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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended September 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number 000-26041
F5 NETWORKS, INC.
(Exact name of Registrant as specified in its charter)
WASHINGTON 91-1714307
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
501 ELLIOTT AVE WEST
SEATTLE, WASHINGTON 98119
(Address of principal executive offices)
(206) 272-5555
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b)
OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, NO PAR VALUE
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (229.405 of this chapter) is not contained herein, and will
not be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [ ]
As of December 1, 2000, the aggregate market value of the Registrant's Common
Stock held by nonaffiliates of the Registrant was $392,846,884 based on the
closing sales price of the Registrant's Common Stock on the Nasdaq National
Market.
As of December 1, 2000, the number of shares of the Registrant's Common Stock
outstanding was 21,696,714.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive proxy statement relating to its 2001
annual meeting of shareholders, to be held on February 21, 2001, are
incorporated by reference into Part III hereof.
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Page 1 of 51 Pages
The Exhibit Index begins on page 52
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F5 NETWORKS, INC.
FORM 10-K
TABLE OF CONTENTS
Page
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PART I.
Item 1. Business....................................................................................... 3
Item 2. Properties..................................................................................... 12
Item 3. Legal Proceedings.............................................................................. 13
Item 4. Submission of Matters to a Vote of Securities Holders.......................................... 13
PART II.
Item 5. Market For Registrant's Common Stock and Related Shareholder Matters........................... 14
Item 6. Selected Financial Data........................................................................ 15
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations........................................................................ 16
Item 7A. Quantitative and Qualitative Disclosure About Market Risk...................................... 28
Item 8. Financial Statements and Supplementary Data.................................................... 29
PART III.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure......................................................................... 49
Item 10. Directors and Executive Officers of the Registrant............................................. 49
Item 11. Executive Compensation......................................................................... 49
Item 12. Security Ownership of Certain Beneficial Owners and Management................................. 49
Item 13. Certain Relationships and Related Transactions................................................. 49
PART IV.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K................................ 49
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PART I
ITEM 1. BUSINESS.
DESCRIPTION OF BUSINESS
F5 is a leading provider of integrated Internet traffic and content
management solutions designed to improve the availability and performance of
Internet-based servers and applications. Our products monitor and manage local
and geographically dispersed servers and intelligently direct traffic to the
server best able to handle a user's request. Our content management products
enable network managers to increase access to content by capturing and storing
it at points between production servers and end-users and ensure that newly
published or updated files and applications are replicated uniformly across all
target servers. When combined with our network management tools, these products
help organizations optimize their network server availability and performance
and cost-effectively manage their Internet infrastructure.
Certain statements under the captions "Risk Factors," "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Business," and elsewhere in this report are "forward-looking statements." These
forward-looking statements include, but are not limited to, statements about our
plans, objectives, expectations and intentions and other statements contained in
this report that are not historical facts. When used in this report, the words
"expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates"
and similar expressions are generally intended to identify forward-looking
statements. Because these forward-looking statements involve risks and
uncertainties, there are important factors that could cause actual results to
differ materially from those expressed or implied by these forward-looking
statements, including our plans, objectives, expectations and intentions and
other factors discussed under "Risk Factors."
INDUSTRY BACKGROUND
Significant growth in the number of Internet users coupled with the
increased availability of powerful new tools and equipment that enable the
development, processing and distribution of data across the Internet, has led to
a proliferation of Internet-based applications and services, such as e-commerce,
e-mail, electronic file transfers and online interactive applications. Network
infrastructures are further strained by unpredictable traffic, the complexity of
the network environment and the increased variety of data, including multimedia
components and video clips. At the same time, the complexity and volume of
Internet traffic has increased dramatically.
An increasing number of businesses rely on the Internet as a fundamental
commerce and communication tool. Failure of these businesses to deliver expected
availability and performance for their Internet-based applications can result in
a significant cost to the organization.
To support the dramatic increases in Internet traffic, many
organizations have aggressively expanded network server capacity. In this
environment, organizations often deploy multiple servers in a group, or array,
which contains individual application-specific servers or redundant servers that
operate together as a virtual large server. Server arrays can reduce single
points of failure and be a cost-effective way to increase the potential capacity
of the system by providing the flexibility to add additional servers to the
array as needed. The practice of deploying server arrays in geographically
dispersed sites to help prevent system failure and direct traffic more
efficiently is also a growing trend.
Along with their benefits, server arrays and geographically dispersed
sites have increased the need for intelligent traffic and content management
devices to optimize server availability and performance. Intelligent traffic
management devices identify which server, whether local or remote, is best able
to handle user requests. They also read and interpret user requests and route
those requests to the most responsive server or to servers or arrays that have
been designated to handle specific types of requests. Content management devices
include controllers that replicate published content to ensure that it is
uniformly available on all servers in a network. Cache servers increase access
to content by capturing and storing content at one or more points between
network servers and users.
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Currently, many available Internet traffic and content management
products are extensions of hardware-based routers, which lack the robust
functionality required to manage the increasing complexity of requests and
responses that characterize business activity on the Internet. These products
are typically not designed to address application availability, nor do they meet
the manageability and scalability required by organizations who depend on the
Internet as a fundamental commerce and communications tool. As a result, we
believe they do not measure up to the demands of today's rapidly changing
Internet environment.
F5 SOLUTION
We develop, market and support intelligent, cost-effective, integrated
Internet traffic and content management solutions designed to ensure that
content and applications on Internet-based servers are continuously and readily
available. Our intelligent traffic management products monitor and manage
locally and geographically dispersed servers, and intelligently direct traffic
to the server best able to handle the user request. Our content management
products help ensure new and updated content is replicated uniformly across all
servers and is readily accessible to all users. As components of an integrated
solution, our products are designed to ensure Internet quality control by
providing the following key benefits:
High system availability. Our integrated suite of products works with
servers deployed in a redundant server array over a local or wide area network
to enhance network performance and reduce single points of failure. Our traffic
management products continuously monitor network performance to enable real-time
detection of server, application and content degradation or failure. Based on
this information, our solutions automatically direct user requests to
functioning servers and applications. Our products also enable network
administrators to deploy new servers and take individual servers offline for
routine maintenance without disrupting service to end users.
Increased performance. Our products provide a significant performance
improvement over other current approaches. Our traffic and content management
products monitor server and application response time and verify content. This
information is used to intelligently direct user requests to the server with the
fastest response time. They also read and interpret individual requests and can
direct those requests to specific servers, arrays or sites based on
predetermined rules defined by network managers. As a complement to these
products, our cache servers improve performance by capturing and storing content
at points between network servers and end-users, where content can be accessed
more quickly. By intelligently directing traffic throughout the network, our
solutions reduce server overload conditions that may cause performance
degradation.
Cost-effective scalability. Our solutions enable more efficient
utilization of existing server capacity by intelligently directing traffic among
servers. This capability allows organizations to optimize the capacity of
existing servers and, as traffic volume dictates, cost-effectively expand server
capacity through incremental additions of relatively low cost servers rather
than upgrading to larger, more expensive servers. Our solutions can be used with
multiple heterogeneous hardware platforms, allowing organizations to protect
their investments in their legacy hardware installations as well as integrate
future hardware investments. In addition, strategic deployment of our cache
products can reduce the load on network servers and minimize the need to add
more expensive production server capacity.
Easier network manageability. Our products collect information that can
be used to facilitate network management and planning from a central location.
Leveraging our products' strategic location in the network, our solutions
collect data that is crucial for traffic analysis and apply proprietary trend
and analysis tools that synthesize this data so that network managers can
forecast network requirements more accurately. In addition, our products
automatically synchronize content across remote locations, helping to ensure
users access to the same content regardless of server location.
Enhanced network control. Our solutions enable organizations to
prioritize and arrange network traffic based on specific rules defined by
network managers. For example, our products may be configured to direct traffic
over the most cost-efficient communication links or, alternatively, to deliver
the most rapid response to requests.
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STRATEGY
Our objective is to be the leading provider of integrated Internet
traffic and content management solutions designed to optimize network
availability and performance. Key components of our strategy include:
Offer complete Internet traffic and content management solutions. We
plan to continue expanding our existing suite of products to provide complete
Internet traffic and content management solutions. We also intend to continue
investing in our professional services group to provide the installation,
training and support services required to help our customers optimize their use
of our integrated traffic and content management products.
Invest in technology to continue to meet customer needs. Our current
technology platform has been designed to quickly and easily expand the features
and functionalities of our suite of products and support the development of
additional products that address the complex and changing needs of our
customers. We will continue to invest in research and development to provide our
customers with complete Internet traffic and content management solutions that
meet their needs.
Expand sales channels and geographic scope of sales. We continue to
invest significant resources in the expansion of our sales channels. In addition
to maintaining a strong direct sales force, we are expanding our indirect sales
channels through leading industry resellers, original equipment manufacturers,
systems integrators, Internet service providers and other channel partners.
Furthermore, we are expanding sales of our Internet traffic and content
management solutions to government entities. We are also aggressively developing
our international sales capabilities, particularly in selected countries in the
European and Asia Pacific markets.
Build and expand relationships with strategic partners. We capitalize on
products, technologies and channels that may be available through partners. We
currently have an OEM relationship with Dell Computer Corporation and a
licensing agreement for our BIG-IP load-balancing technology with Extreme
Networks. We continue to seek relationships with partners that will enable us to
increase the market opportunity for our products and technologies.
Leverage our market leadership to continue to build the F5 brand. We
continue building brand awareness that positions us as one of the leading
providers of intelligent Internet traffic and content management solutions. Our
goal is for the F5 brand to be synonymous with superior network performance,
high quality customer service and ease of use. To achieve these objectives, we
continue to invest in a broad range of marketing programs, including active
tradeshow participation, advertising in print publications, direct marketing,
high-profile Web events and our Internet site.
Pursue strategic acquisitions. We may selectively pursue strategic
acquisition of products and technologies that complement or expand our existing
Internet traffic and content management solutions.
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PRODUCTS AND TECHNOLOGY
We have developed our BIG-IP(R), 3-DNS(R) and GLOBAL-SITE(TM)
Controllers and the SEE-IT(TM) Network Manager as a suite of Internet traffic
and content management products that facilitate high performance, high
availability and scalable access to network server arrays located at a single
site or across multiple, geographically dispersed sites. Recently we added
EDGE-FX(TM) Cache to our suite of products, enabling end-to-end content delivery
solutions. Our ongoing investment in technology is focused on achieving
continuous performance enhancements, increased functionality, enhanced ease of
use and increased product integration. Following is a table of our current
products, followed by a brief description of each product:
PRODUCT NAME DESCRIPTION INTRODUCTION DATE
------------ ----------- -----------------
BIG-IP(R) Controller................ Intelligent load balancer for local area July 1997
networks
3-DNS(R) Controller................. Intelligent load balancer for wide area September 1998
networks
SEE-IT(TM) Network Manager.......... Traffic analysis and network management April 1999
software application for BIG-IP and 3-DNS
GLOBAL-SITE(TM) Controller.......... File replication and synchronization October 1999
controller for managing content across
geographically dispersed Internet sites
EDGE-FX(TM) Cache................... High performance cache server for fast August 2000
delivery of Internet content
BIG-IP Controller. BIG-IP is an intelligent local traffic management
appliance consisting of our proprietary software on a pre-configured,
industry-standard hardware platform. Situated between a network's routers and
server array, BIG-IP continuously monitors the array of local servers to ensure
application availability and performance and automatically directs user requests
to the server best able to handle these requests. By quickly detecting
application and server failures, and directing service toward those servers and
applications that are functioning properly, BIG-IP is designed to shield users
from system failures and provide timely responses to user requests and data
flow. BIG-IP offers a comprehensive selection of load balancing algorithms that
lets network managers choose a load balancing configuration that best suits
their organization's particular needs. In addition, BIG-IP actively queries and
checks content received from applications. If a server and application are
responding to users' requests with incorrect content, BIG-IP redirects requests
to those servers and applications that are responding properly, thereby helping
to ensure the quality of Web content.
BIG-IP is compatible with any system that uses the standard Internet
communication protocol or IP, and can operate with multiple, heterogeneous
hardware platforms. This enables organizations to leverage their existing
infrastructure without limiting their options to meet future network needs.
BIG-IP supports a wide variety of network protocols, including Web, e-mail,
audio, video, database and file transfer protocol. BIG-IP also manages traffic
for network devices such as firewalls that prevent unauthorized access to a
network system, cache servers that store frequently accessed Web content and
multimedia. BIG-IP's ability to intelligently distribute traffic across server
arrays reduces the need for increasingly larger and more expensive servers to
accommodate increases in network traffic. This configuration also reduces the
single point of failure inherent with a single large server and allows for the
orderly addition of new servers or the routine maintenance or upgrades of
servers without disrupting service to the end user.
BIG-IP's unique Layer 7 switching capability enables the successful
delivery of business-critical applications with 24/7 availability, scalability,
and high performance. Examining traffic at Layer 7 allows intelligent quality of
service (QoS) through routing and management decisions made based on application
information. BIG-IP enables the use of all of its Layer 7 features
simultaneously without imposing limitations on the length of the URL,
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cookie, or location of the cookie -- providing intelligent, granular management
of web sites without performance degradation.
Additional BIG-IP features include:
- Secure sockets layer (SSL) session persistence enables server
arrays to support e-commerce and other applications by allowing
users to re-establish a secure connection with a specific server to
complete an unfinished transaction.
- Secure server protection protects against unauthorized use of the
network server array.
- Rate shaping allows priority levels to be assigned to specific
types of traffic.
- Packet filtering enables content providers to direct network
traffic to servers based on criteria set by network managers.
3-DNS Controller. 3-DNS is an intelligent wide area traffic management
appliance that manages and distributes user requests across wide area networks.
3-DNS consists of our proprietary software, which we load on a pre-configured,
industry-standard hardware platform. Like BIG-IP, 3-DNS functions with multiple
heterogeneous hardware platforms and supports a wide variety of network
protocols, including Web, e-mail, audio, video, database and file transfer
protocol, and manages traffic for network devices such as firewalls, cache
servers and multimedia servers.
When an end-user request is received from a local domain name server or
DNS, 3-DNS collects network information and communicates with each site in the
network to determine the site with the fastest response time. 3-DNS, integrated
with BIG-IP, sends the request to the BIG-IP at the site. BIG-IP then directs
the request to the individual server best able to handle it. Although
organizations can deploy a single 3-DNS in their network configuration, multiple
3-DNS Controllers are often deployed within the network to provide redundancy to
help ensure network availability and performance for end users.
Additional 3-DNS features include:
- Dynamic load balancing optimizes use of available network resources
across wide area networks.
- User-defined production rules allow organizations to pre-configure
traffic distribution decisions according to their specific user
requirements.
- Secure server protection offers security features for wide area
networks similar to those BIG-IP provides for local area networks.
SEE-IT Network Manager. SEE-IT is a software application that
communicates with BIG-IP and 3-DNS to help improve the management and
functionality of an organization's network servers. SEE-IT, which runs on an NT
server, uses real-time data collected by BIG-IP and 3-DNS to perform crucial
traffic analysis management functions. By reviewing historical patterns, network
administrators can build predictive models and forecast usage, which helps them
to intelligently plan and budget for additional server and bandwidth capacity.
SEE-IT comes pre-loaded with BIG-IP and 3-DNS and consists of the following
capabilities:
- Real-time monitoring that displays key data on network traffic in
easy-to-read graphical illustrations, thereby enabling network
administrators to quickly obtain information regarding network and
server performance, including data about server status and traffic,
number of connections, active and inactive IP addresses and the
availability of individual applications.
- Forward-looking trend and analysis tools that use the information
generated by BIG-IP to project future network and server needs.
Network managers and system administrators can use these tools to
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create "what if?" scenarios to help forecast the need for
additional servers, interface upgrades and other network capacity
requirements.
GLOBAL-SITE Controller. GLOBAL-SITE, a global data delivery appliance,
has been designed to help organizations automate the distribution and
synchronization of file-based content and applications to local and
geographically dispersed Internet sites. GLOBAL-SITE was developed to work with
our other products to provide an integrated Internet traffic and content
management solution. GLOBAL-SITE consists of our proprietary software, which is
loaded on a preconfigured, industry-standard hardware platform and was developed
to intelligently deploy both program and data files to arrays of heterogeneous
Web servers. GLOBAL-SITE's configuration database allows administrators to
define standard rules for content deployment as well as accommodate unique
content distribution events as needed.
EDGE-FX Cache. EDGE-FX is a price/performance leading Internet cache
server that can be deployed as a standalone device or integrated with our other
products. EDGE-FX consists of software loaded on a pre-configured, industry
standard hardware platform. EDGE-FX accelerates access to web content by storing
frequently requested data at strategic points in a computer network, making it
quickly available to Internet users. As a standalone device, EDGE-FX may be
installed in virtually any network infrastructure. Integrated with our other
traffic and content management products, EDGE-FX enables customers to implement
end-to-end content delivery solutions.
EDGE-FX supports three flexible deployment options to conserve bandwidth
and server resources while accelerating content to Internet users.
