NetApp, Inc. — Form 10-Q summary
Reporting period: Fiscal second quarter and six months ended October 27, 2017; comparative periods ended October 28, 2016. The unaudited quarter comprised 13 weeks. Amounts are in millions except per-share data, percentages, and days.
Business context and financial results
NetApp provides data management products and services for on-premises, private-cloud, and public-cloud environments. It reports one operating segment. The quarter’s growth was driven by product sales, particularly strategic solutions, while maintenance and services revenue declined.
| Metric | Q2 FY2018 | Q2 FY2017 | Six months FY2018 | Six months FY2017 |
|---|---|---|---|---|
| Net revenue | $1,422 | $1,340 | $2,747 | $2,634 |
| Gross profit / margin | $902 / 63% | $829 / 62% | $1,736 / 63% | $1,626 / 62% |
| Operating income / margin | $219 / 15% | $142 / 11% | $367 / 13% | $235 / 9% |
| Net income | $175 | $109 | $311 | $173 |
| Diluted EPS | $0.64 | $0.38 | $1.12 | $0.61 |
| Operating cash flow | $314 | $158 | $564 | $386 |
- Q2 revenue rose 6%; six-month revenue rose 4%. Product revenue increased 14% in Q2 and 12% for the six months. Strategic solutions represented 69% of product revenue; strategic product revenue grew 23% in Q2 and 22% for the six months.
- Software maintenance revenue declined 1% in Q2 and 2% for the six months. Hardware maintenance and other services revenue declined 3% and 5%, respectively, with lower renewal rates and contract ASP cited for hardware maintenance.
- Management attributed improved gross margin principally to higher product ASP, especially for All-Flash FAS. Operating expenses fell as a share of revenue, reflecting higher sales and restructuring-related headcount reductions and other cost savings.
- Six-month effective tax rate was 17.7%, versus 26.1% a year earlier; Q2 rates were 22.2% and 23.2%, respectively. Management cited foreign earnings taxed at lower rates and differing discrete stock-compensation impacts.
Cash, liquidity, and debt
- At October 27, cash and cash equivalents were $3,535 and short-term investments were $2,430, totaling $5,965, up from $4,921 at April 28. Working capital was $2.8 billion. Cash conversion cycle was negative 10 days, compared with 9 days a year earlier and 15 days at fiscal year-end.
- Six-month operating cash flow was $564, including net income of $311; the company also spent $65 on capital expenditures, acquired two businesses for $75, repurchased $300 of stock, and paid $108 in dividends.
- Principal debt was $3,019: $2,300 of senior notes and $719 of commercial paper. Net proceeds of approximately $795 came from issuing $800 of senior notes in September. The company redeemed its $750 December 2017 notes on November 3, 2017, after the reporting date, for $751 plus accrued interest.
- A $1.0 billion revolving credit facility was undrawn at quarter-end; commercial paper capacity was also $1.0 billion. The company reported covenant compliance. About $5.0 billion of cash, cash equivalents, and short-term investments was held internationally; repatriating funds could trigger U.S. taxes under then-current law.
Outlook, commentary, and notable matters
- No specific revenue or earnings guidance is provided in the filing. Management expected available liquidity and operating cash generation to meet requirements for at least the next 12 months. Planned capital expenditures for the remainder of fiscal 2018 were $75–$125.
- The company planned to complete the remaining $494 million of authorized repurchases by May 2018, subject to market and business conditions. A $0.20-per-share dividend was declared November 15, payable January 24, 2018.
- NetApp acquired cloud-management software provider Greenqloud for $51 and software-defined-memory provider Plexistor for $24. It also agreed to sell certain Sunnyvale property for $306; the $118 book-value assets were held for sale, and closings remained subject to conditions and approvals.
- Key stated risks include storage-market and technology transitions, product execution and customer acceptance, competition and cloud/consumption-model shifts, reliance on outsourced manufacturing and limited component suppliers, and sales concentration through distributors. Arrow and Tech Data accounted for 41% of Q2 revenue combined.
- The company disclosed active patent litigation brought by non-practicing entities; it intends to defend the claims, but outcomes could involve damages, product changes, licensing costs, or sales restrictions. No accrual was recorded because losses were not considered probable and reasonably estimable. It also reported tax audits and a Danish withholding-tax dispute referred to the EU Court of Justice.
- Other commitments include $347 of non-cancelable inventory purchases, $199 of other purchase obligations, $31 of construction obligations, and $203 of operating lease payments. A remaining $130 sale-leaseback financing obligation was expected to be resolved when related leases ended in December 2017.
- Management said disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether strategic product growth and higher ASPs can persist as mature-product sales decline and the business transitions platforms.
- Whether maintenance renewal rates and deferred service revenue stabilize; deferred revenue and financed unearned services revenue fell to $3,167 from $3,342 at fiscal year-end.
- Debt and liquidity after the November 3 redemption, including commercial-paper use, interest costs, and the location and potential tax cost of overseas funds.
- Completion and proceeds from the Sunnyvale property sale, and the expected accounting outcome of the sale-leaseback arrangement.
- Exposure from distributor concentration, patent litigation, tax audits and the Danish tax dispute, and commitments tied to inventory demand.