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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 OCTOBER 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.)
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 OCTOBER 29, 1999
----- ----------------
Common Stock.................. 74,669,461
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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 October 29, 1999 and April 30, 1999 2
Condensed Consolidated Statements of Income for the three and six-month periods
ended October 29, 1999 and October 30, 1998 3
Condensed Consolidated Statements of Cash Flows for the six-month periods ended
October 29, 1999 and October 30, 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 15
PART II--OTHER INFORMATION
Item 1. Legal Proceedings 16
Item 2. Changes in Securities 16
Item 3. Defaults Upon Senior Securities 16
Item 4. Submission of Matters to Vote of Securityholders 16
Item 5. Other Information 16
Item 6. Exhibits and Reports on Form 8-K 17
SIGNATURE 18
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PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NETWORK APPLIANCE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
OCTOBER 29, APRIL 30,
1999 1999
----------- ---------
(UNAUDITED) **
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $220,828 $221,284
Short-term investments 51,673 5,800
Accounts receivable, net 78,747 57,163
Inventories 17,542 13,581
Prepaid expenses and other assets 6,290 7,384
Deferred taxes 20,134 10,134
-------- --------
Total current assets 395,214 315,346
PROPERTY AND EQUIPMENT, NET 27,080 19,271
DEPOSITS 7,170 7,000
OTHER ASSETS 4,840 4,730
-------- --------
$434,304 $346,347
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 27,358 $ 15,126
Income taxes payable 460 1,108
Accrued compensation and related benefits 18,986 15,189
Other accrued liabilities 8,611 7,633
Deferred revenue 13,223 11,474
-------- --------
Total current liabilities 68,638 50,530
LONG-TERM OBLIGATIONS 52 93
-------- --------
68,690 50,623
-------- --------
SHAREHOLDERS' EQUITY:
Common stock 280,393 240,093
Retained earnings 85,470 55,954
Cumulative other comprehensive loss (249) (323)
-------- --------
Total shareholders' equity 365,614 295,724
-------- --------
$434,304 $346,347
======== ========
** Derived from audited consolidated financial statements.
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 SIX MONTHS ENDED
--------------------------- --------------------------
OCTOBER 29, OCTOBER 30, OCTOBER 29, OCTOBER 30,
1999 1998 1999 1998
----------- ----------- ----------- -----------
NET SALES $124,712 $ 65,625 $227,991 $123,000
COST OF SALES 51,516 26,881 94,055 50,120
-------- -------- -------- --------
Gross Margin 73,196 38,744 133,936 72,880
-------- -------- -------- --------
OPERATING EXPENSES:
Sales and marketing 32,548 17,064 59,432 31,999
Research and development 13,462 6,722 24,682 12,803
General and administrative 4,487 2,552 8,305 4,437
-------- -------- -------- --------
Total operating expenses 50,497 26,338 92,419 49,239
-------- -------- -------- --------
INCOME FROM OPERATIONS 22,699 12,406 41,517 23,641
OTHER INCOME (EXPENSE):
Interest Income 2,537 550 4,643 1,008
Other income (expense) (356) 445 (399) 108
-------- -------- -------- --------
Total other income, net 2,181 995 4,244 1,116
-------- -------- -------- --------
INCOME BEFORE INCOME TAXES 24,880 13,401 45,761 24,757
PROVISION FOR INCOME TAXES 8,832 5,025 16,245 9,284
-------- -------- -------- --------
NET INCOME $ 16,048 $ 8,376 $ 29,516 $ 15,473
======== ======== ======== ========
NET INCOME PER SHARE:
Basic $ 0.22 $ 0.12 $ 0.40 $ 0.23
======== ======== ======== ========
Diluted $ 0.19 $ 0.11 $ 0.35 $ 0.20
======== ======== ======== ========
Pro Forma - Basic (Note 8) $ 0.11 $ 0.06 $ 0.20 $ 0.11
======== ======== ======== ========
Pro Forma - Diluted (Note 8) $ 0.09 $ 0.06 $ 0.18 $ 0.10
======== ======== ======== ========
SHARES USED IN PER SHARE CALCULATIONS:
Basic 74,122 67,878 73,608 67,468
======== ======== ======== ========
Diluted 84,492 76,112 83,833 75,544
======== ======== ======== ========
Pro Forma - Basic (Note 8) 148,244 135,756 147,216 134,936
======== ======== ======== ========
Pro Forma - Diluted (Note 8) 168,984 152,224 167,666 151,088
======== ======== ======== ========
See accompanying notes to condensed consolidated financial statements.
