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July 26, 2001
NETWORK APPLIANCE INC (NTAP)
Annual Report (SEC form 10-K)
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of our financial condition and results of operations should be read together with the financial statements
and the related notes thereto set forth under "Item 8. Financial Statements and Supplementary Data." This discussion contains
forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in
those forward-looking statements as a result of certain factors, including those set forth in "Item 1. Business Risk Factors" and
elsewhere in this Annual Report on Form 10-K.
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. Today we are a leader in delivering high-performance network storage and content
delivery solutions on a network. Our storage and content delivery platforms (filers and NetCache appliances) are coupled with
content distribution and reporting software. This Center-to-Edge solution offers seamless data management from the back-end
data center to the edge of the network quickly, simply, and reliably.
We derive a substantial portion of our revenue from the sales of our network filer and caching appliances. As a result, a reduction
in the demand for our filer and NetCache appliances due to increased competition, a general decline in the market for network
storage and content delivery or other factors could materially adversely affect our operating results.
Our gross margin has 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;
- product configuration;
- direct versus indirect sales;
- the mix of software as a percentage of revenue;
- the mix and average selling prices of products;
- new product introductions and enhancements; and
- the cost of components, manufacturing labor and quality.
Operating results have not been materially adversely affected by seasonality in the past. However, because of the significant
summer seasonal effects experienced within the industry, particularly in Europe, our future operating results could be materially
adversely affected by seasonality.
For the year ended April 30, 2001 approximately 38.0% of our net sales were derived from 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. For more information on risks associated with our international operations, see "Item 1
Business Risk Factors Risks inherent in our international operations could have a material adverse effect on our operating results."
RESULTS OF OPERATIONS
The following table sets forth certain consolidated statements of income data as a percentage of net sales for the periods
indicated:
YEARS ENDED APRIL 30,
-----------------------
2001 2000 1999
----- ----- -----
Net Sales................................................... 100.0% 100.0% 100.0%
Cost of Sales............................................... 39.9 40.7 40.8
----- ----- -----
Gross Margin.............................................. 60.1 59.3 59.2
----- ----- -----
Operating Expenses:
Sales and Marketing....................................... 28.7 26.6 26.0
Research and Development.................................. 12.0 10.6 10.4
General and Administrative................................ 4.0 3.6 3.4
Amortization of Intangible Assets......................... 1.2 -- --
In-process Research and Development....................... 2.7 -- --
Stock Compensation........................................ 0.6 0.2 0.3
----- ----- -----
Total Operating Expenses.......................... 49.2 41.1 40.1
----- ----- -----
Income From Operations...................................... 10.9 18.2 19.1
Other Income, Net........................................... 2.3 1.5 0.6
----- ----- -----
Income Before Income Taxes.................................. 13.2 19.7 19.7
Provision for Income Taxes.................................. 5.8 7.0 7.4
----- ----- -----
Net Income.................................................. 7.4% 12.7% 12.3%
===== ===== =====
FISCAL 2001 COMPARED TO FISCAL 2000
Business Combinations During the first quarter of fiscal 2001, we acquired Orca Systems, Inc. for a purchase price of $50.0
million in common stock, assumed options and cash, with an obligation to provide 264,497 shares of common stock, which will
result in additional stock compensation charges if certain performance criteria are achieved. We also paid certain transaction costs
and assumed certain operating assets and liabilities. The acquisition was accounted for as a purchase. The purchase price of the
transaction was allocated to the acquired assets and liabilities based on their estimated fair values as of the date of the acquisition.
Amounts allocated to existing workforce and goodwill are being amortized on a straight-line basis over three-and five-year periods,
respectively. Approximately $26.7 million was allocated to in-process research and development and charged to operations
because the acquired technology had not reached technological feasibility and had no alternative uses.
During the third quarter of fiscal 2001, we acquired WebManage Technologies, Inc. for $59.4 million in common stock, assumed
options and cash, with an obligation to provide shares of common stock to be valued at $3.0 million, if certain performance criteria
are achieved. The performance criteria were met in March 2001 and the contingent consideration has been recorded as stock
compensation in the fourth quarter of 2001. We also paid certain transaction costs and assumed certain operating assets and
liabilities. The acquisition was accounted for as a purchase. The purchase price of the transaction was allocated to the acquired
assets and liabilities based on their estimated fair values as of the date of the acquisition. Amounts allocated to existing technology
and workforce are being amortized on a straight-line basis over three years and amounts allocated to goodwill are being amortized
over five years.