- Forward Proxy is deployed in front of Web browsers for internal
user access. EDGE-FX can be positioned as a forward proxy cache,
making it valuable for enterprise Intranets. Instead of sending
requests for Web content directly to the origin server, browsers
are configured to send requests directly to the cache.
- Transparent Forward Proxy, when combined with BIG-IP or a Layer 4
switch, EDGE-FX can be deployed as a transparent proxy cache,
automatically examining each request without the need to
reconfigure Web browsers.
- Reverse Proxy, when deployed in front of web servers for external
user access, EDGE-FX transfers client requests from the Web
server, eliminating the danger of server traffic surges. EDGE-FX
can also lower overall costs by conserving access to origin
servers and bandwidth.
Designed for massive scalability, multiple EDGE-FX can be
managed with the BIG-IP Cache Controller to enable cache farm
load balancing, replication of content across multiple caches,
and Layer 7 management of cached objects.
PRODUCT DEVELOPMENT
We believe that our future success depends on our ability to build upon
our current technology platform, expand the features and functionalities of our
suite of Internet traffic and content management products and develop additional
products that maintain our technological competitiveness. Our product
development group, which is divided along product lines, employs a standard
process for the design, development, documentation and quality control of our
Internet traffic and content management solutions. Each product line is headed
by a lead architect, who is responsible for developing the technology behind the
product. To help develop the technology, the lead architects work closely with
our customers to better understand their requirements. Software engineers who
help design and build the products, and technicians, who perform test
engineering, configuration management, quality assurance and documentation
functions, complete our product development teams. The test engineering team
evaluates the overall quality of our products and determines whether they are
ready for release.
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Our product development expenses for fiscal 2000, 1999 and 1998 were
$14.5 million, $5.6 million and $1.8 million, respectively. We expect our
product development expenses to increase as we hire additional research and
development personnel to develop new products and upgrade our existing ones.
CUSTOMERS
Our target customers include Internet service providers, companies with
large e-commerce sites and high-traffic Internet or intranet Web sites. We have
sold our products directly or through resellers to over 2,500 end-customers as
of September 30, 2000. Our largest reseller, Exodus Communications, accounted
for 14% of our net revenues for the year ended September 30, 2000. During the
fourth quarter of fiscal 2000 ended September 30, no single customer or reseller
accounted for more than 10% total sales.
SALES AND MARKETING
We market and sell our Internet traffic and content management solutions
on a global basis through direct sales and channel partners. We plan to continue
investing significant resources to expand our direct sales force and further
develop our indirect sales channels by developing relationships with leading
industry resellers, original equipment manufacturers, systems integrators,
Internet service providers and other channel partners. Typically, our agreements
with our channel partners are not exclusive and do not prevent our channel
partners from selling competitive products. These agreements typically have
terms of one or two years with no obligation to renew, and typically do not
provide for exclusive sales territories or minimum purchase requirements.
Exodus and Frontier GlobalCenter account for most of our indirect sales.
We are in the process of seeking channel partners for our products in the United
States and selected countries in the European, Asia Pacific and South American
markets. We have increased, and plan to further increase, the number of
individuals focused on sales to government entities, and are developing
strategic relationships that will help facilitate these sales.
Our domestic sales managers are located in Atlanta, Boston, Chicago,
Dallas, Los Angeles, New York, San Francisco, Seattle, and Washington D.C. Our
international sales managers are located in Australia, Canada, China, Germany,
Hong Kong, India, Japan, Korea, Malaysia, Singapore and the United Kingdom. The
inside sales team generates and qualifies leads for our regional sales managers
and help manage accounts by serving as a liaison between our field and internal
corporate resources. Our field systems engineers also support our regional sales
managers by participating in joint sales calls and providing pre-sale technical
resources as needed.
Our marketing programs are focused on creating awareness of our Internet
traffic and content management solutions targeted at information technology
professionals such as chief information officers. We plan to continue building
strong brand awareness to leverage the value of our Internet traffic and content
management products and professional services in the marketplace. We believe
brand visibility is a key factor in increasing customer awareness, and our goal
is for the F5 brand to be synonymous with superior performance, high quality
customer service and ease of use. We market our products and services through a
broad range of marketing programs, including active tradeshow participation,
advertising in print publications, direct marketing, high-profile Web events and
our Internet site.
PROFESSIONAL SERVICES AND TECHNICAL SUPPORT
We believe that our ability to consistently provide high-quality
customer service and support will be a key factor in attracting and retaining
customers. Prior to the installation of our Internet traffic and content
management solutions, our professional services team works with organizations to
analyze and understand their special network needs. They also make
recommendations on how to integrate our solutions to best utilize our product
features and functionality to support their unique network environment. Once our
customers purchase our products, we go on-site to help with installation and
provide an initial training session to help our customers make use of the
functionality built into our products. The installation process generally occurs
within 30 days of product shipment to the customer.
Our technical support team assists our customers with online updates and
upgrades and provides remote support through a 24x7 help desk. We also offer
seminars and training classes for our customers on the configuration
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and use of our products, including local and wide area network system
administration and management. In addition, we provide a full range of
consulting services to our customers, including comprehensive network
management, documentation and performance analysis and capacity planning to
assist in predicting future network requirements.
MANUFACTURING
We outsource the manufacturing of our pre-configured, industry-standard
hardware platforms to three contract manufacturers, who assemble these hardware
platforms to our specifications. These platforms consist primarily of an
Intel-based computing platform, rack-mounted enclosure system and
custom-designed front panel. We install our proprietary software onto the
hardware platforms and conduct functionality testing, quality assurance and
documentation control prior to shipping our products. Subcontractors supply our
contract manufacturers with the standard parts and components for our products,
which consist primarily of motherboards, reboot cards and chassis for our
products, although recently we have begun to stock certain key components.
Generally purchase commitments with our limited source suppliers are on a
purchase order basis.
COMPETITION
Our markets are new, rapidly evolving and highly competitive, and we
expect this competition to persist and intensify in the future. We compete in
the Internet traffic and content management market primarily on the basis of
product price/performance, service, and warranty. Our principal competitors in
the Internet traffic and content management market include CacheFlow, Cisco
Systems, Extreme Networks, Foundry Networks, Inktomi, Network Applicance, Nortel
Networks, RadWare and Resonate.
Cisco Systems has a product offering similar to ours and holds the
dominant share of the market. Cisco has a longer operating history and
significantly greater financial, technical, marketing and other resources than
we do. Cisco also has a more extensive customer base and broader customer
relationships including relationships with many of our current and potential
customers that could be leveraged. In addition, Cisco has large, well
established, worldwide customer support and professional services organizations
and a more extensive direct sales force and sales channels than we do. Cisco and
our other competitors may be able to respond more quickly to new or emerging
technologies and changes in customer requirements than we can. There is also the
possibility that these companies may adopt aggressive pricing policies to gain
market share. As a result, these companies pose a serious competitive threat
that could undermine our ability to win new customers and maintain our existing
customer base. Nevertheless, we believe these threats are mitigated by
differences between the functionality and performance of our products and those
of our competitors, including Cisco.
INTELLECTUAL PROPERTY
We rely on a combination of copyright, trademark and trade secret laws
and restrictions on disclosure to protect our intellectual property rights. We
currently do not have any issued patents but have 10 applications pending for
various aspects of our technology. We also enter into confidentiality or license
agreements with our employees, consultants and corporate partners, and control
access to, and distribution of, our software, documentation and other
proprietary information. However, despite our efforts to protect our proprietary
rights, unauthorized parties may attempt to copy or otherwise obtain and use our
products or technology.
We incorporate software that is licensed from several third party
sources into our products. These licenses generally renew automatically on an
annual basis. We believe that alternative technologies for this licensed
software are available both domestically and internationally.
EMPLOYEES
As of September 30, 2000, we employed 496 full-time persons, 134 of whom
were engaged in product development, 176 in sales and marketing, 111 in
professional services and technical support and 75 in finance, administration
and operations. None of our employees are represented by a labor union and we
have not experienced any work stoppages to date. We consider our employee
relations to be good.
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DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information with respect to our
executive officers and directors as of September 30, 2000:
NAME AGE POSITION
- ---- --- --------
Jeffrey S. Hussey...................... 39 Chairman of the Board and Chief Strategist
John McAdam............................ 49 President, Chief Executive Officer and Director
Carlton G. Amdahl...................... 48 Chief Technology Officer and Director
Robert J. Chamberlain.................. 47 Senior Vice President of Finance, Chief Financial Officer and
Treasurer
Steven Goldman......................... 40 Senior Vice President of Sales, Marketing and Services
Brett L. Helsel........................ 40 Senior Vice President of Product Development
Alan J. Higginson (1)(2) .............. 53 Director
Karl D. Guelich (1)(2) ................ 58 Director
Keith D. Grinstein (1)(2) ............. 40 Director
(1) Member of Audit Committee.
(2) Member of Compensation Committee.
Directors are divided into three classes, with each class as nearly
equal in number as possible with one class elected at each annual meeting to
serve for a three-year term.
Jeffrey S. Hussey co-founded F5 in February 1996 and has been our
Chairman since that time. He has served as our Chief Strategist since July 2000.
From February 1996 to July 2000, Mr. Hussey served as our Chief Executive
Officer and President. From February 1996 to March 1999, Mr. Hussey also served
as our Treasurer. From June 1995 to February 1996, Mr. Hussey served as Vice
President of Alexander Hutton Capital L.L.C., an investment banking firm. From
September 1993 to July 1995, Mr. Hussey served as President of Pacific Comlink,
an inter-exchange carrier providing frame relay and Internet access services to
the Pacific Rim, which he founded in September 1993. Mr. Hussey holds a B.A. in
Finance from Seattle Pacific University and an M.B.A. from the University of
Washington.
John McAdam has served as our President, Chief Executive Officer and a
director since July 2000. Prior to joining F5 Networks, Mr. McAdam served as
General Manager of the Web server sales business at IBM. From January 1995 until
August 1999, Mr. McAdam served as the President and Chief Operating Officer of
Sequent Computer Systems, Inc., a manufacturer of high-end open systems, which
was sold to IBM in September 1999. Mr. McAdam holds a B.Sc. in Computer Science
from the University of Glasgow, Scotland.
Carlton G. Amdahl has served as our Chief Technical Officer since
February 2000, and as a Director since May 1998. Mr. Amdahl has operated Amdahl
Associates, an independent consulting firm specializing in technology
management, product strategy and system architecture since January 1996. Mr.
Amdahl has served as a Director of Network Caching Technology LLC since February
1999. From 1985 to January 1996, Mr. Amdahl served as Chairman of the Board of
Directors and Chief Technical Officer of NetFRAME Systems, a high performance
network server company, which he founded in 1985. Mr. Amdahl is a Stanford
University Sloan Fellow and holds a B.S. degree in Electrical Engineering and
Computer Science from the University of California, Berkeley, and an M.S. in
Management from Stanford University.
Robert J. Chamberlain has served as our Senior Vice President of
Finance, Chief Financial Officer and Treasurer since April 2000 and as our Vice
President of Finance, Chief Financial Officer and Treasurer from March 1999 to
April 2000. From September 1998 to February 1999, Mr. Chamberlain served as
Senior Vice President and Chief Financial Officer of Yesler Software, an early
stage company developing a personal multimedia web communication product. From
February 1998 to July 1998, Mr. Chamberlain served as Co-President of Photodisc,
a provider of digital imagery, which merged with Getty Images Inc. in February
1998. From May 1997 to February 1998, Mr. Chamberlain served as Senior Vice
President and Chief Financial Officer of Photodisc. From April 1996
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to May 1997, Mr. Chamberlain served as Executive Vice President and Chief
Financial Officer of Midcom Communications Inc., a telecommunications service
provider. Mr. Chamberlain holds a B.S. in Business Administration and Accounting
from California State University, Northridge.
Steven Goldman has served as our Senior Vice President of Sales,
Marketing and Services since July 1999 and our Vice President of Sales,
Marketing and Services from July 1997 to July 1999. From December 1996 to
February 1997, Mr. Goldman served as Vice President, Enterprise Sales and
Services, for Microtest, Inc. a network test equipment and CD ROM server
company, after its acquisition of Logicraft. From March 1995 to December 1996,
Mr. Goldman served as Executive Vice President, North American Operations, for
Logicraft, a CD ROM server company, after its merger with Virtual Microsystems,
a CD ROM server company. From 1990 to March 1995, Mr. Goldman served as Vice
President of Sales for Virtual Microsystems. Mr. Goldman holds a B.A. in
Economics from the University of California at Berkeley.
Brett L. Helsel has served as our Senior Vice President of Product
Development since February 2000 and as our Vice President of Product Development
and Chief Technology Officer from May 1998 to February 2000. From April to May
1998, Mr. Helsel served as our Vice President of Advanced Product Architecture.
From March 1997 to March 1998, Mr. Helsel served as Vice President, Product
Development, for Cybersafe, Inc., a provider of enterprise-wide network security
solutions. From April 1994 to October 1997, Mr. Helsel served as Site
Development Manager for Wall Data, a host connectivity software company. Mr.
Helsel holds a B.S. in Geophysics and Oceanography from the Florida Institute of
Technology. Alan J. Higginson has served as one of our directors since May 1996.
From November 1995 to November 1998, Mr. Higginson served as President of
Atrieva Corporation, a provider of advanced data backup and retrieval
technology. From May 1990 to November 1995, Mr. Higginson served as Executive
Vice President of Worldwide Sales and Marketing for Sierra On-line, a developer
of multimedia software for the home personal computer market. From May 1990 to
November 1995, Mr. Higginson served as President of Sierra On-line's Bright Star
division, a developer of educational software. Mr. Higginson holds a B.S. in
Commerce and an M.B.A. from the University of Santa Clara.
Karl D. Guelich has served as one of our directors since June 1999. Mr.
Guelich has been in private practice as a certified public accountant since his
retirement from Ernst & Young in 1993, where he served as the Area Managing
Partner for the Pacific Northwest offices headquartered in Seattle from October
1986 to November 1992. Mr. Guelich holds a B.S. degree in Accounting from
Arizona State University.
Keith D. Grinstein has served as one of our directors since December
1999. Mr. Grinstein has been the Vice Chairman of Nextel International, Inc.
since September 1999. From January 1996 to February 1999, Mr. Grinstein served
as President, Chief Executive Officer and as a director of Nextel International,
Inc. From January 1991 to December 1995, Mr. Grinstein was President and Chief
Executive Officer of the aviation communications division of AT&T Wireless
Services, Inc. Mr. Grinstein had a number of positions at McCaw Cellular and its
subsidiaries, include Vice President, General Counsel and Secretary of LIN
Broadcasting Company, a subsidiary of McCaw Cellular, and Vice President and
Assistant General Counsel of McCaw Cellular. He is currently on the board of
directors for the Ackerley Group, a media and entertainment company. Mr.
Grinstein received a BA from Yale University and a JD from Georgetown
University.
ITEM 2. PROPERTIES.
Our principal administrative, sales, marketing and research development
facilities are located in Seattle, Washington and consist of two buildings
totaling approximately 195,000 square feet. In April 2000, we entered into a
lease agreement for the buildings. The lease commenced in July 2000 on the first
building; and the lease on the second building commenced in October 2000. The
leases for both buildings expire in 2012 with an option for renewal. We also
lease office space for our field personnel in California, New Jersey, Virginia,
Hong Kong, Singapore, Japan, Korea, Australia, India and the United Kingdom.
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ITEM 3. LEGAL PROCEEDINGS.
We are not aware of any pending legal proceedings against us that,
individually or in the aggregate, would have a material adverse effect on our
business, operating results, or financial condition. We may in the future be
party to litigation arising in the course of our business, including claims that
we allegedly infringe third-party trademarks and other intellectual property
rights. Such claims, even if not meritorious, could result in the expenditure of
significant financial and managerial resources.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS.
No matters were submitted to a vote of shareholders during the fourth
quarter of our fiscal year.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS.
MARKET PRICES AND DIVIDENDS ON COMMON STOCK
Our common stock has traded on the Nasdaq National Market since June 4,
1999 under the symbol "FFIV." The following table sets forth the high and low
sales prices of our common stock as reported on Nasdaq.
FISCAL YEAR ENDED SEPTEMBER 30, 1999 HIGH LOW
------- -------
Third Quarter (from June 4, 1999)................................ $45.13 $10.13
Fourth Quarter.................................................. $85.00 $27.75
FISCAL YEAR ENDED SEPTEMBER 30, 2000 HIGH LOW
------- -------
First Quarter.................................................... $160.50 $66.94
Second Quarter................................................... $142.12 $62.12
Third Quarter.................................................... $ 76.50 $28.37
Fourth Quarter.................................................. $ 61.50 $33.00
As of December 1, 2000 there were 128 holders of record of our common
stock, although we believe the number of beneficial holders of our common stock
is substantially greater.
We have never declared or paid cash dividends on our common stock and do
not anticipate paying any dividends in the foreseeable future. We currently
intend to retain our earnings, if any, for developing our business.
