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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
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 JULY 30, 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 IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
495 EAST JAVA DRIVE,
SUNNYVALE, CALIFORNIA 94089
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 822-6000
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Number of shares outstanding of the registrant's class of common stock, as
of the latest practicable date.
OUTSTANDING AT
CLASS JULY 30, 1999
----- --------------
Common Stock....................... 73,571,159
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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 July 30, 1999 and April 30, 1999 2
Condensed Consolidated Statements of Income for the three-month periods
ended July 30, 1999 and July 31, 1998 3
Condensed Consolidated Statements of Cash Flows for the three-month periods ended
July 30, 1999 and July 31, 1998 4
Notes to Condensed Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 8
Item 3. Quantitative and Qualitative Disclosures About Market Risk 14
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings 15
Item 2. Changes in Securities 15
Item 3. Defaults Upon Senior Securities 15
Item 4. Submission of Matters to Vote of Securityholders 15
Item 5. Other Information 15
Item 6. Exhibits and Reports on Form 8-K 16
SIGNATURE 17
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PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NETWORK APPLIANCE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
July 30, April 30,
1999 1999
--------- ---------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 230,025 $ 221,284
Short-term investments 15,869 5,800
Accounts receivable, net 68,910 57,163
Inventories 15,019 13,581
Prepaid expenses and other assets 4,689 7,384
Deferred taxes 13,534 10,134
--------- ---------
Total current assets 348,046 315,346
PROPERTY AND EQUIPMENT, NET 25,016 19,271
DEPOSITS 4,500 7,000
OTHER ASSETS 4,772 4,730
--------- ---------
$ 382,334 $ 346,347
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 22,405 $ 15,126
Income taxes payable 3,928 1,108
Accrued compensation and related benefits 10,213 15,189
Other accrued liabilities 8,890 7,633
Deferred revenue 12,959 11,474
--------- ---------
Total current liabilities 58,395 50,530
LONG-TERM OBLIGATIONS 68 93
--------- ---------
58,463 50,623
--------- ---------
SHAREHOLDERS' EQUITY:
Common stock 254,508 240,093
Retained earnings 69,422 55,954
Cumulative other comprehensive loss (59) (323)
--------- ---------
Total shareholders' equity 323,871 295,724
--------- ---------
$ 382,334 $ 346,347
========= =========
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
------------------------
JULY 30, JULY 31,
1999 1998
-------- --------
NET SALES $103,279 $ 57,375
COST OF SALES 42,539 23,239
-------- --------
Gross Margin 60,740 34,136
-------- --------
OPERATING EXPENSES:
Sales and marketing 26,884 14,935
Research and development 11,220 6,081
General and administrative 3,818 1,885
-------- --------
Total operating expenses 41,922 22,901
-------- --------
INCOME FROM OPERATIONS 18,818 11,235
OTHER INCOME, NET 2,063 121
-------- --------
INCOME BEFORE INCOME TAXES 20,881 11,356
PROVISION FOR INCOME TAXES 7,413 4,259
-------- --------
NET INCOME $ 13,468 $ 7,097
======== ========
NET INCOME PER SHARE:
Basic $ 0.18 $ 0.11
======== ========
Diluted $ 0.16 $ 0.10
======== ========
SHARES USED IN PER SHARE CALCULATIONS:
Basic 73,094 67,096
======== ========
Diluted 83,399 74,542
======== ========
See accompanying notes to condensed consolidated financial statements.
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NETWORK APPLIANCE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
-------------------------
JULY 30, JULY 31,
1999 1998
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 13,468 $ 7,097
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 2,837 2,122
Provision for doubtful accounts 304 100
Deferred income taxes (3,400) (217)
Deferred rent (25) (6)
Changes in assets and liabilities:
Accounts receivable (12,005) (1,734)
Inventories (1,219) (1,021)
Prepaid expenses and other assets 2,595 716
Accounts payable 7,279 (2,500)
Income taxes payable 9,720 3,937
Accrued compensation and related benefits (4,976) (3,226)
Other accrued liabilities 1,257 126
Deferred revenue 1,485 989
--------- ---------
Net cash provided by operating activities 17,320 6,383
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of short-term investments (12,419) (7,080)
Redemptions of short-term investments 2,350 2,950
Purchases of property and equipment (8,306) (2,340)
Payment/refund of deposits, net 2,500 (9,500)
--------- ---------
Net cash used in investing activities (15,875) (15,970)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of long-term obligations -- (3)
Proceeds from sale of common stock, net 7,296 3,751
--------- ---------
Net cash provided by financing activities 7,296 3,748
--------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 8,741 (5,839)
CASH AND CASH EQUIVALENTS:
Beginning of period 221,284 37,315
--------- ---------
End of period $ 230,025 $ 31,476
========= =========
NONCASH INVESTING AND FINANCING ACTIVITIES:
Income tax benefit from employee stock transactions $ 6,900 $ 2,234
SUPPLEMENTAL CASH FLOW INFORMATION:
Income taxes paid $ 34 $ 453
See accompanying notes to condensed consolidated financial statements.