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NETWORK APPLIANCE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
SIX MONTHS ENDED
-----------------------------------
OCTOBER 29, 1999 OCTOBER 30, 1998
---------------- ----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 29,516 $ 15,473
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 5,871 4,792
Provision for doubtful accounts 723 700
Deferred income taxes (10,000) (1,463)
Deferred rent (40) (29)
Changes in assets and liabilities:
Accounts receivable (22,294) (11,329)
Inventories (3,900) (2,019)
Prepaid expenses and other assets 871 472
Accounts payable 12,232 2,361
Income taxes payable 23,752 5,904
Accrued compensation and related benefits 3,798 1,167
Other accrued liabilities 978 1,689
Deferred revenue 1,749 2,449
-------- --------
Net cash provided by operating activities 43,256 20,167
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of short-term investments (51,673) (12,880)
Redemptions of short-term investments 5,800 14,930
Purchases of property and equipment (13,164) (6,183)
Payment/refund of deposits, net (170) (10,500)
-------- --------
Net cash used in investing activities (59,207) (14,633)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of long-term obligations -- (17)
Proceeds from sale of common stock, net 15,495 5,523
-------- --------
Net cash provided by financing activities 15,495 5,506
-------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (456) 11,040
CASH AND CASH EQUIVALENTS:
Beginning of period 221,284 37,315
-------- --------
End of period $220,828 $ 48,355
======== ========
NONCASH INVESTING AND FINANCING ACTIVITIES:
Income tax benefit from employee stock transactions $ 24,400 $ 3,710
SUPPLEMENTAL CASH FLOW INFORMATION:
Income taxes paid net of refund $ 1,407 $ 4,816
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 six-month periods ended October 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, 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 October 29, 1999 includes 13 weeks of operating
activity, compared to 13 weeks of activity for the corresponding period of the
prior fiscal year. The six-months ended October 29, 1999 includes 26 weeks of
activity, compared to 27 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 such 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.
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NETWORK APPLIANCE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
3. INVENTORIES
Inventories consist of the following:
OCTOBER 29, APRIL 30,
1999 1999
---------- ---------
(IN THOUSANDS)
Purchased components $ 3,239 $ 5,316
Work in process 4,066 1,727
Finished goods 10,237 6,538
-------- --------
$ 17,542 $ 13,581
======== ========
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 SIX MONTHS ENDED
OCTOBER 29, OCTOBER 30, OCTOBER 29, OCTOBER 30,
1999 1998 1999 1998
-------- --------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NET INCOME (NUMERATOR):
Net income, basic and diluted $ 16,048 $ 8,376 $ 29,516 $ 15,473
======== ======== ======== ========
SHARES (DENOMINATOR):
Weighted average common shares outstanding 74,170 68,052 73,663 67,796
Weighted average common shares outstanding
subject to repurchase (48) (174) (55) (328)
-------- -------- -------- --------
Shares used in basic computation 74,122 67,878 73,608 67,468
Weighted average common shares outstanding
subject to repurchase 48 174 55 328
Common shares issuable upon exercise of stock
options 10,322 8,060 10,170 7,748
-------- -------- -------- --------
Shares used in diluted computation 84,492 76,112 83,833 75,544
======== ======== ======== ========
NET INCOME PER SHARE:
Basic $ 0.22 $ 0.12 $ 0.40 $ 0.23
======== ======== ======== ========
Diluted $ 0.19 $ 0.11 $ 0.35 $ 0.20
======== ======== ======== ========
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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 SIX MONTHS ENDED
------------------------ -------------------------
OCTOBER 29, OCTOBER 30, OCTOBER 29, OCTOBER 30,
1999 1998 1999 1998
-------- ---------- -------- ------------
(IN THOUSANDS)
Net income $ 16,048 $ 8,376 $29,516 $ 15,473
Change in cumulative translation adjustment (190) (35) 74 (18)
-------- ------- ------- --------
Comprehensive income $ 15,858 $ 8,341 $29,590 $ 15,455
======== ======= ======= ========
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.