Net Sales Net sales increased by 73.7% to $1,006.2 million in fiscal 2001, from $579.3 million in fiscal 2000. Net sales growth was
across all geographies, products and markets. This increase in net sales was primarily attributable to a higher volume of units
shipped, as compared to the corresponding period of the
prior fiscal year. This growth in volume declined in the second half of fiscal 2001. Factors impacting unit growth include:
- demand for our F700 filers utilizing primarily fibre-channel disks;
- introduction of our new higher capacity F840, mid-range F820 and F85 entry-level filer products;
- increased worldwide demand for our NetCache appliances and content delivery network solutions;
- increased worldwide shipment of NetApp Cluster Failover solutions, which require another filer to take over in the event of a
hardware failure;
- increased demand for the SnapMirror software option, which requires multiple filers to provide remote mirroring of data for quick
disaster recovery and backup at remote sites;
- expansion of our sales organization to 976 in fiscal 2001 from 582 in fiscal 2000; and
- increased sales through indirect channels, including sales through our OEM partners, representing 23.9% and 28.0% of total net
sales for fiscal 2001 and 2000, respectively.
Net sales growth was also positively impacted by:
- a higher average selling price of our add-on software options: SnapMirror, SnapRestore and SnapManager for Microsoft
Exchange and Cluster Failover, supporting mission-critical applications;
- a higher average selling price of our new high-end F840 filer;
- a higher average selling price due to the introduction of NetCache software features, including ContentReporter and
ContentDirector;
- 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 demand for our products in the second half of fiscal 2001;
- declining average selling price of the F700 filers and caching products due to competitive pricing; and
- declining unit sales of our older product family.
International net sales (including United States exports) grew by 115.0% for fiscal 2001 as compared to fiscal 2000. International
net sales were $382.5 million, or 38.0% of total net sales for fiscal 2001. The increase in international sales for fiscal 2001, was
primarily a result of European and Asia Pacific net sales growth, due to increased headcount in the direct sales force, increased
indirect channel sales, increased shipments of filers, Cluster Failover solutions and NetCache appliances and increased sales of
add-on software licenses, as compared to the corresponding periods of the prior fiscal year. 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 increased to 60.1% of net sales for fiscal 2001, from 59.3% for fiscal 2000.
Gross margin was favorably impacted by:
- increased licensing of add-on software options such as Multi-Protocol, Cluster Failover, SnapMirror, SnapRestore, SnapManager
and new software introductions including ContentReporter and ContentDirector;
- growth in software subscriptions due primarily to a larger installed base;
- lower costs of key components;
- the increase in product volume;
- increased manufacturing efficiencies; and
- a mix shift to high-end F840 systems sold as diskless upgrades, carrying higher margin than configured systems.
Gross margin was negatively impacted by sales price reductions on storage products due to competitive pricing pressure, higher
disk content with an expanded storage capacity for the F840 filer, lower sales volume in the second half of fiscal 2001, lower of
cost or market adjustments to inventory and increased investments in customer service.
Our gross margin has been and may continue to be affected by a variety of factors, including:
- demand for our products;
- discount levels and price competition;
- product configuration;
- direct versus indirect sales;
- the mix of software as a percentage of revenue;
- the mix and average selling prices of products;
- new product introductions and enhancements; and
- the cost of components, manufacturing labor and quality.
Sales and Marketing Sales and marketing expenses consist primarily of salaries, commissions, advertising and promotional
expenses and certain customer service and support costs. Sales and marketing expenses increased 87.8% to $289.0 million for
fiscal 2001 from $153.9 million for fiscal 2000. These expenses were 28.7% and 26.6% of net sales for fiscal 2001 and 2000,
respectively. The increase in absolute dollars was primarily related to the continued worldwide expansion of our sales and
customer service organizations, expansion of various marketing and industry initiatives, increased commission expenses in the first
three quarters and disposal of certain capital assets in the fourth quarter. Sales and marketing headcount increased to 1,277 in
fiscal 2001 from 775 in fiscal 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 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 96.4% to
$120.9 million in fiscal 2001 from $61.6 million in fiscal 2000. These expenses represented 12.0% and 10.6% of net sales, for
fiscal year 2001 and 2000, respectively. Research and development expenses increased in absolute dollars, primarily as a result of
increased headcount, operating impact of 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, including the NetApp F85, F800 series filers and the new generation of our
NetCache appliances coupled with our content distribution and reporting software. Research and development headcount
increased to 566 in fiscal 2001 from 327 in fiscal 2000. 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 both fiscal 2001 and 2000, no software development costs were capitalized.
General and Administrative General and administrative expenses increased 90.7% to $40.2 million in fiscal 2001, from $21.5
million in fiscal 2000. These expenses represented 4.0% and 3.6% of net sales, for fiscal
2001 and 2000, respectively. Increases in absolute dollars were primarily due to increased headcount, expenses associated with
initiatives to enhance enterprise-wide management information systems and increased professional service fees. General and
administrative headcount increased to 253 in fiscal 2001 from 162 in fiscal 2000. We believe that our general and administrative
expenses will not increase significantly in absolute dollars in fiscal 2002.
