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NTAP > SEC Filings for NTAP > Form 10-Q on 26-Nov-2013All Recent SEC Filings

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Form 10-Q for NETAPP, INC.


26-Nov-2013

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). Forward-looking statements are all statements (and their underlying assumptions) included in this document that refer, directly or indirectly, to future events or outcomes and, as such, are inherently not factual, but rather reflect only our current projections for the future. Consequently, forward-looking statements usually include words such as "estimate," "intend," "plan," "predict," "seek," "may," "will," "should," "would," "could," "anticipate," "expect," "believe," or similar words, in each case, intended to refer to future events or circumstances. A non-comprehensive list of the topics including forward-looking statements in this document includes:

our future financial and operating results;

our strategies;

our beliefs and objectives for future operations, research and development;

political, economic and industry trends;

expected timing of, and benefits from, product introductions, developments, enhancements and acceptance;

expected benefits from acquisitions and joint ventures, growth opportunities and investments;

expected outcomes from legal, regulatory and administrative proceedings;

our competitive position;

our short-term and long-term cash requirements, including without limitation, anticipated capital expenditures;

our anticipated tax rate;

the repayment of our 2.00% Senior Notes due on December 15, 2017 and 3.25% Senior Notes due on December 15, 2022 (collectively referred to as the Senior Notes);

future uses of our cash, including, without limitation, the continuation of our stock repurchase and cash dividend programs.

All forward-looking statements included in this document 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, actual events and results may differ materially from these forward-looking statements. Factors that could cause actual results to differ materially from those described herein include, but are not limited to:

our ability to accurately forecast demand for our products and services, and future financial performance;

our ability to understand, and effectively respond to changes affecting, our market environment, products, technologies and customer requirements;

the overall growth and structure of the data storage industry;

general global political, macroeconomic and market conditions;

disruptions in our supply chain, which could limit our ability to ship products to our customers in the amounts and at the prices forecasted;

failure of our products and services to meet our customers' quality requirements, including, without limitation, any epidemic failure event relating to our products installed by our customers in their systems;


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our ability to maintain our gross profit margins;

our ability to successfully manage our backlog;

the quality of our strategy and our ability to successfully execute on the same, including, without limitation, our organic and acquisition-related growth strategies;

our ability to effectively integrate acquired businesses, products and technologies;

our ability to timely and successfully introduce, and increase volumes of new products and services, and to forecast demand and pricing for the same;

our ability to design, manufacture and market products meeting global environmental standards;

the impact of industry consolidation, affecting our suppliers, competitors, partners and customers;

our ability to successfully recruit and retain critical employees and to manage our investment in people, process and systems;

our ability to maintain our customer, partner, supplier and contract manufacturer relationships on favorable terms and conditions;

the actions of our competitors, most of which are larger and have greater financial and other resources than we have, including, without limitation, their ability to introduce competitive products and to acquire businesses and technologies that negatively impact our strategy, operations or customer demand for our products;

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

the availability of acceptable financing to support our future cash requirements;

valuation and liquidity of our investment portfolio;

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.

Overview

Financial Results and Key Performance Metrics Overview

The following table provides an overview of some of our key financial metrics
(in millions, except per share amounts, percentages and days sales outstanding):



                                              Three Months Ended                       Six Months Ended
                                        October 25,         October 26,         October 25,         October 26,
                                           2013                2012                2013                2012
Net revenues                           $     1,549.9       $     1,541.2       $     3,066.1       $     2,985.8
Gross profit                           $       965.2       $       913.9       $     1,874.8       $     1,764.0
Gross profit margin percentage                  62.3 %              59.3 %              61.2 %              59.1 %
Income from operations                 $       186.9       $       135.3       $       283.8       $       215.5
Income from operations as a
percentage of net revenues                      12.1 %               8.8 %               9.3 %               7.2 %
Net income                             $       166.8       $       109.6       $       248.4       $       173.4
Diluted income per share               $        0.48       $        0.30       $        0.70       $        0.47
Operating cash flows                   $       362.5       $       336.4       $       648.3       $       565.6

                                                                                October 25,          April 26,
                                                                                   2013                2013
Deferred revenue                                                               $     2,931.9       $     3,009.5
Days sales outstanding (DSO)                                                              35                  42


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1.75% Convertible Notes and Hedges

In June 2013, we settled our Convertible Notes. Upon conversion, we repaid the principal amount of $1.3 billion and issued an aggregate of 4.9 million shares of common stock for the excess of the conversion value over the principal amount of the Convertible Notes. Concurrently, we exercised our Convertible Note hedges, for which we received 3.9 million shares from the counterparties.

Dividends and Stock Repurchase Program Activity

In May 2013, our Board of Directors approved a $1.6 billion increase to our stock repurchase program under which during the six months ended October 25, 2013 we repurchased 25.3 million shares of our common stock at an average price of $39.57 per share, for an aggregate of $1.0 billion. We also declared quarterly cash dividends of $0.15 per share of common stock in fiscal 2014, for which we paid an aggregate of $102.7 million during the six months ended October 25, 2013.