7. COMMITMENTS
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 (7.6% at October 29,
1999). The aggregate annual minimum rent commitments under one lease which began
in August 1999, is approximately $3.3 million. The lease payments under the
other two 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 October 29, 1999.
8. SUBSEQUENT EVENTS
On November 16, 1999, the Board of Directors approved a two-for-one
stock split of the Company's common stock to be distributed on or about December
20, 1999 to holders of record on December 10, 1999. Proforma share and per-share
amounts have been presented within the Condensed Consolidated Statements of
Income to reflect the stock split.
In November 1999, we executed an agreement to acquire certain property
in Sunnyvale, California. Under terms of the agreement, we paid $3.0 million of
the $61.0 million purchase price as a nonrefundable deposit subsequent to
October 29, 1999. The agreement allows us to assign our rights and obligations
to a third-party entity should we decide to enter into an operating lease. We
intend to assign our rights and obligations to a third-party entity and enter
into an operating lease provided we can obtain satisfactory leasing terms.
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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 Six Months Ended
------------------------------ -----------------------------
October 29, October 30, October 29, October 30,
1999 1998 1999 1998
----------- ----------- ----------- -----------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 41.3 41.0 41.3 40.7
-------- ------- ------- -------
Gross margin 58.7 59.0 58.7 59.3
-------- ------- ------- -------
Operating expenses:
Sales and marketing 26.1 26.0 26.1 26.0
Research and development 10.8 10.2 10.8 10.4
General and administrative 3.6 3.9 3.6 3.6
-------- ------- ------- -------
Total operating expenses 40.5 40.1 40.5 40.0
-------- ------- ------- -------
Income from operations 18.2 18.9 18.2 19.3
Other income, net 1.8 1.5 1.9 0.9
-------- ------- ------- -------
Income before income taxes 20.0 20.4 20.1 20.2
Provision for income taxes 7.1 7.6 7.1 7.6
-------- ------- ------- -------
Net income 12.9% 12.8% 13.0% 12.6%
======== ======= ======= =======
Net Sales -- Net sales increased by 90.0% to $124.7 million for the
three-months ended October 29, 1999, from $65.6 million for the three-months
ended October 30, 1998. Net sales increased by 85.4% to $228.0 million for the
six-months ended October 29, 1999, from $123.0 million for the six-months ended
October 30, 1998. Net sales growth was across all geographies, products and
markets. This increase in net sales for both the three and six-months ended
October 29, 1999 was primarily attributable to a higher volume of units shipped,
as compared to the corresponding periods of the prior fiscal year. Factors
impacting unit growth include:
- 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;
- acceleration in deployment of our products among Internet and
enterprise related customers, particularly for E-business and new
E-commerce applications;
- strong demand for our F700 filer product family utilizing
primarily fibre-channel connectivity;
- increased worldwide shipment of NetApp(R) Cluster Failover
solutions;
- increased worldwide demand for our NetCache(TM) solutions;
- additional filer demand created by SnapMirror(TM) to store the
remote replicated data for disaster recovery;
- expansion of our direct sales force; and
- sales to our two OEM partners.
