NetApp
NetApp, Inc. (Form: 10-K, Received: 06/23/2011 16:09:57)
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-K

(Mark One)

 

þ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended April 29, 2011

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                     to                     

Commission File Number 0-27130

 

 

NetApp, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware   77-0307520
(State or other jurisdiction of
incorporation or organization)
  (IRS Employer
Identification No.)

495 East Java Drive,

Sunnyvale, California 94089

(Address of principal executive offices, including zip code)

Registrant’s telephone number, including area code:

(408) 822-6000

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

 

Name of Exchange on Which Registered

Common Stock, $0.001 Par Value   The NASDAQ Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act:

None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes   þ     No   ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes   ¨     No   þ

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   þ     No   ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   þ     No   ¨

Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  þ      Accelerated filer  ¨
Non-accelerated filer  ¨ (Do not check if a smaller reporting company)    Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ¨     No   þ

The aggregate market value of voting stock held by non-affiliates of the registrant, as of October 29, 2010, the last day of registrant’s most recently completed second fiscal quarter, was $13,007,545,610 (based on the closing price for shares of the registrant’s common stock as reported by the NASDAQ Global Select Market for the last business day prior to that date). Shares of common stock held by each executive officer, director, and holder of 5% or more of the outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

On June 10, 2011, 371,112,544 shares of the registrant’s common stock, $0.001 par value, were outstanding.

 

 

DOCUMENTS INCORPORATED BY REFERENCE

The information called for by Part III of this Form 10-K is hereby incorporated by reference from the definitive Proxy Statement for our annual meeting of stockholders, which will be filed with the Securities and Exchange Commission not later than 120 days after April 29, 2011.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

PART I   

Item 1

  

Business

     3   

Item 1A

  

Risk Factors

     13   

Item 1B

  

Unresolved Staff Comments

     37   

Item 2

  

Properties

     37   

Item 3

  

Legal Proceedings

     38   

Item 4

  

Submission of Matters to a Vote of Security Holders

     38   
PART II   

Item 5

  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     39   

Item 6

  

Selected Financial Data

     41   

Item 7

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     42   

Item 7A

  

Quantitative and Qualitative Disclosures About Market Risk

     69   

Item 8

  

Financial Statements and Supplementary Data

     72   

Item 9

  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     120   

Item 9A

  

Controls and Procedures

     120   

Item 9B

  

Other Information

     122   
PART III   

Item 10

  

Directors and Executive Officers of the Registrant

     122   

Item 11

  

Executive Compensation

     122   

Item 12

  

Security Ownership of Certain Beneficial Owners and Management

     122   

Item 13

  

Certain Relationships and Related Transactions

     122   

Item 14

  

Principal Accounting Fees and Services

     122   
PART IV   

Item 15

  

Exhibits and Financial Statement Schedules

     122   

Signatures

     123   

Schedule II

     125   

 

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PART I

 

Item 1. Business

Forward Looking Statements

This Annual Report on Form 10-K 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 convertible notes and associated warrants on our earnings per share;

 

   

the conversion, maturation or repurchase of the convertible notes,

 

   

compliance with laws, regulations and debt covenants;

 

   

the continuation of our stock repurchase program; and

 

   

the impact of completed acquisitions

are inherently uncertain as they are based on management’s current expectations and assumptions concerning future events, and they 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 new product introductions;

 

   

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

 

   

the general economic environment and the growth of the storage markets;

 

   

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;

 

   

our ability to successfully manage our backlog and increase revenue;

 

   

our ability to successfully execute on our strategy;

 

   

our ability to effectively integrate acquired products and technologies;

 

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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;

 

   

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;

 

   

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

 

   

those factors discussed under “Risk Factors” elsewhere in this Annual Report on Form 10-K.

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 foregoing factors as well as other important factors, including those described in the Risk Factors included in Item 1A.

Overview

NetApp, Inc. (NetApp) is a leading provider of storage and data management solutions that help increase IT efficiency and flexibility.

Customers around the world choose us for our broad portfolio of application, virtualization, cloud, and service provider solutions that help customers streamline operations and lower the costs associated with storing and managing their data.

We believe that our innovative technologies position us well to take advantage of the market shift from traditional dedicated storage to shared storage in virtualized IT infrastructures. Wherever an organization is on the path to a shared IT infrastructure, NetApp ® solutions bring immediate cost savings and help enable quick response to change. NetApp offers the optimal storage platform for delivering the sustained efficiency and flexibility customers need to enable business success.

Our products and services are designed to meet the expansive requirements and demanding service levels of large enterprises and their mission-critical business applications. In addition, we bring our affordable, enterprise-proven technology to midsize enterprises. To better meet the needs of our customers, we develop integrated solutions that optimize the performance of customers’ applications and their infrastructure in partnership with

 

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key industry leaders such as Cisco Systems, IBM, Microsoft, SAP, Symantec, and VMware. We also design our products to satisfy the demands of high-performance computing and technical data center applications, offering solutions used in the design of semiconductors and automobiles, as well as graphics rendering and seismic exploration.

We were incorporated in 1992 and shipped the world’s first networked storage appliance a year later. Since then, we have brought to market many innovations in storage and data management. We have grown to more than 11,000 employees, including approximately 1,000 additional employees from the recent acquisition of certain assets related to the Engenio external storage systems business (ESG) of LSI Corporation (LSI). We have operations in over 130 locations around the world.

NetApp Product Overview

NetApp offers highly available, scalable, and cost-effective storage solutions that incorporate our unified storage platform and the feature-rich functionality of our data and storage resource management software. The cost savings that can be realized from the NetApp Unified Storage Architecture and the infrastructure consolidation that can be achieved through a single storage platform are significant and can provide a strong platform for a service-oriented IT infrastructure. The NetApp Unified Storage Architecture, secure multi-tenancy capability, scalable systems, efficiency technologies, and data management software functionality provide a powerful combination for enterprises building internal private clouds and for service providers building IT-as-a-service offerings.

We believe that by providing greater efficiency and flexibility, our solutions help improve business productivity, performance, and profitability, while providing investment protection and enhanced asset utilization. Our enterprise-class storage solutions are complemented by our services expertise to enable interoperability and optimization in the context of the application and IT infrastructure within which they are deployed.

Data ONTAP Software

Our fabric-attached storage (FAS) and V-Series storage solutions are based on Data ONTAP ® , a highly scalable and flexible operating system that concurrently supports any mix of storage area network (SAN) and network-attached storage (NAS) environments. This unified storage software platform is compatible with UNIX ® , Linux ® , and Web environments.

The Data ONTAP operating system provides the foundation to build a shared storage infrastructure and an enterprise-wide data fabric for the full breadth of business applications and data storage and protection requirements. Data ONTAP features scalability, secure multi-tenancy, and unification across protocols and disks. Data ONTAP also unifies storage efficiency, data management, and data protection. We believe customers can benefit from these capabilities as they increasingly virtualize application environments. Our deduplication for primary and secondary storage, thin provisioning, and highly efficient hardware help maximize utilization while reducing data center footprint and lowering storage-related power and cooling consumption. A few of the technology features we offer with Data ONTAP include:

 

   

FlexShare ® technology, which directs how storage system resources are used to deliver an appropriate level of service for each application;

 

   

FlexCache ® technology, which allows performance acceleration through the creation of read-only cached volumes by creating caching volumes on multiple storage controllers;

 

   

MultiStore ® software, which allows partitioning of individual physical storage systems into multiple secure and separate logical partitions; and

 

   

RAID-DP ® , a standard Data ONTAP feature that safeguards data from double disk failure. Integrated with our WAFL ® (Write Anywhere File Layout) file system, RAID-DP gives customers data protection plus high performance.

 

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Storage Efficiency

NetApp’s portfolio of efficiency technologies helps our customers reduce their storage spending and get more from the storage assets they already own. Some of the efficiency technologies we offer include:

 

   

FlexVol ® technology, which provides for thin provisioning through virtual volumes, enabling storage architectures to be more efficient and achieve higher utilization using flexible volumes that do not require repartitioning of physical storage space;

 

   

FlexClone ® technology, which enables true data cloning using logical copies that do not require additional physical storage space and allows for instant replication of data volumes and datasets; and

 

   

Deduplication technology, which provides the ability to eliminate duplicate data within primary and secondary disk storage environments, resulting in greater efficiency and higher utilization of storage capacity.

Storage Management and Application Integration Software

NetApp OnCommand ® management software improves storage and service efficiency through functions that help customers control, automate, and analyze their shared storage infrastructures. Our management software family of products provides a broad range of storage and data management tools to simplify IT administration and enhance flexibility and productivity. We deliver differentiated products that support industry open standards and interfaces to deliver this value to customers. We tightly integrate our software with database and business application software from partners such as Microsoft, Oracle, SAP, and VMware in order to optimize the performance of those applications on our storage systems.

Through data center automation tools, we give customers the ability to monitor service levels, manage performance, and support change management in complex enterprise SAN environments. We help customers optimize shared infrastructures by supporting individual application performance, service level, and security needs even while the storage is shared across multiple applications.

FAS Unified Storage Systems Family

The NetApp family of modular, scalable, highly available, unified storage systems supports a full range of data for users on a variety of platforms. In the same way that server virtualization eliminates the sprawl in the application layer, NetApp’s FAS unified architecture streamlines, simplifies, and consolidates the storage layer. The FAS6200, FAS3200, and FAS2000 series of fabric-attached storage systems are designed to consolidate all types of storage workloads — including primary and secondary data, as well as structured and unstructured data — across all key OS platforms and network infrastructures. Also, NetApp unifies storage access for all standard network protocols based on a single HBA technology and standard IP networks. All NetApp FAS systems are interoperable and provide common software services. NetApp provides a data-in-place upgrade path that spans from entry-level platforms for smaller organizations all the way to high-end data center environments. The NetApp FAS unified architecture supports both scale-up and scale-out growth strategies running the highly efficient Data ONTAP operating system.

Virtual Storage Tier

Customers can increase the performance of a NetApp storage controller using our virtual storage tiering, which is available with our Flash Cache modular cache expansion. Virtual storage tiering lowers response times and increases input/output operations of solid state drives without storing additional data on them. Using dynamic storage tiering, it also improves application performance for production workloads residing on any type of disk drive. Dedupe capabilities reduce the I/O load on storage controllers to provide extreme scaling, especially useful with virtual- and cloud-based working sets.

 

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V-Series Family

Our V-Series family is a network-based virtualization solution that consolidates storage from different suppliers behind our data management interface, providing SAN and NAS access to the data stored in heterogeneous storage arrays. With the V-Series solution, customers are able to:

 

   

Transform existing heterogeneous, multivendor storage systems into a single storage pool;

 

   

Simplify storage provisioning and management with Data ONTAP thin provisioning; and

 

   

Dramatically lower backup time, space, and cost with Data ONTAP Snapshot ® copies.

The V-Series family is compatible with the FAS family of storage systems.

Data Protection Software Products

We offer a broad range of integrated data protection solutions for enterprise customer environments that can be tightly integrated with application offerings from partners to increase the speed and efficiency of data protection operations:

 

   

Snapshot technology enables near-instantaneous, space-efficient online backups of large datasets without affecting system performance;

 

   

SnapRestore ® technology uses stored Snapshot backups to recover entire file systems or data volumes in seconds, regardless of capacity or number of files;

 

   

SnapVault ® and Open Systems SnapVault technologies provide network- and storage-optimized disk-to-disk backup solutions;

 

   

MetroCluster™ uniquely combines array-based clustering with synchronous mirroring to deliver continuous availability and zero data loss; and

 

   

SnapMirror ® data replication solution provides disaster recovery protection for business-critical data matched to the recovery point objectives and recovery time objectives of customer environments.

Data Retention and Archive Products

To meet growing regulatory compliance demands faced by most enterprises, we offer a broad suite of products to help enable data permanence, accessibility, and privacy across a variety of different regulations such as the Sarbanes-Oxley Act, 21 CFR Part 11, SEC Rule 17a-4, and HIPAA. Cost-effective, resilient, and reliable storage architectures can be created utilizing NetApp SnapLock ® products.

Flash Cache

NetApp Flash Cache modules optimize the performance of random read-intensive workloads such as file services and messaging. These intelligent read caches speed access to user data, reducing latency by a factor of 10 or more compared to disk drives. Faster response times can translate into higher throughput for random I/O workloads. NetApp Flash Cache gives users performance that is comparable to that of solid state disks (SSDs) without the complexity of another storage tier.

Storage Security Products

Partnering with SafeNet, Inc. enables us to provide a unified platform for data security and key management across IP SAN, NAS, and tape backup environments. The platform combines wire-speed encryption, access controls, authentication, and automated key management to provide strong security for data at rest, while still allowing the capability to search compliant data for legal discovery purposes if the need arises. We also partner with Brocade Communications Systems, Inc. to provide advanced fabric services for SANs. These high-speed, highly reliable hardware devices deliver fabric-based encryption services to secure data assets either selectively or comprehensively.

 

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Object Storage

NetApp StorageGRID ® is a proven object storage software solution designed to manage petabyte-scale, globally distributed repositories of images, video, and records for enterprises and service providers. NetApp StorageGRID provides tremendous scalability by eliminating the typical constraints of data containers in blocks and files. It supports billions of files or objects and petabytes of capacity in hybrid cloud storage architectures with a single global namespace.

NetApp StorageGRID enables intelligent data management and secure content retention. Data placement and secure content retention are optimized by aligning system and business process management metadata with a global policy engine that manages how data is stored, placed, governed, protected, and retrieved. Content is protected from tampering using technologies such as digital fingerprints and encryption.

NetApp Services

Our customers demand high availability and reliability of their storage infrastructure to ensure the successful ongoing operation of their businesses. NetApp’s services are designed with this in mind. We provide professional services, global support solutions, and customer education and training to help customers most effectively manage their data. The professional services and support solutions we offer help our customers to resolve business problems, reduce costs, keep businesses up and running continuously, comply with regulations and policies, and improve overall operational results. We utilize a global, integrated model to provide consistent service delivery and global support during every phase of the customer engagement, including assessment and analysis, planning, design, installation, implementation, integration, optimization, ongoing support, and remote management and monitoring. Services and support often involve phased rollouts, technology transitions and migrations, and other long-term engagements.

Sales, Principal Markets, and Distribution Channels

We market and sell our products in numerous countries throughout the world, and we continue to make investments in our multiyear branding and awareness campaign to increase visibility of NetApp in the broader IT segment.

Our diversified customer base spans a number of customer segments and vertical markets, including energy, financial services, government, high technology, Internet, life sciences and healthcare services, major manufacturing, media, entertainment, animation and video postproduction, and telecommunications. We focus primarily on the data management and storage markets, offering an array of solutions from our high-end products designed for large enterprise customers to entry-level products designed for midsized enterprise customers.

To increase market share, we are focused on diversifying our multichannel distribution strategy. We are strengthening existing partnerships and investing in new partnerships with system integrators and cloud service providers.

As of the end of fiscal 2011, our worldwide sales and marketing function consisted of 4,808 managers, sales representatives, and technical support personnel. We have field sales offices in more than 40 countries. We employ a multichannel distribution strategy, selling products and services to end users and service providers through a direct sales force and through channel partners, including value-added resellers, system integrators, original equipment manufacturers (OEMs), and distributors. During fiscal year 2011, sales through our indirect channels represented 73% of our total net revenues. Sales to customers Arrow Electronics, Inc. and Avnet, Inc., who are distributors, accounted for approximately 18% and 12% of our net revenues, respectively, in fiscal 2011; approximately 14% and 11% of our net revenues, respectively, for fiscal 2010; and approximately 11% and 10% of our net revenues, respectively, for fiscal 2009. Information about our segment disclosures, foreign operations, and net sales attributable to our geographic regions is included in Note 16 of the accompanying consolidated financial statements.

 

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Seasonality

We have historically experienced a decline in revenues in the first quarter of our fiscal year, as the sales organization spends time developing new business after higher close rates in the fourth quarter, and because sales to European customers are historically weaker during the summer months. During the second quarter of our fiscal year, we have historically experienced increased sales, driven by the government sector, concurrent with the end of the U.S. federal government’s fiscal year in September, as well as an increase in business from European markets. We derive a majority of our revenue in any given quarter from orders booked in the same quarter. Bookings and revenues typically follow intraquarter seasonality patterns weighted toward the back end of the quarter.

Backlog

We manufacture products based on a combination of specific order requirements and forecasts of our customers’ demand. Orders are generally placed by customers on an as-needed basis. A substantial portion of our products is sold on the basis of standard purchase orders that are cancellable prior to shipment without penalty. In certain circumstances, purchase orders are subject to change with respect to quantity of product or timing of delivery resulting from changes in customer requirements. Our business is characterized by seasonal and intraquarter variability in demand, as well as short lead times and product delivery schedules. Accordingly, backlog at any given time may not be a meaningful indicator of future revenue.

Manufacturing and Supply Chain

We have outsourced manufacturing operations to third parties located in Memphis, Tennessee; Olive Branch, Mississippi; Livingston, Scotland; Schiphol Airport, The Netherlands; Shanghai and Longhua, China; Singapore and Guadalajara, Mexico. These operations include materials procurement, commodity management, component engineering, test engineering, manufacturing engineering, product assembly, product assurance, quality control, final test, and global logistics. We rely on a limited number of suppliers for materials, as well as several key subcontractors for the production of certain subassemblies and finished systems. We use multiple vendors and have our products manufactured in a number of locations wherever possible to mitigate our supply chain risk. Our strategy has been to develop close relationships with our suppliers, exchanging critical information and implementing joint quality programs. We also use contract manufacturers for the production of major subassemblies to improve our manufacturing continuity of business. This manufacturing strategy minimizes capital investments and overhead expenditures while creating flexibility for rapid expansion.

We were awarded ISO 9001 certification on May 29, 1997, and continue to be ISO 9001 certified. We were awarded ISO 14001 certification on December 8, 2004, and continue to be ISO 14001 certified.

Research and Development

We conduct research and development activities in various locations throughout the world. In fiscal 2011, 2010, and 2009, research and development expenses represented 13%, 14%, and 15% of our net revenues, respectively. These costs relate primarily to personnel and related costs incurred to conduct product development activities. Although we develop many of our products internally, we may acquire technology through business combinations or through licensing from third parties when appropriate. We believe that technical leadership is essential to our success, and we expect to continue to commit substantial resources to research and development.

Competition

We compete with many companies in the markets we serve, including companies that offer a broad spectrum of IT products and services and others that offer a more limited set of storage and data management products or services. In the primary storage market, our system products and associated software portfolio mainly compete with storage system products and data management software from Dell, EMC, Hitachi Data Systems,

 

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HP, IBM, and Oracle Corporation. In the secondary storage market, which includes the disk-to-disk backup, archival and compliance, and business continuity segments, our solutions mainly compete against products from EMC, Hitachi Data Systems, HP, IBM, and Oracle Corporation. In vertical markets — such as content storage, digital media, and graphics — our top competitors include EMC, Hitachi Data Systems, and HP. In the IT infrastructure and service provider markets, we compete primarily with EMC, Hitachi Data Systems, and HP.

We compete with these companies based on market presence, breadth of product offerings, breadth of service offerings and price. Some of these companies also compete by offering storage and data management products or services together with other IT products or services, at minimal or no additional cost, in order to preserve or gain market share.

We believe that we have a number of competitive advantages over many of these companies, including product innovation, the relationships we have with our customers, the deep integration we do with technology partners, and our collaboration with sales partners. We believe the advantages of our products include functionality, scalability, performance, flexibility, quality, and operational efficiency. We believe our advantage also includes the nature of the relationships we form with our customers and sales partners worldwide. We strive to deliver an outstanding experience in every interaction we have with our customers and partners through our product, service, and support offerings, which enable us to provide our customers with a full range of expertise before, during, and after their purchase from us or from one of our sales partners.

An increase in industry consolidation may result in stronger competitors that are better able to compete as sole-source vendors for customers. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties, including some of our partners. It is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share.

Proprietary Rights

We currently rely on a combination of copyright and trademark laws, trade secrets, confidentiality procedures, contractual provisions, and patents to protect our proprietary rights. We seek to protect our software, documentation, and other written materials under trade secret, copyright, and patent laws, which afford only limited protection. We have registered our NetApp name and logo, Network Appliance tm name and logo, Data ONTAP, DataFabric ® , FAServer ® , FlexVol, FilerView ® , NearStore ® , SecureShare ® , SnapDrive ® , SnapLock, SnapManager ® , SnapMirror, SnapRestore, SnapVault, WAFL, and others as trademarks in the United States. Other U.S. trademarks and U.S. registered trademarks are registered internationally as well. We will continue to evaluate the registration of additional trademarks as appropriate. We generally enter into confidentiality agreements with our employees, resellers, customers, and suppliers. We currently have multiple U.S. and international patent applications pending and multiple U.S. patents issued.

In addition, through various licensing arrangements, we receive certain rights to intellectual property of others. We expect to maintain current licensing arrangements and to secure licensing arrangements in the future, as needed and to the extent available on reasonable terms and conditions, to support continued development and sales of our products and services. Some of these licensing arrangements require or might require royalty payments and other licensing fees. The amount of these payments and fees might depend on various factors, including but not limited to the structure of royalty payments; offsetting considerations, if any; and the degree of use of the licensed technology.

The industry in which we compete is characterized by rapidly changing technology, a large number of patents, and frequent claims and related litigation regarding patent and other intellectual property rights, and we are exposed to various risks related to legal proceedings or claims and protection of intellectual property rights. If we are unable to protect our intellectual property, we might be subject to increased competition that could materially and adversely affect our operating results.

 

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Environmental Disclosure

NetApp is committed to minimizing environmental impact through use of NetApp products, activities, and services. The NetApp environmental management system (EMS) provides the framework for setting, implementing, and reviewing the company’s environmental objectives and targets. The NetApp EMS supports:

 

   

Commitment to complying with relevant environmental legislation, regulations, and other customer and community requirements;

 

   

Prevention of pollution;

 

   

Conservation of natural resources; and

 

   

Continual improvement of our environmental management system.

The NetApp EMS makes sure that activities, products, and services conform to the ISO 14001 standard and environmental requirements.

We are voluntarily measuring, monitoring, and publicly reporting our Scope 1 and Scope 2 greenhouse gas emissions. We have established employee commuter programs and education and awareness campaigns, and we continuously seek to optimize the energy efficiency of our buildings, labs, and data centers. At both the global and regional/state levels, various laws and regulations have been implemented or are under consideration to mitigate the effects of climate change caused by greenhouse gas emissions. Environmental laws are complex, change frequently, and have tended to become more stringent over time. It is often difficult to estimate the future impact of environmental matters. Based on current information and subject to the finalization of the proposed regulations, we believe that our primary risk related to climate change is the risk of increased energy costs. However, we do not anticipate being subject to a cap and trade system or any other mitigation measures that would be material to our operations in the near future. Additionally, we have implemented many disaster recovery and business resiliency measures to mitigate the physical risks our facilities, business, and supply chain might face as a consequence of severe weather/climate-related phenomena such as earthquakes, floods, droughts, and other such natural occurrences.

We are also subject to other federal, state, and local regulations regarding workplace safety and protection of the environment. Various international, federal, state, and local provisions regulate the use and discharge of certain hazardous materials used in the manufacture of our products. Failure to comply with environmental regulations in the future could cause us to incur substantial costs or subject us to business interruptions. We believe we are substantially compliant with all applicable environmental laws. All of our products meet the requirements for REACH, WEEE, RoHS, and China RoHS compliance. We have maintained an environmental management system since December 2004 as well as ISO 14001 certification at our corporate headquarters, which represents approximately 40% of our employee population and is one of the largest components of our corporate carbon footprint. As part of ISO 14001 requirements, we set environmental performance goals around reducing energy use per square foot as well as waste generated on site (per employee). We also conduct an annual review and third-party verified audits of our operations, and we monitor environmental legislation and requirements to help make sure we are taking necessary measures to remain in compliance with applicable laws, not only in our operations but also for our products.

Working Capital Practices

Information about our working capital practices is included in Item 7 — “Management’s Discussion and Analysis of Financial Condition and Results of Operation” under the heading “Liquidity and Capital Resources” and is incorporated herein by reference.

 

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Employees

As of April 29, 2011, we had 10,212 employees, of which 4,808 were in sales and marketing, 3,146 were in research and development, 1,248 were in services and manufacturing operations, and 1,010 were in finance and administration. In addition, we added approximately 1,000 employees as a result of the recent acquisition of ESG, which was completed on May 6, 2011. We have never had a work stoppage and consider relations with our employees to be good. Competition for technical personnel in the industry in which we compete is intense. We believe that our future success depends in part on our continued ability to hire, assimilate, and retain qualified personnel. To date, we believe that we have been successful in recruiting qualified employees, but there is no assurance that we will continue to be successful in the future.

