NetApp, Inc. — Q1 Fiscal 2017 Form 10-Q
Reporting period: Three months ended July 29, 2016. Comparatives are the three months ended July 31, 2015. The current quarter had 13 weeks; the prior-year first quarter had 14, which management says boosted prior-year maintenance revenue and expenses. Figures are in millions except per-share data, percentages, and days.
Financial performance
| Metric | Q1 FY2017 | Q1 FY2016 | Change / context |
|---|---|---|---|
| Net revenue | $1,294 | $1,335 | Down 3% |
| Product revenue | $660 | $664 | Down 1%; essentially flat |
| Software maintenance | $241 | $248 | Down 3% |
| Hardware maintenance and other services | $393 | $423 | Down 7% |
| Gross profit / margin | $797 / 62% | $816 / 61% | Margin up 1 percentage point |
| Operating expenses | $704 | $842 | Down 16%; includes no restructuring charge versus $27 prior year |
| Operating income (loss) | $93 | ($26) | Operating margin 7% versus (2%) |
| Net income (loss) | $64 | ($30) | Diluted EPS $0.23 versus ($0.10) |
| Operating cash flow | $228 | $129 | Up $99 |
- Strategic solution product revenue rose 24% to $400, representing 61% of product revenue, compared with 49% a year earlier. cDOT system unit volume increased 35%; lower average selling prices, mix shift, and discounting partly offset the volume increase.
- Mature solution product revenue fell 24% to $260, primarily as 7-mode system unit volume declined 46%. Add-on storage and related OS revenue declined 14%, and OEM revenue declined 20%.
- Management attributed lower year-over-year services revenue mainly to the prior-year quarter’s extra week, which added approximately $40 of maintenance revenue. Expense reductions also reflected cost programs and lower average headcount; the SolidFire acquisition partly offset the reductions.
- Cost of product revenue increased 4% despite slightly lower product revenue. Management cited higher materials costs and lower standard margins, partly offset by lower excess-inventory write-downs.
Cash, debt, and liquidity
- Cash, cash equivalents, and short-term investments totaled $4,421 at July 29, down from $5,303 at April 29. Approximately $3.8 billion was held by foreign subsidiaries and $0.6 billion in the U.S.; repatriation of foreign funds could trigger U.S. and state taxes. NetApp stated its intent was to keep those funds permanently reinvested abroad.
- Working capital was $2.7 billion, down $87 from fiscal year-end. DSO was 35 days, versus 54 days in the prior fiscal fourth quarter and 30 days in the prior-year first quarter; the filing cites seasonality and the prior-year extra week as factors.
- Principal debt was $1.5 billion at quarter-end, all in senior notes; the $850 short-term loan related to the SolidFire acquisition was repaid in full. A $300 revolving credit facility had no borrowings outstanding, and the company reported covenant compliance. Senior note principal maturities are $750 in 2017 and $750 thereafter, as presented in the filing’s fiscal-year maturity schedule.
- Financing cash outflows included $850 to repay the short-term loan, $175 for share repurchases, and $53 for dividends. The company repurchased 7.2 million shares at an average $24.20; $1,324 remained authorized. The August 17, 2016 dividend declaration was $0.19 per share.
- Operating cash flow included $311 from the reduction in accounts receivable, partly offset by lower accrued expenses and deferred revenue. Investing cash flow was $276, including net investment maturities and sales; capital expenditures were $36.
Outlook, risks, and unusual items
- Management expected capital expenditures of $100–$150 for the remainder of FY2017 and believed available liquidity and expected operating cash flow would meet requirements for at least 12 months. It cautioned that operating cash flow may fluctuate and that insufficient liquidity could require spending reductions, restructuring, or new financing. No revenue or earnings guidance was provided in the supplied filing text.
- Key business risks include a weak or changing storage market, technology transitions and customer acceptance of cDOT and other new offerings, competition from cloud, flash, and converged solutions, channel and distributor dependence, component supply constraints, and execution of product transitions and acquisitions. Arrow Electronics and Avnet accounted for 20% and 19% of revenue, respectively.
- Foreign tax audits and transfer-pricing matters remain significant uncertainties. Gross unrecognized tax benefits were $218, including $149 recorded in other long-term liabilities; $154 would affect income tax provision if recognized. The Danish withholding-tax dispute had been referred to the European Court of Justice. The filing records no legal-contingency accrual because claims were not considered probable and/or reasonably estimable.
- NetApp early adopted the stock-based compensation accounting update. It recorded a $13 tax charge in the quarter and a net $21 cumulative-effect increase to retained earnings at adoption. The quarter’s effective tax rate was 30.4%.
- Fiscal 2016 restructuring actions, which reduced global workforce by approximately 14% in aggregate, were substantially complete; no new restructuring charges were recorded in this quarter. A $149 sale-leaseback financing obligation remained on the balance sheet.
- Interest-rate sensitivity: a hypothetical 100-basis-point increase would have reduced fixed-income investment fair value by approximately $21. The company also identified foreign-exchange, cybersecurity, product-quality, tax, and customer-credit risks.
Important facts for investors to verify
- Whether strategic-product growth and cDOT adoption can offset continued declines in mature products, and how the transition affects selling prices and product margins.
- How much reported revenue decline reflects the prior-year extra week versus underlying demand, and whether maintenance revenue stabilizes.
- Whether reduced operating expenses and improved profitability are sustainable without impairing product development, sales execution, or customer support.
- The availability and potential tax cost of foreign-held liquidity, upcoming debt maturities, and the company’s continued ability to fund dividends, repurchases, and investment needs.
- Developments in tax audits and the Danish tax dispute, as well as fulfillment of inventory, lease, purchase, and financing commitments.