Business context and reporting period
NetApp, Inc. provides storage and data-management software, systems and services. This unaudited Form 10-Q covers the 13 weeks ended July 25, 2014 (fiscal 2015 first quarter), with comparison to the quarter ended July 26, 2013 unless otherwise noted. Amounts are in millions except per-share data.
Key financial results
| Metric | Q1 FY2015 | Q1 FY2014 | Change / context |
|---|---|---|---|
| Net revenue | $1,489.2 | $1,516.2 | Down 2% |
| Gross profit / margin | $938.1 / 63.0% | $909.6 / 60.0% | Margin up 3 percentage points |
| Operating income / margin | $159.9 / 10.7% | $96.9 / 6.4% | Improved; prior period included $48.4 restructuring charges |
| Net income | $88.4 | $81.6 | Up 8% |
| Diluted EPS | $0.27 | $0.23 | Weighted-average diluted shares fell to 329.1 from 359.9 |
| Operating cash flow | $215.5 | $285.8 | Down 25% |
Revenue mix: product revenue was $882.6, down 5%; software entitlements and maintenance was $221.3, down 3%; and service revenue was $385.3, up 8%. Management attributed the gross-margin improvement mainly to lower unit materials costs and favorable product mix, along with lower warranty costs and higher service margins. Lower product and SEM revenue outweighed service growth.
Financial position, liquidity and capital allocation
- Cash and cash equivalents were $3,031.6 and short-term investments $2,532.6, totaling $5,564.2 at July 25, versus $5,003.3 at April 25, 2014. Reported working capital was $4.3 billion.
- Long-term debt was $1,494.1 carrying value, or $1.5 billion principal. NetApp issued $500 million of 3.375% senior notes due 2021 in June, receiving $494.7 million net proceeds. No borrowings were outstanding on its $250 million revolving credit facility; the company reported covenant compliance.
- About $4.5 billion of cash, cash equivalents and short-term investments was held by foreign subsidiaries; management said it intended to keep these funds permanently reinvested abroad. Repatriation could trigger taxes.
- NetApp generated $215.5 million from operations, spent $58.4 million on capital expenditures, repurchased $118.9 million of stock and paid $53.4 million in dividends. DSO was 36 days, compared with 47 days at April 25.
- The quarterly dividend declared and paid was $0.165 per share, up from $0.150. Remaining repurchase authorization was approximately $1.0 billion; management planned to complete it by May 2015, subject to conditions.
Changes, outlook, risks and unusual items
- The $71.3 million tax provision and 44.6% effective tax rate (11.6% a year earlier) included a $47.4 million charge related to settlement of the IRS examination of fiscal 2005–2007 returns and remeasurement of uncertain tax positions. The company expected an $8 million refund, excluding interest. Other tax audits remained ongoing; gross unrecognized tax benefits were $277.3 million.
- Management forecast capital expenditures of $125–$175 million for the remainder of fiscal 2015 and expected the March 2014 workforce realignment to be substantially complete in fiscal Q2, with no significant additional charges. The filing does not provide a clear full-year revenue or earnings guidance figure.
- Management said available liquidity and expected operating cash generation should meet requirements for at least the next 12 months. It cautioned that cash flows may fluctuate with results, shipment timing, collections, working capital, tax items and compensation payments.
- Key business risks include constrained IT spending and uncertain demand, product and technology transitions (notably clustered Data ONTAP), pricing and margin pressure, supply-chain dependence, and reliance on indirect sales. Distributors Arrow Electronics and Avnet represented 22% and 16% of quarterly revenue, respectively.
- Other exposures include foreign-exchange and investment-market risk, customer financing guarantees (maximum potential payments of $213.2 million, against $196.8 million of associated deferred revenue), purchase and lease commitments, and ongoing tax disputes. The filing reported no legal-proceeding accrual because losses were not considered probable and/or reasonably estimable.
- Management cited a 100-basis-point interest-rate increase as reducing fixed-income investment fair value by approximately $23 million. The company reported no material deterioration in investment values and no other-than-temporary impairment of investments.
Important facts for investors to verify
- Whether product and SEM revenue trends stabilize and whether newer systems and clustered Data ONTAP gain customer acceptance.
- Whether gross-margin gains persist despite lower system selling prices, competitive pressure and changes in product mix.
- The cash-flow trajectory and how much liquidity is practically available in the United States given the large foreign-held balance and potential repatriation taxes.
- Developments in the remaining IRS and foreign tax audits, uncertain tax positions and the expiration of the Netherlands tax ruling in April 2015.
- Execution and funding of the stated repurchase timetable, dividend policy and fiscal 2015 capital-expenditure range.
- Concentration in major distributors and exposure to supplier commitments, customer financing guarantees and investment-market risk.