This section and other parts of this Form 10-Q contain forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, that involve risks and uncertainties. Forward-looking statements provide current expectations of future events based on certain assumptions and include any statement that does not directly relate to any historical or current fact. Forward-looking statements also can be identified by words such as "future," "anticipates," "believes," "estimates," "expects," "intends," "will," "would," "could," "can," "may," and similar terms. Forward-looking statements are not guarantees of future performance and the actual results ofNetApp, Inc. ("we," "us," or the "Company") may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in Part II, Item 1A of this Form 10-Q under the heading "Risk Factors," which are incorporated herein by reference. The following discussion should be read in conjunction with our consolidated financial statements as of and for the fiscal year endedApril 26, 2019 , and the notes thereto, contained in our Annual Report on Form 10-K, and the condensed consolidated financial statements and notes thereto included elsewhere in this Form 10-Q. We assume no obligation to revise or update any forward-looking statements for any reason, except as required by law. 27
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Overview
Our Company
NetApp is the data authority for hybrid cloud. We provide a full range of hybrid cloud data services that simplify management of applications and data across cloud and on-premises environments to accelerate digital transformation. Together with our partners, we empower global organizations to unleash the full potential of their data to expand customer touchpoints, foster greater innovation and optimize their operations. NetApp delivers a Data Fabric built for the data-driven world. Our Data Fabric simplifies the integration and orchestration of data for applications and analytics in clouds, across clouds and on-premises to accelerate digital transformation. We deliver a Data Fabric with consistent data services for data visibility and insights, data access and control, and data protection and security, that unleashes the power of data to achieve a new competitive advantage.
We focus on delivering an exceptional customer experience to become our customers' preferred data partner. NetApp's unique approach to data services enables organizations to inspire innovation with the cloud, build clouds to accelerate new services, and modernize IT architecture with cloud-connected flash.
With NetApp products and solutions, customers can:
• Continually fuel business growth by delivering data-rich customer
experiences through new application deployments that easily use data and
services regardless of where they reside or in what form.
• Accelerate digital transformation by developing a next-generation,
cloud-architected infrastructure that manages data and services as one integrated resource supporting both public and private clouds. • Free the resources necessary to fund transformation by deploying the
industry's leading flash storage solution, which is highly efficient and
scales from the edge to the core to the cloud.
Customers are attracted by the speed and scale benefits of the public cloud but need new data management capabilities to keep control of data as it moves beyond the walls of the enterprise. NetApp believes the hybrid cloud is fast becoming the dominant model for enterprise IT. Our Data Fabric approach enables our customers to manage, secure and protect their data from on-premises to public to hybrid clouds, all at the scale needed to accommodate the exponential data growth of the digital world. Budget constraints and skill imbalances lead our customers to seek help in integrating, deploying and managing the solutions they need to stay competitive. This drives demand for converged and hyper-converged infrastructure solutions. FlexPod is the converged infrastructure of choice for many of the largest enterprises around the globe. Customers can break free from the limits of first-generation HCI with NetApp HCI and attain guaranteed performance with high levels of flexibility, scale, automation, and integration with the Data Fabric. Flash plays a key role in customers' digital transformation efforts as they seek to gain advantage through greater speed, responsiveness and value from key business applications - all while lowering total cost of ownership. All-flash array technology is the de facto choice as customers seek performance and economic benefits from replacing hard disk installations. With a highly differentiated and broad portfolio of all-flash and hybrid array offerings, NetApp is well positioned to enable customers to accomplish this transition. To provide visibility into our transition from older products to our newer, higher growth products and clarity into the dynamics of our product revenue, we group our products by "Strategic" and "Mature" solutions. As our product portfolio evolves, market dynamics change, and management continues to assess our largest growth opportunities, we periodically change how we group certain products. Beginning in fiscal 2020, Strategic includes All-flash FAS (AFF) products, including all related add-on hardware and operating system (OS) software, private cloud solutions (including SolidFire, converged and hyper-converged infrastructure products, StorageGrid), enterprise software license agreements (ELAs) and other optional add-on software products. Mature now includes Hybrid FAS products, including all related add-on hardware and OS software, original equipment manufacturers (OEM) products, and branded E-Series. Prior to this grouping change, Hybrid FAS products and branded E-Series were included in Strategic, while all add-on hardware and OS software were included in Mature. For comparability, Strategic and Mature revenues presented for the prior year periods have been recast based on the revised groupings. In addition to our products and solutions, we provide a variety of services to our customers, including software maintenance, hardware maintenance and other services including professional services, global support solutions, and customer education and training. Revenues generated by our Cloud Data Services offerings are included in software maintenance revenues. 28
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Financial Results and Key Performance Metrics Overview
The following table provides an overview of some of our key financial metrics (in millions, except per share amounts, percentages and cash conversion cycle): Three Months Ended Six Months Ended October 25, October 26, October 25, October 26, 2019 2018 2019 2018 Net revenues$ 1,371 $ 1,517 $ 2,607 $ 2,991 Gross profit $ 925 $ 974$ 1,741 $ 1,937 Gross profit margin percentage 67 % 64 % 67 % 65 % Income from operations $ 296 $ 286 $ 400 $ 540 Income from operations as a percentage of net revenues 22 % 19 % 15 % 18 % Net income $ 243 $ 241 $ 346 $ 524 Diluted net income per share$ 1.03 $ 0.91 $ 1.44 $ 1.96 Operating cash flows $ (53 ) $ 165 $ 257 $ 491 October 25, April 26, 2019 2019
Deferred revenue and financed unearned services revenue
(4 ) 3
Stock Repurchase Program and Dividend Activity
During the first six months of fiscal 2020, we repurchased 14 million shares of our common stock at an average price of$55.06 per share, for an aggregate of$750 million . We also declared aggregate cash dividends of$0.96 per share in that period, for which we paid an aggregate of$226 million .