REPORT OF OFFERING SECURITIES AND USE OF PROCEEDS
We sold 2,860,000 shares of common stock in our initial public offering
pursuant to a registration statement (No. 333-75817) filed under the Securities
Act of 1933, as amended, that became effective on June 4, 1999. The shares were
sold at a price of $10.00 per share to an underwriting syndicate led by
Hambrecht & Quist, BancBoston Robertson Stephens and Dain Rauscher Wessels. The
offering commenced on June 4, 1999 and was completed on June 9, 1999. An
additional 140,000 of shares of common stock were sold on behalf of a selling
shareholder as part of the initial public offering. Offering proceeds to F5,
after underwriting discounts, net of aggregate expenses of approximately $1.0
million, were approximately $25.5 million. From the time of receipt through
September 30, 2000, the proceeds were applied as follows:
- $6,000,000 was applied toward lease obligations for new office
space secured by an irrevocable standby letter of credit;
- Approximately $5.7 million was used for the construction of the
corporate offices;
- The remainder of the proceeds were approximately $13.8 million and
was applied toward working capital expenditures, including
expenditures for sales and marketing, research and development and
professional services.
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ITEM 6. SELECTED FINANCIAL DATA.
The following selected financial data are derived from our historical
financial statements. The information set forth below should be read in
conjunction with our financial statements, including the notes thereto, and
"Management's Discussion and Analysis of Financial Condition and Results of
Operation" (in thousands, except per share data).
PERIOD FROM
FEB. 26, 1996
FISCAL YEAR ENDED SEPTEMBER 30, (INCEPTION) TO
------------------------------------------------------- SEPT. 30,
2000 1999 1998 1997 1996
-------- -------- -------- -------- --------
STATEMENT OF OPERATIONS DATA:
Net revenues:
Products ................................ $ 87,980 $ 23,420 $ 4,119 $ 229 $ 2
Services ................................ 20,665 4,405 770 -- --
-------- -------- -------- -------- --------
Total net revenues ........................ 108,645 27,825 4,889 229 2
-------- -------- -------- -------- --------
Cost of net revenues:
Products ................................ 24,660 5,582 1,091 71 1
Services ................................ 7,911 1,618 314 -- --
-------- -------- -------- -------- --------
Total cost of net revenues ................ 32,571 7,200 1,405 71 1
-------- -------- -------- -------- --------
Gross profit ............................ 76,074 20,625 3,484 158 1
-------- -------- -------- -------- --------
Operating expenses:
Sales and marketing ..................... 36,890 13,505 3,881 565 62
Research and development ................ 14,478 5,642 1,810 569 103
General and administrative .............. 9,727 3,869 1,041 383 180
Amortization of unearned compensation ... 2,127 2,487 420 69 4
-------- -------- -------- -------- --------
Total operating expenses ................ 63,222 25,503 7,152 1,586 349
-------- -------- -------- -------- --------
Income (loss) from operations ............. 12,852 (4,878) (3,668) (1,428) (348)
Other income (expense), net ............... 2,903 534 (4) (28) 18
-------- -------- -------- -------- --------
Income (loss) before income taxes ......... 15,755 (4,344) (3,672) (1,456) (330)
Provision for income taxes ................ 2,105 -- -- -- --
-------- -------- -------- -------- --------
Net income (loss) ....................... $ 13,650 $ (4,344) $ (3,672) $ (1,456) $ (330)
======== ======== ======== ======== ========
Net income (loss) per share-basic ......... $ 0.65 $ (0.42) $ (0.60) $ (0.24) $ (0.06)
======== ======== ======== ======== ========
Weighted average shares-basic ............. 21,137 10,238 6,086 6,000 5,932
======== ======== ======== ======== ========
Net income (loss) per share -- diluted .... $ 0.59 $ (0.42) $ (0.60) $ (0.24) $ (0.06)
======== ======== ======== ======== ========
Weighted average shares -- diluted ........ 23,066 10,238 6,086 6,000 5,932
======== ======== ======== ======== ========
SEPTEMBER 30,
-----------------------------------------------------------------------
2000 1999 1998 1997 1996
-------- -------- -------- -------- --------
BALANCE SHEET DATA:
Cash and cash equivalents ................. $ 53,017 $ 24,797 $ 6,206 $ 143 $ 624
Working capital (deficit) ................. 65,898 25,876 6,763 (317) 617
Total assets .............................. 122,420 42,846 9,432 919 817
Long-term obligations ..................... -- -- -- 216 29
Redeemable convertible preferred stock .... -- -- 7,688 -- --
Shareholders' equity (deficit) ............ 87,685 31,973 (80) (231) 737
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The following Management's Discussion and Analysis of Financial
Condition and Results of Operations should be read in conjunction with our
Financial Statements and Notes. Our discussion contains forward-looking
statements based upon current expectations. These forward-looking statements
include, but are not limited to, statements about our plans, objectives,
expectations and intentions and other statements that are not historical facts.
Because these forward-looking statements involve risks and uncertainties, our
actual results and the timing of certain events could differ materially from
those anticipated in these forward-looking statements as a result of certain
factors, including those set forth under "Risk Factors, "Business" and elsewhere
in this report.
OVERVIEW
F5 was incorporated on February 26, 1996 and began operations in April
1996. Our fiscal year ended on September 30, 2000.
From our inception through May 1999, we financed our operations and
capital expenditures primarily through the sale of approximately $12.4 million
in equity securities. In June 1999, we completed an initial public offering of
2,860,000 shares of common stock and raised approximately $25.5 million, net of
offering costs. In October 1999, we completed a secondary public offering of
500,000 shares of common stock and raised approximately $31.5 million, net of
offering costs.
For the fiscal years 1998 through 2000, our net revenues were $4.9
million, $27.8 million and $108.6 million respectively. We achieved our first
quarterly profit during the fourth quarter of fiscal year 1999 and our first
annual profit in fiscal year 2000.
Currently, we derive approximately 62% of our net revenues from sales of
BIG-IP, and we expect to derive a significant portion of our net revenues from
sales of BIG-IP in the future. During fiscal year 2000, one of our resellers,
Exodus Communications, accounted for 14% of our net revenues and 8% of our
accounts receivable balance at September 30, 2000.
Net revenues derived from customers located outside of the United States
were $20.6 million in fiscal 2000, $2.2 million in fiscal 1999, and $172,000 in
fiscal 1998. We plan to continue expanding our international operations
significantly, particularly in selected countries in the European and Asia
Pacific markets, because we believe international markets represent a
significant growth opportunity.
Customers who purchase our products have the option to receive
installation services and an initial customer support contract, typically
covering a 12-month period. We generally combine the software license,
installation, and customer support elements of our products into a package with
a single price. We allocate a portion of the sales price to each element of the
bundled package based on their respective fair values when the individual
elements are sold separately. Customers may also purchase consulting services
and renew their initial customer support contract.
Revenues from the sale of our products and software licenses are
recognized, net of allowances for estimated returns, when the product has been
shipped and the customer is obligated to pay for the product. Estimated sales
returns are based on historical experience by product and are recorded at the
time revenues are recognized. Services revenue for installation is recognized
when the product has been installed at the customer's site. Revenues for
customer support are recognized on a straight-line basis over the service
contract term. Consulting services are customarily billed at fixed rates, plus
out-of-pocket expenses, and revenues from consulting services are recognized at
the end of the quarter in which they are performed.
Our ordinary payment terms to our domestic customers are net 30 days,
but we have extended payment terms beyond net 30 days to some customers. For
these arrangements, revenue is recognized ratably over the terms of the
arrangement. Our ordinary payment terms to our international customers are net
60 days.
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In view of the rapidly changing nature of our business and our limited
operating history, we believe that period-to-period comparisons of net revenues
and operating results are not necessarily meaningful and should not be relied
upon as indicators of future performance. To maintain profitability we will need
to increase our net revenues and manage operating expenses. Although we have
experienced rapid growth in net revenues in recent periods, we may not be able
to sustain these growth rates to maintain profitability.
We have recorded a total of $8.2 million of stock compensation costs
since our inception through September 30, 2000. These charges represent the
difference between the exercise price and the deemed fair value of certain stock
options granted to our employees and outside directors. These options generally
vest ratably over a four-year period. We are amortizing these costs using an
accelerated method as prescribed by FASB interpretation No. 28 ("FIN No. 28")
and have recorded stock compensation charges of $2.1 million, $2.5 million and
$420,000 for the years ended September 30, 2000, 1999 and 1998, respectively.
We expect to recognize amortization expense related to unearned
compensation of approximately $2.2 million, $824,000, $60,000 and $0 during the
years ended September 30, 2001, 2002, 2003 and 2004, respectively. We cannot
guarantee, however, that we will not accrue additional stock compensation costs
in the future or that our current estimate of these costs will prove accurate.
RESULTS OF OPERATIONS
The following table sets forth certain financial data as a percentage of
total net revenues for the periods indicated.
YEAR ENDED SEPTEMBER 30,
--------------------------------
2000 1999 1998
----- ----- -----
STATEMENT OF OPERATIONS DATA:
Net revenues:
Products ................................. 81.0% 84.2% 84.3%
Services ................................. 19.0 15.8 15.7
----- ----- -----
Total net revenues ..................... 100.0 100.0 100.0
Cost of net revenues:
Products ................................. 22.7 20.1 22.3
Services ................................. 7.3 5.8 6.4
----- ----- -----
Total cost of net revenues ............. 30.0 25.9 28.7
----- ----- -----
Gross margin ........................... 70.0 74.1 71.3
Operating expenses:
Sales and marketing ...................... 34.0 48.5 79.4
Research and development ................. 13.3 20.3 37.0
General and administrative ............... 9.0 13.9 21.3
Amortization of unearned compensation .... 2.0 8.9 8.6
----- ----- -----
Total operating expenses ............... 58.2 91.6 146.3
----- ----- -----
Income (loss) from operations ............... 11.8 (17.5) (75.0)
Other income (expense), net ................. 2.7 1.9 (0.1)
----- ----- -----
Income (loss) before income taxes ........... 14.5 (15.6) (75.1)
Provision for income taxes .................. 1.9 -- --
----- ----- -----
Net income (loss) ....................... 12.6% (15.6)% (75.1)%
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YEARS ENDED SEPTEMBER 30, 2000 AND 1999
Net Revenues:
Net revenues consist of sales of our products and services, which
include software licenses and related services. Services include revenue from
service and support agreements provided as part of the initial product sale,
installation, sales of extended service and support contracts and consulting
services.
Product revenues. Product revenues increased by 275.7%, from $23.4
million for the year ended September 30, 1999 to $88.0 million for the year
ended September 30, 2000. This increase in product revenues was due to an
increase in the quantity of our products sold, primarily through our indirect
sales channels and to a lesser extent through our direct sales channels.
Service revenues. Service revenues increased by 369.1%, from $4.4
million for the year ended September 30, 1999 to $20.7 million for the year
ended September 30, 2000. This increase was due primarily to an increase in the
installed base of our products and the renewal of service and support contracts.
International revenues represented 7.7% of total revenues for the year
ended September 30, 1999 and 19% of total revenues for the year ended September
30, 2000. This increase represents the growth in demand for our products and an
increase in the number of resellers. We expect international revenues to
continue to represent a significant portion of net revenues, although we cannot
assure you that these revenues as a percentage of net revenues will remain at
current levels. All sales transactions are denominated in U.S. dollars.
As our net revenue base increases, we do not believe we can sustain
percentage growth rates of net revenues that we have experienced historically.
Cost of Net Revenues:
Cost of net revenues consists primarily of outsourced hardware
components and manufacturing, fees for third-party software products integrated
into our products, service and support personnel and an allocation of our
facilities and depreciation expenses.
Cost of product revenues. Cost of product revenues increased 341.8%,
from $5.6 million for the year ended September 30, 1999 to $24.7 million for the
year ended September 30, 2000. Cost of product revenues increased as a percent
of product revenues from 23.8% for the year ended September 30, 1999, to 28.0%
for the year ended September 30, 2000. The increase as a percentage of product
revenues was the result of higher production costs associated with hardware
configuration enhancements. The cost of raw materials may increase, which would
cause the cost of product revenues to increase and have a negative impact on our
gross margin.
Cost of service revenues. Cost of service revenues increased 388.9%,
from $1.6 million for the year ended September 30, 1999 to $7.9 million for the
year ended September 30, 2000. Cost of service revenues increased as a percent
of service revenues from 36.7% for the year ended September 30, 1999 to 38.3%
for the year ended September 30, 2000. The increase in cost of service revenue
as a percentage of service revenues is due to increased personnel costs which
include training and consulting.
Sales and marketing. Our sales and marketing expenses consist primarily
of salaries, commissions and related benefits of our sales and marketing staff,
costs of our marketing programs, including public relations, advertising and
trade shows, and an allocation of our facilities and depreciation expenses.
Sales and marketing expenses increased by 173.2%, from $13.5 million for the
year ended September 30, 1999 to $36.9 million for the year ended September 30,
2000. This increase was due to an increase in sales and marketing personnel and
professional services personnel from 93 to 287, and increased advertising and
promotional activities. We expect to continue increasing sales and marketing
expenses in order to grow net revenues and expand our brand awareness.
Research and development. Our research and development expenses consist
primarily of salaries and related benefits for our product development personnel
and an allocation of our facilities and depreciation expenses.
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Research and development expenses increased by 156.6%, from $5.6 million for the
year ended September 30, 1999 to $14.5 million for the year ended September 30,
2000. This increase was due to an increase in product development personnel from
59 to 134 and nonrecurring charges of $1.6 million consisting of prototype
material expenses and a one time licensing agreement. Our future success is
dependent, in large part on the continued enhancement of our current products
and our ability to develop new, technologically advanced products that meet the
sophisticated needs of our customers. We expect research and development
expenses to increase in future periods.
General and administrative. Our general and administrative expenses
consist primarily of salaries, benefits and related costs of our executive,
finance, human resource and legal personnel, third-party professional service
fees, and an allocation of our facilities and depreciation expenses. General and
administrative expenses increased by 151.4%, from $3.9 million for the year
ended September 30, 1999 to $9.7 million for the year ended September 30, 2000.
This increase was due primarily to an increase in general and administrative
personnel from 35 to 75 and a one time executive recruitment charge of $1.6
million. We expect general and administrative expenses to increase as we expand
our staff, further develop our internal information systems and incur costs
associated with being a publicly held company.
Unearned compensation. We recorded stock compensation charges of $2.5
million and $2.1 million for the years ended September 30, 1999 and 2000,
respectively.
Other income (expense), net. Other income consists primarily of earnings
on our cash and cash equivalents balances. Interest income was $534,000 for the
year ended September 30, 1999 and $3.2 million for the year ended September 30,
2000. There was a one time asset impairment charge of $336,000, associated with
the move to our new corporate headquarters.
Income taxes. The income tax provision increase from zero in fiscal 1999
to $2.1 million in fiscal 2000. The Company utilized a portion of its U.S.
federal and state net operating loss carryforwards in fiscal 2000. The
difference between the statutory rate and the effective rate was due primarily
to previous unrecognized deferred tax assets. FASB statement No. 109 provides
for the recognition of deferred tax assets if realization is more likely than
not. Based on available evidence, which includes our historical operating
performance and the reported cumulative net losses in all prior years, we
historically provided for a full valuation allowance against our net deferred
tax assets. Based on our operating performance, we determined that a certain
portion of these assets are more likely than not to be realizable. As a result,
the valuation allowance has been partially reversed against our net deferred
assets for these assets which are considered realizable. We have maintained a
valuation allowance on our remaining net operating loss carryforwards as of
September 30, 2000 (approximately $4.9 million). These remaining net operating
loss carryforwards primarily relate to the tax benefits associated with our
stock option plans, which will be offset against shareholders' equity.
YEARS ENDED SEPTEMBER 30, 1999 AND 1998
Net Revenues:
Net revenues consist of sales of our products and services, which
include software licenses and related services. Services include revenue from
service and support agreements provided as part of the initial product sale,
installation, sales of extended service and support contracts and consulting
services.
Product revenues. Product revenues increased by 468.6%, from $4.1
million for the year ended September 30, 1998 to $23.4 million for the year
ended September 30, 1999. This increase in product revenues was due to an
increase in the quantity of our products sold, primarily through our indirect
sales channels and to a lesser extent through our direct sales channels.
Service revenues. Service revenues increased by 472.1%, from $770,000
for the year ended September 30, 1998 to $4.4 million for the year ended
September 30, 1999. This increase was due primarily to an increase in the
installed base of our products and the renewal of service and support contracts.
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Cost of Net Revenues:
Cost of net revenues consists primarily of outsourced hardware
components and manufacturing, fees for third-party software products integrated
into our products, service and support personnel and an allocation of our
facilities and depreciation expenses.
Cost of product revenues. Cost of product revenues increased 411.6%,
from $1.1 million for the year ended September 30, 1998 to $5.6 million for the
year ended September 30, 1999. Cost of product revenues decreased as a percent
of product revenues from 26.5% for the year ended September 30, 1998, to 23.8%
for the year ended September 30, 1999. The decrease as a percentage of product
revenues was the result of higher utilization of manufacturing operations,
including increased economies of scale achieved from an increase in production.
