NetApp, Inc. — Form 10-Q Summary
Reporting period: Quarter ended July 31, 2015, the first quarter of fiscal 2016. The quarter covered 14 weeks, compared with 13 weeks in the prior-year quarter ended July 25, 2014. Unless otherwise stated, amounts are in millions.
Business context and financial performance
NetApp provides data storage and management software, systems and services. It reports as one operating segment and sells globally, primarily through indirect channels.
| Metric | Q1 FY2016 | Q1 FY2015 | Change |
|---|---|---|---|
| Net revenue | $1,335 | $1,489 | Down 10% |
| Gross profit / margin | $816 / 61% | $938 / 63% | Margin down 2 points |
| Operating income (loss) / margin | $(26) / (2)% | $160 / 11% | Declined |
| Net income (loss) | $(30) | $88 | Turned to loss |
| Diluted EPS | $(0.10) | $0.27 | Declined |
| Operating cash flow | $129 | $216 | Down $87 |
Revenue by category was product $664 (down 25%), software maintenance $248 (up 12%) and hardware maintenance and other services $423 (up 10%). Product revenue fell $219, partly offset by growth in maintenance and services. Product gross margin was 7 percentage points lower year over year. Management cited foreign-exchange headwinds, lower unit volume, unfavorable mix and greater discounting amid competition; a $11 impairment charge also affected cost of revenue.
Operating expenses were $842, including $27 of restructuring and other charges, versus $778 in the prior-year quarter. Sales and marketing was $492, R&D $244 and G&A $79. The company recorded a $11 impairment of CacheIQ-developed technology after discontinuing its use, allocated between product cost of revenue ($5) and hardware maintenance and services cost ($6).
Liquidity, cash flow and capital structure
At July 31, 2015, cash, cash equivalents and short-term investments totaled $4,950, down from $5,326 at April 24, 2015. Cash and cash equivalents alone were $2,324, up from $1,922. Net cash from investing activities was $742, largely reflecting investment maturities and sales; financing activities used $464, including $430 for share repurchases and $54 for dividends. Operating cash flow included a $361 reduction in receivables and was supported by $69 of depreciation and amortization and $77 of stock-based compensation.
Total assets were $8,697 and total liabilities $5,697. Long-term debt was $1,488 carrying value ($1,500 principal); debt represented 50% of stockholders’ equity. Senior Notes mature in 2017, 2021 and 2022. The $250 revolving credit facility had no borrowings outstanding, and the company reported compliance with debt covenants. Working capital was $3.6 billion; DSO improved to 30 days from 46 days at the prior fiscal year-end.
About $4.6 billion of cash, cash equivalents and short-term investments was held by foreign subsidiaries and generally intended to remain permanently invested outside the U.S.; repatriation could incur U.S. and state taxes. Management believed available liquidity and expected operating cash flows would meet requirements for at least 12 months.
Changes, outlook, risks and contingencies
- Revenue and product transition: Management attributed weaker product sales to an industry in transition, customer movement toward new architectures and hybrid cloud, and migration from Data ONTAP 7-Mode to clustered Data ONTAP. Configured-system revenue fell 25%; revenue declined across FAS platforms and was flat for E-Series systems.
- Restructuring: A May 2015 realignment reduced the global workforce by approximately 3%. The company recorded $27 of charges, primarily severance, and expected the work to be substantially complete by the end of Q2 FY2016, with no significant additional charges expected.
- Spending and capital returns: Capital expenditures for the remainder of FY2016 were expected to be $150–$200. The company planned to complete the remaining $2.0 billion share-repurchase authorization by May 2018, with the first $1 billion expected by May 2016; these plans may change. A $0.18-per-share dividend was declared for payment in October 2015. No specific revenue or earnings guidance is provided in the filing text.
- Tax matters: The IRS signed a closing agreement on transfer-pricing arrangements for fiscal 2008–2010; the company recorded a $13 tax expense related to the audit adjustment and related tax positions. It disclosed up to $10 of potential additional tax expense from a disputed issue and said unrecognized tax benefits could decrease by up to $47 within 12 months. The Danish withholding-tax dispute remained pending.
- Commitments and legal matters: Non-cancelable inventory purchase commitments were $262; construction obligations were $45 and other purchase obligations $178. Non-cancelable operating lease payments totaled $205. Management reported no material losses to date under financing programs; certain recourse arrangements could expose the company to unpaid lease payments if end users default. No accrual was recorded for ordinary-course legal matters because losses were not considered probable and/or reasonably estimable; Part II reported no legal proceedings.
- Key risks: The filing highlights technology and product-transition execution, competition and pricing pressure, demand and forecasting variability, channel and distributor concentration, supplier and outsourced-manufacturing dependence, foreign-exchange exposure, cybersecurity and product-quality risks, and tax and repatriation uncertainty. Arrow Electronics and Avnet represented 22% and 18% of revenue, respectively.
Most important facts for investors to verify
- Whether product demand and clustered Data ONTAP adoption improve, and whether the decline in product revenue and gross margin persists.
- How results compare after accounting for the extra week in Q1 FY2016 and the effects of foreign exchange, discounting and product mix.
- Whether operating cash generation can support planned buybacks, dividends and capital spending, particularly given the overseas concentration of liquidity.
- Progress and final cost of the workforce realignment, and any further asset impairments or restructuring charges.
- Developments in IRS and other tax matters, including the disputed potential $10 expense and the possible reduction in unrecognized tax benefits.
- Exposure from distributor concentration, inventory commitments and recourse financing guarantees.