Executive Officers

Our executive officers and their ages as of May 24, 2011, are as follows:

 

Name

   Age     

Position

Thomas Georgens

     51       President, Chief Executive Officer, Director

Manish Goel

     46       Executive Vice President, Products

Steven J. Gomo

     59      

Executive Vice President, Finance and Chief

Financial Officer

Matthew K. Fawcett

     43      

Senior Vice President, General Counsel and

Corporate Secretary

Robert E. Salmon

     50       Executive Vice President, Field Operations

Thomas Georgens is our president and chief executive officer. From February 2008 to August 2009, Mr. Georgens served as our president and chief operating officer and was responsible for all product operations and field operations worldwide. Mr. Georgens has also been a member of our Board of Directors since March 2008. Mr. Georgens joined NetApp in October 2005 as executive vice president and general manager of enterprise storage systems and was named executive vice president of product operations where he served in that role from January 2007 to February 2008. Before joining NetApp, Mr. Georgens spent nine years at Engenio, a former subsidiary of LSI Corporation, with the last two years as chief executive officer. He has also served in various other positions, including president of LSI Logic Storage Systems and executive vice president of LSI Corporation. Prior to LSI Corporation, Mr. Georgens spent 11 years at EMC in a variety of engineering and marketing positions. Mr. Georgens holds a BS degree and an ME degree in computer and systems engineering from Rensselaer Polytechnic Institute as well as an MBA degree from Babson College.

Manish Goel was appointed the executive vice president of product operations in June 2009, overseeing all aspects of technology strategy and product engineering across the Company’s product portfolio. Mr. Goel has held a variety of leadership roles in corporate development, sales, and business unit general management since he joined NetApp in 2002. Prior to NetApp, Mr. Goel led corporate and business development activities for Cadence Design Systems and Copper Mountain Networks. Prior to that, he spent four years as a strategy consultant for McKinsey and Co. and six years as a systems software engineer. Mr. Goel holds a BS degree in electrical engineering from IIT Chennai and an MBA degree in finance from the Wharton School of Business.

Steven J. Gomo joined NetApp in August 2002 as senior vice president of finance and chief financial officer. He was appointed executive vice president of finance and chief financial officer in October 2004. Prior to joining the Company, he served as chief financial officer for Gemplus International S.A., headquartered in Luxembourg from November 2000 to April 2002 and as chief financial officer of Silicon Graphics, Inc., from February 1998 to August 2000. Prior to February 1998, he worked at Hewlett-Packard Company for 24 years in various positions, including financial management, corporate finance, general management, and manufacturing. Mr. Gomo currently serves on the board of SanDisk Corporation and Enphase Energy. Mr. Gomo holds an MBA degree from Santa Clara University and a BS degree in business administration from Oregon State University.

 

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Matthew K. Fawcett joined the Company in September 2010 as senior vice president, general counsel and corporate secretary. Prior to joining NetApp, from 1999 to August 2010, Mr. Fawcett served in various legal positions at JDS Uniphase Corporation, including as senior vice president, general counsel and corporate secretary. Prior to joining JDSU, Mr. Fawcett was counsel at Fujitsu and worked in private practice at Morrison & Foerster LLP. Fawcett holds a BA degree from the University of California at Berkeley and a JD degree from the University of California at Los Angeles.

Robert E. Salmon joined NetApp in January 1994 and was appointed executive vice president, field operations in December 2005. Mr. Salmon has served as the Company’s executive vice president of worldwide sales since September 2004. From August 2003 to September 2004, Mr. Salmon served as the Company’s senior vice president of worldwide sales, and from May 2000 to August 2003, Mr. Salmon served as the Company’s vice president of North American sales. Prior to his tenure at NetApp Mr. Salmon spent nearly 10 years with Sun Microsystems and Data General Corporation. Mr. Salmon graduated from California State University, Chico with a BS degree in computer science.

Additional Information

Our Internet address is www.netapp.com. We make available through our Internet Web site our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.

The SEC maintains an Internet site ( www.sec.gov ) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The public also may read and copy these filings at the SEC’s Public Reference Room at 100 F Street N.E., Washington, DC 20549. Information about this Public Reference Room is available by calling (800) SEC-0330.

 

Item 1A. Risk Factors

The following risk factors and other information included in this Annual Report on Form 10-K should be carefully considered. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we presently deem less significant may also impair our business operations. Please see Item 1. Business — Forward Looking Statements of this Annual Report on Form 10-K for a discussion of the forward-looking statements that are qualified by these risk factors. If any of the events or circumstances described in the following risk factors actually occurs, our business, operating results, and financial condition could be materially adversely affected.

Our operating results may be adversely affected by uncertain economic and market conditions.

We are subject to the effects of general global economic and market conditions. Challenging economic conditions worldwide or in certain geographic regions have from time to time contributed to slowdowns in the computer, storage, and networking industries at large, as well as the information technology (IT) market, resulting in:

 

   

Reduced demand for our products as a result of constraints on IT-related spending by our customers;

 

   

Increased price competition for our products from competitors;

 

   

Deferment of purchases and orders by customers due to budgetary constraints or changes in current or planned utilization of our systems;

 

   

Risk of excess and obsolete inventories;

 

   

Risk of supply constraints:

 

   

Excess facilities costs;

 

   

Higher overhead costs as a percentage of revenues;

 

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Negative impacts from increased financial pressures on customers, distributors and resellers;

 

   

Negative impacts from increased financial pressures on key suppliers or contract manufacturers; and

 

   

Potential discontinuance of product lines or businesses and related asset impairments.

Any of the above-mentioned factors could have a material and adverse effect on our business and financial performance.

Our quarterly operating results may fluctuate, which could adversely impact our common stock price.

We believe that period-to-period comparisons of our results of operations are not necessarily meaningful and should not be relied upon as indicators of future performance. Our operating results have been in the past, and will continue to be, subject to quarterly fluctuations as a result of numerous factors, some of which may contribute to more pronounced fluctuations during times of economic volatility. These factors include, but are not limited to, the following:

 

   

Fluctuations in demand for our products and services, in part due to changes in general economic conditions and specific economic conditions in the storage and data management market;

 

   

A shift in federal government spending patterns;

 

   

Changes in sales and implementation cycles for our products and reduced visibility into our customers’ spending plans and associated revenues;

 

   

The level of price and product competition in our target markets;

 

   

The impact of economic uncertainty on our customers’ budgets and IT spending capacity;

 

   

Our ability to maintain appropriate inventory levels and purchase commitments;

 

   

Our reliance on a limited number of suppliers, and industry consolidation in our supply base, which could subject us to periodic supply-and-demand, price rigidity, and quality issues with our components;

 

   

The timing of bookings, the cancellation of significant orders and the management of, or fluctuations in, our backlog;

 

   

Product configuration and mix;

 

   

The extent to which our customers renew their service and maintenance contracts with us;

 

   

Seasonality, such as our historical seasonal decline in revenues in the first quarter of our fiscal year and seasonal increase in revenues in the second quarter of our fiscal year, with the latter due in part to the impact of the U.S. federal government’s September 30 fiscal year end on the timing of its orders;

 

   

Linearity, such as our historical intraquarter bookings and revenue pattern in which a disproportionate percentage of each quarter’s total bookings and related revenue occur in the last month of the quarter;

 

   

Announcements and introductions of, and transitions to, new products by us or our competitors;

 

   

Deferrals of customer orders in anticipation of new products or product enhancements introduced by us or our competitors;

 

   

Our ability to develop, introduce, and market new products and enhancements in a timely manner;

 

   

Our ability to effectively integrate acquired products and technologies;

 

   

Our levels of expenditure on research and development and sales and marketing programs;

 

   

Our ability to effectively manage our operating expenses;

 

   

Adverse movements in foreign currency exchange rates in the countries in which we do business;

 

   

The dilutive impact of our $1.265 billion of 1.75% convertible senior notes due June 2013 (the “Notes”) and related warrants on our earnings per share;

 

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Excess or inadequate facilities;

 

   

Actual events, circumstances, outcomes and amounts differing from judgments, assumptions, and estimates used in determining the values of certain assets (including the amounts of valuation allowances), liabilities, and other items reflected in our consolidated financial statements;

 

   

Disruptions resulting from new systems and processes as we continue to enhance and scale our system infrastructure;

 

   

Disruptions resulting from reliance on third-party systems and processes during the transition period following the completion of mergers or other acquisitions; and

 

   

Future accounting pronouncements and changes in accounting rules, such as the increased use of fair value measures, changes in accounting standards related to revenue recognition, lease accounting, and financial instruments and the potential requirement that U.S. registrants prepare financial statements in accordance with International Financial Reporting Standards (IFRS).

Due to such factors, operating results for future periods are difficult to predict, and, therefore, prior results are not necessarily indicative of results to be expected in future periods. Any of the foregoing factors, or any other factors discussed elsewhere herein, could have a material adverse effect on our business, results of operations, and financial condition. It is possible that in one or more quarters our results may fall below our forecasts and the expectations of public market analysts and investors. In such event, the trading price of our common stock would likely decrease.

Our revenues for a particular period are difficult to forecast, and a shortfall in revenues may harm our business and our operating results.

Our revenues for a particular period are difficult to forecast, especially in times of economic uncertainty. Because the storage and data management market is rapidly evolving, our sales cycle varies substantially from customer to customer, and we rely increasingly on sales through our indirect channel partners, including value-added resellers, systems integrators, distributors, OEMs and strategic business partners. New product introductions and the transition from old to new products also increase the complexities of forecasting revenues.

In addition, we derive a majority of our revenues in any given quarter from orders booked in the same quarter. Bookings typically follow intra-quarter seasonality patterns weighted toward the back end of the quarter. If we do not achieve bookings in the latter part of a quarter consistent with our quarterly targets, our financial results will be adversely impacted. Additionally, due to the complexities associated with revenue recognition, we may not accurately forecast our non-deferred and deferred revenues, which could adversely impact our results of operations.

We use a “pipeline” system, a common industry practice, to forecast bookings and trends in our business. Sales personnel monitor the status of potential business and estimate when a customer will make a purchase decision, the dollar amount of the sale and the products or services to be sold. These estimates are aggregated periodically to generate a bookings pipeline. Our pipeline estimates may prove to be unreliable either in a particular quarter or over a longer period of time, in part because the “conversion rate” of the pipeline into revenues varies from customer to customer, can be difficult to estimate, and requires management judgment, and also because customers’ purchasing decisions are subject to delay, reduction or cancellation. Small deviations from our forecasted conversion rate may result in inaccurate plans and budgets and could materially and adversely impact our business or our planned results of operations. In addition, the risks inherent in using a “pipeline” system are magnified with respect to indirect sales made through our channel partners because we have less control over, and visibility into, the sales process of our channel partners.

Economic uncertainties have caused, and may in the future again cause, consumers, businesses and governments to defer purchases in response to tighter budgets, credit, decreased cash availability and declining customer confidence. Accordingly, future demand for our products could differ from our current expectations.

 

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We have experienced periods of alternating growth and decline in revenues and operating expenses. If we are not able to successfully manage these fluctuations, our business, financial condition and results of operations could be significantly impacted.

Changing market conditions and economic uncertainty create a challenging operating environment for our business. It is critical that we maintain appropriate alignment between our cost structure and our expected growth and revenues, while at the same time, continuing to make strategic investments for future growth.

Our expense levels are based in part on our expectations as to future revenues, and a significant percentage of our expenses are fixed. We have a limited ability to quickly or significantly reduce our fixed costs, and if revenue levels are below our expectations, operating results will be adversely impacted. During periods of uneven growth, we may incur costs before we realize the anticipated related benefits, which could harm our operating results. We have made, and will continue to make, significant investments in engineering, sales, service and support, marketing programs and other functions to support and grow our business. We are likely to recognize the costs associated with these investments earlier than some of the related anticipated benefits (revenue growth), and the return on these investments may be lower, or may develop more slowly, than we expect, which could harm our business, operating results and financial condition.

Conversely, if we are unable to effectively manage our resources and capacity during periods of increasing demand for our products, we could also experience an adverse impact on our business, operating results and financial condition and our customer relationships may be adversely impacted. If the storage and data management market fails to grow, or grows slower than we expect, our revenues will be adversely affected. Also, even if spending in the IT market increases, our revenues may not grow at the same pace.

Our gross margins have varied over time and may continue to vary, and such variation makes it more difficult to forecast our earnings.

Our total gross margins are impacted by the mix of our product, software entitlements and maintenance and services revenues.

Our product gross margins have been and may continue to be affected by a variety of factors, including:

 

   

Demand for storage and data management products;

 

   

Pricing actions, rebates, sales initiatives, discount levels, and price competition;

 

   

Changes in the mix between direct versus indirect and OEM sales, particularly as a result of the recent acquisition of certain assets related to the Engenio external storage systems business (ESG) of LSI Corporation (LSI), which is based on a lower gross margin OEM business model;

 

   

Changes in customer, geographic, or product mix, including mix of configurations within products;

 

   

The timing and amount of revenue recognized and deferred;

 

   

New product introductions and enhancements;

 

   

Licensing and royalty arrangements;

 

   

Excess inventory levels or purchase commitments as a result of changes in demand forecasts or last time buy purchases;

 

   

Possible product and software defects as we transition our products; and

 

   

The cost of components, contract manufacturing costs, quality, warranty, and freight.

 

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Changes in software entitlements and maintenance gross margins may result from various factors, such as:

 

   

The size of the installed base of products under support contracts;

 

   

The timing of technical support service contract renewals; and

 

   

Demand for and the timing of delivery of upgrades.

Changes in service gross margins may result from various factors, such as:

 

   

The mix of customers;

 

   

The size and timing of service contract renewals;

 

   

Spares stocking requirements to support new product introductions;

 

   

The level of spending on our customer support infrastructure;

 

   

The volume, cost and use of outside partners to deliver support services on our behalf; and

 

   

Product quality and serviceability issues.

Due to such factors, gross margins are subject to variation from period to period and are difficult to predict.

An increase in competition and industry consolidation could materially and adversely affect our operating results.

The storage and data management markets are intensely competitive and are characterized by rapidly changing technology. In the storage market, our primary and near-line storage system products and our associated software portfolio compete primarily with storage system products and data management software from EMC (including its recent acquisition of Isilon), Hitachi Data Systems, HP, IBM, Dell and Oracle Corporation. In the secondary storage market, which includes the disk-to-disk backup, compliance and business continuity segments, our solutions compete primarily against products from EMC and Oracle Corporation.

There has been a trend toward industry consolidation in our markets for several years. We expect this trend to continue as companies attempt to strengthen or hold their market positions in an evolving industry, as companies become unable to maintain their competitive positions or continue operations and as customers demand more flexible business models and terms. We believe that industry consolidation may result in stronger competitors that are better able to compete for customers as sole-source vendors. In addition, current and potential competitors have established or may establish strategic alliances among themselves or with third parties, including some of our partners. It is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. We may not be able to compete successfully against current or future competitors. Competitive pressures we face could materially and adversely affect our business and operating results.

Disruption of, or changes in, our distribution model could harm our sales.

If we fail to develop and maintain strong relationships with our channel partners, or if our channel partners fail to effectively manage the sale of our products or services on our behalf, our revenues and gross margins could be adversely affected.

We market and sell our storage data management solutions directly through our worldwide sales force and indirectly through channel partners such as value-added resellers, systems integrators, distributors, OEMs and strategic business partners, and we derive a significant portion of our revenues from these indirect channels. During fiscal 2011, revenues generated from sales through our indirect channel distribution accounted for 73% of our revenues, and we expect this percentage to continue to increase over time as we further develop these channels or acquire products distributed through indirect channels. In order for us to maintain or increase our revenues, we must effectively manage our relationships with channel partners.

 

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Several factors could result in disruption of or changes in our indirect channel distribution model, which could materially harm our revenues and gross margins, including the following:

 

   

Our indirect channel partners may compete directly with other channel partners or with our direct sales force. Due to these conflicts, our indirect channel partners could stop or reduce their efforts in marketing our products.

 

   

Our indirect channel partners may demand that we absorb a greater share of the risks that their customers may ask them to bear;

 

   

Our indirect channel partners may have insufficient financial resources and may not be able to withstand changes and challenges in business conditions; and

 

   

Our indirect channel partners’ financial condition or operations may weaken.

There is no assurance that we will be able to attract new indirect channel partners, retain these indirect channel partners or that we will be able to secure additional or replacement indirect channel partners in the future, especially in light of changes in end customer demand patterns and changes in available and competing technologies from competitors. The loss of one or more of our key indirect channel partners in a given geographic area could harm our operating results within that area, as qualifying and developing new indirect channel partners typically requires a significant investment of time and resources before acceptable levels of productivity are met. Our inability to effectively establish, train, retain and manage our indirect channel partners could harm our sales.

In addition, we depend on our indirect channel partners to comply with applicable regulatory requirements in the jurisdictions in which they operate. Their failure to do so could have a material adverse effect on our revenues and operating results.

Our OEM relationship with IBM may not continue to generate significant revenues.

In April 2005, we entered into an OEM agreement with IBM, which enables IBM to sell IBM-branded solutions based on our unified solutions, including NearStore ® and V-Series systems, as well as associated software offerings. In addition, by acquiring ESG, we have assumed LSI’s rights under a second OEM agreement with IBM, which enables IBM to sell certain ESG solutions. While these agreements are part of our general strategy to expand our reach to more customers and into more countries, we do not have an exclusive relationship with IBM under either OEM agreement, and there is no minimum commitment for any given period of time. Therefore, our relationship with IBM may not continue to generate significant revenues or, in the case of the OEM agreement related to ESG, may not allow us to capture certain anticipated benefits of the ESG acquisition. In addition, we have no control over the products that IBM selects to sell, or its release schedule and timing of those products; nor do we control its pricing.

In the event that sales through our OEM relationship with IBM increase, which we expect will occur as a result of the ESG transaction, we may experience distribution channel conflicts between our direct sales force and the OEM or among our channel partners. If we fail to minimize channel conflicts, or if our OEM relationship does not continue to generate significant revenues, our operating results and financial condition could be harmed.

A portion of our revenues is generated by large, recurring purchases from various customers, resellers and distributors. A loss, cancellation or delay in purchases by any of these parties has and in the future could negatively affect our revenues.

During fiscal 2011, sales to distributors Arrow Electronics, Inc. and Avnet, Inc. accounted for approximately 18% and 12%, respectively of our net revenues. We also have significant OEM agreements with IBM, which, as described above, enable IBM to sell IBM-branded solutions based on our solutions, as well as an agreement with Fujitsu Technology Solutions (Fujitsu), which enables Fujitsu to lease, sell, market and resell our

 

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products to end users and Fujitsu sales partners worldwide, to integrate our products into Fujitsu bundled offerings, and to market our support services. The loss of orders from these, or any of our more significant customers, strategic partners, distributors or resellers could cause our revenues and profitability to suffer.

We generally do not enter into binding purchase commitments with our customers for an extended period of time, and thus we may not be able to continue to receive large, recurring orders from these customers, resellers or distributors. For example, our reseller agreements generally do not require minimum purchases and our customers, resellers and distributors can stop purchasing and marketing our products at any time.

Unfavorable economic conditions may negatively impact our operations by affecting the solvency of our customers, resellers and distributors, or the ability of our customers to obtain credit to finance purchases of our products. If the uncertainty in the economy continues, or conditions deteriorate, and our sales decline, our financial condition and operating results could be adversely impacted.

Because our expenses are based on our revenue forecasts, a substantial reduction or delay in sales of our products to, or unexpected returns from customers and resellers, or the loss of any significant customer or reseller, could harm our business. We expect that our largest customers in the future could be different from our largest customers today. End users could stop purchasing and indirect channel partners could stop marketing our products at any time. The loss of one or more of our key indirect channel partners or the failure to obtain and ship a number of large orders each quarter could harm our operating results. In addition, a change in the pricing practices of one or more of our large indirect channel partners could adversely affect our revenues and gross margins.

The U.S. government has contributed to our revenue growth and has become an important customer for us. Future revenues from the U.S. government are subject to shifts in government spending patterns. A decrease in government demand for our products could materially affect our revenues. In addition, our business could be adversely affected as a result of future examinations by the U.S. government.

The U.S. government has become an important customer for the storage and data management market generally and for us in particular; however, government demand is unpredictable, and there can be no assurance that we will maintain or grow our revenues from the U.S. government. Government agencies are subject to budgetary processes and expenditure constraints that could lead to delays or decreased capital expenditures in IT spending. If the government or individual agencies within the government reduce or shift their capital spending patterns, our revenues and operating results may be harmed.

In addition, selling our products to the U.S. government, whether directly or indirectly, also subjects us to certain regulatory requirements. For example, in April 2009, we entered into a settlement agreement with the United States of America, acting through the United States Department of Justice (DOJ) and on behalf of the General Services Administration (the “GSA”) related to a dispute regarding our discount practices and compliance with the price reduction clause provisions of GSA contracts for certain specified prior years. Failure to comply with U.S. government regulatory requirements by us or our reseller partners could subject us to fines and other penalties, which could have a material adverse effect on our revenues, operating results and financial position.

If we are unable to maintain our existing relationships and develop new relationships with major strategic partners, our revenues may be impacted negatively.

An element of our strategy to increase revenues is to strategically partner with major third-party software and hardware vendors to integrate our products into their products and also co-market our products with them. We have significant partner relationships with database, business application, backup management and server virtualization companies, including Microsoft, Oracle, SAP, Symantec and VMware. In January 2010, we announced an expansion of our collaboration with Cisco and VMware, including a cooperative support arrangement, and in October 2010, we expanded our relationship with Fujitsu Technology Solutions. A number

 

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of these strategic partners are industry leaders that offer us expanded access to segments of the storage and data management market. There is intense competition for attractive strategic partners, and even if we can establish relationships with these or other partners, these partnerships may not generate significant revenues or may not continue to be in effect for any specific period of time. If these relationships are not maintained or fail to materialize as expected, we could experience lower than expected revenue growth, suffer delays in product development, or experience other operational difficulties.

In addition, some of our partners, including Oracle, Cisco and VMware, are also partnering with other storage vendors which may increase the availability of competing solutions, harm our ability to continue as the vendor of choice for those partners and harm our ability to grow our business with those partners.

We intend to continue to establish and maintain business relationships with technology companies to expand our marketing reach and accelerate the development of our storage and data management solutions. To the extent that we are unsuccessful in developing new relationships or maintaining our existing relationships, our future revenues and operating results could be negatively impacted. In addition, the loss of a strategic partner could have a material adverse effect on our revenues and operating results.

Our future financial performance depends on growth in the storage and data management markets. If the performance of these markets does not meet the expectations upon which we calculate and forecast our revenues, our operating results will be materially and adversely impacted.

All of our products address the storage and data management markets. Accordingly, our future financial performance will depend in large part on continued growth in the storage and data management markets and on our ability to adapt to emerging standards in these markets. The markets for storage and data management have been recently adversely impacted by the global economic uncertainty, and as a result of continued uncertainty, the markets may not grow as anticipated or may decline.

Additionally, emerging standards in these markets may adversely affect the UNIX ® , Windows ® and the World Wide Web server markets upon which we depend. For example, we provide our open access data retention solutions to customers within the financial services, healthcare, pharmaceutical and government market segments, industries that are subject to various evolving governmental regulations with respect to data access, reliability and permanence (such as Rule 17(a)(4) of the Securities Exchange Act of 1934, as amended) in the United States and in the other countries in which we operate. If our products do not meet and continue to comply with these evolving governmental regulations in this regard, customers in these market and geographical segments will not purchase our products, and we will not be able to expand our product offerings in these market and geographical segments at the rates which we have forecasted.

Supply chain issues, including financial problems of contract manufacturers or component suppliers, or a shortage of adequate component supply or manufacturing capacity that increases our costs or causes a delay in our ability to fulfill orders, could have a material adverse impact on our business and operating results, and our failure to estimate customer demand properly may result in excess or obsolete component supply, which could adversely affect our gross margins.

The fact that we do not own or operate our manufacturing facilities and supply chain exposes us to risks, including reduced control over quality assurance, production costs and product supply, which could have a material adverse impact on the supply of our products and on our business and operating results. We rely on a limited number of suppliers for components utilized in the assembly of our products, which has and could subject us to future periodic supply constraints and price rigidity. In addition, pursuant to the terms of the asset purchase agreement we entered into with LSI in connection with the acquisition of certain assets related to ESG, we have the right to place orders with contract manufacturers and suppliers through LSI and access LSI’s systems in order to help us manage the ESG business for a period of time following the acquisition. Financial problems of either contract manufacturers, component suppliers or other parties in our supply chain, including LSI, and reservation

 

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of manufacturing capacity at our contract manufacturers by other companies, inside or outside of our industry, could either limit supply or increase costs of our products. Qualifying a new contract manufacturer and commencing volume production is expensive and time-consuming, and disruption or termination of manufacturing capacity with respect to any contract manufacturer could negatively impact our ability to manufacture and sell our products.

We intend to regularly introduce new products and product enhancements, which will require us to rapidly achieve volume production by coordinating with our contract manufacturers and suppliers. A reduction or interruption in supply; a significant increase in the price of one or more components; a failure to adequately procure inventory by our contract manufacturers; a failure to timely cancel, reschedule, or adjust our requirements based on our business needs; or a decrease in demand for our products could materially adversely affect our business, operating results, and financial condition and could materially damage customer relationships. Furthermore, as a result of binding price or purchase commitments with suppliers, we may be obligated to purchase components at prices that are higher than those available in the current market. In the event that we become committed to purchase components at prices in excess of the current market price when the components are actually used, our gross margins could decrease. As the demand for our products has increased, we have experienced, and may continue to experience tightening of supply of some components leading to longer lead times and component supply constraints, which has resulted in and in the future could continue to result in the delay of shipments.

