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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JANUARY 29, 1999
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
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
2770 SAN TOMAS EXPRESSWAY, 95051
SANTA CLARA, CALIFORNIA (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 367-3000
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.
OUTSTANDING AT
CLASS JANUARY 29, 1999
----- ----------------
Common Stock.................. 69,396,295
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TABLE OF CONTENTS
PAGE NO.
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PART I -- FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of January 29, 1999 and April 30, 1998 2
Condensed Consolidated Statements of Income for the three and nine months
ended January 29, 1999 and January 23, 1998 3
Condensed Consolidated Statements of Cash Flows for the nine-month periods ended
January 29, 1999 and January 23, 1998 4
Notes to Condensed Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk 16
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 18
SIGNATURE 19
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PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NETWORK APPLIANCE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
JANUARY 29, APRIL 30,
1999 1998
----------- ---------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 59,886 $ 37,315
Short-term investments 8,150 10,800
Accounts receivable, net 50,735 34,313
Inventories 11,751 8,707
Prepaid expenses and other 3,235 2,524
Deferred taxes 9,963 5,280
--------- ---------
Total current assets 143,720 98,939
PROPERTY AND EQUIPMENT, NET 17,204 12,217
DEPOSITS 7,000 --
OTHER ASSETS 4,724 4,580
--------- ---------
$ 172,648 $ 115,736
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 8,296 $ 10,041
Income taxes payable 1,384 1,782
Accrued compensation and related benefits 11,672 8,485
Other accrued liabilities 7,362 4,201
Deferred revenue 8,078 4,799
--------- ---------
Total current liabilities 36,792 29,308
LONG-TERM OBLIGATIONS 116 163
--------- ---------
36,908 29,471
--------- ---------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Common stock 90,655 65,924
Retained earnings 45,208 20,341
Cumulative translation adjustment (123) --
--------- ---------
Total shareholders' equity 135,740 86,265
--------- ---------
$ 172,648 $ 115,736
========= =========
See accompanying notes to condensed consolidated financial statements
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NETWORK APPLIANCE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------- -------------------------
JANUARY 29, JANUARY 23, JANUARY 29, JANUARY 23,
1999 1998 1999 1998
----------- ----------- ----------- -----------
NET SALES $ 75,616 $ 43,984 $198,616 $115,805
COST OF SALES 30,818 17,880 80,938 47,196
-------- -------- -------- --------
Gross Margin 44,798 26,104 117,678 68,609
-------- -------- -------- --------
OPERATING EXPENSES:
Sales and marketing 19,831 11,187 51,830 29,352
Research and development 7,815 4,420 20,618 11,738
General and administrative 2,655 1,852 7,092 4,701
-------- -------- -------- --------
Total operating expenses 30,301 17,459 79,540 45,791
-------- -------- -------- --------
INCOME FROM OPERATIONS 14,497 8,645 38,138 22,818
OTHER INCOME, NET 542 243 1,658 640
-------- -------- -------- --------
INCOME BEFORE INCOME TAXES 15,039 8,888 39,796 23,458
PROVISION FOR INCOME TAXES 5,645 3,333 14,929 8,797
-------- -------- -------- --------
NET INCOME $ 9,394 $ 5,555 $ 24,867 $ 14,661
======== ======== ======== ========
NET INCOME PER SHARE (1):
Basic $ 0.14 $ 0.08 $ 0.37 $ 0.23
======== ======== ======== ========
Diluted $ 0.12 $ 0.08 $ 0.32 $ 0.21
======== ======== ======== ========
SHARES USED IN PER SHARE CALCULATIONS (1):
Basic 68,738 65,422 67,803 64,562
======== ======== ======== ========
Diluted 78,932 72,500 76,679 71,448
======== ======== ======== ========
(1) Share and per share amounts have been adjusted to reflect the two-for-one
stock split which was effective December 21, 1998.