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NETWORK APPLIANCE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The accompanying condensed consolidated financial statements have
been prepared by Network Appliance, Inc. without audit and reflect all
adjustments, which are, in the opinion of management, necessary for a fair
presentation of our financial position and results of operations for the interim
periods. The statements have been prepared in accordance with the regulations of
the Securities and Exchange Commission (SEC). Accordingly, they do not include
all information and footnotes required by generally accepted accounting
principles. The results of operations for the three-month period ended July 30,
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, 1999
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, dilution 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 2000 is a 52-week year. Fiscal 1999 was a
53-week year. The quarter ended July 30, 1999 includes 13 weeks of operating
activity, compared to 14 weeks of activity for the corresponding period of the
prior fiscal year.
Foreign Currency Translation - In the first quarter of fiscal 2000,
we determined that the functional currencies of certain of our foreign
subsidiaries had changed from the local currencies to the Euro. Accordingly,
assets and liabilities of our foreign subsidiaries are translated into Euro 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 other comprehensive loss. The effect of the
change in functional currencies did not have a material impact on our
consolidated financial position, results of operations or cash flows.
3. INVENTORIES
Inventories consist of the following:
JULY 30, APRIL 30,
1999 1999
------- -------
(IN THOUSANDS)
Purchased components $ 3,552 $ 5,316
Work in process 2,186 1,727
Finished goods 9,281 6,538
------- -------
$15,019 $13,581
======= =======
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NETWORK APPLIANCE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
4. COMMON STOCK AND 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:
THREE MONTHS ENDED
-----------------------
JULY 30, JULY 31,
1999 1998
-------- --------
(In thousands, except per share amounts)
NET INCOME (NUMERATOR):
Net income, basic and diluted $ 13,468 $ 7,097
======== ========
SHARES (DENOMINATOR):
Weighted average common shares outstanding 73,155 67,582
Weighted average common shares outstanding
subject to repurchase (61) (486)
-------- --------
Shares used in basic computation 73,094 67,096
Weighted average common shares outstanding
subject to repurchase 61 486
Common shares issuable upon exercise of stock
options 10,244 6,960
-------- --------
Shares used in diluted computation 83,399 74,542
======== ========
NET INCOME PER SHARE:
Basic $ 0.18 $ 0.11
======== ========
Diluted $ 0.16 $ 0.10
======== ========
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NETWORK APPLIANCE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
5. COMPREHENSIVE INCOME
The components of comprehensive income, net of tax, are as follows:
THREE MONTHS ENDED
--------------------
JULY 30, JULY 31,
1999 1998
------- -------
(IN THOUSANDS)
Net income $13,468 $ 7,097
Change in cumulative translation adjustment 264 17
------- -------
Comprehensive income $13,732 $ 7,114
======= =======
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 hedging
accounting when certain conditions are met. This statement is effective for all
fiscal quarters of fiscal years beginning after June 15, 2000. 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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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:
THREE MONTHS ENDED
-----------------------
JULY 30, JULY 31,
1999 1998
-------- --------
Net sales 100.0% 100.0%
Cost of sales 41.2 40.5
------ ------
Gross margin 58.8 59.5
------ ------
Operating expenses:
Sales and marketing 26.0 26.0
Research and development 10.9 10.6
General and administrative 3.7 3.3
------ ------
Total operating expenses 40.6 39.9
------ ------
Income from operations 18.2 19.6
Other income, net 2.0 0.2
------ ------
Income before income taxes 20.2 19.8
Provision for income taxes 7.2 7.4
------ ------
Net income 13.0% 12.4%
====== ======
Net Sales -- Net sales increased by 80.0% to $103.3 million for the
three months ended July 30, 1999, from $57.4 million for the three months ended
July 31, 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:
o growth in the network attached storage market, increased market
acceptance of the appliance concept and the growing enterprise
market driven by the need for reliable internet infrastructure;
o acceleration in deployment of our products among Internet and
enterprise related customers, particularly for E-business and new
E-commerce applications;
o strong demand for our F700 filer product family utilizing
primarily fibre-channel connectivity;
o increased worldwide shipment of NetApp(R) Cluster Failover;
o increased worldwide demand for our NetCache(TM) solutions;
o additional filer demand created by SnapMirror(TM) to store the
remote replicated data for disaster recovery;
o expansion of our direct sales force and
o initial sales to our two new OEM partners.
