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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 10-Q
---------------
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JULY 27, 2001
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 27, 2001
- ----------------------- ---------------
Common Stock........... 330,203,694
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TABLE OF CONTENTS
PAGE NO.
--------
PART I -- FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of July 27, 2001 and April 30, 2001 2
Condensed Consolidated Statements of Operations for the three-month periods
ended July 27, 2001 and July 28, 2000 3
Condensed Consolidated Statements of Cash Flows for the three-month periods ended
July 27, 2001 and July 28, 2000 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 23
PART II--OTHER INFORMATION
Item 1. Legal Proceedings 25
Item 2. Changes in Securities 25
Item 3. Defaults Upon Senior Securities 25
Item 4. Submission of Matters to Vote of Securityholders 25
Item 5. Other Information 25
Item 6. Exhibits and Reports on Form 8-K 25
SIGNATURE 26
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PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NETWORK APPLIANCE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
JULY 27, APRIL 30,
2001 2001
----------- -----------
(UNAUDITED) **
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 239,287 $ 271,931
Short-term investments 129,378 92,094
Accounts receivable, net 155,166 186,956
Inventories 23,764 22,504
Prepaid expenses and other assets 28,096 25,745
Deferred income taxes 35,737 36,287
----------- -----------
Total current assets 611,428 635,517
RESTRICTED CASH 199,983 193,747
PROPERTY AND EQUIPMENT, NET 100,789 103,238
INTANGIBLE ASSETS, NET 74,284 79,510
OTHER ASSETS 23,675 24,240
----------- -----------
$ 1,010,159 $ 1,036,252
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 48,208 $ 64,892
Income taxes payable 16,050 21,844
Accrued compensation and related benefits 26,217 50,523
Other accrued liabilities 29,682 23,198
Deferred revenue 54,284 58,316
----------- -----------
Total current liabilities 174,441 218,773
LONG-TERM DEFERRED REVENUE 16,772 12,882
LONG-TERM OBLIGATIONS 137 149
----------- -----------
Total liabilities 191,350 231,804
----------- -----------
SHAREHOLDERS' EQUITY:
Common stock 631,171 616,595
Deferred stock compensation (10,767) (12,044)
Retained earnings 204,119 204,632
Cumulative other comprehensive loss (5,714) (4,735)
----------- -----------
Total shareholders' equity 818,809 804,448
----------- -----------
$ 1,010,159 $ 1,036,252
=========== ===========
** 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 OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED
------------------------
JULY 27, JULY 28,
2001 2000
--------- --------
NET SALES $ 200,426 $231,159
COST OF SALES 88,077 89,457
--------- --------
Gross Margin 112,349 141,702
--------- --------
OPERATING EXPENSES:
Sales and marketing 71,642 63,818
Research and development 29,083 23,623
General and administrative 10,262 8,879
Amortization of intangible assets 5,226 666
In-process research and development -- 26,688
Stock compensation (1) 2,699 429
--------- --------
Total operating expenses 118,912 124,103
--------- --------
INCOME (LOSS) FROM OPERATIONS (6,563) 17,599
--------- --------
OTHER INCOME:
Interest income 5,482 4,264
Other income (expense), net 12 116
--------- --------
Total other income, net 5,494 4,380
--------- --------
INCOME (LOSS) BEFORE INCOME TAXES (1,069) 21,979
PROVISION (BENEFIT) FOR INCOME TAXES (556) 17,003
--------- --------
NET INCOME (LOSS) $ (513) $ 4,976
========= ========
NET INCOME (LOSS) PER SHARE:
Basic $ (0.00) $ 0.02
========= ========
Diluted $ (0.00) $ 0.01
========= ========
SHARES USED IN PER SHARE CALCULATIONS:
Basic 329,336 313,559
========= ========
Diluted 329,336 359,778
========= ========
(1) Stock compensation
Sales and marketing $ 313 $ 241
Research and development 2,243 82
General and administrative 143 106
--------- --------
$ 2,699 $ 429
========= ========
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 27, 2001 JULY 28, 2000
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (513) $ 4,976
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation 10,614 5,892
In-process research and development -- 26,688
Amortization of intangible assets 5,226 666
Stock compensation 2,699 429
Provision for doubtful accounts 1,639 172
Deferred income taxes 3,927 (2,114)
Deferred rent (12) --
Changes in assets and liabilities net of effects of businesses acquired:
Accounts receivable 30,117 (29,412)
Inventories (2,810) (4,988)
Prepaid expenses and other assets (4,567) 9,141
Accounts payable (16,684) 15,875
Income taxes payable (5,794) 22,491
Accrued compensation and related benefits (24,306) (1,446)
Other accrued liabilities 6,484 7,137
Deferred revenue (142) 8,308
--------- ---------
Net cash provided by operating activities 5,878 63,815
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of short-term investments (76,486) (51,699)
Redemptions of short-term investments 38,018 45,109
Purchases of property and equipment (6,822) (21,034)
Purchase of equity securities (150) (1,000)
Purchase of businesses, net of cash acquired -- (2,161)
--------- ---------
Net cash used in investing activities (45,440) (30,785)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock, net 13,154 19,705
Increase in restricted cash (6,236) --
--------- ---------
Net cash provided by financing activities 6,918 19,705
--------- ---------
NET CHANGE IN CASH AND CASH EQUIVALENTS (32,644) 52,735
CASH AND CASH EQUIVALENTS:
Beginning of period 271,931 279,014
--------- ---------
End of period $ 239,287 $ 331,749
========= =========
NONCASH INVESTING AND FINANCING ACTIVITIES:
Income tax benefit from employee stock transactions $ -- $ 18,000
Conversion of evaluation inventory to fixed assets 1,321 2,728
Common stock issued and options assumed for acquired businesses -- 47,579
Milestone shares issued (Note 5) 1,434 --
SUPPLEMENTAL CASH FLOW INFORMATION:
Income taxes paid 62 54
See accompanying notes to condensed consolidated financial statements.
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NETWORK APPLIANCE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS)
(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, results of operations and cash flows for the interim
periods presented. The statements have been prepared in accordance with the
regulations of the Securities and Exchange Commission (SEC) for interim
financial statements. Accordingly, they do not include all information and
footnotes required by accounting principles generally accepted in the United
States of America for annual financial statements.
These financial statements should be read in conjunction with the
audited consolidated financial statements and accompanying notes included in our
Annual Report on Form 10-K for the year ended April 27, 2001. The results of
operations for the three-month period ended July 27, 2001 are not necessarily
indicative of the operating results to be expected for the full fiscal year or
future operating periods.
2. RECLASSIFICATIONS
Certain reclassifications have been made to prior-period balances, none
of which affected our financial position, results of operations and cash flows,
to present the consolidated financial statements on a consistent basis.