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Net sales growth was also positively impacted by:
- a higher average selling price due to the introduction of new
software features: SnapMirror, SnapRestore(TM) and Cluster
Failover, supporting mission-critical applications;
- the increase in storage capacity;
- increased add on software revenue from multi-protocol solutions;
and
- higher software subscription and service revenues to support a
growing installed base.
Overall net sales growth was partially offset by declining unit sales
of our older product family.
International net sales (including United States exports) grew by
102.2% and 111.5% for the three and six-month periods ended October 29, 1999, as
compared to the comparable period of the prior fiscal year. International net
sales were $34.2 million, or 27.5% of total net sales, and $62.7 million, or
27.5% of total net sales, for the three and six-month periods ended October 29,
1999, respectively. The increase in international sales for the three and
six-month periods ended October 29, 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 and six-month periods
ended October 29, 1999, was also primarily driven by increased indirect sales
through resellers, 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 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 58.7% for the
three-months ended October 29, 1999 from 59.0% for the three-months ended
October 30, 1998. Gross margin decreased to 58.7% for the six-months ended
October 29, 1999 from 59.3% for the six-months ended October 30, 1998. Gross
margin was negatively impacted by recent price reductions on disk drives due to
competitive pricing pressure from other storage vendors.
Gross margin was also favorably impacted by:
- increased licensing of add on software from multi-protocol,
Cluster Failover, SnapMirror and SnapRestore;
- growth in software subscription and service revenues due to a
larger installed base;
- the increase in product volume;
- lower costs of key components; and
- increased manufacturing efficiencies.
Our gross margin has been and will continue to be affected by a variety
of factors, including:
- competition;
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- product configuration;
- direct versus indirect sales;
- the mix and average selling prices of products, including
software licenses;
- new product introductions and enhancements; and
- the cost of components and manufacturing labor.
Sales and Marketing -- Sales and marketing expenses consist primarily
of salaries, commissions, advertising and promotional expenses and certain
customer service and support costs. Sales and marketing expenses increased 90.7%
to $32.5 million for the three-months ended October 29, 1999 from $17.1 million
for the three-months ended October 30, 1998. Sales and marketing expenses
increased 85.7% to $59.4 million for the six-months ended October 29, 1999 from
$32.0 million for the six-months ended October 30, 1998. These expenses were
26.1% and 26.0% of net sales for the three-months ended October 29, 1999 and
October 30, 1998, respectively, and were 26.1% and 26.0%, respectively, of net
sales for the six-months periods then ended. The increase in absolute dollars
was primarily related to the continued worldwide expansion and increased
headcount growth of our sales and customer service organizations, 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, non-recurring
engineering charges and fees paid to outside consultants. Research and
development expenses increased 100.0% to $13.5 million for the three-months
ended October 29, 1999 from $6.7 million for the three-months ended October 30,
1998. These expenses represented 10.8% and 10.2% of net sales, respectively, for
the three-months ended October 29, 1999 and October 30, 1998. For the six-month
periods, research and development expenses increased 92.8% to $24.7 million in
fiscal 2000 from $12.8 million in fiscal 1999, and represented 10.8% and 10.4%
of net sales, respectively, for those periods. Research and development expenses
increased in absolute dollars, primarily as a result of increased headcount,
ongoing support of current and future product development and enhancement
efforts, prototyping expenses and non-recurring engineering charges associated
with the development of new products and technologies. These new products
included the F700 series filers, the Cluster Failover solutions, the C700
family, new enterprise software offerings and data management tools with
SnapMirror, SnapRestore and SecureAdmin(TM) as well as Netcache software release
4.0 and architecture supporting the next-generation of web and digital media. 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
six-months ended October 29, 1999 and October 30, 1998, no software development
costs were capitalized.
