NetApp, Inc. — Form 10-Q Summary
Reporting period: First quarter of fiscal 2020, the three months ended July 26, 2019. Comparisons are with the three months ended July 27, 2018 unless noted. NetApp provides enterprise data-management, storage and hybrid-cloud products and services.
Financial results and liquidity
| Metric | Q1 FY2020 | Prior period | Change |
|---|---|---|---|
| Net revenue | $1.236 billion | $1.474 billion | Down 16% |
| Gross profit / margin | $816 million / 66% | $963 million / 65% | Margin up 1 percentage point |
| Operating income / margin | $104 million / 8% | $254 million / 17% | Down $150 million |
| Net income | $103 million | $283 million | |
| Diluted EPS | $0.42 | $1.05 | |
| Cash from operations | $310 million | $326 million |
- Revenue mix: Product revenue was $644 million, down 26%; software maintenance was $250 million, up 9%; hardware maintenance and other services were $342 million, down 8%. Strategic product revenue fell 29% to $337 million; Mature product revenue fell 23% to $307 million. Prior-year Strategic/Mature figures were recast after a category-definition change.
- Cash and liquidity: Cash, cash equivalents and short-term investments totaled $3.532 billion at quarter-end, versus $3.899 billion at April 26, 2019. Working capital was $1.3 billion. Operating cash flow was $310 million; investing cash flow was $938 million, including about $1.0 billion of net investment maturities and sales; financing cash flow was negative $603 million.
- Debt: Principal debt was $1.580 billion, including $1.550 billion of senior notes and $30 million of commercial paper. A $400 million senior-note principal payment was due in September 2019. The $1.0 billion revolving credit facility was undrawn; the company reported covenant compliance.
- Other measures: Deferred revenue and financed unearned services revenue was $3.510 billion, down from $3.668 billion at April 26. Cash conversion cycle was negative 10 days, versus 3 days at April 26. The company held $392 million in non-cancelable inventory purchase commitments.
Material changes and management commentary
- Management attributed the revenue decline primarily to lower product sales, with unfavorable foreign exchange also contributing. It cited less favorable macroeconomic conditions and go-to-market execution issues with some large global accounts. Strategic-product declines reflected lower All-Flash FAS sales and prior-year ELA software-license revenue that did not recur; Mature-product declines reflected lower FAS Hybrid and OEM sales.
- Software maintenance growth partly offset product weakness. Hardware maintenance revenue declined, which management linked to lower average selling prices on recently executed contracts and lower renewal rates.
- Gross margin increased to 66%, but product gross margin declined three percentage points, partly because prior-year ELA license revenue carried unusually high margins. Operating expenses were broadly steady in dollars, so their share of revenue rose as sales fell.
- Operating cash flow was lower year over year. Cash-flow working-capital movements included lower receivables, payables and accrued expenses, and a decline in deferred revenue; the company cited seasonal maintenance-contract renewals and fiscal-year-end compensation payouts among the drivers.
Outlook, unusual items and risks
- The filing discusses revised fiscal 2020 guidance issued August 1, 2019, but the supplied filing text does not provide a clear numerical guidance range. Management said available liquidity should meet requirements for at least the next 12 months. Expected capital expenditures for the remainder of fiscal 2020 were $125 million to $175 million.
- NetApp acquired Cognigo Research Ltd. on May 23 for $58 million in cash. The acquisition added data-discovery and classification software; the company said it was not material enough to present pro forma results.
- A May 2019 restructuring plan reduced the global workforce by approximately 2% and generated $21 million in charges, primarily severance. Completion was expected by the end of fiscal Q2 2020, with no significant additional charges expected.
- Adoption of lease accounting standard ASC 842 added approximately $149 million of operating lease right-of-use assets and $158 million of lease liabilities at transition; it had no material effect on the income statement or cash flows.
- The company sold approximately $1.0 billion of corporate bonds and recognized a $14 million gain. This was an unusual contributor to other income.
- A purported securities class action was filed August 14, alleging misleading statements about fiscal 2020 guidance issued May 22; the complaint seeks unspecified damages tied to the subsequent share-price decline. NetApp said it believes the complaint is without merit and intends to defend it. The filing also describes ongoing patent litigation and tax audits; no material accrual was recorded for the discussed legal matters.
- Key disclosed risks include product-market transitions and cloud competition, sales execution and quarterly forecasting, dependence on channel partners and distributors, customer and distributor concentration, supply-chain constraints, foreign-exchange exposure, cybersecurity and data privacy, and legal and tax contingencies. Arrow Electronics and Tech Data represented 25% and 20% of quarterly revenue, respectively.
Important facts for investors to verify
- Obtain the August 1, 2019 fiscal 2020 guidance revision and compare its assumptions with subsequent results; the filing text here gives no numerical revised range.
- Track whether product revenue and All-Flash FAS sales stabilize, and whether management resolves the cited execution issues at large accounts.
- Monitor maintenance-contract renewal rates and the growth or decline of deferred revenue as indicators of recurring revenue trends.
- Confirm repayment or refinancing of the $400 million senior notes due September 2019, and assess cash remaining after dividends, repurchases and commitments.
- Follow developments in the securities lawsuit, tax audits and other legal contingencies, including any material changes in estimated exposure.