See accompanying notes to condensed consolidated financial statements
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NETWORK APPLIANCE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
--------------------------
JANUARY 29, JANUARY 23,
1999 1998
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 24,867 $ 14,661
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 7,091 3,885
Provision for doubtful accounts 5,675 216
Deferred income taxes (4,683) (77)
Deferred rent (47) (29)
Changes in assets and liabilities:
Accounts receivable (22,199) (12,989)
Inventories (3,065) 875
Prepaid expenses and other assets (1,069) (764)
Accounts payable (1,745) 2,489
Income taxes payable 11,812 1,657
Accrued compensation and related benefits 3,187 2,433
Other accrued liabilities 3,385 1,737
Deferred revenue 3,279 2,105
-------- --------
Net cash provided by operating activities 26,488 16,199
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of short-term investments (15,230) (7,600)
Redemptions of short-term investments 17,880 9,266
Purchases of property and equipment (11,615) (4,886)
Payment of deposits, net (7,000) --
-------- --------
Net cash used in investing activities (15,965) (3,220)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of long-term obligations -- (12)
Proceeds from sale of common stock, net 12,048 4,815
-------- --------
Net cash provided by financing activities 12,048 4,803
-------- --------
NET INCREASE IN CASH AND CASH EQUIVALENTS 22,571 17,782
CASH AND CASH EQUIVALENTS:
Beginning of period 37,315 21,520
-------- --------
End of period $ 59,886 $ 39,302
======== ========
NONCASH INVESTING AND FINANCING ACTIVITIES:
Deferred stock compensation $ 473 $ 714
Income tax benefit from employee stock transactions $ 12,210 $ --
SUPPLEMENTAL CASH FLOW INFORMATION:
Income taxes paid $ 7,031 $ 7,138
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 and nine-month periods ended January 29,
1999 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, 1998
and the risk factors as set forth in our Annual Report on Form 10-K, including,
without limitation, risks relating to history of operating losses, fluctuating
operating results, dependence on new products, rapid technological change,
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, the effect of certain anti-takeover provisions and the Year 2000
Issue. Any party interested in reviewing these publicly available documents
should contact the SEC or our Chief Financial Officer.
2. SIGNIFICANT ACCOUNTING POLICIES
Fiscal Periods - We operate on a 52-week or 53-week year ending on the last
Friday in April. Fiscal 1999 is a 53-week year. Fiscal 1998 was a 52-week year.
The quarter ended January 29, 1999 includes 13 weeks of operating activity,
compared to 13 weeks of activity for the corresponding period of the prior
fiscal year. The nine months ended January 29, 1999 includes 40 weeks of
activity, compared to 39 weeks of activity for the corresponding period of the
prior fiscal year.
Foreign Currency Translation - In the first quarter of fiscal 1999, we
determined that the functional currencies of certain of our foreign subsidiaries
had changed from the U.S. dollar to the local currencies. Accordingly, assets
and liabilities of our foreign subsidiaries are translated in U.S. dollars at
the exchange rates in effect as of the balance sheet date, and results of
operations for each subsidiary are translated using average rates in effect for
the period presented. Translation adjustments have been included within
shareholders' equity as a cumulative translation adjustment. The effect of the
change in functional currencies did not have a material impact on our
consolidated financial position, results of operations or cash flow.
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NETWORK APPLIANCE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
3. INVENTORIES
Inventories consist of the following:
JANUARY 29, APRIL 30,
1999 1998
-------------- -------------
(IN THOUSANDS)
Purchased components $ 4,410 $ 4,494
Work in process 2,825 1,889
Finished goods 4,516 2,324
----------------------
$11,751 $ 8,707
======================
4. COMMITMENTS
In June 1998, we executed an agreement to acquire 5.9 acres of land in
Sunnyvale, California and the accompanying 127,000 square foot building. Under
terms of the agreement, we paid $5.5 million of the $33.8 million purchase price
as a nonrefundable deposit. In January 1999, we assigned our rights and
obligations under the agreement to a third-party entity and in exchange received
back our $5.5 million deposit. We subsequently entered into a $44.0 million
operating lease for this property. Our lease payments will vary based on the
London Interbank Offered Rate (LIBOR) plus a spread. 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 $44.0 million , or arrange for the
sale of the property to a third party for at least $44.0 million 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 $37.0 million. The lease also requires us to maintain specified
financial covenants with which we were in compliance as of January 29, 1999.