Amortization of Intangible Assets Amortization of intangible assets represents the excess of the aggregate purchase price over the
fair value of the tangible and identifiable intangible assets acquired by us. Intangible assets as of April 30, 2001, including goodwill,
existing workforce and technology, are being amortized over the estimated useful life of three to five-year periods. 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 was $11.7 million and $0.2 million in fiscal
2001 and 2000, respectively.
In-process Research and Development We incurred in-process research and development charges of approximately $26.7 million
in fiscal 2001 related to the acquisition of Orca. The purchase price of the transaction was allocated to the acquired assets and
liabilities based on their estimated fair values as of the date of the acquisition. Approximately $26.7 million was allocated to
in-process research and development and charged to operations, because the acquired technology had not reached technological
feasibility and had no alternative uses. The value was determined by estimating the costs to develop the acquired in-process
technology into commercially viable products, estimating the resulting net cash flows from such projects, and discounting the net
cash flows back to their present value. The discount rate included a factor that took into account the uncertainty surrounding the
successful development of the acquired in-process technology. These estimates are subject to change, given the uncertainties of
the development process, and no assurance can be given that deviations from these estimates will not occur. Excluding the charge
that may result from 264,497 contingently issuable common shares, research and development costs to bring the products from
Orca to technological feasibility are not expected to have a material impact on our future results of operations or financial
condition.
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 enables data
transfers straight from the file server, allowing clusters of application servers in heterogeneous environments to share data from
the memory of one system to the memory of another without involving general-purpose operating systems, thereby improving CPU
utilization and speeding up data access. We expect to continue the development of products using this protocol and believe that
there is a reasonable chance of successfully delivering initial products in calendar year 2001. However, there is risk associated
with the completion of the in-process project and there can be no assurance that such project will meet with either technological or
commercial success. Failure to successfully develop and commercialize this in-process project would result in the loss of the
expected economic return inherent in the fair value allocation. Additionally, the value of other intangible assets acquired may
become impaired. The risks associated with the research and development are still considered high and no assurance can be made
that upcoming products will meet market expectations or gain market acceptance.
Stock Compensation We account for stock-based employee compensation arrangements in accordance with provisions of APB
No. 25, "Accounting for Stock Issued to Employees," for employee compensation awards 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 $6.2 million and $1.3 million in fiscal 2001 and 2000, respectively. This increase was
primarily attributable to the recognition of stock compensation of unvested options assumed in the WebManage acquisition,
issuance of contingently issuable milestones shares, 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 $23.4 million and $9.0 million in fiscal 2001 and 2000, respectively. The
increase in interest income was primarily due to increased cash and short-term investments generated from operations and net
proceeds from stock option exercises.
Provision for Income Taxes Our effective tax was 34.5%, excluding the effect of non-deductible amortization of goodwill and
acquired in-process research and development of $35.5 million for fiscal 2001. The effective tax rate for fiscal 2000 was 35.5%.
The effective tax rates differed from the U.S. statutory rate primarily due to state taxes, credits, tax exempt interest, goodwill
amortization and acquired in-process research and development.
FISCAL 2000 COMPARED TO FISCAL 1999
Net Sales Net sales increased by 100.2% to $579.3 million in fiscal 2000, from $289.4 million in fiscal 1999. Net sales growth was
across all geographies, products and markets. This increase was primarily attributable to a higher volume of units shipped, as
compared to the corresponding period of the prior fiscal year. Factors impacting unit growth include:
- strong demand for our F700 filer products utilizing primarily fibre-channel connectivity;
- increased worldwide demand for our NetCache solutions;
- increased worldwide shipment of NetApp Cluster Failover solutions, which require another filer to take over in the event of a
hardware failure;
- increased demand for the SnapMirror software option, which requires multiple filers to provide remote mirroring of data for quick
disaster recovery and backup at remote sites;
- expansion of our sales organization to 582 in fiscal 2000, from 309 in fiscal 1999; and
- increased sales through indirect channels, representing 28.0% of total sales compared to 25.2% in the prior year, including sales
through our two OEM partners.
Net sales growth was also positively impacted by:
- a higher average selling price due to the introduction of new software features: SnapMirror, SnapRestore 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 products and declining average selling price of the
caching products due primarily to competitive pricing pressure.
International net sales (including United States exports) grew by 100.4% for fiscal 2000, as compared to fiscal 1999. International
net sales were $177.9 million, or 30.7% of total net sales for fiscal 2000. The increase in international sales for fiscal 2000, was
primarily a result of European sales growth, due to increased headcount in the direct sales force, increased indirect channel sales,
increased shipments of filers, Cluster Failover solutions, NetCache appliances and increased sales of add-on software licenses.