Senior Notes Maturity
OnSeptember 27, 2019 , we made an aggregate cash payment of$400 million to extinguish our 2.00% Senior Notes at maturity. This repayment was funded through the sale of short-term commercial paper notes issued under our existing program and cash on hand. Real Estate Transaction InSeptember 2017 , we entered into an agreement to sell certain land and buildings located inSunnyvale, California , through two separate and independent closings, the first of which was completed in the third quarter of fiscal 2018. The remaining properties, consisting of land, were classified as assets held for sale, and included as other current assets in our condensed consolidated balance sheets as ofApril 26, 2019 . OnAugust 29, 2019 , the second closing occurred and we consummated the sale of the land, with a net book value of$53 million , and received cash proceeds of$96 million , resulting in a gain, net of direct selling costs, of$38 million .
Critical Accounting Policies and Estimates
Our condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted inthe United States of America , which require management to make judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, net revenues and expenses, and the disclosure of contingent assets and liabilities. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. We believe that the accounting estimates employed and the resulting balances are reasonable; however, actual results may differ from these estimates and such differences may be material. The summary of our significant accounting policies is included under Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations of our fiscal 2019 Form 10-K. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably possible could materially impact the financial statements. There have been no material changes to the critical accounting policies and estimates as filed in such report.
New Accounting Standards
See Note 1 - Description of Business and Significant Accounting policies for the impact to our financial statements of the adoption of the accounting standard Leases (ASC 842) in the first quarter of fiscal 2020. 29
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See Note 2 - Recent Accounting Standards Not Yet Effective of the Notes to Condensed Consolidated Financial Statements for a full description of new accounting pronouncements, including the respective expected dates of adoption and effects on our financial statements.
Results of Operations
Our fiscal year is reported as a 52- or 53-week year that ends on the last Friday in April. Fiscal years 2020 and 2019 are each 52-week years, with 13 weeks in each of their quarters. Unless otherwise stated, references to particular years, quarters, months and periods refer to the Company's fiscal years ended in April and the associated quarters, months and periods of those fiscal years.
The following table sets forth certain Condensed Consolidated Statements of Operations data as a percentage of net revenues for the periods indicated:
Three Months Ended Six Months Ended October 25, October 26, October 25, October 26, 2019 2018 2019 2018 Revenues: Product 56 % 60 % 54 % 60 % Software maintenance 19 16 19 16 Hardware maintenance and other services 25 24 26 25 Net revenues 100 100 100 100 Cost of revenues: Cost of product 25 28 25 28 Cost of software maintenance 1 1 1 1 Cost of hardware maintenance and other services 7 7 7 7 Gross profit 67 64 67 65 Operating expenses: Sales and marketing 28 27 30 27 Research and development 15 14 16 14 General and administrative 5 5 5 5 Restructuring charges - - 1 1 Gain on sale or derecognition of assets (3 ) - (1 ) - Total operating expenses 46 45 51 47 Income from operations 22 19 15 18 Other income, net - - 1 1 Income before income taxes 22 19 16 19 Provision for income taxes 4 3 3 1 Net income 18 % 16 % 13 % 18 %
Percentages may not add due to rounding
Discussion and Analysis of Results of Operations
Overview
Net revenues for the second quarter and first six months of fiscal 2020 were$1,371 million and$2,607 million , respectively, reflecting a decrease of$146 million , or 10%, and$384 million , or 13%, respectively, compared to the corresponding periods of the prior year, primarily reflecting lower product revenues, and to a lesser extent, the unfavorable impact of foreign exchange rate fluctuations in the quarter. Hardware maintenance and other services revenues also decreased compared to the corresponding periods of the prior year, offset by an increase in software maintenance revenues. Gross profit as a percentage of net revenues for the second quarter and first six months of fiscal 2020 increased by three and a half percentage points and two percentage points, respectively, compared to the corresponding periods in fiscal 2019, primarily reflecting higher margins on product revenues and hardware maintenance and other services revenues. Gross profit margins on product revenues increased by two and a half percentage points in the second quarter of fiscal 2020 and were relatively flat in the first six months of fiscal 2020, compared to the corresponding periods of fiscal 2019. Gross profit margins in both the second quarter and first six months of fiscal 2020 benefitted from a higher mix of All Flash FAS (AFF) product sales and cost reductions. These benefits were partially offset in the second quarter of fiscal 2020, and fully offset in the first six months of fiscal 2020, by high-margin revenue recognized related to the software license components of several ELAs in the corresponding periods of fiscal 2019, which did not repeat in fiscal 2020. 30 -------------------------------------------------------------------------------- Sales and marketing, research and development, and general and administrative expenses for the second quarter and the first six months of fiscal 2020 totaled$667 million , or 49% of net revenues and$1,358 million , or 52% of revenues, respectively, representing an increase of three and a half percentage points and six percentage points, respectively, when compared to the corresponding periods of fiscal 2019, primarily due to lower net revenues in the current year periods.
