<PAGE> 1
================================================================================
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 OCTOBER 27, 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)
<TABLE>
<S> <C>
CALIFORNIA 77-0307520
(STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION) (IRS EMPLOYER IDENTIFICATION NO.)
</TABLE>
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 OCTOBER 27, 2000
----- ----------------
<S> <C>
Common Stock............. 320,844,719
</TABLE>
================================================================================
<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 October 27, 2000 and April 30, 2000 2
Condensed Consolidated Statements of Income for the three and six-month periods
ended October 27, 2000 and October 29, 1999 3
Condensed Consolidated Statements of Cash Flows for the six-month periods ended
October 27, 2000 and October 29, 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 17
Item 2. Changes in Securities 17
Item 3. Defaults Upon Senior Securities 17
Item 4. Submission of Matters to Vote of Securityholders 17
Item 5. Other Information 17
Item 6. Exhibits and Reports on Form 8-K 17
SIGNATURE 18
</TABLE>
1
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NETWORK APPLIANCE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
OCTOBER 27, APRIL 30,
2000 2000
----------- -----------
(UNAUDITED) **
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 305,831 $ 279,014
Short-term investments 142,244 74,477
Accounts receivable, net 161,917 108,902
Inventories 22,867 20,434
Prepaid expenses and other assets 21,955 27,958
Deferred income taxes 25,477 22,215
--------- ---------
Total current assets 680,291 533,000
RESTRICTED CASH 63,150 --
PROPERTY AND EQUIPMENT, NET 81,595 47,949
INTANGIBLE ASSETS, NET 22,636 389
OTHER ASSETS 9,681 10,895
--------- ---------
$ 857,353 $ 592,233
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 58,523 $ 34,061
Accrued compensation and related benefits 66,025 34,902
Other accrued liabilities 35,015 21,288
Deferred revenue 45,913 23,182
--------- ---------
Total current liabilities 205,476 113,433
LONG-TERM OBLIGATIONS 52 54
--------- ---------
205,528 113,487
--------- ---------
SHAREHOLDERS' EQUITY:
Common stock 480,861 351,519
Retained earnings 170,082 129,746
Cumulative other comprehensive income (loss) 882 (2,519)
--------- ---------
Total shareholders' equity 651,825 478,746
--------- ---------
$ 857,353 $ 592,233
========= =========
</TABLE>
** Derived from audited consolidated financial statements.
See accompanying notes to condensed consolidated financial statements.
2
<PAGE> 4
NETWORK APPLIANCE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
-------------------------- --------------------------
OCTOBER 27, OCTOBER 29, OCTOBER 27, OCTOBER 29,
2000 1999 2000 1999
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
NET SALES $ 260,777 $ 124,712 $ 491,936 $ 227,991
COST OF SALES 99,314 51,516 188,771 94,055
--------- --------- --------- ---------
Gross Margin 161,463 73,196 303,165 133,936
--------- --------- --------- ---------
OPERATING EXPENSES:
Sales and marketing 72,445 32,548 136,504 59,432
Research and development 28,357 13,462 52,062 24,682
General and administrative 10,244 4,437 19,229 8,205
Amortization of intangible assets 1,273 50 1,939 100
In-process research and development -- -- 26,688 --
--------- --------- --------- ---------
Total operating expenses 112,319 50,497 236,422 92,419
--------- --------- --------- ---------
INCOME FROM OPERATIONS 49,144 22,699 66,743 41,517
--------- --------- --------- ---------
OTHER INCOME (EXPENSE):
Interest income 5,309 2,537 9,573 4,643
Other income (expense), net 202 (356) 318 (399)
--------- --------- --------- ---------
Total other income, net 5,511 2,181 9,891 4,244
--------- --------- --------- ---------
INCOME BEFORE INCOME TAXES 54,655 24,880 76,634 45,761
PROVISION FOR INCOME TAXES 19,295 8,832 36,298 16,245
--------- --------- --------- ---------
NET INCOME $ 35,360 $ 16,048 $ 40,336 $ 29,516
========= ========= ========= =========
NET INCOME PER SHARE(1):
Basic $ 0.11 $ 0.05 $ 0.13 $ 0.10
========= ========= ========= =========
Diluted $ 0.10 $ 0.05 $ 0.11 $ 0.09
========= ========= ========= =========
SHARES USED IN PER SHARE CALCULATIONS(1):
Basic 318,223 296,488 315,891 294,432
========= ========= ========= =========
Diluted 364,035 337,968 361,906 335,332
========= ========= ========= =========
</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.
