NetApp, Inc. — Form 10-Q Summary
Reporting period: Fiscal first quarter 2019, the three months ended July 27, 2018. NetApp provides enterprise data-management software, systems and services for on-premises and cloud environments. Comparative results are for the three months ended July 28, 2017; prior-period figures were restated for ASC 606.
Financial performance
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Net revenue | $1.474 billion | $1.321 billion | +12% |
| Gross profit / margin | $963 million / 65% | $824 million / 62% | Margin +3 percentage points |
| Operating income / margin | $254 million / 17% | $140 million / 11% | Higher |
| Net income | $283 million | $131 million | Higher |
| Diluted EPS | $1.05 | $0.47 | Higher |
| Cash from operations | $326 million | $250 million | +$76 million |
- Product revenue rose 20% to $875 million; software maintenance increased 3% to $229 million, while hardware maintenance and other services were essentially flat at $370 million.
- Strategic product revenue increased 23% to $612 million; mature product revenue rose 15% to $263 million. Product gross margin benefited from higher-margin enterprise license agreement (ELA) software revenue and higher average selling prices.
- Operating expenses totaled $709 million, including $19 million of restructuring charges. R&D rose 8% to $208 million; sales and marketing fell 3% to $409 million.
- Cash, cash equivalents and short-term investments totaled $4.811 billion at quarter-end, down from $5.391 billion at April 27, 2018. Working capital was approximately $3.0 billion. Cash conversion cycle was negative 20 days, versus negative 14 days at the prior fiscal year-end.
- Debt principal was $1.750 billion: $1.550 billion of senior notes and $200 million of commercial paper. The $1.0 billion revolving credit facility was undrawn; the company reported compliance with debt covenants.
- Investing activities provided $186 million, including net investment maturities and sales; capital expenditures were $64 million. Financing activities used $812 million, including $500 million of share repurchases, $105 million of dividends paid and $185 million of net commercial-paper repayment.
Material changes and unusual items
- Adoption of ASC 606 under the full retrospective method changed ELA accounting: license fees are now recognized upfront. NetApp said this generated approximately $90 million of Q1 FY2019 product revenue incremental to what the prior standard would have recognized. The company attributed a substantial part of the margin improvement to these ELA revenues. ASC 606 did not affect cash flows.
- The comparative quarter was restated under ASC 606; reported year-over-year comparisons therefore use the restated figures.
- The company recognized a $34 million discrete tax benefit related to intercompany transactions, contributing to an income-tax benefit of $11 million and a reported effective tax rate of negative 4.0%. The prior-year effective tax rate was 9.7%.
- A May 2018 restructuring reduced global headcount by less than 2% and generated $19 million of charges, primarily severance. NetApp expected to complete the plan by fiscal Q2 2019 with no significant additional charges.
- NetApp repurchased 7 million shares at an average $74.37 per share. The remaining repurchase authorization was $3.5 billion. The quarterly dividend declared was $0.40 per share, twice the prior-year amount.
Outlook, risks and contingencies
- NetApp expected fiscal 2019 remaining-period capital expenditures of $100 million to $150 million. Management said available liquidity, operating cash flow and financing access should meet requirements for at least the next 12 months; this is not a revenue or earnings forecast.
- Approximately 50% of the $3.260 billion deferred-revenue and financed-unearned-services balance was expected to be recognized over the next 12 months, and approximately 26% over months 13–24. The company cautioned that cancellable orders and backlog are not necessarily meaningful indicators of future revenue.
- Key risks include intense competition and technology transitions (including cloud and consumption models), dependence on channel partners and a small number of distributors, component-supplier and outsourced-manufacturing risks, quarterly booking and shipment variability, cybersecurity and product-quality exposure, foreign-exchange and interest-rate risks, and evolving tax rules.
- Two distributors accounted for 39% of quarterly revenue: Arrow Electronics, 22%, and Tech Data, 17%.
- NetApp reported ongoing patent litigation and other legal claims; it recorded no material accrual for these matters and said outcomes are uncertain. It also had $351 million of gross unrecognized tax benefits, of which $319 million was recorded in other long-term liabilities. The company could not estimate the possible 12-month change from tax audits and statutes of limitation.
- U.S. tax-reform accounting remained incomplete. A 100-basis-point increase in market interest rates was estimated to reduce the fair value of fixed-income investments by approximately $55 million.
Important facts for investors to verify
- How much of the reported revenue, earnings and margin growth reflects recurring demand versus the timing change for ELA license revenue under ASC 606.
- Whether strategic-product growth and higher average selling prices continue, and how the phaseout of 7-mode systems affects product mix.
- Whether operating cash generation can support capital spending, dividends and repurchases while maintaining liquidity; cash and investments declined by $580 million during the quarter.
- Whether major distributor concentration, supplier commitments and channel or shipment variability create material revenue or working-capital volatility.
- Developments in tax audits, U.S. tax-reform estimates and the Danish tax dispute, as well as outcomes of pending intellectual-property litigation.