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NTAP > SEC Filings for NTAP > Form 10-Q on 30-Nov-2012All Recent SEC Filings

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Form 10-Q for NETAPP, INC.


30-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act), and is subject to the safe harbor provisions set forth in the Exchange Act. Forward-looking statements usually contain the words "estimate," "intend," "plan," "predict," "seek," "may," "will," "should," "would," "could," "anticipate," "expect," "believe," or similar expressions and variations or negatives of these words or expressions. In addition, any statements that refer to expectations, projections, or other characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. All forward-looking statements, including but not limited to, statements about:

our future financial and operating results;

our business strategies;

management's plans, beliefs and objectives for future operations, research and development;

economic and industry trends or trend analysis;

product introductions, development, enhancements and acceptance;

acquisitions and joint ventures, growth opportunities, investments and legal proceedings;

competitive positions;

future cash flows and cash deployment strategies;

short-term and long-term cash requirements, including anticipated capital expenditures;

our anticipated tax rate;

the dilutive effect of our 1.75% Convertible Senior Notes due June 2013 (the Notes) and associated warrants on our earnings per share;

the conversion, maturation or repurchase of the Notes;

compliance with laws, regulations and debt covenants; and

the continuation of our stock repurchase program

are inherently uncertain as they are based on management's current expectations and assumptions concerning future events, and are subject to numerous known and unknown risks and uncertainties. Therefore, our actual results may differ materially from the forward-looking statements contained herein. Factors that could cause actual results to differ materially from those described herein include, but are not limited to:

acceptance of, and demand for, our products, including our recent product introductions;

our ability to increase our customer base, market share and revenue;

general global macroeconomic and market conditions, particularly in the Eurozone, and the continuing deliberations regarding future tax and fiscal policy in the United States;

the amount of orders received in future periods;

our ability to ship our products in a timely manner;

our ability to achieve anticipated pricing, cost, and gross margins levels;


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our ability to successfully manage our backlog and increase revenue;

our ability to successfully execute on our strategies;

our ability to effectively integrate acquired products and technologies;

our ability to successfully introduce new products and forecast demand for those products;

our ability to maintain the quality of our hardware, software and services offerings;

our ability to adapt to changes in market demand;

demand for our services and support and the growth of the storage markets generally;

our ability to identify and respond to significant market trends and emerging standards;

the impact of industry consolidation;

our ability to successfully manage our investment in people, process, and systems;

our ability to maintain our partner, supplier and contract manufacturer relationships;

the ability of our suppliers and contract manufacturers to meet our requirements;

the ability of our competitors to introduce new products that compete successfully with our products;

our ability to grow direct and indirect sales and to efficiently utilize global service and support;

variability in our gross margins;

our ability to sustain and/or improve our cash and overall financial position;

our cash requirements and terms and availability of financing;

valuation and liquidity of our investment portfolio;

our ability to finance business acquisitions, construction projects and capital expenditures through cash from operations and/or financing;

our ability to finance the exercise of our option to buy out our synthetic leases when their terms expire;

the results of our ongoing litigation, tax audits, government audits, inquiries and investigations; and

those factors discussed under the heading "Risk Factors" elsewhere in this Quarterly Report on Form 10-Q.

Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof and are based upon information available to us at this time. These statements are not guarantees of future performance. We disclaim any obligation to update information in any forward-looking statement. Actual results could vary from our forward-looking statements due to the foregoing factors as well as other important factors.

Critical Accounting Estimates and Policies

Our discussion and analysis of financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of such statements requires us to make estimates and assumptions that affect the reported amounts of revenues and expenses during the reporting periods and the reported amounts of assets, liabilities and equity as of the date of the financial statements. Our estimates are based on historical experience and other assumptions that we consider to be appropriate under the circumstances. However, future results may vary from our estimates.

We believe the accounting policies discussed under Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the fiscal year ended April 27, 2012 are significantly affected by critical accounting estimates and that they are both highly important to the portrayal of our financial condition and results of operations and require difficult management judgments and assumptions about matters that are inherently uncertain. There have been no material changes to the critical accounting policies and estimates as filed in such report.


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New Accounting Standards

See Note 3 of the accompanying condensed consolidated financial statements for a full description of new accounting pronouncements, including the respective expected dates of adoption and effects on results of operations and financial condition.