Net Revenues (in millions, except percentages):
Three Months Ended Six Months Ended October 25, October 26, October 25, October 26, 2019 2018 % Change 2019 2018 % Change Net revenues$ 1,371 $ 1,517 (10 )%$ 2,607 $ 2,991 (13 )% The decrease in net revenues for the second quarter and first six months of fiscal 2020 compared to the corresponding periods of fiscal 2019 was primarily due to a decrease in product revenues of$142 million and$373 million , respectively. Product revenues as a percentage of net revenues decreased by four percentage points and five and a half percentage points in the second quarter and first six months of fiscal 2020, respectively, compared to the corresponding periods of fiscal 2019. The following customers, each of which is a distributor, accounted for 10% or more of net revenues: Three Months Ended Six Months Ended October 25, October 26, October 25, October 26, 2019 2018 2019 2018 Arrow Electronics, Inc. 24 % 24 % 24 % 23 % Tech Data Corporation 21 % 21 % 21 % 19 %
Product Revenues (in millions, except percentages):
Three Months Ended Six Months Ended October 25, October 26, October 25, October 26, 2019 2018 % Change 2019 2018 % Change Product revenues $ 771 $ 913 (16 )%$ 1,415 $ 1,788 (21 )% Product revenues are derived through the sale of our strategic and mature solutions, and consist of sales of configured AFF and Hybrid systems, which are bundled hardware and software products, as well as add-on flash, disk and/or hybrid storage and related OS, private cloud solutions (including SolidFire, converged and hyper-converged infrastructure products, StorageGrid), original equipment manufacturer (OEM) products and add-on optional software. Under the revised Strategic and Mature product groupings, as described in the Overview section above, product revenues from strategic solutions represented 57% and 55% of product revenues in the second quarter and first six months of fiscal 2020, respectively, compared to 53% and 54% in the corresponding periods of the prior year, respectively. Product revenues from mature solutions represented 43% and 45% of product revenues in the second quarter and first six months of fiscal 2020, respectively, compared to 47% and 46% in the corresponding periods of the prior year, respectively. Product revenues declined in the second quarter and first six months of fiscal 2020 compared to the corresponding periods of the prior year primarily due less favorable macroeconomic conditions, lower enterprise IT spending and, in the first quarter of fiscal 2020, go-to-market execution issues experienced with some of our largest global customer accounts. Total product revenues from strategic solutions totaled$442 million in the second quarter of fiscal 2020 reflecting a 9% decrease from$485 million in the second quarter of fiscal 2019. Total product revenues from strategic solutions totaled$779 million in the first six months of fiscal 2020 reflecting a 19% decrease from$960 million in the first six months of fiscal 2019. These decreases were primarily due to a substantial amount of revenue recognized in the prior year periods related to the software license components of several ELAs which did not repeat, a decrease in add-on optional software sales in the current year periods and, for the six month period, decreased sales of AFF products. These decreases were partially offset by an increase in revenues from private cloud solutions in both fiscal 2020 periods and, for the second quarter, increased sales of AFF products. Total product revenue from mature solutions totaled$329 million in the second quarter of fiscal 2020 reflecting a 23% decrease from$428 million in the second quarter of fiscal 2019. Total product revenue from mature solutions totaled$636 million in the first six months of fiscal 2020 reflecting a 23% decrease from$828 million in the first six months of fiscal 2019. These decreases were primarily due to decreased sales of FAS Hybrid and OEM products, as well as add-on storage, in the current year periods. 31
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Software Maintenance Revenues (in millions, except percentages):
Three Months Ended Six Months Ended October 25, October 26, October 25, October 26, 2019 2018 % Change 2019 2018 % Change
Software maintenance revenues $ 254 $ 236
8 % $ 504 $ 465 8 %
Software maintenance revenues are associated with contracts which entitle customers to receive unspecified product upgrades and enhancements on a when-and-if-available basis, bug fixes and patch releases, as well as internet and telephone access to technical support personnel located in our global support centers.
The fluctuations in software maintenance revenues reflect fluctuations in the aggregate contract value of the installed base under software maintenance contracts, which is recognized as revenue ratably over the terms of the underlying contracts.
Hardware Maintenance and Other Services Revenues (in millions, except percentages): Three Months Ended Six Months Ended October 25, October 26, October 25, October 26, 2019 2018 % Change 2019 2018 % Change Hardware maintenance and other services revenues $ 346 $ 368 (6 )% $ 688 $ 738 (7 )%
Hardware maintenance and other services revenues include hardware maintenance, professional services, and educational and training services revenues.
Hardware maintenance contract revenues decreased year over year, at$286 million and$570 million , respectively, for the second quarter and first six months of fiscal 2020, compared to$303 million and$606 million , respectively, for the corresponding periods of the prior year. The decreases were primarily attributable to a decline in average selling price on contracts executed recently. Professional services and educational and training services revenues were$60 million and$118 million , respectively, for the second quarter and first six months of fiscal 2020, compared to$65 million and$132 million , respectively, for the corresponding periods of the prior year.
Revenues by Geographic Area:
Three Months Ended Six Months Ended October 25, October 26, October 25, October 26, 2019 2018 2019 2018United States ,Canada andLatin America (Americas) 56 % 57 % 54 % 57 % Europe, Middle East and Africa (EMEA) 29 % 28 % 31 % 29 % Asia Pacific (APAC) 14 % 15 % 15 % 14 %
Percentages may not add due to rounding
Americas revenues consist of sales toAmericas commercial andU.S. public sector markets. During the first six months of fiscal 2020,Americas revenues were negatively impacted by general macroeconomic conditions in the region and, in the first quarter of fiscal 2020, go-to-market execution issues with some of our largest customer accounts, which was reflected in the geographic distribution of revenues as a percentage of net revenues in the second quarter and first six months of fiscal 2020 compared to the corresponding periods of fiscal 2019.
Cost of Revenues
Our cost of revenues consists of three elements: (1) cost of product revenues, which includes the costs of manufacturing and shipping our storage products, amortization of purchased intangible assets, inventory write-downs, and warranty costs, (2) cost of software maintenance, which includes the costs of providing software maintenance and third-party royalty costs and (3) cost of hardware maintenance and other services revenues, which includes costs associated with providing support activities for hardware maintenance, global support partnership programs, professional services and educational and training services.