In June 1998, we signed a 25-year operating lease requiring annual lease
payments of $3.1 million, commencing in October 1999, for a 6.2-acre plot in
Sunnyvale, California and an option agreement to purchase the 6.2 acres of land.
Under terms of the option agreement, we paid a $4.5 million nonrefundable
deposit. The option allows us to purchase the land, within a 90-day period,
commencing in December 1999 at a purchase price of $23.7 million. Our rights and
obligations under this agreement may be assigned to third parties, which we
intend to do if we can obtain satisfactory leasing terms.
In August 1998, we entered into an agreement to acquire 6.0 acres of land in
Sunnyvale, California and the accompanying 79,000 square foot building. Under
terms of the agreement, we paid $2.5 million of the $16.8 million purchase price
as a deposit, including $0.5 million in November 1998 upon satisfaction of
certain conditions under the agreement. The deposits are nonrefundable with
limited exceptions. Our rights and obligations under this agreement may be
assigned to third parties, which we intend to do if we can obtain satisfactory
leasing terms.
Excluding the commitments related to the aforementioned properties, which we
intend to assign to third parties and establish as operating leases, we
currently have no significant commitments other than commitments under operating
leases.
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NETWORK APPLIANCE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
5. LINE OF CREDIT
In July 1998, we negotiated a $5.0 million unsecured revolving credit
facility with a domestic commercial bank. Under terms of the credit facility,
which expires in July 1999, we must maintain various financial covenants. Any
borrowings under this agreement bear interest at either LIBOR plus 1% or at the
Lender's "prime" lending rate, such rate determined at our discretion. In
December 1998, we drew a $2.5 million letter of credit against this line of
credit to facilitate payments associated with the August 1998 acquisition of
land in Sunnyvale, California and the accompanying 79,000 square foot building.
6. COMMON STOCK AND NET INCOME PER SHARE
We have adopted the provisions of Statement of Financial Accounting
Standards No. 128, "Earnings Per Share" (SFAS 128), effective in the third
quarter of fiscal 1998. SFAS 128 requires the presentation of basic and diluted
net income per share. Basic net income per share is computed by dividing income
available to common stockholders by the weighted average number of common shares
outstanding for that period. Diluted net income per share is computed giving
effect to all dilutive potential shares that were outstanding during the period.
Dilutive potential common shares consist of incremental common shares subject to
repurchase and common shares issuable upon exercise of stock options.
On December 21, 1998, We effected a two-for-one stock split of the
outstanding shares of common stock. All share and per share amounts in these
consolidated financial statements have been adjusted to give effect to the stock
split.
The following is a reconciliation of the numerators and denominators of the
basic and diluted net income per share computations for the periods presented:
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NETWORK APPLIANCE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
JANUARY 29, JANUARY 23, JANUARY 29, JANUARY 23,
1999 1998 1999 1998
----------- ----------- ----------- -----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NET INCOME (NUMERATOR):
Net income, basic and diluted $ 9,394 $ 5,555 $ 24,867 $ 14,661
======== ======== ======== ========
SHARES (DENOMINATOR):
Weighted average common shares outstanding 68,812 66,704 68,144 66,234
Weighted average common shares outstanding
subject to repurchase (74) (1,282) (341) (1,672)
-------- -------- -------- --------
Shares used in basic computation 68,738 65,422 67,803 64,562
Weighted average common shares outstanding
subject to repurchase 74 1,282 341 1,672
Common shares issuable upon exercise of stock
options 10,120 5,796 8,535 5,214
-------- -------- -------- --------
Shares used in diluted computation 78,932 72,500 76,679 71,448
======== ======== ======== ========
Net Income Per Share:
Basic $ 0.14 $ 0.08 $ 0.37 $ 0.23
======== ======== ======== ========
Diluted $ 0.12 $ 0.08 $ 0.32 $ 0.21
======== ======== ======== ========
7. COMPREHENSIVE INCOME
We have adopted Statement of Financial Accounting Standards (SFAS) No. 130,
"Reporting Comprehensive Income," as of the first quarter of fiscal 1999. SFAS
No. 130 establishes new rules for the reporting and display of comprehensive
income and its components; however, it has no impact on our net income or
shareholders' equity.