Our business operations are subject to business interruptions and other events beyond our control. Such events could make it difficult or impossible for us to receive components from our suppliers and create delays and inefficiencies in our supply chain.

Our acquisitions may disrupt our existing business and harm our results of operations.

As part of our strategy, we are continuously evaluating opportunities to buy other businesses or technologies that would complement our current products, expand the breadth of our markets, or enhance our technical capabilities. In fiscal year 2011, we completed acquisitions of two technology companies, and on May 6, 2011, we completed the acquisition of certain assets related to ESG. The acquisition and ongoing integration of new businesses into our business may adversely affect our operations or profitability. We may not achieve the anticipated cost savings and synergies or realize our estimated revenue, gross margin, profit or other financial projections or business objectives in a timely manner or at all due to a number of factors, including the following:

 

   

The inability to successfully integrate the operations, technologies, products, personnel and business systems of the acquired companies;

 

   

In the case of an asset purchase, the failure to acquire all of the assets necessary to operate the acquired business;

 

   

The diversion of management’s attention from normal daily operations of the existing business;

 

   

The loss of key employees of the acquired business could adversely impact our ability to manage the business and our ability to realize our financial forecasts;

 

   

The inability to retain the customers and partners of acquired businesses following the acquisition;

 

   

Substantial transaction costs and accounting charges; and

 

   

Exposure to litigation related to acquisitions.

Acquisitions may also result in risks to our existing business, including:

 

   

Deterioration of our internal control over financial reporting as a result of inconsistencies between our standards, procedures and policies and those of the acquired business;

 

   

Reliance on the selling party’s processes, data, supply chain management and reporting during the transition period following the completion of an acquisition;

 

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Dilution of our current stockholders’ percentage ownership to the extent we issue new equity;

 

   

Assumption of additional liabilities;

 

   

Incurrence of additional debt or a decline in available cash;

 

   

Adverse effects to our financial statements, such as the need to incur restructuring charges;

 

   

Liability for intellectual property infringement and other litigation claims, which we may or may not be aware of at the time of acquisition; and

 

   

Creation of goodwill or other intangible assets that could result in significant future amortization expense or impairment charges.

The failure to achieve the anticipated benefits of an acquisition may also result in impairment charges for goodwill and purchased intangible assets. For example, we have in the past discontinued certain products which were originally acquired through business acquisitions. Additional or realized risks of this nature could have a material adverse effect on our business, financial condition and results of operations.

We are exposed to the credit and non-payment risk of our customers, resellers, and distributors, especially during times of economic uncertainty and tight credit markets, which could result in material losses.

Most of our sales to customers are on an open credit basis, with typical payment terms of 30 days. While we monitor individual customer payment capability in granting such open credit arrangements, and seek to limit such open credit to amounts we believe are reasonable, we may experience losses due to a customer’s inability to pay.

Beyond our open credit arrangements, we also have recourse and nonrecourse customer financing leasing arrangements using third-party leasing companies. Under the terms of recourse leases, which are treated as off-balance sheet arrangements, we remain liable for the aggregate unpaid remaining lease payments to the third-party leasing company in the event of end-user customer default.

We also offer financing arrangements whereby the end-user customer pays a fixed monthly amount plus a variable amount based on actual storage capacity used. These arrangements subject us to additional risk with respect to revenue recognition and profitability due to the uncertainties associated with the variable portion of the arrangements. In addition, from time to time we provide guarantees for a portion of other financing arrangements under which we could be called upon to make payments to our funding parties in the event of nonpayment by end-user customers.

We expect demand for customer financing to continue. During periods of economic uncertainty, our exposure to credit risks from our customers increases. In addition, our exposure to credit risks of our customers may increase further if our customers and their customers or their lease financing sources are adversely affected by global economic conditions.

In the past, there have been bankruptcies by our customers to whom we had extended open credit or provided lease financing arrangements, causing us to incur bad debt charges, and, in the case of financing arrangements, a loss of revenues. We may be subject to similar losses in future periods. Any future losses could harm our business and have a material adverse effect on our operating results and financial condition. Additionally, to the extent that the recent turmoil in the credit markets makes it more difficult for customers to obtain open credit or lease financing, those customers’ ability to purchase our products could be adversely impacted, which in turn could have a material adverse impact on our financial condition and operating results.

 

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The market price for our common stock has fluctuated significantly in the past and will likely continue to do so in the future.

The market price for our common stock has experienced substantial volatility in the past, and several factors could cause substantial fluctuation in the future. These factors include but are not limited to:

 

   

Fluctuations in our operating results compared to prior periods and forecasts;

 

   

Variations between our operating results and either the guidance we have furnished to the public or the published expectations of securities analysts;

 

   

Industry consolidation and the resulting perception of increased competition;

 

   

Economic developments in the storage and data management market as a whole;

 

   

Fluctuations in the valuation of companies perceived by investors to be comparable to us;

 

   

Changes in analysts’ recommendations or projections;

 

   

Changes in our relationships with our suppliers, customers, channel and strategic partners;

 

   

Announcements of the completion or dissolution of strategic alliances within the industry;

 

   

Dilutive impacts of our convertible Notes and related warrants;

 

   

International conflicts and acts of terrorism;

 

   

Announcements of new products, applications, or product enhancements by us or our competitors;

 

   

Announcements related to planned or completed mergers or other acquisitions by us or our competitors;

 

   

Inquiries by the SEC, NASDAQ, law enforcement, or other regulatory bodies; and

 

   

General market conditions, including recent global or regional economic uncertainties.

In addition, the stock market has experienced volatility that has particularly affected the market prices of the equity securities of many technology companies. Certain macroeconomic factors such as changes in interest rates, the market climate for the technology sector, and levels of corporate spending on IT, could continue to have an impact on the trading price of our stock, and the market price of our common stock may fluctuate significantly in the future.

Changes in market conditions have led, and in the future could lead, to charges related to the discontinuance of certain of our products and asset impairments.

In response to changes in economic conditions and market demands, we may decide to strategically realign our resources and consider cost containment measures including restructuring, disposing of, or otherwise discontinuing certain products. Any decision to limit investment in, dispose of, or otherwise exit products may result in the recording of charges to earnings, including inventory and technology-related or other intangible asset write-offs, workforce reduction costs, charges relating to consolidation of excess facilities, cancellation penalties or claims from third parties who were resellers or users of discontinued products, which would harm our operating results. Our estimates with respect to the useful life or ultimate recoverability of our carrying basis of assets, including purchased intangible assets, could change as a result of such assessments and decisions. Additionally, we are required to perform goodwill impairment tests on an annual basis, and between annual tests in certain circumstances when impairment indicators exist or if certain events or changes in circumstances have occurred. Future goodwill impairment tests may result in charges to earnings, which could materially harm our operating results.

 

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If we are unable to develop and introduce new products and respond to technological change, if our new products do not achieve market acceptance, if we fail to manage the interoperability and transition between our new and old products, or if we cannot provide the expected level of service and support for our new products, our operating results could be materially and adversely affected.

Our future growth depends upon the successful development and introduction of new hardware and software products. Due to the complexity of storage subsystems and storage security appliances and the difficulty in gauging the engineering effort required to produce new products, such products are subject to significant technical risks. In addition, our new products must respond to technological changes and evolving industry standards. If we are unable, for technological or other reasons, to develop and introduce new products in a timely manner in response to changing market conditions or customer requirements, or if such products do not achieve market acceptance, our operating results could be materially and adversely affected. New or additional product introductions increase the complexities of forecasting revenues, and subject us to additional financial and operational risks. If they are not managed effectively, we could experience material risks to our operations, financial condition and business model.

As new or enhanced products are introduced, we must attempt to successfully manage the interoperability and transition from older products in order to minimize disruption in customers’ ordering patterns, avoid excessive levels of older product inventories, and ensure that enough supplies of new products can be delivered to meet customers’ demands.

As we enter new or emerging markets, we will likely increase demands on our service and support operations and may be exposed to additional competition. We may not be able to provide products, service and support to effectively compete for these market opportunities.

Due to the global nature of our business, risks inherent in our international operations could have a material adverse effect on our business.

Although a substantial portion of our business is located and conducted in the United States, a significant portion of our operations are located, and a significant portion of our revenues are derived, outside of the United States. During fiscal 2011, our international revenues accounted for 49% of our total revenues. A substantial portion of our products are manufactured outside of the U.S., and we have research and development and service centers overseas. Accordingly, our business and our future operating results could be adversely affected by a variety of factors affecting our international operations, some of which are beyond our control, including regulatory, political, or economic conditions in a specific country or region, trade protection measures and other regulatory requirements, government spending patterns, and acts of terrorism and international conflicts. In addition, we may not be able to maintain or increase international market demand for our products.

We face exposure to adverse movements in foreign currency exchange rates as a result of our international operations. These exposures may change over time as business practices evolve, and they could have a material adverse impact on our financial results and cash flows. Our international sales are denominated in U.S. dollars and in foreign currencies. An increase in the value of the U.S. dollar relative to foreign currencies could make our products more expensive and therefore potentially less competitive in foreign markets. Conversely, lowering our price in local currency may result in lower U.S.-based revenues. A decrease in the value of the U.S. dollar relative to foreign currencies could increase operating expenses in foreign markets. Additionally, we have exposures to emerging market currencies, which can experience extreme volatility. We utilize forward and option contracts to hedge our foreign currency exposure associated with certain assets and liabilities as well as anticipated foreign currency cash flows on a short-term basis. All balance sheet hedges are marked to market through earnings every quarter. The time-value component of our cash flow hedges is recorded in earnings while all other gains and losses are marked to market through other comprehensive income until forecasted transactions occur, at which time such realized gains and losses are recognized in earnings. These hedges attempt to reduce, but do not always entirely eliminate, the impact of currency exchange movements. Factors that could have a

 

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negative impact on the effectiveness of our hedging program include inaccuracies in forecasting, widening interest rate differentials, and volatility in the foreign exchange market. Our hedging strategies may not be successful and currency exchange rate fluctuations could have a material adverse effect on our operating results.

Additional risks inherent in our international business activities generally include, among others, longer accounts receivable payment cycles and difficulties in managing international operations.

In addition, due to the global nature of our business, we are subject to complex legal and regulatory requirements in the United States and the foreign jurisdictions in which we operate and sell our products, including antitrust and anti-competition laws, rules and regulations, general import/export restrictions, and regulations related to data privacy. For example, United States Government export restrictions impede our ability to sell our products to certain end users. The United States, through the Bureau of Industry Security, places restrictions on the export of certain encryption technology. These restrictions may include: the requirement to have a license to export the technology; the requirement to have software licenses approved before export is allowed; and outright bans on the licensing of certain encryption technology to particular end users or to all end users in a particular country. Our products are subject to various levels of export restrictions. These export restrictions could negatively impact our business. We are also subject to the potential loss of proprietary information due to piracy, misappropriation or laws that may be less protective of our intellectual property rights than U.S. laws. Such factors could have an adverse impact on our business, operating results and financial position.

Moreover, in many foreign countries, particularly in those with developing economies, it is common to engage in business practices that are prohibited by our internal policies and procedures, or U.S. laws and regulations applicable to us, such as the Foreign Corrupt Practices Act. There can be no assurance that all of our employees, contractors and agents, as well as those companies to which we outsource certain of our business operations, will comply with these policies, procedures, laws and/or regulations. Any such violation could subject us to fines and other penalties, which could have a material adverse effect on our business, financial condition or results of operations.

Changes in our effective tax rate or adverse outcomes resulting from examination of our income tax returns could adversely affect our results.

Our effective tax rate could be adversely affected by several factors, many of which are outside of our control, including:

 

   

Earnings being lower than anticipated in countries where we are taxed at lower rates as compared to the U.S. statutory tax rate;

 

   

Material differences between forecasted and actual tax rates as a result of a shift in the mix of pretax profits and losses by tax jurisdiction, our ability to use tax credits, or effective tax rates by tax jurisdiction that differ from our estimates;

 

   

Changing tax laws or related interpretations, accounting standards, regulations, and interpretations in multiple tax jurisdictions in which we operate, as well as the requirements of certain tax rulings;

 

   

An increase in expenses not deductible for tax purposes, including certain stock-based compensation expense, write-offs of acquired in-process research and development, and impairment of goodwill;

 

   

The tax effects of purchase accounting for acquisitions and restructuring charges that may cause fluctuations between reporting periods;

 

   

Changes related to our ability to ultimately realize future benefits attributed to our deferred tax assets, including those related to other-than-temporary impairments;

 

   

Tax assessments resulting from income tax audits or any related tax interest or penalties could significantly affect our income tax provision for the period in which the settlements take place; and

 

   

A change in our decision to indefinitely reinvest foreign earnings.

 

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We receive significant tax benefits from sales to our non-U.S. customers. These benefits are contingent upon existing tax laws and regulations in the United States and in the countries in which our international operations are located. Future changes in domestic or international tax laws and regulations could adversely affect our ability to continue to realize these tax benefits. We have not provided for United States federal and state income taxes or foreign withholding taxes that may result from future remittances of undistributed earnings of foreign subsidiaries. The Obama administration and Congress have announced several proposals to reform United States tax rules, including proposals that may result in a reduction or elimination of the deferral of United States income tax on our future unrepatriated earnings. Should such anti-deferral provisions be enacted, our effective tax rate could be adversely affected.

We are currently undergoing federal income tax audits in the United States and several foreign tax jurisdictions. The rights to some of our intellectual property (IP) are owned by certain of our foreign subsidiaries, and payments are made between U.S. and foreign tax jurisdictions relating to the use of this IP in a qualified cost sharing arrangement. In recent years, several other U.S. companies have had their foreign IP arrangements challenged as part of IRS examinations, which has resulted in material proposed assessments and/or litigation with respect to those companies.

During fiscal year 2009, we received Notices of Proposed Adjustments from the IRS in connection with a federal income tax audit of our fiscal 2003 and 2004 tax returns. We filed a protest with the IRS in response to the Notices of Proposed Adjustments and subsequently received a rebuttal from the IRS examination team in response to our protest. In April 2011, we executed a closing agreement with the IRS Appeals Office to close this examination. The Notices of Proposed Adjustments in this audit focused primarily on issues relating to the timing and the amount of income recognized, deductions taken and on the level of cost allocations made to foreign operations during the audit years. The settlement of our 2003-2004 IRS examination resulted in additional liability of $10.8 million, which is almost entirely offset by net operating loss carryforwards. As a result of the examination settlement, we have reduced our reserve for uncertain tax positions and recognized a net benefit of $21.1 million.

During fiscal year 2010, the IRS commenced the examination of our fiscal 2005 through 2007 federal income tax returns, and in addition, the California Franchise Tax Board began the examination of our fiscal 2007 and 2008 California income tax returns. These audits are currently in progress.

On September 17, 2010, the Danish tax authorities issued a decision concluding that distributions declared in 2005 and 2006 from the Company’s Danish subsidiary, for which the Company has not paid or accrued any taxes, are subject to Danish at-source dividend withholding tax. The Company has appealed this assessment decision with the Danish National Tax Tribunal.

If the ultimate determination of income taxes or at-source withholding taxes assessed under the current IRS audits or under audits being conducted in any of the other tax jurisdictions in which we operate results in an amount in excess of the tax provision we have recorded or reserved for, our operating results, cash flows and financial condition could be adversely affected.

Our international operations currently benefit from a tax ruling concluded in the Netherlands which expires on April 30, 2015 and results in a lower level of earnings subject to tax in the Netherlands. If we are unable to negotiate a similar tax ruling upon expiration of the current ruling, our effective tax rate could increase and our operating results could be adversely affected. Our effective tax rate could also be adversely affected by different and evolving interpretations of existing law or regulations, which in turn would negatively impact our operating and financial results as a whole. Our effective tax rate could also be adversely affected if there is a change in international operations and how the operations are managed and structured. The price of our common stock could decline to the extent that our financial results are materially affected by an adverse change in our effective tax rate.

 

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Our leverage and debt service obligations and note conversion may adversely affect our financial condition, results of operations and earnings per share.

As a result of the sale of our Notes, we have a greater amount of debt than we have maintained in the past. In addition, we have various synthetic lease arrangements related to some of our facilities at our corporate headquarters in Sunnyvale, California, and, subject to the restrictions in our existing and any future financing agreements, we may incur additional debt. Our maintenance of higher levels of indebtedness could have adverse consequences including:

 

   

Impacting our ability to satisfy our obligations;

 

   

Increasing the portion of our cash flows from operations that may have to be dedicated to interest and principal payments and may not be available for operations, working capital, capital expenditures, expansion, acquisitions or general corporate or other purposes;

 

   

Impairing our ability to obtain additional financing in the future;

 

   

Limiting our flexibility in planning for, or reacting to, changes in our business and industry; and

 

   

Making us more vulnerable to downturns in our business, our industry or the economy in general.

Our ability to meet our expenses and debt obligations will depend on our future performance, which will be affected by financial, business, economic, regulatory and other factors. We will not be able to control many of these factors, such as economic conditions and governmental regulations. Furthermore, our operations may not generate sufficient cash flows to enable us to meet our expenses and service our debt. As a result, we may be required to repatriate funds from our foreign subsidiaries which could result in a significant tax liability to us. If we are unable to generate sufficient cash flows from operations, or if we are unable to repatriate sufficient or any funds from our foreign subsidiaries, in order to meet our expenses and debt service obligations, we may need to enter into new financing arrangements to obtain the necessary funds, or we may be required to raise additional funds through other means. If we determine it is necessary to seek additional funding for any reason, we may not be able to obtain such funding or, if funding is available, obtain it on acceptable terms. If we fail to make a payment on our debt, we could be in default on such debt, and this default could cause us to be in default on our other outstanding indebtedness.

Any conversion of our Notes may cause dilution to our shareholders and to our earnings per share. If the price of our common stock exceeds the conversion price, initially $31.85 per share, the Notes will cause an increase in diluted share count and result in lower reported earnings per share. For at least 20 trading days during the 30 consecutive trading days ended March 31, 2011, our common stock price exceeded the conversion threshold price of $41.41 per share set forth for these Notes. Accordingly, the Notes are convertible at the holder’s option through June 30, 2011. Based on the trading price of our common stock on April 29, 2011, we had approximately 16 million shares of common stock potentially issuable on conversion of our Notes. Upon conversion of any Notes, we will deliver cash up to the principal amount of the Notes and, with respect to any excess conversion value greater than the principal amount of the Notes, shares of our common stock, which would result in dilution to our shareholders.

The Note hedges and warrant transactions that we entered into in connection with the sale of the Notes may affect the trading price of our common stock.

In connection with the issuance of the Notes, we entered into privately negotiated convertible Note hedge transactions with certain option counterparties (the Counterparties), which are expected to offset the potential dilution to our common stock upon any conversion of the Notes. At the same time, we also entered into warrant transactions with the Counterparties pursuant to which we may issue shares of our common stock above a certain strike price. In connection with these hedging transactions, the Counterparties may have entered into various over-the-counter derivative transactions with respect to our common stock or purchased shares of our common stock in secondary market transactions at or following the pricing of the Notes. Such activities may have had the effect of increasing the price of our common stock. The Counterparties are likely to modify their hedge positions

 

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from time to time prior to conversion or maturity of the Notes by purchasing and selling shares of our common stock or entering into other derivative transactions. Additionally, these transactions may expose us to counterparty credit risk for nonperformance. The effect, if any, of any of these transactions and activities on the market price of our common stock or the Notes will depend, in part, on market conditions and cannot be ascertained at this time, but any of these activities could adversely affect the value of our common stock. In addition, if our stock price exceeds the strike price for the warrants, there could be additional dilution to our shareholders, which could adversely affect the value of our common stock.

In April 2010, we terminated our Note hedge transaction with Lehman Brothers OTC Derivatives, Inc. (Lehman OTC), which was a counterparty to 20% of our Note hedges, as a result of the bankruptcy filing by Lehman OTC, which constituted an event of default under the Note hedge. Because we have decided not to replace this Note hedge, we are subject to potential dilution on the unhedged portion of our Notes upon conversion if on the date of conversion the per-share market price of our common stock exceeds the conversion price of $31.85. The terms of the Notes, the rights of the holders of the Notes and other counterparties to Note hedges and warrants were not affected by the termination of this Note hedge.

The price of our common stock could also be affected by sales of our common stock by investors who view the Notes as a more attractive means of equity participation in our company and by hedging or arbitrage trading activity that we expect to develop involving our common stock by holders of the Notes. The hedging or arbitrage could, in turn, affect the trading price of the Notes and warrants.

Future issuances of common stock related to our Notes, warrants, stock options, restricted stock units, and our Employee Stock Purchase Plan may adversely affect the trading price of our common stock and the Notes.

The conversion of some or all of our outstanding Notes will dilute the ownership interest of existing stockholders to the extent we deliver common stock upon conversion of the Notes. For at least 20 trading days during the 30 consecutive trading days ended March 30, 2011, our common stock price exceeded the conversion threshold price of $41.41 per share set forth for these Notes. Accordingly, the Notes are convertible at the holder’s option through June 30, 2011. Upon conversion of any Notes, we will satisfy our obligation by delivering cash for the principal amount of the Notes and shares of common stock, if any, to the extent the conversion value exceeds the principal amount. Any new issuance of equity securities, including the issuance of shares upon conversion of the Notes or the exercise of related warrants which are not offset by our Note hedges, could dilute the interests of our then-existing stockholders, including holders who receive shares upon conversion of their Notes, and could substantially decrease the trading price of our common stock and the Notes. In addition, any sales in the public market of any common stock issuable upon such conversion or the exercise of warrants could adversely affect prevailing market prices of our common stock.

As of April 29, 2011, eligible individuals under our stock option and restricted stock unit plans held options to purchase approximately 25 million shares of our common stock and a total of approximately 10 million restricted stock units, respectively. If all the outstanding options were exercised, the proceeds to the Company would average approximately $27 per share. We also had 14 million shares of our common stock reserved for issuance under our stock plans with respect to equity awards that have not been granted. The exercise of all of the outstanding options and/or the vesting of all outstanding restricted shares and restricted stock units would dilute the interests of our then-existing stockholders, and any sales in the public market of the common stock issuable upon such exercise could adversely affect the trading price of our common stock.

In addition, we have an Employee Stock Purchase Plan (ESPP) under which employees are entitled to purchase shares of our common stock at 85% of the fair market value at certain specified dates over a two-year period. As of April 29, 2011, we had approximately 4 million shares of our common stock available for issuance under the ESPP. The issuance of shares under the ESPP would dilute the interests of our then-existing stockholders, and any sales in the public market of the common stock issuable upon such exercise could adversely affect the trading price of our common stock.

 

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We may issue equity securities in the future for a number of reasons, including to finance our operations related to business strategy (including in connection with acquisitions, strategic alliances or other transactions), to increase our capital, to adjust our ratio of debt to equity, to satisfy our obligations upon the exercise of outstanding warrants or options upon conversion of the Notes, or for other reasons.

We are exposed to fluctuations in the market values of our portfolio investments and in interest rates; impairment of our investments could harm our financial results.

At April 29, 2011, we had $5.2 billion in cash, cash equivalents, available-for-sale securities and restricted cash and investments. We invest our cash in a variety of financial instruments, consisting principally of investments in U.S. Treasury securities, commercial paper, U.S. government agency bonds, corporate bonds, certificates of deposit, and money market funds. These investments are subject to general credit, liquidity, market and interest rate risks, which have been exacerbated by unusual events such as the financial and credit crisis, and bankruptcy filings in the United States which have affected various sectors of the financial markets and led to global credit and liquidity issues. These securities are generally classified as “available-for-sale” and, consequently, are recorded on our consolidated balance sheets at fair value with unrealized gains or losses reported as a component of accumulated other comprehensive income (loss), net of tax.

Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate debt securities may have their market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates. Currently, we do not use derivative financial instruments in our investment portfolio. We may suffer losses if forced to sell securities that have experienced a decline in market value because of changes in interest rates. Currently, we do not use financial derivatives to hedge our interest rate exposure.

The fair value of our investments may change significantly due to events and conditions in the credit and capital markets. Any investment securities that we hold or the issues comprising such securities could be subject to review for possible downgrade. Any downgrade in these credit ratings may result in an additional decline in the estimated fair value of our investments. Changes in the various assumptions used to value these securities and any increase in the markets’ perceived risk associated with such investments may also result in a decline in estimated fair value.

On occasion, we make strategic investments in other companies, including private equity funds, which may decline in value and/or not meet desired objectives. The success of these investments depends on various factors over which we may have limited or no control. As of April 29, 2011, we had an investment with the carrying value of $1.3 million in a private equity fund.

In the event of adverse conditions in the credit and capital markets, our investment portfolio may be impacted and we could determine that some or all of our investments have experienced an other-than-temporary decline in fair value, requiring impairment, which could adversely impact our financial position and operating results.