Cost of Product Revenues (in millions, except percentages):
Three Months Ended Six Months Ended October 25, October 26, October 25, October 26, 2019 2018 % Change 2019 2018 % Change Cost of product revenues $ 341 $ 428 (20 )% $ 653 $ 826 (21 )% 32
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The changes in cost of product revenues consisted of the following (in percentage points of the total change):
Three Months Ended Six Months Ended Fiscal 2020 to Fiscal 2020 to Fiscal 2019 Fiscal 2019 Percentage Change Percentage Change Points Points Materials costs (23 ) (23 ) Excess and obsolete inventory 2 1 Other 1 1 Total change (20 ) (21 ) Cost of product revenues represented 44% and 46% of product revenues for the second quarter and first six months of fiscal 2020, respectively, compared to 47% and 46% for the corresponding periods of fiscal 2019. Materials costs represented 86% and 84% of product costs for the second quarter and first six months of fiscal 2020, respectively, compared to 91% and 89% in the corresponding periods of fiscal 2019. Materials costs decreased$98 million and$190 million in the second quarter and first six months of fiscal 2020, respectively, compared to the corresponding periods of the prior year, primarily due to a decline in product revenue and, to a lesser extent, a decline in the price of certain product components. The average unit materials costs of both AFF and FAS Hybrid systems decreased in the second quarter and first six months of fiscal 2020 compared to the corresponding periods of fiscal 2019.
Margins on revenue recognized for strategic solutions increased during the second quarter and first six months of fiscal 2020 compared to the corresponding periods of fiscal 2019, while margins for mature solutions were relatively flat.
Cost of Software Maintenance Revenues (in millions, except percentages):
Three Months Ended Six Months Ended October 25, October 26, October 25, October 26, 2019 2018 % Change 2019 2018 % Change Cost of software maintenance revenues $ 11 $ 8 38 % $ 21 $ 15 40 % Cost of software maintenance revenues in dollars were relatively flat in the second quarter and first six months of fiscal 2020 compared to the corresponding periods of fiscal 2019 and represented 4% of software maintenance revenues for second quarter and first six months of fiscal 2020, and 3% for the corresponding periods of fiscal 2019. Cost of Hardware Maintenance and Other Services Revenues (in millions, except percentages): Three Months Ended Six Months Ended October 25, October 26, October 25, October 26, 2019 2018 % Change 2019 2018 % Change Cost of hardware maintenance and other services revenues $ 94 $ 107 (12 )% $ 192 $ 213 (10 )% Cost of hardware maintenance and other services revenues decreased by$13 million , or 12%, and$21 million , or 10%, respectively, for the second quarter and first six months of fiscal 2020 compared to the corresponding periods of fiscal 2019, in line with the decreases in hardware maintenance and other services revenues, and also as a result of cost savings initiatives. Costs represented 27% of hardware maintenance and other services revenues in the second quarter, and 28% in the first six months of fiscal 2020, compared to 29% in the second quarter and first six months of fiscal 2019.
Operating Expenses
Sales and Marketing, Research and Development and General and Administrative Expenses
Compensation costs represent the largest component of operating expenses. Included in compensation costs are salaries, benefits, other compensation-related costs, stock-based compensation expense and employee incentive compensation plan costs.
Total compensation costs included in operating expenses decreased by$9 million and$13 million , respectively, or 2%, in the second quarter and first six months of fiscal 2020, compared to the corresponding periods of the prior year primarily due to lower incentive compensation expense and, to a lesser extent, the favorable impact of foreign exchange rate fluctuations, partially offset by higher salaries expense, reflecting a 2% increase in average headcount in the fiscal 2020 periods. 33
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Sales and Marketing (in millions, except percentages):
Three Months Ended Six Months Ended October 25, October 26, October 25, October 26, 2019 2018 % Change 2019 2018 % Change
Sales and marketing expenses $ 389 $ 408
(5 )% $ 794 $ 817 (3 )% Sales and marketing expenses consist primarily of compensation costs, commissions, outside services, allocated facilities and information technology (IT) costs, advertising and marketing promotional expense and travel and entertainment expense. Three Months Ended Six Months Ended Fiscal 2020 to Fiscal Fiscal 2020 to Fiscal 2019 2019 Percentage Change Percentage Change Points Points Compensation costs (1 ) (1 ) Advertising and marketing promotional expense (3 ) (2 ) Other (1 ) - Total change (5 ) (3 ) Compensation costs decreased slightly for the second quarter and first six months of fiscal 2020 compared to the corresponding periods of the prior year, reflecting a 2% decrease in average headcount in each of the current year periods. Advertising and marketing promotional expense decreased in the second quarter and first six months of fiscal 2020, primarily due to certain annual marketing events being held earlier in the prior year. Sales and marketing expenses in the second quarter and first six months of fiscal 2020 also benefitted slightly from foreign exchange rate fluctuations.
Research and Development (in millions, except percentages):
Three Months Ended Six Months Ended October 25, October 26, October 25, October 26, 2019 2018 % Change 2019 2018 % Change
Research and development expenses $ 209 $ 211
(1 )% $ 424 $ 419 1 % Research and development expenses consist primarily of compensation costs, allocated facilities and IT costs, depreciation, equipment and software-related costs, prototypes, non-recurring engineering charges and other outside services costs. Changes in research and development expense consisted of the following: Three Months Ended Six Months Ended Fiscal 2020 to Fiscal Fiscal 2020 to Fiscal 2019 2019 Percentage Change Percentage Change Points Points Compensation costs 1 2 Development projects and outside services (1 ) (1 ) Other (1 ) - Total change (1 ) 1 The increase in compensation costs for the second quarter and first six months of fiscal 2020 compared to the corresponding periods in the prior year was attributable to an increase in average headcount of 9% and 8%, respectively, resulting in higher salaries, benefits and stock-based compensation expense, partially offset by lower incentive compensation expense. The increase in headcount reflects our investment in additional engineering resources to support the expansion and enhancement of products and solutions targeted at our most important customer and market opportunities. Development projects and outside services expense for the second quarter and first six months of fiscal 2020 decreased slightly as a result of lower spending on materials and services associated with engineering activities to develop new and enhanced products, due to the timing of new product introductions.
