NetApp, Inc. — Form 10-Q Summary
Business context and period: NetApp provides storage and data-management software, systems and services. This fiscal 2015 third-quarter report covers the three and nine months ended January 23, 2015; comparisons are with the corresponding periods ended January 24, 2014. The financial statements are unaudited.
Financial performance
| Metric | Q3 FY2015 | Q3 FY2014 | Nine months FY2015 | Nine months FY2014 |
|---|---|---|---|---|
| Revenue | $1,551.3M | $1,610.0M | $4,583.0M | $4,676.1M |
| Gross profit / margin | $977.4M / 63.0% | $1,002.3M / 62.3% | $2,898.0M / 63.2% | $2,877.1M / 61.5% |
| Operating income / margin | $202.5M / 13.1% | $226.7M / 14.1% | $554.9M / 12.1% | $510.5M / 10.9% |
| Net income | $176.8M | $192.1M | $425.0M | $440.5M |
| Diluted EPS | $0.56 | $0.55 | $1.31 | $1.25 |
| Operating cash flow | $274.6M | $331.8M | $871.5M | $980.1M |
Quarterly revenue fell 4% and nine-month revenue fell 2%. Product revenue declined 8% in Q3 and 6% year to date; service revenue grew 7% and 8%, respectively. Software entitlements and maintenance revenue was flat for Q3 and down 2% year to date. Product revenue mix declined, while service grew; gross margin improved, but quarterly operating margin and net income declined.
Liquidity, debt and capital returns
- Cash, cash equivalents and short-term investments totaled $5.25B at January 23, 2015, versus $5.00B at April 25, 2014. Working capital was $4.1B; DSO improved to 39 days from 47.
- Long-term debt was $1.495B carrying value, or $1.5B principal, compared with $995.5M carrying value and $1.0B principal at fiscal year-end. Net proceeds of $494.7M came from issuing $500M of 3.375% senior notes due 2021. No borrowings were outstanding on the $250M revolving facility; the company reported covenant compliance.
- Nine-month operating cash flow was $871.5M. Investing cash flow was a use of $178.6M, including $84.6M for acquisitions and $138.1M in capital expenditures. Financing cash flow was a use of $389.3M, including $918.9M of repurchases and $156.9M of dividends. Cash increased $248.7M.
- Repurchased 23.1M shares for $918.9M over nine months. The board subsequently added $2.5B to repurchase authorization; management planned to complete the remaining approximately $206M authorization by May 2015 and the additional authorization by May 2018. A $0.165-per-share dividend was declared for payment in April 2015.
- Approximately $4.6B of cash, cash equivalents and short-term investments was held by foreign subsidiaries; management intends to keep those funds permanently reinvested abroad. Repatriation could trigger U.S. and state taxes.
Changes, outlook and risks
- Management attributed revenue softness mainly to lower product sales, including declines in add-on storage and OEM products. A pricing-strategy change reduced hardware prices while charging for operating-system software based on storage capacity. Configured-system volumes increased, but average selling prices fell. Service growth reflected a larger installed base and higher maintenance contract values.
- Quarterly revenue was reduced by $22.4M from unfavorable foreign exchange. Gross margin benefited from lower warranty costs and, year to date, product and service margin improvements. Operating expenses were broadly flat in dollars but higher as a share of revenue.
- The March 2014 realignment, including an approximately 4% workforce reduction, was completed in the second quarter of fiscal 2015; no restructuring charge was recorded in the current nine-month period. The prior-year comparable period included $49.5M of restructuring charges.
- Management expected liquidity to meet operating, investment, debt-service and capital-return needs for at least 12 months. It anticipated $25M–$75M of capital expenditures for the remainder of fiscal 2015. The filing provides no specific revenue or earnings guidance.
- The company acquired Riverbed’s SteelStore product-line assets and other software intangible assets for a combined $84.6M in October 2014. Acquisitions were deemed immaterial for pro forma results.
- Tax matters were significant: a $47.4M tax provision followed the IRS settlement of fiscal 2005–2007 audits; nine-month effective tax rate rose to 22.5% from 14.3%. Gross unrecognized tax benefits were $275.4M, and the IRS was auditing fiscal 2008–2010 returns. Transfer pricing disputes and other jurisdictional audits remain risks.
- Key business risks include constrained IT spending and uncertain storage-market growth, product transitions and customer adoption of clustered Data ONTAP, competition, channel and distributor concentration, supply-chain dependence, pricing and margin pressure, foreign exchange, cybersecurity, and tax and regulatory exposure. Arrow and Avnet represented 23% and 16% of nine-month revenue, respectively. No legal-proceeding accrual was recorded; the filing reports no pending legal proceedings.
Important facts for investors to verify
- Whether product revenue and pricing trends stabilize and whether service growth can offset product weakness.
- How much of cash and investments is practically available in the United States, given foreign-held funds and potential repatriation taxes.
- Cash generation after repurchases, dividends, acquisition spending and debt interest, and execution of announced repurchase plans.
- Outcomes and potential cash impacts of U.S. and foreign tax audits, including transfer-pricing matters.
- Customer adoption, migration and execution risks related to clustered Data ONTAP and newer product offerings.
- Distributor concentration, supply commitments and potential effects of demand shortfalls on inventory and margins.