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Net sales growth was also positively impacted by:
o a higher average selling price of our F700 filer product family
due primarily to the increase in storage content;
o the introduction of new software features with SnapMirror,
SnapRestore(TM) and Cluster Failover and;
o increased add on software licenses from multi-protocol, software
subscription and service revenues due to a growing installed base.
Factors which partially offset overall net sales growth include
declining unit sales of our older product family and decreases in base prices of
our current product line due to competitive forces from the recent disk
repricing.
International net sales (including United States exports) grew by
124.0% for the three-month period ended July 30, 1999, as compared to the
comparable period of the prior fiscal year. International net sales were $28.4
million, or 27.5% of total net sales, for the three-month period ended July 30,
1999. The increase in international sales for the three-month period ended July
30, 1999, was primarily a result of European sales growth, due to increased
headcount in the direct sales force, increased indirect channel sales through
resellers, increased shipments of filers, Cluster Failover solutions, NetCache
appliances and increased sales of add-on software licenses. Asia Pacific net
sales growth for the three-month period ended July 30, 1999, was also driven by
increased headcount in the direct sales force, increased shipments of filers,
NetCache appliances and increased sales of add-on software licenses, as compared
to the corresponding period 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 58.8% for the
three months July 30, 1999 from 59.5% for the three months ended July 31, 1998.
Primary factors negatively impacting gross margin were:
o the increase in the sales volume of the F700 product family
carrying additional costs associated with greater disk drive and
memory content;
o recent price reductions on disk drives due to competitive pricing
pressure from other storage vendors.
Factors negatively impacting gross margin were partially offset by:
o the increase in product volume;
o lower costs of key components and
o increased manufacturing efficiencies.
Gross margin was also favorably impacted by the licensing of add on
software from multi-protocol, Cluster Failover, SnapMirror and SnapRestore and
support contracts, and by growth in software subscription and service revenues
due to a larger installed base.
Our gross margin has been and will continue to be affected by a
variety of factors, including:
o competition;
o product configuration;
o direct versus indirect sales;
o the mix and average selling prices of products, including software
licensing;
o new product introductions and enhancements; and
o the cost of components and manufacturing labor.
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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 80.0%
to $26.9 million for the three months ended July 30, 1999 from $14.9 million for
the three months ended July 31, 1998. These expenses were 26.0% of net sales for
both the three months ended July 30, 1999 and July 31, 1998, respectively. 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.
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 84.5% to $11.2 million
for the three months ended July 30, 1999 from $6.1 million for the three months
ended July 31, 1998. These expenses represented 10.9% and 10.6% of net sales,
respectively, for the three months ended July 30, 1999 and July 31, 1998.
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. These new products included the F700 series filers,
the Cluster Failover solutions, the C700 family and Netcache software release,
as well as new enterprise software offerings and data management tools with
SnapMirror, SnapRestore and SecureAdmin(TM). 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 months ended July 30, 1999 and July
31, 1998, no software development costs were capitalized.
General and Administrative -- General and administrative expenses
were $3.8 million for the three months ended July 30, 1999, as compared to $1.9
million for the three months ended July 31, 1998. These expenses represented
3.7% and 3.3% of net sales for the three months ended for such periods.
Increases in absolute dollars were primarily due to increased headcount,
expenses associated with initiatives to implement enterprise-wide management
information systems, increases 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 $2.1 million and $0.1
million for the three months ended July 30, 1999 and July 31, 1998,
respectively. The increase was due primarily to interest income earned on the
net proceeds from the March 1999 follow-on public offering, cash generated from
operations and net proceeds from stock option exercises. The first quarter of
fiscal 1999 included losses from foreign currency transactions compared to
minimal foreign currency losses recorded in the current quarter, primarily the
result of the implementation of our new hedging program.
Provision for Income Taxes -- Our effective tax rate was 35.5% for
the three-months period ended July 30, 1999 compared to 37.5% for the
three-months period ended July 31, 1998. The effective tax rates differed from
the U.S. statutory rate of 35% primarily due to state taxes partially offset by
earnings of foreign subsidiaries being taxed at lower rates.