General and Administrative (in millions, except percentages):
Three Months Ended Six Months Ended October 25, October 26, October 25, October 26, 2019 2018 % Change 2019 2018 % Change
General and administrative expenses $ 69 $ 69
- % $ 140 $ 142 (1 )% 34
-------------------------------------------------------------------------------- General and administrative expenses consist primarily of compensation costs, professional and corporate legal fees, outside services and allocated facilities and IT support costs. Changes in general and administrative expense consisted of the following: Three Months Ended Six Months Ended Fiscal 2020 to Fiscal 2020 to Fiscal Fiscal 2019 2019 Percentage Change Percentage Change Points Points Compensation costs (10 ) (9 ) Professional and legal fees and outside services 13 11 Facilities and IT support costs (6 ) (5 ) Other 3 2 Total change - (1 ) While average headcount increased in the second quarter and first six months of fiscal 2020 compared to the corresponding periods of the prior year, compensation costs decreased because a greater percentage of employees were located in lower cost geographies. The increases in professional and legal fees and outside services expense in the second quarter and first six months of fiscal 2020 were primarily due to the higher spending levels on business transformation projects, while the decreases in facilities and IT support costs were primarily due to lower spending levels on IT projects.
Restructuring Charges (in millions, except percentages):
Three Months Ended Six Months Ended October 25, October 26, October 25, October 26, 2019 2018 % Change 2019 2018 % Change Restructuring charges $ - $ - NM $ 21 $ 19 NM NM - Not Meaningful In the first quarter of fiscal 2020, we announced a restructuring plan (theMay 2019 Plan) to reduce costs and redirect resources to our highest return activities, which included a reduction in our global workforce of approximately 2%. Charges related to the plan consisted primarily of employee severance-related costs. Substantially all activities under the plan have been completed. See Note 12 - Restructuring Charges of the Notes to Condensed Consolidated Financial Statements for more details.
Gain on sale or derecognition of assets (in millions, except percentages):
Three Months Ended Six Months Ended October 25, October 26, October 25, October 26, 2019 2018 % Change 2019 2018 % Change Gain on sale or derecognition of assets $ (38 ) $ - NM $ (38 ) $ - NM NM - Not Meaningful InSeptember 2017 , we entered into an agreement to sell certain land and buildings located inSunnyvale, California , through two separate and independent closings, the first of which was completed in the third quarter of fiscal 2018. The remaining properties, consisting of land, were classified as assets held for sale, and included as other current assets in our condensed consolidated balance sheet as ofApril 26, 2019 . OnAugust 29, 2019 , the second closing occurred and we consummated the sale of the land, with a net book value of$53 million , and received cash proceeds of$96 million . resulting in a gain, net of direct selling costs, of$38 million .
Other Income, Net (in millions, except percentages)
The components of other income, net were as follows:
Three Months Ended Six Months Ended October 25, October 26, October 25, October 26, 2019 2018 % Change 2019 2018 % Change Interest income $ 12 $ 21 (43 )% $ 31 $ 46 (33 )% Interest expense (12 ) (14 ) (14 )% (27 ) (28 ) (4 )% Other income, net 3 - NM 14 7 100 % Total $ 3 $ 7 (57 )% $ 18 $ 25 (28 )% NM - Not Meaningful 35
-------------------------------------------------------------------------------- Interest income decreased in the second quarter and first six months of fiscal 2020 compared to the corresponding periods of the prior year due to a reduction in size of our investment portfolio as a result of our sale of approximately$1.0 billion of available-for-sale debt securities in the first quarter of fiscal 2020. Other income, net increased in the first six months of fiscal 2020 compared to the corresponding period of fiscal 2019 as a result of the$14 million gain we realized from the sale of these securities, partially offset by differences in foreign exchange gains and losses. Interest expense remained relatively flat in the second quarter and first six months of fiscal 2020 compared to the corresponding periods of the prior year, as we repaid our maturing Senior Notes but increased our average outstanding commercial paper balance.
Provision for Income Taxes (in millions, except percentages):
Three Months Ended Six Months Ended October 25, October 26, October 25, October 26, 2019 2018 % Change 2019 2018 % Change Provision for income taxes $ 56 $ 52 8 % $ 72 $ 41 76 % Our effective tax rate for the second quarter of fiscal 2020 was 18.7% compared to 17.7% for the second quarter of fiscal 2019. Our effective tax rate for the first six months of fiscal 2020 was 17.2% compared to 7.3% for the corresponding period of fiscal 2019. Our effective tax rates reflect the impact of a significant amount of our earnings, primarily income from our European operations, being taxed in foreign jurisdictions at rates below theU.S. statutory tax rate. Our effective tax rate increased for the second quarter of fiscal 2020 compared to the corresponding period of the prior year primarily due to the discrete tax charge on the sale of land inSunnyvale, California and the differences in discrete benefits for stock-based compensation. Our effective tax rate increased for the first six months of fiscal 2020 compared to the corresponding period in the prior year primarily due to the discrete tax benefits related to the adoption of the new revenue standard in fiscal 2019, and the same items that impacted the second quarter effective tax rate. OnDecember 22, 2017 , the Tax Cuts and Jobs Act ("TCJA") was enacted into law. The TCJA made significant changes to theU.S. corporate income tax system including a reduction of theU.S. federal corporate income tax rate from 35% to 21%, the imposition of a one-time transition tax on deferred foreign earnings, and the creation of new taxes on certain foreign-sourced earnings. As ofApril 26, 2019 , we had completed the accounting for the tax impacts of the TCJA, however, we will continue to assess the impact of further guidance from federal and state tax authorities on our business and consolidated financial statements, and recognize any adjustments in the period in which they are determined. During fiscal 2019, we adopted the new revenue accounting standard and, during the six months endedOctober 26, 2018 , we recognized a$34 million discrete tax benefit for adjustments to certain intercompany transactions resulting from the retrospective application of the new revenue accounting standard. As ofOctober 25, 2019 , we had$294 million of gross unrecognized tax benefits. Inclusive of penalties, interest and certain income tax benefits,$246 million would affect our provision for income taxes if recognized, and$251 million has been recorded in other long-term liabilities. We continue to monitor the progress of ongoing discussions with tax authorities and the impact, if any, of the expected expiration of the statute of limitations in various taxing jurisdictions. We believe that within the next 12 months, it is reasonably possible that either certain audits will conclude, certain statutes of limitations will lapse, or both. As a result of uncertainties regarding tax audits and their possible outcomes, an estimate of the range of possible impacts to unrecognized tax benefits in the next twelve months cannot be made at this time.
