SecProbe.io

CORRESP
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corresp

August 31, 2006

Via FedEx: 7915.3967.4830

Via EDGAR

Securities and Exchange Commission

One Solution Place

100 F Street, N.E.

Washington, D.C. 20549-4561

    Attn:

    Chris White

    Craig Wilson

    Re:

    Network Appliance, Inc.

    Review of Form 10-K
for the fiscal year
ended April 30, 2005,
and fiscal year ended
April 30, 2006

    and Forms 8-K, filed
August 17, 2005,
November 16, 2005,
February 15, 2006, and
May 24, 2006

    File No. 000-27130

Ladies and Gentlemen:

     Network Appliance (the “Company”) submits this letter in response to comments from the Staff
of the Securities and Exchange Commission (the “Staff”) received by letter dated July 28, 2006
relating to the Company’s Forms 10-K for the fiscal year ended April 30, 2005, and fiscal year
ended April 30, 2006, and Forms 8-K filed on August 17, 2005, November 16, 2005, February 15, 2006,
and May 24, 2006.

     In this letter, we have recited the comments from the Staff in italicized, bold type and have
followed each comment with the Company’s response.

Page 1

Form 10-K for the Fiscal Year Ended April 30, 2006

Item 7. Management’s Discussion and Analysis of Finance Condition and Results of
Operations

Overview, page 34

    1.

    We note your response to prior comment number 1, which states, “the key indicators
of financial condition and operating performance disclosed in its Form 10-K include many
of the same indicators management reviews in assessing the financial performance of its
business and discusses in its analyst calls and investors presentations.” In preparing
MD&A, financial measures generally are the starting point in understanding your key
variables and other factors impacting the business. In your Management Discussion Section
of the Fourth Quarter 2006 Earnings Call, dated May 24, 2006, you disclosed non-financial
key indicators of operating performance that you have not disclosed in your Form 10-K. In
that discussion your CEO addresses non-financial indicators such as the increase in total
units shipped, average capacity and the amount of petabytes of storage shipped. Tell us
what consideration you gave to disclosure of these non-financial key variables and factors
used to manage your business. Disclosure would be required in your periodic reports if
this is material information to investors. See Section III.B.1 of SEC Release 33-8350,
“Commission Guidance Regarding Management’s Discussion and Analysis of Financial Condition
and Results of Operations.”

The Company advises the Staff that we have considered Section III.B.1 of SEC Release 38-8350,
“Commission Guidance Regarding Management’s Discussion and Analysis of Financial Condition and
Results of Operations.” On our Fourth Quarter 2006 Earnings Call, our CEO discussed several
metrics including increases in units shipped and capacity increases for several of our
products. Although we do not consider these metrics to be key indicators of our business, we
do believe these metrics may provide further perspective and detail to our financial results.
The Company will continue to assess the significance of these and other variables and metrics
and will disclose such factors in future filings, beginning with our 10-Q for the period ended
July 31, 2006 as required by SEC rules and guidance.

Critical Accounting Estimates and Policies, page 36

    2.

    We note your response to prior comment number 2 and reissue and clarify the comment.
Your critical accounting policies should describe more fully your estimates and
assumptions that are highly uncertain or susceptible to change and the related material
impact on financial condition or operating performance. For example, your valuation of
goodwill and intangibles disclosure on page 38 states, “The allocation process requires
extensive use of estimates and assumptions, including estimates of future cash flows
expected to be generated by the acquired assets.” Your disclosure of such estimates and
assumptions should discuss why they bear risk of change, how you arrived at

Page 2

    the estimate, accuracy of the estimate/assumption in the past, how they have changed, and reasonably
likely future changes. It appears that you also use estimates and assumptions of future
taxable earnings to determine the adequacy of your deferred tax assets and to determine
your restructuring accrual. Please tell us the estimates and assumptions that are highly
uncertain or susceptible to change that you have identified and how you plan to address
any revision to disclosure to comply with Financial Reporting Release No. 60 and SEC
Release 33-8350, Section V.