The components of comprehensive income, net of tax, are as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
JANUARY 29, JANUARY 23, JANUARY 29, JANUARY 23,
1999 1998 1999 1998
----------- ----------- ----------- -----------
(IN THOUSANDS)
Net income $ 9,394 $ 5,555 $ 24,867 $ 14,661
Change in cumulative translation adjustment (105) -- (123) --
-------- -------- -------- --------
Comprehensive income $ 9,289 $ 5,555 $ 24,744 $ 14,661
======== ======== ======== ========
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NETWORK APPLIANCE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
8. NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures About Segments of an
Enterprise and Related Information," which establishes interim and annual
reporting standards for an enterprise's business segments and related
disclosures about its products, services and geographic areas. We have not yet
identified our reporting segments. This statement is effective for us beginning
at fiscal year end 1999. Adoption of this statement is not expected to impact
our consolidated financial position, results of operations or cash flows.
In the first quarter of fiscal 1999, we adopted Statement of Position (SOP)
97-2, "Software Revenue Recognition," which provides guidance on applying
generally accepted accounting principles in recognizing revenue for software
transactions. SOP 97-2 requires, among other things, revenue earned on software
arrangements involving multiple elements to be allocated to each element based
on the relative fair values of the elements. Adoption of this statement did not
have a material impact on our consolidated financial position, results of
operations or cash flows.
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 hedging
accounting when certain conditions are met. This statement is effective for all
fiscal quarters of fiscal years beginning after June 15, 1999. On a
forward-looking basis, 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.
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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:
THREE MONTHS ENDED NINE MONTHS ENDED
JANUARY 29, JANUARY 23, JANUARY 29, JANUARY 23,
1999 1998 1999 1998
----------- ----------- ----------- -----------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 40.8% 40.7% 40.8% 40.8%
------ ------ ------ ------
Gross margin 59.2% 59.3% 59.2% 59.2%
------ ------ ------ ------
Operating expenses:
Sales and marketing 26.2% 25.4% 26.1% 25.3%
Research and development 10.3% 10.0% 10.4% 10.1%
General and administrative 3.5% 4.2% 3.5% 4.1%
------ ------ ------ ------
Total operating expenses 40.0% 39.6% 40.0% 39.5%
------ ------ ------ ------
Income from operations 19.2% 19.7% 19.2% 19.7%
Other income, net 0.7% 0.5% 0.8% 0.6%
------ ------ ------ ------
Income before income taxes 19.9% 20.2% 20.0% 20.3%
Provision for income taxes 7.5% 7.6% 7.5% 7.6%
------ ------ ------ ------
Net income 12.4% 12.6% 12.5% 12.7%
====== ====== ====== ======
Net Sales -- Net sales increased by 71.9% to $75.6 million for the three
months ended January 29, 1999, from $44.0 million for the three months ended
January 23, 1998. This increase 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: expansion of our direct sales force;
increased unit shipments principally due to the successful launching of our F700
filer product family during the second quarter of fiscal 1999; the increased
worldwide shipment of NetApp(R) cluster failover and NetCache(TM) solutions;
increases in licensing of multi-protocol software, software subscription and
service revenues due to a growing installed base; and increased sales of
multi-protocol systems. Net sales growth was also positively impacted by a
higher average selling price of the newly introduced F700 filer product family
due primarily to the increase in storage content utilizing primarily
fibre-channel connectivity. Factors which partially offset overall net sales
growth include declining unit sales of our older product family and decreases in
base prices of our older product line due to competitive forces.
Net sales increased by 71.5% to $198.6 million for the nine months ended
January 29, 1999, from $115.8 million for the nine months ended January 23,
1998. This increase 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: expansion of our direct sales force;
increased unit shipments principally due to the successful launching of our F700
filer product family during the second quarter of fiscal 1999, the increased
worldwide shipment of NetApp cluster failover and NetCache solutions and the
growth in sales of the NetApp F630; increases in licensing of multi-protocol
software, software subscription and service revenues due to a growing installed
base; and increased sales of multi-protocol systems. Net sales growth was also
positively impacted by a higher average selling price of the newly introduced
F700 filer product family due primarily to the increase in storage content, and
an increase in the average selling price of the NetApp F630 primarily
facilitated by the incorporation of fibre-channel disk drives which increase
system
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capacity. Factors which partially offset overall net sales growth include
declining unit sales of our older product family and decreases in base prices of
our older product line due to competitive forces.
