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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 10-Q
---------------
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JULY 28, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________ .
COMMISSION FILE NUMBER 0-27130
NETWORK APPLIANCE, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 77-0307520
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
495 EAST JAVA DRIVE,
SUNNYVALE, CALIFORNIA 94089
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 822-6000
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Number of shares outstanding of the registrant's class of common stock, as
of the latest practicable date.
<TABLE>
<CAPTION>
OUTSTANDING AT
CLASS JULY 28, 2000
----- -------------
<S> <C>
Common Stock............. 316,049,875
</TABLE>
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<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE NO.
--------
PART I -- FINANCIAL INFORMATION
<S> <C>
Item 1. Condensed Consolidated Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of July 28, 2000 and April 30, 2000 2
Condensed Consolidated Statements of Income for the three-month periods
ended July 28, 2000 and July 30, 1999 3
Condensed Consolidated Statements of Cash Flows for the three-month periods ended
July 28, 2000 and July 30, 1999 4
Notes to Condensed Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk 15
PART II--OTHER INFORMATION
Item 1. Legal Proceedings 16
Item 2. Changes in Securities 16
Item 3. Defaults Upon Senior Securities 16
Item 4. Submission of Matters to Vote of Securityholders 16
Item 5. Other Information 16
Item 6. Exhibits and Reports on Form 8-K 16
SIGNATURE 17
</TABLE>
1
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PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NETWORK APPLIANCE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
JULY 28, APRIL 30,
2000 2000
----------- ----------
(UNAUDITED) **
ASSETS
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 331,749 $ 279,014
Short-term investments 105,203 74,477
Accounts receivable, net 138,201 108,902
Inventories 22,866 20,434
Prepaid expenses and other assets 14,927 27,958
Deferred income taxes 16,850 22,215
--------- ---------
Total current assets 629,796 533,000
PROPERTY AND EQUIPMENT, NET 65,787 47,949
INTANGIBLE ASSETS, NET 23,909 389
OTHER ASSETS 9,660 10,895
--------- ---------
$ 729,152 $ 592,233
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 49,967 $ 34,061
Accrued compensation and related benefits 33,456 34,902
Other accrued liabilities 32,961 21,288
Deferred revenue 31,648 23,182
--------- ---------
Total current liabilities 148,032 113,433
LONG-TERM OBLIGATIONS 54 54
--------- ---------
148,086 113,487
--------- ---------
SHAREHOLDERS' EQUITY:
Common stock 437,232 351,519
Retained earnings 134,722 129,746
Cumulative other comprehensive income (loss) 9,112 (2,519)
--------- ---------
Total shareholders' equity 581,066 478,746
--------- ---------
$ 729,152 $ 592,233
========= =========
** Derived from audited consolidated financial statements.
</TABLE>
See accompanying notes to condensed consolidated financial statements
2
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NETWORK APPLIANCE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
------------------------
JULY 28, JULY 30,
2000 1999
--------- ---------
<S> <C> <C>
NET SALES $ 231,159 $ 103,279
COST OF SALES 89,457 42,539
--------- ---------
Gross Margin 141,702 60,740
--------- ---------
OPERATING EXPENSES:
Sales and marketing 64,059 26,884
Research and development 23,705 11,220
General and administrative 8,985 3,768
Amortization of intangible assets 666 50
In-process research and development 26,688 --
--------- ---------
Total operating expenses 124,103 41,922
--------- ---------
INCOME FROM OPERATIONS 17,599 18,818
--------- ---------
OTHER INCOME (EXPENSE):
Interest income 4,264 2,126
Other income (expense), net 116 (63)
--------- ---------
Total other income, net 4,380 2,063
--------- ---------
INCOME BEFORE INCOME TAXES 21,979 20,881
PROVISION FOR INCOME TAXES 17,003 7,413
--------- ---------
NET INCOME $ 4,976 $ 13,468
========= =========
NET INCOME PER SHARE(1):
Basic $ 0.02 $ 0.05
========= =========
Diluted $ 0.01 $ 0.04
========= =========
SHARES USED IN PER SHARE CALCULATIONS(1):
Basic 313,559 292,376
========= =========
Diluted 359,778 333,596
========= =========
</TABLE>
(1) Share and per share amounts have been adjusted to reflect the two-for-one
stock splits which were effective December 20, 1999 and March 22, 2000.
See accompanying notes to condensed consolidated financial statements.
