NetApp, Inc. — Form 10-Q Summary
Business context and reporting period
NetApp provides data-management software, systems and services for on-premises and cloud environments. This unaudited filing covers fiscal third quarter and the first nine months of fiscal 2020, ended January 24, 2020; comparisons are with periods ended January 25, 2019. Dollar amounts are in millions unless stated otherwise.
Financial results and liquidity
| Metric | Three months | Nine months |
|---|---|---|
| Revenue | $1,404, down 10% | $4,011, down 12% |
| Gross margin | 67%, versus 63% | 67%, versus 64% |
| Operating income / margin | $268 / 19%, versus $311 / 20% | $668 / 17%, versus $851 / 19% |
| Net income | $277, versus $249 | $623, versus $773 |
| Diluted EPS | $1.21, versus $0.98 | $2.64, versus $2.94 |
| Operating cash flow | $420, versus $451 | $677, versus $942 |
- Quarterly product revenue fell 19% to $787; software maintenance rose 10% to $263; hardware maintenance and other services declined 1% to $354. For the nine months, product revenue fell 20% to $2,202, software maintenance rose 9% to $767, and hardware maintenance and other services fell 5% to $1,042.
- Cash, cash equivalents and short-term investments totaled $3,008 at January 24, down from $3,899 at April 26, 2019. Working capital was $0.7 billion, down $1.0 billion from fiscal year-end.
- Debt principal totaled approximately $1,844: $1,150 of senior notes and $694 of commercial paper. The $1.0 billion revolving credit facility was undrawn; the company reported compliance with debt covenants.
- For the first nine months, NetApp generated $677 of operating cash flow, received $1,300 from investment maturities, sales and collections, and used $1,520 in financing activities. Financing included $1,250 of share repurchases, $334 of dividends and repayment of $400 of senior notes.
Material changes versus prior periods
- Revenue weakness was principally driven by lower product sales. Management cited less favorable macroeconomic conditions, lower enterprise IT spending and first-quarter go-to-market execution issues with some large global accounts.
- Strategic product revenue declined 7% in the quarter and 15% year to date; mature product revenue declined 32% and 26%, respectively. Strategic products made up a larger proportion of product revenue, but both categories declined.
- Gross margin improved, primarily due to higher margins on products and services, a higher mix of All Flash FAS sales and cost reductions. Year-to-date margin also faced comparison with prior-year enterprise license agreement revenue that did not recur.
- Quarterly net income increased despite lower operating income, aided by a $50 discrete tax benefit from the lapse of statutes of limitations; the quarterly tax provision was a benefit of $1 versus an expense of $70 a year earlier. Year-to-date net income declined.
- Net cash from operations fell year over year. The filing cites lower accrued expenses, including fiscal 2019 commission and incentive payments and income-tax payments, among the working-capital movements.
Outlook, risks and unusual items
- Management stated that existing liquidity, operating cash generation and access to capital were expected to meet requirements for at least the next 12 months. Planned capital expenditures for the remainder of fiscal 2020 were $50–$75.
- The filing gives no new quantified revenue or earnings forecast. It notes that results and operating cash flows may fluctuate with demand, shipment timing, collections, inventory, supplier payments and compensation payments.
- A $38 gain was recorded in the first nine months from the sale of Sunnyvale land for $96 cash proceeds. NetApp also acquired Cognigo for $58 in cash; the acquisition was not material to reported results.
- NetApp adopted the new lease standard, recognizing $142 of operating lease right-of-use assets and $149 of lease liabilities at January 24, 2020. The company reported no material income-statement or cash-flow impact from adoption.
- Risks include technology and product transitions, competition and cloud adoption, channel and distributor dependence, supply-chain disruption, cybersecurity, foreign exchange and tax exposures. The filing specifically cited the novel coronavirus outbreak originating in China as a possible supply-chain and international-operations risk.
- Legal matters include a securities class action concerning fiscal 2020 guidance revised in August 2019, ongoing patent disputes and a Danish withholding-tax matter. The company said it intended to defend the claims; no material legal accrual was recorded. Gross unrecognized tax benefits were $187.
- Two distributors represented 45% of quarterly revenue combined: Arrow Electronics 25% and Tech Data 20%. This concentration increases exposure to changes in distributor ordering.
Important facts for investors to verify
- Whether product-demand weakness and the cited sales-execution issues persist, and whether strategic-product growth resumes.
- How much of the improved quarterly net income reflects the nonrecurring $50 tax benefit, versus ongoing operating performance.
- Whether operating cash flow recovers and how repurchases, dividends and commercial-paper borrowings affect liquidity and debt.
- Developments in the securities action, patent litigation and tax audits, including the Danish tax dispute and possible changes to unrecognized tax benefits.
- Exposure to distributor concentration, the China-related outbreak and other supply-chain or macroeconomic disruptions.