The increase in absolute dollars was due primarily to an increase in product
revenues. The cost of raw materials may increase, which would cause the cost of
product revenues to increase and have a negative impact on our gross margin.
Cost of service revenues. Cost of service revenues increased 415.3%,
from $314,000 for the year ended September 30, 1998 to $1.6 million for the year
ended September 30, 1999. Cost of service revenues decreased as a percent of
service revenues from 40.8% for the year ended September 30, 1998 to 36.7% for
the year ended September 30, 1999. The decrease in cost of service as a
percentage of service revenues is due to increased economies of scale achieved
from increased service revenues. The increase in cost of service revenues in
absolute dollars was due primarily to increased personnel costs which include
training and consulting.
Sales and marketing. Our sales and marketing expenses consist primarily
of salaries, commissions and related benefits of our sales and marketing staff,
costs of our marketing programs, including public relations, advertising and
trade shows, and an allocation of our facilities and depreciation expenses.
Sales and marketing expenses increased by 248.0%, from $3.9 million for the year
ended September 30, 1998 to $13.5 million for the year ended September 30, 1999.
This increase was due to an increase in sales and marketing personnel and
professional services personnel from 37 to 93, and increased advertising and
promotional activities. We expect to continue increasing sales and marketing
expenses in order to grow net revenues and expand our brand awareness.
Research and development. Our research and development expenses consist
primarily of salaries and related benefits for our product development personnel
and an allocation of our facilities and depreciation expenses. Research and
development expenses increased by 211.7%, from $1.8 million for the year ended
September 30, 1998 to $5.6 million for the year ended September 30, 1999. This
increase was due to an increase in product development personnel from 27 to 59.
Our future success is dependent, in large part on the continued enhancement of
our current products and our ability to develop new, technologically advanced
products that meet the sophisticated needs of our customers. We expect research
and development expenses to increase in future periods.
General and administrative. Our general and administrative expenses
consist primarily of salaries, benefits and related costs of our executive,
finance, human resource and legal personnel, third-party professional service
fees, and an allocation of our facilities and depreciation expenses. General and
administrative expenses increased by 271.7%, from $1.0 million for the year
ended September 30, 1998 to $3.9 million for the year ended September 30, 1999.
This increase was due primarily to an increase in general and administrative
personnel from 16 to 35. We expect general and administrative expenses to
increase as we expand our staff, further develop our internal information
systems and incur costs associated with being a publicly held company.
Unearned compensation. We recorded stock compensation charges of
$420,000 and $2.5 million for the years ended September 30, 1998 and 1999,
respectively.
Interest income (expense) net. Interest income consists of earnings on
our cash and cash equivalent balances offset by interest expense associated with
debt obligations. Net interest expense was $4,000 for the year ended September
30, 1998 compared to net interest income of $534,000 for the year ended
September 30, 1999. This increase was due primarily to the investment of the
proceeds received from our initial public offering in June 1999.
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Income taxes. As of September 30, 1999, we had approximately $7.8
million of net operating loss carryforwards for federal income tax purposes.
Accordingly, there was no provision for federal or state income taxes for any
prior period. Utilization of the net operating loss carryforwards may be subject
to annual limitations due to the ownership change limitations contained in the
Internal Revenue Code of 1986 and similar state provisions. Annual limitations
may result in the expiration of the net operating losses before we can utilize
them. The federal net operating loss carryforwards will expire at various dates
beginning in 2011 through 2019 if we do not use them.
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QUARTERLY RESULTS OF OPERATIONS
The following tables present our unaudited quarterly results of
operations for the eight quarters ended September 30, 2000 in dollars and as a
percentage of net revenues. You should read the following tables in conjunction
with our financial statements and related notes included elsewhere in this
report. We have prepared this unaudited information on the same basis as the
audited financial statements. These tables include all adjustments, consisting
only of normal recurring adjustments that we consider necessary for a fair
presentation of our operating results for the quarters presented. You should not
draw any conclusions about our future results from the results of operations for
any quarter.
THREE MONTHS ENDED
----------------------------------------------------------------------------------------
SEPT. 30, JUNE 30, MARCH 31, DEC. 31, SEPT. 30, JUNE 30, MARCH 31, DEC. 31,
2000 2000 2000 1999 1999 1999 1999 1998
--------- --------- --------- --------- --------- --------- --------- ---------
Net Revenues:
Products .......................... $ 29,259 $ 23,834 $ 18,532 $ 16,282 $ 11,548 $ 6,444 $ 3,146 $ 2,282
Services .......................... 7,388 5,387 5,072 2,891 2,215 1,161 616 413
--------- --------- --------- --------- --------- --------- --------- ---------
Total net revenues ............. 36,647 29,221 23,604 19,173 13,763 7,605 3,762 2,695
--------- --------- --------- --------- --------- --------- --------- ---------
Cost of net revenues:
Products .......................... 8,951 6,032 5,053 4,624 2,497 1,636 825 624
Services .......................... 2,822 2,238 1,792 1,059 642 396 384 196
--------- --------- --------- --------- --------- --------- --------- ---------
Total cost of net revenues ..... 11,773 8,270 6,845 5,683 3,139 2,032 1,209 820
--------- --------- --------- --------- --------- --------- --------- ---------
Gross profit ................... 24,874 20,951 16,759 13,490 10,624 5,573 2,553 1,875
--------- --------- --------- --------- --------- --------- --------- ---------
Operating expenses:
Sales and marketing ............... 12,121 10,575 8,452 5,742 4,392 4,010 2,887 2,216
Research and development .......... 6,070 3,422 2,761 2,225 1,831 1,466 1,324 1,021
General and administrative ........ 4,279 2,222 1,748 1,478 1,724 954 666 525
Amortization of unearned
compensation .................. 680 434 470 543 690 759 670 368
--------- --------- --------- --------- --------- --------- --------- ---------
Total operating expenses ....... 23,150 16,653 13,431 9,988 8,637 7,189 5,547 4,130
--------- --------- --------- --------- --------- --------- --------- ---------
Income (loss) from operations ........ 1,724 4,298 3,328 3,502 1,987 (1,616) (2,994) (2,255)
Other income (expense), net .......... 489 855 818 741 348 97 31 58
--------- --------- --------- --------- --------- --------- --------- ---------
Income (loss) before income taxes .... 2,213 5,153 4,146 4,243 2,335 (1,519) (2,963) (2,197)
--------- --------- --------- --------- --------- --------- --------- ---------
Provision for income taxes ........... 797 1,308 -- -- -- -- -- --
--------- --------- --------- --------- --------- --------- --------- ---------
Net income (loss) ............... $ 1,416 $ 3,845 $ 4,146 $ 4,243 $ 2,335 $ (1,519) $ (2,963) $ (2,197)
========= ========= ========= ========= ========= ========= ========= =========
Net Revenues:
Products .......................... 79.8% 81.6% 78.5% 84.9% 83.9% 84.7% 83.6% 84.7%
Services .......................... 20.2 18.4 21.5 15.1 16.1 15.3 16.4 15.3
--------- --------- --------- --------- --------- --------- --------- ---------
Total net revenues ............. 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
--------- --------- --------- --------- --------- --------- --------- ---------
Cost of net revenues:
Products .......................... 24.4 20.6 21.4 24.1 18.1 21.5 21.9 23.1
Services .......................... 7.7 7.7 7.6 5.5 4.7 5.2 10.2 7.3
--------- --------- --------- --------- --------- --------- --------- ---------
Total cost of net revenues ..... 32.1 28.3 29.0 29.6 22.8 26.7 32.1 30.4
--------- --------- --------- --------- --------- --------- --------- ---------
Gross margin ................... 67.9 71.7 71.0 70.4 77.2 73.3 67.9 69.6
--------- --------- --------- --------- --------- --------- --------- ---------
Operating expenses:
Sales and marketing ............... 33.1 36.2 35.8 29.9 32.0 52.7 76.7 82.2
Research and development .......... 16.6 11.7 11.7 11.6 13.3 19.3 35.2 37.8
General and administrative ........ 11.7 7.6 7.4 7.7 12.5 12.5 17.8 19.5
Amortization of unearned
compensation .................. 1.9 1.5 2.0 2.8 5.0 10.0 17.8 13.7
--------- --------- --------- --------- --------- --------- --------- ---------
Total operating expenses ....... 63.2 57.0 56.9 52.1 62.8 94.5 147.5 153.2
--------- --------- --------- --------- --------- --------- --------- ---------
Income (loss) from operations ........ 4.7 14.7 14.1 18.3 14.4 (21.2) (79.6) (83.6)
Other income (expense), net .......... 1.3 2.9 3.5 3.9 2.6 1.3 0.8 2.1
--------- --------- --------- --------- --------- --------- --------- ---------
Income (loss) before income taxes .... 6.0 17.6 17.6 22.1 17.0 (19.9) (78.8) (81.5)
--------- --------- --------- --------- --------- --------- --------- ---------
Provision for income taxes ........... 2.2 4.5 -- -- -- -- -- --
--------- --------- --------- --------- --------- --------- --------- ---------
Net income (loss) ............... 3.9% 13.2% 17.6% 22.1% 17.0% (19.9)% (78.8)% (81.5)%
========= ========= ========= ========= ========= ========= ========= =========
22
23
Our quarterly operating results have fluctuated significantly and we
expect that future operating results will be subject to similar fluctuations for
a variety of factors, many of which are substantially outside our control. See
"Risk Factors-Our quarterly operating results are volatile and may cause our
stock price to fluctuate."
LIQUIDITY AND CAPITAL RESOURCES
From our inception through May 1999, we financed our operations and
capital expenditures primarily through the sale of approximately $12.4 million
in equity securities. In June 1999 we completed an initial public offering of
2,860,000 shares of common stock and raised approximately $25.5 million, net of
offering costs. In October 1999, we completed a secondary public offering of
500,000 shares of common stock and raised approximately $31.4 million, net of
offering costs.
Cash used in our operating activities was $2.0 million for the year
ended September 30, 1999. Cash provided by our operating activities was $9.8
million for the year ended September 30, 2000. Net cash for fiscal year 2000
outflows resulted from increases in accounts receivable due to increased sales
and other current assets and were partially offset by increases in accounts
payable, accrued liabilities and deferred revenues. Net cash inflows for fiscal
year 2000 was the result of the Company becoming profitable in the second
quarter of 2000. We anticipate that in the future we may offer financing to
certain resellers. To the extent such financing is offered, cash used in
operating activities will increase to fund the increase in outstanding accounts
receivable.
Cash used in investing activities was $5.6 million for the year ended
September 30, 1999 and $16.5 million for the year ended September 30, 2000,
which includes $13.3 million used to purchase property and equipment and $3.2
million used to invest in restricted cash. The components of restricted cash
consist of an irrevocable standby letters of credit, totaling $6.0 million to
fund our commitment to lease office space.
As of September 30, 1999, our principal commitments consisted of
obligations outstanding under operating leases. In April 2000, we entered into a
lease agreement on two buildings for a new corporate headquarters. The lease
commenced in July 2000 on the first building; and the lease on the second
building commenced in October 2000. The lease for both buildings expires in
2012 with an option for renewal. The company established a restricted escrow
account in connection with this lease agreement. Under the term of the lease, a
$6 million irrevocable standby letter of credit is required through November
2012, unless the lease is terminated before then. This amount has been included
on the Company's balance sheet as of September 30, 2000 as a component of
restricted cash. Although we have no other material commitments, we anticipate a
substantial increase in our capital expenditures and lease commitments
consistent with our anticipated growth in our operations, infrastructure and
personnel. In the future we may also require a larger inventory of products in
order to provide better availability to customers and achieve purchasing
efficiencies. Any such increase can be expected to reduce cash, cash equivalents
and short-term investments. We expect that our existing cash balances and cash
from operations will be sufficient to meet our anticipated working capital and
capital expenditures for the foreseeable future.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities." This statement requires that all derivative instruments be recorded
on the balance sheet at their fair value. Changes in the fair value of
derivatives are recorded each period in current earnings or other comprehensive
income, depending on whether a derivative is designated as part of a hedge
transaction and, if it is, the type of hedge transaction. In July 1999, the FASB
issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging
Activities Deferral of the Effective Date of FASB Statement No. 133." SFAS No.
137 deferred the effective date of SFAS No. 133 until fiscal years beginning
after June 15, 2000. The Company does not use derivative instruments, therefore
the adoption of this statement will not have any effect on the Company's results
of operations or its financial position.
In December 1999, SEC Staff Accounting Bulletin No. 101 ("SAB 101"),
"Revenue Recognition in Financial Statements," was issued. This pronouncement
summarizes certain of the SEC staff's views in applying generally accepted
accounting principles to revenue recognition. SAB 101 is required to be adopted
by the
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Company for the year ended September 30, 2001. The Company is currently
reviewing the requirements of SAB 101 and assessing its impact on the Company's
financial statements.
RISK FACTORS
In addition to the other information in this report, the following risk
factors should be carefully considered in evaluating our company and its
business.
OUR QUARTERLY OPERATING RESULTS ARE VOLATILE AND MAY CAUSE OUR STOCK PRICE TO
FLUCTUATE.
Our quarterly operating results have varied significantly in the past
and will vary significantly in the future, which makes it difficult for us to
predict our future operating results. In particular, we anticipate that the size
of customer orders may increase as we continue to focus on larger business
accounts. A delay in the recognition of revenue, even from just one account, may
have a significant negative impact on our results of operations for a given
period. In the past, a significant portion of our sales have been realized near
the end of a quarter. Accordingly, a delay in an anticipated sale past the end
of a particular quarter may negatively impact our results of operations for that
quarter. Furthermore, we base our decisions regarding our operating expenses on
anticipated revenue trends and our expense levels are relatively fixed.
Consequently, if revenue levels fall below our expectations, our net income
(loss) will decrease (increase) because only a small portion of our expenses
vary with our revenues. See Item 7 of Part II -- "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
We believe that period-to-period comparisons of our results of
operations are not meaningful and should not be relied upon as indicators of
future performance. Our operating results may be below the expectations of
securities analysts and investors in some future quarter or quarters. Our
failure to meet these expectations will likely seriously harm the market price
of our common stock.
OUR SUCCESS DEPENDS ON SALES OF OUR BIG-IP(R).
We currently derive approximately 62% of our net revenues from sales of
our BIG-IP product line. In addition, we expect to derive a significant portion
of our net revenues from sales of BIG-IP in the future. Implementation of our
strategy depends upon BIG-IP being able to solve critical network availability
and performance problems of our customers. If BIG-IP is unable to solve these
problems for our customers, our business and results of operations will be
seriously harmed.
OUR SUCCESS DEPENDS ON OUR TIMELY DEVELOPMENT OF NEW PRODUCTS AND FEATURES.
We expect the Internet traffic and content management market to be
characterized by rapid technological change, frequent new product introductions,
changes in customer requirements and evolving industry standards. We are
currently developing new features for our existing products. We expect to
continue to develop new products and new product features in the future. If we
fail to develop and deploy new products and new product features on a timely
basis, our business and results of operations may be seriously harmed. See Item
1 of Part I -- "Business -- Product Development."
WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY IN THE EMERGING INTERNET TRAFFIC AND
CONTENT MANAGEMENT MARKET.
Our markets are new, rapidly evolving and highly competitive, and we
expect competition to persist and intensify in the future. Our principal
competitors in the Internet traffic and content management market include Cisco
Systems, Nortel Networks, RadWare and Resonate. We expect to continue to face
additional competition as new participants enter the Internet traffic and
content management market. In addition, larger companies with significant
resources, brand recognition and sales channels may form alliances with or
acquire competing Internet traffic and content management solutions and emerge
as significant competitors. Potential competitors may bundle their products or
incorporate an Internet traffic and content management component into existing
products in a manner that discourages users from purchasing our products.
Potential customers may also choose to purchase additional or larger servers
instead of our products. See Item 1 of Part I -- "Business -- Competition."
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25
OUR EXPANSION INTO INTERNATIONAL MARKETS MAY NOT SUCCEED.
We intend to continue expanding into international markets. We have
limited experience in marketing, selling and supporting our products
internationally. International sales represented 19% of our net revenues for the
year ended September 30, 2000, 7.7% of our net revenues for the year ended
September 30, 1999, and 3.5% for the year ended September 30, 1998. We have
engaged sales personnel in Australia, Europe, Asia Pacific and Latin America.
Our continued growth will require further expansion of our international
operations in selected countries in the European and Asia Pacific markets. If we
are unable to expand our international operations successfully and in a timely
manner, our business and results of operations may be seriously harmed. Such
expansion may be more difficult or take longer than we anticipate, and we may
not be able to successfully market, sell, deliver and support our products
internationally.
WE MAY NOT BE ABLE TO SUSTAIN OR DEVELOP NEW DISTRIBUTION RELATIONSHIPS.
Our sales strategy requires that we establish multiple distribution
channels in the United States and internationally through leading industry
resellers, original equipment manufacturers, systems integrators, Internet
service providers and other channel partners. We have a limited number of
agreements with companies in these channels, and we may not be able to increase
our number of distribution relationships or maintain our existing relationships.