3
<PAGE> 5
NETWORK APPLIANCE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
-----------------------------------
OCTOBER 27, 2000 OCTOBER 29, 1999
---------------- ----------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 40,336 $ 29,516
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 13,466 5,871
In-process research and development 26,688 --
Amortization of intangibles 1,939 --
Provision for doubtful accounts 813 723
Deferred income taxes (6,356) (10,000)
Deferred rent (2) (40)
Changes in assets and liabilities:
Accounts receivable (53,968) (22,294)
Inventories (10,735) (3,900)
Prepaid expenses and other assets 2,696 871
Accounts payable 24,431 12,232
Income taxes payable 44,960 23,752
Accrued compensation and related benefits 24,577 3,798
Other accrued liabilities 16,269 978
Deferred revenue 22,574 1,749
--------- ---------
Net cash provided by operating activities 147,688 43,256
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of short-term investments (125,894) (51,673)
Redemptions of short-term investments 70,829 5,800
Purchases of property and equipment (39,386) (13,164)
Purchase of equity investment (1,000) --
Purchase of Orca Systems, net of cash acquired (2,161) --
Payment/refund of deposits, net -- (170)
--------- ---------
Net cash used in investing activities (97,612) (59,207)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock, net 39,891 15,495
Restricted cash (63,150) --
--------- ---------
Net cash provided by (used in) financing activities (23,259) 15,495
--------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS 26,817 (456)
CASH AND CASH EQUIVALENTS:
Beginning of period 279,014 221,284
--------- ---------
End of period $ 305,831 $ 220,828
========= =========
NONCASH INVESTING AND FINANCING ACTIVITIES:
Income tax benefit from employee stock transactions $ 41,000 $ 24,400
Common stock issued and options assumed for Orca acquisition $ 47,579 $ --
SUPPLEMENTAL CASH FLOW INFORMATION:
Income taxes paid net of refund $ (3,946) $ 1,407
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE> 6
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 and six-month periods ended October 27,
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 October 27, 2000 includes 13 weeks of operating activity, compared
to 13 weeks of activity for the corresponding period of the prior fiscal year.
The six-months ended October 27, 2000 includes 26 weeks of activity, compared to
26 weeks of activity for the corresponding period of the prior fiscal year.
3. INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
OCTOBER 27, APRIL 30,
2000 2000
----------- ---------
(IN THOUSANDS)
<S> <C> <C>
Purchased components $10,384 $ 9,230
Work in process 2,769 646
Finished goods 9,714 10,558
------- -------
$22,867 $20,434
======= =======
</TABLE>
5
<PAGE> 7
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 SIX MONTHS ENDED
OCTOBER 27, OCTOBER 29, OCTOBER 27, OCTOBER 29,
2000 1999 2000 1999
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NET INCOME (NUMERATOR):
Net income, basic and diluted $ 35,360 $ 16,048 $ 40,336 $ 29,516
========= ========= ========= =========
SHARES (DENOMINATOR):
Weighted average common shares outstanding 318,520 296,680 316,135 294,652
Weighted average common shares outstanding
subject to repurchase (297) (192) (245) (220)
--------- --------- --------- ---------
Shares used in basic computation 318,223 296,488 315,890 294,432
Weighted average common shares outstanding
subject to repurchase 297 192 245 220
Common shares issuable upon exercise of stock
options 45,515 41,288 45,771 40,680
--------- --------- --------- ---------
Shares used in diluted computation 364,035 337,968 361,906 335,332
========= ========= ========= =========
NET INCOME PER SHARE:
Basic $ 0.11 $ 0.05 $ 0.13 $ 0.10
========= ========= ========= =========
Diluted $ 0.10 $ 0.05 $ 0.11 $ 0.09
========= ========= ========= =========
</TABLE>
5. COMPREHENSIVE INCOME
The components of comprehensive income, net of tax, are as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
OCTOBER 27, OCTOBER 29, OCTOBER 27, OCTOBER 29,
2000 1999 2000 1999
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
(IN THOUSANDS)
Net income $ 35,360 $ 16,048 $ 40,336 $ 29,516
Foreign currency translation adjustment (1,556) (190) (1,392) 74
Unrealized gain on investments (6,674) -- 4,793 --
-------- -------- -------- --------
Comprehensive income $ 27,130 $ 15,858 $ 43,737 $ 29,590
======== ======== ======== ========
</TABLE>
6
<PAGE> 8
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
During the second quarter of fiscal 2001, we have entered into a $126.0
million operating lease which replaced the existing $62.0 million operating
lease, to develop 363,500 square feet of buildings in our Sunnyvale headquarters
facility. The lease is for five years and can be renewed for two five-year
periods, subject to the approval of the third-party entity. At the expiration or
termination of the lease, we have the option to either purchase the property for
$126.0 million, or arrange for the sale of the property to a third party for at
least $126.0 with a contingent liability for any deficiency. If the property is
not purchased or sold as described above, we will be obligated for an additional
lease payment of approximately $113.8 million. Restricted cash, classified as
non-current assets collateralizing this lease was $63.2 million at October 27,
2000.
Including the aforementioned lease, we have commitments related to
operating lease arrangements, under which we have an option to purchase the
Sunnyvale headquarters properties for an aggregate of $309.0 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 $276.6 million.
The lease payments under the $126.0 million operating lease,
collateralized by restricted securities, will vary based on the London Interbank
Offered Rate (LIBOR) plus a spread (6.9% at October 27, 2000). All of the
remaining operating leases require monthly payments, which vary, based on LIBOR
plus a spread (8.1% at October 27, 2000).
The operating leases mentioned above require us to maintain specified
financial covenants with which we were in compliance as of October 27, 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 October 27, 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-
7
<PAGE> 9
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. Costs incurred prior to establishment of technological
feasibility are charged to research and development expense and have not been
material through October 27, 2000.
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. In November
2000, under terms of the agreement, we have completed the acquisition of
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.
8
<PAGE> 10
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 SIX MONTHS ENDED
------------------------- -------------------------
OCTOBER 27, OCTOBER 29, OCTOBER 27, OCTOBER 29,
2000 1999 2000 1999
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net sales 100.0 % 100.0 % 100.0 % 100.0 %
Cost of sales 38.1 41.3 38.4 41.3
----- ----- ----- -----
Gross margin 61.9 58.7 61.6 58.7
----- ----- ----- -----
Operating expenses:
Sales and marketing 27.8 26.1 27.8 26.1
Research and development 10.8 10.8 10.5 10.8
General and administrative 3.9 3.6 3.9 3.6
Amortization of intangible assets 0.5 -- 0.4 --
In-process research and development -- -- 5.4 --
----- ----- ----- -----
Total operating expenses 43.0 40.5 48.0 40.5
----- ----- ----- -----
Income from operations 18.9 18.2 13.6 18.2
Total other income, net 2.1 1.8 2.0 1.9
----- ----- ----- -----
Income before income taxes 21.0 20.0 15.6 20.1
Provision for income taxes 7.4 7.1 7.4 7.1
----- ----- ----- -----
Net income 13.6 % 12.9 % 8.2 % 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 109.1% to $260.8 million for the
three-month period ended October 27, 2000, from $124.7 million for the
three-month period ended October 29, 1999. Net sales increased by 115.8% to
$491.9 million for the six-months ended October 27, 2000, from $228.0 million
for the six-months ended October 29, 1999. Net sales growth was across all
geographies, products and
9
<PAGE> 11
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:
- strong demand for our F700 filers utilizing primarily fibre-channel
connectivity;
- introduction of our new higher capacity F840 filer product;
- increased worldwide demand for our NetCache(TM) solutions, a content
delivery network solution, including capabilities for providing
video-on-demand and content management across the Internet and
Intranet;
- 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 806 as of October 27, 2000
from 393 as of October 29, 1999; and
- increased sales through indirect channels, including sales through
our OEM partners, representing 25.7% and 26.1% of total net sales
for the three and six-month periods ended October 27, 2000,
respectively, as compared to 32.5% and 31.5% of total net sales for
three and six-month periods ended October 29, 1999, respectively.