A significant portion of our cash and cash equivalents balances are held overseas. If we are not able to generate sufficient cash domestically in order to fund our U.S. operations and strategic opportunities, and to service our debt, we may incur a significant tax liability in order to repatriate the overseas cash balances, or we may need to raise additional capital in the future.

A portion of our earnings which is generated from our international operations is held and invested by certain of our foreign subsidiaries. These amounts are not freely available for dividend repatriation to the United States without triggering significant adverse tax consequences. As a result, if the cash generated by our domestic operations is not sufficient to fund our domestic operations, our broader corporate initiatives such as stock repurchases, acquisitions, and other strategic opportunities, and to service our outstanding indebtedness, we may

 

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need to raise additional funds through public or private debt or equity financings, or we may need to obtain new credit facilities to the extent we choose not to repatriate our overseas cash. Such additional financing may not be available on terms favorable to us, or at all, and any new equity financings or offerings would dilute our current stockholders’ ownership. Furthermore, lenders, particularly in light of the current challenges in the credit markets, may not agree to extend us new, additional or continuing credit. If adequate funds are not available, or are not available on acceptable terms, we may be forced to repatriate our foreign cash and incur a significant tax expense or we may not be able to take advantage of strategic opportunities, develop new products, respond to competitive pressures or repay our outstanding indebtedness. In any such case, our business, operating results or financial condition could be adversely impacted.

Our synthetic leases are off-balance sheet arrangements that could negatively affect our financial condition and operating results. We have invested substantial resources in new facilities and physical infrastructure, which will increase our fixed costs. Our operating results could be harmed if our business does not grow proportionately to our increase in fixed costs.

We have various synthetic lease arrangements with BNP Paribas Leasing Corporation as lessor (BNPPLC) for our headquarters office buildings and land in Sunnyvale, California. These synthetic leases qualify for operating lease accounting treatment under the accounting guidance for leases and are not considered variable interest entities under applicable accounting guidance. Therefore, we do not include the properties or the associated debt on our consolidated balance sheets.

Our future minimum lease payments under these synthetic leases limit our flexibility in planning for, or reacting to, changes in our business by restricting the funds available for use in addressing such changes. If we are unable to grow our business and revenues proportionately to our increase in fixed costs, our operating results will be harmed. If we elect not to purchase the properties at the end of the lease term, we have guaranteed a minimum residual value to BNPPLC. If the fair value of the properties declines below that guaranteed minimum residual value, our residual value guarantee would require us to pay the difference to BNPPLC. As of April 29, 2011, the estimated fair value of the properties was approximately $35.8 million below the guaranteed minimum residual value, which we are accruing over the remaining term of the respective leases. Any further decline in the fair value of the properties could adversely impact our cash flows, financial condition and operating results.

As a result of excess capacity in our Sunnyvale facilities, certain of our facilities subject to synthetic lease arrangements have been subleased or are vacant. These subleases will expire at various times through 2015 and some are at terms that do not generate sufficient sublease income to cover the carrying costs of these facilities. In addition, we may experience changes in our operations in the future that could result in additional excess capacity and vacant facilities. We will continue to be responsible for all carrying costs of these facilities under operating leases until such time as we can sublease these facilities or terminate the applicable leases based on the contractual terms of the operating lease agreements, and these costs may have an adverse effect on our business, operating results and financial condition.

We are subject to restrictive and financial covenants in our synthetic lease arrangements. The restrictive covenants may restrict our ability to operate our business.

Our ongoing extension of credit under our synthetic lease arrangements are subject to continued compliance with financial covenants. If we do not comply with these restrictive and financial covenants or otherwise default under the arrangements, we may be required to repay any outstanding amounts or repurchase the properties which are subject to the synthetic lease arrangements. If we lose access to the synthetic lease arrangements, we may not be able to obtain alternative financing on acceptable terms, which could limit our operating flexibility.

The agreements governing our synthetic lease arrangements contain restrictive covenants that limit our ability to operate our business, including restrictions on our ability to:

 

   

Incur indebtedness;

 

 

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Incur indebtedness at the subsidiary level;

 

   

Grant liens;

 

   

Sell all or substantially all our assets:

 

   

Enter into certain mergers;

 

   

Change our business;

 

   

Enter into swap agreements;

 

   

Enter into transactions with our affiliates; and

 

   

Enter into certain restrictive agreements.

As a result of these restrictive covenants, our ability to respond to changes in business and economic conditions and to obtain additional financing, if needed, may be restricted. We may also be prevented from engaging in transactions that might otherwise be beneficial to us, such as strategic acquisitions or joint ventures.

Our failure to comply with the restrictive and financial covenants could result in a default under our synthetic lease arrangements, which would give the counterparties thereto the ability to exercise certain rights, including the right to accelerate the amounts owed thereunder and to terminate the arrangements. In addition, our failure to comply with these covenants and the acceleration of amounts owed under synthetic lease arrangements could result in a default under the Notes, which could permit the holders to accelerate the Notes. If all of our debt is accelerated, we may not have sufficient funds available to repay such debt.

We have credit exposure to our hedging counterparties.

In order to minimize volatility in earnings associated with fluctuations in the value of foreign currency relative to the U.S. Dollar, we utilize forward and option contracts to hedge our exposure to foreign currencies. As a result of entering into these hedging contracts with major financial institutions, we may be subject to counterparty nonperformance risk. Should there be a counterparty default, we could be exposed to the net losses on the hedged arrangements or be unable to recover anticipated net gains from the transactions.

Funds associated with certain of our auction rate securities may not be accessible for more than 12 months and our auction rate securities may experience further other-than-temporary declines in value, which would adversely affect our earnings.

Auction rate securities (ARSs) held by us are securities with long-term nominal maturities, which, in accordance with investment policy guidelines, had credit ratings of AAA and Aaa at time of purchase. Interest rates for ARS are reset through a “Dutch auction” each month, which prior to February 2008 had provided a liquid market for these securities.

All of our ARSs are backed by pools of student loans guaranteed by the U.S. Department of Education, and we believe the credit quality of these securities is high, based on this guarantee. However, liquidity issues in the global credit markets resulted in the failure of auctions for certain of our ARS investments, with a par value of $71.3 million. For each failed auction, the interest rate resets to a maximum rate defined for each security and the ARS continues to pay interest in accordance with its terms, although the principal associated with the ARS will not be accessible until there is a successful auction or such time as other markets for ARS investments develop or the final maturity of the individual securities.

As of April 29, 2011, we determined there was a total decline in the fair value of our ARS investments of approximately $6.2 million, of which we have recorded cumulative net temporary impairment charges of $4.1 million, and $2.1 million was recognized as an other-than-temporary impairment charge. In addition, we have classified all of our auction rate securities as long-term assets in our consolidated balance sheets at April 29, 2011 as our ability to liquidate such securities in the next 12 months is uncertain. Although we currently have the

 

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ability and intent to hold these ARS investments until recovery in market value or until maturity, if current market conditions deteriorate, or the anticipated recovery in market values does not occur, we may be required to record additional impairment charges in future quarters. We intend, and have the ability, to hold these investments until the market recovers.

We may need to undertake cost-reduction initiatives and restructuring initiatives in the future.

We have previously recognized restructuring charges related to initiatives to realign our business strategies and resize our business in response to economic and market conditions, including those announced in February 2009 and December 2008. We may undertake future cost-reduction initiatives and restructuring plans that may adversely impact our operations and we may not realize all of the anticipated benefits of our prior or any future restructurings.

Our business and operations are experiencing rapid growth and organizational change. If we fail to effectively manage such growth and change in a manner that preserves our reputation and the key aspects of our corporate culture, our business and operating results could be harmed.

Due to recent organic growth and acquisitions, we have experienced, and may continue to experience, rapid growth and organizational change, which has placed, and may continue to place, significant demands on our management, operational and financial resources. Our headcount has grown from approximately 8,300 employees on April 30, 2010 to over 11,000 employees following the ESG acquisition in May 2011. We will incur significant expenditures and the allocation of valuable management resources to assimilate our additional human resources in a manner that preserves the key aspects of our corporate culture and enables us to maintain our reputation in the marketplace. If we do not effectively manage our growth and train, retain and manage our employee base, our corporate culture could be undermined, the quality of our products and customer service could suffer, and our reputation could be harmed, each of which could adversely impact our business, financial condition and results of operations.

In addition, as our headcount increases, our costs will also increase. Our business will be harmed if our efforts to expand our organization and headcount are not accompanied by a corresponding increase in revenues.

If we are unable to establish fair value for any undelivered element of a sales arrangement, all or a portion of the revenues relating to the arrangement could be deferred to future periods.

In the course of our sales efforts, we often enter into multiple element arrangements that include software related elements consisting of non-essential software and undelivered software entitlements and maintenance. If we are required to change the pricing of our software-related elements through discounting, or otherwise introduce variability in the pricing of such elements, we may be unable to maintain Vendor Specific Objective Evidence of fair value of the undelivered elements of the arrangement, and would therefore be required to delay the recognition of all or a portion of the related arrangement. A delay in the recognition of revenues may cause fluctuations in our financial results and may adversely affect our operating margins.

We are continually seeking ways to make our cost structure, business processes and systems more efficient, including moving activities from higher-cost to lower-cost owned locations, outsourcing certain business process functions and implementing new business information systems. Problems with the execution of these activities could have an adverse effect on our business or results of operations.

We continuously seek to make our cost structure and business processes more efficient. We are focused on increasing workforce flexibility and scalability, and improving overall competitiveness by leveraging our global capabilities, as well as external talent and skills worldwide. For example, certain engineering activities and projects that were formerly performed in the U.S. have been moved to lower cost international locations and we rely on partners or third-party service providers for the provision of certain business process functions and activities in IT, human resources and accounting.

 

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The challenges involved with moving or outsourcing activities include executing business functions in accordance with local laws and other obligations while maintaining adequate standards, controls and procedures. We are also subject to increased business continuity risks as we increase our reliance on outsource providers. For example, we may no longer be able to exercise control over some aspects of the future development, support or maintenance of outsourced operations and processes, including the management and internal controls associated with those outsourced business operations and processes, which could adversely affect our business. If we are unable to effectively utilize or integrate and interoperate with external resources or if our partners or third party service providers experience business difficulties or are unable to provide business services as anticipated, we may need to seek alternative service providers or resume providing these business processes internally, which could be costly and time-consuming and have a material adverse effect on our operating results. In addition, we may not achieve the expected benefits of our business process improvement initiatives.

We are currently implementing changes to our business information systems and processes and other IT initiatives. These initiatives involve a large investment of capital and resources and significant changes to our current operating processes. Failure to properly implement one or more of these initiatives, or an interruption in service or unavailability of our systems, could result in lost business and increased costs which could negatively impact our business, results of operations and cash flows.

We are subject to risks related to the provision of employee health care benefits and recent health care reform legislation.

We use a combination of insurance and self-insurance for workers’ compensation coverage and health care plans. We record expenses under these plans based on estimates of the number and costs of expected claims, administrative costs and stop-loss premiums. These estimates are then adjusted each year to reflect actual costs incurred. Actual costs under these plans are subject to variability depending primarily upon participant enrollment and demographics, the actual number and costs of claims made and whether and how much the stop-loss insurance we purchase covers the cost of these claims. In the event that our cost estimates differ from actual costs, we could incur additional unplanned health care costs which could adversely impact our financial condition.

In March 2010, comprehensive health care reform legislation under the Patient Protection and Affordable Care Act (HR 3590) and the Health Care Education and Affordability Reconciliation Act (HR 4872) was passed and signed into law. Among other things, the health reform legislation includes guaranteed coverage requirements, eliminates pre-existing condition exclusions and annual and lifetime maximum limits, restricts the extent to which policies can be rescinded, and imposes new and significant taxes on health insurers and health care benefits. Provisions of the health reform legislation become effective at various dates over the next several years. The Department of Health and Human Services, the National Association of Insurance Commissioners, the Department of Labor and the Treasury Department have yet to issue necessary enabling regulations and guidance with respect to the health care reform legislation.

Due to the breadth and complexity of the health reform legislation, the lack of implementing regulations and interpretive guidance, and the phased-in nature of the implementation, it is difficult to predict the overall impact of the health reform legislation on our business over the coming years. Possible adverse affects of the health reform legislation include reduced revenues, increased costs, exposure to expanded liability and requirements for us to revise the ways in which we conduct business or risk of loss of business. In addition, our results of operations, financial position, and cash flows could be materially adversely affected.

We depend on attracting and retaining qualified personnel. If we are unable to attract and retain such personnel, our operating results could be materially and adversely impacted.

Our continued success depends, in part, on our ability to identify, attract, motivate and retain qualified personnel. Because our future success is dependent on our ability to continue to enhance and introduce new products, we are particularly dependent on our ability to identify, attract, motivate and retain qualified engineers with the requisite education, background and industry experience. Competition for qualified employees,

 

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particularly in Silicon Valley, can be intense. The loss of the services of a significant number of our employees, particularly our engineers, salespeople and key managers, could be disruptive to our development efforts or business relationships and could materially and adversely affect our operating results.

A component of our strategy to hire and retain personnel consists of long-term compensation in the form of equity-based grants. We face increased risk of the inability to continue to offer equity if we are unable to obtain shareholder approval in light of increased shareholder activism, heightened focus on corporate compensation practices, and increased scrutiny of the dilutive effects of such equity compensation programs. Such inability could adversely impact our ability to continue to attract and retain employees.

In addition, because of the structure of our incentive compensation plans, we may be at increased risk of losing employees and other service providers at certain points in time. For example, the retention value of our compensation plans decreases after the payment of bonuses or the vesting of stock options, employee stock purchase rights or other equity compensation. As a result, employees may be more likely to leave us during periods following such payments or the vesting of such rights. The loss of services of a significant number of our key employees during a short period of time could be disruptive to our product development and sales efforts and adversely impact our business relationships and operating results.

Our business could be materially and adversely affected as a result of a natural disaster, terrorist acts or other catastrophic events.

We depend on the ability of our personnel, raw materials, equipment and products to move reasonably unimpeded around the world. Any political, military, terrorism, global trade, world health or other issue that hinders this movement or restricts the import or export of materials could lead to significant business disruptions. Furthermore, any strike, economic failure or other material disruption caused by fire, floods, hurricanes, earthquakes, volcanoes, power loss, power shortages, environmental disasters, telecommunications or business information systems failures, break-ins and similar events could also adversely affect our ability to conduct business. If such disruptions result in cancellations of customer orders or contribute to a general decrease in economic activity or corporate spending on information technology, or directly impact our marketing, manufacturing, financial and logistics functions, our results of operations and financial condition could be materially adversely affected. In addition, our headquarters are located in Northern California, an area susceptible to earthquakes. If any significant disaster were to occur, our ability to operate our business could be impaired.

Undetected software errors, hardware errors, or failures found in new products may result in loss of or delay in market acceptance of our products, which could increase our costs and reduce our revenues. Product quality problems could lead to reduced revenues, gross margins and operating results.

Our products may contain undetected software errors, hardware errors or failures when first introduced or as new versions are released. Despite testing by us and by current and potential customers, errors may not be found in new products until after commencement of commercial shipments, resulting in loss of or delay in market acceptance, which could materially and adversely affect our operating results.

In addition, if we fail to remedy a product defect, we may experience a failure of a product line, temporary or permanent withdrawal from a product or market, damage to our reputation, inventory costs or product reengineering expenses, and these occurrences could have a material impact on our revenues, gross margins and operating results. We may be subject to losses that may result from or are alleged to result from defects in our products, which could subject us to claims for damages, including consequential damages.

 

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We are exposed to various risks related to legal proceedings or claims and protection of intellectual property rights, which could adversely affect our operating results.

We may be a party to lawsuits and other claims in the normal course of our business from time to time, including intellectual property, commercial, product liability, employment, class action, whistleblower and other litigation and claims, and governmental and other regulatory investigations and proceedings. Litigation can be expensive, lengthy and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict. An unfavorable resolution of a particular lawsuit could have a material adverse effect on our business, operating results, or financial condition.

If we are unable to protect our intellectual property, we may be subject to increased competition that could materially and adversely affect our operating results. Our success depends significantly upon our proprietary technology. We rely on a combination of copyright and trademark laws, trade secrets, confidentiality procedures, contractual provisions, and patents to protect our proprietary rights. We seek to protect our software, documentation and other written materials under trade secret, copyright and patent laws, which afford only limited protection. Some of our U.S. trademarks are registered internationally as well. We will continue to evaluate the registration of additional trademarks as appropriate. We generally enter into confidentiality agreements with our employees and with our resellers, strategic partners and customers. We currently have multiple U.S. and international patent applications pending and multiple U.S. patents issued. The pending applications may not be approved, and our existing and future patents may be challenged. If such challenges are brought, the patents may be invalidated. We may not be able to develop proprietary products or technologies that are patentable, and patents issued to us may not provide us with any competitive advantages and may be challenged by third parties. Further, the patents of others may materially and adversely affect our ability to do business. In addition, a failure to obtain and defend our trademark registrations may impede our marketing and branding efforts and competitive position.

Litigation may be necessary to protect our proprietary technology. Any such litigation may be time-consuming and costly. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or obtain and use information that we regard as proprietary. In addition, the laws of some foreign countries do not protect proprietary rights to as great an extent as do the laws of the United States. Our means of protecting our proprietary rights may not be adequate or our competitors may independently develop similar technology, duplicate our products, or design around patents issued to us or other intellectual property rights of ours.

We are subject to intellectual property infringement claims. We may, from time to time, receive claims that we are infringing third parties’ intellectual property rights. Third parties may in the future, claim infringement by us with respect to current or future products, patents, trademarks or other proprietary rights. We expect that companies in the network storage and data management market will increasingly be subject to infringement claims as the number of products and competitors in our industry segment grows and the functionality of products in different industry segments overlaps. Any such claims could be time consuming, result in costly litigation, cause product shipment delays, require us to redesign our products or enter into royalty or licensing agreements, any of which could materially and adversely affect our operating results. Such royalty or licensing agreements, if required, may not be available on terms acceptable to us or at all.

Our business could be materially adversely affected by changes in regulations or standards regarding energy efficiency of our products and climate change issues.

We continually seek ways to increase the energy efficiency of our products. Recent analyses have estimated the amount of global carbon emissions that are due to information technology products. As a result, governmental and non-governmental organizations have turned their attention to development of regulations and standards to drive technological improvements and reduce such amount of carbon emissions. There is a risk that the development of these standards will not fully address the complexity of the technology developed by the IT

 

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industry or will favor certain technological approaches. Depending on the regulations or standards that are ultimately adopted, compliance could adversely affect our business, financial condition or operating results.

Climate change issues, energy usage and emissions controls may result in new environmental legislation and regulations, at any or all of the international, federal and state levels, that may unfavorably impact us, our suppliers, and our customers in how we conduct our business including the design, development, and manufacturing of our products. This could cause us to incur additional direct costs in complying with any new environmental regulations, as well as increased indirect costs resulting from our customers, suppliers or both incurring additional compliance costs that get passed on to us. These costs may adversely impact our operations and financial condition.

Our business and results of operations could be adversely impacted as a consequence of regulations or business trends such as:

 

   

Decreased demand for storage products that produce significant greenhouse gases;

 

   

Increased demand for storage products that produce lower emissions and are more energy efficient, and increased competition to develop such products; and

 

   

Reputational risk based on negative public perception of publicly reported data on our greenhouse gas emissions.

Our business is subject to increasingly complex corporate governance, public disclosure, accounting and tax requirements that have increased both our costs and the risk of noncompliance.

Because our common stock is publicly traded, we are subject to certain rules and regulations of federal, state and financial market exchange entities charged with the protection of investors and the oversight of companies whose securities are publicly traded. These entities, including the Public Company Accounting Oversight Board, the SEC, and NASDAQ, have implemented requirements and regulations and continue developing additional regulations and requirements in response to corporate scandals and laws enacted by Congress, most notably the Sarbanes-Oxley Act of 2002. Our efforts to comply with these regulations have resulted in, and are likely to continue resulting in, increased general and administrative expenses and diversion of management time and attention from revenue-generating activities to compliance activities.

We have completed our evaluation of our internal controls over financial reporting for the fiscal year ended April 29, 2011 as required by Section 404 of the Sarbanes-Oxley Act of 2002. Although our assessment, testing and evaluation resulted in our conclusion that, as of April 29, 2011, our internal controls over financial reporting were effective, we cannot predict the outcome of our testing in future periods. If our internal controls are ineffective in future periods, our business and reputation could be harmed. We may incur additional expenses and commitment of management’s time in connection with further evaluations, both of which could materially increase our operating expenses and accordingly reduce our operating results.

On July 21, 2010, the President signed into law the Dodd-Frank Act. Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years, making it difficult to anticipate the overall financial impact on us. However, as we continue to implement changes in response to this new law and its associated regulations, we expect to incur additional operating costs that could have a material adverse effect on our financial condition and results of operations.

Because new and modified laws, regulations, and standards are subject to varying interpretations in many cases due to their lack of specificity, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This evolution may result in continuing uncertainty regarding compliance matters and additional costs necessitated by ongoing revisions to our disclosure and governance practices.

 

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If a data center or other third party who relies on our products experiences a disruption in service or a loss of data, such disruption or loss could be attributed to the quality of our products, thereby causing financial or reputational harm to our business.

Third-party vendors, including data centers, SaaS, cloud computing and Internet infrastructure and bandwidth providers rely on our products for their data storage needs. We exercise little control over how these third-party vendors use or maintain our products, and in some cases improper usage or maintenance could impair the performance of our products. A disruption in the services provided by these third-party vendors, or the loss of data stored by such vendors, could result in financial or reputational harm to our business to the extent that such disruption or loss is caused by, or perceived by our customers to have been caused by, defects in our products. Moreover, the risk of reputational harm may be magnified and/or distorted through the rapid dissemination of information over the Internet, including through news articles, blogs, chat rooms, and social media sites.

Security and privacy breaches may expose us to liability, and our reputation and business could suffer.

We obtain and store sensitive data related to our employees, customers and partners, including intellectual property, books of record and personally identifiable information. It is critical to our business strategy that our infrastructure remains secure and is perceived by our employees, customers and partners to be secure. If our security measures are breached as a result of technical problems, third-party actions, employee error, or malfeasance, our reputation could be damaged and our business could suffer.

Changes in financial accounting standards may cause adverse unexpected fluctuations and affect our reported results of operations.

A change in accounting standards or practices and varying interpretations of existing accounting pronouncements, such as the changes to revenue recognition standards that we recently adopted, the increased use of fair value measures, additional proposed changes to revenue recognition, lease accounting, financial instruments and other accounting standards, and the potential requirement that U.S. registrants prepare financial statements in accordance with International Financial Reporting Standards (IFRS), could have a significant effect on our reported financial results or the way we conduct our business.

Implementation of accounting regulations and related interpretations and policies, particularly those related to revenue recognition, could cause us to defer recognition of revenue or recognize lower revenue, which may affect our results of operations.

 

Item 1B. Unresolved Staff Comments

None.

 

Item 2. Properties

We own approximately 1.1 million square feet of facilities at our Sunnyvale, California headquarters, of which we occupy approximately 0.9 million square feet. In addition, we have commitments related to various lease arrangements with BNP Paribas LLC (BNP) for approximately 0.6 million square feet of additional facilities, of which we occupy approximately 0.3 million square feet (as further described below under “Contractual Obligations” in Item 7 and Note 18 of the accompanying consolidated financial statements under Item 8). Our headquarters site supports corporate general administration, sales and marketing, research and development, global services, and operations.

We own approximately 0.6 million square feet of facilities in Research Triangle Park (RTP), North Carolina, of which we occupy approximately 0.5 million square feet. This site supports research and development, global services and sales and marketing.

 

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In connection with the acquisition of ESG, which closed on May 6, 2011, we have acquired forty acres of land and a 0.3 million square foot facility in Wichita, Kansas. This site supports sales and marketing, research and development, and global services.

We lease and occupy approximately 0.3 million square feet of facilities in Bangalore, India. This site supports sales and marketing, research and development, and global services. We also own fifteen acres of land in Bangalore, India to be held for future development.

We lease other sales offices and research and development facilities throughout the U.S. and internationally. We expect that our existing facilities and those being developed worldwide are suitable and adequate for our requirements over at least the next two years and that additional space will be available as needed.

See additional discussion regarding properties in Note 18 of the accompanying consolidated financial statements under Item 8. and Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.

 

Item 3. Legal Proceedings

On October 13, 2010, Amalgamated Bank (as trustee of the Longview Largecap 500 Index Fund and the Longview Largecap 500 Index Veba Fund) filed a derivative lawsuit on behalf of NetApp, Inc. and NetApp U.S. Public Sector, Inc. in the Superior Court of the State of California, Santa Clara County. The lawsuit named 15 of our current and former directors as defendants. On February 3, 2011, the plaintiff filed an amended complaint in response to motions to dismiss that we and the individual defendants had filed. Like the original complaint, the amended complaint includes claims of breach of fiduciary duty and waste of corporate assets and alleges that the defendants failed to monitor internal controls to ensure that we complied with legal requirements in our General Services Administration (GSA) contracting activities, resulting in us incurring defense and settlement costs. The amended complaint seeks disgorgement of salaries and other compensation from the defendants and additional unspecified damages. We and the individual defendants filed motions to dismiss the amended complaint in early March 2011, and the hearing on these motions is scheduled for July 15, 2011.