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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 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.
We conduct business internationally. For the three months ended July
30, 1999, approximately 27.5% 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 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. 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.
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 2000 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.
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LIQUIDITY AND CAPITAL RESOURCES
As of July 30, 1999, as compared to the April 30, 1999 balances, our
cash, cash equivalents and short-term investments increased by $18.8 million to
$245.9 million. Working capital increased by $24.8 million to $289.7 million. We
generated cash from operating activities totaling $17.3 million and $6.4 million
for the three-month periods ended July 30, 1999 and July 31, 1998, respectively.
Net cash provided by operating activities for the three-month period ended July
30, 1999 principally related to net income of $13.5 million, increases in
accounts payable, income taxes payable, deferred revenue and other accrued
liabilities and decreases in prepaid expenses and other assets, coupled with
depreciation and amortization which are non-cash expenses, partially offset by
increases in accounts receivable, inventories, deferred income taxes and
decreases in accrued compensation and related benefits.
We used $8.3 million and $2.3 million of cash during the three-month
periods ended July 30, 1999 and July 31, 1998, respectively, to purchase
property and equipment. The increases were primarily attributed to our
relocation in June 1999 to the Sunnyvale headquarters facility. During the
current quarter, we received back our $2.5 million deposit in connection with
the $36.0 million operating lease. We have used $10.1 million and $4.1 million
during the three-month periods ended July 30, 1999 and July 31, 1998,
respectively, for net short-term investment purchases. Financing activities
provided $7.3 million and $3.7 million during the three-month periods ended July
30, 1999 and July 31, 1998, respectively. The increase in cash provided by
financing activities for the three months ended July 30, 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 fiscal 1999, we executed agreements to acquire approximately 18
acres of land in Sunnyvale, California and to develop 393,000 square feet of
buildings. We subsequently assigned our rights and obligations under all the
agreements for the Sunnyvale facilities to a third-party entity and entered into
three operating leases. The leases require monthly payments which vary based on
the London Interbank Offered Rate (LIBOR) plus a spread (6.7% at July 30, 1999).
The aggregate annual minimum rent commitments under the $44.0 million lease is
approximately $2.9 million which began in August 1999. The lease payments under
the $48.0 million and $36.0 million operating leases are expected to commence in
June 2000 and will also vary based on LIBOR plus a spread.
The operating leases mentioned above require us to maintain specified
financial covenants with which we were in compliance as of July 30, 1999.
Excluding the commitments related to the aforementioned properties,
which we have assigned to third parties and accounted for 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, are
sufficient to fund our operations for at least the next twelve months.
YEAR 2000
The Year 2000 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
addressing the critical areas of our internal computer systems, products and
relationships with external organizations for Year 2000 compliance. We are
addressing Year 2000 compliance for both our IT and non-IT systems, which
typically include embedded technology such as microcontrollers.
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As part of our general systems upgrade we have evaluated and selected
various significant computer software applications which are represented by
vendors as Year 2000 compliant. We have substantially completed installation of
such software in our domestic operations by the end of the first quarter of
fiscal 2000 which will be followed by installation in our international
operations throughout fiscal 2000. 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 compliant prior to December 31,
1999. We believe that our current products are Year 2000 compliant, and our new
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 service providers and suppliers, however, our
principal service providers and suppliers have represented to us that they are
Year 2000 compliant. We can give you 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 in connection with our overall general
systems upgrade program, including both internal and third party costs, 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 can not 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
Year 2000 compliant, 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 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. 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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15
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk related to fluctuations in interest
rates and in foreign currency exchange rates. We use certain derivative
financial instruments to manage these risks. We do not use derivative financial
instruments for speculative or trading purposes. All financial instruments are
used in accordance with management-approved policies.
Market Interest Risk
Short-term Investments - As of July 30, 1999, we had short-term
investments of $15.9 million. These short-term investments consist of highly
liquid investments with original maturities at the date of purchase between
three and twelve months. These investments are subject to interest rate risk and
will decrease in value if market interest rates increase. A hypothetical 10
percent increase in market interest rates from levels at July 30, 1999, 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.
Operating Lease Commitments - As of July 30, 1999, 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. However, a
hypothetical 10 percent decrease in interest rates would not have a material
impact on us. Increases in interest rates could, however, increase our rent
expenses associated with future lease payments. We do not currently hedge
against interest rate increases.