General and Administrative -- General and administrative expenses
increased 75.8% to $4.5 million for the three-months ended October 29, 1999,
from $2.6 million for the three-months ended October 30, 1998. These expenses
represented 3.6% and 3.9% of net sales for the three-months ended for such
periods. For the six-month periods, general and administrative expenses
increased 87.2% to $8.3 million in fiscal 2000 from $4.4 million in fiscal 1999
and represented 3.6% of net sales for both periods. Increases in absolute
dollars were primarily due to increased headcount, expenses associated with
initiatives to implement enterprise-wide management information systems,
increases in professional services, consulting fees and outside service fees. 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 $2.2 million and $1.0
million for the three-months ended October 29, 1999 and October 30, 1998,
respectively. During the six-months ended October 29, 1999, other income was
$4.2 million, as compared to $1.1 million in the corresponding period of the
prior year. 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.
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The second quarter of fiscal 1999 included gains from foreign currency
transactions as compared to the second quarter of fiscal 2000, where gains or
losses from foreign transactions are mitigated primarily through our hedging
program.
Provision for Income Taxes -- Our effective tax rate was 35.5% for the
three and six-month periods ended October 29, 1999 compared to 37.5% for the
three and six-month periods ended October 30, 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.
CERTAIN RISK FACTORS
Although we have experienced significant revenue growth in recent
periods, this growth may not be indicative of our future operating results. As a
result, we believe that period-to-period comparisons of our results of operation
are not necessarily meaningful and should not be relied upon as indicators of
future performance. Many of the factors that could cause our quarterly operating
results to fluctuate significantly in the future are beyond our control and
include the following:
- - the level of competition in our target product markets;
- - the size, timing, and cancellation of significant orders;
- - product configuration and mix;
- - market acceptance of new products and product enhancements;
- - new product announcements or introductions by us or our competitors;
- - deferrals of customer orders in anticipation of new products or product
enhancements;
- - changes in pricing by us or our competitors;
- - our ability to timely develop, introduce and market new products and
enhancements;
- - supply constraints;
- - technological changes in our target product markets;
- - the levels of expenditure on research and development and expansion of
our sales and marketing programs;
- - seasonality; and
- - general economic trends.
In addition, sales for any future quarter may vary and accordingly be
inconsistent with our plans. We generally operate with limited order backlog
because our products are typically shipped shortly after orders are received. As
a result, product sales in any quarter are generally dependent on orders booked
and shipped in that quarter. Product sales are difficult to forecast because the
network file server market is rapidly evolving and our sales cycle varies
substantially from customer to customer.
We conduct business internationally. For both the three and six-months
ended October 29, 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.
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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.
LIQUIDITY AND CAPITAL RESOURCES
As of October 29, 1999, as compared to the April 30, 1999 balances, our
cash, cash equivalents and short-term investments increased by $45.4 million to
$272.5 million. Working capital increased by $61.8 million to $326.6 million. We
generated cash from operating activities totaling $43.3 million and $20.2
million for the six-month periods ended October 29, 1999 and October 30, 1998,
respectively. Net cash provided by operating activities for the six-month period
ended October 29, 1999 principally related to net income of $29.5 million,
increases in accounts payable, income taxes payable, accrued compensation and
related benefits, 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, and deferred income taxes.
We used $13.2 million and $6.2 million of cash during the six-month
periods ended October 29, 1999 and October 30, 1998, respectively, for capital
expenditures. The increases were primarily attributed to upgrades of software
and computer equipment purchases and furniture and fixtures for the Sunnyvale
headquarters facility. We have used $45.9 million during the six-month period
ended October 29, 1999 and provided for $2.1 million during the six-month period
ended October 30, 1998, for net short-term investment purchases.
During the six-month period of fiscal 2000, we received back our $2.5
million deposit in connection with the $36.0 million operating lease. In
September 1999, we executed an agreement to acquire 9.9 acres of land in
Sunnyvale, California and the accompanying 178,996 square foot building. Under
terms of the agreement, we paid $2.7 million of the $23.4 million purchase price
as a nonrefundable deposit. The agreement allows us to assign our rights and
obligations to a third-party entity should we decide to enter into an operating
lease. We intend to assign our rights and obligations to a third-party entity
and enter into an operating lease provided we can obtain satisfactory leasing
terms.