Results of Operations

The following table sets forth certain Condensed Consolidated Statements of
Operations data as a percentage of net revenues for the periods indicated:



                                                        Three Months Ended                       Six Months Ended
                                                 October 26,          October 28,         October 26,         October 28,
                                                     2012                2011                2012                2011
Revenues:
Product                                                   64.6 %              67.4 %               63.4 %             66.8 %
Software entitlements and maintenance                     14.2                13.1                 14.7               13.4
Service                                                   21.2                19.5                 21.9               19.8

Net revenues                                             100.0               100.0                100.0              100.0
Cost of revenues:
Cost of product                                           31.0                30.5                 31.1               30.3
Cost of software entitlements and maintenance              0.4                 0.4                  0.5                0.4
Cost of service                                            9.3                 8.5                  9.3                8.3

Gross profit                                              59.3                60.6                 59.1               61.0

Operating expenses:
Sales and marketing                                       31.7                30.1                 32.5               30.7
Research and development                                  14.5                13.3                 14.9               13.4
General and administrative                                 4.3                 4.3                  4.5                4.4
Acquisition-related expense                                 -                  0.1                   -                 0.1

Total operating expenses                                  50.5                47.8                 51.9               48.6

Income from operations                                     8.8                12.8                  7.2               12.4
Other expense, net                                        (0.5 )              (0.6 )               (0.4 )             (0.6 )

Income before income taxes                                 8.3                12.2                  6.8               11.8
Provision for income taxes                                 1.2                 1.2                  1.0                1.5

Net income                                                 7.1 %              11.0 %                5.8 %             10.3 %

Discussion and Analysis of Results of Operations

Overview

Net revenues for the three and six months ended October 26, 2012 were $1,541.2 million, up $34.2 million, or 2%, and $2,985.8 million, up $20.6 million, or 1%, respectively, compared to the prior year. The increases were due to increases in hardware maintenance contract and software entitlements and maintenance (SEM) revenues, partially offset by decreases in product revenues.

Gross margin percentage decreased during the three and six months ended October 26, 2012 compared to the prior year, primarily due to changes in mix, hardware-related warranty expense and unfavorable exchange rates.

Sales and marketing, research and development, and general and administrative expenses for the three and six months ended October 26, 2012 totaled $778.6 million and $1,548.5 million, respectively, up 8% in each period, compared to the prior year. These increases were primarily due to a 7% and 11% increase in the average headcount during the three and six months ended October 26, 2012, respectively, compared to the prior year and higher compensation cost per headcount. Exchange rates had a favorable impact on expenses.

Net Revenues (in millions, except percentages):



                                                         Three Months Ended                                  Six Months Ended
                                             October 26,       October 28,                      October 26,       October 28,
                                                2012              2011          % Change           2012              2011          % Change
Net revenues                                $     1,541.2     $     1,507.0             2 %    $     2,985.8     $     2,965.2             1 %


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Net revenues increased by $34.2 million, or 2% for the three months ended October 26, 2012, compared to the prior year. The increase in net revenues was due to increases in service and SEM revenues of $54.6 million, partially offset by a decrease in product revenues of $20.4 million. Product revenues comprised 65% of net revenues for the three months ended October 26, 2012, compared to 67% of net revenues for the three months ended October 28, 2011.

Net revenues increased by $20.6 million, or 1%, for the six months ended October 26, 2012, compared to the prior year. The increase in net revenues was due to increases in service and SEM revenues of $108.7 million, partially offset by a decrease in product revenues of $88.1 million. Product revenue comprised 63% of net revenues for the six months ended October 26, 2012, compared to 67% of net revenues for the six months ended October 28, 2011.

Sales through our indirect channels represented 82% and 80% of net revenues for the three and six months ended October 26, 2012, respectively, compared to 80% and 78% of net revenues for the three and six months ended October 28, 2011, respectively. Included in indirect channel sales were $209.6 million and $418.5 million of OEM revenue during the three and six months ended October 26, 2012, respectively, compared to $229.6 million and $443.0 million during the three and six months ended October 28, 2011, respectively.

The following customers, each of which is a distributor, accounted for 10% or more of net revenues:

                                                     Three Months Ended                         Six Months Ended
                                              October 26,           October 28,        October 26,            October 28,
                                                 2012                  2011               2012                   2011
Arrow Electronics, Inc.                                 20 %                  18 %               18 %                    16 %
Avnet, Inc.                                             15 %                  13 %               14 %                    12 %

Product Revenues (in millions, except percentages):



                                                           Three Months Ended                                    Six Months Ended
                                              October 26,       October 28,                        October 26,       October 28,
                                                 2012              2011           % Change            2012              2011           % Change
Product revenues                             $       995.8     $     1,016.2             (2 )%    $     1,893.8     $     1,981.9             (4 )%

Product revenues decreased by $20.4 million, or 2%, and by $88.1 million, or 4%, during the three and six months ended October 26, 2012, respectively, compared to the prior year. Product revenues consist of configured systems, which include bundled hardware and software products, and non-configured products, which consist primarily of add-on storage, OEM products and add-on hardware and software products.