Net sales growth was also positively impacted by:
- a higher average selling price due to the introduction of software
features: SnapMirror, SnapRestore(TM) and SnapManager(TM) for
Microsoft(R) Exchange and Cluster Failover, supporting
mission-critical applications;
- a higher average selling price of our new high-end F840 filer;
- 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 filers and caching
products due to competitive pricing; and
- declining unit sales of our older product family.
International net sales (including United States exports) grew by 146.5%
and 151.4% for the three and six-month periods ended October 27, 2000, as
compared to the comparable period of the prior fiscal year. International net
sales were $84.4 million, or 32.4% of total net sales, and $157.5 million, or
32.0% of total net sales, for the three and six-month periods ended October 27,
2000. The increase in international sales for the three and six-month periods
ended October 27, 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 periods 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 61.9% for the three-month
period ended October 27, 2000 from 58.7% for the three-month period ended
October 29, 1999. Gross margin increased to 61.6% for the six-month period ended
October 27, 2000 from 58.7% for the six-month period ended October 29, 1999.
10
<PAGE> 12
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;
~ lower costs of key components;
~ the increase in product volume;
~ increased manufacturing efficiencies; and
~ a mix shift to high-end F840 systems sold as diskless upgrades,
carrying higher margin than configured systems.
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.
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, manufacturing labor and quality.
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
122.6% to $72.4 million for the three-month period ended October 27, 2000 from
$32.5 million for the three-month period ended October 29, 1999. Sales and
marketing expenses increased 129.7% to $136.5 million for the six-month period
ended October 27, 2000 from $59.4 million for the six-month period ended October
29, 1999. These expenses were both 27.8% and 26.1% of net sales for the three
and six-month periods ended October 27, 2000 and October 29, 1999, respectively.
The increase in absolute dollars was primarily related to the continued
worldwide expansion of our sales and customer service organizations, expansion
of various marketing and industry initiatives and increased commission expenses.
Sales and marketing headcount increased to 1,052 at October 27, 2000 from 524 at
October 29, 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 110.6% to $28.4 million for the three-month
period ended October 27, 2000 from $13.5 million for the three-month period
ended October 29, 1999. These expenses represented 10.8% of net sales, for both
the three-month periods ended October 27, 2000 and October 29, 1999. For the
six-month periods, research and development expenses increased 110.9% to $52.1
million in fiscal 2001 from $24.7 million in fiscal 2000, and represented 10.5%
and 10.8% of net sales, respectively, for those periods. 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 444 at October 27, 2000 from 233
at October 29, 1999.