3. SIGNIFICANT ACCOUNTING POLICIES
Fiscal Periods - We operate on a 52-week or 53-week year ending on the
last Friday in April. Fiscal 2002 is a 52-week year. Fiscal 2001 was a 52-week
year. The quarter ended July 27, 2001 includes 13 weeks of operating activity,
compared to 13 weeks of activity for the corresponding period of the prior
fiscal year.
Foreign Currency Translation -- In the first quarter of fiscal 2002, we
determined that the functional currency of one of our subsidiaries had changed
from the Euro to the US Dollar. Accordingly, all monetary assets and liabilities
were translated at the current exchange rate in effect as of the balance sheet
date, nonmonetary assets and liabilities were translated at historical rates and
net sales and expenses were translated at average exchange rates in effect
during the period. Transaction gains and losses, which are included in other
income (expense) in the accompanying consolidated statements of operations, have
not been significant.
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NETWORK APPLIANCE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS)
(UNAUDITED)
4. INVENTORIES
Inventories consist of the following:
JULY 27, APRIL 30,
2001 2001
----------- -----------
(IN THOUSANDS)
Purchased components $ 11,554 $ 11,106
Work in process 505 560
Finished goods 11,705 10,838
----------- -----------
$ 23,764 $ 22,504
=========== ===========
5. STOCK COMPENSATION
We record stock compensation in accordance with provisions of Accounting
Principle Board No. 25, "Accounting for Stock Issued to Employees," for employee
awards and in accordance with the disclosure provisions of Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation," for non-employee awards. Accordingly, we recognize the intrinsic
value for employees and the fair value for non-employees as stock compensation
expense over the vesting terms of the awards. During the first quarter of fiscal
2002, under terms of the acquisition agreement with Orca Systems, Inc. ("Orca"),
we issued an additional 66 shares of common stock to former Orca shareholders
upon meeting certain performance criteria. The fair market value of the shares
of $1,434 was measured on the date the performance criteria were met and was
recognized as stock compensation.
6. DERIVATIVE INSTRUMENTS
Effective May 1, 2001, we adopted SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," as amended, which establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities.
Under SFAS No. 133, certain contracts that were not formerly considered
derivatives may now meet the definition of a derivative. SFAS No. 133 requires
that all derivatives be recognized as either assets or liabilities at fair
value. Derivatives that are not designated as hedges are adjusted to fair value
through earnings. If the derivative is designated as a hedge, depending on the
nature of the exposure being hedged, changes in fair value will either be offset
against the change in fair value of the hedged asset, liability, or firm
commitment through earnings, or recognized in other comprehensive income until
the hedged item is recognized in earnings. The ineffective portion of the hedge
is recognized in earnings immediately.
As a result of our significant international operations, we are subject
to risks associated with fluctuating exchange rates. We use foreign currency
forward contracts, to attempt to minimize the impact of exchange rate movements
on our balance sheet relating to certain foreign currency assets and
liabilities. Gains and losses on these undesignated derivatives offset gains and
losses on the assets and liabilities being hedged and the net amount is included
in earnings. For the first three months of fiscal 2002, net losses generated by
hedged assets and liabilities totaled $246, which were offset by gains on the
related derivative instruments of $265. We do not enter into derivative
financial instruments for speculative or trading purposes.
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NETWORK APPLIANCE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS)
(UNAUDITED)
Currently, we do not enter into any foreign exchange forward contracts
to hedge exposures related to forecasted transactions, firm commitments or
equity investments. The adoption of SFAS No. 133 did not have a significant
impact on our financial position, results of operations or cash flow.
7. EARNINGS PER SHARE
Basic and diluted net income (loss) per share are computed using
weighted-average common shares outstanding in accordance with SFAS No. 128,
"Earnings Per Share." Diluted net income per share also includes the effect of
stock options.
At July 27, 2001 and July 28, 2000, 73,945 and 983 shares of common
stock options with a weighted average exercise price of $21.48 and $81.39,
respectively, were excluded from the diluted net income (loss) per share
computation as their effect would be antidilutive due to the net loss for the
three-month period ended July 27, 2001 and due to the fact that the exercise
prices were greater than the average market price of the common shares for the
three-month period ended July 28, 2000.
The following is a reconciliation of the numerators and denominators of
the basic and diluted earnings per share computations for the periods presented:
THREE MONTHS ENDED
JULY 27, JULY 28,
2001 2000
--------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NET INCOME (LOSS) (NUMERATOR):
Net income (loss), basic and diluted $ (513) $ 4,976
========= =========
SHARES (DENOMINATOR):
Weighted average common shares outstanding 329,550 313,750
Weighted average common shares outstanding
subject to repurchase (214) (191)
--------- ---------
Shares used in basic computation 329,336 313,559
Weighted average common shares outstanding
subject to repurchase -- 191
Common shares issuable upon exercise of stock
options -- 46,028
--------- ---------
Shares used in diluted computation 329,336 359,778
========= =========
NET INCOME (LOSS) PER SHARE:
Basic $ (0.00) $ 0.02
========= =========
Diluted $ (0.00) $ 0.01
========= =========
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NETWORK APPLIANCE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS)
(UNAUDITED)
8. COMPREHENSIVE INCOME (LOSS)
The components of comprehensive income (loss), net of tax, were as
follows:
THREE MONTHS ENDED
JULY 27, JULY 28,
2001 2000
------- -------
(IN THOUSANDS)
Net income (loss) $ (513) $ 4,976
Foreign currency translation adjustment (263) 157
Unrealized gain (loss) on investments (716) 11,474
------- -------
Comprehensive income (loss) $(1,492) $16,607
======= =======
9. COMMITMENTS
We have commitments related to operating lease arrangements for our
headquarter site in Sunnyvale, California, under which we have options to
purchase various properties at the expiration or termination of the leases for
$309,000, or arrange for the sale of the property to third parties for at least
$309,000 with a contingent liability for any deficiency. If the property is not
purchased or sold as described above, we will be obligated for additional lease
payments of approximately $276,566.
Restricted cash, classified as non-current assets collateralizing these
leases, was $195,258 at July 27, 2001. The lease payments under operating leases
collateralized by restricted cash, will vary based on London Interbank Offered
Rate (LIBOR) plus a spread (4.1% at July 27, 2001). The remaining
non-collateralized operating lease requires monthly payments, which vary, based
on LIBOR plus a spread (5.3% at July 27, 2001). The operating leases mentioned
above require us to maintain specified financial covenants with which we were in
compliance as of July 27, 2001.
We also entered into agreements and established Network Appliance
accounts with Goldman, Sachs and Co. and Deutsche Banc Alex. Brown whereby we
guarantee any defaults by our President, Mr. Thomas F. Mendoza, of certain
margin loans made to him by these financial institutions on his Network
Appliance stock. The amount of the guarantee is limited to the difference
between the amount of such loans and fair market value of the Network Appliance
stock securing the loans. As of July 27, 2001, the ending balance in these
accounts was approximately $4,725 in order to collateralize the margin
requirement and as of that date the amount Network Appliance would owe, that was
not covered by the value of the stock, was $0. The balance under these accounts
mentioned above was classified as restricted cash.
10. NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board issued SFAS No.
141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible
Assets". Under SFAS No. 141, all business combinations initiated after June 30,
2001 must be accounted for using the purchase method. Under SFAS No. 142,
goodwill and intangible assets with indefinite lives are no longer amortized but
are reviewed annually for impairment (or more frequently if indicators of
impairment arise). Separable intangible assets that are not deemed to have
indefinite lives will continue to be amortized over their useful lives (but with
no maximum life). The amortization provisions of SFAS No. 142 apply to goodwill
and intangible assets acquired after June 30, 2001. With respect to goodwill and
intangible assets acquired prior to July 1, 2001, we are required to adopt SFAS
No. 142 effective April 27, 2002. Upon adoption of SFAS
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NETWORK APPLIANCE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS)
(UNAUDITED)
No. 142, we will stop the amortization of goodwill with a net carrying value of
approximately $48,912 at April 26, 2002 and the annual amortization of $14,575
that resulted from business combinations initiated prior to the adoption. We
will evaluate goodwill under the SFAS No. 142 transitional impairment test. Any
transitional impairment loss will be recognized as a change in accounting
principle on the date of adoption. If any impairment of goodwill is recognized
prior to the date of adoption, the loss will be charged to operating expenses.
11. SUBSEQUENT EVENTS
In August 2001, we announced a restructuring and our intention to reduce
our workforce by approximately 8 percent, or approximately 200 employees. The
action is required to properly align and manage the business commensurate with
our current revenue levels. As a result of this planned workforce reduction, we
expect to incur a one-time charge of approximately $6,000 to $8,000 for
severance and other related costs in the quarter ending October 26, 2001.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
In addition to historical information, this Form 10-Q contains
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These
statements may contain words such as "expects," "anticipates," "intends,"
"plans," "believes," "estimates," or other words indicating future results.
These forward-looking statements are subject to certain risks and uncertainties
that could cause actual results to differ materially from those reflected in the
forward-looking statement. Factors that could cause or contribute to such
differences include, but are not limited to, those discussed in the following
sections entitled "Risk Factors" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations." This discussion should be read
in conjunction with our Annual Report on Form 10-K for the year ended April 27,
2001. We undertake no obligation to revise or publicly release the results of
any revision to these forward-looking statements. Given these risks and
uncertainties, readers are cautioned not to place undue reliance on such
forward-looking statements.
OVERVIEW
We pioneered the concept of the "network appliance" for storage, an
extension of the industry trend toward dedicated, specialized products that
perform a single function. Our storage and content delivery platforms (filers
and NetCache(R) appliances) are coupled with content distribution and reporting
software. This Center-to-Edge(TM) solution offers seamless data management from
the back-end data center to the edge of the network quickly, simply, and
reliably. The Network Appliance product portfolio utilizes our innovative data
access software, known as the Data ONTAP(TM) operating system, as well as
standards-compliant hardware. It also offers multiprotocol support and
integration for UNIX(R) and Windows(R) environments.
RECENT EVENT
In August 2001, we announced a restructuring and our intention to reduce
our workforce by approximately 8 percent, or approximately 200 employees. The
action is required to properly align and manage the business commensurate with
our current revenue levels. As a result of this planned workforce reduction, we
expect to incur a one-time charge of approximately $6 million to $8 million for
severance and other related costs in the quarter ending October 26, 2001.
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RESULTS OF OPERATIONS
The following table sets forth certain consolidated statements of
operations data as a percentage of net sales for the periods indicated:
THREE MONTHS ENDED
--------------------
JULY 27, JULY 28,
2001 2000
------- -------
Net sales 100.0 % 100.0 %
Cost of sales 43.9 38.7
----- -----
Gross margin 56.1 61.3
----- -----
Operating expenses:
Sales and marketing 35.8 27.6
Research and development 14.5 10.2
General and administrative 5.1 3.8
Amortization of intangible assets 2.6 0.3
In-process research and development -- 11.6
Stock compensation 1.4 0.2
----- -----
Total operating expenses 59.4 53.7
----- -----
Income (loss) from operations (3.3) 7.6
Total other income, net 2.8 1.9
----- -----
Income (loss) before income taxes (0.5) 9.5
Provision (benefit) for income taxes (0.2) 7.4
----- -----
Net income (loss) (0.3)% 2.1 %
===== =====
Net Sales -- Net sales decreased by 13.3% to $200.4 million for the
three-month period ended July 27, 2001, from $231.2 million for the three-month
period ended July 28, 2000. The decline in net sales was due to a decrease in
sales to Internet-based companies and weak capital spending among technology
companies, primarily in North America. This decrease in net sales was
specifically attributable to a lower volume of units shipped, as compared to the
corresponding period of the prior fiscal year.
Factors negatively impacting net sales include:
- - reduced demand for our products resulting from deteriorating macro
economic conditions;
- - smaller orders from enterprise customers as infrastructure deployments
are slowly ramping up;
- - continued weakness in technology spending from Internet- and
technology-related customers;
- - slower sales from low-end filer product;
- - decreased sales through indirect channels, including sales through our
OEM partners, representing 19.0% and 26.6% of total net sales for the
first quarter of fiscal 2002 and 2001, respectively;
- - reduced revenue from software licenses;
- - declining average selling price of the F700 filers and older caching
products; and
- - declining unit sales of our older products.
Net sales were favorably impacted by the following factors:
- - competitive pricing and aggressive discounting;
- - a higher average selling price of our new products: higher capacity
F840, mid-range F820 and entry-level F85 filer products as well as new
NetCache appliances and software features;
- - Center-to-Edge data fabric solutions that bundle filers with caching and
content delivery software providing for enterprise storage
infrastructure;
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- - increased revenue and units shipped from our new content delivery
solutions, including new NetCache platforms C6100, C3100 and C1105 and
new NetCache software;
- - competitive pricing advantage offered by the Total Cost of Ownership
(TCO) proposition in four aspects: lower acquisition cost, reduced
administrative overhead, minimized service cost and reduced downtime of
critical business applications;
- - data management and content delivery software offering a unique set of
features to ensure mission-critical availability, while reducing the
complexity of enterprise storage management;
- - higher software subscription and service revenues to support a growing
installed base;
- - increased add-on software revenue from Multi-Protocol solutions; and
- - expansion of our sales organization to 1,009 as of July 27, 2001 from
704 as of July 28, 2000.
International net sales (including United States exports) grew by 6.9%
and 157.3% for the three months ended July 27, 2001 and July 28, 2000,
respectively. International net sales were $78.1 million, or 39.0% of total net
sales, and $73.1 million, or 31.6% of total net sales, for the three-month
periods ended July 27, 2001 and July 28, 2000, respectively. The moderate
increase in international sales for the three months ended July 27, 2001 was
primarily a result of our increased sales and marketing efforts internationally
offset by a slower demand in Europe and Asia Pacific markets, as compared to the
three months ended July 28, 2000. We expect to continue to selectively add sales
capacity 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 our international net sales will not
increase in fiscal 2002 at the rate at which they grew in fiscal 2001.
