NetApp, Inc. — Form 10-Q Summary
Reporting period: Third quarter and first nine months of fiscal 2014, ended January 24, 2014. Comparisons are with the corresponding periods ended January 25, 2013, except balance-sheet comparisons, which are against April 26, 2013. NetApp supplies enterprise storage and data-management hardware, software and services.
Financial performance
| Metric | Q3 FY2014 | Q3 FY2013 | Nine months FY2014 | Nine months FY2013 |
|---|---|---|---|---|
| Net revenue | $1,610.0 million | $1,630.1 million | $4,676.1 million | $4,615.9 million |
| Gross profit / margin | $1,002.3 million / 62.3% | $964.9 million / 59.2% | $2,877.1 million / 61.5% | $2,728.9 million / 59.1% |
| Operating income / margin | $226.7 million / 14.1% | $187.9 million / 11.5% | $510.5 million / 10.9% | $403.4 million / 8.8% |
| Net income | $192.1 million | $158.1 million | $440.5 million | $331.5 million |
| Diluted EPS | $0.55 | $0.43 | $1.25 | $0.90 |
| Operating cash flow | $331.8 million | $365.1 million | $980.1 million | $930.7 million |
Revenue mix and drivers: Q3 product revenue fell 4% to $1,015.0 million; software entitlements and maintenance fell 1% to $227.0 million; service revenue rose 8% to $368.0 million. For the nine months, product revenue decreased 2%, while service revenue increased 9% and software entitlements and maintenance increased 3%. Management attributed product weakness mainly to lower OEM sales. Service growth reflected a larger installed base and higher maintenance contract values.
Margins and expenses: Management cited lower unit materials costs and supply-chain efficiencies, favorable configuration mix and lower OEM revenue mix as contributors to higher gross margins. Q3 operating expenses were $775.6 million, versus $777.0 million; nine-month operating expenses were $2,366.6 million, including $49.5 million in restructuring charges. Research and development expense increased, while sales and marketing expense declined.
Cash, liquidity and debt: At January 24, cash and cash equivalents were $2,152.7 million and short-term investments were $2,916.6 million, totaling $5,069.3 million, down from $6,952.6 million at fiscal year-end. Working capital was $3.8 billion and DSO was 33 days, versus 42 days at April 26, 2013. The company repaid $1,264.9 million of convertible notes upon their June 2013 maturity; remaining senior-note principal was $1.0 billion, due in 2017 and 2022. No borrowings were outstanding under the $250 million revolving credit facility, and the company reported covenant compliance.
Capital returns: During the nine months, NetApp repurchased 37.6 million shares for $1.507 billion and paid $153.1 million in dividends. The remaining repurchase authorization was $1.499 billion. A $0.15-per-share dividend was declared February 12, 2014, payable April 22, 2014.
Material changes versus the prior period
- Q3 revenue declined 1%, but nine-month revenue increased 1%; product declines were partly offset by growth in services and, year to date, maintenance and software entitlements.
- Gross margin improved 3.1 percentage points in Q3 and 2.4 points for the first nine months. Operating margin increased 2.6 points in Q3 and 2.1 points year to date.
- Nine-month net income rose to $440.5 million from $331.5 million. Diluted EPS increased to $1.25 from $0.90, alongside a lower diluted share count.
- Cash and short-term investments declined by approximately $1.9 billion, primarily reflecting convertible-note repayment and share repurchases. Debt fell substantially as the convertible notes matured.
- The company initiated a restructuring in May 2013, reducing its global workforce by approximately 7%; $49.5 million of severance charges were recorded, and the work was substantially completed by quarter-end.
Outlook, risks and unusual items
- Outlook: No specific revenue or earnings guidance is provided in the supplied filing text. Management expected existing liquidity and operating cash generation to meet requirements for at least the next 12 months. Capital expenditures for the remainder of fiscal 2014 were expected to be $25 million to $75 million. NetApp planned $500 million of repurchases by the end of May 2014, subject to market and other conditions.
- Product transition and competition: Management identified development and customer adoption of clustered Data ONTAP as important, including challenges migrating customers and delivering required features. Risks include demand forecasting, pricing pressure, product quality, and competition.
- Channels and supply chain: Indirect channels generated 82% of nine-month revenue. Arrow Electronics accounted for 21% and Avnet for 16%; the company also relies on third parties and a limited number of suppliers for manufacturing and components. Purchase commitments included $240.2 million with contract manufacturers.
- Tax matters: Unrecognized tax benefits were $207.8 million; $135.8 million, including interest and penalties, would affect tax expense if recognized. U.S. and foreign tax examinations remain ongoing, including IRS audits and a disputed Danish withholding-tax matter. Management said the timing and amount of any changes in uncertain tax positions could not be determined.
- Other contingencies: The filing reports no legal-proceedings accrual because losses were not considered probable and/or reasonably estimable. Financing guarantees had maximum potential payments of $218.0 million, offset by $203.8 million of associated deferred revenue. The filing also describes media allegations that products may have reached Syria through a third party; NetApp said it was reviewing the allegations and cooperating with U.S. officials.
- Market risks: A hypothetical 100-basis-point rise in interest rates would have reduced fixed-income investment fair value by approximately $31 million. Auction-rate securities had a $40.4 million estimated fair value and limited liquidity. About $4.1 billion of cash, cash equivalents and investments was held internationally; repatriation could trigger U.S. taxes, and management intended to keep those funds permanently reinvested abroad.
Important facts for investors to verify
- Whether product and OEM revenue trends stabilize, and whether growth in maintenance and services continues to offset product declines.
- Whether gross-margin gains from supply-chain efficiencies and mix are sustainable amid pricing, component-cost and competitive pressures.
- Customer and channel concentration, especially Arrow and Avnet, and the significance and trajectory of OEM sales.
- Progress and customer acceptance of clustered Data ONTAP, including migration, feature readiness and product-quality execution.
- Cash available for U.S. needs given the overseas cash position, potential repatriation taxes, planned repurchases and dividends.
- Developments in tax audits, the Syria-related inquiry, investment valuations and other commitments or contingencies.