Liquidity, Capital Resources and Cash Requirements
October 25 ,April 26 , (In millions, except percentages) 2019
2019
Cash, cash equivalents and short-term investments
$ 1,649 $ 1,799
The following is a summary of our cash flow activities:
Six Months Ended October 25, October 26, (In millions) 2019 2018 Net cash provided by operating activities $ 257 $ 491 Net cash provided by investing activities 1,116
381
Net cash used in financing activities (1,148 ) (1,429 ) Effect of exchange rate changes on cash, cash equivalents and restricted cash (5 ) (25 ) Net increase (decrease) in cash, cash equivalents and restricted cash $ 220$ (582 ) 36
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Cash Flows
As ofOctober 25, 2019 , our cash, cash equivalents and short-term investments were$3.0 billion , a decrease of$0.9 billion fromApril 26, 2019 . The decrease was primarily due to$750 million paid for the repurchase of our common stock,$400 million used for the repayment of our Senior Notes dueSeptember 2019 ,$226 million used for the payment of dividends, and$68 million in purchases of property and equipment, partially offset by$249 million in proceeds from the issuance of commercial paper notes, net,$96 million in proceeds from the sale of properties, and$257 million of cash provided by operating activities. Working capital decreased by$0.7 billion to$1.0 billion as ofOctober 25, 2019 compared toApril 26, 2019 primarily due to the decreases in cash, cash equivalents and short-term investments discussed above.
Cash Conversion Cycle
The following table presents the components of our cash conversion cycle:
Three Months Ended October 25, April 26, October
26,
(In days) 2019 2019 2018 Days sales outstanding (1) 52 70
46
Days inventory outstanding (2) 23 21
14
Days payables outstanding (3) (78 ) (87 ) (79 ) Cash conversion cycle (4) (4 ) 3 (19 )
Days may not add due to rounding
(1) Days sales outstanding, referred to as DSO, calculates the average collection
period of our receivables. DSO is based on ending accounts receivable and net
revenue for each period. DSO is calculated by dividing accounts receivable by
average net revenue per day for the current quarter (91 days for each of the
quarters presented above). DSO for the second quarter of fiscal 2020
increased compared to the corresponding period of fiscal 2019 due to less
favorable shipping linearity and the timing of shipments to certain large
customers, while it decreased compared to the fourth quarter of fiscal 2019
due to lower seasonal invoicing levels and more favorable shipping linearity.
(2) Days inventory outstanding, referred to as DIO, measures the average number
of days from procurement to sale of our products. DIO is based on ending
inventory and cost of revenues for each period. DIO is calculated by dividing
ending inventory by average cost of revenues per day for the current quarter.
DIO for the second quarter of fiscal 2020 increased compared to the
corresponding period of fiscal 2019 as a result of higher levels of on hand
inventory and lower cost of goods sold in the current year period, while it
was relatively flat compared to the fourth quarter of fiscal 2019.
(3) Days payables outstanding, referred to as DPO, calculates the average number
of days our payables remain outstanding before payment. DPO is based on
ending accounts payable and cost of revenues for each period. DPO is
calculated by dividing accounts payable by average cost of revenues per day
for the current quarter. DPO for the second quarter of fiscal 2020 was
relatively consistent with the corresponding period of fiscal 2019, while it
decreased compared to the fourth quarter of 2019, primarily due to the timing
of purchases from contract manufacturers.
(4) The cash conversion cycle is the sum of DSO and DIO less DPO. Items which may
cause the cash conversion cycle in a particular period to differ include, but
are not limited to, changes in business mix, changes in payment terms
(including extended payment terms from suppliers), the extent of shipment
linearity, seasonal trends and the timing of revenue recognition and
inventory purchases within the period.
Cash Flows from Operating Activities
During the first six months of fiscal 2020, we generated cash from operating activities of$257 million , reflecting net income of$346 million , adjusted by non-cash depreciation and amortization of$99 million , stock-based compensation of$82 million , and a gain on sale of properties of$38 million , compared to$491 million of cash generated from operating activities during the first six months of fiscal 2019.
Changes in assets and liabilities in the first six months of fiscal 2020 included the following:
• Accounts receivable decreased$435 million , reflecting lower DSO. • Accounts payable decreased$157 million , reflecting lower DPO. • Accrued expenses decreased$315 million , primarily due to employee
compensation payouts related to fiscal year 2019 commissions and incentive
compensation plans and payments of income taxes.
• Deferred revenue and financed unearned services revenue decreased
million, primarily due to a decrease in deferred software and hardware maintenance contract revenues reflecting the seasonality of maintenance contract renewal activities. We expect that cash provided by operating activities may materially fluctuate in future periods due to a number of factors, including fluctuations in our operating results, shipment linearity, accounts receivable collections performance, inventory and supply chain management, vendor payment initiatives, tax benefits or charges from stock-based compensation, and the timing and amount of compensation and other payments. 37
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Cash Flows from Investing Activities
During the first six months of fiscal 2020, we generated$1.1 billion from maturities and sales of investments, net of purchases, and paid$68 million for capital expenditures, while during the first six months of fiscal 2019, we generated$489 million from maturities and sales of investments, net of purchases, and paid$107 million for capital expenditures. Additionally, during the first six months of fiscal 2020, we received$96 million for the sale of land inSunnyvale, California and paid$56 million net to acquire a privately-held company.
