NetApp, Inc. — Fiscal 2018 Third-Quarter Form 10-Q
Reporting period: Three and nine months ended January 26, 2018; comparable periods ended January 27, 2017. Amounts are in U.S. dollars, millions except per-share data.
Business context and results
NetApp provides storage, data-management and hybrid-cloud products and services. Fiscal 2018 third-quarter revenue rose 8%, led by product sales, while maintenance and other services revenue declined. Strategic solutions represented 70% of product revenue, up from 65% in the prior-year quarter.
| Metric | Q3 FY2018 | Q3 FY2017 | Nine months FY2018 | Nine months FY2017 |
|---|---|---|---|---|
| Revenue | $1,523 | $1,404 | $4,270 | $4,038 |
| Gross profit / margin | $941 / 62% | $851 / 61% | $2,677 / 63% | $2,477 / 61% |
| Operating income | $471 | $183 | $838 | $418 |
| Net income (loss) | $(506) | $146 | $(195) | $319 |
| Diluted EPS | $(1.89) | $0.52 | $(0.72) | $1.13 |
| Operating cash flow | $420 | $235 | $984 | $621 |
Q3 product revenue increased 17% to $920; software maintenance fell 1% to $237 and hardware maintenance and other services fell 4% to $366. Management attributed stronger product margins principally to higher average selling prices, especially for All-Flash FAS, and favorable foreign exchange. Nine-month sales and marketing, R&D and G&A expenses totaled $2,057, down as a share of revenue, partly reflecting lower average headcount and cost reductions.
Cash, debt and liquidity
- Cash, cash equivalents and short-term investments were $5,619 at January 26, 2018, versus $4,921 at April 28, 2017; $5,057 was held internationally and $562 in the U.S.
- Nine-month operating cash flow was $984; investing cash use was $141 and financing cash use was $350. Cash and cash equivalents increased $530 to $2,974.
- Principal debt was $2,182: $1,550 of senior notes and $632 of commercial paper. The company reported $1,540 of long-term debt on the balance sheet and no amount drawn on its $1.0 billion revolving credit facility. Debt covenants were met.
- Working capital was $3.2 billion. The cash conversion cycle was negative 11 days, compared with 15 days at fiscal year-end; management cited improved payables management and extended supplier payment terms.
- Management said available liquidity and expected operating cash flows should meet requirements for at least 12 months. Capital expenditures for the remainder of FY2018 were expected to be $50–$100.
Material changes, unusual items and outlook
- Tax reform drove the reported net loss. The quarter included an $856 provisional tax charge related to U.S. tax reform—$739 for the one-time transition tax and $117 from remeasurement of deferred taxes—plus a separate $72 tax charge associated with property transactions. Q3 income tax provision was $991; the nine-month effective tax rate was 122.6%. The tax accounting remained provisional and could be adjusted materially as guidance and analysis develop. NetApp intended to pay the transition tax over eight years.
- Property gains boosted operating income. The company recognized $218 of gains: $142 from a property sale yielding $210 cash proceeds and $76 from ending a sale-leaseback financing arrangement, including extinguishment of $130 in financing obligations. A further property closing was expected within 12 months, subject to conditions, for $96 cash proceeds.
- NetApp repurchased $450 of shares during the nine months and paid $161 in dividends. Remaining buyback authorization was $344; the company said it planned to complete it by May 2018. A $0.20-per-share dividend was declared for payment April 25, 2018.
- No specific revenue or earnings guidance was provided in the supplied filing text. Management noted that operating cash flow may fluctuate with operating results, collections, inventory, supplier payments and tax-related items.
- Key risks include rapid storage-market and technology changes, cloud and consumption-model competition, product transitions, dependence on channel partners and a limited supplier base, foreign-exchange and investment risks, and cybersecurity or product-quality events. Two distributors accounted for 41% of Q3 revenue and 42% of nine-month revenue.
- The company was involved in patent litigation and tax audits; it recorded no material legal accrual and said adverse outcomes could nevertheless have a material impact. A Danish tax case was before the EU Court of Justice, with an opinion and judgment expected by fiscal year-end.
- NetApp planned to adopt the new revenue-recognition standard in FY2019, preliminarily using full retrospective adoption, but had not determined whether the impact would be material. It expected lease-accounting adoption in FY2020 to increase reported assets and liabilities.
Important facts for investors to verify
- Separate recurring operating performance from the $218 property gains and assess product growth against declines in maintenance revenue.
- Track final U.S. tax-reform accounting, transition-tax payments, and the effect of tax audits and uncertain tax positions.
- Monitor cash generation and working-capital trends, particularly the contribution from extended supplier payment terms.
- Review debt and commercial-paper levels, upcoming maturities, share repurchases, dividends and the status of the remaining property sale.
- Assess distributor concentration, strategic-product growth, mature-product declines and the impact of market shifts toward cloud and subscription models.