In addition, we have commitments related to operating lease
arrangements, under which we have an option to purchase the properties for an
aggregate of $128.0 million, or arrange for the sale of the properties to a
third party for at least the option price with a contingent liability for any
deficiency.
Financing activities provided $15.5 million and $5.5 million during the
six-month periods ended October 29, 1999 and October 30, 1998, respectively. The
increase in cash provided by financing activities for the six-months ended
October 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.
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In November 1999, we executed an agreement to acquire certain property
in Sunnyvale, California. Under terms of the agreement, we paid $3.0 million of
the $61.0 million purchase price as a nonrefundable deposit subsequent to
October 29, 1999. The agreement allows us to assign our rights and obligations
to a third-party entity should we decide to enter into an operating lease. We
intend to assign our rights and obligations to a third-party entity and enter
into an operating lease provided we can obtain satisfactory leasing terms.
Excluding the commitments related to the aforementioned properties,
which we intend to assign to third parties and account 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.
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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.
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 during the second 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 systems 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 have communicated 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 have assessed 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
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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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk related to fluctuations in interest rates
and in foreign currency exchange rates. We use certain derivative financial
instruments to manage these risks. We do not use derivative financial
instruments for speculative or trading purposes. All financial instruments are
used in accordance with management-approved policies.
Market Interest Risk
Short-term Investments - As of October 29, 1999, we had short-term
investments of $51.7 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 October 29, 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 October 29, 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. However, our investment portfolio offers a
natural hedge against interest rate risk from our operating lease commitments
in the event of a significant increase in the market interest rate.
The hypothetical changes and assumptions discussed above will be
different from what actually occurs in the future. Furthermore, such
computations do not anticipate actions that may be taken by management, should
the hypothetical market changes actually occur over time. As a result, the
effect on actual earnings in the future will differ from those described above.
Foreign Currency Exchange Rate Risk - We hedge risks associated with
foreign currency transactions in order to minimize the impact of changes in
foreign currency exchange rates on earnings. We utilize forward contracts to
hedge against the short-term impact of foreign currency fluctuations on certain
assets and liabilities denominated in foreign currencies. All hedge instruments
are marked to market through earnings every period. We believe that these
forward contracts do not subject us to undue risk due to foreign exchange
movements because gains and losses on these contracts are offset by losses and
gains on the underlying assets and liabilities.
All contracts have a maturity of less than one year and we do not defer
any gains and losses, as they are all accounted for through earnings every
period.
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The following table provides information about our foreign exchange
forward contracts outstanding on October 29, 1999, (in thousands):
Buy/ Foreign Contract Value Fair Value
Currency Sell Currency Amount USD in USD
- -------- ----- --------------- ------------- ----------
EUR Sell 14,954 16,042 15,730
GBP Sell 4,985 8,056 8,192
CHF Buy 1,288 852 845
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
10.41 Purchase and Sale Agreement dated September 9, 1999, by and
between Trinet Essential Facilities XII, Inc., and the Company
10.42 Agreement of Assignment of Lease, dated September 3, 1999, by
and between Lockheed Martin Corporation, and the Company
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
Senior Vice President Finance and
Operations, Chief Financial
Officer and Secretary
Date: December 2, 1999
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EXHIBIT INDEX
DESCRIPTION
EXHIBIT
NUMBER
- -------
10.41 Purchase and Sale Agreement, dated September 9, 1999, by and between
Trinet Essential Facilities XII, Inc., and the Company
10.42 Agreement of Assignment of Lease, dated September 3, 1999 by and
between Lockheed Martin Corporation and the Company
27.1 Financial Data Schedule
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