One of our resellers, Exodus Communications, accounted for 14% of our net
revenues for the year ended September 30, 2000, and 8% of our accounts
receivable balance at September 30, 2000. Our inability to effectively establish
our indirect sales channels will seriously harm our business and results of
operations.
OUR SUCCESS DEPENDS ON OUR ABILITY TO ATTRACT, TRAIN AND RETAIN QUALIFIED
MARKETING AND SALES, PROFESSIONAL SERVICES AND CUSTOMER SUPPORT PERSONNEL.
Our products require a sophisticated marketing and sales effort targeted
at several levels within a prospective customer's organization. Competition for
qualified sales personnel is intense, and we might not be able to hire the kind
and number of sales personnel we are targeting. Our inability to retain and hire
qualified sales personnel may seriously harm our business and results of
operations.
We currently have a professional services and customer support
organization and will need to increase our staff to support new customers and
the expanding needs of existing customers. The installation of Internet traffic
and content management solutions, the integration of these solutions into
existing networks and the ongoing support can be complex. Accordingly, we need
highly-trained professional services and customer support personnel. Hiring
professional services and customer support personnel is very competitive in our
industry due to the limited number of people available with the necessary
technical skills and understanding of our products. Our inability to attract,
train or retain the number of highly qualified professional services and
customer support personnel that our business needs may seriously harm our
business and results of operations.
WE DEPEND ON OUR KEY PERSONNEL AND THE LOSS OF ANY KEY PERSONNEL MAY HARM OUR
BUSINESS AND RESULTS OF OPERATIONS.
Our success depends to a significant degree upon the continued
contributions of our key management, product development, sales and marketing
and finance personnel, many of whom will be difficult to replace. The loss of
services of any of our key personnel may seriously harm our business and results
of operations. We do not have employment contracts with any of our key
personnel.
IT IS DIFFICULT TO PREDICT OUR FUTURE OPERATING RESULTS BECAUSE WE HAVE AN
UNPREDICTABLE SALES CYCLE.
We are unable to predict our sales cycle because we have limited
experience selling our products. Historically, our sales cycle has ranged from
approximately two to three months. Sales of BIG-IP, 3-DNS, GLOBAL-SITE, SEE-IT,
and EDGE-FX require us to educate potential customers on their use and benefits.
The sale of our products is subject to delays from the lengthy internal
budgeting, approval and competitive evaluation processes that large corporations
and governmental entities may require. For example, customers frequently begin
by evaluating our products on a limited basis and devote time and resources to
testing our products before they
25
26
decide whether or not to purchase. Customers may also defer orders as a result
of anticipated releases of new products or enhancements by us or our
competitors. As a result, our products have an unpredictable sales cycle that
contributes to the uncertainty of our future operating results.
THE AVERAGE SELLING PRICES OF OUR PRODUCTS MAY DECREASE AND OUR COSTS MAY
INCREASE, WHICH MAY NEGATIVELY IMPACT GROSS PROFITS.
We anticipate that the average selling prices of our products will
decrease in the future in response to competitive pricing pressures, increased
sales discounts, new product introductions by us or our competitors or other
factors. Therefore, in order to maintain our gross profits, we must develop and
introduce new products and product enhancements on a timely basis and
continually reduce our product costs. Our failure to do so will cause our net
revenue and gross profits to decline, which will seriously harm our business and
results of operations. In addition, we may experience substantial
period-to-period fluctuations in future operating results due to the erosion of
our average selling prices.
OUR BUSINESS MAY BE HARMED IF OUR CONTRACT MANUFACTURERS ARE NOT ABLE TO PROVIDE
US WITH ADEQUATE SUPPLIES OF OUR PRODUCTS.
We rely on third party contract manufacturers to assemble our products.
We outsource the manufacturing of our pre-configured, industry-standard hardware
platforms to three contract manufacturers who assemble these hardware platforms
to our specifications. We have experienced minor delays in shipments from these
contract manufacturers in the past which have not had a material impact on our
results of operations. We may experience delays in the future or other problems,
such as inferior quality and insufficient quantity of product, any of which may
seriously harm our business and results of operations. The inability of our
contract manufacturers to provide us with adequate supplies of our products or
the loss of our contract manufacturers may cause a delay in our ability to
fulfill orders while we obtain a replacement manufacturer and may seriously harm
our business and results of operations.
If the demand for our products grows, we will need to increase our
material purchases, contract manufacturing capacity and internal test and
quality functions. Any disruptions in product flow may limit our revenue, may
seriously harm our competitive position and may result in additional costs or
cancellation of orders by our customers. See Item 1 of Part I --
"Business -- Manufacturing."
OUR BUSINESS COULD SUFFER IF THERE ARE ANY INTERRUPTIONS OR DELAYS IN THE SUPPLY
OF HARDWARE COMPONENTS FROM OUR THIRD-PARTY SOURCES.
We currently purchase several hardware components used in the assembly
of our products from limited sources. Lead times for these components vary
significantly. Any interruption or delay in the supply of any of these hardware
components, or the inability to procure a similar component from alternate
sources at acceptable prices within a reasonable time, will seriously harm our
business and results of operations. See Item 1 of Part I --
"Business--Manufacturing."
UNDETECTED SOFTWARE ERRORS MAY SERIOUSLY HARM OUR BUSINESS AND RESULTS OF
OPERATIONS.
Software products frequently contain undetected errors when first
introduced or as new versions are released. We have experienced these errors in
the past in connection with new products and product upgrades. We expect that
these errors will be found from time to time in new or enhanced products after
commencement of commercial shipments. These problems may cause us to incur
significant warranty and repair costs, divert the attention of our engineering
personnel from our product development efforts and cause significant customer
relations problems. We may also be subject to liability claims for damages
related to product errors. While we carry insurance policies covering this type
of liability, these policies may not provide sufficient protection should a
claim be asserted. A material product liability claim may seriously harm our
business and results of operations.
Our products must successfully operate with products from other vendors.
As a result, when problems occur in a network, it may be difficult to identify
the source of the problem. The occurrence of software errors, whether caused by
our products or another vendor's products, may result in the delay or loss of
market acceptance of our products. The occurrence of any of these problems may
seriously harm our business and results of operations.
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WE MAY NOT ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY AND OUR PRODUCTS MAY
INFRINGE ON THE INTELLECTUAL PROPERTY RIGHTS OF THIRD PARTIES.
We rely on a combination of copyright, trademark and trade secret laws
and restrictions on disclosure of confidential and proprietary information to
protect our intellectual property rights. Despite our efforts to protect our
proprietary rights, unauthorized parties may attempt to copy or otherwise obtain
and use our products or technology. Monitoring unauthorized use of our products
is difficult, and we cannot be certain that the steps we have taken will prevent
misappropriation of our technology, particularly in foreign countries where the
laws may not protect our proprietary rights as fully as in the United States. In
addition, we have not entered into non-competition agreements with several of
our former employees.
From time to time, third parties may assert exclusive patent, copyright,
trademark and other intellectual property rights claims or initiate litigation
against us or our contract manufacturers, suppliers or customers with respect to
existing or future products. Although we have not been a party to any claims
alleging infringement of intellectual property rights, we cannot assure you that
we will not be subject to these claims in the future. We may in the future
initiate claims or litigation against third parties for infringement of our
proprietary rights to determine the scope and validity of our proprietary rights
or those of our competitors. Any of these claims, with or without merit, may be
time-consuming, result in costly litigation and diversion of technical and
management personnel or require us to cease using infringing technology, develop
noninfringing technology or enter into royalty or licensing agreements. Such
royalty or licensing agreements, if required, may not be available on acceptable
terms, if at all. In the event of a successful claim of infringement and our
failure or inability to develop non-infringing technology or license the
infringed or similar technology on a timely basis, our business and results of
operations may be seriously harmed.
LAWS RELATING TO ENCRYPTED SOFTWARE MAY LIMIT THE MARKETABILITY OF OUR PRODUCTS.
The encryption technology contained in our products is subject to United
States export controls. These export controls limit our ability to distribute
encrypted software outside of the United States and Canada. While we take
precautions against unlawful exportation, this exportation inadvertently may
have occurred in the past or may occur from time to time in the future,
subjecting us to potential liability and serious harm. We may also encounter
difficulties competing with non-United States producers of products containing
encrypted software, who may both import their products into the United States
and sell products overseas.
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
Interest Rate Risk. We do not hold derivative financial instruments or
equity securities in our investment portfolio. Our cash equivalents consist of
high-quality securities, as specified in our investment policy guidelines. The
policy limits the amount of credit exposure to any one issue or issuer to a
maximum of 20% of the total portfolio with the exception of treasury securities,
commercial paper and money market funds, which are exempt from size limitation.
The policy limits all short-term investments to mature in two years or less,
with the average maturity being one year or less. These securities are subject
to interest rate risk and will decrease in value if interest rates increase.
MATURING IN
-----------------------------------------------------------------------------
SEPTEMBER 30, 2000: THREE MONTHS THREE MONTHS GREATER THAN
OR LESS TO ONE YEAR ONE YEAR TOTAL FAIR VALUE
------------ ------------ ------------ --------- ----------
(IN THOUSANDS)
Included in cash and cash equivalents .... $ 13,717 $ 0 $ 0 $ 13,717 $ 13,717
Weighted average interest rate ......... 6.4% -- --
Included in short-term investments ....... $ 6,126 $ 26,523 $ 2,014 $ 34,663 $ 34,603
Weighted average interest rates ........ 6.6% 6.7% 7.0%
MATURING IN
-----------------------------------------------------------------------------
SEPTEMBER 30, 2000: THREE MONTHS THREE MONTHS GREATER THAN
OR LESS TO ONE YEAR ONE YEAR TOTAL FAIR VALUE
------------ ------------ ------------ --------- ----------
(IN THOUSANDS)
Included in cash and cash equivalents .. $ 14,367 $ 0 $ 0 $ 14,367 $ 14,367
Weighted average interest rate ....... 5.1% -- --
Included in short-term investments ..... $ 5,315 $ 3,813 $ 0 $ 9,128 $ 9,047
Weighted average interest rates ...... 5.5% 5.7% --
Foreign Currency Risk. Currently the majority of our sales and expenses
are denominated in U.S. dollars and as a result, we have not experienced
significant foreign exchange gains and losses to date. While we have conducted
some transactions in foreign currencies during the fiscal year ended September
30, 2000 and expect to continue to do so, we do not anticipate that foreign
exchange gains or losses will be significant. We have not engaged in foreign
currency hedging to date, however we may do so in the future.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
INDEX TO FINANCIAL STATEMENTS Page
----
Report of Independent Accountants............................................................. 30
Consolidated Balance Sheets................................................................... 31
Consolidated Statements of Operations......................................................... 32
Consolidated Statements of Shareholders' Equity............................................... 33
Consolidated Statements of Cash Flows......................................................... 34
Notes to Consolidated Financial Statements.................................................... 35
29
30
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
F5 Networks, Inc.
In our opinion, the consolidated financial statements listed in the index
appearing under Items 14(a)(1) present fairly, in all material respects, the
financial position of F5 Networks, Inc. and its subsidiaries at September 30,
2000 and 1999, and the results of their operations and their cash flows for each
of the three years in the period ended September 30, 2000 in conformity with
accounting principles generally accepted in the United States of America. In
addition, in our opinion, the financial statement schedules listed in the index
appearing under Item 14(a)(2) presents fairly, in all material respects, the
information set forth therein when read in conjunction with the related
consolidated financial statements. These financial statements and financial
statement schedule are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits. We conducted our audits of
these statements in accordance with auditing standards generally accepted in the
United States of America, which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
PRICEWATERHOUSECOOPERS LLP
Seattle, Washington
October 27, 2000
30
31
F5 NETWORKS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
SEPTEMBER 30, SEPTEMBER 30,
2000 1999
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents ................................................... $ 53,017 $ 24,797
Accounts receivable, net of allowances of $1,666 and $826 ................... 38,237 10,353
Inventories ................................................................. 5,231 618
Other current assets ........................................................ 2,290 981
Deferred income taxes ....................................................... 1,858 --
--------- --------
Total current assets .................................................... 100,633 36,749
--------- --------
Restricted cash ................................................................ 6,182 3,013
Property and equipment, net .................................................... 13,524 2,834
Other assets, net .............................................................. 541 250
Deferred income taxes .......................................................... 1,540 --
--------- --------
Total assets ............................................................ $ 122,420 $ 42,846
========= ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable ............................................................. $ 10,561 $ 2,700
Accrued liabilities .......................................................... 7,975 3,808
Deferred revenue ............................................................. 16,199 4,365
--------- --------
Total current liabilities ............................................... 34,735 10,873
--------- --------
Commitments: (See note 8)
Shareholders' equity:
Common stock, no par value; 100,000 shares authorized, 21,613 and 18,161
shares issued and outstanding ............................................. 87,419 45,760
Note receivable from shareholder ............................................... (469) (750)
Accumulated other comprehensive loss ........................................... (52) (3)
Unearned compensation .......................................................... (3,061) (3,232)
Retained earnings (deficit) .................................................... 3,848 (9,802)
--------- --------
Total shareholders' equity ................................................... 87,685 31,973
--------- --------
Total liabilities and shareholders' equity ................................... $ 122,420 $ 42,846
========= ========
The accompanying notes are an integral part of these
consolidated financial statements.
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32
F5 NETWORKS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED SEPTEMBER 30,
--------------------------------------
2000 1999 1998
-------- -------- -------
Net revenues:
Products .................................. $ 87,980 $ 23,420 $ 4,119
Services .................................. 20,665 4,405 770
-------- -------- -------
Total net revenues .................... 108,645 27,825 4,889
-------- -------- -------
Cost of net revenues:
Products .................................. 24,660 5,582 1,091
Services .................................. 7,911 1,618 314
-------- -------- -------
Total cost of net revenues ............ 32,571 7,200 1,405
-------- -------- -------
Gross profit ................................... 76,074 20,625 3,484
-------- -------- -------
Operating expenses:
Sales and marketing ....................... 36,890 13,505 3,881
Research and development .................. 14,478 5,642 1,810
General and administrative ................ 9,727 3,869 1,041
Amortization of unearned compensation ..... 2,127 2,487 420
-------- -------- -------
Total operating expenses .............. 63,222 25,503 7,152
-------- -------- -------
Income (loss) from operations .................. 12,852 (4,878) (3,668)
Other income (expense), net .................... 2,903 534 (4)
-------- -------- -------
Income (loss) before income taxes .............. 15,755 (4,344) (3,672)
Provision for income taxes ..................... 2,105 -- --
-------- -------- -------
Net income (loss) ...................... $ 13,650 $ (4,344) $(3,672)
======== ======== =======
Net income (loss) per share -- basic ........... $ 0.65 $ (0.42) $ (0.60)
======== ======== =======
Weighted average shares -- basic ............... 21,137 10,238 6,086
======== ======== =======
Net income (loss) per share -- diluted ......... $ 0.59 $ (0.42) $ (0.60)
======== ======== =======
Weighted average shares -- diluted ............. 23,066 10,238 6,086
======== ======== =======
The accompanying notes are an integral part of these
consolidated financial statements.
32
33
F5 NETWORKS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)
CONVERTIBLE PREFERRED STOCK AMOUNT
--------------------------------------------
SHARES SERIES A SERIES B SERIES C
-------- -------- -------- --------
BALANCE, SEPTEMBER 30, 1997 .................................................... 556 $ 1,123 $ 208
Sales of Series B Convertible Preferred Stock (net of issuance costs of $30) ... 1,094 1,740
Sales of Series C Convertible Preferred Stock (net of issuance costs of $7) ... 156 $ 1,493
Value ascribed to warrants issued in conjunction with sales of Convertible
Preferred Stock ............................................................. (292) (75)
Exercise of stock options by employees .........................................
Exercise of stock warrants .....................................................
Repurchase of common stock under shareholder agreement .........................
Issuance of common stock under shareholder agreement ...........................
Conversion of note payable to common stock .....................................
Unearned compensation ..........................................................
Amortization of unearned compensation ..........................................
Net loss .......................................................................
-------- -------- -------- --------
BALANCE, SEPTEMBER 30, 1998 .................................................... 1,806 1,123 1,656 1,418
Exercise of stock options by employees .........................................
Exercise of stock warrants .....................................................
Note receivable from shareholder for exercise of stock options .................
Unearned compensation ..........................................................
Amortization of unearned compensation ..........................................
Conversion of convertible preferred stock to common stock in connection
with the initial public offering ........................................... (1,806) (1,123) (1,656) (1,418)
Issuance of common stock in an initial public offering (net of issuance costs
of $3,051) .................................................................
Net loss .......................................................................
Other comprehensive loss, net of tax:
Foreign currency translation adjustment .....................................
Unrealized loss on securities ...............................................
Comprehensive Loss .............................................................
-------- -------- -------- --------
BALANCE, SEPTEMBER 30, 1999 ....................................................
Exercise of stock options by employees .........................................
Exercise of stock warrants .....................................................
Issuance of stock under employee stock purchase plan ...........................
Payment on note receivable from shareholder ....................................
Tax benefit from employee stock transactions ...................................
Issuance of common stock in a secondary public offering ........................
(net of issuance costs of $2,025)
Unearned compensation ..........................................................