In the second quarter of fiscal 2001, we began shipping the F840
high-end filer platform and Data ONTAP(TM) 6.0. The new products allow the
company to offer increased capacity in a single filer, up to 6 terabytes and 12
terabytes in a cluster failover F840c, configuration. Additionally, we enhanced
our NetCache solution to allow enterprises and service providers the ability to
efficiently manage, store, and deliver rich content across the network. The new
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<PAGE> 13
NetCache high-performance content delivery platforms are comprised of two new
content delivery appliances and software. The C6100 is the high-end content
delivery appliance for back-end enterprise or content delivery network
deployment and the low-profile C1105 is designed for remote offices around the
globe, both of which support the new NetCache 5.0 software. The NetCache
platform with NetCache 5.0 software offers live and video-on-demand capability.
We also announced two new content management software offerings from the recent
WebManage acquisition, ContentReporter(TM) and ContentDirector(TM), delivering
an integrated solution for powerful tracking, analysis and content distribution
across the network. In the first quarter of fiscal 2001, we began shipping the
NetCache C1100, our low-end content delivery product designed for enterprise
customers and Internet Service Providers.
In fiscal 2000, we began shipping new enterprise software offerings and
data management tools with SnapManager for Microsoft Exchange 1.0 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), and 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 and
six-month periods ended October 27, 2000 and October 29, 1999, no software
development costs were capitalized.
General and Administrative -- General and administrative expenses
increased 130.9% to $10.2 million for the three-month period ended October 27,
2000, from $4.4 million for the three-month period ended October 29, 1999. These
expenses represented 3.9% and 3.6% of net sales for the three-month periods
ended for such periods. For the six-month periods, general and administrative
expenses increased 134.4% to $19.2 million in fiscal 2001 from $8.2 million in
fiscal 2000 and represented 3.9% and 3.6% of net sales, respectively, for those
periods. Increases in absolute dollars were primarily due to increased
headcount, expenses associated with initiatives to enhance enterprise-wide
management information systems and increased professional service fees. General
and administrative headcount increased to 204 at October 27, 2000 from 105 at
October 29, 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 October 27, 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 was $1.3 million and $1.9 million, respectively, for the
three and six-month periods ended October 27, 2000.
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.
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<PAGE> 14
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 approximately 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 $5.5 million and
$2.2 million for the three-month periods ended October 27, 2000 and October 29,
1999, respectively. During the six-month period ended October 27, 2000, total
other income, net, was $9.9 million, as compared to $4.2 million in the
corresponding period of the prior year. The increase in interest income was
primarily due to increased cash and short-term investments generated from
operations, net proceeds from stock option exercises and net proceeds from the
March 1999 follow-on public offering.
Provision for Income Taxes -- Our estimated effective tax rate for the
three and six-month periods ended October 27, 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 and six-month periods ended October 29, 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.
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
13
<PAGE> 15
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. International sales (including U.S.
exports) were approximately 32.4% and 32.0% of total net sales for the three and
six-month periods ended October 27, 2000, respectively. 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.
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 October 27, 2000, as compared to the April 30, 2000 balances, our
cash, cash equivalents and short-term investments increased by $94.6 million to
$448.1 million. Working capital increased by $55.2 million to $474.8 million.
The increase was a result of unrealized gain on a publicly held investment. We
generated cash from operating activities totaling $147.7 million and $43.3
million for the six-month periods ended October 27, 2000 and October 29, 1999,
respectively. Net cash provided by operating activities for the six-month period
ended October 27, 2000 was principally related to net income of $40.3 million,
increases in accounts payable, income taxes payable, accrued compensation and
related benefits, 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.
We used $39.4 million and $13.2 million of cash during the six-month
periods ended October 27, 2000 and October 29, 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
14
<PAGE> 16
headquarters facility. We have used $55.1 million and $45.9 million during the
six-month periods ended October 27, 2000 and October 29, 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 six-month period ended October
27, 2000 also included an equity investment of $1.0 million, recorded at cost,
which approximated fair market value.
We have used $23.3 million during the six-month period ended October
27, 2000 for financing activities and received $15.5 million for the
corresponding period of the prior fiscal year. The increase in cash provided by
sales of common stock for the six-month period ended October 27, 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.
