NetApp, Inc. — Form 10-Q Summary
Business context and period: NetApp provides data management software, systems and services for on-premises, private- and public-cloud environments. This unaudited filing covers the second quarter and first six months of fiscal 2020, ended October 25, 2019; comparisons are with the corresponding periods of fiscal 2019. Amounts are in U.S. dollars, millions, except per-share data and percentages.
Financial performance
| Metric | Quarter ended Oct. 25, 2019 | Prior-year quarter | Six months ended Oct. 25, 2019 | Prior-year six months |
|---|---|---|---|---|
| Revenue | $1,371 | $1,517 | $2,607 | $2,991 |
| Gross profit | $925 | $974 | $1,741 | $1,937 |
| Gross margin | 67% | 64% | 67% | 65% |
| Operating income | $296 | $286 | $400 | $540 |
| Operating margin | 22% | 19% | 15% | 18% |
| Net income | $243 | $241 | $346 | $524 |
| Diluted EPS | $1.03 | $0.91 | $1.44 | $1.96 |
| Operating cash flow | $(53) | $165 | $257 | $491 |
- Revenue mix: Quarterly product revenue was $771 million, down 16%; software maintenance was $254 million, up 8%; hardware maintenance and other services were $346 million, down 6%. First-half product revenue fell 21%, while software maintenance rose 8% and hardware maintenance and other services declined 7%.
- Product trends: Quarterly Strategic solutions revenue was $442 million, down 9%; Mature solutions revenue was $329 million, down 23%. The company changed its Strategic/Mature product classifications in fiscal 2020 and recast prior periods for comparison.
- Cash and liquidity: Cash, cash equivalents and short-term investments totaled $2.987 billion at quarter-end, versus $3.899 billion at April 26, 2019. Working capital was approximately $1.0 billion, down about $0.7 billion. Cash and cash equivalents alone were $2.545 billion.
- Debt: Principal debt was $1.649 billion, comprising $1.150 billion of senior notes and $499 million of commercial paper. Net of cash, cash equivalents and short-term investments, this represents approximately $1.338 billion of net cash. The $1.0 billion revolving credit facility was undrawn, and the company reported covenant compliance.
- Other metrics: Deferred revenue and financed unearned services revenue was $3.468 billion, down from $3.668 billion at fiscal year-end; the company expects to recognize approximately 49% within 12 months. The cash conversion cycle was negative four days, compared with three days at fiscal year-end.
Material changes and management commentary
- Revenue declined 10% for the quarter and 13% for the first half, primarily because of lower product sales. Management cited less favorable macroeconomic conditions, lower enterprise IT spending and, in the first quarter, go-to-market execution issues with some large global accounts. Foreign exchange also adversely affected quarterly revenue.
- Gross margin improved, primarily due to a higher mix of All-Flash FAS products and cost reductions. Management said lower materials costs and higher strategic-solution margins helped; prior-year high-margin software license revenue from several enterprise license agreements did not recur, offsetting some benefits.
- Quarterly operating income increased despite lower revenue, helped by lower operating expenses and a $38 million gain on the sale of Sunnyvale land. First-half operating income and net income declined year over year.
- First-half operating cash flow fell to $257 million from $491 million. The company cited lower deferred revenue and payments for fiscal 2019 commissions and incentives and income taxes; the quarter itself had negative operating cash flow of $53 million.
- Capital returns in the first half included $750 million of share repurchases and $226 million of dividends. The company repurchased 14 million shares at an average $55.06 per share. A further $0.48-per-share dividend was declared November 13, 2019.
Outlook, risks and unusual items
- Management said available liquidity, expected operating cash flow and financing access should meet requirements for at least the next 12 months, while noting cash generation could fluctuate and additional cost reductions or financing might be needed if liquidity proved insufficient.
- Capital expenditures for the remainder of fiscal 2020 were projected at $75 million to $100 million. The filing text provided here does not give a clear current full-year revenue or earnings forecast. It notes that fiscal 2020 guidance was revised August 1, 2019.
- The $38 million land-sale gain arose from $96 million of proceeds on land with a $53 million net book value. The company also recognized a $14 million gain on sales of investment securities in the first half. The first-half effective tax rate was 17.2%, versus 7.3% a year earlier; the prior period included a $34 million discrete tax benefit related to adoption of the revenue standard.
- A May 2019 restructuring plan reduced the global workforce by approximately 2%; substantially all activities were completed. First-half restructuring charges were $21 million.
- Key risks include continued weakness in enterprise IT spending and traditional storage markets, execution and product-transition challenges, competition and cloud/consumption-model shifts, dependence on channel partners and distributors, supply-chain constraints, and foreign-exchange exposure. Arrow Electronics and Tech Data each represented at least 21% of quarterly revenue, together about 45%.
- A securities class action filed August 14, 2019 alleges misleading statements about fiscal 2020 guidance issued May 22, 2019; the company says it will defend the case and considers it without merit. The filing also discusses ongoing patent litigation and tax audits, including a Danish withholding-tax dispute. No material accrual was recorded for the legal matters described.
- Unrecognized tax benefits totaled $294 million; $246 million, inclusive of specified adjustments, would affect the tax provision if recognized. The company said it could not estimate the range of possible changes over the next 12 months.
Important facts for investors to verify
- Whether product revenue stabilizes after the reported declines, including the performance of All-Flash FAS, private-cloud solutions and Mature products.
- Whether the first-half cash-flow decline and negative quarterly operating cash flow reverse, and how working-capital movements affect cash conversion.
- The current fiscal 2020 revenue and earnings outlook following the August 1 guidance revision; the filing text provided here does not state the revised forecast figures.
- Debt and liquidity trends, including commercial-paper refinancing, overseas concentration of cash and planned capital returns.
- Developments in the securities class action, patent cases, tax audits and Danish tax dispute, as well as any resulting financial exposure.
- Impact of distributor concentration, macroeconomic conditions, go-to-market execution and product-transition risks on future results.