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NETWORK APPLIANCE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
------------------------------
JULY 28, 2000 JULY 30, 1999
------------- -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 4,976 $ 13,468
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 6,987 2,837
In-process research and development 26,688 --
Provision for doubtful accounts 172 304
Deferred income taxes (2,114) (3,400)
Deferred rent -- (25)
Changes in assets and liabilities:
Accounts receivable (29,412) (12,005)
Inventories (4,988) (1,219)
Prepaid expenses and other assets 9,141 2,595
Accounts payable 15,875 7,279
Income taxes payable 22,491 9,720
Accrued compensation and related benefits (1,446) (4,976)
Other accrued liabilities 7,137 1,257
Deferred revenue 8,308 1,485
--------- ---------
Net cash provided by operating activities 63,815 17,320
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of short-term investments (51,699) (12,419)
Redemptions of short-term investments 45,109 2,350
Purchases of property and equipment (21,034) (8,306)
Purchase of equity investment (1,000) --
Purchase of Orca Systems, net of cash acquired (2,161) --
Payment/refund of deposits, net -- 2,500
--------- ---------
Net cash used in investing activities (30,785) (15,875)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock, net 19,705 7,296
--------- ---------
Net cash provided by financing activities 19,705 7,296
--------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS 52,735 8,741
CASH AND CASH EQUIVALENTS:
Beginning of period 279,014 221,284
--------- ---------
End of period $ 331,749 $ 230,025
========= =========
NONCASH INVESTING AND FINANCING ACTIVITIES:
Income tax benefit from employee stock transactions $ 18,000 $ 6,900
Common stock issued and options assumed for Orca acquisition $ 47,579 $ --
SUPPLEMENTAL CASH FLOW INFORMATION:
Income taxes paid net of refund $ (3,946) $ 34
</TABLE>
See accompanying notes to condensed consolidated financial statements.
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NETWORK APPLIANCE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The accompanying condensed consolidated financial statements have been
prepared by Network Appliance, Inc. without audit and reflect all adjustments,
which are, in the opinion of management, necessary for a fair presentation of
our financial position and results of operations for the interim periods. The
statements have been prepared in accordance with the regulations of the
Securities and Exchange Commission (SEC). Accordingly, they do not include all
information and footnotes required by generally accepted accounting principles.
The results of operations for the three-month period ended July 28, 2000 are not
necessarily indicative of the operating results to be expected for the full
fiscal year or future operating periods. The information included in this report
should be read in conjunction with the audited consolidated financial statements
and notes thereto for the fiscal year ended April 30, 2000 and the risk factors
as set forth in our Annual Report on Form 10-K, including, without limitation,
risks relating to fluctuating operating results, customer and market acceptance
of new products, dependence on new products, rapid technological change,
litigation, dependence on growth in the network file server market, expansion of
international operations, product concentration, changing product mix,
competition, management of expanding operations, dependence on high-quality
components, dependence on proprietary technology, intellectual property rights,
dependence on key personnel, volatility of stock price, shares eligible for
future sale, effect of certain anti-takeover provisions and dilution.
2. FISCAL PERIODS
We operate on a 52-week or 53-week year ending on the last Friday in April.
Fiscal 2001 is a 52-week year. Fiscal 2000 was a 52-week year. The quarter ended
July 28, 2000 includes 13 weeks of operating activity, compared to 13 weeks of
activity for the corresponding period of the prior fiscal year.
3. INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
JULY 28, APRIL 30,
2000 2000
-------- ---------
(IN THOUSANDS)
<S> <C> <C>
Purchased components $ 9,347 $ 9,230
Work in process 5,290 646
Finished goods 8,229 10,558
------- -------
$22,866 $20,434
======= =======
</TABLE>
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NETWORK APPLIANCE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
4. NET INCOME PER SHARE
The following is a reconciliation of the numerators and denominators of the
basic and diluted net income per share computations for the periods presented:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-------------------------
JULY 28, JULY 30,
2000 1999
--------- ---------
<S> <C> <C>
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NET INCOME (NUMERATOR):
Net income, basic and diluted $ 4,976 $ 13,468
========= =========
SHARES (DENOMINATOR):
Weighted average common shares outstanding 313,750 292,620
Weighted average common shares outstanding
subject to repurchase (191) (244)
--------- ---------
Shares used in basic computation 313,559 292,376
Weighted average common shares outstanding
subject to repurchase 191 244
Common shares issuable upon exercise of stock
options 46,028 40,976
--------- ---------
Shares used in diluted computation 359,778 333,596
========= =========
NET INCOME PER SHARE:
Basic $ 0.02 $ 0.05
========= =========
Diluted $ 0.01 $ 0.04
========= =========
</TABLE>
5. COMPREHENSIVE INCOME
The components of comprehensive income, net of tax, are as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
----------------------
JULY 28, JULY 30,
2000 1999
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Net income $ 4,976 $13,468
Foreign currency translation adjustment 157 256
Unrealized gain on investments 11,474 8
------- -------
Comprehensive income $16,607 $13,732
======= =======
</TABLE>
6
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NETWORK APPLIANCE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
6. NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for
Derivative Instruments and Hedging Activities," which defines derivatives,
requires that all derivatives be carried at fair value, and provides for hedge
accounting when certain conditions are met. This statement is effective for all
fiscal quarters of fiscal years beginning after June 15, 2000. Although we have
not fully assessed the implications of this new statement, we do not believe
adoption of this statement will have a material impact on our consolidated
financial position, results of operations or cash flows.
