,188.8 carrying amount classified as long-term at quarter-end. The notes may be reclassified as short-term if conversion conditions are met in a future quarter. Other long-term financing arrangements totaled $14.7.
Changes versus prior comparable periods
- Engenio, acquired for $480.0 cash in May 2011, contributed $178.3 of Q3 revenue and $517.8 for the nine months since acquisition. Its lower-margin OEM products contributed to weaker gross margins; acquisition-related costs were $3.5 in Q3 and $7.4 for nine months.
- Operating expenses increased 20% in Q3 and 22% for nine months, with higher headcount, compensation, and stock-based compensation. Average headcount rose 25% and 27%, respectively, with Engenio representing about 10% of average headcount.
- Net income and diluted EPS declined in both comparison periods despite revenue growth. A $11.7 discrete tax expense related to an IRS settlement affected the quarter and nine-month results.
- Deferred revenue increased to $2,545.8 from $2,314.9 at April 29, 2011. Accounts-receivable days sales outstanding improved to 40 days from 47.
Outlook, risks, contingencies, and unusual items
- Management expected existing liquidity and operating cash flows to meet requirements for at least the next 12 months. It forecast capital expenditures of $45–$65 over the next three months. The filing provides no specific revenue or earnings guidance.
- Management cited uncertain economic conditions, competitive pricing and gross-margin variability, demand and forecast uncertainty, dependence on distributors and suppliers, and the Thailand floods’ effect on disk-drive supply and pricing. Disk prices had increased, and further increases could affect supply and margins.
- Approximately 78% of nine-month revenue flowed through indirect channels. Arrow Electronics represented 16% and Avnet 12% of nine-month revenue, creating distributor concentration risk.
- About $2.5 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.
- NetApp held $51.0 of auction-rate securities classified as non-current because near-term liquidity was uncertain. The company reported cumulative temporary impairment charges and warned that further market deterioration could require additional impairment.
- Contractual obligations totaled $2,325.3, including $1,298.1 for convertible notes and $898.5 of off-balance-sheet commitments. Synthetic-lease property values were estimated to be $51.0 below cost, with a $32.4 reserve; the company reported compliance with lease financial covenants.
- The company reported a derivative shareholder lawsuit alleging fiduciary-duty breaches related to government contracting; no legal accrual was recorded because outcomes were not determinable. It also disclosed DOJ/GSA discussions regarding contract compliance and media allegations that products reached Syria through a third party. NetApp said it was conducting an internal review, notified export authorities, and offered cooperation; potential penalties could include fines or government-contracting restrictions.
- The IRS began an examination of fiscal 2008–2010 returns in February 2012; California tax audits were also ongoing. Unrecognized tax benefits were $155.5. The Danish Tax Tribunal ruled in NetApp’s favor on a withholding-tax dispute, subject to possible appeal.
Important facts for investors to verify
- Whether revenue growth, particularly Engenio OEM sales, can be sustained without further pressure on gross and operating margins.
- Whether disk-drive supply and pricing disruptions related to Thailand affect shipments, costs, or customer demand.
- The conversion status, cash repayment requirements, and potential dilution associated with the $1.265 billion notes due 2013 and related warrants and hedges.
- Developments in the export-control review, DOJ/GSA discussions, shareholder litigation, and tax examinations or settlements.
- The accessibility and valuation of international liquidity and auction-rate securities, and the company’s ability to meet lease and other contractual obligations.