NTAP

NetApp, Inc. 10-Q Filing Summary

Business Context and Reporting Period

Company: NetApp, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: October 30, 2009 (First half of Fiscal Year 2010)
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

Material Changes vs. Prior Period

• Revenue: Net revenues were nearly flat for the three-month period (-0.2%) and decreased 2% for the six-month period compared to the prior year. Product revenues declined 8% (three months) and 10% (six months), while Software Entitlements and Maintenance (SEM) revenues increased 11% and 13%, respectively.
• Profitability: Net income increased significantly, up 122% for the three months and 89% for the six months compared to the prior year. This was driven by improved gross margins (due to lower material costs and favorable revenue mix) and a one-time benefit from merger termination proceeds.
• Merger Termination Proceeds: The company recorded net proceeds of $41.1 million in the six-month period following the termination of a proposed merger with Data Domain, Inc. This included a $57.0 million termination fee net of $15.9 million in costs.
• Operating Expenses: Total operating expenses increased slightly (2%) year-over-year, primarily due to a 14-week quarter in the current period versus 13 weeks in the prior year, and increased incentive compensation, partially offset by restructuring savings.
• Investment Gains/Losses: The company recorded a net gain on investments of $2.8 million for the three months ended Oct 30, 2009, compared to a net loss of $22.6 million in the prior year period. The prior year loss included significant other-than-temporary impairment charges related to Lehman Brothers securities.

Guidance, Outlook, Risks, and Unusual Items

• Outlook: Management noted stabilization in the macroeconomic environment and strong demand for storage efficiency solutions. They believe current cash sources are sufficient to fund operations for at least the next 12 months.
• Unusual Items:
  • Merger Termination: As noted above, the $41.1 million net gain from the Data Domain merger termination is a non-recurring item.
  • Accounting Change: The company adopted new guidance for accounting for convertible debt (FASB ASC 470-20) effective April 25, 2009, resulting in retrospective adjustments to prior period interest expense and net income.
  • Restructuring: Recorded $1.2 million (three months) and $2.7 million (six months) in restructuring charges related to workforce reductions and facility closures.

• Risks and Contingencies:
  • Investment Portfolio: The company holds $39.8 million in the Reserve Primary Fund (which suspended redemptions in 2008) and $69.0 million in Auction Rate Securities (ARS). There is a risk of further impairment or inability to liquidate these assets.
  • Legal Proceedings: Ongoing patent litigation with Sun Microsystems; outcome is uncertain. A settlement with the U.S. GSA regarding discount practices was finalized in April 2009 for $128.7 million.
  • Convertible Notes: $1.265 billion principal amount of 1.75% Convertible Senior Notes due 2013. The company has entered into note hedges and warrant transactions to mitigate dilution.
  • Tax Risks: The company is under examination by the IRS for fiscal years 2003 and 2004. Additionally, the Xilinx court decision impacted the company's tax provision, leading to an additional $32.6 million liability for uncertain tax positions.

Key Facts for Investor Verification

• Liquidity Position: Verify the total liquid assets of approximately $3.0 billion (Cash + Short-term investments) against the $1.265 billion principal of convertible notes and other obligations.
• Investment Impairments: Monitor the status of the $39.8 million investment in the Reserve Primary Fund and $69.0 million in Auction Rate Securities for potential further write-downs or liquidity constraints.
• Revenue Mix Shift: Confirm the trend of declining product revenue versus growing recurring software and service revenue, which impacts gross margin stability.
• Debt Accounting: Review the impact of the new convertible debt accounting standard on reported interest expense and net income, noting the non-cash nature of the debt discount amortization.
• Legal Exposure: Track the status of the Sun Microsystems patent litigation and the outcome of the ongoing IRS audit regarding fiscal years 2003 and 2004.