7. COMMITMENTS
We have commitments related to operating lease arrangements, under which we
have an option to purchase the Sunnyvale headquarters properties for an
aggregate of $245.0 million, or arrange for the sale of the properties to a
third party for at least the option price with a contingent liability for any
deficiency. If the properties under these leases are not purchased or sold, we
will be obligated for additional lease payments of approximately $214.0 million.
All of these operating leases require monthly payments, which vary, based
on the London Interbank Offered Rate (LIBOR) plus a spread (8.0% at July 28,
2000).
The operating leases mentioned above require us to maintain specified
financial covenants with which we were in compliance as of July 28, 2000.
8. ACQUISITION
In June 2000, we completed the acquisition of Orca Systems, Inc. (Orca), a
developer of high performance Virtual Interface (VI) Architecture software for
UNIX(R) and Windows NT(R) enterprise-class systems, based in Waltham,
Massachusetts. The acquisition fits with our strategy of developing highly
available and reliable intelligent storage solutions that improve the
performance of today's Internet and enterprise applications and strengthen our
ability to develop next generation storage networking architectures and
protocols. The acquisition was accounted for as a purchase. Under terms of the
agreement, we acquired Orca for $50.0 million in common stock, assumed options
and cash, with an obligation to provide 264,497 shares of common stock (valued
at $22.5 million based on our closing stock price on July 28, 2000), if certain
performance criteria are achieved. We also paid certain transaction costs and
assumed certain operating assets and liabilities.
The purchase price of the transaction was allocated to the acquired assets
and liabilities based on their estimated fair values as of the date of the
acquisition. Approximately $26.7 million was allocated to in-process research
and development and charged to operations because the acquired technology had
not reached technological feasibility and had no alternative uses. The value was
determined by estimating the costs to develop the acquired in-process technology
into commercially viable products, estimating the resulting net cash flows from
such projects, and discounting the net cash flows back to their present value.
The discount rate included a factor that took into account the uncertainty
surrounding the successful development of the acquired in-process technology.
These estimates are subject to change, given the uncertainties of the
development process, and no assurance can be given that deviations from these
estimates will not occur. Excluding the charge that may result from 264,497
contingently issuable common shares, research and development costs to bring the
products from Orca to technological feasibility are not expected to have a
material impact on our future results of operations or financial condition.
7
<PAGE> 9
The total purchase price and final allocation among the tangible and intangible
assets and liabilities acquired (including purchased in-process technology) is
summarized as follows (in thousands):
<TABLE>
<CAPTION>
Total Purchase Price: Amortization Period
(Years)
-------------------
<S> <C> <C>
Total cash consideration $ 2,000
Shares issued 23,526
Value of options assumed 24,053
Transaction costs 458
----------
$ 50,037
==========
Purchase Price Allocation:
Tangible assets $ 353
Intangible assets:
Existing Workforce 423 3
Goodwill 24,101 5
In-process R&D 26,688 Expensed
Tangible liabilities (1,359)
Deferred tax liabilities (169)
----------
$ 50,037
==========
</TABLE>
Pro forma results of operations have not been presented since the effects
of the acquisition were not material to our consolidated financial position,
results of operations or cash flows for the periods presented.
9. SUBSEQUENT EVENT
In September 2000, we entered into a definitive agreement to acquire
privately-held WebManage Technologies, Inc. ("WebManage"), a developer of
content management, distribution, and analysis software solutions. Under terms
of the agreement, we will acquire WebManage for approximately $75.0 million in
common stock, assumed options, and cash. The acquisition will be accounted for
using the purchase method of accounting.