Amortization of unearned compensation ..........................................
Net income .....................................................................
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustment .....................................
Unrealized gain on securities ..............................................
Comprehensive income ...........................................................
-------- -------- -------- --------
BALANCE, SEPTEMBER 30, 2000 ....................................................
======== ======== ======== ========
SUBSCRIPTIONS
COMMON STOCK /NOTES RECEIVABLE
-------------------- FROM
SHARES AMOUNT SHAREHOLDERS
-------- -------- -----------------
BALANCE, SEPTEMBER 30, 1997 .................................................... 6,000 $ 393
Sales of Series B Convertible Preferred Stock (net of issuance costs of $30) ...
Sales of Series C Convertible Preferred Stock (net of issuance costs of $7) ...
Value ascribed to warrants issued in conjunction with sales of Convertible
Preferred Stock ............................................................. 367
Exercise of stock options by employees ......................................... 216 29
Exercise of stock warrants ..................................................... 5 5
Repurchase of common stock under shareholder agreement ......................... (2,600) (245)
Issuance of common stock under shareholder agreement ........................... 1,800 172
Conversion of note payable to common stock ..................................... 600 209
Unearned compensation .......................................................... 1,945
Amortization of unearned compensation ..........................................
Net loss .......................................................................
-------- -------- --------
BALANCE, SEPTEMBER 30, 1998 .................................................... 6,021 2,875
Exercise of stock options by employees ......................................... 588 256
Exercise of stock warrants ..................................................... 428 420
Note receivable from shareholder for exercise of stock options ................. 150 750 $ (750)
Unearned compensation .......................................................... 4,025
Amortization of unearned compensation ..........................................
Conversion of convertible preferred stock to common stock in connection
with the initial public offering ........................................... 8,114 11,885
Issuance of common stock in an initial public offering (net of issuance costs
of $3,051) ................................................................. 2,860 25,549
Net loss .......................................................................
Other comprehensive loss, net of tax:
Foreign currency translation adjustment .....................................
Unrealized loss on securities ...............................................
Comprehensive Loss .............................................................
-------- -------- --------
BALANCE, SEPTEMBER 30, 1999 .................................................... 18,161 45,760 (750)
Exercise of stock options by employees ......................................... 669 716
Exercise of stock warrants ..................................................... 2,199 1,414
Issuance of stock under employee stock purchase plan ........................... 84 1,198
Payment on note receivable from shareholder .................................... 281
Tax benefit from employee stock transactions ................................... 4,900
Issuance of common stock in a secondary public offering ........................ 500 31,475
(net of issuance costs of $2,025) ..............................................
Unearned compensation .......................................................... 1,956
Amortization of unearned compensation ..........................................
Net income .....................................................................
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustment .....................................
Unrealized gain on securities ..............................................
Comprehensive income ...........................................................
-------- -------- --------
BALANCE, SEPTEMBER 30, 2000 .................................................... 21,613 $ 87,419 $ (469)
======== ======== ========
ACCUMULATED OTHER
UNEARNED COMPREHENSIVE ACCUMULATED
COMPENSATION INCOME/ (LOSS) DEFICIT TOTAL
------------ ----------------- ----------- --------
BALANCE, SEPTEMBER 30, 1997 .................................................. $ (169) $ (1,786) $ (231)
Sales of Series B Convertible Preferred Stock (net of issuance costs of $30) . 1,740
Sales of Series C Convertible Preferred Stock (net of issuance costs of $7) . 1,493
Value ascribed to warrants issued in conjunction with sales of Convertible
Preferred Stock ...........................................................
Exercise of stock options by employees ....................................... 29
Exercise of stock warrants ................................................... 5
Repurchase of common stock under shareholder agreement ....................... (245)
Issuance of common stock under shareholder agreement ......................... 172
Conversion of note payable to common stock ................................... 209
Unearned compensation ........................................................ (1,945)
Amortization of unearned compensation ........................................ 420 420
Net loss ..................................................................... (3,672) (3,672)
-------- -------- -------- --------
BALANCE, SEPTEMBER 30, 1998 .................................................. (1,694) (5,458) (80)
Exercise of stock options by employees ....................................... 256
Exercise of stock warrants ................................................... 420
Note receivable from shareholder for exercise of stock options ...............
Unearned compensation ........................................................ (4,025)
Amortization of unearned compensation ........................................ 2,487 2,487
Conversion of convertible preferred stock to common stock in connection
with the initial public offering ......................................... 7,688
Issuance of common stock in an initial public offering (net of issuance costs
of $3,051) ............................................................... 25,549
Net loss ..................................................................... (4,344)
Other comprehensive loss, net of tax:
Foreign currency translation adjustment ................................... $ (1)
Unrealized loss on securities ............................................. (2)
Comprehensive Loss ........................................................... (4,347)
-------- -------- -------- --------
BALANCE, SEPTEMBER 30, 1999 .................................................. (3,232) (3) (9,802) 31,973
Exercise of stock options by employees ....................................... 716
Exercise of stock warrants ................................................... 1,414
Issuance of stock under employee stock purchase plan ......................... 1,198
Payment on note receivable from shareholder .................................. 281
Tax benefit from employee stock transactions ................................. 4,900
Issuance of common stock in a secondary public offering ...................... 31,475
(net of issuance costs of $2,025) ............................................
Unearned compensation ........................................................ (1,956)
Amortization of unearned compensation ........................................ 2,127 2,127
Net income ................................................................... 13,650
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustment ................................... (274)
Unrealized gain on securities ............................................. 225
Comprehensive income ......................................................... 13,601
-------- -------- -------- --------
BALANCE, SEPTEMBER 30, 2000 .................................................. $ (3,061) $ (52) $ 3,848 $ 87,685
======== ======== ======== ========
The accompanying notes are an integral part of these
consolidated financial statements.
33
34
F5 NETWORKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED SEPTEMBER 30,
----------------------------------
2000 1999 1998
-------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) .............................................. $ 13,650 $ (4,344) $ (3,672)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Provisions for asset write downs ............................... 1,377 -- --
Unrealized gain on investments ................................. 225 -- --
Amortization of unearned compensation .......................... 2,127 2,487 420
Provision for doubtful accounts and sales returns .............. 2,876 1,183 605
Depreciation and amortization .................................. 2,335 573 323
Non cash interest expense ...................................... -- -- 12
Deferred income taxes .......................................... (3,398) -- --
Tax benefit from exercise of stock options ..................... 4,900 -- --
Changes in operating assets and liabilities:
Accounts receivable ........................................ (30,715) (9,508) (2,308)
Inventories ................................................ (5,639) (519) (22)
Other current assets ....................................... (315) (731) (186)
Other assets ............................................... (1,306) (181) (136)
Accounts payable and accrued liabilities ................... 11,940 5,473 806
Deferred revenue ........................................... 11,769 3,578 604
-------- -------- --------
Net cash provided by (used in) operating activities ...... 9,826 (1,989) (3,554)
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in restricted cash .............................. (3,169) (3,013) --
Issuance of notes to officer ............................... -- -- (10)
Purchases of property and equipment ........................ (13,334) (2,631) (731)
-------- -------- --------
Net cash used in investing activities .................... (16,503) (5,644) (741)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock in an initial
public offering ............................................ -- 25,549 --
Proceeds from secondary public offering, net of
issuance costs ............................................. 31,475 -- --
Proceeds from issuance of convertible preferred stock ...... -- -- 10,416
Proceeds from the exercise of stock options and warrants ... 3,328 676 34
Proceeds from payments on shareholder loan ................. 281 -- --
Repurchase of common stock under shareholder agreement ..... -- -- (245)
Proceeds from issuance of common stock under
shareholder agreement ...................................... -- -- 172
Proceeds from line of credit ............................... -- -- 825
Repayments of line of credit ............................... -- -- (825)
Principal payments on capital lease obligations ............ -- -- (19)
-------- -------- --------
Net cash provided by financing activities ................ 35,084 26,225 10,358
-------- -------- --------
Net increase in cash and cash equivalents ................ 28,407 18,592 6,063
Effect of exchange rate changes on cash and cash
equivalents .............................................. (187) (1) --
Cash and cash equivalents, at beginning of year ................ 24,797 6,206 143
-------- -------- --------
Cash and cash equivalents, at end of year ...................... $ 53,017 $ 24,797 $ 6,206
======== ======== ========
The accompanying notes are an integral part of these
consolidated financial statements.
34
35
F5 NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. THE COMPANY AND BASIS OF PRESENTATION:
F5 Networks, Inc. (the "Company") was incorporated on February 26, 1996
in the State of Washington.
F5 is a leading provider of integrated Internet traffic and content
management solutions designed to improve the availability and performance of
mission-critical Internet-based servers and applications. The Company's
proprietary software-based solutions monitor and manage local and geographically
dispersed servers and intelligently direct traffic to the server best able to
handle a user's request. The Company operates in one segment providing
integrated Internet traffic and content management solutions.
The Company purchases material component parts and certain licensed
software from suppliers and generally contracts with third parties for the
assembly of products.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
PRINCIPLES OF CONSOLIDATION
The financial statements consolidate the accounts of F5 Networks, Inc.
and its wholly owned subsidiaries F5 Networks, Ltd., F5 Networks, Singapore Pte.
Ltd. and F5 Networks, Japan K.K. The companies are collectively hereinafter
referred to as the "Company". All intercompany transactions have been
eliminated.
SEGMENT INFORMATION
The Company has adopted Statement of Financial Accounting Standards No.
131, "Disclosures about Segments of an Enterprise and Related Information"
("SFAS No. 131"). SFAS No. 131 supersedes Statement of Financial Accounting
Standards No. 14, "Financial Reporting for Segments of a Business Enterprise,"
replacing the "industry segment" approach with the "management" approach. The
management approach designates the internal organization that is used by
management for making operating decisions and assessing performance as the
source of the Company's reportable segments. SFAS No. 131 also requires
disclosures about products and services, geographic areas, and major customers.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities as of the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
Cash equivalents are highly liquid investments, consisting of
investments in money market funds and short-term investments which are readily
convertible to cash without penalty and subject to insignificant risk of changes
in value. The Company's cash and cash equivalents balance consists of the
following:
SEPTEMBER 30,
--------------------
2000 1999
------- -------
(IN THOUSANDS)
Cash .......................... $18,354 $15,671
Short-term investments ........ 34,663 9,126
------- -------
$53,017 $24,797
======= =======
35
36
F5 NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONCENTRATION OF CREDIT RISK
The Company places its temporary cash investments with 4 major financial
institutions.
The Company's customers are from diverse industries and geographic
locations. Net revenues from international customers are denominated in U.S.
Dollars and were approximately $20,598,000, $2,153,000 and $172,000 for the
years ended September 30, 2000, 1999 and 1998, respectively. One customer
accounted for 14% and 22% of net revenues for the years ended September 30, 2000
and 1999, respectively. For the year ended September 30, 1998 no single customer
accounted for more than 10% of the Company's net revenues. One customer
represented 8% and 16% of accounts receivable for the years ended September 30,
2000 and 1999 respectively. The Company does not require collateral to support
credit sales. Allowances are maintained for potential credit losses and sales
returns.
INVENTORIES
Inventories consist of hardware, software and related component parts
and are recorded at the lower of cost or market (as determined by the first-in,
first-out method).
RESTRICTED CASH
Restricted cash represents a restricted escrow account established in
connection with a lease agreement for the company's corporate headquarters.
Under the term of the lease, a $6 million standby letter of credit is required
through November 2012, unless the lease is terminated before then.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Equipment under capital leases
is stated at the lower of the present value of the minimum lease payments
discounted at the Company's incremental borrowing rate at the beginning of the
lease term or fair value at the inception of the lease. Depreciation of property
and equipment and amortization of capital leases are provided on the
straight-line method over the estimated useful lives of the assets of 2 to 5
years. Leasehold improvements are amortized over the lesser of the term of the
lease or the estimated useful life of the improvements.
The cost of normal maintenance and repairs is charged to expense as
incurred and expenditures for major improvements are capitalized at cost. Gains
or losses on the disposition of assets in the normal course of business are
reflected in the results of operations at the time of disposal.
SOFTWARE DEVELOPMENT COSTS
Software development costs incurred in conjunction with product
development are charged to research and development expense until technological
feasibility is established. Thereafter, until the product is released for sale,
software development costs are capitalized and reported at the lower of
unamortized cost or net realizable value of each product. The establishment of
technological feasibility and the on-going assessment of recoverability of costs
require considerable judgment by the Company with respect to certain internal
and external factors, including, but not limited to, anticipated future gross
product revenues, estimated economic life and changes in hardware and software
technology. The Company amortizes capitalized software costs using the
straight-line method over the estimated economic life of the product, generally
two years.
VALUATION OF LONG-LIVED ASSETS
The Company periodically evaluates the carrying value of long-lived
assets to be held and used, including, but not limited to, property and
equipment, other assets deferred income taxes, when events and circumstances
warrant such a review. The carrying value of a long-lived asset is considered
impaired when the anticipated undiscounted cash flow
36
37
F5 NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
from the asset is separately identifiable and is less than its carrying value.
In that event, a loss is recognized based on the amount by which the carrying
value exceeds the fair value of the long-lived asset. Fair value is determined
primarily using the anticipated cash flows discounted at a rate commensurate
with the risk involved. Losses on long-lived assets to be disposed of are
determined in a similar manner, except that fair values are reduced for the cost
to dispose.
REVENUE RECOGNITION
The Company recognizes software revenue under Statement of Position
97-2, "Software Revenue Recognition," and SOP 98-9 "Modification of SOP 97-2,
Software Revenue Recognition, with Respect to Certain Transactions."
The Company sells products through resellers, original equipment
manufacturers and other channel partners, as well as to end users, under similar
terms. The Company generally combines software license, installation and
customer support elements into a package with a single "bundled" price. The
Company allocates a portion of the sales price to each element of the bundled
package based on their respective fair values when the individual elements are
sold separately. Revenues from the license of software, net of an allowance for
estimated returns, are recognized when the product has been shipped and the
customer is obligated to pay for the product. Installation revenue is recognized
when the product has been installed at the customer's site. Revenues for
customer support are recognized on a straight-line basis over the service
contract term. Estimated sales returns are based on historical experience by
product and are recorded at the time revenues are recognized.
The following is a breakdown of revenues by shipment destination for the
years ended 2000, 1999 and 1998:
SEPTEMBER 30,
-------------------------------------
2000 1999 1998
-------- -------- --------
(IN THOUSANDS)
United States.... $ 88,047 $ 25,672 $ 4,717
Europe .......... 7,029 1,655 153
Asia Pacific..... 13,569 498 19
-------- -------- --------
$108,645 $ 27,825 $ 4,889
======== ======== ========
WARRANTY EXPENSE
The Company offers product warranties of generally 90 days. Estimated
future warranty obligations related to products are provided by charges to
operations in the period in which the related revenue is recognized. These
estimates are based on historical warranty experience and other relevant
information of which the Company is aware. During the years ended September 30,
2000, 1999 and 1998 warranty expense was $2,319,000, $309,000 and $83,000
respectively.
ADVERTISING
Advertising costs are expensed as incurred. Advertising expense was
approximately $1,614,000, $992,000 and $256,000 for the years ended September
30, 2000, 1999 and 1998, respectively.
37
38
F5 NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
INCOME TAXES
The Company accounts for income taxes under the liability method of
accounting. Under the liability method, deferred taxes are determined based on
the differences between the financial statement and tax bases of assets and
liabilities at enacted tax rates in effect in the year in which the differences
are expected to reverse. Valuation allowances are established, when necessary,
to reduce deferred tax assets to amounts expected to be realized.
FOREIGN CURRENCY TRANSLATION
The financial statements of F5 Networks, Ltd., F5 Networks, Singapore
Pte. Ltd. and F5 Networks, Japan K.K. have been translated into U.S. dollars in
accordance with Statement of Financial Accounting Standards No. 52 "Foreign
Currency Translation." Under the provisions of this Statement, all assets and
liabilities in the balance sheet of the subsidiaries are translated at year-end
exchange rates, and translation gains and losses are reported as a component of
comprehensive income (loss) and are accumulated in a separate component of
shareholders' equity. During 2000 and 1999 the Company charged to operations
$(84,000) and $2,000, respectively, resulting from such transactions.
COMPREHENSIVE INCOME (LOSS)
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income," in June 1997.
This statement establishes standards for reporting and displaying comprehensive
income in the financial statements and was adopted by the Company during the
quarter ended September 30, 1999. In addition to net income (loss),
comprehensive income (loss) includes charges or credits to equity that are not
the result of transactions with shareholders. The Company has included
components of comprehensive income within the Consolidated Statements of
Shareholders' Equity.