Gross Margin -- Gross margin decreased to 56.1% for the three-month
period ended July 27, 2001 from 61.3% for the three-month period ended July 28,
2000.
Gross margin was negatively impacted by:
- - the decrease in product sales volume;
- - sales price reductions due to competitive pricing pressure;
- - pricing discounts;
- - lower of cost or market adjustments to inventory;
- - reduced licensing of add-on software options such as Cluster Failover,
SnapMirror(TM), SnapRestore(TM) and SnapManager(TM), partially offset by
increased licensing of new NetCache software, including
ContentReporter(TM) and ContentDirector(TM);
- - higher disk content with an expanded storage capacity for the higher-end
filers including the F840 filer; and
- - increased investments in customer service.
Gross margin was favorably impacted by:
- - lower costs of key components;
- - higher average selling prices for our new products;
- - cost control and reduction efforts, including a one week facility
shutdown; and
- - growth in software subscriptions due primarily to a larger installed
base.
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 12.3% to $71.6
million for the three-month period ended July 27, 2001 from $63.8 million for
the three-month periods ended July 28, 2000. These expenses were 35.8% and 27.6%
of net sales for the three-month periods ended July 27, 2001 and July 28, 2000,
respectively. The increase in absolute dollars was primarily related to the
continued worldwide investment in our sales and customer service organizations
and continued spending in various marketing and industry initiatives, partially
offset by various cost control and reduction measures, lower commission expenses
and other profit-dependent payroll related expenses. Sales and marketing
headcount increased to 1,316 at July 27, 2001 from 916 at July 28, 2000. We
expect to continue to selectively add sales capacity in an effort to expand
domestic and
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international markets, introduce new products, establish and expand new
distribution channels and increase product and company awareness. We do not
expect to increase our sales and marketing expenses materially in fiscal 2002.
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 23.1% to $29.1 million for the three-month period
ended July 27, 2001 from $23.6 million for the three-month period ended July 28,
2000. These expenses represented 14.5% and 10.2% of net sales for the
three-month periods ended July 27, 2001 and July 28, 2000, respectively.
Research and development expenses increased in absolute dollars, primarily as a
result of increased headcount, the operating impact of the Orca and WebManage
acquisitions, 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, partially
offset by cost control, reduction in discretionary spending efforts and lower
profit-related payroll and related costs. Research and development headcount
increased to 567 at July 27, 2001 from 381 at July 28, 2000.
During the first quarter of fiscal 2002, we continued our enterprise
focus by introducing new Center-to-Edge solutions for global Information
Technology (IT) infrastructures, offering greater data availability and enhanced
disaster recovery:
- - NetApp(R) DataFabric(TM) Manager, a software package for global
enterprise and content delivery network deployments allowing IT staff to
monitor and configure multiple storage and content delivery appliances
throughout a network;
- - new Fibre Channel Fabric Tape Storage Area Network (SAN) Backup
solutions, along with leading data protection companies, underscoring
our open storage networking approach to data management;
- - DiskShelf14, a new 14-slot Fibre Channel disk drive shelf that holds up
to one terabyte of data. Customers will benefit from the increased data
storage and performance densities, which help to lower their overall
cost of storage;
- - SnapManager 1.1 for Microsoft(R) Exchange 5.5 environments, a new
version of the industry-leading online backup and rapid data recovery
solution. SnapManager 1.1 simplifies data management by providing near
instantaneous on-line backup and recovery, faster response times, and
enhanced Windows(R) 2000 support;
- - SecureShare(R) Quota Manager 2.0, a graphical user interface tool to
centrally manage and control hard and soft quotas on thousands of
Microsoft Windows NT(R)/2000 versions working with many NetApp filers.
The solution is based on the Microsoft Management Console standard
interface, and allows for a single point of control across multiple
filers.
We believe that our future performance will depend in large part on our
ability to maintain and enhance our current product line, develop new products
that achieve market acceptance, maintain technological competitiveness and meet
an expanding range of customer requirements. We intend to continuously expand
our existing product offerings and introduce new products and expect that such
expenditures will continue to increase moderately in absolute dollars. For the
three-month periods ended July 27, 2001 and July 28, 2000, no software
development costs were capitalized.
General and Administrative -- General and administrative expenses
increased 15.6% to $10.3 million for the three-month period ended July 27, 2001,
from $8.9 million for the three-month period ended July 28, 2000. These expenses
represented 5.1% and 3.8% of net sales for the three-month periods ended July
27, 2001 and July 28, 2000, respectively. Increases in absolute dollars were
primarily due to increased headcount, expenses associated with initiatives to
enhance enterprise-wide management information systems and an increase in the
allowance for bad debts, partially offset by cost control, reduction in
discretionary spending efforts and lower profit-dependent personnel and other
expenses. General and administrative headcount increased to 261 at July 27, 2001
from 181 at July 28, 2000. We believe that our general and administrative
expenses will not increase significantly in absolute dollars in fiscal 2002.
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Amortization of Intangible Assets -- Amortization of intangible assets
represents the amortization on acquired intangible assets and the excess of the
aggregate purchase price over the fair value of the tangible and identifiable
intangible assets acquired by us. Intangible assets as of July 27, 2001,
including goodwill, existing workforce and technology, are being amortized over
estimated useful lives of three to five years. We assess the recoverability of
intangible assets by determining whether the amortized asset over its useful
life may be recovered through estimated useful cash flows. Amortization of
intangible assets charged to operations increased due to a full quarter impact
of the acquisitions occurring in fiscal 2002 and was $5.2 million and $0.7
million in the first quarter of fiscal 2002 and 2001, respectively.
In-process Research and Development -- We incurred in-process research
and development charges of approximately $26.7 million in the first quarter of
fiscal 2001 related to the acquisition of Orca. The purchase price of the
transaction was allocated to the acquired assets and liabilities based on their
estimated fair values as of the date of the acquisition. Approximately $26.7
million was allocated to in-process research and development and charged to
operations, because the acquired technology had not reached technological
feasibility and had no alternative uses. The value was determined by estimating
the costs to develop the acquired in-process technology into commercially viable
products, estimating the resulting net cash flows from such projects, and
discounting the net cash flows back to their present value. The discount rate
included a factor that took into account the uncertainty surrounding the
successful development of the acquired in-process technology. These estimates
are subject to change, given the uncertainties of the development process, and
no assurance can be given that deviations from these estimates will not occur.
Excluding the charge that may result from the remaining 198,373 contingently
issuable common shares, research and development costs to bring the products
from Orca to technological feasibility are not expected to have a material
impact on our future results of operations or financial condition. Costs
incurred prior to establishment of technological feasibility are charged to
research and development expense and have not been material through July 27,
2001.