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This Form 10-Q contains forward-looking statements about future results,
which are subject to risks and uncertainties, including those discussed below.
Our actual results may differ significantly from the results discussed in the
forward-looking statements. We are subject to a variety of other additional risk
factors, more fully described in our Annual Report on Form 10-K filed with the
Securities and Exchange Commission.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
The following table sets forth certain consolidated statements of income
data as a percentage of net sales for the periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------
JULY 28, JULY 30,
2000 1999
------- --------
<S> <C> <C>
Net sales 100.0% 100.0%
Cost of sales 38.7 41.2
------ ------
Gross margin 61.3 58.8
------ ------
Operating expenses:
Sales and marketing 27.7 26.0
Research and development 10.3 10.9
General and administrative 3.9 3.7
Amortization of intangible assets 0.3 --
In-process research and development 11.5 --
------ ------
Total operating expenses 53.7 40.6
------ ------
Income from operations 7.6 18.2
Total other income, net 1.9 2.0
------ ------
Income before income taxes 9.5 20.2
Provision for income taxes 7.4 7.2
------ ------
Net income 2.1% 13.0%
====== ======
</TABLE>
Business Combinations -- During the first quarter of fiscal 2001, we
acquired Orca, for a purchase price of $50.0 million, including common stock,
assumed options and cash, with an obligation to provide 264,497 shares of common
stock, if certain performance criteria are achieved. We also paid certain
transaction costs and assumed certain operating assets and liabilities. The
acquisition was accounted for as a purchase. The purchase price of the
transaction was allocated to the acquired assets and liabilities based on their
estimated fair values as of the date of the acquisition. Amounts allocated to
existing workforce and goodwill are being amortized on a straight-line basis
over three- and five-year periods, respectively. Approximately $26.7 million was
allocated to in-process research and development and charged to operations
because the acquired technology had not reached technological feasibility and
had no alternative uses.
Pro forma results of operations have not been presented since the effects
of the acquisition were not material to our consolidated financial position,
results of operations or cash flows for the periods presented.
Net Sales -- Net sales increased by 123.8% to $231.2 million for the
three-month period ended July 28, 2000, from $103.3 million for the three-month
period ended July 30, 1999. Net sales growth was across all geographies,
products and markets. This increase in net sales was primarily attributable to a
higher volume of units shipped, as compared to the corresponding period of the
prior fiscal year. Factors impacting unit growth include:
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- strong demand for our F700 filer product family utilizing primarily
fibre-channel connectivity;
- increased worldwide demand for our NetCache(TM) solutions;
- increased worldwide shipment of NetApp(R) Cluster Failover solutions,
which require another filer to take over in the event of a hardware
failure;
- increased demand for the SnapMirror(TM) software option, which
requires multiple filers to provide remote mirroring of data for quick
disaster recovery and backup at remote sites;
- expansion of our sales organization to 704 as of July 28, 2000 from
344 as of July 30, 1999; and
- increased sales through indirect channels, representing 26.6% and
32.5% of total sales for the first quarter of fiscal 2001 and 2000,
respectively, including sales through our OEM partners.
Net sales growth was also positively impacted by:
- a higher average selling price due to the introduction of new software
features: SnapMirror, SnapRestore(TM) and SnapManager(TM) for
Microsoft(R) Exchange and Cluster Failover, supporting
mission-critical applications;
- the increase in storage capacity;
- increased add-on software revenue from multi-protocol solutions; and
- higher software subscription and service revenues to support a growing
installed base.
Overall net sales growth was partially offset by:
- declining average selling price of the F700 and caching product family
due to competitive pricing pressure; and
- declining unit sales of our older product family.
International net sales (including United States exports) grew by 157.3%
for the three-month period ended July 28, 2000, as compared to the comparable
period of the prior fiscal year. International net sales were $73.1 million, or
31.6% of total net sales, for the three-month period ended July 28, 2000. The
increase in international sales for the three-month period ended July 28, 2000,
was primarily a result of European and Asia Pacific net sales growth, due to
increased headcount in the direct sales force, increased indirect channel sales,
increased shipments of filers, Cluster Failover solutions, NetCache appliances
and increased sales of add-on software licenses as compared to the corresponding
period of the prior fiscal year. We believe that our continued growth and
profitability is dependent in part on the successful expansion of our
international operations, and therefore, have committed significant resources to
increase international sales.
We cannot assure you that our net sales will continue to increase in
absolute dollars or at the rate at which they have grown in recent fiscal
periods.