International net sales (including United States exports) grew by 167.6% and
119.3%, for the three and nine-month periods ended January 29, 1999,
respectively, as compared to comparable periods of the prior fiscal year.
International net sales were $31.3 million, or 41.4% of total net sales, and
$60.9 million, or 30.7% of total net sales, for the three and nine months ended
January 29, 1999, respectively. The increase in international sales for the
three and nine-month periods ended January 29, 1999, was primarily a result of
European sales growth, due to increased headcount in the direct sales force,
indirect channel sales through resellers, shipments of filers and sales of our
new NetApp Cluster Failover solutions and NetCache appliances. Asia Pacific net
sales growth for the three and nine-month periods ended January 29, 1999, was
also driven by increased headcount in the direct sales force, increased
shipments of filers and the sale of NetCache appliances, as compared to the
corresponding periods of the prior fiscal year.
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 decreased slightly to 59.2% for the three
months ended January 29, 1999 from 59.3% for the three months ended January 23,
1998 but remained constant at 59.2% for the nine-month periods ended January 29,
1999 and January 23, 1998. Primary factors positively impacting gross margin
were the increase in product volume, lower costs of key components, increased
manufacturing efficiencies, increased market acceptance of our product line with
the continuance of the cost-reduced designs introduced in the second quarter of
fiscal 1999, the introduction of the F700 filer product family and NepApp
Cluster Failover system during the second quarter of fiscal 1999 and the revenue
growth in NetCache appliances. Gross margin was also favorably impacted by the
licensing of multi-protocol software and support contracts, and by growth in
software subscription and service revenues due to a larger installed base.
Primary factors negatively impacting gross margin were the increase in the sales
volume of the F700 product family maintaining incremental costs associated with
greater disk drive and memory content and the effect of base system price
reductions across the full range of older generations filers.
Our gross margin has been and will continue to be affected by a variety of
factors, including: competition; product configuration; direct versus indirect
sales; the mix and average selling prices of products, including software
licensing; new product introductions and enhancements; and the cost of
components and manufacturing labor. Our gross margin may also vary based upon
the configuration of systems that are sold and whether they are sold directly or
through indirect channels. Highly configured systems have historically generated
lower overall gross margin percentages due to greater disk drive and memory
content.
Sales and Marketing -- Sales and marketing expenses consist primarily of
salaries, commissions, advertising and certain promotional expenses and customer
service and support costs. Sales and marketing expenses increased 77.3% to $19.8
million for the three months ended January 29, 1999 from $11.2 million for the
three months ended January 23, 1998. For the nine months ended January 29, 1999,
sales and marketing expenses of $51.8 million reflect an increase of 76.6% over
the comparable period of fiscal 1998. These expenses were 26.2% and 25.4% of net
sales for the three months ended January 29, 1999 and January 23, 1998,
respectively, and were 26.1% and 25.3%, respectively, of net sales for the nine
months then ended. The increase in absolute dollars was primarily related to the
continued expansion of our sales and marketing organization, including growth in
the domestic and international direct sales forces and increased commission
expenses. 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. 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.
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Research and Development -- Research and development expenses consist
primarily of salaries and benefits, prototype expenses, and fees paid to outside
consultants. Research and development expenses increased 76.8% to $7.8 million
for the three months ended January 29, 1999 from $4.4 million for the three
months ended January 23, 1998. These expenses represented 10.3% and 10.0% of net
sales, respectively for the three months ended January 29, 1999 and January 23,
1998. For the nine-month periods, research and development expenses increased
75.7% to $20.6 million in fiscal 1999 from $11.7 in fiscal 1998, and represented
10.4% and 10.1% 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 and prototyping expenses associated with the development
of new products, including the NetApp F700 series filers and the C700 family,
the second generation of our NetCache appliances. 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 to introduce new products and expect that such expenditures will continue to
increase in absolute dollars. For the three and nine months ended January 29,
1999 and January 23, 1998, no software development costs were capitalized.