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 July 30, 1999, (in thousands):
BUY/ FOREIGN CONTRACT VALUE FAIR VALUE
CURRENCY SELL CURRENCY AMOUNT USD IN USD
- --------------------------------------------------------------------------------------
EUR Buy 5,026 5,256 5,391
EUR Sell 16,273 16,548 17,455
GBP Buy 1,000 1,639 1,619
GBP Sell 3,752 6,162 6,073
CHF Sell 1,891 1,265 1,271
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16
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
15
17
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
10.27 Construction Management Agreement (Phase II - Improvements),
dated May 3, 1999, by and between BNP Leasing Corporation and
the Registrant
10.28 Lease Agreement (Phase II - Improvements), dated May 3, 1999, by
and between BNP Leasing Corporation and the Registrant
10.29 Lease Agreement (Phase II - Land), dated May 3, 1999, by and
between BNP Leasing Corporation and the Registrant
10.30 Pledge Agreement (Phase II - Land), dated May 3, 1999, by and
between BNP Leasing Corporation and the Registrant
10.31 Pledge Agreement (Phase II - Improvements), dated May 3, 1999,
by and between BNP Leasing Corporation and the Registrant
10.32 Purchase Agreement (Phase II - Land), dated May 3, 1999, by and
between BNP Leasing Corporation and the Registrant
10.33 Purchase Agreement (Phase II - Improvements), dated May 3, 1999,
by and between BNP Leasing Corporation and the Registrant
10.34 Construction Management Agreement (Phase III - Improvements),
dated June 16, 1999, by and between BNP Leasing Corporation and
the Registrant
10.35 Lease Agreement (Phase III - Improvements), dated June 16, 1999,
by and between BNP Leasing Corporation and the Registrant
10.36 Lease Agreement (Phase III - Land), dated June 16, 1999, by and
between BNP Leasing Corporation and the Registrant
10.37 Pledge Agreement (Phase III - Land), dated June 16, 1999, by and
between BNP Leasing Corporation and the Registrant
10.38 Pledge Agreement (Phase III - Improvements), dated June 16,
1999, by and between BNP Leasing Corporation and the Registrant
10.39 Purchase Agreement (Phase III - Land), dated June 16, 1999, by
and between BNP Leasing Corporation and the Registrant
10.40 Purchase Agreement (Phase III - Improvements), dated June 16,
1999, by and between BNP Leasing Corporation and the Registrant
27.1 Financial Data Schedule
(b) REPORTS ON FORM 8-K
None
16
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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
Senior Vice President Finance and Operations,
Chief Financial Officer and Secretary
Date: August 31, 1999
17
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EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
10.27 Construction Management Agreement (Phase II - Improvements), dated
May 3, 1999, by and between BNP Leasing Corporation and the
Registrant
10.28 Lease Agreement (Phase II - Improvements), dated May 3, 1999, by and
between BNP Leasing Corporation and the Registrant
10.29 Lease Agreement (Phase II - Land), dated May 3, 1999, by and between
BNP Leasing Corporation and the Registrant
10.30 Pledge Agreement (Phase II - Land), dated May 3, 1999, by and
between BNP Leasing Corporation and the Registrant
10.31 Pledge Agreement (Phase II - Improvements), dated May 3, 1999, by
and between BNP Leasing Corporation and the Registrant
10.32 Purchase Agreement (Phase II - Land), dated May 3, 1999, by and
between BNP Leasing Corporation and the Registrant
10.33 Purchase Agreement (Phase II - Improvements), dated May 3, 1999, by
and between BNP Leasing Corporation and the Registrant
10.34 Construction Management Agreement (Phase III - Improvements), dated
June 16, 1999, by and between BNP Leasing Corporation and the
Registrant
10.35 Lease Agreement (Phase III - Improvements), dated June 16, 1999, by
and between BNP Leasing Corporation and the Registrant
10.36 Lease Agreement (Phase III - Land), dated June 16, 1999, by and
between BNP Leasing Corporation and the Registrant
10.37 Pledge Agreement (Phase III - Land), dated June 16, 1999, by and
between BNP Leasing Corporation and the Registrant
10.38 Pledge Agreement (Phase III - Improvements), dated June 16, 1999, by
and between BNP Leasing Corporation and the Registrant
10.39 Purchase Agreement (Phase III - Land), dated June 16, 1999, by and
between BNP Leasing Corporation and the Registrant
10.40 Purchase Agreement (Phase III - Improvements), dated June 16, 1999,
by and between BNP Leasing Corporation and the Registrant
27.1 Financial Data Schedule
18