STOCK-BASED COMPENSATION
The Company accounts for stock-based employee compensation arrangements
in accordance with the provisions of Accounting Principles Board Opinion No. 25
("APB No. 25"), "Accounting for Stock Issued to Employees" and FASB
interpretation No. 44 ("FIN No. 44") accounting for certain transactions
involving stock compensation, and complies with the disclosure provisions of
Statement of Financial Accounting Standards No. 123 ("SFAS No. 123"),
"Accounting for Stock-Based Compensation." Under APB No. 25, compensation
expense is based on the difference, if any, on the date of the grant, between
the deemed fair value of the Company's stock and the exercise price of the
option. The unearned compensation is being amortized in accordance with
Financial Accounting Standards Board Interpretation No. 28 on an accelerated
basis over the vesting period of the individual options. The Company accounts
for equity instruments issued to nonemployees in accordance with the provisions
of SFAS No. 123.
FAIR VALUE OF FINANCIAL INSTRUMENTS
For certain financial instruments, including cash and cash equivalents,
accounts receivable, accounts payable and accrued liabilities, recorded amounts
approximate market value, due to the short maturities of these instruments.
NET INCOME (LOSS) PER SHARE
In accordance with SFAS No. 128, basic net income (loss) per share has
been computed using the weighted-average number of shares of common stock
outstanding during the period, except that pursuant to Securities and Exchange
Commission Staff Accounting Bulletin No. 98, if applicable, common shares issued
presented for nominal consideration in each of the periods have been included in
the calculation as if they were outstanding for all periods presented.
38
39
F5 NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Basic net income (loss) per share is computed by dividing net income
(loss) by the weighted average number of common shares outstanding during the
period. Diluted net income (loss) per share is computed by dividing net income
(loss) by the weighted average number of common and dilutive common stock
equivalent shares outstanding during the period. For periods in which the
Company incurred a net loss, dilutive common stock equivalent shares are
excluded from the calculation as their impact would have been antidilutive.
The following table sets forth the computation of basic and diluted net
income (loss) per share for the years ended September 30, 2000, 1999 and 1998.
YEAR ENDED SEPTEMBER 30,
----------------------------------------
2000 1999 1998
--------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
NUMERATOR:
Net income (loss) ........................................ $ 13,650 $ (4,344) $ (3,672)
========= ========= =========
DENOMINATOR:
Weighted average shares outstanding -- basic ............. 21,137 10,238 6,086
Dilutive effect of common shares from stock options ...... 1,918 -- --
Dilutive effect of common shares from warrants ........... 11 -- --
--------- --------- ---------
Weighted average shares outstanding -- diluted ........... 23,066 10,238 6,086
========= ========= =========
Basic net income (loss) per share ........................... $ 0.65 $ (0.42) $ (0.60)
========= ========= =========
Diluted net income (loss) per share ......................... $ 0.59 $ (0.42) $ (0.60)
========= ========= =========
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities." This statement requires that all derivative instruments be recorded
on the balance sheet at their fair value. Changes in the fair value of
derivatives are recorded each period in current earnings or other comprehensive
income, depending on whether a derivative is designated as part of a hedge
transaction and, if it is, the type of hedge transaction. In July 1999, the FASB
issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging
Activities Deferral of the Effective Date of FASB Statement No. 133." SFAS No.
137 deferred the effective date of SFAS No. 133 until fiscal years beginning
after June 15, 2000. The Company does not use derivative instruments, therefore
the adoption of this statement will not have any effect on the Company's results
of operations or its financial position.
In December 1999, SEC Staff Accounting Bulletin No. 101 ("SAB 101"),
"Revenue Recognition in Financial Statements," was issued. This pronouncement
summarizes certain of the SEC staff's views in applying generally accepted
accounting principles to revenue recognition. SAB 101 is required to be adopted
by the Company for the year ended September 30, 2001. The Company is currently
reviewing the requirements of SAB 101 and assessing its impact on the Company's
financial statements.
39
40
F5 NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. INVENTORIES:
Inventories are comprised of the following:
SEPTEMBER 30,
------------------
2000 1999
------ ------
(IN THOUSANDS)
Finished goods $2,045 $ 420
Raw materials 3,186 198
------ ------
$5,231 $ 618
====== ======
4. PROPERTY AND EQUIPMENT:
At September 30, 2000 and 1999, property and equipment consist of the
following:
SEPTEMBER 30,
-----------------------
2000 1999
-------- --------
(IN THOUSANDS)
Computer equipment $ 7,167 $ 2,316
Office furniture and equipment 3,783 888
Leasehold improvements 5,673 419
-------- --------
16,623 3,623
Accumulated depreciation and amortization (3,099) (789)
-------- --------
Property and equipment, net $ 13,524 $ 2,834
======== ========
Depreciation expense was approximately $2,300,000, $479,000 and $244,000
for the years ended September 30, 2000, 1999 and 1998 respectively.
5. ACCRUED LIABILITIES:
At September 30, 2000 and 1999, accrued liabilities consist of the
following:
SEPTEMBER 30,
------------------
2000 1999
------ ------
(IN THOUSANDS)
Accrued payroll and benefits $3,874 $1,946
Accrued sales and use taxes 791 566
Warranty accrual 401 224
Offering costs -- 365
Income taxes payable 589 --
Deferred rent 238 --
Accrued sales and marketing 528 --
Recruitment costs 350 --
Other 1,204 707
------ ------
$7,975 $3,808
====== ======
40
41
F5 NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
6. INCOME TAXES:
Income before income taxes consists of the following:
SEPTEMBER 30,
--------------------------------------
2000 1999 1998
-------- -------- --------
(IN THOUSANDS)
U.S ................ $ 17,976 $ (4,364) $ (3,672)
International ...... (2,221) 20 --
-------- -------- --------
$ 15,755 $ (4,344) $ (3,672)
======== ======== ========
The provision for income taxes for the fiscal year 2000 consists of the
following:
SEPTEMBER 30,
--------------
2000
--------------
(IN THOUSANDS)
CURRENT TAX EXPENSE:
U.S. federal ..................... $ 5,325
State ............................ 647
Foreign .......................... (469)
-------
Total current provision ............ 5,503
DEFERRED TAX PROVISION (BENEFIT):
U.S. federal ..................... (3,227)
State ............................ (171)
Foreign .......................... --
-------
Total deferred tax ................. (3,398)
-------
Total provision for income taxes ... $ 2,105
=======
No provision for federal or state income taxes has been recorded for the
years ended September 30, 1999 and 1998, as the Company incurred a loss.
The effective rate differs from the U.S. federal statutory rate as
follows:
SEPTEMBER 30,
-----------------------------------
2000 1999 1998
------- ------- -------
(IN THOUSANDS)
Income tax provision at statutory rate ..... $ 5,514 $(1,477) $(1,248)
Sales taxes, net of federal benefit ........ 409 -- --
Impact of international operations ......... 308 -- --
Federal research and development credits ... (1,315) -- --
Impact of stock option compensation ........ (450) (248) 110
Other ...................................... 1,037 81 37
Change in valuation allowance .............. (3,398) 1,644 1,101
------- ------- -------
Total ...................................... $ 2,105 $ -- $ --
======= ======= =======
41
42
F5 NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The tax effects of the temporary differences that give rise to significant
portions of the deferred tax assets are as follows:
SEPTEMBER 30,
-----------------------------------
2000 1999 1998
------- ------- -------
(IN THOUSANDS)
DEFERRED TAX ASSETS:
Net operating loss carryforwards ............... $ 4,884 $ 2,665 $ 1,573
Exercise of stock options ...................... 278 105 --
Allowance for doubtful accounts ................ 617 281 80
Accrued compensation and benefits .............. 815 213 61
Depreciation ................................... 158 58 9
Tax credit carryforwards ....................... 1,540 -- --
------- ------- -------
8,292 3,322 1,723
VALUATION ALLOWANCE FOR DEFERRED TAX ASSETS ...... (4,884) (3,314) (1,670)
------- ------- -------
3,408 8 53
DEFERRED TAX LIABILITIES:
Deductible prepaid expenses and other .......... (10) (8) (53)
------- ------- -------
NET DEFERRED TAX ASSETS ......................... $ 3,398 $ -- $ --
======= ======= =======
The Company's deferred tax assets include net operating loss
carryforwards of approximately $4.9 million. Until June 30, 2000, the Company
had provided a full valuation allowance against deferred tax assets. Based upon
available evidence, which include a review of historical operating performance
and forecasted profitability, the Company determined that certain of these
deferred tax assets are more likely than not realizable and therefore has
reduced the valuation allowance related to those deferred tax assets. These
remaining net operating loss carryforwards of approximately $4.9 million
primarily relate to the tax benefits associated with stock option plans. If
these assets become recognizable, the net operating loss carryforwards related
to stock option plan benefits will be offset against shareholders equity.
During fiscal year 2000, the Company recorded tax benefits related to
the exercise of employee stock options in the amount of $9.8 million. These
effects have been recorded to additional paid-in capital on realized benefits,
and will be recorded to additional paid-in capital when net operating losses
related to stock option plans reverse.
The net operating loss carryforwards and research and development tax
credit carryforwards begin to expire fiscal year 2011. The company expects to
utilize these carryforwards prior to expiration.
7. SHAREHOLDERS' EQUITY:
a. Preferred Stock
In April 1998, the Company issued 156,250 shares of the Company's Series
C Convertible Preferred Stock and warrants to purchase 187,500 shares of the
Company's common stock at $1.60 per share for an aggregate purchase price of
$1.5 million. The Company has allocated approximately $75,000 of the purchase
price of the Series C Convertible Preferred Stock as the value of the warrants
issued. On February 1, 1999 these warrants were exercised. The holders of the
Series C Convertible Preferred Stock have certain voting rights and liquidation
preferences equal to $9.60 per share. Each share of Series C Convertible
Preferred Stock was converted into six shares of the Company's common stock.
In August 1998, the Company issued 1,138,438 shares of Series D
Redeemable Convertible Preferred Stock for an aggregate purchase price of
approximately $7.7 million. The Company was required to redeem all outstanding
shares of the Series D Redeemable Convertible Preferred Stock at $6.79 per
share, plus all declared and unpaid
42
43
F5 NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
dividends, either in August 2005 or in three annual installments beginning
August 2003 at the request of holders of at least two-thirds of the outstanding
Series D Redeemable Convertible Preferred Stock. The holders of the Series D
Redeemable Convertible Preferred Stock had certain voting rights and liquidation
preferences equal to $13.58 per share. Each share of Series D Redeemable
Convertible Preferred Stock was converted into two shares of the Company's
common stock.
b. Common Stock
On December 2, 1996 and January 27, 1999 the Company authorized a 3 for
1 and 2 for 1 stock split, in the form of stock dividends, respectively on the
Company's common stock. All references to number of shares and per share amounts
of the Company's common stock in the accompanying financial statements and notes
have been restated to reflect these stock splits.
Upon incorporation of the Company, the founding shareholders entered
into an agreement (as amended, the "Shareholder Agreement") which, among other
things, called for a mandatory offer to sell the shareholders' stock, first to
the remaining founders, then to the Company, in the event of termination of
their employment with the Company. In February 1998, one of the founders, who
was also an officer of the Company, and the Company purchased 2,600,000 shares
of the Company's common stock under the Shareholder Agreement from two founders
who had terminated their employment. The Company facilitated the transactions
between the shareholders under the Shareholder Agreement, retaining 800,000 of
the repurchased shares.
c. Initial Public Offering
On June 4, 1999, the Company issued 2,860,000 shares of its common stock
at an initial public offering price of $10.00 per share. Also sold in this
offering were 590,000 shares held by selling shareholders, including 450,000
shares sold upon the exercise of the underwriters' overallotment option. The net
proceeds to the Company from the offering, net of offering costs of
approximately $3.1 million were approximately $25.5 million. Concurrent with the
initial public offering, each outstanding share or the Company's convertible
preferred stock was automatically converted into common stock.
d. Secondary Public Offering
In October of 1999, the Company completed and issued 500,000 shares of
its common stock in a secondary public offering at a price of $67.00 per share.
Also sold in this offering were 2,030,000 shares of common stock held by selling
shareholders. The net proceeds to the Company, from the offering, net of
offering costs of approximately $350,000 were approximately $31.5 million.
e. Warrants
In February 1999, the Company issued a warrant to purchase up to 12,500
shares of the Company's common stock at $8.00 per share to a certain customer in
conjunction with a sale of products.
The Company has issued warrants to purchase common stock to a certain
customer. The aggregate consideration for each respective transaction was
allocated to securities or debt and the warrants based on their relative fair
values. All the warrants were exercisable at the time of issuance. The
assumptions applied in the determination of the fair value of warrants issued
were (i) use of the Black-Scholes pricing model, (ii) risk free interest rates
ranging from 5.2% to 6.2%, (iii) expected volatility rates of approximately 70%
(based on disclosed expected volatility rates of comparable companies) and
actual volatility subsequent to the initial public offering, (iv) assumed
expected lives of 4 to 10 years, and (v) no expected dividends.
43
44
F5 NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At September 30, 2000, warrants outstanding were as follows:
SHARES OF EXERCISE AGGREGATE
WARRANT TO PURCHASE COMMON STOCK PRICE EXERCISE PRICE
------------------- ------------ -------- --------------
Common stock......................................... 12,500 8.00 100,000
------ --------
12,500 $100,000
====== ========
f. Equity Incentive Plans
In January 1997, Company's shareholders approved the Amended and
Restated 1996 Stock Option Plan (the "1996 Employee Plan") that provides for
discretionary grants of non-qualified and incentive stock options for employees
and other service providers, and the Amended and Restated Directors'
Nonqualified Stock Option Plan (the "1996 Directors' Plan"), which provides for
automatic grants of non-qualified stock options to eligible non-employee
directors. A total of 2,600,000 shares of common stock has been reserved for
issuance under the 1996 Employee Plan and the 1996 Directors' Plan. Employees'
stock options typically vest over a period of four years from the grant date;
director options typically vest over a period of three years from the grant
date. All options under the 1996 Employee Plan and the 1996 Directors' Plan
expire 10 years after the grant date. This repricing was accounted for as a
cancellation of existing stock options and grant of new stock options. All
outstanding, unvested options under the 1996 Employee Plan and the 1996
Director's Plan vest in full upon a change in control of the Company. The
Company does not intend to grant any additional options under either of these
Plans.
In November 1998, the Company's shareholders adopted the 1998 Equity
Incentive Plan (the "1998 Plan"), which provides for discretionary grants of
non-qualified and incentive stock options, stock purchase awards and stock
bonuses for employees and other service providers. A total of 3,300,000 shares
of common stock have been reserved for issuance under the 1998 Plan. Stock
options granted under this plan typically vest over a period of four years from
the grant date, and expire 10 years from the grant date. The Company has not
granted any stock purchase awards or stock bonuses under the 1998 Plan. Upon
certain changes in control of the Company, the surviving entity will either
assume or substitute all outstanding options or stock awards under the 1998
Plan. If the surviving entity determines not to assume or substitute such
options or awards, then with respect to persons whose service with the Company
or an affiliate of the Company has not terminated before a change in control,
the vesting of 50% of these options or stock awards (and the time during which
these awards may be exercised) will accelerate and the options or awards
terminated if not exercised before the change in control.
In April 1999, the Company's shareholders adopted the 1999 Non-Employee
Directors' Stock Option Plan which provides for automatic grants to F5
non-employee directors of options to purchase shares of the Company's common
stock. The board administers the plan and cannot delegate administration to a
committee. The plan reserved an aggregate of 100,000 shares of common stock for
issuance, subject to adjustment in the event of certain capital changes.
In July 2000, the Company's Board of Directors adopted the 2000
Employee Equity Incentive Plan (the "2000 Plan"), which provides for
discretionary grants of non-qualified stock options, stock purchase awards and
stock bonuses for non-executive employees and other service providers. A total
of 2,000,000 shares of common stock have been reserved for issuance under the
2000 Plan. Stock options granted under this plan typically vest over a period of
four years from the grant date, and expire 10 years from the grant date. The
Company has not granted any stock purchase awards or stock bonuses under the
2000 Plan. Upon certain changes in control of the Company, the surviving entity
will either assume or substitute all outstanding options or stock awards under
the 2000 Plan. If the surviving entity determines not to assume or substitute
such options or awards, then with respect to persons whose service with the
Company or an affiliate of the Company has not terminated before a change in
control, the vesting of 50% of these
44
45
F5 NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
options or stock awards (and the time during which these awards may be
exercised) will accelerate and the options or awards terminated if not exercised
before the change in control.
In July 2000, the Company's Board of Directors adopted two nonqualified
stock option plans (the "McAdam Plans") in connection with hiring John McAdam,
the Company's President and Chief Executive Officer. The first McAdam Plan
provides for a grant of 645,000 non-qualified stock options for Mr. McAdam that
vest over a period of four years from the grant date. The second McAdam Plan
provides for a grant of 50,000 options for Mr. McAdam that vest over a period of
two years from the grant date. All options under the McAdam Plans expire 10
years from the grant date, and upon certain changes in control of the Company,
the vesting of 100% of these options (and the time during which these awards may
be exercised) will accelerate and the options or awards terminated if not
exercised before the change in control.