General and Administrative -- General and administrative expenses were $2.7
million for the three months ended January 29, 1999, as compared to $1.9 million
for the three months ended January 23, 1998. These expenses represented 3.5% and
4.2% of net sales for the three months ended for such periods. For the
nine-month periods, general and administrative expenses increased 50.9% to $7.1
million in fiscal 1999 from $4.7 million in fiscal 1998 and represented 3.5% and
4.1% of net sales, respectively, for those periods. Increases in absolute
dollars were primarily due to increased headcount, and increases to the
allowance for doubtful accounts and outside service fees. We believe that our
general and administrative expenses will increase in absolute dollars as we
continue to build our infrastructure.
Other Income, net -- Other income, net, was $0.5 million and $0.2 million
for the three months ended January 29, 1999 and January 23, 1998, respectively.
During the nine months ended January 29, 1999, other income was $1.7 million, as
compared to $0.6 million in the corresponding period of the prior year. The
increase was due primarily to foreign currency exchange gains recorded in the
second quarter of fiscal 1999.
Provision for Income Taxes -- Our effective tax rate was 37.5% for both the
three and nine-month periods ended January 29, 1999 and January 23, 1998.
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 and 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 file server market is rapidly evolving and our sales cycle varies
substantially from customer to customer.
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We conduct business internationally. For the nine months ended January 29,
1999, approximately 31% of our net sales were to international customers
(including United States 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 do not currently engage in hedging transactions, but
may do so in the future.
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 1999 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.
This Form 10-Q contains forward-looking statements about future results,
which are subject to risks and uncertainties. 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.
LIQUIDITY AND CAPITAL RESOURCES
As of January 29, 1999, as compared to the April 30, 1998 balances, our
cash, cash equivalents and short-term investments increased by $19.9 million to
$68.0 million. Working capital increased by $37.3 million to $106.9 million,
impacted primarily by increases in cash and cash equivalents, accounts
receivable, inventories and deferred taxes and a decrease in accounts payable,
partially offset by increases in deferred revenue, accrued compensation and
related benefits, income taxes payable and other accrued liabilities, and a
decrease in short-term investments. We generated cash from operating activities
totaling $26.5 million and $16.2 million for the nine-month periods ended
January 29, 1999 and January 23, 1998, respectively. Net cash provided by
operating activities for the nine-month period ended January 29, 1999
principally related to net income of $24.9 million, increases in income taxes
payable, deferred revenue and other accrued liabilities, coupled with
depreciation and amortization which are non-cash expenses, partially offset by
increases in accounts receivable, inventories, prepaid expenses and other assets
and deferred income taxes and decreases in accounts payable.
We used $11.6 million and $4.9 million of cash during the nine-month periods
ended January 29, 1999 and January 23, 1998, respectively, to purchase property
and equipment. We were provided with $2.7 million and $1.7 million during the
nine-month periods ended January 29, 1999 and January 23, 1998, respectively,
for net short-term investment redemptions. Financing activities provided $12.0
million and $4.8 million during the nine-month periods ended January 29, 1999
and January 23, 1998, respectively.
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The increase in cash provided by financing activities for the nine months ended
January 29, 1999, 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.
In June 1998, we executed an agreement to acquire 5.9 acres of land in
Sunnyvale, California and the accompanying 127,000 square foot building. Under
terms of the agreement, we paid $5.5 million of the $33.8 million purchase price
as a nonrefundable deposit. In January 1999, we assigned our rights and
obligations under the agreement to a third-party entity and in exchange received
back our $5.5 million deposit. We subsequently entered into a $44.0 million
operating lease for this property. Our lease payments will vary based on the
London Interbank Offered Rate (LIBOR) plus a spread. 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 $44.0 million , or arrange for the
sale of the property to a third party for at least $44.0 million 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 $37.0 million. The lease also requires us to maintain specified
financial covenants with which we were in compliance as of January 29, 1999.