Total configured system revenues of $531.2 million increased by $10.1 million, or 2%, during the three months ended October 26, 2012, compared to the prior year, primarily due to increases in the 2000 and 6000 series systems, partially offset by a decrease in the 3000 series systems. Configured systems unit volume increased 15% during the three months ended October 26, 2012, compared to the prior year. Unit volume of the 2000 and 6000 series increased and unit volume of the 3000 series systems decreased, reflecting a shift in customer demand from certain 3000 series systems to recently introduced 2000 series systems and increased demand for 6000 series systems. The average selling prices (ASPs) of total configured systems decreased during the three months ended October 26, 2012, compared to the prior year, due to a shift in sales from higher priced 3000 series systems to lower priced 2000 series systems, as well as product mix within the various series, partially offset by an increase in sales from the higher priced 6000 series systems. In addition, ASPs were negatively impacted by unfavorable foreign currency rates and higher discounting.

Non-configured product revenues of $464.6 million decreased $30.5 million, or 6%, during the three months ended October 26, 2012, compared to the prior year. This decrease was primarily due to lower revenue from non-configured OEM products, which declined 13% during the three months ended October 26, 2012 compared to the prior year. Non-configured product revenues were unfavorably impacted by product mix.

Total configured system revenues of $993.4 million decreased by $37.8 million, or 4%, during the six months ended October 26, 2012, compared to the prior year, primarily due to a decrease in the 3000 series systems, partially offset by an increase in the 2000 series systems. Configured systems unit volume increased 12% during the six months ended October 26, 2012, compared to the same period in the prior year. Unit volume of the 2000 series increased and unit volume of the 3000 series systems decreased, reflecting a shift in customer demand from certain 3000 series systems to the recently introduced 2000 series systems. The ASPs of total configured systems decreased during the six months ended October 26, 2012, compared to the prior year, primarily due to a shift in sales from higher priced 3000 series systems to lower priced 2000 series systems, as well as product mix within the various series. In addition, ASPs decreased due to unfavorable foreign currency rates.


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Non-configured product revenues of $900.4 million decreased $50.3 million, or 5%, during the six months ended October 26, 2012, compared to the prior year. This decrease was primarily due to lower revenue from non-configured OEM products, which declined 8%, and lower add-on storage revenue. Non-configured product revenues were unfavorably impacted by product and customer mix.

Our systems are highly configurable to respond to customer requirements in the open systems storage markets that we serve. This can cause a wide variation in product configurations that can significantly impact revenues, cost of revenues and gross profit performance. Pricing changes, discounting practices, product competition, foreign currency, unit volumes, customer mix, natural disasters and product material costs can also impact revenues, cost of revenues and/or gross profit performance. Disks are a significant component of our storage systems. Industry disk pricing has fallen every year; however, when supplies are constrained, disk prices may increase. To the extent that disk prices increase or decrease, we intend to pass along those price increases or decreases to our customers while working to maintain relatively constant profit margins on our disk drives. As our sales price per terabyte continues to decline, improved system performance, increased capacity and software to manage this increased capacity have an offsetting impact on product revenues.

Software Entitlements and Maintenance Revenues (in millions, except percentages):

                                                               Three Months Ended                                   Six Months Ended
                                                  October 26,       October 28,                       October 26,       October 28,
                                                     2012              2011           % Change           2012              2011           % Change
Software entitlements and maintenance revenues   $       219.4     $       198.0             11 %    $       437.9     $       396.2             11 %

SEM revenues increased $21.4 million and $41.7 million, or 11% each, during the three and six months ended October 26, 2012, respectively, compared to the prior year. The increases in each period were due to increases in the aggregate contract values of the installed base under SEM contracts, which is recognized as revenue ratably over the terms of the underlying contracts.

Service Revenues (in millions, except percentages):



                                                           Three Months Ended                                   Six Months Ended
                                              October 26,       October 28,                       October 26,       October 28,
                                                 2012              2011           % Change           2012              2011           % Change
Service revenues                             $       326.0     $       292.8             11 %    $       654.1     $       587.1             11 %

Service revenues include hardware maintenance, professional services and educational and training services. Service revenues increased $33.2 million and $67.0 million, or 11% each, during the three and six months ended October 26, 2012, respectively, compared to the prior year.