 

Item 4. Reserved

 

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PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our common stock commenced trading on the NASDAQ Global Select Market (and its predecessor, the Nasdaq National Market) on November 21, 1995, and is traded under the symbol “NTAP.” As of June 10, 2011 there were 753 holders of record of the common stock. The closing price for our common stock on June 10, 2011 was $49.01. The following table sets forth for the periods indicated the high and low closing sale prices for our common stock as reported on the NASDAQ Global Select Market.

 

     Fiscal 2011      Fiscal 2010  
     High      Low      High      Low  

First Quarter

   $ 44.03       $ 31.47       $ 23.56       $ 16.93   

Second Quarter

     53.25         37.58         29.50         21.55   

Third Quarter

     59.48         49.25         34.54         27.60   

Fourth Quarter

     60.60         45.70         36.17         29.83   

The following graph shows a five-year comparison of cumulative total return on our common stock, the NASDAQ Composite Index and the S&P 500 Information Technology Index from April 30, 2006 through April 29, 2011. The past performance of our common stock is no indication of future performance.

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*

Among NetApp, Inc., The NASDAQ Composite Index

And The S&P Information Technology Index

LOGO

 

* $100 invested on 4/30/06 in stock or index, including reinvestment of dividends.

Fiscal year ending April 30.

Copyright © 2011 S&P, a division of The McGraw-Hill Companies Inc. All rights reserved.

 

     4/06      4/07      4/08      4/09      4/10      4/11  

NetApp, Inc.

     100.00         100.38         65.28         49.37         93.53         140.57   

NASDAQ Composite

     100.00         111.24         107.01         75.98         109.83         129.57   

S&P Information Technology

     100.00         109.94         111.04         81.40         116.80         132.17   

 

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We believe that a number of factors may cause the market price of our common stock to fluctuate significantly. See “Item 1A. Business — Risk Factors.”

Dividend Policy

We have never paid cash dividends on our capital stock. We currently anticipate retaining all available funds, if any, to finance internal growth and product development as well as other possible management initiatives, including stock repurchases and acquisitions. Payment of dividends in the future will depend upon our earnings and financial condition and such other factors as the Board of Directors may consider or deem appropriate at the time.

Securities Authorized for Issuance under Equity Compensation Plans

Information regarding securities authorized for issuance under equity compensation plans is incorporated by reference to our Proxy Statement for the 2011 Annual Meeting of Stockholders.

Unregistered Securities Sold in Fiscal 2011

We did not sell any unregistered securities during fiscal 2011.

Issuer Purchases of Equity Securities

On May 13, 2003, we announced that our Board of Directors had authorized a stock repurchase program. As of April 29, 2011, our Board of Directors had authorized the repurchase of up to $4,023.6 million of common stock under this program. We did not repurchase any common stock during the fiscal 2011. As of April 29, 2011, we had repurchased 104.3 million shares of our common stock at a weighted-average price of $28.06 per share for an aggregate purchase price of $2,927.4 million since inception of the stock repurchase program, and the remaining authorized amount for stock repurchases under this program was $1,096.3 million with no termination date.

 

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Item 6. Selected Financial Data

The following selected consolidated financial data set forth below was derived from our historical audited consolidated financial statements and should be read in conjunction with, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Financial Statements and Supplementary Data,” and other financial data included elsewhere in this Annual Report on Form 10-K. Our historical results of operations are not necessarily indicative of results of operations to be expected for any future period.

 

     Fiscal Year Ended  
     April 29,
2011
     April 30,
2010
     April 24,
2009
     April 25,
2008
     April 27,
2007
 
     (In millions, except per-share amounts)  

Net revenues(1)

   $ 5,122.6       $ 3,931.4       $ 3,406.4       $ 3,303.2       $ 2,804.3   

Total cost of revenue

     1,793.9         1,412.2         1,416.5         1,289.8         1,099.8   
                                            

Gross profit

     3,328.7         2,519.2         1,989.9         2,013.4         1,704.5   

Total operating expenses

     2,504.4         2,030.8         1,942.7         1,699.8         1,403.3   
                                            

Income from operations

     824.3         488.4         47.2         313.6         301.2   
                                            

Net income(1)

   $ 673.1       $ 400.4       $ 64.6       $ 309.7       $ 297.7   
                                            

Net income per share, basic

   $ 1.87       $ 1.18       $ 0.20       $ 0.88       $ 0.80   
                                            

Net income per share, diluted

   $ 1.71       $ 1.13       $ 0.19       $ 0.86       $ 0.77   
                                            

Shares used in basic net income per share calculation

     360.9         339.6         330.3         351.7         371.2   
                                            

Shares used in diluted net income per share calculation

     393.7         353.2         334.6         361.1         388.5   
                                            

 

     April 29,
2011
     April 30,
2010
     April 24,
2009
     April 25,
2008
     April 27,
2007
 
     (In millions)  

Cash, cash equivalents and short-term investments

   $ 5,174.7       $ 3,724.0       $ 2,604.3       $ 1,164.4       $ 1,308.8   

Working capital

     2,992.4         2,626.1         1,759.5         653.3         1,053.3   

Total assets

     8,498.8         6,494.4         5,384.4         4,071.0         3,658.5   

Short-term debt(2)

     1,150.4         —           —           —           85.1   

Long-term debt and other

     192.9         1,273.4         1,219.3         318.7         9.5   

Total stockholders’ equity

     3,730.2         2,530.5         1,784.2         1,700.3         1,989.0   

 

(1) In fiscal 2011, we adopted new accounting standards related to revenue recognition. Net revenues and net income were higher by $129.2 million and $53.0 million, respectively, as a result of adoption of these new standards. Net revenues for fiscal 2009 included a GSA settlement of $128.7 million.
(2) Based upon the closing price of our common stock for the prescribed measurement period in fiscal 2011, the contingent conversion threshold of the 1.75% Convertible Senior Notes due 2013 (the Notes) was exceeded as of April 29, 2011. As a result, the Notes are convertible at the option of the holder through June 30, 2011. Accordingly, since the terms of the Notes require the principal to be settled in cash, we reclassified from stockholders’ equity to temporary equity the portion of the Notes attributable to the conversion feature which had not yet been accreted to its face value and the Notes have been classified as a current liability. For the holders to be able to continue to convert the Notes, our closing stock price must exceed $41.41 for 20 out of the last 30 trading days of each future calendar quarter. If this threshold is not met, the Notes will be reclassified to long-term debt and the remaining portion of the Notes attributable to the conversion feature not yet accreted to its face value will be reclassified back to equity.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial condition and results of operations should be read together with the financial statements and the related notes set forth under “Item 8. Financial Statements and Supplementary Data”. The following discussion also contains trend information and other forward looking statements that involve a number of risks and uncertainties. The Risk Factors set forth in “Item 1. Business” are hereby incorporated into the discussion by reference.

Overview

Revenues for fiscal 2011 were $5.1 billion, up $1.2 billion, or 30%, from fiscal 2010. The improved revenue performance in fiscal 2011 was predominantly the result of strong demand for our storage efficiency and data management solutions including the new products launched in November 2010. Additionally, net revenues for fiscal 2011 include a favorable impact of $129.2 million from the adoption of new accounting standards related to revenue recognition. Revenues for fiscal 2010 were $3.9 billion, up $0.5 billion, or 15%, from fiscal 2009. Improved revenue performance in fiscal 2010 was the result of improvements in product, software entitlements and maintenance (SEM) and service revenues. Revenues in fiscal 2009 were negatively impacted by a $128.7 million settlement with the General Services Administration (GSA). The dispute related to our discounting practices and compliance with the price reduction provisions of GSA contracts between August 1997 and February 2005.

Gross profit as a percentage of net revenues increased during fiscal 2011 primarily as a result of higher product and service revenues at improved margins. The gross profit margin percentage increased during fiscal 2010 due largely to reductions in product materials cost, partially offset by a decrease in the overall average selling prices of our products, as well as an increase in our SEM and services revenues mix relative to product revenues. In addition, our gross profit margin percentage in fiscal 2009 was negatively impacted by the GSA settlement.

Operating expenses, excluding restructuring and other charges and acquisition related (income) expense, net, for fiscal 2011 totaled $2.5 billion, up 21% from fiscal 2010. The increase is primarily due to a 17% increase in average headcount in fiscal 2011 and higher levels of incentive compensation and commission expense due to higher revenues and operating profits. Salary and related expenses during fiscal 2011 were favorably impacted by having 52 weeks in fiscal 2011 compared to 53 weeks in fiscal 2010. During fiscal 2010, operating expenses, excluding restructuring and other charges and acquisition related (income) expense, net, totaled $2.1 billion, up 10% from fiscal 2009 and reflected the impact of an increase in incentive compensation and commissions expense related to our stronger sales and operating profit performance, as well as having 53 weeks in fiscal 2010 compared to 52 weeks in fiscal 2009.

During fiscal 2010, we entered into a merger agreement with Data Domain, Inc., which was subsequently terminated on July 8, 2009. In accordance with the agreement, we received a $57.0 million termination fee, which, when netted against $15.9 million of incremental third-party costs we incurred relating to the terminated merger transaction, resulted in net proceeds of $41.1 million.

Subsequent Event

On May 6, 2011, we completed the acquisition of certain assets and liabilities related to the Engenio external storage systems business (ESG) of LSI Corporation (LSI). We paid LSI $480 million in cash and assumed certain assets and liabilities related to ESG. This acquisition will enable us to further expand our OEM channel, and address emerging and fast-growing segments of the storage market such as video, including full-motion video capture and digital video surveillance, as well as high-performance computing applications, such as genomics sequencing and scientific research.

 

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The transaction is expected to materially impact our results of operations in fiscal 2012 and beyond. We expect fiscal 2012 ESG product revenues to consist primarily of revenues from sales to their existing OEMs, with new business developing slowly over the course of the year. The fiscal 2012 consolidated product gross margin percentage is expected to decrease compared to fiscal 2011, reflecting the impact on our existing business of the lower gross margin ESG OEM revenues.

Critical Accounting Estimates and Policies

Our discussion and analysis of financial condition and results of operations are based upon our 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 period and the reported amounts of assets and liabilities as of the date of the financial statements. Our estimates are based on historical experience and other assumptions that we consider to be appropriate in the circumstances. However, actual future results may vary from our estimates.

We believe that the following accounting policies are significantly affected by critical accounting estimates and that they are both highly important to the portrayal of our financial condition and results and require difficult management judgments and assumptions about matters that are inherently uncertain. Note 2 of the accompanying consolidated financial statements describes the significant accounting policies used in the preparation of the consolidated financial statements. Certain of these significant accounting policies are considered to be critical accounting policies.

We believe the accounting policies described below are those that most frequently require us to make estimates and judgments and therefore are critical to the understanding of our results of operations.

Revenue Recognition, Reserves and Allowances

Revenue Recognition  — We recognize revenue when:

 

   

Persuasive evidence of an arrangement exists:  It is our customary practice to have a purchase order and/or contract prior to recognizing revenue on an arrangement from our end users, customers, value-added resellers, or distributors.

 

   

Delivery has occurred:  Our product is physically delivered to our customers, generally with standard transfer terms such as FOB origin. We typically do not allow for restocking rights with any of our value-added resellers or distributors. Products shipped with acceptance criteria or return rights are not recognized as revenue until all criteria are achieved. If undelivered products or services exist that are essential to the functionality of the delivered product in an arrangement, delivery is not considered to have occurred.

 

   

The fee is fixed or determinable:  Arrangements with payment terms extending beyond our standard terms, conditions and practices are not considered to be fixed or determinable. Revenue from such arrangements is recognized at the earlier of customer payment or when the fees become due and payable. We typically do not allow for price-protection rights with any of our value-added resellers or distributors.

 

   

Collection is reasonably assured:  If there is considerable doubt surrounding the credit worthiness of a customer at the outset of an arrangement, the associated revenue is deferred and recognized upon cash receipt.

Our multiple element arrangements include our systems and one or more of the following undelivered elements: SEM and premium hardware maintenance. Our SEM entitle our customers to receive unspecified product upgrades and enhancements on a when-and-if-available basis, bug fixes, and patch releases. Premium hardware maintenance services include contracts for technical support and minimum response times. Revenues

 

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from SEM and premium hardware maintenance services are recognized ratably over the contractual term, generally from one to five years. We also offer extended service contracts (which extend our standard parts warranty and may include premium hardware maintenance) at the end of the warranty term; revenues from these contracts are recognized ratably over the contract term. We also sell professional services either on a time and materials basis or under fixed price standard projects; we recognize revenue for these services as they are performed. Revenue from hardware installation services is recognized in the period the services are delivered.

In October 2009, the FASB amended the accounting standards for revenue recognition to exclude tangible products containing software components and non-software components that function together to deliver the tangible product’s essential functionality from the scope of the software revenue recognition guidance. Concurrently, the FASB also amended the accounting standards for multiple deliverable revenue arrangements to:

 

   

provide updated guidance on whether multiple deliverables exist, how the deliverables in an arrangement should be separated, and how the arrangement consideration should be allocated among its elements;

 

   

require an entity to allocate revenue in an arrangement that has separate units of accounting using best estimated selling prices (BESP) of deliverables if a vendor does not have vendor-specific objective evidence (VSOE) of fair value or third-party evidence of selling price (TPE); and

 

   

eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method to the separate units of accounting.

We elected to early adopt these standards in the fourth quarter of fiscal 2011, and the standards were applied retrospectively from the beginning of fiscal 2011 for new and materially modified revenue arrangements originating after April 30, 2010.

The majority of our products are hardware systems containing software components that function together to provide the essential functionality of the product. Therefore, our hardware systems and software components essential to the functionality of the hardware systems are considered non-software deliverables and therefore are not subject to industry-specific software revenue recognition guidance.

Our product revenue also includes revenue from the sale of non-essential software products. Non-essential software products may operate on our hardware systems, but are not considered essential to the functionality of the hardware. Non-essential software sales generally include a perpetual license to our software. Non-essential software sales continue to be subject to the industry-specific software revenue recognition guidance. For arrangements within the scope of the new guidance, a deliverable constitutes a separate unit of accounting when it has standalone value and there are no customer negotiated refunds or return rights for the delivered elements.

For transactions entered into or materially modified after April 30, 2010, we recognize revenue in accordance with the new accounting standards when applicable. Certain arrangements with multiple deliverables may continue to have software deliverables that are subject to the existing software revenue recognition guidance along with non-software deliverables that are subject to the new standards. The revenue for these multiple element arrangements is allocated to the software deliverables and the non-software deliverables as a group based on the relative selling prices of all of the deliverables in the arrangement using the selling price hierarchy set forth in the new standards.

For our non-software deliverables, we recognize revenue based on the new standards and allocate the arrangement consideration based on the relative selling price of the deliverables. For our non-software deliverables, we use BESP as our selling price. For our software entitlements and support services, we generally use VSOE as our selling price. When we are unable to establish selling price using VSOE for our software entitlements and support services, we use BESP in our allocation of arrangement consideration.

 

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VSOE of fair value for elements of an arrangement is based upon the normal pricing and discounting practices for those services when sold separately. In determining VSOE, we require that a substantial majority of the selling prices for an element fall within a reasonably narrow pricing range, generally evidenced by a substantial majority of such historical stand-alone transactions falling within a reasonably narrow range. In addition, we consider major service type, customer classifications, and other variables in determining VSOE.

When VSOE cannot be established, the Company attempts to establish selling price of each element based on TPE. TPE is determined based on competitor prices for similar deliverables when sold separately. Generally, our go-to-market strategy differs from that of our peers and our offerings contain a significant level of differentiation such that the comparable pricing of products with similar functionality cannot be obtained. Furthermore, we are unable to reliably determine what similar competitor products’ selling prices are on a stand-alone basis. Therefore, the Company is typically not able to determine TPE for our products or services.

When we are unable to establish selling price of our non-software deliverables using VSOE or TPE, we use BESP in our allocation of arrangement consideration. The objective of BESP is to determine the price at which we would transact a sale if the product or service were sold on a stand-alone basis. BESP is determined for a product or service by considering multiple factors including, but not limited to, cost of products, gross margin objectives, historical pricing practices, customer classes and distribution channels. In determining BESP, we require that the majority of the selling prices fall within a reasonable pricing range, generally evidenced by a majority of such historical transactions falling within a reasonable range.

We regularly review VSOE, TPE, and BESP and maintain internal controls over the establishment and updates of these estimates.

For sales of software deliverables after April 30, 2010 and for all transactions entered into prior to the first quarter of fiscal year 2011, we recognize revenue based on software revenue recognition guidance. Under the software revenue recognition guidance, we use the residual method to recognize revenue when a multiple element arrangement includes one or more elements to be delivered at a future date and VSOE of fair value of all undelivered elements exists. In the majority of our contracts, the only element that remains undelivered at the time of delivery of the product is SEM and/or service. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the contract fee is recognized as product revenue. If evidence of the fair value of one or more undelivered elements does not exist, all revenue is generally deferred until the earlier of when delivery of those elements occurs or when fair value can be established. In instances where the only undelivered element without fair value is SEM, the entire arrangement is recognized ratably over the maintenance period.

Net revenues and net income for the year ended April 29, 2011 were higher by $129.2 million and $53.0 million, respectively, as a result of adoption of the new revenue recognition accounting standards. We are not able to reasonably estimate the effect of adopting these standards on future financial periods as the impact will vary based on the nature and volume of new or materially modified sales transactions in any given period. In terms of the timing and pattern of revenue recognition, we expect that these new accounting standards will facilitate our efforts to optimize our offerings due to better alignment between the economics of an arrangement and the related accounting. This may lead us to engage in new go-to-market practices in the future. In particular, we expect that the amended accounting standards will enable us to better integrate products and services (for which we have not established VSOE) into existing offerings and solutions. As our go-to-market strategies evolve, we may modify our pricing practices in the future, which could result in changes in selling prices, including both VSOE and BESP.

We record reductions to revenue for estimated sales returns at the time of shipment. Sales returns are estimated based on historical sales returns, current trends, and our expectations regarding future experience. We monitor and analyze the accuracy of sales returns estimates by reviewing actual returns and adjust them for future expectations to determine the adequacy of our current and future reserve needs. If actual future returns and allowances differ from past experience, additional allowances may be required.

 

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We also maintain a separate allowance for doubtful accounts for estimated losses based on our assessment of the collectability of specific customer accounts and the aging of the accounts receivable. We analyze accounts receivable and historical bad debts, customer concentrations, customer solvency, current economic and geographic trends, and changes in customer payment terms and practices when evaluating the adequacy of our current and future allowance. In circumstances where we are aware of a specific customer’s inability to meet its financial obligations to us, a specific allowance for bad debt is estimated and recorded, which reduces the recognized receivable to the estimated amount we believe will ultimately be collected. We monitor and analyze the accuracy of our allowance for doubtful accounts estimate by reviewing past collectability and adjusting it for future expectations to determine the adequacy of our current and future allowance. Our reserve levels have generally been sufficient to cover credit losses. Our allowance for doubtful accounts as of April 29, 2011 was $0.5 million, compared to $1.6 million as of April 30, 2010. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

Inventory Valuation and Purchase Order Accruals

Inventories are stated at the lower of cost or market (which approximates actual cost on a first-in, first-out basis). We perform an excess and obsolete analysis of our inventory based upon assumptions about future demand and market conditions. We adjust the inventory value based on estimated excess and obsolete inventories determined primarily by future demand forecasts. Although we strive for accuracy in our forecasts of future product demand, any significant unanticipated changes in demand or technological developments could have a significant impact on the value of our inventory commitments and on our reported results. If actual market conditions are less favorable than those projected, additional write-downs and other charges against earnings may be required. If actual market conditions are more favorable, we may realize higher gross profits in the period when the written-down inventory is sold. Historically, our inventory valuation adjustments have been sufficient to cover any excess and obsolete exposure and have not required material adjustments in subsequent periods.

In the normal course of business we make commitments to our third party contract manufacturers to manage lead times and meet product forecasts, and to other parties to purchase various key components used in the manufacture of our products. We establish accruals for estimated losses on purchased commitments when we believe it is probable that the components will not be utilized in future operations. To the extent that such forecasts are not achieved, our commitments and associated accruals may change.

We are subject to a variety of federal, state, local, and foreign environmental regulations relating to the use, storage, discharge, and disposal of hazardous chemicals used in the manufacture of our products, which may require design changes or recycling of products we manufacture. We will continue to monitor our compliance with these regulations, which may require us to incur higher costs, and adversely impact our operating results.

Business Combinations

We allocate the purchase price of acquired companies to identifiable assets acquired and liabilities assumed at their acquisition date fair values. Goodwill as of the acquisition date is measured as the excess of consideration transferred over the net of the acquisition date fair values of the assets acquired and the liabilities assumed. Significant management judgments and assumptions are required in determining the fair value of acquired assets and liabilities, particularly acquired intangible assets which typically comprise acquired technology, trademarks and tradenames, customer contracts and relationships and covenants not to compete.

The valuation of purchased intangible assets is principally based upon estimates of the future performance and cash flows from the acquired business. If different assumptions are used, it could materially impact the purchase price allocation and our financial position and results of operations. Management’s estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. As a result, during the measurement period, which may be up to one year from the acquisition date, we record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill to the extent that we identify adjustments to the preliminary purchase price allocation.

 

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Valuation of Goodwill and Intangibles

Purchased intangible assets are amortized over their useful lives unless these lives are determined to be indefinite. In-process research and development is capitalized at fair value and classified as indefinite-lived assets until completion or abandonment and is subject to periodic review for impairment. Accordingly, the allocation of acquisition cost to identifiable intangible assets has a significant impact on our future operating results. The allocation process requires extensive use of estimates and assumptions, including estimates of future cash flows expected to be generated by the acquired assets. Should conditions be different than management’s assessment, material write-downs of the fair value of intangible assets may be required. We periodically review the estimated remaining useful lives of our intangible assets. A reduction in the estimate of remaining useful life could result in accelerated amortization expense or a write-down in future periods. As such, any future write-downs of these assets would adversely affect our operating results.

We perform an annual review of the valuation of goodwill in the fourth quarter of each fiscal year, or more often if indicators of impairment exist. Triggering events for impairment reviews may be indicators such as adverse industry or economic trends, restructuring actions, lower projections of profitability, or a sustained decline in our market capitalization. Evaluations of possible impairment and, if applicable, adjustments to carrying values require us to estimate, among other factors, future cash flows, useful lives, and fair market values of our reporting units and assets. When we conduct our evaluation of goodwill, the fair value of goodwill is assessed using valuation techniques that require significant management judgment. Should conditions be different from management’s last assessment, significant write-downs of goodwill may be required, which would adversely affect our operating results. In fiscal 2011, we performed such evaluation and determined the fair value substantially exceeded the carrying value and therefore, found no impairment of goodwill.

Restructuring Reserves

We recognize a liability for restructuring costs when the liability is incurred. The restructuring accruals are based upon management estimates at the time they are recorded. These estimates can change depending upon changes in facts and circumstances subsequent to the date the original liability was recorded. The main components of our restructuring charges are workforce reduction, intangibles and fixed assets write-offs and non-cancelable lease costs related to excess facilities. Severance-related charges are accrued when it is determined that a liability has been incurred, which is generally when individuals have been notified of their termination dates and expected severance payments. We record contract cancellation costs when contracts are terminated. The decision to eliminate excess facilities results in charges for lease termination fees and future commitments to pay lease charges, net of estimated future sublease income. We recognize charges for elimination of excess facilities when we have vacated the premises. Intangible asset write-offs consist of impairment of acquired intangible assets related to our decision to cease the development and availability of specific products. Fixed assets write-offs primarily consist of equipment, software and furniture associated with excess facilities being eliminated, and are based on an estimate of the amounts and timing of future cash flows related to the expected future remaining use and ultimate sale or disposal of the equipment and furniture.

Our estimates involve a number of risks and uncertainties, some of which are beyond our control, including future real estate market conditions and our ability to successfully enter into subleases or lease termination agreements with terms as favorable as those assumed when arriving at our estimates. We regularly evaluate a number of factors to determine the appropriateness and reasonableness of our restructuring accruals, including the various assumptions noted above. If actual results differ significantly from our estimates, we may be required to adjust our restructuring accruals in the future.

Product Warranties

Estimated future warranty costs are expensed as a cost of product revenues when revenue is recognized, based on estimates of the costs that may be incurred under our warranty obligations including material, distribution and labor costs. Our accrued liability for estimated future warranty costs is included in other accrued

 

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liabilities and other long-term obligations on the accompanying consolidated balance sheets. Factors that affect our warranty liability include the number of installed units, estimated material costs, estimated distribution costs and estimated labor costs. We periodically assess the adequacy of our warranty accrual and adjust the amount as considered necessary.

Stock-Based Compensation

We account for stock-based compensation using the Black-Scholes option pricing model to estimate the fair value of each option grant on the date of grant. Our option pricing model requires the input of highly subjective assumptions, including the expected stock price volatility, expected term, and forfeiture rate. Any changes in these highly subjective assumptions significantly impact stock-based compensation expense.