Gross Margin -- Gross margin increased to 61.3% for the three-month period
ended July 28, 2000 from 58.8% for the three-month period ended July 30, 1999.
Gross margin was favorably impacted by:
- increased licensing of add-on software options such as:
multi-protocol, Cluster Failover, SnapMirror, SnapRestore and
SnapManager;
- growth in software subscriptions due primarily to a larger installed
base;
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<PAGE> 12
- lower costs of key components;
- the increase in product volume; and
- increased manufacturing efficiencies.
Gross margin was negatively impacted by sales price reductions on storage
products due to competitive pricing pressure from other storage vendors and
increased investments in customer service personnel in areas such as logistics
and professional services.
Our gross margin has been and may continue to be affected by a variety of
factors, including:
- competition;
- product configuration;
- direct versus indirect sales;
- the mix of software as a percentage of revenue;
- the mix and average selling prices of products;
- new product introductions and enhancements; and
- the cost of components and manufacturing labor.
Sales and Marketing -- Sales and marketing expenses consist primarily of
salaries, commissions, advertising and promotional expenses and certain customer
service and support costs. Sales and marketing expenses increased 138.3% to
$64.1 million for the three-month period ended July 28, 2000 from $26.9 million
for the three-month period ended July 30, 1999. These expenses were 27.7% and
26.0% of net sales for the three-month periods ended July 28, 2000 and July 30,
1999, respectively. The increase in absolute dollars was primarily related to
the continued worldwide expansion, increased headcount growth of our sales and
customer service organizations, expansion of various marketing and industry
initiatives and increased commission expenses. Sales and marketing headcount
increased to 916 at July 28, 2000 from 451 at July 30, 1999. We expect to
continue to increase our sales and marketing expenses in an effort to expand
domestic and international markets, introduce new products, establish and expand
new distribution channels and increase product and company awareness.
Research and Development -- Research and development expenses consist
primarily of salaries and benefits, prototype expenses, non-recurring
engineering charges and fees paid to outside consultants. Research and
development expenses increased 111.3% to $23.7 million for the three-month
period ended July 28, 2000 from $11.2 million for the three-month period ended
July 30, 1999. These expenses represented 10.3% and 10.9% of net sales,
respectively, for the three-month periods ended July 28, 2000 and July 30, 1999.
Research and development expenses increased in absolute dollars, primarily as a
result of increased headcount, ongoing support of current and future product
development and enhancement efforts, prototyping expenses and non-recurring
engineering charges associated with the development of new products and
technologies. Research and development headcount increased to 381 at July 28,
2000 from 215 at July 30, 1999. In the first quarter of fiscal 2001, we shipped
the NetCache C1100, our low-end content delivery product designed for enterprise
customers and Internet Service Providers. We also announced a new release of
Data ONTAP(TM) software that offers expanded storage capacity, increased
memory-accessing efficiencies, quicker Snapshot(TM) creation, improved mirroring
performance and additional reliability. In fiscal 2000, we shipped new
enterprise software offerings and data management tools with SnapManager for
Microsoft Exchange and ApplianceWatch(TM). We also introduced new caching
products which included NetCache software release 4.0 and NetCache 4.1, adding
streaming media support for MMS/RTSP protocols, Microsoft(R) Windows Media(TM) ,
Apple(R) Quicktime(TM), delivering live broadcasting on the Internet. We believe
that our future performance will depend in large part on our ability to maintain
and enhance our current product line, develop new products that achieve market
acceptance, maintain technological competitiveness and meet an expanding range
of customer requirements. We intend to continuously expand our existing product
offerings and introduce new products and expect that such expenditures will
continue to increase in absolute dollars. For the three-month periods ended July
28, 2000 and July 30, 1999, no software development costs were capitalized.
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<PAGE> 13
General and Administrative -- General and administrative expenses increased
138.5% to $9.0 million for the three-month period ended July 28, 2000, from $3.8
million for the three-month period ended July 30, 1999. These expenses
represented 3.9% and 3.7% of net sales for the three-month periods ended for
such periods. Increases in absolute dollars were primarily due to increased
headcount, expenses associated with initiatives to implement enterprise-wide
management information systems, increases in professional services, consulting
fees and outside service fees. General and administrative headcount increased to
181 at July 28, 2000 from 92 at July 30, 1999. We believe that our general and
administrative expenses will increase in absolute dollars as we continue to
build our infrastructure.