The Company requests that the Staff review Appendix A for the Company’s response. To
facilitate the Staff’s review, in the Appendix we have displayed our Critical Accounting
Estimates and Policies in a matrix format to address why these estimates bear risk of change,
how the Company arrived at these estimates, the accuracy of estimates in the past, how the
estimates changed and reasonably likely future changes to these estimates. Planned revisions
are shown as underlined. The Company proposes to include these revised Critical Accounting
Estimates and Policies beginning in our Form 10-Q for the quarter ended July 28, 2006. Please
note that the discussion regarding “Accounting for Stock-Based Compensation” has also been
updated to reflect the adoption of SFAS 123(R) in this quarter.

New Accounting Standards, page 41

    3.

    We note your response to prior comment number 3 regarding the impact of implementing
SFAS 123R. Your response states, “We are still assessing the impact and will complete the
assessment at the end of our first fiscal quarter of 2007.” We further note you have
disclosed the impact of implementing SFAS 123R on your first quarter of 2007 on page 43.
Clarify whether you have estimated the quantitative impact the standard is expected to
have on your financial statements for the fiscal year ended April 30, 2007. In this
respect, we note your fiscal year 2007 outlook discussed in your Form 8-K filed on May 24,
2006, which provides earnings guidance for your year ended 2007.

The Company advises the Staff that in the annual guidance provided in our fiscal 2007 outlook,
we noted the difficulty of estimating stock compensation expense for the year given the
unpredictable nature of variables such as the Company’s stock price, number of options to be
granted, volatility and associated income tax impacts. Therefore, we estimated a target range
based upon assumptions existing at the time of the guidance. Given the close proximity of the
first quarter relative to May 24, 2006, we were able to provide a more accurate estimate of
the impact of adoption of SFAS 123(R) on our first quarter earnings which we disclosed in our
Form 10-K than for our full fiscal year 2007. We have now finalized our analysis of the impact
of SFAS 123(R) on our fiscal year 2007 projections and will include the estimate in our Form
10-Q for the quarter ended July 28, 2006.

Page 3

Results of Operations

Fiscal 2006 Compared to Fiscal 2005, page 44

    4.

    Your response to prior comment number 4 states you “will continue to evaluate and
disclose as appropriate the quantification of positive and negative factors affecting
revenues.” Your disclosure states product revenues were favorably affected by increased
revenues from current products and the introduction of new products. Your disclosure also
states product revenues were negatively affected by lower-cost-per-megabyte disks and
declining average selling prices and units shipped of your older products. However, your
disclosure does not quantify the impact of the favorable and negative factors that affect
product revenues. Therefore we reissue the portion of prior comment number 4 which
requests you to quantify the extent, to which increases in revenues are attributable to
increases in prices, the volume of goods or services being sold, or to the introduction of
new products or services. We refer you to Regulation S-K, Item 303(a)(3)(iii).

    The Company advises the staff that it will further enhance its disclosures to describe
changes in revenue beginning with its Form 10-Q for the quarter ended July 28, 2006. Our
disclosure will quantify the impact of meaningful favorable and negative factors affecting
product revenues. Some of the factors we will consider for quantifying include:

    •

    Revenue increases due to new products

    •

    Revenue increases due to unit and volume increases

    •

    Revenue changes due to pricing and configurations on existing products

    •

    Revenue changes due to sales to indirect channels

    •

    Impact of lower cost-per-megabyte disks

    •

    Decreases in revenue on products no longer shipped

Note 2. Significant Accounting Policies

Revenue Recognition and Allowance, page 65

    5.

    We note the portion of your response to prior comment number 6 which indicates your
server and storage device are in the scope of SOP 97-2. That is, your response concludes
“[Y]our firmware and operating software are essential to the functionality of [y]our
storage devices. Accordingly, [you] believe that SOP 97-2 applies to the hardware servers
and storage devices [you] sell.” Clarify whether you have concluded that your software is
essential to the functionality of your server. As part of your response, tell us whether
the server has substantive functionality without the software. In addition, clarify how
you have determined your software is essential to the functionality of your storage
device. Tell us whether the storage device has substantive functionality without the
software.

Page 4

The Company advises the Staff that with regard to both our servers and storage devices, our
proprietary operating system software, or “microcode” is essential to the functionality of both our
server and our storage devices.

As is relates to our servers, which are effectively “appliances” that perform uniquely due to our
patented ONTAP WAFL (write anywhere file layout) microcode required to operate the system, the
hardware is not useful for the purpose designed without such microcode.