Loss Contingencies

We are subject to the possibility of various loss contingencies arising in the course of business. We consider the likelihood of the loss or impairment of an asset or the incurrence of a liability as well as our ability to reasonably estimate the amount of loss in determining loss contingencies. An estimated loss contingency is accrued when it is probable that a liability has been incurred or an asset has been impaired and the amount of loss can be reasonably estimated. We regularly evaluate current information available to us to determine whether such accruals should be adjusted.

Fair Value Measurements and Impairments

All of our available-for-sale investments and nonmarketable securities are subject to periodic impairment review. Investments are considered to be impaired when a decline in fair value is judged to be other-than-temporary. This determination requires significant judgment. For publicly traded investments, impairment is determined based upon the specific facts and circumstances present at the time, including factors such as current economic and market conditions, the credit rating of the security’s issuer, the length of time an investment’s fair value has been below our carrying value, and our ability and intent to hold investments to maturity or for a period of time sufficient to allow for any anticipated recovery in fair value. If an investment’s decline in fair value, caused by factors other than changes in interest rates, is deemed to be other-than-temporary, we reduce its carrying value to its estimated fair value, as determined based on quoted market prices, liquidation values or other metrics. For investments in publicly held companies, we recognize an impairment charge when the decline in the fair value of our investment is below its cost basis and is judged to be other-than-temporary. The ultimate value realized on these investments is subject to market price volatility until they are sold.

Pursuant to the accounting guidance for fair value measurement and its subsequent updates, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date. The accounting guidance establishes a hierarchy for inputs used in measuring fair value that minimizes the use of unobservable inputs by requiring the use of observable market data when available. Observable inputs are inputs that market participants would use in pricing the asset or liability based on active market data. Unobservable inputs are inputs that reflect the assumptions market participants would use in pricing the asset or liability based on the best information available in the circumstances.

The fair value hierarchy is broken down into the three input levels summarized below:

 

   

Level 1 — Valuations are based on quoted prices in active markets for identical assets or liabilities, and readily accessible by us at the reporting date. Examples of assets and liabilities utilizing Level 1 inputs are certain money market funds, U.S. Treasuries and trading securities with quoted prices on active markets.

 

   

Level 2 — Valuations based on inputs other than the quoted prices in active markets that are observable either directly or indirectly in active markets. Examples of assets and liabilities utilizing Level 2 inputs are U.S. government agency bonds, corporate bonds, commercial paper, certificates of deposit and over-the-counter derivatives.

 

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Level 3 — Valuations based on unobservable inputs in which there is little or no market data, which require us to develop our own assumptions. Examples of assets and liabilities utilizing Level 3 inputs are cost method investments, auction rate securities (ARS) and the Primary Fund.

We measure our available-for-sale securities at fair value on a recurring basis. Available-for-sale securities include U.S. Treasury securities, U.S. government agency bonds, corporate bonds, commercial paper, ARSs, money market funds and certificates of deposit. Where possible, we utilize quoted market prices to measure and such items are classified as Level 1 in the hierarchy. When quoted market prices for identical assets are unavailable, varying valuation techniques are used. Such assets are classified as Level 2 or Level 3 in the hierarchy. We classify items in Level 2 if investments are valued using observable inputs to quoted market prices, benchmark yields, reported trades, broker/dealer quotes or alternative pricing sources with reasonable levels of price transparency. We classify items in Level 3 if investments are valued using a pricing model, based on unobservable inputs in the market or that require us to develop our own assumptions. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the investment.

We are also exposed to market risk relating to our available-for-sale investments due to uncertainties in the credit and capital markets. The fair value of our investments may change significantly due to events and conditions in the credit and capital markets. These securities/issuers could be subject to review for possible downgrade. Any downgrade in these credit ratings may result in an additional decline in the estimated fair value of our investments. We monitor and evaluate the accounting for our investment portfolio on a quarterly basis for additional other-than-temporary impairment charges.

We actively review current investment ratings, company specific events, and general economic conditions in managing our investments and determining whether there is a significant decline in fair value that is other-than-temporary. As of April 29, 2011 and April 30, 2010, our short-term and long-term investments in marketable securities have been classified as “available-for-sale” and are carried at fair value. Available-for-sale investments with original maturities of greater than three months at the date of purchases are classified as short-term investments as these investments generally consist of marketable securities that are intended to be available to meet current cash requirements. Currently, all marketable securities held by us are classified as available-for-sale and our entire ARS portfolio is classified as long-term investments.

Our ARS portfolio consists of securities with long-term nominal maturities which, in accordance with investment policy guidelines, had credit ratings of AAA and Aaa at the time of purchase. During fiscal 2008, we reclassified all of our investments in ARS from short-term investments to long-term investments as we believed our ability to liquidate these investments in the next twelve months was uncertain. Based on an analysis of the fair value and marketability of these investments, we recorded cumulative temporary impairment charges of approximately $4.5 million and $3.3 million during fiscal 2011 and 2010, respectively, partially offset by $0.4 million and $0.7 million, respectively, in unrealized gains within other comprehensive income (loss). During fiscal 2009, we recorded cumulative temporary impairment charges of approximately $7.0 million, partially offset by $0.3 million in unrealized gains within other comprehensive income (loss). In addition, during fiscal 2009, we recorded an other-than-temporary impairment charge of $2.1 million due to a significant decline in the estimated fair values of certain of our ARS related to credit quality risk and rating downgrades.

The valuation models used to estimate the fair value of our ARS include numerous assumptions such as assessments of the underlying structure of each security, expected cash flows, discount rates, credit ratings, workout periods, and overall capital market liquidity. These assumptions, assessments and the interpretations of relevant market data are subject to uncertainties, are difficult to predict and require significant judgment. The use of different assumptions, or applying different judgments to inherently subjective matters and changes in future market conditions could result in significantly different estimates of fair value. There is no assurance as to when the market for auction rate securities will stabilize. The fair value of our ARS could change significantly based on market conditions and continued uncertainties in the credit markets. If these uncertainties continue or if these

 

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securities experience credit rating downgrades, we may incur additional temporary impairment related to our auction rate securities portfolio. We will continue to monitor the fair value of our ARS and relevant market conditions and will record additional temporary or other-than-temporary impairments if future circumstances warrant such charges.

As a result of the bankruptcy filing of Lehman Brothers, which occurred during fiscal 2009, we recorded an other-than-temporary impairment charge of $11.8 million on our corporate bonds related to investments in Lehman Brothers securities and approximately $9.3 million on our investments in the Primary Fund that held Lehman Brothers investments. During fiscal 2010, we sold our remaining holdings of Lehman Brothers bonds and the Primary Fund made multiple distributions of its assets to its investors, and as of April 30, 2010, we recovered our recorded investment, with the exception of $0.2 million, for which we recognized an additional loss. As of April 30, 2010, we no longer had any direct or indirect investments related to Lehman Brothers and have recognized all related losses in our statements of operations.

During fiscal 2011, 2010 and 2009, recognized gains and losses on available-for-sale investments were not material. Management determines the appropriate classification of investments at the time of purchase and reevaluates the classification at each reporting date. The fair value of our marketable securities, including those included in cash equivalents and long-term investments, was $4,043.6 million and $3,619.2 million as of April 29, 2011 and April 30, 2010, respectively.

To determine the fair value of nonmarketable investments, we use the most recent information available to us, including new financings or estimates of current fair value, as well as traditional valuation techniques. It is our policy to review the fair value of these investments on a regular basis to determine whether the investments in these companies are other-than-temporarily impaired. In the case of privately-held companies, this evaluation is based on information that we request from these companies. If we believe the carrying value of an investment is in excess of fair value, and this difference is other-than-temporary, it is our policy to write down the investment to fair value. The carrying value of our investments in privately-held companies was $1.3 million and $1.4 million as of April 29, 2011 and April 30, 2010, respectively. During fiscal 2011 and 2010, we recorded $0.1 million of net impairment charges and $3.4 million of realized gains in our consolidated statements of operations, respectively, for our investments in privately-held companies, and adjusted the carrying amount of those investments to fair value, as we deemed the decline in the value of these assets to be other-than-temporary.

Income Taxes

The determination of our tax provision is subject to judgments and estimates due to the complexity of the tax law that we are subject to in several tax jurisdictions. Earnings derived from our international business are generally taxed at rates that are lower than U.S. rates, resulting in a lower effective tax rate than the U.S. statutory tax rate of 35.0%. The ability to maintain our current effective tax rate is contingent on existing tax laws in both the United States and the respective countries in which our international subsidiaries are located. Future changes in domestic or international tax laws could affect the continued realization of the tax benefits we are currently receiving. In addition, a decrease in the percentage of our total earnings from international business or a change in the mix of international business among particular tax jurisdictions could increase our overall effective tax rate.

We account for income taxes by recognizing deferred tax assets and liabilities for the effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. We reduce deferred tax assets by a valuation allowance if it is more likely than not that some or all of the deferred tax asset will not be realized. Tax attributes related to the exercise of employee stock options are not realized until they result in a reduction of taxes payable. We do not include unrealized stock option attributes as components of our gross deferred tax assets and corresponding valuation allowance disclosures.

 

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We have provided a valuation allowance of $45.5 million as of April 29, 2011, compared to $28.3 million as of April 30, 2010 and $28.0 million as of April 24, 2009, on certain of our deferred tax assets. The change in valuation allowance in fiscal 2011 was primarily related to the realizability of state credit carryforwards as a result of the expected application of the California single sales factor apportionment election. The change in valuation allowance in fiscal 2010 was primarily related to changes in blended state tax rates. The tax effected amounts of gross unrealized net operating loss and business tax credit carryforwards are $414.2 million as of April 29, 2011.

We recognize tax liabilities for uncertain tax positions by applying a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. We recognize the tax liability for uncertain income tax positions on income tax returns based on a two-step process. The first step is to determine whether it is more likely than not that each income tax position would be sustained upon audit. The second step is to estimate and measure the tax benefit as the amount that has a greater than 50% likelihood of being realized upon ultimate settlement with the tax authority. Estimating these amounts requires us to determine the probability of various possible outcomes. We evaluate these uncertain tax positions on a quarterly basis. This evaluation is based on the consideration of several factors, including changes in facts or circumstances, changes in applicable tax law, settlement of issues under audit and new exposures. If we later determine that our exposure is lower or that the liability is not sufficient to cover our revised expectations, we adjust the liability and effect a related change in our tax provision during the period in which we make such determination.

New Accounting Standards

See Note 4 of the accompanying 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 Consolidated Statements of Operations data as a percentage of net revenues for the periods indicated:

 

     Year Ended  
   April 29,
2011
    April 30,
2010
    April 24,
2009
 

Revenues:

      

Product

     65.7     60.6     63.2

Software entitlements and maintenance

     14.1        17.3        18.2   

Service

     20.2        22.1        22.4   

GSA settlement

                   (3.8
                        

Net revenues

     100.0        100.0        100.0   

Cost of revenues:

      

Cost of product

     26.2        24.8        29.6   

Cost of software entitlements and maintenance

     0.3        0.3        0.3   

Cost of service

     8.5        10.8        11.7   
                        

Gross profit

     65.0        64.1        58.4   
                        

Operating expenses:

      

Sales and marketing

     31.2        32.9        34.8   

Research and development

     12.7        13.6        14.6   

General and administrative

     4.9        6.1        6.0   

Restructuring and other charges

            0.1        1.6   

Acquisition related (income) expense, net

     0.1        (1.0       
                        

Total operating expenses

     48.9        51.7        57.0   
                        

Income from operations

     16.1        12.4        1.4   

Other expense, net:

      

Interest income

     0.8        0.9        1.7   

Interest expense

     (1.5     (1.9     (1.9

Other income (expense), net

     0.1               (1.0
                        

Total other expense, net

     (0.6     (1.0     (1.2
                        

Income before income taxes

     15.5        11.4        0.2   

Provision for (benefit from) income taxes

     2.4        1.2        (1.7
                        

Net income

     13.1     10.2     1.9
                        

Discussion and Analysis of Results of Operations

Net Revenues  — Our net revenues for fiscal 2011, 2010 and 2009 were as follows (in millions, except percentages):

 

     Year Ended  
   April 29, 2011      April 30, 2010      % Change     April 24, 2009      % Change  

Net revenues

   $ 5,122.6       $ 3,931.4         30   $ 3,406.4         15

Net revenues increased by $1.2 billion, or 30%, in fiscal 2011 compared to fiscal 2010 and by $525.0 million, or 15%, in fiscal 2010 compared to fiscal 2009. The increase in our net revenues for fiscal 2011 was primarily due to an increase in product revenues, which comprised 66% of net revenues in fiscal 2011 compared to 61% in fiscal 2010. Additionally, net revenues for fiscal 2011 include a favorable impact of $129.2 million from the adoption of new accounting standards related to revenue recognition. The increase in net revenues in fiscal 2010 was also primarily related to an increase in product revenues. Net revenues for fiscal 2009 were negatively impacted by the $128.7 million GSA settlement.

 

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Sales through our indirect channels represented 73%, 69% and 69% of net revenues for fiscal 2011, 2010 and 2009, respectively. The indirect channel mix for 2009 would have been 3% lower if not for the impact of the GSA settlement.

The following table sets forth sales to customers, who are distributors, who accounted for 10% or more of net revenues (in millions, except percentages):

 

     Year Ended  
   April 29,
2011
     % of Net
Revenues
    April 30,
2010
     % of Net
Revenues
    April 24,
2009
     % of Net
Revenues
 

Arrow Electronics, Inc.

   $ 903.0         18   $ 550.7         14   $ 360.3         11

Avnet, Inc.

     639.0         12     444.0         11     356.4         10

Product Revenues (in millions, except percentages):

 

     Year Ended  
   April 29, 2011      April 30, 2010      % Change     April 24, 2009      % Change  

Product revenues

   $ 3,367.1       $ 2,381.1         41   $ 2,152.7         11

Product revenues increased by $986.0 million, or 41%, in fiscal 2011 compared to fiscal 2010, and increased by $228.4 million, or 11%, in fiscal 2010 compared to fiscal 2009. Product revenues for fiscal 2011 include a 4% favorable impact from the adoption of new accounting standards related to revenue recognition. Product revenues consist of configured systems, which are comprised of bundled hardware and software products, as well as add-on hardware and software and other products. Configured systems unit volume increased by 46% in fiscal 2011 compared to fiscal 2010, with increases between 40% and 50% in large, medium-sized and smaller systems, and increased 19% in fiscal 2010 compared to fiscal 2009, with the largest increase in smaller systems. Total configured system revenues increased by $690.3 million in fiscal 2011, compared to fiscal 2010, with the largest increase in medium-sized systems. Total configured system revenues increased by $139.9 million in fiscal 2010, compared to fiscal 2009, with the largest increase in medium-sized systems.

During fiscal 2011, large, medium-sized and smaller systems generated approximately 22%, 57% and 21% of configured systems revenues, respectively, compared to approximately 23%, 56% and 21%, respectively in fiscal 2010 and approximately 24%, 55% and 21%, respectively in fiscal 2009. Overall average selling prices (ASPs) decreased in fiscal 2011 compared to fiscal 2010 due primarily to lower ASPs per unit in large-sized systems as manufacturing cost reductions were passed along to customers as price reductions. ASPs declined in fiscal 2010 compared to fiscal 2009 due primarily to a shift in mix towards smaller systems, as well as lower ASPs per unit in medium-sized and smaller systems.

In addition, our net add-on hardware, software and other product revenues accounted for a $295.7 million increase in fiscal 2011 compared to fiscal 2010, primarily due to customers increasing the capacity and/or functionality of their storage systems. Our net add-on hardware, software and other product revenues accounted for an $88.5 million increase in fiscal 2010 compared to fiscal 2009, primarily due to customers increasing the capacity of their storage systems.

Our systems are highly configurable to respond to customer requirements in the open systems storage markets that we serve. This wide variation in customer configurations can significantly impact revenues, cost of revenues, and gross profit performance. Price changes, foreign currency, unit volumes, customer mix and product configuration can also impact revenues, cost of revenues and gross profit performance. Disks are a significant component of our storage systems. Industry disk pricing continues to fall every year, and we pass along those price 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.

 

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

 

     Year Ended  
   April 29, 2011      April 30, 2010      % Change     April 24, 2009      % Change  

Software entitlements and maintenance revenues

   $ 720.6       $ 679.8         6   $ 618.3         10

SEM revenues increased by $40.8 million, or 6%, in fiscal 2011 compared to fiscal 2010 and increased $61.5 million, or 10%, in fiscal 2010 compared to fiscal 2009. These increases were the result of an increase 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. Adoption of new accounting standards related to revenue recognition did not have a significant impact on SEM revenues.

Service Revenues (in millions, except percentages):

 

     Year Ended  
   April 29, 2011      April 30, 2010      % Change     April 24, 2009      % Change  

Service revenues

   $ 1,034.9       $ 870.5         19   $ 764.1         14

Service revenues include hardware maintenance, professional services and educational and training services. Service revenues increased by $164.4 million, or 19%, in fiscal 2011, compared to fiscal 2010 and by $106.4 million, or 14%, in fiscal 2010, compared to fiscal 2009. Adoption of new accounting standards related to revenue recognition did not have a significant impact on service revenues.

Hardware maintenance contract revenues increased 23% in fiscal 2011 compared to fiscal 2010 and increased 20% in fiscal 2010 compared to fiscal 2009, as a result of an increase in the installed base under service contracts. Professional services and educational and training services revenues increased 11% for fiscal 2011, compared to fiscal 2010 and increased 4% for fiscal 2010, compared to fiscal 2009.

GSA settlement (in millions, except percentages):

 

     Year Ended  
     April 29, 2011      April 30, 2010      % Change      April 24, 2009     % Change  

GSA settlement

   $       $         NM       $ (128.7     (100 )% 

 

NM — Not meaningful.

During fiscal 2009 we recorded $128.7 million as a reduction of revenues for the GSA settlement.

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

 

     Year Ended  
     April 29, 2011      April 30, 2010      % Change     April 24, 2009      % Change  

Americas (United States, Canada and Latin America)

   $ 2,899.0       $ 2,208.1         31   $ 1,805.2         22

Europe, Middle East and Africa (EMEA)

     1,719.1         1,329.1         29     1,213.3         10

Asia Pacific and Japan (APAC)

     504.5         394.2         28     387.9         2
                               

Net revenues

   $ 5,122.6       $ 3,931.4         $ 3,406.4      

Sales to the United States accounted for 89%, 89% and 90% of Americas’ revenues in fiscal 2011, 2010 and 2009, respectively. Revenues from the Americas geographic area increased $690.9 million in fiscal 2011 compared to fiscal 2010. Revenues from the Americas geographic area increased by $402.9 million in fiscal 2010

 

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compared to fiscal 2009, due to an increase in gross revenues of $531.6 million and the negative impact in fiscal 2009 of the $128.7 million GSA settlement. Sales to Germany accounted for 12%, 11% and 11% of net revenues in fiscal 2011, 2010 and 2009, respectively. No other single foreign country accounted for ten percent or more of net revenues in any of the years 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 systems, 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. Cost of revenues also reflect the adoption of the new accounting standards related to revenue recognition.

Our gross profit is impacted by a variety of factors including pricing and discount practices, product configuration, channel sales mix, revenue mix and product material costs. Service gross profit is also 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 our shipment volumes, product and services mix, average selling prices and pricing actions 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):

 

     Year Ended  
     April 29, 2011      April 30, 2010      % Change     April 24, 2009      % Change  

Cost of product revenues

   $ 1,342.0       $ 976.4         37   $ 1,007.6         (3 )% 

Cost of product revenues increased by $365.6 million, or 37%, in fiscal 2011 compared to fiscal 2010 and decreased by $31.2 million, or 3%, in fiscal 2010 compared to fiscal 2009. The changes were comprised of the following elements (in percentage points of the total change):

 

     Year Ended
Fiscal 2010  to
Fiscal 2011

Percentage
Change
Points
     Year Ended
Fiscal 2009  to
Fiscal 2010

Percentage
Change
Points
 

Materials costs

     34         1   

Excess and obsolete inventory

             (2

Warranty

     1         (1

Manufacturing overhead

     1           

Other

     1         (1
                 

Total change

     37         (3
                 

In fiscal 2011, the increase in materials cost is primarily due to the 46% increase in configured systems unit volume, and includes the impact from adoption of the new accounting standards related to revenue recognition. Average materials costs per unit in fiscal 2011 did not significantly change from fiscal 2010. Our fiscal 2011 cost of product revenues includes:

 

  (i) an increase of $222.7 million in material costs related to increased volumes in configured systems;

 

  (ii) an increase of $15.8 million in warranty expenses; and

 

  (iii) an increase of $127.1 million in costs of hardware add-ons and other product costs.

 

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In fiscal 2010, the decrease in materials cost reflects a decrease in unit costs in our medium-sized and smaller systems, partially offset by an increase of in high-end systems unit cost. Average materials costs per unit were favorably impacted by lower average per unit materials costs in our medium-sized and smaller systems due to favorable materials pricing in fiscal 2010, partially offset by an increase in average per unit materials costs in our high-end systems. Our fiscal 2010 cost of product revenues includes:

 

  (i) a decrease of $9.9 million in material costs, despite an increase in total units shipped;

 

  (ii) a decrease of $11.3 million in warranty expenses; and

 

  (iii) a decrease of $8.6 million in inventory valuation charges.

Cost of product revenues represented 40% of product revenue for 2011 compared to 41% for 2010, and 47% for 2009. The overall reduction of costs as a percentage of revenues for both fiscal 2011 and 2010 was the result of reductions in materials cost per unit outpacing sales price reductions.

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

 

     Year Ended  
     April 29, 2011      April 30, 2010      % Change     April 24, 2009      % Change  

Cost of software entitlements and maintenance revenues

   $ 15.7       $ 12.3         28   $ 9.2         34

Cost of SEM revenues increased by $3.4 million, or 28% in fiscal 2011 compared to fiscal 2010 and increased $3.1 million, or 34%, in fiscal 2010 compared to fiscal 2009 primarily due to an increase in software related service support costs. Cost of SEM revenues represented 2% of SEM revenues for each of fiscal 2011, 2010 and 2009, respectively.

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

 

     Year Ended  
     April 29, 2011      April 30, 2010      % Change     April 24, 2009      % Change  

Cost of service revenues

   $ 436.2       $ 423.5         3   $ 399.7         6

Cost of service revenues increased by $12.7 million, or 3%, in fiscal 2011 compared to fiscal 2010 primarily due to an increase in service and support purchased from third parties, as well as an increase in logistics costs, and increased by $23.8 million, or 6%, in fiscal 2010 compared to fiscal 2009 due to increased commissions and incentive compensation plan expenses, as well as an increase in service and support purchased from third parties. Costs represented 42%, 49% and 52%, respectively, of service revenues for fiscal 2011, 2010 and 2009. The decrease in service cost of revenues as a percentage of service revenue in fiscal 2011 compared to fiscal 2010, and fiscal 2010 compared to fiscal 2009 was primarily due to improved productivity.

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 and related benefits, stock-based compensation costs and employee incentive compensation plan costs. Compensation costs included in operating expenses increased approximately $202.3 million, or 18%, during fiscal 2011 compared to fiscal 2010, primarily due to:

(i) an increase in salaries, benefits and other compensation related costs due to an increase in average headcount, primarily in sales, marketing and engineering functions, of $169.9 million;

 

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(ii) an increase in incentive compensation expense reflecting stronger operating performance and increased headcount of $16.7 million; and

(iii) an increase in stock based compensation of $15.7 million.

In addition, sales and marketing expenses reflected an increase in commissions expense of $30.2 million during fiscal 2011, reflecting stronger sales performance compared to fiscal 2010.

Compensation costs included in operating expenses increased approximately $108.6 million, or 11%, during fiscal 2010 compared to fiscal 2009, primarily due to:

(i) a $75.6 million increase in employee incentive compensation due to stronger operating profit performance;

(ii) a $16.4 million increase in stock based compensation; and

(iii) a $16.5 million increase in salaries, benefits and other compensation related costs.

In addition, sales and marketing expenses reflected an increase in commissions expense of $60.7 million during fiscal 2010, reflecting stronger sales performance compared to fiscal 2009.

Sales and Marketing (in millions, except percentages) —

 

     Year Ended  
     April 29, 2011      April 30, 2010      % Change     April 24, 2009      % Change  

Sales and marketing expenses

   $ 1,597.0       $ 1,293.7         23   $ 1,186.1         9

Sales and marketing expense consists primarily of compensation costs, commissions, outside services, allocated facilities and IT costs, advertising and marketing promotional expense, and travel and entertainment expense. In addition, during fiscal 2009, we recorded a $9.4 million loss on impairment of a sales force automation tool. Sales and marketing expenses increased due to the following:

 

     Year Ended
Fiscal 2010  to
Fiscal 2011

Percentage
Change
Points
     Year Ended
Fiscal 2009  to
Fiscal 2010

Percentage
Change
Points
 

Salaries

     6           

Incentive plan compensation

     1         3   

Stock based compensation

     1         1   

Other compensation and benefit costs

     3         1   

Commissions

     2         5   

Outside services

     5           

Advertising and marketing promotional expense

     1         (1

Travel and entertainment expense

     1         (1

Facilities and IT support costs

     2         1   

Asset impairment

             (1

Other

     1         1   
                 

Total change

     23         9   
                 

The increase in salaries and related expenses in fiscal 2011 reflects an increase in average sales and marketing headcount of 20%, compared to the prior year. Outside services increased to support sales and marketing initiatives.