Hardware maintenance contract revenues comprised 74% and 72% of service revenues for the three and six months ended October 26, 2012, respectively, and 71% and 70% for the three and six months ended October 28, 2011, respectively. These revenues increased $33.0 million, or 16%, and $62.6 million, or 15%, during the three and six months ended October 26, 2012, respectively, compared to the prior year, as a result of increases in the installed base and aggregate contract values under service contracts. Professional services and educational and training services comprised 26% and 28% of service revenues for the three and six months ended October 26, 2012, respectively, and 29% and 30% of service revenues for the three and six months ended October 28, 2011, respectively.

Revenues by Geographic Area (in millions, except percentages):



                                                           Three Months Ended                                   Six Months Ended
                                              October 26,       October 28,                       October 26,       October 28,
                                                 2012              2011           % Change           2012              2011           % Change
Americas (United States, Canada and Latin
America)                                     $       897.3     $       897.1             -  %    $     1,698.4     $     1,710.5             (1 )%
Europe, Middle East and Africa (EMEA)                437.7             428.9              2 %            877.0             885.6             (1 )%
Asia Pacific and Japan (APAC)                        206.2             181.0             14 %            410.4             369.1             11 %

Net revenues                                 $     1,541.2     $     1,507.0                     $     2,985.8     $     2,965.2


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Americas revenues consist of Americas commercial and U.S. public sector markets.

Sales to customers inside the United States comprised 89% and 86% of Americas net revenues during the three months ended October 26, 2012 and October 28, 2011, respectively, and 89% and 85% of Americas net revenues during the six months ended October 26, 2012 and October 28, 2011, respectively. During both the three and six months ended October 26, 2012, EMEA revenues were negatively impacted by the general macroeconomic conditions in the region, as well as unfavorable foreign currency rates. No single foreign country accounted for 10% or more of net revenues in any of the periods presented.

Cost of Revenues

Our cost of revenues consists of three elements: (1) cost of product revenues, which includes the costs of manufacturing and shipping of our storage products, amortization of purchased intangible assets, inventory write-downs, and warranty costs; (2) cost of SEM, which includes the costs of providing SEM and third-party royalty costs and (3) cost of service revenues, which reflects costs associated with providing support activities for hardware, global support partnership programs, professional services and educational and training services.

Our gross profit is impacted by a variety of factors, including pricing changes, discounting practices, foreign currency, product configuration, unit volumes, customer mix, revenue mix, natural disasters and product material costs. Service gross profit is typically impacted by factors such as changes in the size of our installed base of products, as well as the timing of support service initiations and renewals, and incremental investments in our customer support infrastructure. If any of these factors that impact our gross profit are adversely affected, whether by economic uncertainties or for other reasons, our gross profit could decline.

Cost of Product Revenues (in millions, except percentages):



                                              Three Months Ended                                     Six Months Ended
                                 October 26,        October 28,                        October 26,        October 28,
                                    2012               2011           % Change            2012               2011           % Change
Cost of product revenues        $       477.3      $       460.7              4 %     $       929.5      $       898.1              3 %

Cost of product revenues increased $16.6 million, or 4%, and $31.4 million, or 3%, during the three and six months ended October 26, 2012, respectively, compared to the prior year. The changes consisted of the following elements (in percentage points of the total change):

                                              Three Months Ended                      Six Months Ended
                                          Fiscal 2013 to Fiscal 2012            Fiscal  2013 to Fiscal 2012
                                              Percentage Change                      Percentage Change
                                                    Points                                 Points
Materials cost                                                      1                                      1
Warranty                                                            3                                      3
Excess and obsolete inventory                                      -                                      (1 )

Total change                                                        4                                      3

Materials cost represented 83% and 85% of product costs for the three months ended October 26, 2012 and October 28, 2011, respectively, and increased $6.3 million from the prior year primarily due to a 15% unit volume increase in configured systems, partially offset by materials cost reductions due to a change in mix towards lower cost 2000 series systems. Other product costs of sales for the three months ended October 26, 2012 included an $11.4 million increase in hardware-related warranty expense compared to the prior year.

Materials cost represented 82% and 84% of product costs for the six months ended October 26, 2012 and October 28, 2011, respectively, and increased $7.7 million from the prior year primarily due to a 12% unit volume increase in configured systems, partially offset by materials cost reductions due to a change in mix towards lower cost 2000 series systems. Other product costs of sales for the six months ended October 26, 2012 included a $23.4 million increase in hardware-related warranty expense.

Cost of product revenues represented 48% and 49% of product revenue for the . . .

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