Amortization of Intangible Assets -- Amortization of intangible assets
represents the excess of the aggregate purchase price over the fair value of the
tangible and identifiable intangible assets acquired by us. Intangible assets as
of July 28, 2000, including goodwill, are being amortized over the estimated
useful life of three to five-year periods. We assess the recoverability of
goodwill by determining whether the amortized asset over its useful life may be
recovered through estimated useful cash flows. Amortization of intangible assets
charged to operations in the first quarter of fiscal 2001 was approximately $0.7
million.
In-process Research and Development -- We incurred in-process research and
development charges of approximately $26.7 million in the first quarter of
fiscal 2001 related to the acquisition of Orca. The purchase price of the
transaction was allocated to the acquired assets and liabilities based on their
estimated fair values as of the date of the acquisition. Approximately $26.7
million was allocated to in-process research and development and charged to
operations, because the acquired technology had not reached technological
feasibility and had no alternative uses. The value was determined by estimating
the costs to develop the acquired in-process technology into commercially viable
products, estimating the resulting net cash flows from such projects, and
discounting the net cash flows back to their present value. The discount rate
included a factor that took into account the uncertainty surrounding the
successful development of the acquired in-process technology. These estimates
are subject to change, given the uncertainties of the development process, and
no assurance can be given that deviations from these estimates will not occur.
Excluding the charge that may result from 264,497 contingently issuable common
shares, research and development costs to bring the products from Orca to
technological feasibility are not expected to have a material impact on our
future results of operations or financial condition.
We believe we could utilize the Orca acquisition to develop the first
virtual interface-based (VI) next generation of network attached storage
systems. We are leveraging VI architecture to develop the Direct File Access
System (DAFS) protocol. DAFS enables block data transfers straight from the file
server, allowing clusters of application servers in heterogeneous environments
to share data from the memory of one system to the memory of another without
involving general-purpose operating systems, thereby improving CPU utilization
and speeding up data access. We expect to continue the development of products
using this protocol and believe that there is a reasonable chance of
successfully completing such development efforts by the middle of year 2001.
However, there is risk associated with the completion of the in-process project
and there can be no assurance that such project will meet with either
technological or commercial success. Failure to successfully develop and
commercialize this in-process project would result in the loss of the expected
economic return inherent in the fair value allocation. Additionally, the value
of other intangible assets acquired may become impaired. The risks associated
with the research and development are still considered high and no assurance can
be made that upcoming products will meet market expectations or gain market
acceptance.
Total Other Income, net -- Total other income, net, was $4.4 million and
$2.1 million for the three-month periods ended July 28, 2000 and July 30, 1999,
respectively. The increase was due primarily to cash generated from operations,
net proceeds from stock option exercises and interest income earned on the net
proceeds from the March 1999 follow-on public offering.
Provision for Income Taxes -- Our estimated effective tax rate for the
three-month period ended July 28, 2000 was 34.5%, excluding the effect of the
write-off of acquired in-process research and development of $26.7 million,
which is not deductible for income tax purposes. The effective tax rate for the
three-month period ended July 30, 1999 was 35.5%. The effective tax rates
differed from the U.S. statutory rate primarily due to state taxes, credits and
tax exempt interest.
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<PAGE> 14
CERTAIN RISK FACTORS
Although we have experienced significant revenue growth in recent periods,
this growth may not be indicative of our future operating results. As a result,
we believe that period-to-period comparisons of our results of operation are not
necessarily meaningful and should not be relied upon as indicators of future
performance. Many of the factors that could cause our quarterly operating
results to fluctuate significantly in the future are beyond our control and
include the following:
- the level of competition in our target product markets;
- the size, timing, and cancellation of significant orders;
- product configuration and mix;
- market acceptance of new products and product enhancements;
- new product announcements or introductions by us or our competitors;
- deferrals of customer orders in anticipation of new products or
product enhancements;
- changes in pricing by us or our competitors;
- our ability to timely develop, introduce and market new products and
enhancements;
- supply constraints;
- technological changes in our target product markets;
- the levels of expenditure on research and development and expansion of
our sales and marketing programs;
- seasonality; and
- general economic trends.
In addition, sales for any future quarter may vary and accordingly be
inconsistent with our plans. We generally operate with limited order backlog
because our products are typically shipped shortly after orders are received. As
a result, product sales in any quarter are generally dependent on orders booked
and shipped in that quarter. Product sales are difficult to forecast because the
network attached storage market is rapidly evolving and our sales cycle varies
substantially from customer to customer.