Restructuring and Other Charges

In May 2013, we initiated a business restructuring plan under which we realigned internal resources, resulting in a reduction of our global workforce by approximately 7%, for which we have recognized $49.5 million of employee severance costs in the six months ended October 25, 2013.

Critical Accounting Policies and Estimates

Our condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, which require management to make judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, net revenue and expenses, and the disclosure of contingent assets and liabilities. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. We believe that the accounting estimates employed and the resulting balances are reasonable; however, actual results may differ from these estimates and such differences may be material.

The summary of significant accounting policies is included in 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 26, 2013. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably possible could materially impact the financial statements. There have been no material changes to the critical accounting policies and estimates as filed in such report.

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.


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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 25,          October 26,         October 25,         October 26,
                                                     2013                2012                2013                2012
Revenues:
Product                                                   61.6 %              64.6 %               61.5 %             63.4 %
Software entitlements and maintenance                     15.0                14.2                 15.0               14.7
Service                                                   23.4                21.2                 23.5               21.9

Net revenues                                             100.0               100.0                100.0              100.0
Cost of revenues:
Cost of product                                           27.3                31.0                 28.4               31.1
Cost of software entitlements and maintenance              0.5                 0.4                  0.5                0.5
Cost of service                                            9.9                 9.3                  9.9                9.3

Gross profit                                              62.3                59.3                 61.2               59.1

Operating expenses:
Sales and marketing                                       30.9                31.7                 30.9               32.5
Research and development                                  14.7                14.5                 14.9               14.9
General and administrative                                 4.5                 4.3                  4.5                4.5
Restructuring and other charges                            0.1                  -                   1.6                 -

Total operating expenses                                  50.2                50.5                 51.9               51.9

Income from operations                                    12.1                 8.8                  9.3                7.2
Other income (expense), net                                0.3                (0.5 )                 -                (0.4 )

Income before income taxes                                12.4                 8.3                  9.3                6.8
Provision for income taxes                                 1.6                 1.2                  1.2                1.0

Net income                                                10.8 %               7.1 %                8.1 %              5.8 %

Discussion and Analysis of Results of Operations

Overview

Net revenues for the three and six months ended October 25, 2013 were $1,549.9 million, up $8.7 million, or 1%, and $3,066.1 million, up $80.3 million, or 3%, respectively, compared to the prior year. The increase for the three months ended October 25, 2013 was primarily due to increases in hardware maintenance contract and software entitlements and maintenance (SEM) revenues, partially offset by a decrease in product revenues. The increase for the six months ended October 25, 2013 was primarily due to increases in hardware maintenance contract and SEM revenues.

Gross profit as a percentage of revenue increased 3% and 2% during the three and six months periods ended October 25, 2013, respectively, compared to the same period in the prior year, primarily due to lower unit materials costs due to supply chain efficiencies, and in the six months ended October 25, 2013, higher average selling price (ASP) for total configured systems. Additionally, gross profit was favorably impacted by changes in the mix between platforms and lower OEM revenues.

Sales and marketing, research and development, and general and administrative expenses for the three and six months ended October 25, 2013 totaled $777.2 million and $1,541.5 million, a decrease of 1% and 2%, respectively, as a percentage of revenue compared to the same periods in the prior year, reflecting cost control programs implemented in fiscal 2014.

Net Revenues (in millions, except percentages):



                                              Three Months Ended                                  Six Months Ended
                                  October 25,       October 26,                      October 25,       October 26,
                                     2013              2012          % Change           2013              2012          % Change
Net revenues                     $     1,549.9     $     1,541.2             1 %    $     3,066.1     $     2,985.8             3 %


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The increase in net revenues for the three months ended October 25, 2013 was primarily due to increases in service and SEM revenues of $36.8 million and $12.4 million, respectively, partially offset by a decrease in product revenues of $40.5 million. The decrease in product revenue was due to a $57.4 million decrease in OEM product revenue, partially offset by a $16.9 million increase in branded product revenue. Product revenues comprised 62% of net revenues for the three months ended October 25, 2013 compared to 65% of net revenues for the three months ended October 26, 2012.

The increase in net revenues for the six months ended October 25, 2013 was primarily due to increases in service and SEM revenues of $65.6 million and $22.4 million, respectively, partially offset by a decrease in product revenues of $7.7 million. The decrease in product revenue was due to a $99.5 million decrease in OEM product revenue, mostly offset by a $91.8 million increase in branded product revenue. Product revenues comprised 62% of net revenues for the six months ended October 25, 2013 compared to 63% of net revenues for the six months ended October 26, 2012.

Sales through our indirect channels represented 83% and 81% of net revenues for the three and six months ended October 25, 2013, respectively, compared to 82% and 80% of net revenues for the three and six months ended October 26, 2012. Included in indirect channel sales were $151.1 million and $317.6 million of OEM revenue during the three and six months ended October 25, 2013, respectively, compared to $209.6 million and $418.5 million during the three and six months ended October 26, 2012, 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 25,            October 26,          October 25,             October 26,
                                          2013                   2012                 2013                    2012

Arrow Electronics, Inc.(1)                       23 %                   21 %                 22 %                     19 %
Avnet, Inc.(1)                                   16 %                   15 %                 16 %                     15 %

(1) Net revenues for Arrow Electronics, Inc. for the three and six months ended October 26, 2012 have been corrected from 20% and 18%, respectively, previously disclosed to 21% and 19%, respectively. Net revenues for Avnet, Inc. for the six months ended October 26, 2012 have been corrected from 14% previously disclosed to 15%.

