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NTAP > SEC Filings for NTAP > Form 10-Q on 28-Aug-2014All Recent SEC Filings

Show all filings for NETAPP, INC.

Form 10-Q for NETAPP, INC.


28-Aug-2014

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, customer acceptance of and benefits from, product introductions, developments and enhancements;

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, 3.375% Senior Notes due on June 15, 2021 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:

the overall growth and structure of the data storage industry;

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

general global political, macroeconomic and market conditions;

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

our ability to successfully manage our backlog;

our ability to successfully execute on our strategy to generate profitable growth and stockholder return;

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


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

our ability to maintain our gross profit margins;

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 gain customer acceptance of new products;

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;

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

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

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

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

our ability to resolve ongoing litigation, tax audits, government audits, inquiries and investigations in line with our expectations;

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

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

valuation and liquidity of our investment portfolio;

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

our ability to anticipate techniques used to obtain unauthorized access or to sabotage systems and to implement adequate preventative measures against cybersecurity and other security breaches; 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.


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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
                                                           July 25,       July 26,
                                                             2014           2013
  Net revenues                                             $ 1,489.2      $ 1,516.2
  Gross profit                                             $   938.1      $   909.6
  Gross profit margin percentage                                63.0 %         60.0 %
  Income from operations                                   $   159.9      $    96.9
  Income from operations as a percentage of net revenues        10.7 %          6.4 %
  Net income                                               $    88.4      $    81.6
  Diluted net income per share                             $    0.27      $    0.23
  Operating cash flows                                     $   215.5      $   285.8




                                              July 25,      April 25,
                                                2014           2014
               Deferred revenue               $ 3,076.3     $  3,100.2
               Days sales outstanding (DSO)          36             47

3.375% Senior Notes due 2021

On June 5, 2014 we issued $500.0 million aggregate par value of 3.375% Senior Notes, with a maturity date of June 15, 2021 and received proceeds of $494.7 million, net of discount and issuance costs, which will be used for general corporate purposes, including possible stock repurchases, dividends, capital expenditures, working capital and potential acquisitions and strategic transactions.

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 revenues 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 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 25, 2014. 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 2 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
                                                     July 25,         July 26,
                                                       2014             2013
     Revenues:
     Product                                              59.3 %           61.4 %
     Software entitlements and maintenance                14.8             15.1
     Service                                              25.9             23.5

     Net revenues                                        100.0            100.0
     Cost of revenues:
     Cost of product                                      26.5             29.7
     Cost of software entitlements and maintenance         0.5              0.5
     Cost of service                                      10.0              9.8

     Gross profit                                         63.0             60.0

     Operating expenses:
     Sales and marketing                                  32.3             30.9
     Research and development                             15.3             15.0
     General and administrative                            4.7              4.5
     Restructuring and other charges                        -               3.2

     Total operating expenses                             52.3             53.6

     Income from operations                               10.7              6.4
     Other expense, net                                     -              (0.3 )

     Income before income taxes                           10.7              6.1
     Provision for income taxes                            4.8              0.7

     Net income                                            5.9 %            5.4 %

Discussion and Analysis of Results of Operations

Overview

Net revenues for the three months ended July 25, 2014 were $1,489.2 million, down $27.0 million, or 2%, compared to the three months ended July 26, 2013, reflecting a decrease in product and software entitlements and maintenance (SEM) revenues, partially offset by an increase in hardware maintenance contract revenues.

Gross profit as a percentage of net revenues increased 3% during the three months ended July 25, 2014, compared to the three months ended July 26, 2013, primarily due to lower average unit materials costs due to product mix, partially offset by a lower average selling price (ASP) for all configured systems platforms. Additionally, gross profit was favorably impacted by lower OEM revenues and higher margins on service revenues.

Sales and marketing, research and development, and general and administrative expenses for the three months ended July 25, 2014 totaled $778.2 million, up 2% as a percentage of net revenues, compared to the three months ended July 26, 2013, primarily due to increases in compensation costs.

Net Revenues (in millions, except percentages):



                                          Three Months Ended
                               July  25,      July  26,
                                  2014           2013         % Change
                Net revenues   $  1,489.2     $  1,516.2             (2 )%

The decrease in net revenues for the three months ended July 25, 2014 was primarily due to a decrease in product and SEM revenues of $48.2 million and $7.2 million, respectively, partially offset by an increase in service revenues of $28.4 million. Product revenues comprised 59% of net revenues for the three months ended July 25, 2014 compared to 61% of net revenues for the three months ended July 26, 2013.


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Sales through our indirect channels represented 79% of net revenues for the three months ended July 25, 2014, compared to 80% of net revenues for the three months ended July 26, 2013. Included in indirect channel sales were $128.7 million and $166.5 million of OEM revenue during the three months ended July 25, 2014 and July 26, 2013, respectively.

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

                                              Three Months Ended
                                          July 25,           July 26,
                                            2014               2013
               Arrow Electronics, Inc.           22 %               21 %
               Avnet, Inc.                       16 %               16 %

Product Revenues (in millions, except percentages):



                                            Three Months Ended
                                 July  25,       July  26,
                                   2014            2013          % Change
             Product revenues   $     882.6     $     930.8             (5 )%

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 $526.2 million decreased by $10.8 million for the three months ended July 25, 2014 compared to the three months ended July 26, 2013. Revenues from FAS mid-range, high-end systems and E-Series (which includes our all flash EF systems) increased, offset by decreases in FAS entry level systems. Total configured systems unit volume decreased 2% during the three months ended July 25, 2014, compared to the three months ended July 26, 2013, primarily due to a unit volume decrease in the FAS entry level systems, partially offset by increases in unit volume of the FAS mid-range and high-end systems and E Series systems. These changes in unit volume reflect a shift in customer demand to our newer FAS mid-range and high-end products and higher demand for our E-Series systems, and away from our older FAS entry level systems. The average selling prices (ASPs) decreased across all FAS system and E Series platforms in the three months ended July 25, 2014, compared to the three months ended July 26, 2013, due to higher demand of newer lower priced products within their respective platform. However, overall ASPs of configured systems were relatively flat during the three months ended July 25, 2014 compared to the corresponding period in the prior year due to favorable product mix towards higher priced platforms.