Due to all of the foregoing factors, it is possible that in one or more
future quarters our results may fall below the expectations of public market
analysts and investors. In such event, the trading price of our common stock
would likely decrease.
We conduct business internationally. For the three-month period ended July
28, 2000, approximately 31.6% of our net sales were to international customers
(including U.S. exports). Accordingly, our future operating results could be
materially adversely affected by a variety of factors, some of which are beyond
our control, including regulatory, political or economic conditions in a
specific country or region, trade protection measures and other regulatory
requirements and government spending patterns.
Our international sales are denominated in U.S. dollars and in foreign
currencies. An increase in the value of the U.S. dollar relative to foreign
currencies could make our products more expensive and, therefore, potentially
less competitive in foreign markets. For international sales and expenditures
denominated in foreign currencies, we are subject to risks associated with
currency fluctuations. We hedge risks associated with foreign currency
transactions in order to minimize the impact of changes in foreign currency
exchange rates on earnings. We utilize forward contracts to hedge trade and
intercompany receivables and payables. All hedge contracts are marked to market
through earnings every period.
Additional risks inherent in our international business activities
generally include, among others, longer accounts receivable payment cycles,
difficulties in managing international operations and potentially adverse tax
consequences. We cannot assure you that such factors will not materially
adversely affect our future international sales and, consequently, our operating
results.
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<PAGE> 15
Although operating results have not been materially and adversely affected
by seasonality in the past, because of the significant seasonal effects
experienced within the industry, particularly in Europe, we cannot assure you
that our future operating results will not be adversely affected by seasonality.
We believe that continued growth and profitability will require successful
expansion of our international operations and sales and therefore we have
committed significant resources to such expansion. In order to successfully
expand international sales in fiscal 2001 and subsequent periods, we must
strengthen foreign operations, hire additional personnel and recruit additional
international distributors and resellers. This will require significant
management attention and financial resources and could materially adversely
affect our operating results. To the extent that we are unable to effect these
additions in a timely manner, our growth, if any, in international sales will be
limited, and our operating results could be materially adversely affected. In
addition, we cannot assure you that we will be able to maintain or increase
international market demand for our products.
LIQUIDITY AND CAPITAL RESOURCES
As of July 28, 2000, as compared to the April 30, 2000 balances, our cash,
cash equivalents and short-term investments increased by $83.5 million to $437.0
million. Working capital increased by $62.2 million to $481.8 million. The
increase was also a result of unrealized gain on a publicly held investment. We
generated cash from operating activities totaling $63.8 million and $17.3
million for the three-month periods ended July 28, 2000 and July 30, 1999,
respectively. Net cash provided by operating activities for the three-month
period ended July 28, 2000 was principally related to net income of $5.0
million, increases in accounts payable, income taxes payable, deferred revenue
and other accrued liabilities, decreases in prepaid expenses and other, coupled
with depreciation and amortization, in-process research and development,
partially offset by increases in accounts receivable, inventories and deferred
income taxes and decreases in accrued compensation and related benefits.
We used $21.0 million and $8.3 million of cash during the three-month
periods ended July 28, 2000 and July 30, 1999, respectively, for capital
expenditures. The increase was primarily attributed to upgrades of software and
computer equipment purchases and furniture and fixtures for the Sunnyvale
headquarters facility. We have used $6.6 million and $10.1 million during the
three-month periods ended July 28, 2000 and July 30, 1999, respectively, for net
short-term investments. In June 2000, we acquired Orca for a purchase price of
approximately $50.0 million, including common stock, contingently issuable
common stock, assumed options, cash payments of $2.0 million and related
transaction costs. Investing activities in the three-month period ended July 28,
2000 also included an equity investment of $1.0 million, recorded at cost, which
approximated fair market value.
Financing activities provided $19.7 million and $7.3 million during the
three-month periods ended July 28, 2000 and July 30, 1999, respectively. The
increase in cash provided by financing activities for the three-month period
ended July 28, 2000, compared to the corresponding period of the prior fiscal
year, was due to an increased quantity of stock options exercised at a higher
average exercise price and a greater number of employees participating in the
employee stock purchase plan.
Excluding the commitments related to operating lease arrangements for
various properties in our Sunnyvale headquarters, which aggregate $245.0
million, we currently have no significant commitments other than commitments
under operating leases. We believe that our existing liquidity and capital
resources, including the available amounts under our $5.0 million line of
credit, are sufficient to fund our operations for at least the next twelve
months.