 

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Research and Development (in millions, except percentages) —

 

     Year Ended  
     April 29, 2011      April 30, 2010      % Change     April 24, 2009      % Change  

Research and development expenses

   $ 648.6       $ 535.7         21   $ 498.5         7

Research and development expense consists primarily of compensation costs, allocated facilities and IT costs, depreciation and amortization, equipment and software related costs, prototypes, non-recurring engineering, or (NRE) charges and other outside services costs. Research and development expenses increased due to the following:

 

     Year Ended
Fiscal 2010  to
Fiscal 2011

Percentage
Change
Points
    Year Ended
Fiscal 2009  to
Fiscal 2010

Percentage
Change
Points
 

Salaries

     8        (1

Incentive plan compensation

     1        6   

Stock based compensation

     1          

Other compensation and benefit costs

     2          

Travel and entertainment expense

     1          

Facilities and IT support costs

     4        2   

NRE charges

     (1     1   

Outside services

     1          

Equipment and software related costs

     1          

Other

     3        (1
                

Total change

     21        7   
                

The fiscal 2011 increase in salaries and related expenses reflects a 28% increase in average engineering headcount compared to fiscal 2010.

We believe that our future performance will depend in large part on our ability to maintain and enhance our current product line, develop new products that achieve market acceptance, maintain technological competitiveness and meet an expanding range of customer requirements. We expect to continue to spend on current and future product development efforts, broaden our existing product offerings and introduce new products that expand our solutions portfolio.

General and Administrative (in millions, except percentages):

 

     Year Ended  
     April 29, 2011      April 30, 2010      % Change     April 24, 2009      % Change  

General and administrative expenses

   $ 251.3       $ 238.8         5   $ 203.7         17

 

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General and administrative expense consists primarily of compensation costs, professional and corporate legal fees, outside services and allocated facilities and IT costs. General and administrative expenses increased due to the following:

 

     Year Ended
Fiscal 2010  to
Fiscal 2011

Percentage
Change
Points
    Year Ended
Fiscal 2009  to
Fiscal 2010

Percentage
Change
Points
 

Salaries

     3        1   

Incentive plan compensation

     1        8   

Stock based compensation

     1        4   

Other compensation and benefit costs

     (1     3   

Professional and corporate legal fees

     (5     (1

Outside services

     3          

IT costs

     1        1   

Other

     2        1   
                

Total change

     5        17   
                

The fiscal 2011 increase in salaries and related expenses reflects a 10% increase in average general and administrative headcount compared to fiscal 2010. The increase in outside services in fiscal 2011 reflects additional spending on contractors. Partially offsetting the increase in general and administrative expense was a decrease in legal fees due to the resolution of the Sun Microsystems litigation in fiscal 2011.

Restructuring and Other Charges (in millions, except percentages):

 

     Year Ended  
     April 29, 2011      April 30, 2010      % Change     April 24, 2009      % Change  

Restructuring and other charges

   $ 1.8       $ 2.5         (28 )%    $ 54.4         (95 )% 

In the fourth quarter of 2011, we incurred severance-related restructuring charges of $2.4 million relating to the acquisition of Akorri Networks, Inc. (Akorri), that were partially offset by a reversal of $0.6 million related to our fiscal 2009 restructuring plans.

In fiscal 2010, we incurred $2.5 million related to both our fiscal 2009 restructuring plans and our fiscal 2002 restructuring plan.

In fiscal 2009, we announced our fiscal 2009 restructuring plans that resulted in restructuring charges totaling $54.4 million.

Fiscal 2009 Restructuring Plans — In February 2009, we announced our decision to execute a worldwide restructuring program, which included a reduction in workforce, the closing or downsizing of certain facilities, and the establishment of a plan to outsource certain internal activities. In December 2008, we announced our decision to cease the development and availability of our SnapMirror ® for Open Systems product, which was originally acquired through our acquisition of Topio in fiscal 2007. As part of this decision, we also announced the closure of our engineering facility in Haifa, Israel. As of April 29, 2011, we had no further facilities-related lease payment reserves related to these activities.

Fiscal 2002 Restructuring Plan — As of April 29, 2011, we have no material balances remaining in facility restructuring reserves established as part of a restructuring plan in fiscal 2002 related to future lease commitments on exited facilities, net of expected sublease income.

See Note 7 of the accompanying consolidated financial statements for more information.

 

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Acquisition Related (Income) Expense, Net (in millions, except percentages):

 

     Year Ended  
     April 29, 2011      April 30, 2010     % Change      April 24, 2009      % Change  

Acquisition related (income) expense, net

   $ 5.7       $ (39.9     NM       $         NM   

 

NM — Not meaningful.

During fiscal 2011, we incurred $5.7 million of costs including due diligence, legal and other one-time integration charges associated with our acquisitions of Bycast Inc. (Bycast), Akorri and ESG.

On May 20, 2009, we announced that we had entered into a merger agreement with Data Domain, Inc. (Data Domain) under which we would acquire Data Domain in a stock and cash transaction. On July 8, 2009, Data Domain’s Board of Directors terminated the merger agreement and pursuant to the terms of the agreement, Data Domain paid us a $57.0 million termination fee. We incurred $15.9 million of incremental third-party costs relating to the terminated merger transaction during the same period, resulting in net proceeds of $41.1 million recorded in the consolidated statements of operations during fiscal 2010. During fiscal 2010, we paid $1.2 million of acquisition related expenses related to the acquisition of Bycast.

See Notes 6 and 20 of the accompanying financial statements for more information.

Other Income and Expense

Interest Income (in millions, except percentages):

 

     Year Ended  
     April 29, 2011      April 30, 2010      % Change     April 24, 2009      % Change  

Interest income

   $ 39.9       $ 31.2         28   $ 57.6         (46 )% 

The increase in interest income for fiscal 2011 compared to fiscal 2010 was primarily due to higher levels of cash equivalent and investment balances in fiscal 2011. The decrease in interest income for fiscal 2010 compared to fiscal 2009, was primarily due to lower market yields on our cash and investment portfolio.

Interest Expense (in millions, except percentages):

 

     Year Ended  
     April 29, 2011     April 30, 2010     % Change     April 24, 2009     % Change  

Interest expense

   $ (75.9   $ (74.1     2   $ (63.4     17

Interest expense was relatively flat for fiscal 2011 compared to fiscal 2010. Interest expense increased $10.7 million for fiscal 2010 compared to fiscal 2009, primarily due to interest expense on our 1.75% Notes, issued on June 10, 2008, which were outstanding for the full year ended April 30, 2010, but only for a partial period in the prior year.

During fiscal 2011, 2010 and 2009, we recognized incremental non-cash interest expense from the amortization of debt discount and issuance costs relating to our Notes of approximately $53.1 million, $50.8 million and $41.0 million, respectively. The coupon interest expense related to the Notes was $22.1 million, $22.5 million and $19.4 million for fiscal 2011, 2010 and 2009, respectively.

 

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Other Income (Expense), Net (in millions, except percentages):

 

     Year Ended  
     April 29, 2011      April 30, 2010     % Change     April 24, 2009     % Change  

Realized gain on investments, net

   $ 3.5       $ 3.9        (10 )%    $        NM   

Impairment of investments

                           (29.5     (100 )% 

Other expenses, net

     2.3         (2.4     NM        (3.6     (33 )% 
                             

Other income (expense), net

   $ 5.8       $ 1.5        287   $ (33.1     NM   
                             

 

NM — Not meaningful

Other income (expense), net in fiscal 2011 included $3.5 million of net gains on investments, consisting primarily of a $2.5 million distribution from our investment in the Primary Fund and gains on investments in privately held companies. Other expenses, net included $3.0 million in other income, partially offset by $0.7 million in net losses on foreign currency transactions and related hedging activities.

Other income (expense), net in fiscal 2010 included $3.9 million of net gains on investments, consisting primarily of a gain on investments in privately held companies of $3.7 million and $1.0 million net gain on our investment in the Primary Fund and Lehman Brothers securities, offset by net losses on other investments of $0.8 million. Other expenses included $5.3 million in net losses on foreign currency transactions and related hedging activities, partially offset by other income of $2.9 million.

Other income (expense), net in fiscal 2009 included a net impairment loss related to our investments in privately held companies of $6.3 million, an other-than-temporary impairment charge on our available-for-sale investments related to direct and indirect investments in Lehman Brothers securities of $21.1 million, and an other-than-temporary decline in the value of our ARS of $2.1 million. Other expenses included $5.0 in net exchange losses from foreign currency transactions and related hedging activities, partially offset by other income of $1.4 million.

Provision for (Benefit from) Income Taxes (in millions, except percentages):

 

     Year Ended  
     April 29, 2011      April 30, 2010      % Change     April 24, 2009     % Change  

Provision for (benefit from) income taxes

   $ 121.0       $ 46.6         160   $ (56.3     NM   

 

NM — Not meaningful.

Our effective tax rate for fiscal 2011 was 15.2%, compared to an effective tax rate of 10.4% for fiscal 2010, and an effective tax benefit of 681.5% for fiscal 2009. Our effective tax rate reflects our corporate legal entity structure and the global nature of our business with a significant amount of our profits generated and taxed in foreign jurisdictions at rates below the U.S. statutory tax rate. The effective tax rate for both fiscal 2011 and fiscal 2010 was favorably impacted by the geographic mix of profits. The tax benefit rate for fiscal 2009 reflected losses generated in the U.S. during that period that were partially offset by profits generated in foreign tax jurisdictions where the tax rates were below the U.S. statutory rate.

The effective tax rate of 15.2% in fiscal 2011 included a benefit of $146.9 million, or 18.5 percentage points, related to foreign income tax rates that are lower than the U.S. federal statutory rate of 35%, a benefit of $17.8 million, or 2.2 percentage points, related to research and development tax credits, a benefit of $1.3 million, or 0.2 percentage points, related to stock-based compensation and an IRS audit settlement of $21.1 million, or 2.7 percentage points, partially offset by the unfavorable impact of $31.1 million, or 3.9 percentage points, related to state income taxes.

 

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The effective tax rate of 10.4% in fiscal 2010 included a benefit of $105.3 million, or 23.5 percentage points, related to foreign income tax rates that are lower than the U.S. federal statutory rate of 35%, a benefit of $7.8 million, or 1.7 percentage points, related to research and development tax credits, a benefit of $2.6 million, or 0.6 percentages points, related to stock-based compensation, partially offset by the unfavorable impact of $2.6 million, or 0.6 percentage points, related to state income taxes.

The effective tax benefit of 681.5% for fiscal 2009 included the benefit of $51.0 million related to foreign income tax rates that are lower than the U.S. federal statutory rate of 35%, a benefit of $9.2 million related to research and development tax credits, a benefit of $7.9 million related to state income taxes, partially offset by the unfavorable impact of $10.2 million related to stock-based compensation.

Liquidity and Capital Resources

The following sections discuss our principal liquidity requirements, as well as our sources and uses of cash flows on our liquidity and capital resources. The principal objectives of our investment policy are the preservation of principal and maintenance of liquidity. We attempt to mitigate default risk by investing in high-quality investment grade securities, limiting the time to maturity and by monitoring the counter-parties and underlying obligors closely. We believe our cash equivalents and short-term investments are liquid and accessible. We are not aware of any significant deterioration in the fair value of our cash equivalents or investments from the values reported as of April 29, 2011.

Liquidity Sources, Cash Requirements

Our principal sources of liquidity as of April 29, 2011 consisted of approximately $5.2 billion in cash, cash equivalents and short-term investments, as well as cash we expect to generate from operations.

Cash, cash equivalents and short-term investments consist of the following:

 

     April 29, 2011      April 30, 2010  

Cash and cash equivalents

   $ 2,757.3       $ 1,705.0   

Short-term investments

     2,417.4         2,019.0   
                 

Total cash, cash equivalents and short-term investments

   $ 5,174.7       $ 3,724.0   
                 

As of April 29, 2011, $3.0 billion of cash, cash equivalents and short-term investments were held in the United States, while $2.2 billion were held in foreign countries. Most of the amounts held outside the United States may be repatriated to the United States but, under current law, would be subject to U.S. federal and state income taxes. As of April 29, 2011, we have not provided for U.S. federal and state income taxes on approximately $872.1 million of undistributed earnings of our foreign subsidiaries, as such earnings are considered indefinitely reinvested outside the United States. If we repatriate foreign earnings for cash requirements in the United States, we would incur U.S. federal and state income tax, reduced by the current amount of our U.S. federal and state net operating loss and tax credit carryforwards. However, our intent is to keep these funds permanently reinvested outside of the U.S. and our current plans do not demonstrate a need to repatriate them to fund our U.S. operations. Our principal liquidity requirements are to fund the $480 million purchase price of our fiscal 2012 acquisition of certain assets related to ESG, meet our working capital needs, support ongoing business activities, fund research and development, meet capital expenditure needs, invest in critical or complementary technologies, and to service our debt and synthetic leases. Our contractual obligations as of April 29, 2011 are summarized below in the Contractual Obligations tables.

Key factors that could affect our cash flows include changes in our revenue mix and profitability, our ability to effectively manage our working capital, in particular, accounts receivable and inventories, our ability to effectively integrate acquired products, businesses and technologies, including ESG and conversions of our Notes

 

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by holders. Based on our current business outlook, we believe that our sources of cash will satisfy our working capital needs, capital expenditures, investment requirements, stock repurchases, contractual obligations, commitments, interest payments on our Notes and other liquidity requirements associated with operations and meet our cash requirements for at least the next 12 months. However, in the event our liquidity is insufficient, we may be required to further curtail spending and implement additional cost saving measures and restructuring actions. We cannot be certain that we will continue to generate cash flows at or above current levels or that we will be able to obtain additional financing, if necessary, on satisfactory terms, if at all.

Our investment portfolio, including auction rate securities has been and will continue to be exposed to market risk due to trends in the credit and capital markets. We continue to closely monitor current economic and market events to minimize our market risk on our investment portfolio. Based on our ability to access our cash and short-term investments, our expected operating cash flows, and our other potential sources of cash, we do not anticipate that the lack of liquidity of these investments will impact our ability to fund working capital needs, capital expenditures, acquisitions or other cash requirements. We intend to and believe that we have the ability to hold these investments until the market recovers. If current market conditions deteriorate, we may be required to record additional charges to earnings in future periods.

Capital Expenditure Requirements

Our capital expenditures were $222.7 million during fiscal 2011. We anticipate capital expenditures for fiscal 2012 to be between $250.0 million and $300.0 million. We expect to fund our capital expenditures, including our commitments related to facilities, equipment, operating leases and internal-use software development projects over the next few years through existing cash, cash equivalents, investments and cash generated from operations. The timing and amount of our capital requirements cannot be precisely determined and will depend on a number of factors, including future demand for products, changes in the network storage industry, hiring plans and our decisions related to the financing of our facilities and equipment requirements. We expect that our existing facilities and those being developed in Sunnyvale, California; Research Triangle Park, North Carolina; and worldwide are adequate for our requirements over at least the next two years and that additional space will be available as needed.

Acquisition Related Requirements

On May 6, 2011, we completed the acquisition of certain assets related to the ESG business. We paid LSI $480 million in cash and also assumed certain assets and liabilities related to ESG. As of April 29, 2011, we had incurred approximately $4.8 million in acquisition and one-time integration related expenses for ESG which are included in acquisition related (income) expense, net, in our consolidated statements of operations. As part of our efforts to integrate ESG into our business, we expect to incur additional one-time integration, restructuring and impairment charges. See Note 20 of the accompanying financial statements for more information.

Cash Flows

As of April 29, 2011, compared to April 30, 2010, our cash and cash equivalents and short-term and long-term investments increased by $1.5 billion to $5.2 billion. The increase was primarily a result of $1.3 billion of cash provided by operating activities and to a lesser extent from issuances of common stock related to employee stock option exercises and purchases under the employee stock purchase plan of $196.5 million, net of tax benefit, partially offset by $74.9 million and $61.6 million net cash paid in connection with the acquisitions of Bycast and Akorri, respectively and $222.7 million in capital expenditures. We derive our liquidity and capital resources primarily from our cash flow from operations and from working capital. Accounts receivable days sales outstanding as of April 29, 2011 increased to 47 days, compared to 37 days as of April 30, 2010, as material supply constraints through the middle of the fourth quarter of fiscal 2011 contributed to a back-end loaded shipment profile, which in turn, drove the increase in days sales outstanding. Working capital increased by $366.3 million to $3.0 billion as of April 29, 2011, compared to $2.6 billion as of April 30, 2010, primarily due

 

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to an increase in cash, cash equivalents and short-term investments of $1.5 billion, partially offset by the reclassification of our $1.2 billion Notes to current liabilities as the underlying contingent conversion threshold was exceeded at April 29, 2011.

Cash Flows from Operating Activities

During fiscal 2011 and 2010, we generated cash from operating activities of $1.3 billion and $975.0 million, respectively. The primary sources of cash from operating activities in fiscal 2011 consisted of net income of $673.1 million, adjusted by non-cash stock-based compensation expense of $175.2 million and depreciation and amortization expense of $165.6 million. Significant changes in assets and liabilities impacting operating cash flows in fiscal 2011 included an increase in accounts receivable of $262.7 million due to the backend loaded shipment profile during the fourth quarter of fiscal year 2011, an increase in deferred revenue of $382.9 million primarily resulting from overall growth in shipments, and an increase in accrued compensation and other current liabilities of $118.8 million due to our increase in headcount. The primary sources of cash from operating activities in fiscal 2010 consisted of net income of $400.4 million, adjusted by non-cash stock-based compensation expense of $159.8 million and depreciation and amortization expense of $166.0 million. Significant changes in assets and liabilities impacting operating cash flows in fiscal 2010 included an increase in deferred revenue of $176.7 million and an increase in accrued compensation and other current liabilities of $53.2 million.

We expect that cash provided by operating activities may fluctuate in future periods as a result of a number of factors, including fluctuations in our operating results, shipment linearity, accounts receivable collections performance, inventory and supply chain management, tax benefits from stock-based compensation, and the timing and amount of compensation and other payments.

Cash Flows from Investing Activities

Capital expenditures for fiscal 2011 were $222.7 million. We paid $418.5 million for net purchases and redemptions of our investments in fiscal 2011. During fiscal 2011, we completed our acquisitions of Bycast and Akorri for total cash payments of $74.9 million and $61.6 million, respectively, net of cash acquired. Capital expenditures for fiscal 2010 were $135.6 million, which included the purchase of fifteen acres of land in Bangalore, India for approximately $28.5 million. We paid $860.3 million for net purchases and redemptions of short-term investments in fiscal 2010.

Cash Flows from Financing Activities

We received $450.9 million from financing activities in fiscal 2011, which primarily consisted of $324.2 million of proceeds from employee equity award plans, net of shares withheld for taxes, and $127.7 million of excess tax benefit from stock-based compensation. We received $219.9 million from financing activities in fiscal 2010, which primarily consisted of $197.1 million of proceeds from employee equity award plans, net of shares withheld for taxes and $14.2 million from the settlement of a Note hedge with Lehman Brothers.

Net proceeds from the issuance of common stock related to employee participation in employee equity award programs have historically been a significant component of our liquidity. The extent to which our employees exercise stock options or participate in our ESPP program generally increases or decreases based upon changes in the market price of our common stock. As a result, our cash flow resulting from the issuance of common stock in connection with these programs and related tax benefits will vary.

Stock Repurchase Program

Since the May 13, 2003 inception of our stock repurchase program through April 29, 2011, our Board of Directors has authorized the repurchase of up to $4.0 billion of common stock under such stock repurchase program. At April 29, 2011, $1.1 billion remains available under these authorizations. The stock repurchase program may be suspended or discontinued at any time.

 

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Convertible Notes

As of April 29, 2011, we had $1.265 billion principal amount of 1.75% Convertible Senior Notes due 2013 (See Note 10 of the accompanying consolidated financial statements). The Notes will mature on June 1, 2013, unless earlier repurchased or converted. Based upon the closing price of our common stock for the prescribed measurement period in fiscal 2011, the contingent conversion threshold of the Notes was exceeded as of April 29, 2011. Accordingly, the carrying value of the Notes was classified as a current liability at April 29, 2011. Since the Notes are convertible at the option of the holder and the principal amount is required to be paid in cash, the difference between the principal amount and the carrying value of the Notes is reflected as convertible debt in mezzanine on our balance sheet as of April 29, 2011. The determination of whether or not the Notes are convertible must continue to be performed on an ongoing basis. Consequently, the Notes may not be convertible in future quarters, and therefore may again be classified as long-term debt, if the contingent conversion threshold is not met in such quarters. As of April 29, 2011, shares issued related to conversion of the Notes were minimal. Receipts of shares related to the Note hedge transactions were minimal and there was no cash or shares delivered in relation to the warrant transactions as of April 29, 2011.

Contractual Obligations

The following summarizes our contractual obligations at April 29, 2011 and the effect such obligations are expected to have on our liquidity and cash flows in future periods (in millions):

 

     2012     2013     2014     2015     2016     Thereafter      Total  

Off-balance sheet commitments:

               

Office operating lease payments

   $ 30.3      $ 26.4      $ 22.5      $ 20.9      $ 14.9      $ 11.7       $ 126.7   

Real estate lease payments(1)

     3.2        129.2                                     132.4   

Less: sublease income

     (1.4     (1.4     (1.1     (1.1     (0.5             (5.5

Equipment operating lease payments

     21.5        13.2        6.5        0.6                       41.8   

Purchase commitments with contract manufacturers(2)

     171.0        3.6        1.2        0.2                       176.0   

Capital expenditures

     32.1        4.0                                     36.1   

Other purchase obligations(3)

     171.7        62.5        18.7        13.9        3.2                270.0   
                                                         

Total off balance-sheet commitments

     428.4        237.5        47.8        34.5        17.6        11.7         777.5   

1.75% Convertible notes(4)

     1,287.1                                            1,287.1   

Long-term financing arrangements

     5.7        6.0        0.2                              11.9   

Uncertain tax positions(5)

                  104.2   
                                                         

Total

   $ 1,721.2      $ 243.5      $ 48.0      $ 34.5      $ 17.6      $ 11.7       $ 2,180.7   
                                                         

Other Commercial Commitments:

               

Letters of credit

   $ 4.0      $ 0.1      $      $      $      $ 1.2       $ 5.3   
                                                         

Some of the amounts we include in this table are based on management’s estimates and assumptions about these obligations, including their duration, the possibility of renewal or termination, anticipated actions by management and third parties and other factors. Because these estimates and assumptions are necessarily subjective, our actual future obligations may vary from those reflected in the table. We expect to fund our contractual obligations and other commitments in the table above through existing cash, cash equivalents, investments, and cash generated from operations or obtain additional financing, if necessary.

 

(1) Included in real estate lease payments pursuant to four financing arrangements with BNP Paribas LLC (BNPPLC) are (i) lease commitments of $3.2 million in fiscal 2012; and $2.1 million in fiscal 2013, which are based on either the LIBOR rate at April 29, 2011 plus a spread or a fixed rate for terms of five years, and (ii) at the expiration or termination of the lease, a supplemental payment obligation equal to our minimum guarantee of $127.1 million in the event that we elect not to purchase or arrange for sale of the buildings.

 

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(2) Contract manufacturer commitments consist of obligations for on hand inventories and non-cancelable purchase orders with our contract manufacturer. We record a liability for firm, noncancelable, and nonreturnable purchase commitments for quantities in excess of our future demand forecasts, which is consistent with the valuation of our excess and obsolete inventory. As of April 29, 2011, the liability for these purchase commitments in excess of future demand was approximately $4.5 million and is recorded in other current liabilities.
(3) Purchase obligations represent an estimate of all open purchase orders and contractual obligations in the ordinary course of business, other than commitments with contract manufacturers and suppliers, for which we have not received the goods or services. Purchase obligations do not include contracts that may be cancelled without penalty. Although open purchase orders are considered enforceable and legally binding, the terms generally allow us the option to cancel, reschedule, and adjust our requirements based on our business needs prior to the delivery of goods or performance of services.
(4) Amount includes the $1.265 billion principal amount of 1.75% Notes due 2013 and the estimated fiscal 2012 interest payment for the Notes of $22.1 million. Based upon the closing price of our common stock for the prescribed measurement period during fiscal 2011, the contingent conversion threshold on the Notes was exceeded. As a result, the Notes are convertible at the option of the holder through June 30, 2011. Accordingly, since the terms of the Notes require the principal to be settled in cash, we reclassified from equity the portion of the Notes attributable to the conversion feature, which had not yet been accreted to its face value, and reclassified the Notes to current liabilities. For the holders to be able to continue to convert the Notes, our closing stock price must exceed $41.41 for 20 out of the last 30 trading days of each future calendar quarter. If this threshold is not met, the Notes will be reclassified to long-term debt.
(5) As of April 29, 2011, our liability for uncertain tax positions was $104.2 million, which due to the uncertainty of the timing of future payments, are presented in the total column on a separate line in this table.