We believe we can utilize the Orca acquisition to develop the first
virtual interface-based (VI) next generation of network storage systems. We are
leveraging VI architecture to develop the Direct Access File System (DAFS)
protocol. DAFS, as a file access protocol, reduces application server workloads
by eliminating the need for meta-data transfers and bypassing the overhead found
in traditional network protocol stacks. More importantly it leverages next
generation network capabilities such as remote direct memory access (RDMA) that
are found in VI and InfiniBand. We expect to continue the development of
products using this protocol and believe that there is a reasonable chance of
successfully delivering initial products in early calendar year 2002. However,
there is risk associated with the completion of the in-process project and there
can be no assurance that such project will meet with either technological or
commercial success. Failure to successfully develop and commercialize this
in-process project would result in the loss of the expected economic return
inherent in the fair value allocation. Additionally, the value of other
intangible assets acquired may become impaired. The risks associated with the
research and development are still considered high and no assurance can be made
that upcoming products will meet market expectations or gain market acceptance.
Stock Compensation -- We account for stock-based employee compensation
arrangements in accordance with provisions of APB No. 25, "Accounting for Stock
Issued to Employees," and comply with the provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation," for non-employee compensation awards.
Accordingly, we recognize the intrinsic value for employees and the fair value
for non-employees as stock compensation expense over the vesting terms of the
awards. Stock compensation expenses were $2.7 million and $0.4 million in the
first quarter of fiscal 2002 and 2001, respectively. This increase was primarily
attributable to the recognition of stock compensation on options assumed in the
WebManage acquisition, the issuance of 66,124 contingently issuable milestones
shares relating to Orca valued at $1.4 million, increased participation in the
salaried stock option grant program by certain highly compensated employees and
non-employee stock options awards.
Total Other Income, net -- Total other income, net, was $5.5 million and
$4.4 million for the three-month periods ended July 27, 2001 and July 28, 2000,
respectively. The increase is attributable to increased interest income
primarily due to higher average investment balances from cash, short-term
investments and restricted cash generated from operations and net proceeds from
stock option exercises,
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partially offset by lower average interest rates. We expect interest income to
moderately decline in future quarters in fiscal 2002, as existing investments
mature and proceeds are reinvested in a lower interest-rate environment.
Provision (Benefit) for Income Taxes -- For the three-month period ended
July 27, 2001, we applied an annual rate of 52% to pretax income. Our estimate
is based on existing tax laws and our current projections of income and
distributions of income among different entities and tax jurisdictions, and is
subject to change, based primarily on varying levels of profitability.
LIQUIDITY AND CAPITAL RESOURCES
As of July 27, 2001, as compared to the April 30, 2001 balances, our
cash, cash equivalents and short-term investments increased by $4.6 million to
$368.7 million. Working capital increased by $20.2 million to $437.0 million. We
generated cash from operating activities totaling $5.9 million and $63.8 million
for the three-month periods ended July 27, 2001 and July 28, 2000, respectively.
Net cash provided by operating activities for the three-month period ended July
27, 2001 was principally related to decreases in accounts receivable and
deferred income taxes and increases in other accrued liabilities, coupled with
depreciation, amortization of intangibles and stock compensation, partially
offset by net loss of $0.5 million, decreases in accounts payable, income taxes
payable, accrued compensation and related benefits, deferred revenue and
increases in inventories and prepaid expenses and other assets.
The primary factors that impacted the period-to-period change in cash
flows relating to operating activities included the following:
- lower accounts receivable balances due to lower sales and more
collections in the first quarter of fiscal 2002;
- non-cash acquisition-related charges, stock compensation and
depreciation included in net income (loss).
The above factors were partially offset by the effects of:
- decreased balances for accounts payable and deferred revenue due
to lower levels of business activity in the first quarter of
fiscal 2002;
- decreased accrued compensation and related benefits due to
payouts of profit dependent personnel expenses accrued in fiscal
2001 and paid in fiscal 2002, vacation taken during a July 2001
facility shutdown and lower commission accrual as a result of
lower levels of sales;
- decreased income taxes payable, primarily reflecting lower
profitability in fiscal 2002;
- lower net income in the first quarter of fiscal 2002.
Since we have curtailed capital expenditures, purchases of property and
equipment were only $6.8 million in the first quarter of fiscal 2002, compared
to $21.0 million the same period a year ago. The decrease was primarily
attributed to the slowdown in hiring and various cost control and cutting
measures. We have used $38.5 million and $6.6 million during the three-month
periods ended July 27, 2001 and July 28, 2000, respectively, for net purchases
of short-term investments. In the first quarter of fiscal 2001, we acquired Orca
for a purchase price of approximately $50.0 million, including common stock,
contingently issuable common stock, assumed options, cash payments of $2.0
million and related transaction costs. Investing activities in the three-month
period ended July 27, 2001 also included new equity investments of $0.2 million.
We have received $6.9 million and $19.7 million during the three-month
periods ended July 27, 2001 and July 28, 2000, respectively, from financing
activities, primarily from the sale of common stock. The decrease in cash
provided by sales of common stock for the three-month period ended July 27,
2001, compared to the corresponding period of the prior fiscal year, was
primarily due to lower stock option exercise proceeds as a result of the recent
decline in our stock price. This decrease was partially offset by a
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greater number of employees participating in the employee stock purchase plan
and an increase in restricted cash. See "Commitments, Note 9 to the Notes to the
Condensed Consolidated Financial Statements."
Excluding the commitments related to operating lease arrangements for
various properties in our Sunnyvale headquarters, which aggregate $309.0
million, we currently have no significant commitments other than commitments
under operating leases. We believe that our existing liquidity and capital
resources, including the available amounts under our $5.0 million line of
credit, are sufficient to fund our operations for at least the next twelve
months. We may also investigate other financing alternatives; however, we cannot
be certain that additional financing will be available on satisfactory terms.
NEW ACCOUNTING STANDARDS
In June 2001, the Financial Accounting Standards Board issued SFAS No.
141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible
Assets". Under SFAS No. 141, all business combinations initiated after June 30,
2001 must be accounted for using the purchase method. Under SFAS No. 142,
goodwill and intangible assets with indefinite lives are no longer amortized but
are reviewed annually for impairment (or more frequently if indicators of
impairment arise). Separable intangible assets that are not deemed to have
indefinite lives will continue to be amortized over their useful lives (but with
no maximum life). The amortization provisions of SFAS No. 142 apply to goodwill
and intangible assets acquired after June 30, 2001. With respect to goodwill and
intangible assets acquired prior to July 1, 2001, we are required to adopt SFAS
No. 142 effective April 27, 2002. Upon adoption of SFAS No. 142, we will stop
the amortization of goodwill with a net carrying value of approximately $48,912
at April 26, 2002 and the annual amortization of $14,575 that resulted from
business combinations initiated prior to the adoption. We will evaluate goodwill
under the SFAS No. 142 transitional impairment test. Any transitional impairment
loss will be recognized as a change in accounting principle on the date of
adoption. If any impairment of goodwill is recognized prior to the date of
adoption, the loss will be charged to operating expenses.