Offsetting this increase for the six-month period ended October 27, 2000 was
restricted cash of $63.2 million used to collateralize the $126.0 million
operating lease. See Note 7 to the Notes to the Condensed Consolidated
Financial Statements.
Excluding the commitments related to operating lease arrangements for
various properties in our Sunnyvale headquarters, which aggregate $309.0
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 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 October 27, 2000, we had short-term
investments of $142.2 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 October 27, 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.
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<PAGE> 17
Operating Lease Commitments - As of October 27, 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 $2.4 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. Moreover, the $126.0 million
operating lease is collateralized with investments that have similar, and thus
offsetting, interest rate characteristics.
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.
The following table provides information about our foreign exchange
forward contracts outstanding on October 27, 2000, (in thousands):
<TABLE>
<CAPTION>
BUY/ FOREIGN CONTRACT VALUE FAIR VALUE
CURRENCY SELL CURRENCY AMOUNT USD IN USD
-----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
AUD Sell 6,711 $3,565 $3,497
AUD Buy 2,771 $1,444 $1,444
CHF Sell 18,665 $12,261 $12,256
CHF Buy 11,641 $7,665 $7,644
GBP Sell 31,233 $52,886 $53,942
GBP Buy 17,848 $29,820 $29,749
EUR Sell 57,248 $68,592 $68,924
EUR Buy 104,493 $123,285 $127,008
</TABLE>
16
<PAGE> 18
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
10.67 Closing Certificate (Phase IV) and Agreement, dated October 2,
2000, by and between BNP Leasing Corporation and the Company
10.68 Construction Management Agreement (Phase IV), dated October 2,
2000, by and between BNP Leasing Corporation and the Company
10.69 Purchase Agreement (Phase IV - Land), dated October 2, 2000,
by and between BNP Leasing Corporation and the Company
10.70 Pledge Agreement (Phase IV - Land), dated October 2, 2000, by
and between BNP Leasing Corporation and the Company
10.71 Lease Agreement (Phase IV - Land), dated October 2, 2000, by
and between BNP Leasing Corporation and the Company
10.72 Purchase Agreement (Phase IV - Improvements), dated October 2,
2000, by and between BNP Leasing Corporation and the Company
10.73 Pledge Agreement (Phase IV - Improvements), dated October 2,
2000, by and between BNP Leasing Corporation and the Company
10.74 Lease Agreement (Phase IV - Improvements), dated October 2,
2000, by and between BNP Leasing Corporation and the Company
27 Financial Data Schedule
(b) REPORTS ON FORM 8-K
None
17
<PAGE> 19
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: December 11, 2000
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<PAGE> 20
<TABLE>
<CAPTION>
EXHIBIT EXHIBIT INDEX
NUMBER DESCRIPTION
<S> <C> <C>
10.67 Closing Certificate (Phase IV) and Agreement, dated October 2,
2000, by and between BNP Leasing Corporation and the Company
10.68 Construction Management Agreement (Phase IV), dated October 2,
2000, by and between BNP Leasing Corporation and the Company
10.69 Purchase Agreement (Phase IV - Land), dated October 2, 2000,
by and between BNP Leasing Corporation and the Company
10.70 Pledge Agreement (Phase IV - Land), dated October 2, 2000, by
and between BNP Leasing Corporation and the Company
10.71 Lease Agreement (Phase IV - Land), dated October 2, 2000, by
and between BNP Leasing Corporation and the Company
10.72 Purchase Agreement (Phase IV - Improvements), dated October 2,
2000, by and between BNP Leasing Corporation and the Company
10.73 Pledge Agreement (Phase IV - Improvements), dated October 2,
2000, by and between BNP Leasing Corporation and the Company
10.74 Lease Agreement (Phase IV - Improvements), dated October 2,
2000, by and between BNP Leasing Corporation and the Company
27 Financial Data Schedule
</TABLE>
19