Non-configured product revenues of $356.4 million decreased $37.4 million, or 10%, during the three months ended July 25, 2014 compared to the three months ended July 26, 2013. This decrease was primarily due to lower revenues from non-configured OEM products, which declined 23%, and add-on storage, which declined 13%, but was partially offset by a 82% increase in revenues from add-on software. The decrease in add-on storage and increase in add-on software are largely due to the change in our pricing strategy that was effective in the fourth quarter of fiscal 2014, whereby we now charge for operating system software for storage capacity but have lowered prices on storage hardware.

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. 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
                                                       July  25,        July  26,
                                                         2014             2013           % Change
Software entitlements and maintenance revenues        $     221.3      $     228.5              (3 )%

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.


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The decrease in SEM revenues for the three months ended July 25, 2014 was due to a decrease in the aggregate contract value of the installed base under SEM contracts.

Service Revenues (in millions, except percentages):



                                            Three Months Ended
                                  July  25,       July  26,
                                    2014            2013         % Change
              Service revenues   $     385.3     $     356.9             8 %

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

Hardware maintenance contract revenues comprised 79% of service revenues for the three months ended July 25, 2014, compared to 77% for the three months ended July 26, 2013. These revenues increased $29.2 million, or 11%, during the three months ended July 25, 2014, compared to the corresponding period 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 21% and 23% of service revenues for the three months ended July 25, 2014 and July 26, 2013, respectively.

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



                                                                 Three Months Ended
                                                      July 25,       July 26,
                                                        2014           2013          % Change
Americas (United States, Canada and Latin America)    $   831.2      $   858.5              (3 )%
Europe, Middle East and Africa                            444.9          448.0              (1 )%
Asia Pacific                                              213.1          209.7               2 %

Net revenues                                          $ 1,489.2      $ 1,516.2

Americas revenues consist of sales to Americas commercial and U.S. public sector markets. Sales to customers inside the United States comprised 90% of Americas net revenues during each of the three months ended July 25, 2014 and July 26, 2013. No single foreign country accounted for 10% or more of our net revenues for any period 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 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 includes costs associated with providing support activities for hardware maintenance, 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.


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



                                                Three Months Ended
                                       July 25,       July 26,
                                         2014           2013        % Change
           Cost of product revenues   $    394.2     $    449.9           (12 )%

The changes in cost of product revenues consisted of the following (in percentage points of the total change):

                                               Three Months Ended
                                           Fiscal  2015 to Fiscal 2014
                                                Percentage Change
                                                     Points
          Materials cost                                             (8 )
          Warranty                                                   (3 )
          Excess and obsolete inventory                              (1 )

          Total change                                              (12 )

Cost of product revenues represented 45% and 48% of product revenues for the three months ended July 25, 2014 and July 26, 2013, respectively.

Materials cost represented 85% and 83% of product costs for the three months ended July 25, 2014 and July 26, 2013, respectively.

Materials cost decreased $36.7 million in the three months ended July 25, 2014 compared to the three months ended July 26, 2013. Material costs were favorably impacted by a 2% unit volume decrease in configured systems in the three months ended July 25, 2014, compared to the corresponding period of the prior year. The average unit materials costs decreased for our FAS entry level and mid-range systems, but increased for our FAS high-end and E Series systems. Our overall materials unit cost for configured systems decreased due to favorable changes in product mix. Additionally, materials cost was favorably impacted by lower OEM product volume compared to the corresponding period in the prior year and to lower materials cost of add-on hardware, partially offset by higher materials cost of add-on storage. As a result of these factors, we experienced higher gross margins on products in the three months ended July 25, 2014 compared to the three months ended July 26, 2013. In addition, cost of product revenues in the three months ended July 25, 2014 was favorably impacted by a $13.4 million decrease in warranty expense and a $3.7 million decrease in excess and obsolete inventory write-downs compared to the corresponding period in the prior year.

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

                                                                       Three Months Ended
                                                            July 25,         July 26,
                                                              2014             2013          % Change
Cost of software entitlements and maintenance revenues     $      8.2        $     7.5               9 %

Cost of SEM revenues increased primarily due to higher royalty costs in the three months ended July 25, 2014 compared to the three months ended July 26, 2013. Cost of SEM revenues represented 4% and 3% of SEM revenues for the three months ended July 25, 2014 and July 26, 2013, respectively.

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



                                                 Three Months Ended
                                       July 25,       July 26,
                                         2014           2013         % Change
           Cost of service revenues   $    148.7     $    149.2             -  %

Cost of service revenues were relatively flat during the three months ended July 25, 2014 compared to the three months ended July 26, 2013, primarily due to an increase in spares materials costs, largely offset by lower logistics, materials rework and service delivery costs. Costs represented 39% and 42% of service revenues for the three months ended July 25, 2014 and July 26, 2013, respectively.

Operating Expenses

Sales and Marketing, Research and Development and General and Administrative Expenses

Compensation costs comprise the largest component of operating expenses. Included in compensation costs are salaries, benefits, other compensation-related costs, stock-based compensation expense and employee incentive compensation plan costs.

Total compensation costs included in operating expenses increased $1.7 million for the three months ended July 25, 2014 compared to the corresponding period in the prior year, reflecting relatively flat headcount compared to the prior year period.


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Sales and Marketing (in millions, except percentages):


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