NetApp, Inc. — Form 10-Q summary
Reporting period: Third quarter and first nine months of fiscal 2019, ended January 25, 2019; comparisons are with periods ended January 26, 2018. Amounts are in U.S. dollars; financial statement amounts are in millions unless noted.
Business context and financial performance
NetApp provides data-management software, systems and services, positioning its offerings around hybrid cloud, flash storage and its Data Fabric strategy. The company reports one operating segment.
| Metric | Q3 FY2019 | Q3 FY2018 | Nine months FY2019 | Nine months FY2018 |
|---|---|---|---|---|
| Net revenue | $1,563 | $1,539 | $4,554 | $4,275 |
| Gross profit / margin | $982 / 63% | $956 / 62% | $2,919 / 64% | $2,680 / 63% |
| Operating income / margin | $311 / 20% | $490 / 32% | $851 / 19% | $846 / 20% |
| Net income (loss) | $249 | $(479) | $773 | $(174) |
| Diluted earnings (loss) per share | $0.98 | $(1.79) | $2.94 | $(0.65) |
| Operating cash flow | $451 | $420 | $942 | $984 |
- Q3 revenue increased 2%; nine-month revenue rose 7%. Product revenue increased 2% and 10%, respectively. Software maintenance revenue grew 8% in Q3 and 5% for nine months; hardware maintenance and other services revenue declined 2% and 1%.
- Strategic product revenue was $674 million in Q3, up 3%, and $1.935 billion for nine months, up 12%. Management cited All-Flash FAS and hyper-converged infrastructure growth. Mature product revenue decreased 1% in Q3 and increased 6% for nine months.
- Gross margin improved, reflecting higher product margins; management cited higher average selling prices, lower component costs in Q3, and ELA software-license revenue recognized under the new revenue standard during the nine-month period.
- Q3 operating income fell from the prior year despite higher revenue, largely because the prior-year quarter included a $218 million property-sale gain. The 2018 comparison also reflects exceptional tax expense, including U.S. tax reform charges.
Cash, debt and capital allocation
- At January 25, 2019, cash, cash equivalents and short-term investments totaled $4.049 billion, down from $5.391 billion at April 27, 2018. Approximately $3.8 billion was held by foreign subsidiaries and $0.2 billion in the U.S.
- Nine-month operating cash flow was $942 million, versus $984 million. Investing activities provided $521 million, including net investment maturities and sales; financing activities used $2.117 billion.
- Financing uses included $1.611 billion to repurchase 22 million shares and $306 million in dividends. Net cash, cash equivalents and restricted cash decreased $671 million during the period.
- Principal debt was approximately $1.714 billion: $1.55 billion of senior notes and $164 million of commercial paper. The balance sheet classified $399 million of long-term debt as current. A $1.0 billion revolving credit facility was undrawn; the company reported covenant compliance.
- Working capital was $1.9 billion, down $1.5 billion from fiscal year-end. Deferred revenue and financed unearned services revenue totaled $3.357 billion, approximately unchanged from April 27, 2018.
- The board declared a $0.40-per-share dividend payable April 24, 2019. Remaining repurchase authorization was $2.389 billion.
Outlook, accounting changes and risks
- Management said available liquidity and expected operating cash generation should meet requirements for at least the next 12 months. Capital expenditures for the remainder of fiscal 2019 were expected to be $50 million to $100 million. The filing provides no specific revenue or earnings guidance.
- ASC 606 was adopted retrospectively in fiscal 2019. For enterprise license agreements, license revenue is generally recognized upfront; management reported about $110 million of incremental product revenue in the first nine months compared with the prior accounting method, with none in Q3. The company said adoption’s overall impact on prior periods was not significant.
- Management cited uncertain economic conditions, technology transitions, competition from cloud and other storage providers, product execution and quality, reliance on channel partners and suppliers, and foreign-exchange exposure as risks. U.S.–China trade tensions and Brexit were also identified as potential risks.
- Two distributors, Arrow Electronics and Tech Data, accounted for 25% and 20% of Q3 revenue, respectively. The filing also describes patent litigation and tax audits. No material legal-contingency accrual was recorded; management cautioned that an unfavorable outcome could have a material adverse effect.
- Non-cancelable inventory purchase commitments were $501 million; operating lease payments totaled $164 million. The company had $220 million of other purchase obligations and $4 million of construction obligations.
- Tax matters include $382 million of gross unrecognized tax benefits and $326 million recorded in other long-term liabilities. The Danish tax dispute remained pending; the filing states its outcome and potential tax-audit impacts cannot be reliably estimated.
Most important facts for investors to verify
- Whether product and strategic-solution growth persists after separating the approximately $110 million ASC 606 ELA revenue timing effect.
- Whether operating cash generation remains adequate alongside substantial buybacks, dividends, debt maturities and capital spending.
- How distributor concentration, channel order timing and macroeconomic conditions affect quarterly revenue and collections.
- Developments in tax audits and the Danish tax proceeding, as well as any material change in legal contingencies.
- Whether reported margin trends continue without prior-year property-sale gains or unusual tax effects.