In June 1998, we signed a 25-year operating lease requiring annual lease
payments of $3.1 million, commencing in October 1999, for a 6.2-acre plot in
Sunnyvale, California and an option agreement to purchase the 6.2 acres of land.
Under terms of the option agreement, we paid a $4.5 million nonrefundable
deposit. The option allows us to purchase the land, within a 90-day period,
commencing in December 1999 at a purchase price of $23.7 million. Our rights and
obligations under this agreement may be assigned to third parties, which we
intend to do if we can obtain satisfactory leasing terms.
In July 1998, we negotiated a $5.0 million unsecured revolving credit
facility with a domestic commercial bank. Under terms of the credit facility,
which expires in July 1999, we must maintain various financial covenants. Any
borrowings under this agreement bear interest at either LIBOR plus 1% or at the
Lender's "prime" lending rate, such rate determined at our discretion. In
December 1998, we drew a $2.5 million letter of credit against our line of
credit to facilitate requirements associated with the acquisition of land in
Sunnyvale, California and the accompanying 79,000 square foot building,
described below.
In August 1998, we entered into an agreement to acquire 6.0 acres of land in
Sunnyvale, California and the accompanying 79,000 square foot building. Under
terms of the agreement, we paid $2.5 million of the $16.8 million purchase price
as a deposit, including $0.5 million in November 1988 upon satisfaction of
certain conditions under the agreement. The deposits are nonrefundable with
limited exceptions. Our rights and obligations under this agreement may be
assigned to third parties, which we intend to do if we can obtain satisfactory
leasing terms.
Excluding the commitments related to the aforementioned properties, which we
intend to assign to third parties and establish as operating leases, 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 the $5.0 million line of credit described in Note 5,
are sufficient to fund our operations for at least the next twelve months.
YEAR 2000
The Year 2000 (Y2K) issue refers to computer programs which use two digits
rather than four to define a given year and which therefore might read a date
using "00" as the year 1900 rather than the year 2000. As a result, many
companies' systems and software may need to be upgraded or replaced in order to
function correctly after December 31, 1999.
We are currently conducting a general software upgrade and replacement
program to enhance our computer systems and applications, in particular those
systems and applications related to our manufacturing, distribution and
financial operations. As part of this larger program we are continuing to
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address the critical areas of our internal computer systems, products and
relationships with external organizations for Year 2000 compliance. We are
addressing for Year 2000 compliance both our information technology (IT) and
non-IT systems, which typically included embedded technology such as
microcontrollers.
As part of our larger efforts general systems upgrade we have evaluated and
selected significant computer software applications which are represented by
vendors as Year 2000 compliant. We expect to complete installation of such
software in our domestic operations by the first quarter of fiscal year 2000,
followed by installation in our international operations by mid-year 1999. Most
of our existing business applications are already supported by Year 2000
compliant software. With the system changes implemented to date and other
planned changes, we anticipate that our internal computer software applications
will be Year 2000 complaint prior to December 31, 1999. We believe that our
current products are Year 2000 compliant, and our products are being designed to
be Year 2000 compliant.
We rely on numerous third party vendors for certain products and services.
We are communicating with our principal service providers and suppliers to
assess their Year 2000 readiness. Responses indicate that our significant
service providers currently have compliant versions of their systems available
or are well into the renovation and testing phases with completion scheduled
prior to December 31, 1999. We are still assessing the effect Year 2000 issues
will have on our suppliers, however, our principal service providers and
suppliers have represented to us that they are Year 2000 compliant. However, we
can give no guarantee that the systems and products of these service providers
and suppliers on which we rely are, or will be, Year 2000 compliant.
Our contingency planning for Year 2000 issues relates primarily to the
efforts of our third-party vendors. In the event of any Year 2000 disruptions
related to third-party software, we expect to follow the individual vendor's
contingency directives. With respect to suppliers, we will consider alternative
sources as a contingency plan, if necessary. Contingency planning will continue
throughout 1999 and our plans will be modified based upon the progress of our
remediation efforts, system updates and installations and based upon our
communications with selected suppliers. We have determined that our "worst case"
scenario relates to Year 2000 compliance problems of our third party vendors and
suppliers and other external organizations which if not remedied could
materially adversely affect our operating results.