RISK FACTORS
The following risk factors and other information included in this Form
10-Q should be carefully considered. The risks and uncertainties described below
are not the only ones we face. Additional risks and uncertainties not presently
known to us or that we presently deem less significant may also impair our
business operations. If any of the following risks actually occur, our business,
operating results, and financial condition could be materially adversely
affected.
FACTORS BEYOND OUR CONTROL COULD CAUSE OUR QUARTERLY RESULTS TO FLUCTUATE.
Although we have experienced significant revenue growth in recent
periods prior to the third quarter of fiscal 2001, 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 operations 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:
- general economic trends;
- global trends related to Information Technology spending;
- demand for storage and content delivery products;
- 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 develop, introduce, and market new products and
enhancements in a timely manner;
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- 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; and
- seasonality.
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 also difficult to forecast
because the network storage market is rapidly evolving and our sales cycle
varies substantially from customer to customer.
Due to all of the foregoing factors, it is possible that in one or more
future quarters our results may fall below the expectations of public market
analysts and investors, as has been the case through the last two quarters of
fiscal 2001 and first quarter of fiscal 2002. In such event, the trading price
of our common stock would likely decrease.
OUR GROSS MARGINS MAY VARY BASED ON THE CONFIGURATION OF OUR PRODUCTS.
We derive a significant portion of our sales from the resale of disk
drives as components of our filers, and the resale market for hard disk drives
is highly competitive and subject to intense pricing pressures. Our sales of
disk drives generate lower gross margin percentages than those of our filer
products. As a result, as we sell more highly configured systems with greater
disk drive content, overall gross margin percentages will be negatively
affected. Conversely, we believe our increased licensing of add-on software
products may favorably impact gross margins.
Our gross margins have been and may continue to be affected by a variety
of other factors, including:
- demand for storage and content delivery products;
- discount levels and price competition;
- direct versus indirect sales;
- the mix of software as a percentage of revenue;
- the mix and average selling prices of products;
- new product introductions and enhancements; and
- the cost of components, manufacturing labor, and quality.
A SIGNIFICANT PERCENTAGE OF OUR EXPENSES ARE FIXED WHICH COULD AFFECT OUR NET
INCOME.
Our expense levels are based in part on our expectations as to future
sales and a significant percentage of our expenses are fixed. As a result, if
sales levels are below expectations, as has been the case through the second
half of fiscal 2001 and the first quarter of fiscal 2002, net income will be
disproportionately affected.
OUR FUTURE FINANCIAL PERFORMANCE DEPENDS ON GROWTH IN THE NETWORK STORAGE AND
CONTENT DELIVERY MARKET AND ANY LACK OF GROWTH WILL HAVE A MATERIAL ADVERSE
EFFECT ON OUR OPERATING RESULTS.
All of our products address the storage and content delivery market.
Accordingly, our future financial performance will depend in large part on
continued growth in the storage and content delivery market and on emerging
standards in these markets. We cannot assure you that the market for storage and
content delivery will continue to grow or that emerging standards in these
markets will not adversely affect the growth of UNIX, Windows NT and the World
Wide Web server markets. In addition, our business also depends on general
economic and business conditions. A reduction in demand for network storage and
content delivery caused by weakening economic conditions and decreases in
corporate spending has resulted in decreased revenues or lower revenue growth
rates. The network storage and content delivery market growth declined
significantly beginning in the third quarter of fiscal 2001, causing both our
revenues and operating results to decline. If the network storage and content
delivery markets grow more
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slowly than anticipated or if network storage and content delivery based on
emerging standards other than those adopted by us become increasingly accepted
by the market, our operating results could be materially adversely affected.
THE MARKET PRICE FOR OUR COMMON STOCK HAS FLUCTUATED SIGNIFICANTLY IN THE PAST
AND WILL LIKELY CONTINUE TO DO SO IN THE FUTURE.
The market price for our common stock has been volatile in the past, and
several factors could cause the price to fluctuate substantially in the future.
These factors include:
- fluctuations in our operating results;
- fluctuations in the valuation of companies perceived by
investors to be comparable to us;
- a shortfall in revenues or earnings compared to securities
analysts' expectations;
- changes in analysts' recommendations or projections;
- announcements of new products, applications or product
enhancements by us or our competitors; and
- changes in our relationships with our suppliers, customers and
strategic partners.
In addition, the stock market has experienced volatility that has
particularly affected the market prices of equity securities of many high
technology companies. Additionally, certain macro economic factors such as
changes in interest rates as well as market climate for the high technology
sector could also have an impact on the trading price of our stock. As a result,
the market price of our common stock may fluctuate significantly in the future
and any broad market decline, as well as our own operating results, may
materially adversely affect the market price of our common stock.
THE SUCCESS OF OUR NETCACHE APPLIANCE PRODUCTS DEPENDS UPON MARKET ACCEPTANCE OF
CACHING TECHNOLOGY AND CONTINUED GROWTH IN THE CONTENT DELIVERY MARKET.
In late 1997, we released our NetCache appliance products, a new
category of hardware-based Internet caching appliances designed to speed and
manage the delivery of information stored on the Web. However, hardware-based
caching technology is still developing.
Our future financial performance will depend in part on the acceptance
of caching technology and the acceptance of our NetCache appliance products. We
cannot assure you that the caching appliance market will continue to grow at
previous rates or at all.
IF WE ARE UNABLE TO DEVELOP AND INTRODUCE NEW PRODUCTS AND RESPOND TO
TECHNOLOGICAL CHANGE, OR IF OUR NEW PRODUCTS DO NOT ACHIEVE MARKET ACCEPTANCE,
OUR OPERATING RESULTS COULD BE MATERIALLY ADVERSELY AFFECTED.
Our future growth depends upon the successful development and
introduction of new hardware and software products. Due to the complexity of
storage sub-systems and Internet caching devices, and the difficulty in gauging
the engineering effort required to produce new products, such products are
subject to significant technical risks. However, we cannot assure you that any
of our new products will achieve market acceptance. Additional product
introductions in future periods may also impact the sales of existing products.
In addition, our new products must respond to technological changes and evolving
industry standards. If we are unable, for technological or other reasons, to
develop and introduce new products in a timely manner in response to changing
market conditions or customer requirements, or if such products do not achieve
market acceptance, our operating results could be materially adversely affected.
WE DEPEND ON ATTRACTING AND RETAINING QUALIFIED TECHNICAL AND SALES PERSONNEL.