Cash Flows from Financing Activities
During the first six months of fiscal 2020, we used$750 million for the repurchase of fourteen million shares of our common stock,$226 million for the payment of dividends, and$400 million for the repayment of our Senior Notes dueSeptember 2019 , partially offset by$249 million in proceeds from the issuance of commercial paper notes, net, compared to$1.1 billion used for the repurchase of fourteen million shares of common stock,$207 million used for the payment of dividends, and$135 million used for the repayment of commercial paper notes, net, during the first six months of fiscal 2019. Key factors that could affect our cash flows include changes in our revenue mix and profitability, our ability to effectively manage our working capital, in particular, accounts receivable, accounts payable and inventories, the timing and amount of stock repurchases and payment of cash dividends, the impact of foreign exchange rate changes, our ability to effectively integrate acquired products, businesses and technologies and the timing of repayments of our debt. Based on past performance and our current business outlook, we believe that our sources of liquidity, including potential future issuances of debt, equity or other securities, will satisfy our working capital needs, capital expenditures, investment requirements, stock repurchases, cash dividends, contractual obligations, commitments, principal and interest payments on our debt and other liquidity requirements associated with operations and meet our cash requirements for at least the next 12 months. However, in the event our liquidity is insufficient, we may be required to curtail spending and implement additional cost saving measures and restructuring actions or enter into new financing arrangements. We cannot be certain that we will continue to generate cash flows at or above current levels or that we will be able to obtain additional financing, if necessary, on satisfactory terms, if at all.
Liquidity
Our principal sources of liquidity as ofOctober 25, 2019 consisted of cash, cash equivalents and short-term investments, cash we expect to generate from operations, and our commercial paper program and related credit facility. Cash, cash equivalents and short-term investments consisted of the following (in millions): October 25, April 26, 2019 2019 Cash and cash equivalents$ 2,545 $ 2,325 Short-term investments 442 1,574 Total$ 2,987 $ 3,899 As ofOctober 25, 2019 andApril 26, 2019 ,$2.9 billion and$3.7 billion , respectively, of cash, cash equivalents and short-term investments were held by various foreign subsidiaries and were generally based inU.S. dollar-denominated holdings, while$0.1 billion and$0.2 billion , respectively, were available in theU.S. The TCJA imposed a one-time transition tax on substantially all accumulated foreign earnings throughDecember 31, 2017 , and generally allows companies to make distributions of foreign earnings without incurring additional federal taxes. As a part of the recognition of the impacts of the TCJA, we have reviewed our projected global cash requirements and have determined that certain historical and future foreign earnings will no longer be indefinitely reinvested. Our principal liquidity requirements are primarily to meet our working capital needs, support ongoing business activities, fund research and development, meet capital expenditure needs, invest in critical or complementary technologies, service interest and principal payments on our debt, fund our stock repurchase program, and pay dividends, as and if declared. The principal objectives of our investment policy are the preservation of principal and maintenance of liquidity. We attempt to mitigate default risk by investing in high-quality investment grade securities, limiting the time to maturity and monitoring the counter-parties and underlying obligors closely. We believe our cash equivalents and short-term investments are liquid and accessible. We are not aware of any significant deterioration in the fair value of our cash equivalents or investments from the values reported as ofOctober 25, 2019 . 38
-------------------------------------------------------------------------------- Our investment portfolio has been and will continue to be exposed to market risk due to trends in the credit and capital markets. We continue to closely monitor current economic and market events to minimize the market risk of our investment portfolio. We routinely monitor our financial exposure to both sovereign and non-sovereign borrowers and counterparties. We utilize a variety of planning and financing strategies in an effort to ensure our worldwide cash is available when and where it is needed. Based on past performance and current expectations, we believe our cash and cash equivalents, investments, cash generated from operations, and ability to access capital markets and committed credit lines will satisfy, through at least the next 12 months, our liquidity requirements, both in total and domestically, including the following: working capital needs, capital expenditures, stock repurchases, cash dividends, contractual obligations, commitments, principal and interest payments on debt, and other liquidity requirements associated with our operations. We also have an automatic shelf registration statement on file with theSecurities and Exchange Commission (SEC). We may in the future offer an additional unspecified amount of debt, equity and other securities.
Senior Notes
The following table summarizes the principal amount of our Senior Notes as of
3.375% Senior Notes Due June 2021$ 500 3.25% Senior Notes Due December 2022 250 3.30% Senior Notes Due September 2024 400 Total$ 1,150 Interest on the Senior Notes is payable semi-annually. For further information on the underlying terms, see Note 8 - Financing Arrangements of the Notes to Condensed Consolidated Financial Statements.
Commercial Paper Program and Credit Facility
We have a commercial paper program (the Program), under which we may issue unsecured commercial paper notes. Amounts available under the Program may be borrowed, repaid and re-borrowed, with the aggregate face or principal amount of the notes outstanding under the Program at any time not to exceed$1.0 billion . The maturities of the notes can vary, but may not exceed 397 days from the date of issue. The notes are sold under customary terms in the commercial paper market and may be issued at a discount from par or, alternatively, may be sold at par and bear interest at rates dictated by market conditions at the time of their issuance. The proceeds from the issuance of the notes are used for general corporate purposes. As ofOctober 25, 2019 , we had commercial paper notes outstanding with an aggregate principal amount of$499 million , a weighted-average interest rate of 2.20% and maturities ranging from 7 days to 91 days. In connection with the Program, we have a senior unsecured credit agreement that expires onDecember 10, 2021 . The credit agreement provides a$1.0 billion revolving unsecured credit facility that serves as a back-up for the Program. Proceeds from the facility may also be used for general corporate purposes, providing another potential source of liquidity to the extent that the credit facility exceeds the outstanding debt issued under the Program. The credit agreement also includes options that allow us to request an increase in the facility of up to an additional$300 million and to extend its maturity date for two additional one-year periods, both subject to certain conditions. As ofOctober 25, 2019 , we were in compliance with all associated covenants in this agreement. No amounts were drawn against this facility during any of the periods presented.