The costs we expect to incur, including both internal and third party costs,
in connection with our overall general systems upgrade program, are primarily
external costs for software licenses, and implementation and consulting
services. These systems and applications were selected primarily for features
and functionality in addition to Year 2000 compliance. Accordingly, we do not
itemize costs of Year 2000 compliance separately.
Our expectations regarding the impact of Year 2000 issues are forward
looking statements and actual results could vary due to the factors discussed in
this section. While we believe that the estimated cost of becoming Year 2000
compliant will not be significant to our operating results, failure to complete
all the work in a timely manner could materially adversely affect our operating
results. While we expect all planned work to be completed, we cannot guarantee
that all systems will be in compliance by the Year 2000, the systems of
suppliers and other companies and government agencies on which we rely will be
converted in a timely manner, or that our contingency planning will be able to
fully address all potential interruptions. Therefore, Year 2000 issues could
cause delays in our ability to produce or ship our products, process
transactions or otherwise conduct business in any of our markets. Year 2000
issues could lower demand for our products while increasing our costs. The
occurrence of one or more of these factors could materially adversely affect our
operating results.
NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures About Segments of an
Enterprise and Related Information," which establishes interim and annual
reporting standards for an enterprise's business segments and related
disclosures about its products, services and geographic areas. We have not yet
identified our reporting
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segments. This statement is effective for us beginning at fiscal year end 1999.
Adoption of this statement is not expected to impact our consolidated financial
position, results of operations or cash flows.
In the first quarter of fiscal 1999, we adopted Statement of Position (SOP)
97-2, "Software Revenue Recognition," which provides guidance on applying
generally accepted accounting principles in recognizing revenue for software
transactions. SOP 97-2 requires, among other things, revenue earned on software
arrangements involving multiple elements to be allocated to each element based
on the relative fair values of the elements. Adoption of this statement did not
have a material impact on our consolidated financial position, results of
operations or cash flows.
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 hedging
accounting when certain conditions are met. This statement is effective for all
fiscal quarters of fiscal years beginning after June 15, 1999. On a
forward-looking basis, 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
Not Applicable
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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
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
3.2 Certificate of Amendment to the Restated Articles of
Incorporation of the Registrant
10.21 Amended Purchase and Sale Agreement, dated December 9,
1998, by and between Martin/Crossman, LLC and the
Registrant
10.22 Amended Purchase and Sale Agreement, dated December 21,
1998, by and between 495 Java Drive Associates, L.P. and
the Registrant
10.23 Lease Agreement, dated January 20, 1999, by and between BNP
Leasing Corporation and the Registrant
10.24 Purchase Agreement, dated January 20, 1999, by and between
BNP Leasing Corporation and the Registrant
10.25 Pledge Agreement, dated January 20, 1999, by and between
BNP Leasing Corporation, Banque Nationale De Paris and the
Registrant
10.30 OEM Distribution and License Agreement, dated November 6,
1998, by and between Fujitsu Limited and the Registrant
27.1 Financial Data Schedule
(b) REPORTS ON FORM 8-K
None
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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
Vice President Finance and
Operations,Chief Financial Officer
(Principal Financial Officer)
Date: March 15, 1999
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EXHIBIT INDEX
DESCRIPTION
EXHIBIT
NUMBER
3.2 Certificate of Amendment to the Restated Articles of
Incorporation of the Registrant
10.21 Amended Purchase and Sale Agreement, dated December 9,
1998, by and between Martin/Crossman, LLC and the
Registrant
10.22 Amended Purchase and Sale Agreement, dated December 21,
1998, by and between 495 Java Drive Associates, L.P. and
the Registrant
10.23 Lease Agreement, dated January 20, 1999, by and between BNP
Leasing Corporation and the Registrant
10.24 Purchase Agreement, dated January 20, 1999, by and between
BNP Leasing Corporation and the Registrant
10.25 Pledge Agreement, dated January 20, 1999, by and between
BNP Leasing Corporation, Banque Nationale De Paris and the
Registrant
10.30 OEM Distribution and License Agreement, dated November 6,
1998, by and between Fujitsu Limited and the Registrant
27.1 Financial Data Schedule
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