Asia Pacific net sales growth for fiscal 2000, was also primarily driven by increased sales through resellers, increased headcount
in the direct sales force, increased shipments of filers, and NetCache appliances and increased sales of add-on software licenses,
as compared to fiscal 1999.
We cannot assure you that our net sales will continue to increase in absolute dollars or at the rate at which they have grown in
recent fiscal periods.
Gross Margin Gross margin increased slightly to 59.3% of net sales for fiscal 2000, from 59.2% for fiscal 1999.
Gross margin was favorably impacted by:
- increased licensing of add-on software options such as: multi-protocol, Cluster Failover, SnapMirror and SnapRestore associated
with new filers shipped;
- growth in software subscription due primarily to a larger installed base;
- increased manufacturing efficiencies;
- the increase in product volume; and
- lower costs of key components.
Gross margin was negatively impacted by sales price reductions on storage products due to competitive pricing pressure from
other storage vendors and increased investments in customer service personnel in areas such as logistics and professional
services.
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 104.4% to $153.9 million for
fiscal 2000 from $75.3 million for fiscal 1999. These expenses were 26.6% and 26.0% of net sales for fiscal 2000 and 1999,
respectively. 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. Sales and marketing headcount
increased from 411 at April 30, 1999 to 775 at April 30, 2000. In fiscal 2000, we launched various marketing and advertising
programs, which also contributed to absolute dollar increases in sales and marketing 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 105.5% to
$61.6 million in fiscal 2000 from $30.0 million in fiscal 1999. These expenses represented 10.6% and 10.4% of net sales, for fiscal
2000 and 1999, respectively. Research and development expenses increased in absolute dollars, primarily as a result of increased
headcount, ongoing support of current and future product development and enhancement efforts, prototyping expenses and
non-recurring engineering charges associated with the development of new products and technologies. Research and development
headcount increased from 198 at April 30, 1999 to 327 at April 30, 2000. In fiscal 2000, we shipped new enterprise software
offerings and data management tools with SnapManager for Microsoft Exchange and ApplianceWatch. We also introduced new
caching products which included NetCache software release 4.0 and NetCache 4.1, adding streaming media support for Apple
QuickTime, Microsoft Windows Media and RealNetworks Real System G2 users, delivering live broadcasting on the Internet. In
fiscal 1999, we introduced the F700 series filers, the Cluster Failover solutions, the C700 caching products, SnapMirror,
SnapRestore, and SecureAdmin(TM). We believe that our future performance will depend in large part on our ability to maintain
and enhance our current product line, develop new products that achieve market acceptance, maintain technological
competitiveness and meet an expanding range of customer requirements. We intend to continuously expand our existing product
offerings and introduce new products and expect that such expenditures will continue to increase in absolute dollars. For both
fiscal 2000 and 1999, no software development costs were capitalized.
General and Administrative General and administrative expenses increased 114.1% to $21.1 million in fiscal 2000, from $9.9
million in fiscal 1999. These expenses represented 3.6% and 3.4% of net sales, for fiscal 2000 and 1999, respectively. 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. General and administrative headcount increased from 80 at April
30, 1999 to 162 at April 30, 2000. We believe that our general and administrative expenses will increase in absolute dollars as we
continue to build our infrastructure.
Total Other Income, Net Total other income, net, was $9.0 million and $1.9 million in fiscal 2000 and 1999, respectively. The
increase was due primarily to interest income earned on the net proceeds from the March 1999 follow-on public offering, cash
generated from operations, and net proceeds from stock option exercises. Fiscal 1999 included losses from foreign currency
transactions as compared to fiscal 2000, where gains or losses from foreign transactions have been partially mitigated through our
hedging program.
Provision for Income Taxes Our effective tax rate was 35.5% for fiscal 2000 compared to 37.5% for the fiscal 1999. The
effective tax rates differed from the U.S. statutory rate primarily due to state taxes, credits and tax exempt interest.
LIQUIDITY AND CAPITAL RESOURCES
As of April 30, 2001, as compared to the April 30, 2000 balances, our cash, cash equivalents and short-term investments increased
by $10.5 million to $364.0 million. Working capital decreased by $3.1 million to $416.7 million. The decrease was primarily a result
of $193.7 million restricted cash used to collateralize our operating leases. We generated cash from operating activities totaling
$218.4 million and $118.1 million in fiscal 2001 and fiscal 2000, respectively. Net cash provided by operating activities in fiscal
2001 was principally related to net income of $74.9 million, increases in accounts payable, income taxes payable, accrued
compensation and related benefits and def |
