NetApp, Inc. — Fiscal 2023 Second-Quarter 10-Q
Reporting period: Quarter ended October 28, 2022; comparisons are with the quarter ended October 29, 2021. Unless otherwise noted, financial amounts are in millions of dollars. NetApp provides hybrid-cloud storage and infrastructure products and services, and public-cloud offerings.
Financial performance
| Metric | Q2 FY2023 | Q2 FY2022 | Change |
|---|---|---|---|
| Revenue | $1,663 | $1,566 | Up 6% |
| Product revenue | $837 | $814 | Up 3% |
| Services revenue | $826 | $752 | Up 10% |
| Gross profit / margin | $1,087 / 65.4% | $1,059 / 67.6% | Margin down 2.2 percentage points |
| Operating income / margin | $282 / 17% | $294 / 19% | Income down 4% |
| Net income | $750 | $224 | |
| Diluted EPS | $3.41 | $0.98 |
For the six months ended October 28, 2022, revenue was $3,255, up 8%; operating income was $537 versus $543; net income was $964 versus $426; and diluted EPS was $4.34 versus $1.86. Results for both the quarter and half year include a $524 tax benefit from an intra-entity transfer of intellectual property, which substantially boosted reported net income.
- Revenue mix and segments: Q2 Hybrid Cloud revenue was $1,521, up from $1,479; Public Cloud revenue was $142, up 63% from $87. Public Cloud growth reflected customer demand and contributions from acquisitions. Services growth was driven partly by public-cloud revenue and support contracts. Foreign exchange reduced revenue growth by approximately five percentage points.
- Margins and costs: Higher component and freight costs, supply constraints, and currency movements pressured product margins. Consolidated gross margin declined year over year; segment gross margins were 66.1% for Hybrid Cloud and 68.3% for Public Cloud, compared with 68.2% and 71.3%, respectively. Operating expenses rose, including R&D, while operating margin fell.
- Cash flow: First-half operating cash flow was $495, down from $540. Investing used $916, including $491 net cash for acquisitions, while financing used $979, including $500 for repurchases, $218 in dividends, and $250 to redeem notes. Cash, cash equivalents and short-term investments fell to $3,033 from $4,134 at fiscal year-end.
- Liquidity and debt: Net working capital was $1,200, down $784 from April 29, 2022. Principal debt was $2,400, with $2,387 recorded as long-term debt; the company had no commercial paper outstanding and no credit-facility borrowings. A $1.0 billion revolving facility was available. Management said available liquidity and expected operating cash flows should meet requirements for at least 12 months.
- Other balance-sheet items: Deferred revenue and financed unearned services revenue totaled $4,051, down from $4,232. Approximately 49% was expected to be recognized as revenue in the next 12 months. Goodwill rose to $2,767, including $421 from the Instaclustr acquisition.
Material changes and management commentary
- Net revenue grew, but product revenue growth was modest and consolidated gross margin and operating income declined. Services, particularly Public Cloud, were the stronger growth contributors.
- Management reported slower customer demand in Q2 amid global economic uncertainty, alongside inflation, foreign-exchange volatility, and supply-chain constraints. Supply issues raised component and freight costs and delayed some customer orders. The company cautioned these conditions could continue to affect demand, fulfillment, costs, and revenue growth.
- NetApp acquired Instaclustr for approximately $498 million in May 2022. The company expects growth opportunities and revenue synergies; acquisition impact was not material enough to present pro forma results.
- Fiscal 2023 restructuring included a workforce reduction of approximately 1% and continued work related to establishing an international headquarters in Cork, Ireland. First-half restructuring charges were $22; additional charges were expected during the remainder of the fiscal year.
- The company discontinued operations in Russia, Belarus, and certain regions of Ukraine in Q2. Management said the impact on Q2 and first-half results was not significant. Other income included $21 of non-refundable Russian customer payments for support the company could not provide, and a first-quarter $32 gain on sale of a minority investment.
Outlook, risks and contingencies
- The filing does not provide a clear full-year revenue or earnings forecast. NetApp expected capital expenditures of $100–$200 for the remainder of fiscal 2023 and stated that operating cash flow may fluctuate materially.
- Risks highlighted include uncertain economic conditions and possible recession, reduced customer demand, foreign-exchange movements, component availability and higher freight costs, and delayed order fulfillment. The company also identified tax-law changes and ongoing tax audits as potential sources of adverse impact.
- The $524 IP-transfer tax benefit depends on a valuation based on projected cash flows and significant management assumptions. NetApp said it expects to realize the associated deferred tax asset and will assess recoverability quarterly. The six-month effective tax rate was negative 67.7%, versus 17.6% a year earlier.
- NetApp reported $225 of gross unrecognized tax benefits, of which $140 would affect the tax provision if recognized. It is involved in tax audits and disputes, including a Danish withholding-tax matter; the company is pursuing its position on appeal.
- The filing describes ongoing patent litigation and other ordinary-course legal proceedings. No material accrual was recorded for the patent matters; management said adverse outcomes could result in damages, injunctions, or other material effects. A securities class action was approved for settlement and dismissed with prejudice in September 2022.
- Non-cancelable inventory purchase commitments were approximately $600, with another $300 of other purchase obligations. The company also disclosed customer-financing guarantees and service-contract exposure, but said associated contingencies were not significant and material payments were considered remote.
Most important facts for investors to verify
- How much of reported earnings growth reflects the one-time $524 IP-transfer tax benefit, and how the deferred tax asset’s valuation and recoverability develop.
- Whether customer demand, supply constraints, component and freight costs, and foreign-exchange effects improve or worsen—and their effect on revenue growth and margins.
- Public Cloud growth and profitability, including the contribution and integration of Instaclustr and CloudCheckr.
- Cash generation and liquidity after acquisition spending, repurchases, dividends, debt repayments, and remaining capital and purchase commitments.
- Developments in tax audits and the Danish tax appeal, intellectual-property litigation, and the company’s restructuring costs.