Product Revenues (in millions, except percentages):



                                                 Three Months Ended                                    Six Months Ended
                                    October 25,       October 26,                        October 25,       October 26,
                                       2013              2012           % Change            2013              2012           % Change
Product revenues                   $       955.3     $       995.8             (4 )%    $     1,886.1     $     1,893.8             -  %

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 $549.1 million increased by $12.5 million, or 2%, during the three months ended October 25, 2013 compared to the same period in the prior year, primarily due to an increase in the 3000 series systems revenues, partially offset by a decrease in the 2000 series systems revenues. Total configured systems unit volume increased 5% during the three months ended October 25, 2013 compared to the same period in the prior year. Unit volume of the 3000 series increased, while unit volume of the 2000 series systems decreased, reflecting a shift in demand of the older 2000 series systems to newer 3000 series systems. The ASP of total configured systems decreased during the three months ended October 25, 2013 compared to the same period in the prior year, with decreases in the 2000 and 3000 series ASPs.

Non-configured product revenues of $406.0 million decreased $53.1 million, or 12%, during the three months ended October 25, 2013 compared to the same period in the prior year. This decrease was primarily due to lower revenue from non-configured OEM products, which declined 29%.

Total configured system revenues of $1,086.1 million increased by $83.6 million, or 8%, during the six months ended October 25, 2013 compared to the same period in the prior year, due to revenue increases across all platforms, with the largest increases in the 6000 series systems. Total configured systems unit volume increased 7% during the six months ended October 25, 2013 compared to the same period in the prior year reflecting unit increases in all platforms. The ASP of total configured systems increased during the six months ended October 25, 2013 compared to the same period in the prior year, due to a higher ASP in our more highly configured 6000 series, partially offset by lower ASP in the 2000 and 3000 series.

Non-configured product revenues of $799.9 million decreased $91.4 million, or 10%, during the six months ended October 25, 2013 compared to the same period in the prior year. This decrease was primarily due to lower revenue from non-configured OEM products, which declined 26%.


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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 profits. Pricing changes, discounting practices, product competition, foreign currency, unit volumes, customer mix, natural disasters and product materials costs can also impact revenues, cost of revenues and/or gross profits. 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. While our sales price per terabyte historically declines over time, improved system performance, increased capacity and software to manage this increased capacity have an offsetting favorable impact on product revenues.

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

                                                Three Months Ended                                     Six Months Ended
                                   October 25,        October 26,                        October 25,        October 26,
                                      2013               2012           % Change            2013               2012           % Change
Software entitlements and
maintenance revenues              $       231.8      $       219.4              6 %     $       460.3      $       437.9              5 %

SEM revenues are associated with contracts which entitle customers to receive unspecified product upgrades and enhancements on a when-and-if-available basis, as well as bug fixes and patch releases.

The increases in SEM revenues for both the three and six months ended October 25, 2013 were due to increases in the aggregate contract value 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 25,        October 26,                         October 25,        October 26,
                                     2013               2012            % Change            2013               2012            % Change
Service revenues                 $       362.8      $       326.0              11 %     $       719.7      $       654.1              10 %

Service revenues include hardware maintenance, professional services, and educational and training services.

Hardware maintenance contract revenues comprised 76% of service revenues for each of the three and six months ended October 25, 2013, and 74% and 72% for the three and six months ended October 26, 2012, respectively. These revenues increased $36.5 million, or 15%, and $76.0 million, or 16% during the three and six months ended October 25, 2013, respectively, compared to the same periods in 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 24% of service revenues for each of the three and six months ended October 25, 2013, and 26% and 28% of service revenues for the three and six months ended October 26, 2012, respectively.

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



                                                Three Months Ended                                  Six Months Ended
                                   October 25,       October 26,                       October 25,       October 26,
                                      2013              2012           % Change           2013              2012          % Change
Americas (United States, Canada
and Latin America)                $       899.2     $       897.3             -  %    $     1,757.7     $     1,698.4             3 %
Europe, Middle East and Africa            445.0             437.7              2 %            893.0             877.0             2 %
Asia Pacific                              205.7             206.2             -  %            415.4             410.4             1 %

Net revenues                      $     1,549.9     $     1,541.2                     $     3,066.1     $     2,985.8

Americas revenues consist of Americas commercial and U.S. public sector revenues. Sales to customers inside the United States comprised 89% of Americas net revenues during each of the three months ended October 25, 2013 and October 26, 2012, and 90% and 89% of Americas net revenues during the six months ended October 25, 2013 and October 26, 2012, respectively. No single foreign country accounted for 10% or more of our net revenues for any period presented.


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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 . . .

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