As of April 29, 2011, we have four leasing arrangements (Leasing Arrangements 1, 2, 3 and 4) with BNPPLC which require us to lease certain of our land to BNPPLC for a period of 99 years and to lease approximately 0.6 million square feet of office space for our headquarters in Sunnyvale, which had an original cost of $149.6 million. Under these leasing arrangements, we pay BNPPLC minimum lease payments, which vary based on LIBOR plus a spread or a fixed rate on the costs of the facilities on the respective lease commencement dates. We make payments for each of the leases for a term of five years. We have the option to renew each of the leases for two consecutive five-year periods upon approval by BNPPLC. Upon expiration (or upon any earlier termination) of the lease terms, we must elect one of the following options: (i) purchase the buildings from BNPPLC at cost; (ii) if certain conditions are met, arrange for the sale of the buildings by BNPPLC to a third party for an amount equal to at least 85% of the costs (residual guarantee), and be liable for any deficiency between the net proceeds received from the third party and such amounts; or (iii) pay BNPPLC supplemental payments for an amount equal to at least 85% of the costs (residual guarantee), in which event we may recoup some or all of such payments by arranging for a sale of each or all buildings by BNPPLC during the ensuing two-year period. The following table summarizes the costs, the residual guarantee, the applicable LIBOR plus spread or fixed rate at April 29, 2011 and the date we began to make payments for each of our leasing arrangements (in millions):

 

Leasing

Arrangements

   Cost    Residual
Guarantee
   LIBOR
Plus
Spread or
Fixed Rate
  Lease
Commencement
Date
   Term

1

   $48.5    $41.2    3.69%   January 2008    5 years

2

    80.0      68.0    0.79%   December 2007    5 years

3

    10.5       8.9    3.67%   December 2007    5 years

4

    10.6       9.0    3.69%   December 2007    5 years

All leases require us to maintain specified financial covenants with which we were in compliance as of April 29, 2011. Such financial covenants include a maximum ratio of Total Debt to Earnings before Interest, Taxes, Depreciation and Amortization of less than three to one and a minimum amount of Unencumbered Cash

 

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and Short-Term Investments of $300 million. Our failure to comply with these financial covenants could result in a default under the leases which, subject to our right and ability to exercise our purchase option, would give BNPPLC the right to, among other things, (i) terminate our possession of the leased property and require us to pay lease termination damages and other amounts as set forth in the lease agreements, or (ii) exercise certain foreclosure remedies. If we were to exercise our purchase option, or be required to pay lease termination damages, these payments would significantly reduce our available liquidity, which could constrain our operating flexibility.

As of April 29, 2011, we estimated that the fair value of the properties under synthetic lease was $35.8 million less than their aggregate residual guarantees. We are accruing for this deficiency over the remaining terms of the respective leases. As of April 29, 2011, a deficiency reserve of $16.1 million was included in other long-term liabilities.

We may from time to time terminate one or more of our leasing arrangements and repay amounts outstanding in order to meet our operating or other objectives.

Legal Contingencies

We are subject to various legal proceedings and claims which may arise in the normal course of business. No accrual has been recorded as of April 29, 2011, as the outcome of these legal matters is currently not determinable.

On October 13, 2010, Amalgamated Bank (as trustee of the Longview Largecap 500 Index Fund and the Longview Largecap 500 Index Veba Fund) filed a derivative lawsuit on behalf of NetApp, Inc. and NetApp U.S. Public Sector, Inc. in the Superior Court of the State of California, Santa Clara County. The lawsuit named 15 of our current and former directors as defendants. On February 3, 2011, the plaintiff filed an amended complaint in response to motions to dismiss that we and the individual defendants had filed. Like the original complaint, the amended complaint includes claims of breach of fiduciary duty and waste of corporate assets and alleges that the defendants failed to monitor internal controls to ensure that we complied with legal requirements in our General Services Administration (GSA) contracting activities, resulting in us incurring defense and settlement costs. The amended complaint seeks disgorgement of salaries and other compensation from the defendants and additional unspecified damages. We and the individual defendants filed motions to dismiss the amended complaint in early March 2011, and the hearing on these motions is scheduled for July 15, 2011.

Off-Balance Sheet Arrangements

During the ordinary course of business, we provide standby letters of credit or other guarantee instruments to third parties as required for certain transactions initiated either by us or our subsidiaries. As of April 29, 2011, our financial guarantees of $5.3 million that were not recorded on our balance sheet consisted of standby letters of credit related to workers’ compensation, a customs guarantee, a corporate credit card program, foreign rent guarantees and surety bonds, which were primarily related to self-insurance.

We use derivative instruments to manage exposures to foreign currency risk. Our primary objective in holding derivatives is to reduce the volatility of earnings and cash flows associated with changes in foreign currency. The program is not designated for trading or speculative purposes. Currently, we do not enter into any foreign exchange forward contracts to hedge exposures related to firm commitments or nonmarketable investments. Our major foreign currency exchange exposures and related hedging programs are described below:

 

   

We utilize monthly foreign currency forward and options contracts to hedge exchange rate fluctuations related to certain foreign monetary assets and liabilities.

 

   

We use currency forward contracts to hedge exposures related to forecasted sales denominated in certain foreign currencies. These contracts are designated as cash flow hedges and in general closely match the underlying forecasted transactions in duration.

 

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As of April 29, 2011, our notional fair value of foreign exchange forward and foreign currency option contracts totaled $592.4 million. We do not believe that these derivatives present significant credit risks, because of the short term maturity of the outstanding contracts at any point in time, the counterparties to the derivatives consist of major financial institutions, and we manage the notional amount of contracts entered into with any one counterparty. Other than the risk associated with the financial condition of the counterparties, our maximum exposure related to foreign currency forward and option contracts is limited to the premiums paid. See Note 12 of the accompanying consolidated financial statements for more information related to our hedging activities.

In the ordinary course of business, we enter into recourse lease financing arrangements with third-party leasing companies and from time to time provide guarantees for a portion of other financing arrangements under which we could be called upon to make payments to the third-party funding companies in the event of nonpayment by end-user customers. See Note 18 of the accompanying consolidated financial statements for more information related to these financing arrangements.

We enter into indemnification agreements with third parties in the ordinary course of business. Generally, these indemnification agreements require us to reimburse losses suffered by the third party due to various events, such as lawsuits arising from patent or copyright infringement. These indemnification obligations are considered off-balance sheet arrangements under accounting guidance.

We have commitments related to four lease arrangements with BNPPLC for approximately 0.6 million square feet of office space for our headquarters in Sunnyvale, California (as further described above under “Contractual Obligations”). Our future minimum lease payments and residual guarantees under these real estate leases will amount to a total of $132.4 million as discussed above in “Contractual Obligations”.

We have evaluated our accounting for these leases as required by guidance on accounting for variable interest entities and have determined the following:

 

   

BNPPLC is a leasing company for BNP Paribas in the United States. BNPPLC is not a “special purpose entity” organized for the sole purpose of facilitating the leases to us. The obligation to absorb expected losses and receive expected residual returns rests with the parent, BNP Paribas. Therefore, we are not the primary beneficiary of BNPPLC as we do not absorb the majority of BNPPLC’s expected losses or expected residual returns; and

 

   

BNPPLC has represented in the related closing agreements that the fair value of the property leased to us by BNPPLC is less than half of the total of the fair values of all assets of BNPPLC, excluding any assets of BNPPLC held within a silo. Further, the property leased to NetApp is not held within a silo. The definition of “held within a silo” means that BNPPLC has obtained funds equal to or in excess of 95% of the fair value of the leased asset to acquire or maintain its investment in such asset through nonrecourse financing or other contractual arrangements, the effect of which is to leave such asset (or proceeds thereof) as the only significant asset of BNPPLC at risk for the repayment of such funds.

Accordingly, under current accounting guidance, we are not required to consolidate either the leasing entity or the specific assets that we lease under the BNPPLC lease.

 

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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to market risk related to fluctuations in interest rates, market prices, and foreign currency exchange rates. We use certain derivative financial instruments to manage these risks. We do not use derivative financial instruments for speculative or trading purposes. All financial instruments are used in accordance with management-approved policies.

Market Risk and Market Interest Risk

Investment and Interest Income  — As of April 29, 2011, we had available-for-sale investments of $2.5 billion. Our investment portfolio primarily consists of investments with original maturities at the date of purchase of greater than three months, which are classified as available-for-sale. These investments, consisting primarily of corporate bonds, commercial paper, U.S. government agency bonds, U.S. Treasuries, and certificates of deposit, are subject to interest rate and interest income risk and will decrease in value if market interest rates increase. A hypothetical 10 percent increase in market interest rates from levels at April 29, 2011 would cause the fair value of these available-for-sale investments to decline by approximately $3.6 million. Volatility in market interest rates over time will cause variability in our interest income. We do not use derivative financial instruments in our investment portfolio.

Our investment policy is to limit credit exposure through diversification and investment in highly rated securities. We further mitigate concentrations of credit risk in our investments by limiting our investments in the debt securities of a single issuer and by diversifying risk across geographies and type of issuer. We actively review, along with our investment advisors, current investment ratings, company specific events and general economic conditions in managing our investments and in determining whether there is a significant decline in fair value that is other-than-temporary. We will monitor and evaluate the accounting for our investment portfolio on a quarterly basis for additional other-than-temporary impairment charges.

We are also exposed to market risk relating to our auction rate securities due to uncertainties in the credit and capital markets. As of April 29, 2011, we recorded cumulative temporary impairment charges of $4.5 million, offset by $0.4 million of unrealized gains related to these securities. The fair value of our auction rate securities may change significantly due to events and conditions in the credit and capital markets. These securities/issuers could be subject to review for possible downgrade. Any downgrade in these credit ratings may result in an additional decline in the estimated fair value of our auction rate securities. Changes in the various assumptions used to value these securities and any increase in the markets’ perceived risk associated with such investments may also result in a decline in estimated fair value.

If current market conditions deteriorate, or the anticipated recovery in market values does not occur, we may be required to record additional unrealized losses in other comprehensive income (loss) or other-than-temporary impairment charges to earnings in future quarters. We intend, and have the ability, to hold these investments until the market recovers. We do not believe that the lack of liquidity relating to our portfolio investments will impact our ability to fund working capital needs, capital expenditures or other operating requirements. See Note 9 of the accompanying consolidated financial statements in Part II, Item 8; Management’s Discussion and Analysis of Financial Condition and Results of Operations, “Liquidity and Capital Resources,” in Part II, Item 7; and Risk Factors in Part I, Item 1A of this Annual Report on Form 10-K for a description of recent market events that may affect the value and liquidity of the investments in our portfolio that we held at April 29, 2011.

Lease Commitments  — As of April 29, 2011, one of our four lease arrangements with BNPPLC is based on a floating interest rate. The minimum lease payments will vary based on LIBOR plus a spread. All of our leases have an initial term of five years, and we have the option to renew these leases for two consecutive five-year periods upon approval by BNPPLC. A hypothetical 10 percent increase in market interest rate from the level at April 29, 2011 would increase our lease payments on this one floating lease arrangement under the initial five-year term by an immaterial amount. We do not currently hedge against market interest rate increases.

 

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Convertible Notes  — In June 2008, we issued $1.265 billion principal amount of 1.75% Notes due 2013, of which $1.017 billion was allocated to debt and $0.248 billion was allocated to equity. Holders may convert the Notes prior to maturity upon the occurrence of certain circumstances, including, but not limited to:

 

   

during the five business day period after any five consecutive trading day period in which the trading price of the Notes for each day in this five consecutive trading day period was less than 98% of an amount equal to (i) the last reported sale price of our common stock multiplied by (ii) the conversion rate on such day;

 

   

during any calendar quarter if the last reported sale price of our common stock for 20 or more trading days in a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter exceeds 130% of the applicable conversion price in effect for the Notes on the last trading day of such immediately preceding calendar quarter; or

 

   

upon the occurrence of specified corporate transactions under the indenture for the Notes.

The Notes are convertible into the right to receive cash in an amount up to the principal amount and shares of our common stock for the conversion value in excess of the principal amount, if any, at an initial conversion rate of 31.4006 shares of common stock per $1,000 principal amount of Notes, subject to adjustment as described in the indenture governing the Notes, which represents an initial conversion price of $31.85 per share.

Concurrent with the issuance of the Notes, we entered into convertible Note hedge transactions and separately, warrant transactions, to reduce the potential dilution from the conversion of the Notes and to mitigate any negative effect such conversion may have on the price of our common stock. In fiscal 2010, we terminated the hedge transaction with a counterparty to 20% of our Note hedges, and because we have decided not to replace the hedge, we are subject to potential dilution on the 20% unhedged portion of our Notes upon conversion if on the date of conversion the per-share market price of our common stock exceeds the conversion price of $31.85.

For at least 20 trading days during the 30 consecutive trading days ended March 31, 2011, our common stock price exceeded the conversion threshold price of $41.41 per share set forth for these Notes. Accordingly, the Notes are convertible at the holder’s option through June 30, 2011, and the carrying value of the Notes was classified as a current liability as of April 29, 2011. Since the Notes are convertible at the option of the holder and the principal amount is required to be paid in cash, the difference between the principal amount and the carrying value of these Notes is reflected as convertible debt in mezzanine on our consolidated balance sheets as of April 29, 2011. The determination of whether or not the Notes are convertible must continue to be performed on a quarterly basis. Consequently, the Notes may not be convertible in future quarters, and therefore may again be classified as long-term debt, if the contingent conversion thresholds are not met in such quarters.

Upon conversion of any Notes, we deliver cash up to the principal amount of the Notes and, with respect to any excess conversion value greater than the principal amount of the Notes, shares of our common stock. As of April 29, 2011, shares issued related to the Notes were minimal. Based on the closing price of our common stock of $52.11 on April 29, 2011, the if-converted value of our Notes exceeded their principal amount by approximately $834.3 million.

The fair value of our Notes is subject to interest rate risk, market risk and other factors due to the convertible feature. Generally, the fair value of Notes will increase as interest rates fall and/or our common stock price increases, and decrease as interest rates rise and/or our common stock price decreases. The interest and market value changes affect the fair value of our Notes, but do not impact our financial position, cash flows, or results of operations due to the fixed nature of the debt obligations. We do not carry the Notes at fair value, but present the fair value of the principal amount of our Notes for disclosure purposes. As of April 29, 2011, the principal amount of our Notes, which consists of the combined debt and mezzanine components, was $1.265 billion, and the total estimated fair value of such was $2.1 billion based on the closing trading price of $168 per $100 of our Notes as of that date.

 

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Foreign Currency Exchange Rate Risk and Foreign Exchange Forward Contracts

We hedge risks associated with foreign currency transactions to minimize the impact of changes in foreign currency exchange rates on earnings. We utilize forward and option contracts to hedge against the short-term impact of foreign currency fluctuations on certain assets and liabilities denominated in foreign currencies. All balance sheet hedges are marked to market through earnings every period. We also use foreign exchange forward contracts to hedge foreign currency forecasted transactions related to forecasted sales transactions. These derivatives are designated as cash flow hedges under accounting guidance for derivatives and hedging. For cash flow hedges outstanding at April 29, 2011, the time-value component is recorded in earnings while all other gains or losses were included in other comprehensive income.

We do not enter into foreign exchange contracts for speculative or trading purposes. In entering into forward and option foreign exchange contracts, we have assumed the risk that might arise from the possible inability of counterparties to meet the terms of their contracts. We attempt to limit our exposure to credit risk by executing foreign exchange contracts with creditworthy multinational commercial banks. All contracts have a maturity of less than one year.

The following table provides information about our currency forward contracts outstanding on April 29, 2011 and April 30, 2010 (in millions):

 

     April 29, 2011      April 30, 2010  

Currency

   Local
Currency
Amount
     Notional
Contract
Amount
(USD)
     Fair
Value
(USD)
     Local
Currency
Amount
     Notional
Contract
Amount
(USD)
     Fair
Value
(USD)
 

Forward Contracts:

                 

Euro

     241.6       $ 357.7       $ 357.4         235.9       $ 313.5       $ 313.6   

British Pound Sterling

     55.0         91.7         91.9         49.7         76.0         75.9   

Canadian Dollar

     53.1         56.0         56.1         28.6         28.1         28.1   

Australian Dollar

     31.5         34.4         34.4         25.0         23.2         23.0   

Other

     N/A         52.6         52.5         N/A         43.6         43.6   

 

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Item 8. Financial Statements and Supplementary Data

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

NetApp, Inc.

Sunnyvale, California

We have audited the accompanying consolidated balance sheets of NetApp, Inc. and subsidiaries (collectively, the “Company”) as of April 29, 2011 and April 30, 2010, and the related consolidated statements of operations, cash flows, and stockholders’ equity and comprehensive income for each of the three years in the period ended April 29, 2011. Our audits also included the financial statement schedule listed in Item 15. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the consolidated financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of April 29, 2011 and April 30, 2010, and the results of its operations and its cash flows for each of the three years in the period ended April 29, 2011, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

As discussed in Note 2 to the consolidated financial statements, in the year ended April 29, 2011, the Company changed its method of recognizing revenue for multiple element arrangements in accordance with the Financial Accounting Standards Board’s Accounting Standards Update (ASU) 2009-13, Multiple-Deliverable Revenue Arrangements and ASU 2009-14, Certain Revenue Arrangements that include Software Elements .

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of April 29, 2011, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated June 23, 2011 expressed an unqualified opinion on the Company’s internal control over financial reporting.

/s/ DELOITTE & TOUCHE LLP

San Jose, California

June 23, 2011

 

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NETAPP, INC.

CONSOLIDATED BALANCE SHEETS

 

     April 29,
2011
    April 30,
2010
 
     (In millions, except  
     par value)  
ASSETS   

Current assets:

    

Cash and cash equivalents

   $ 2,757.3      $ 1,705.0   

Short-term investments

     2,417.4        2,019.0   

Accounts receivable, net of allowances of $0.5 million and $1.6 million at April 29, 2011 and April 30, 2010, respectively

     742.6        471.5   

Inventories

     108.5        112.9   

Other current assets

     339.4        228.7   
                

Total current assets

     6,365.2        4,537.1   

Property and equipment, net

     911.6        804.4   

Goodwill

     760.3        681.0   

Other intangible assets, net

     53.0        25.1   

Long-term investments and restricted cash

     69.2        72.8   

Other non-current assets

     339.5        374.0   
                

Total assets

   $ 8,498.8      $ 6,494.4   
                
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Current Liabilities:

    

Accounts payable

   $ 232.8      $ 184.6   

Accrued compensation and related benefits

     437.2        379.1   

Other current liabilities

     325.8        212.2   

1.75% Convertible Senior Notes Due 2013

     1,150.4        0.0   

Short-term deferred revenue

     1,226.6        1,135.1   
                

Total current liabilities

     3,372.8        1,911.0   

1.75% Convertible Senior Notes Due 2013

     0.0        1,101.5   

Other long-term liabilities

     192.9        171.9   

Long-term deferred revenue

     1,088.3        779.5   
                

Total liabilities

     4,654.0        3,963.9   
                

Commitments and contingencies (Note 18)

    

1.75% Convertible Senior Notes Due 2013

     114.6        0.0   
                

Stockholders’ equity:

    

Preferred stock, $0.001 par value, 5.0 shares authorized; no shares issued or outstanding in 2011 and 2010

     0.0        0.0   

Common stock, $0.001 par value, 885.0 shares authorized; 473.3 and 451.6 shares issued at April 29, 2011 and April 30, 2010

     0.5        0.5   

Additional paid-in capital

     3,970.3        3,453.7   

Treasury stock at cost (104.3 shares at April 29, 2011 and April 30, 2010)

     (2,927.4     (2,927.4

Retained earnings

     2,674.0        2,000.9   

Accumulated other comprehensive income

     12.8        2.8   
                

Total stockholders’ equity

     3,730.2        2,530.5   
                

Total liabilities and stockholders’ equity

   $ 8,498.8      $ 6,494.4   
                

See notes to consolidated financial statements.

 

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NETAPP, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

 

     Year Ended  
     April 29,
2011
    April 30,
2010
    April 24,
2009
 
     (In millions, except per share amounts)  

Revenues:

      

Product

   $ 3,367.1      $ 2,381.1      $ 2,152.7   

Software entitlements and maintenance

     720.6        679.8        618.3   

Service

     1,034.9        870.5        764.1   

GSA settlement

     0.0        0.0        (128.7
                        

Net revenues

     5,122.6        3,931.4        3,406.4   
                        

Cost of revenues:

      

Cost of product

     1,342.0        976.4        1,007.6   

Cost of software entitlements and maintenance

     15.7        12.3        9.2   

Cost of service

     436.2        423.5        399.7   
                        

Total cost of revenues

     1,793.9        1,412.2        1,416.5   
                        

Gross profit

     3,328.7        2,519.2        1,989.9   
                        

Operating expenses:

      

Sales and marketing

     1,597.0        1,293.7        1,186.1   

Research and development

     648.6        535.7        498.5   

General and administrative

     251.3        238.8        203.7   

Restructuring and other charges

     1.8        2.5        54.4   

Acquisition related (income) expense, net

     5.7        (39.9     0.0   
                        

Total operating expenses

     2,504.4        2,030.8        1,942.7   
                        

Income from operations

     824.3        488.4        47.2   

Other expense, net:

      

Interest income

     39.9        31.2        57.6   

Interest expense

     (75.9     (74.1     (63.4

Other income (expense), net

     5.8        1.5        (33.1
                        

Total other expense, net

     (30.2     (41.4     (38.9
                        

Income before income taxes

     794.1        447.0        8.3   

Provision for (benefit from) income taxes

     121.0        46.6        (56.3
                        

Net income

   $ 673.1      $ 400.4      $ 64.6   
                        

Net income per share:

      

Basic

   $ 1.87      $ 1.18      $ 0.20   
                        

Diluted

   $ 1.71      $ 1.13      $ 0.19   
                        

Shares used in net income per share calculations:

      

Basic

     360.9        339.6        330.3   
                        

Diluted

     393.7        353.2        334.6   
                        

See notes to consolidated financial statements.

 

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NETAPP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

     Year Ended  
     April 29,
2011
    April 30,
2010
    April 24,
2009
 
     (In millions)  

Cash flows from operating activities:

      

Net income

   $ 673.1      $ 400.4      $ 64.6   

Adjustments to reconcile net income to net cash provided by operating activities:

      

Depreciation and amortization

     165.6        166.0        170.5   

Stock-based compensation

     175.2        159.8        140.8   

Accretion of discount and issuance costs on notes

     53.1        50.8        41.0   

Unrealized losses on derivative activities

     9.9        0.0        0.0   

Deferred income taxes

     (26.3     (11.3     (124.6

Tax benefit (charges) from stock-based compensation

     128.5        (0.9     45.4   

Excess tax benefit from stock-based compensation

     (127.7     (8.6     (36.7

Other non-cash items, net

     4.9        9.7        57.8   

Changes in assets and liabilities, net of acquisition of businesses:

      

Accounts receivable

     (262.7     (21.3     128.7   

Inventories

     4.4        (52.1     9.1   

Other operating assets

     6.0        (36.8     (0.8

Accounts payable

     38.7        42.7        (27.0

Accrued compensation and other current liabilities

     118.8        53.2        190.5   

Deferred revenue

     382.9        176.7        219.3   

Other operating liabilities

     1.9        46.7        10.6   
                        

Net cash provided by operating activities

     1,346.3        975.0        889.2   
                        

Cash flows from investing activities:

      

Purchases of investments

     (2,190.9     (2,632.6     (1,152.5

Redemptions of investments

     1,772.4        1,772.3        1,035.7   

Reclassification from cash and cash equivalents to short-term investments

     0.0        0.0        (598.0

Purchases of property and equipment

     (222.7     (135.6     (289.6

Acquisition of businesses, net of cash acquired

     (136.5     0.0        0.0   

Other investing activities, net

     0.5        8.2        1.1   
                        

Net cash used in investing activities

     (777.2     (987.7     (1,003.3
                        

Cash flows from financing activities:

      

Issuance of common stock

     324.2        197.1        85.9   

Repurchases of common stock

     0.0        0.0        (400.0

Excess tax benefit from stock-based compensation

     127.7        8.6        36.7   

Issuance of long-term debt

     0.0        0.0        1,238.4   

Sale of common stock warrants

     0.0        0.0        163.1   

Settlement (purchase) of note hedge

     0.0        14.2        (254.9

Repayment of long-term debt

     0.0        0.0        (172.6

Other financing activities

     (1.0     0.0        0.0   
                        

Net cash provided by financing activities

     450.9        219.9        696.6   
                        

Effect of exchange rate changes on cash and cash equivalents

     32.3        3.6        (24.8

Net increase in cash and cash equivalents

     1,052.3        210.8        557.7   

Cash and cash equivalents:

      

Beginning of year

     1,705.0        1,494.2        936.5   
                        

End of year

   $ 2,757.3      $ 1,705.0      $