While it is theoretically possible for the server to be used without this microcode, it would
require significant research and development effort to develop or customize another operating
system to operate the server as intended as a storage device. Our proprietary microcode does not
provide support for running other third-party applications. Additionally, the custom hardware
design would make it difficult and uneconomical for our server to function as a general purpose
server. Therefore, our server does not have substantive functionality without our operating
software.

We commonly refer to the hardware component of our server as the “filer head” that operates as a
unique appliance to store and manage data only when our specialized storage devices have been
connected and both are running with our proprietary operating system. The functionality and
feature set provided by the combination of our server, our software and our storage devices is what
we refer to as of “appliance simplicity”, one of our key marketing strategies, and it is this value
proposition that contributes to margins significantly higher than a general purpose device.
Additionally, our proprietary operating system software is not “general purpose” and does not run
on other vendors’ hardware.

Regarding our storage devices, as previously noted, our proprietary firmware is required to allow
our storage devices to operate with our servers. This firmware, which is built into the storage
device, makes the device only compatible with our server. i.e., it cannot be connected to a
competitor’s server or otherwise connected to a customer’s network. Likewise, the disk drives
inside the storage device are customized to our specifications and will only operate within our
storage device; they cannot be removed and used outside of the storage device. The storage device’s
functionality is dependent on both our firmware and our operating software which allows the server
to access the storage capacity of the device. Therefore, the storage device does not have
substantive functionality without our operating software.

Accordingly, we have referenced EITF 03-5 and concluded that because the software is essential to
the functionality of the hardware, the hardware should be considered software related and therefore
subject to the provisions of SOP 97-2.

    6.

    We note the portion of your response to prior comment number 6 which indicates
hardware installation services are not in the scope of SOP 97-2. We note your conclusion
is based on the fact that software is not essential to the functionality of the
installation service. Tell us how your separation of the

Page 5

    installation services as a
separate unit of accounting complies with EITF 00-21. As part of your response, clarify
how you have determined there is objective and reliable evidence of fair value of the
hardware installation services; we refer you to paragraph 9 of the EITF 00-21. Further
explain the basis for your revenue and expense recognition and timing for installation
services and reference the authoritative literature supporting your accounting.

The Company advises the Staff that we did not apply either SOP 97-2 or EITF 00-21 to determine
whether installation services represent a separate unit of accounting because we concluded that the
portion of undelivered services at the time of delivery are considered an inconsequential and
perfunctory obligation under SAB Topic 13. Therefore we did not consider installation services an
element or deliverable in the arrangement. Accordingly, we accrued the cost of performing any
remaining services at the time of delivery of the system in order to match the revenue recognized
at the time.

If one were however to conclude that the installation services represent a deliverable in the
arrangement, the Company would be required to analyze such services under EITF 00-21 to determine
whether it may be accounted for as a separate unit of accounting. Paragraph 9 of EITF 00-21 lists
the following three criteria that have to be met in order for a deliverable to be accounted for as
a separate unit of accounting:

    a)

    The delivered item(s) has value to the customer on a standalone basis. That
item(s) has value on a standalone basis if it is sold separately by any vendor or the
customer could resell the delivered item(s) on a standalone basis. In the context of
a customer’s ability to resell the delivered item(s), the Task Force observed that
this criterion does not require the existence of an observable market for that
deliverable(s).

    b)

    There is objective and reliable evidence of the fair value of the undelivered
item(s).

    c)

    If the arrangement includes a general right of return relative to the
delivered item, delivery or performance of the undelivered item(s) is considered
probable and substantially in the control of the vendor.

We have concluded that our installation services would qualify as a separate unit of accounting
under paragraph 9 of EITF 00-21 because;

    a)

    Our system has value on a standalone basis to our customers. We believe the system
has standalone value because we often sell our system without installation services and
some of our customers do resell our systems on a stand-alone basis.

    b)

    We have sufficient objective and reliable evidence of the fair value for the
undelivered portion of the installation services which are performed after the system is
delivered and revenue is recognized. More specifically, as described in our previous
letter of May 31, 2006, 80% or more of the work covered by installation fees is typically
completed prior to shipment; the undelivered installation services at the time revenue is
recognized typically consist of 4 to 8 hours of work per