NetApp, Inc. — Form 10-Q Summary
Business context and reporting period. NetApp provides data storage and management software, systems and services. This unaudited quarterly report covers the 13 weeks ended October 28, 2016, and the six months then ended, in fiscal 2017. Comparisons are to the corresponding fiscal 2016 periods; fiscal 2016’s first quarter included an extra week, affecting year-to-date service revenue comparisons.
Financial results
| Metric | Three months ended Oct. 28, 2016 | Prior comparable quarter | Six months ended Oct. 28, 2016 | Prior comparable six months |
|---|---|---|---|---|
| Revenue | $1,340 million | $1,445 million | $2,634 million | $2,780 million |
| Gross profit margin | 62% | 61% | 62% | 61% |
| Operating income | $142 million | $145 million | $235 million | $119 million |
| Net income | $109 million | $114 million | $173 million | $84 million |
| Diluted EPS | $0.38 | $0.39 | $0.61 | $0.28 |
| Operating cash flow | $158 million | $145 million | $386 million | $274 million |
- Quarterly revenue fell 7%; product revenue declined 13% to $710 million. Software maintenance revenue rose 4% to $242 million, while hardware maintenance and other services fell 2% to $388 million.
- Strategic product revenue increased 1% in the quarter to $439 million, while mature product revenue decreased 29% to $270 million. Management attributed the overall product weakness primarily to higher discounting and customers’ ongoing transition from older products.
- Operating margin was 11% for the quarter versus 10% a year earlier, and 9% for the six months versus 4%. Lower operating expenses, including restructuring-related headcount reductions and cost initiatives, supported year-to-date operating income.
- Cash, cash equivalents and short-term investments totaled $4.357 billion at October 28, down from $5.303 billion at April 29. Net cash provided by operating activities was $386 million for the six months. Working capital was $2.7 billion, down $94 million.
- Principal debt was $1.5 billion, versus $2.35 billion at April 29. NetApp repaid its $850 million acquisition-related short-term loan; $1.5 billion of senior notes remained outstanding. No borrowings were outstanding under its $300 million revolving credit facility, and the company reported compliance with debt covenants.
- Cash, cash equivalents and investments held internationally were $3.9 billion; management said these funds were intended to remain permanently reinvested abroad. Repatriation could result in additional taxes.
Changes, outlook and risks
- Revenue declines reflected weaker product sales and increased discounting. Maintenance revenue comparisons were also affected by one additional week of amortization in fiscal 2016’s first quarter. Strategic products gained share of product revenue, but mature products continued to contract.
- On November 3, 2016, NetApp announced a further workforce reduction of approximately 6%, with expected charges of $50 million to $60 million, primarily cash costs. Most charges were expected in fiscal 2017’s third quarter; implementation was expected through the fourth quarter.
- Management expected capital expenditures of $75 million to $100 million for the remainder of fiscal 2017 and believed available liquidity and expected operating cash flows would meet requirements for at least 12 months. The filing does not provide revenue or earnings guidance.
- The company declared a subsequent quarterly dividend of $0.19 per share, payable January 25, 2017. It repurchased $292 million of shares during the six months and reported $1.208 billion of remaining repurchase authorization.
- Key risks include continued storage-market transition and competition; customer acceptance and execution of newer products; discounting and product mix pressure on margins; reliance on distributors and suppliers; foreign-exchange, cybersecurity, and tax risks; and execution of restructuring and acquisition integration. Arrow Electronics and Avnet each represented at least 10% of revenue, together accounting for 43% in the quarter.
- NetApp reported $212 million of gross unrecognized tax benefits and ongoing tax examinations. The Danish withholding-tax dispute had been referred to the European Court of Justice. No accrual was recorded for legal matters because losses were not considered probable and/or reasonably estimable.
- The filing reports adoption of new stock-based compensation accounting in fiscal 2017, including a $17 million discrete income-tax charge for the six months. Management said disclosure controls were effective and identified no material change in internal control over financial reporting.
Most important facts to verify
- Confirm the revenue figure: the financial statements and MD&A tables report six-month revenue of $2.634 billion, but one MD&A narrative passage says $2.364 billion, apparently a typographical inconsistency.
- Assess whether strategic-product growth can offset continued declines in mature products without further discounting or margin pressure.
- Review the cash-flow and capital-allocation effects of the new restructuring, planned repurchases, dividends, and the December 2017 maturity of $750 million in senior notes.
- Monitor distributor concentration, foreign-cash repatriation implications, and outcomes of tax audits and the Danish tax dispute.