The Company applies the provisions prescribed in APB No. 25 and related
interpretations in accounting for stock options. In certain instances, the
Company has issued stock options with an exercise price less than the deemed
fair value of the Company's common stock at the date of grant. Accordingly,
total compensation costs related to these stock options of approximately
$1,956,000, $4,025,000 and $1,945,000 was deferred during fiscal years 2000,
1999 and 1998, respectively, and is being amortized over the vesting period of
the options, generally four years. Amortization of stock compensation costs of
approximately $2,127,000, $2,487,000 and $420,000 has been recognized as an
expense for the years ended September 30, 2000, 1999 and 1998, respectively.
A summary of stock option transactions are as follows:
WEIGHTED
OUTSTANDING AVERAGE EXERCISE
OPTIONS PRICE PER SHARE
----------------- ----------------
Balance at September 30, 1997....................................... 1,226,000 $ 0.15
Options granted..................................................... 1,543,000 0.29
Options exercised................................................... (215,750) 0.11
Options canceled.................................................... (476,000) 0.11
---------
Balance at September 30, 1998....................................... 2,077,250 0.26
Options granted..................................................... 1,343,371 9.82
Options exercised................................................... (738,191) 1.33
Options canceled.................................................... (197,800) 1.15
---------
Balance at September 30, 1999....................................... 2,484,630 5.05
Options granted..................................................... 3,979,695 62.52
Options exercised................................................... (668,456) 1.07
Options canceled.................................................... (492,598) 69.06
---------
Balance at September 30, 2000....................................... 5,303,271 42.69
=========
45
46
F5 NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The weighted-average fair values and weighted-average exercise prices
per share at the date of grant for options granted for the years ended September
30, 2000, 1999 and 1998 were as follows:
YEAR ENDED
SEPTEMBER 30,
---------------------------------
2000 1999 1998
-------- -------- --------
Weighted-average fair value of options granted with exercise prices
equal to the market value of the stock at the date of grant......................... $48.61 $15.69 $0.08
Weighted-average exercise price of options granted with exercise
prices equal to the market value of the stock at the date of grant.................. 63.25 30.52 0.50
Weighted-average fair value of options granted with exercise prices
less than the market value of the stock at the date of grant........................ 42.56 4.54 1.60
Weighted-average exercise price of options granted with exercise
prices less than the market value of the stock at the date of grant................. 0.00 1.24 0.28
The following table summarizes information about fixed-price options
outstanding at September 30, 2000 as follows:
WEIGHTED
WEIGHTED AVERAGE AVERAGE
NUMBER REMAINING WEIGHTED AVERAGE NUMBER EXERCISABLE
EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE PRICE
-------------------------- ------------- ------------------ ------------------ ------------- -------------
$ 0.00 -- $ 0.75......... 1,098,697 7.48 $ 0.29 358,232 $ 0.40
1.50 -- 36.75......... 1,063,149 9.00 17.92 136,485 5.45
37.00 -- 46.25......... 1,088,471 9.80 42.65 3,441 42.96
46.50 -- 89.50......... 1,239,154 9.55 59.83 74,014 66.09
89.88 -- 152.63......... 813,800 9.31 106.25 27,290 109.54
1999 EMPLOYEE STOCK PURCHASE PLAN
In May 1999, the board of directors approved the adoption of the 1999
Employee Stock Purchase Plan (the "Purchase Plan"). A total of 1,000,000 shares
of common stock has been reserved for issuance under the Purchase Plan. The
Purchase Plan permits eligible employees to acquire shares of the Company's
common stock through periodic payroll deductions of up to 15% of base
compensation. No employee may purchase more than $25,000 worth of stock,
determined at the fair market value of the shares at the time such option is
granted, in one calendar year. The Purchase Plan has been implemented in a
series of offering periods, each 6 months in duration. The price at which the
common stock may be purchased is 85% of the lesser of the fair market value of
the Company's common stock on the first day of the applicable offering period or
on the last day of the respective purchase period.
46
47
F5 NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Pro forma information regarding net loss is required by SFAS No. 123, and has
been determined as if the Company had accounted for its stock options under the
minimum value method of that statement for all periods prior to the Company
becoming a public entity and fair value method of that statement for all periods
subsequent to the Company becoming a public entity. The fair value of each
option is estimated at the date of grant with the following weighted-average
assumptions used for the years ended September 30, 2000, 1999 and 1998:
STOCK OPTION PLAN EMPLOYEE STOCK PURCHASE PLAN
--------------------------------- ---------------------------------
YEAR ENDED SEPTEMBER 30, YEAR ENDED SEPTEMBER 30,
--------------------------------- ---------------------------------
2000 1999 1998 2000 1999 1998
-------- -------- -------- -------- -------- ---------
Risk-free interest rate................................ 6.12% 5.47% 4.62% 5.50% -- --
Dividend yield......................................... 0.00% 0.00% 0.00% -- -- --
Expected term of option................................ 4 years 4 years 4 years 6 months -- --
Volatility subsequent to initial public offering....... 111.87% 69.87% -- 111.87% -- --
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized over the options' vesting period. The Company's pro forma
net income (loss) would have been as follows:
YEAR ENDED SEPTEMBER 30,
------------------------------------
2000 1999 1998
----------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net income (loss) as reported....................................... $ 13,650 $(4,344) $(3,672)
Net income (loss) pro forma......................................... (40,648) (5,151) (3,742)
Net income (loss) per share as reported............................. .59 (0.42) (0.60)
Net income (loss) per share pro forma............................... (1.92) (0.50) (0.61)
8. COMMITMENTS:
Future minimum operating lease payments (net of sublease proceeds) for
future fiscal years, as of September 30, 2000, are approximately as follows:
OPERATING LEASE
PAYMENTS
--------------
(IN THOUSANDS)
2001................................................................................. $ 3,957
2002................................................................................. 4,630
2003................................................................................. 4,345
2004................................................................................. 5,277
2005................................................................................. 5,289
Thereafter........................................................................... 38,445
--------
Total................................................................................ $ 61,943
========
Rent expense under noncancelable operating leases amounted to
approximately $1,869,000, $464,000 and $145,000 for the years ended September
30, 2000, 1999, and 1998, respectively. Sublease income for the years ended
2001, 2002 and 2003 is expected to be approximately $820,000, $920,000 and
$950,000, respectively. These amounts have been netted from the amounts in the
above schedule.
47
48
F5 NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In April 2000, we entered into a lease agreement on two buildings for a
new corporate headquarters. The lease commenced in July 2000 on the first
building; and the lease on the second building commenced in October 2000.
The lease for both buildings expires in 2012 with an option for renewal. The
company established a restricted escrow account in connection with this lease
agreement. Under the term of the lease, a $6 million irrevocable standby letter
of credit is required through November 2012, unless the lease is terminated
before then. This amount has been included on the Company's balance sheet as of
September 30, 2000 as a component of restricted cash.
9. RELATED PARTY TRANSACTIONS:
In March 1999, the Company issued 150,000 shares of common stock to an
officer of the Company in exchange for a note receivable. These shares were
acquired by exercising stock options that vest over a period of four years. The
note bears interest at a rate of 4.83%, is collateralized by the shares,
partially guaranteed by the officer and is due in 2003. In 2000, total payments
of $281,000 were received on the loan. Under the pledge agreement, the Company
has the obligation to repurchase any remaining unvested shares, and the note
becomes due upon the officer's termination. Further, the shares may not be
transferred until they are vested and paid for, and the related portion of the
loan is repaid.
10. EMPLOYEE BENEFIT PLANS:
The Company provides a 401(k) savings plan whereby eligible employees
may voluntarily contribute a percentage of their compensation. Under the
provision of the plan the Company may, at their discretion, match a portion of
the employees' eligible contributions. The Company's contribution will vest
over a period of four years. Contributions to the plan during the years ended
September 30, 2000, 1999 and 1998 were approximately $833,000, $612,000 and $0,
respectively.
11. SUPPLEMENTAL CASH FLOW INFORMATION:
Supplemental disclosure of cash flow information is summarized below
for the years ended September 30, 2000, 1999 and 1998:
YEAR ENDED SEPTEMBER 30,
--------------------------------------------
2000 1999 1998
---------- ---------- -----------
Noncash investing and financing activities:
Conversion of note payable and related accrued
interest to Series B Convertible Preferred Stock......................... $ -- $ -- $ 520
Value ascribed to warrants in conjunction with sale of Convertible
Preferred Stock.......................................................... -- -- 367
Note receivable from shareholder for exercise of options................... -- 750 --
Conversion of note payable to common stock................................. -- -- 209
Cash paid for interest........................................................ -- -- 30
Deferred compensation for options granted..................................... 2,128 -- --
Reduction to deferred compensation due to cancelled stock option
grants................................................................... (172) -- --
48
49
PART III
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
See "Directors and Executive Officers of the Registrant" under Item 1,
Part I above.
Information concerning compliance with Section 16 of the Securities
Exchange Act is incorporated herein by reference to information appearing in the
Company's Proxy Statement for its annual meeting of shareholders to be held on
February 21, 2001, which information appears under the caption "Section 16(a)
Beneficial Ownership Reporting Compliance." Such Proxy Statement will be filed
within 120 days of the Company's last fiscal year-end, September 30, 2000.
ITEMS 11, 12 AND 13
The information called for by Items 11, 12 and 13 of this Part III is
included in the Company's Proxy Statement relating to the Company's annual
meeting of shareholders to be held on February 21, 2001 and is incorporated
herein by reference. The information appears in the Proxy Statement under the
captions "Election of Directors," "Remuneration of Executive Officers," and
"Voting Securities and Principal Holders." Such Proxy Statement will be filed
within 120 days of the Company's last fiscal year-end, September 30, 2000.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Index to Consolidated Financial Statements and Financial Statements
schedules:
(1) Consolidated Financial Statements.
Report of PricewaterhouseCoopers LLP, Independent Accountants
Consolidated Balance Sheets as of September 30, 2000 and 1999
Consolidated Statements of Operations for the years ended September 30,
2000, 1999 and 1998
Consolidated Statements of Shareholders' Equity for the years ended
September 30, 2000, 1999 and 1998
Consolidated Statements of Cash Flows for the years ended September 30,
2000, 1999 and 1998
Notes to Consolidated Financial Statements
(2) Consolidated Financial Statement Schedule.
Valuation and Qualifying Accounts and Reserves.
(b) Reports on Form 8-K:
None.
49
50
(c) Exhibits:
EXHIBIT
NUMBER
(REFERENCED TO
ITEM 601 OF EXHIBIT
REGULATION S-K) DESCRIPTION
--------------- -----------
3.1 -- Amended and Restated Articles of Incorporation of the Registration, as amended.(1)
3.2 -- Bylaws of the Registrant, as currently in effect.(1)
4.1 -- Specimen Common Stock Certificate.(1)
10.1 -- Form of Indemnification Agreement between the Registrant and each of its directors and
certain of its officers.(1)
10.2 -- 1998 Equity Incentive Plan.(1)
10.3 -- Form of Option Agreement under the 1998 Equity Incentive Plan.(1)
10.4 -- 1999 Employee Stock Purchase Plan.(1)
10.5 -- Amended and Restated Directors' Nonqualified Stock Option Plan.(1)
10.6 -- Form of Option Agreement under the Amended and Restated Directors' Nonqualified Stock Option
Plan.(1)
10.7 -- Amended and Restated 1996 Stock Option Plan.(1)
10.8 -- Form of Option Agreement under the Amended and Restated 1996 Stock Option Plan.(1)
10.9 -- 1999 Non-Employee Directors' Stock Option Plan.(1)
10.10 -- Form of Option Agreement under 1999 Non-Employee Directors' Stock Option Plan.(1)
10.11 -- NonQualified Stock Option Agreement between John McAdam and the Company dated July 24, 2000.
10.12 -- NonQualified Stock Option Agreement between John McAdam and the Company dated July 24, 2000.
10.13 -- Office Lease Agreement, dated July 31, 1999, between Registrant and 401 Elliott West LLC.(2)
10.14 -- Agreement, dated February 19, 1999, between the Registrant and Steven Goldman.(1)
10.15 -- Investor Rights Agreement, dated August 21, 1998, between Registrant and certain holders of
the Registrant's Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock
and Series D Preferred Stock.(1)
10.16 -- Early Exercise Stock Purchase Agreement, dated March 10, 1999, between Registrant and Robert
J. Chamberlain.(1)
23.1* -- Consent of PricewaterhouseCoopers LLP, Independent Accountants.
27.1* -- Financial Data Schedule.
- ----------
* Filed herewith.
(1) Incorporated by reference from Registration Statement on Form S-1, File
No. 333-75817.
(2) Incorporated by reference from Registration Statement on Form S-1, File
No. 333-86767.
50
51
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
F5 NETWORKS, INC.
Dated: December 13, 2000
By: /s/ JOHN McADAM
------------------------------
John McAdam
Chief Executive Officer and President
Pursuant to the requirements of the Securities Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
By: /s/ JOHN McADAM Chief Executive Officer, President and Director December 13, 2000
------------------------------------------------ (Principal Executive Officer)
John McAdam
By: /s/ JEFFREY S. HUSSEY Chairman of the Board and Chief Strategist December 13, 2000
------------------------------------------------
Jeffrey S. Hussey
By: /s/ ROBERT J. CHAMBERLAIN Senior Vice President, Chief Financial Officer December 13, 2000
------------------------------------------------ (Principal Finance and Accounting Officer)
Robert J. Chamberlain
By: /s/ CARLTON G. AMDAHL Chief Technology Officer and Director December 13, 2000
------------------------------------------------
Carlton G. Amdahl
By: /s/ KEITH D. GRINSTEIN Director December 13, 2000
------------------------------------------------
Keith D. Grinstein
By: /s/ KARL D. GUELICH Director December 13, 2000
------------------------------------------------
Karl D. Guelich
By: /s/ ALAN J. HIGGINSON Director December 13, 2000
------------------------------------------------
Alan J. Higginson
51
52
EXHIBIT INDEX
EXHIBIT
NUMBER
(REFERENCED TO
ITEM 601 OF EXHIBIT
REGULATION S-K) DESCRIPTION
--------------- -----------
3.1 -- Amended and Restated Articles of Incorporation of the Registration, as amended.(1)
3.2 -- Bylaws of the Registrant, as currently in effect.(1)
4.1 -- Specimen Common Stock Certificate.(1)
10.1 -- Form of Indemnification Agreement between the Registrant and each of its directors and
certain of its officers.(1)
10.2 -- 1998 Equity Incentive Plan.(1)
10.3 -- Form of Option Agreement under the 1998 Equity Incentive Plan.(1)
10.4 -- 1999 Employee Stock Purchase Plan.(1)
10.5 -- Amended and Restated Directors' Nonqualified Stock Option Plan.(1)
10.6 -- Form of Option Agreement under the Amended and Restated Directors' Nonqualified Stock Option
Plan.(1)
10.7 -- Amended and Restated 1996 Stock Option Plan.(1)
10.8 -- Form of Option Agreement under the Amended and Restated 1996 Stock Option Plan.(1)
10.9 -- 1999 Non-Employee Directors' Stock Option Plan.(1)
10.10 -- Form of Option Agreement under 1999 Non-Employee Directors' Stock Option Plan.(1)
10.11 -- NonQualified Stock Option Agreement between John McAdam and the Company dated July 24, 2000.
10.12 -- NonQualified Stock Option Agreement between John McAdam and the Company dated July 24, 2000.
10.13 -- Office Lease Agreement, dated July 31, 1999, between Registrant and 401 Elliott West LLC.(2)
10.14 -- Agreement, dated February 19, 1999, between the Registrant and Steven Goldman.(1)
10.15 -- Investor Rights Agreement, dated August 21, 1998, between Registrant and certain holders of
the Registrant's Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock
and Series D Preferred Stock.(1)
10.16 -- Early Exercise Stock Purchase Agreement, dated March 10, 1999, between Registrant and Robert
J. Chamberlain.(1)
23.1* -- Consent of PricewaterhouseCoopers LLP, Independent Accountants.
27.1* -- Financial Data Schedule.
- ------------------
* Filed herewith.
(1) Incorporated by reference from Registration Statement on Form S-1, File
No. 333-75817.
(2) Incorporated by reference from Registration Statement on Form S-1, File
No. 333-86767.
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53
F5 NETWORKS, INC.
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
(IN THOUSANDS)
BALANCE AT CHARGES TO
BEGINNING OF COSTS & CHARGES TO BALANCE AT END
DESCRIPTION FISCAL PERIOD EXPENSES OTHER ACCOUNTS DEDUCTIONS OF FISCAL PERIOD
- ----------- ------------- -------- -------------- ---------- ----------------
Year Ended September 30, 1998
Allowance for doubtful accounts................. $ -- $ 120 $ -- $ 31 $ 89
Allowance for sales returns..................... -- 485 -- 193 292
Tax valuation allowance......................... 570 -- 1,100 -- 1,670
Year Ended September 30, 1999
Allowance for doubtful accounts................. 89 409 -- 85 413
Allowance for sales returns..................... 292 774 -- 653 413
Tax valuation allowance......................... 1,670 -- 1,644 -- 3,314
Year Ended September 30, 2000
Allowance for doubtful accounts................. 413 880 -- 435 858
Allowance for sales returns..................... 413 1,996 -- 1,601 808
Tax valuation allowance......................... 3,314 -- 2,117 547 4,884
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