Our continued success depends, in part, on our ability to identify,
attract, motivate and retain qualified technical and sales personnel. Because
our future success is dependent on our ability to continue to enhance and
introduce new products, we are particularly dependent on our ability to
identify, attract, motivate and retain qualified engineers with the requisite
education, backgrounds and industry experience. Competition for qualified
engineers, particularly in Silicon Valley, is intense. The loss of the services
of a
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significant number of our engineers or sales people could be disruptive to our
development efforts or business relationships and could materially adversely
affect our operating results.
RISKS INHERENT IN OUR INTERNATIONAL OPERATIONS COULD HAVE A MATERIAL ADVERSE
EFFECT ON OUR OPERATING RESULTS.
We conduct business internationally. For the three-month periods ended
July 27, 2001 and July 28, 2000, approximately 39.0% and 31.6% of our net sales,
respectively, 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. There can be no assurance that such hedging
strategy will be successful and that currency exchange rate fluctuations will
not have a material adverse effect on our operating results.
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. Such factors could materially adversely affect our future
international sales and, consequently, our operating results.
Although operating results have not been materially adversely affected
by seasonality in the past, because of the significant seasonal effects
experienced within the industry, particularly in Europe, our future operating
results could be materially adversely affected by seasonality.
We cannot assure you that we will be able to maintain or increase
international market demand for our products. We believe our net sales will not
increase in fiscal 2002 at the rate at which they grew in fiscal 2001.
AN INCREASE IN COMPETITION COULD MATERIALLY ADVERSELY AFFECT OUR OPERATING
RESULTS.
The storage and content delivery markets are intensely competitive and
are characterized by rapidly changing technology.
In the storage market, our filer appliances and data management software
compete primarily against storage products and data management software from EMC
Corporation, Hitachi Data Systems, Compaq Computer Corporation, Sun
Microsystems, Inc., Hewlett-Packard Company, and IBM Corporation. We also
encounter less frequent competition from companies including MTI Corp., Procom
Technology, LSI Logic Corp., and Auspex Systems, Inc.
In the content delivery market, our NetCache appliances and content
delivery software compete against caching appliance and content delivery
software vendors including Cisco Systems, Inc., CacheFlow, Inc., Inktomi Corp.,
Akamai Technologies, Inc., and Volera.
This past year has seen an increasing number of new, privately held
companies attempting to enter our markets, some of which may become significant
competitors in the future.
We believe that the principal competitive factors affecting our market
include but are not limited to:
- Response time and performance
- Scalability
- Data availability
- Multiprotocol data sharing
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- Acquisition price and low overall total cost of ownership
- Ease-of-use and deployment
- Customer service and support
Although we believe that our products currently compete favorably with
respect to these factors, we can not assure you that we can maintain our
competitive position against current and potential competitors, especially those
with significantly greater financial, marketing, service, support, technical,
and other resources.
Increased competition could result in price reductions, reduced gross
margins and loss of market share, any of which could materially adversely affect
our operating results. Our competitors may be able to respond more quickly than
we can to new or emerging technologies and changes in customer requirements, or
devote greater resources to the development, promotion, sale and support of
their products. In addition, current and potential competitors have established
or may establish cooperative relationships among themselves or with third
parties. Accordingly, it is possible that new competitors or alliances among
competitors may emerge and rapidly acquire significant market share. We cannot
assure you that we will be able to compete successfully against current or
future competitors. Competitive pressures we face could materially adversely
affect our operating results.
WE RELY ON A LIMITED NUMBER OF SUPPLIERS AND ANY DISRUPTION OR TERMINATION OF
THESE SUPPLY ARRANGEMENTS COULD DELAY SHIPMENT OF OUR PRODUCTS AND COULD
MATERIALLY ADVERSELY AFFECT OUR OPERATING RESULTS.
We rely on a limited number of suppliers of several key components
utilized in the assembly of our products. We purchase most of our disk drives
through a single supplier. We purchase computer boards and microprocessors from
a limited number of suppliers. Our reliance on a limited number of suppliers
involves several risks, including:
- a potential inability to obtain an adequate supply of required
components because we do not have long-term supply commitments;
- supplier capacity constraints;
- price increases;
- timely delivery; and
- component quality.
In the future, we intend to increasingly rely on contract manufacturers
to assemble our products. If our contract manufacturers' operations were
interrupted for any reason, our ability to meet scheduled product deliveries to
customers would be materially adversely affected.
Component quality is particularly significant with respect to our
supplier of disk drives. In order to meet product performance requirements, we
must obtain disk drives of extremely high quality and capacity. In addition,
there are periodic supply and demand issues for disk drives, microprocessors and
for semiconductor memory components, which could result in component shortages,
selective supply allocations and increased prices of such components. We cannot
assure you that we will be able to obtain our full requirements of such
components in the future or that prices of such components will not increase. In
addition, problems with respect to yield and quality of such components and
timeliness of deliveries could occur. Disruption or termination of the supply of
these components could delay shipments of our products and could materially
adversely affect our operating results. Such delays could also damage
relationships with current and prospective customers.
WE CANNOT ASSURE YOU THAT WE WILL NOT INCUR PROBLEMS WITH CURRENT OR FUTURE
EQUITY INVESTMENTS AND ACQUISITIONS OR THAT WE WILL REALIZE VALUE FROM SUCH
STRATEGIC RELATIONSHIPS.
We are continuously evaluating alliances and external investment in
technologies related to our business. We have already made relatively small
strategic investments in a number of network storage related technology
companies and acquired two companies since the beginning of fiscal 2001. Equity
investments may result in the loss of investment capital. Acquisitions of
companies or products and alliances and strategic investments entail numerous
risks, and we cannot assure you that we will be able to successfully integrate
acquired operations and products or to realize anticipated synergies, economies
of
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scale, or other value. In addition, we may experience a diversion of
management's attention, the loss of key employees of acquired operations or the
inability to recover strategic investments in development stage entities. Any
such problems could have a material adverse effect on our business, financial
condition and results of operation.
WE DO NOT HAVE EXCLUSIVE RELATIONSHIPS WITH OUR DISTRIBUTORS AND ACCORDINGLY
THERE IS A RISK THAT THOSE DISTRIBUTORS MAY GIVE HIGHER PRIORITY TO PRODUCTS OF
OTHER SUPPLIERS, WHICH COULD MATERIALLY ADVERSELY AFFECT OUR OPERATING RESULTS.
Our distribution customers generally offer products of several different
companies, including products of our competitors. Accordingly, there is risk
that these distributors may give higher priority to products of other suppliers,
which could materially adversely affect our operating results.
UNDETECTED SOFTWARE ERRORS OR FAILURES FOUND IN NEW PRODUCTS MAY RESULT IN LOSS
OF OR DELAY IN MARKET ACCEPTANCE OF OUR PRODUCTS WHICH COULD MATERIALLY
ADVERSELY AFFECT OUR OPERATING RESULTS.
Our products may contain undetected software errors or failures when
first introduced or as new versions are released. Despite testing by us and by
current and potential customers, errors may not be found in new products until
after commencement of commercial shipments, resulting in loss of or delay in
market acceptance, which could materially adversely affect our operating
results.
IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY WE MAY BE SUBJECT TO
INCREASED COMPETITION THAT COULD MATERIALLY ADVERSELY AFFECT OUR OPERATING
RESULTS.
Our success depends significantly upon our proprietary technology. We
currently rely on a combination of copyright and trademark laws, trade secrets,
confidentiality procedures, contractual provisions and patents to protect our
proprietary rights. We seek to protect our software, documentation and other
written materials under trade secret, copyright and patent laws, which afford
only limited protection. Other United States trademarks and some of the other
United States--registered trademarks are registered internationally as well. We
will continue to evaluate the registration of additional trademarks as
appropriate. We generally enter into confidentiality agreements with our
employees and with our resellers and customers. We currently have multiple
United States and international patent applications pending and multiple United
States patents issued. The pending applications may not be approved and if
patents are issued, such patents may be challenged. If such challenges are
brought, the patents may be invalidated. We cannot assure you that we will
develop proprietary products or technologies that are patentable, that any
issued patent will provide us with any competitive advantages or will not be
challenged by third parties, or that the patents of others will not materially
adversely affect our ability to do business.
Litigation may be necessary to protect our proprietary technology. Any
such litigation may be time-consuming and costly. Despite our efforts to protect
our proprietary rights, unauthorized parties may attempt to copy aspects of our
products or to obtain and use information that we regard as proprietary. In
addition, the laws of some foreign countries do not protect proprietary rights
to as great an extent as do the laws of the United States. We cannot assure you
that our means of protecting our proprietary rights will be adequate or that our
competitors will not independently develop similar technology, duplicate our
products or design around patents issued to us or other intellectual property
rights of ours.
We are subject to intellectual property infringement claims. We may,
from time to time receive claims that we are infringing third parties'
intellectual property rights. Third parties may in the future claim infringement
by us with respect to current or future products, patents, trademarks or other
proprietary rights. We expect that companies in the appliance market will
increasingly be subject to infringement claims as the number of products and
competitors in our industry segment grows and the functionality of products in
different industry segments overlaps. Any such claims could be time-consuming,
result in costly litigation, cause product shipment delays, require us to
redesign our products or require us to enter into royalty or licensing
agreements, any of which could materially adversely affect our operating
results. Such royalty or licensing agreements, if required, may not be available
on terms acceptable to us or at all.
PROTECTIVE ANTI-TAKEOVER PROVISIONS IN OUR CHARTER AND BYLAWS COULD MATERIALLY
ADVERSELY AFFECT STOCKHOLDERS.
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Our Board of Directors has the authority to issue up to 5,000,000 shares
of preferred stock and to determine the price, rights, preferences, privileges
and restrictions, including voting rights, of those shares without any further
vote or action by the shareholders. The rights of the holders of common stock
will be subject to, and may be materially adversely affected by, the rights of
the holders of any preferred stock that may be issued in the future. The
issuance of preferred stock could have the effect of making it more difficult
for a third party to acquire a majority of our outstanding voting stock.
Further, certain provisions of our bylaws pertaining to the future elimination
of cumulative voting and shareholder action by written consent could delay or
make more difficult a proxy contest involving us, which could materially
adversely affect the market price of our common stock.
WE RELY ON A CONTINUOUS POWER SUPPLY AND ANY POWER SHORTAGE COULD INTERRUPT OUR
MANUFACTURING OPERATIONS AND COULD MATERIALLY ADVERSELY AFFECT OUR OPERATING
RESULTS.
California is in the midst of an energy crisis that could disrupt our
operations and increase our expenses. In the event of an acute power shortage,
that is, when power reserves for the State of California fall below certain
critical levels, California has on some occasions implemented, and may in the
future continue to implement, rolling blackouts. We currently have limited
backup generators or alternate sources of power in the event of a blackout, and
our current insurance does not provide coverage for any damages we or our
customers/suppliers may suffer as a result of any interruption in our power
supply. If blackouts interrupt our power supply or our suppliers' power supply,
we could be temporarily unable to continue operations at our California
facilities. Any such interruption in our ability to continue operations at our
facilities or our suppliers' facilities to manufacture products could damage our
reputation, harm our ability to retain existing customers and to obtain new
customers, and could result in lost revenue, any of which could materially
adversely affect our operating results.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk related to fluctuations in interest rates,
market prices and 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 Board-approved policies.
Market Interest and Interest Income Risk
Interest and Investment Income -- As of July 27, 2001, we had short-term
investments of $129.4 million. Our investment portfolio consists of highly
liquid investments with original maturities at the date of purchase between
three and twelve months and investment in marketable equity securities in
certain technology companies. These highly liquid investments, consisting
primarily of government and corporate debt securities, are subject to interest
rate and interest income risk and will decrease in value if market interest
rates increase. A hypothetical 10 percent increase in market interest rates from
levels at July 27, 2001, would cause the fair value of these short-term
investments to decline by an immaterial amount. Because we have the ability to
hold these investments until maturity we would not expect any significant
decline in value of our investments caused by market interest rate changes.
Declines in interest rates over time will, however, reduce our interest income.
We do not use derivative financial instruments in our investment portfolio.
Operating Lease Commitments -- As of July 27, 2001, we have outstanding
lease commitments to a third-party entity under operating lease agreements,
which vary based on a monthly LIBOR rate plus a spread. A hypothetical 10
percent increase in interest rates would increase our annual rent expense under
operating lease commitments by approximately $1.3 million. Increases in interest
rates could, however, increase our rent expenses associated with future lease
payments. We do not currently hedge against interest rate increases. Our
investment portfolio offers a natural hedge against interest rate risk from our
operating lease commitments in the event of a significant increase in the market
interest rate. Moreover, a total of $195.3 million in operating leases are
collateralized with investments that have similar, and thus offsetting, interest
rate characteristics.
Market Price Risk
Equity Securities -- We are also exposed to market price risk on our
equity securities included in our short-term investments. These investments are
in publicly traded companies in the volatile high-technology industry sector. We
do not attempt to reduce or eliminate our market exposure on these securities
and as a result, the amount of income and cash flow that we ultimately realize
from these investments in future periods may vary materially from the current
unrealized amount. A 50% adverse change in the equity price would result in an
approximate $4.2 million decrease in the fair value of our equity securities as
of July 27, 2001.
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.
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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 27, 2001, (in thousands):
BUY/ FOREIGN CONTRACT VALUE FAIR VALUE
CURRENCY SELL CURRENCY AMOUNT USD IN USD
- -----------------------------------------------------------------------------------
AUD Sell 5,911 $ 2,978 $ 2,983
CHF Sell 1,539 $ 895 $ 895
GBP Sell 13,235 $18,817 $18,840
EUR Sell 47,465 $41,409 $41,437
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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
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
None
(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
Executive Vice President Finance and
Operations, and Chief Financial Officer
Date: September 10, 2001
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