NEW ACCOUNTING STANDARDS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which defines derivatives, requires that
all derivatives be carried at fair value, and provides for hedging accounting
when certain conditions are met. This statement is effective for all fiscal
quarters of fiscal years beginning after June 15, 2000. Although we have not
fully assessed the
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<PAGE> 16
implications of this new statement, we do not believe adoption of this statement
will have a material impact on our consolidated financial position, results of
operations or cash flows.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk related to fluctuations in interest rates and
in foreign currency exchange rates. We use certain derivative financial
instruments to manage these risks. We do not use derivative financial
instruments for speculative or trading purposes. All financial instruments are
used in accordance with management-approved policies.
Market Interest Risk
Short-term Investments - As of July 28, 2000, we had short-term investments
of $105.2 million. Our investment portfolio consists of highly liquid
investments with original maturities at the date of purchase between three and
twelve months. These investments are subject to interest rate risk and will
decrease in value if market interest rates increase. A hypothetical 10 percent
increase in market interest rates from levels at July 28, 2000, would cause the
fair value of these short-term investments to decline by an immaterial amount.
Because we have the ability to hold these investments until maturity we would
not expect any significant decline in value of our investments caused by market
interest rate changes. Declines in interest rates over time will, however,
reduce our interest income. We do not use derivative financial instruments in
our investment portfolio.
Our investment portfolio also includes common stock holdings in a certain
publicly held technology company. We are exposed to fluctuations in the market
price of our equity investment in this company. At the same time, we are
precluded from selling the value of any of our holdings until December 2000, due
to the typical 180 day lockup provision. As a result of these factors, the
amount of income and cash flow that we ultimately realize from this investment
in future periods may vary materially from the current unrealized amount.
Operating Lease Commitments - As of July 28, 2000, we have outstanding
lease commitments to a third-party entity under operating lease agreements,
which vary based on a monthly LIBOR rate plus a spread. A hypothetical 10
percent increase in interest rates would increase our annual rent expense under
operating lease commitments by approximately $2.0 million. Increases in interest
rates could, however, increase our rent expenses associated with future lease
payments. We do not currently hedge against interest rate increases. Our
investment portfolio offers a natural hedge against interest rate risk from our
operating lease commitments in the event of a significant increase in the market
interest rate.
The hypothetical changes and assumptions discussed above will be different
from what actually occurs in the future. Furthermore, such computations do not
anticipate actions that may be taken by management, should the hypothetical
market changes actually occur over time. As a result, the effect on actual
earnings in the future will differ from those described above.
Foreign Currency Exchange Rate Risk - We hedge risks associated with
foreign currency transactions in order to minimize the impact of changes in
foreign currency exchange rates on earnings. We utilize forward contracts to
hedge against the short-term impact of foreign currency fluctuations on certain
assets and liabilities denominated in foreign currencies. All hedge instruments
are marked to market through earnings every period. We believe that these
forward contracts do not subject us to undue risk due to foreign exchange
movements because gains and losses on these contracts are offset by losses and
gains on the underlying assets and liabilities.
All contracts have a maturity of less than one year and we do not defer any
gains and losses, as they are all accounted for through earnings every period.
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<PAGE> 17
The following table provides information about our foreign exchange forward
contracts outstanding on July 28, 2000, (in thousands):
<TABLE>
<CAPTION>
BUY/ FOREIGN CONTRACT VALUE FAIR VALUE
CURRENCY SELL CURRENCY AMOUNT USD IN USD
-------- ---- --------------- -------------- ------------
<S> <C> <C> <C> <C>
EUR Sell 46,218 $50,125 $50,183
EUR Buy 89,681 $96,511 $97,373
GBP Sell 21,987 $35,344 $35,804
GBP Buy 15,597 $25,262 $25,398
CHF Sell 14,987 $ 9,644 $ 9,644
CHF Buy 4,684 $ 3,015 $ 3,014
</TABLE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
27 Financial Data Schedule
(b) REPORTS ON FORM 8-K
None
16
<PAGE> 18
SIGNATURE
Pursuant to the requirements of the Securities and Exchange Act of 1934, as
amended, the registrant duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
NETWORK APPLIANCE INC.
(Registrant)
/s/ JEFFRY R. ALLEN
----------------------------------------
Jeffry R. Allen
Executive Vice President Finance
and Operations,
Chief Financial Officer and Secretary
Date: September 11, 2000
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<PAGE> 19
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION
-------------- -----------
<S> <C>
27 Financial Data Schedule
</TABLE>
18