Capital Expenditure Requirements
We expect to fund our capital expenditures, including our commitments related to facilities, equipment, operating leases and internal-use software development projects over the next few years through existing cash, cash equivalents, investments and cash generated from operations. The timing and amount of our capital requirements cannot be precisely determined and will depend on a number of factors, including future demand for products, changes in the network storage industry, hiring plans and our decisions related to the financing of our facilities and equipment requirements. We anticipate capital expenditures for the remainder of fiscal 2020 to be between$75 million and$100 million .
Dividends and Stock Repurchase Program
On
Our Board of Directors has authorized the repurchase of up to$13.6 billion of our common stock under our stock repurchase program. Under this program, we may purchase shares of our outstanding common stock through solicited or unsolicited transactions in the open market, in privately negotiated transactions, through accelerated share repurchase programs, pursuant to a Rule 10b5-1 plan or in such other manner as deemed appropriate by our management. The stock repurchase program may be suspended or discontinued at any time. Since theMay 13, 2003 inception of this program throughOctober 25, 2019 , we repurchased a total of 327 million shares of our common stock at an average price of$38.20 per share, for an aggregate purchase price of$12.5 billion . As ofOctober 25, 2019 , the remaining authorized amount for stock repurchases under this program was$1.1 billion . 39
-------------------------------------------------------------------------------- The timing and amount of stock repurchase transactions and future dividends will depend on market conditions, corporate business and financial considerations and regulatory requirements. Contractual Obligations
Purchase Orders and Other Commitments
In the ordinary course of business, we make commitments to our third-party contract manufacturers to manage manufacturer lead times and meet product forecasts, and to other parties to purchase various key components used in the manufacture of our products. A significant portion of our reported purchase commitments arising from these agreements consists of firm, non-cancelable, and unconditional commitments. As ofOctober 25, 2019 , we had$447 million in non-cancelable purchase commitments for inventory. We record a liability for firm, non-cancelable and unconditional purchase commitments for quantities in excess of our future demand forecasts consistent with the valuation of our excess and obsolete inventory. To the extent that such forecasts are not achieved, our commitments and associated accruals may change. In addition to inventory commitments with contract manufacturers and component suppliers, we have open purchase orders and construction related obligations associated with our ordinary course of business for which we have not received goods or services. As ofOctober 25, 2019 , we had$5 million in construction related obligations and$244 million in other purchase obligations.
Unrecognized Tax Benefits
As ofOctober 25, 2019 , our liability for uncertain tax positions was$251 million , including interest, penalties and certain income tax benefits. Due to uncertainties regarding tax audits and their possible outcomes, we are unable to make reasonably reliable estimates of the period of cash settlement with the taxing authorities. Financing Guarantees While most of our arrangements for sales include short-term payment terms, from time to time we provide long-term financing to creditworthy customers. We have generally sold receivables financed through these arrangements on a non-recourse basis to third party financing institutions within 10 days of the contracts' dates of execution, and we classify the proceeds from these sales as cash flows from operating activities in our condensed consolidated statements of cash flows. We account for the sales of these receivables as "true sales" as defined in the accounting standards on transfers of financial assets, as we are considered to have surrendered control of these financing receivables. Provided all other revenue recognition criteria have been met, we recognize product revenues for these arrangements, net of any payment discounts from financing transactions, upon product acceptance. We sold$34 million and$43 million of receivables during the first six months of fiscal 2020 and fiscal 2019, respectively. In addition, we enter into arrangements with leasing companies for the sale of our hardware systems products. These leasing companies, in turn, lease our products to end-users. The leasing companies generally have no recourse to us in the event of default by the end-user and we recognize revenue upon delivery to the end-user customer, if all other revenue recognition criteria have been met. Some of the leasing arrangements described above have been financed on a recourse basis through third-party financing institutions. Under the terms of recourse leases, which are generally three years or less, we remain liable for the aggregate unpaid remaining lease payments to the third-party leasing companies in the event of end-user customer default. These arrangements are generally collateralized by a security interest in the underlying assets. Where we provide a guarantee for recourse leases and collectability is probable, we account for these transactions as sales type leases. If collectability is not probable, the cash received is recorded as a deposit liability and revenue is deferred until the arrangement is deemed collectible. For leases that we are not a party to, other than providing recourse, we recognize revenue when control is transferred. As ofOctober 25, 2019 andApril 26, 2019 , the aggregate amount by which such contingencies exceeded the associated liabilities was not significant. To date, we have not experienced significant losses under our lease financing programs or other financing arrangements. We have entered into service contracts with certain of our end-user customers that are supported by third-party financing arrangements. If a service contract is terminated as a result of our non-performance under the contract or our failure to comply with the terms of the financing arrangement, we could, under certain circumstances, be required to acquire certain assets related to the service contract or to pay the aggregate unpaid payments under such arrangements. As ofOctober 25, 2019 , we have not been required to make any payments under these arrangements, and we believe the likelihood of having to acquire a material amount of assets or make payments under these arrangements is remote. The portion of the financial arrangement that represents unearned services revenue is included in deferred revenue and financed unearned services revenue in our condensed consolidated balance sheets.
Indemnification Agreements
We enter into indemnification agreements with third parties in the ordinary course of business. Generally, these indemnification agreements require us to reimburse losses suffered by the third-parties due to various events, such as lawsuits arising from patent or copyright infringement. These indemnification obligations are considered off-balance sheet arrangements under accounting guidance. 40
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Legal Contingencies
We are subject to various legal proceedings and claims which arise in the normal course of business. See further details on such matters in Note 16 - Commitments and Contingencies of the Notes to Condensed Consolidated Financial Statements. 41
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