9. Recent Accounting Pronouncements

In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities (“SFAS 146”). SFAS 146 requires that a liability for costs associated with exit or disposal activities be recognized and measured at fair value when the liability is incurred. SFAS 146 is effective for exit or disposal activities that are initiated after December 31, 2002. We do not expect the adoption of SFAS 146 to have a material impact on our financial statements.

Item 2. 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 consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on December 19, 2002. Our discussion contains forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, 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” and “Business” in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2002, and elsewhere in this report.

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Net revenues. Total net revenues were $27.1 million for the three months ended December 31, 2002, consistent with the $27.0 million for the same period in the prior year. Product revenues decreased by 5.6% to $19.5 million for the three months ended December 31, 2002 from $20.7 million for the same period in the prior year. This decrease is primarily due to weakness in the Japan and Asia markets. Services revenues increased by 18.7% to $7.6 million for the three months ended December 31, 2002 from $6.4 million for the same period in the prior year. The increase in services revenues is due primarily to growth in the number of customers renewing their original service maintenance contracts. Going forward we expect services revenues will continue to represent a significant portion of total net revenues.

International revenues represented approximately 30.4% and 34.9% of total net revenues for the three months ended December 31, 2002 and 2001, respectively. This decrease in international revenues is primarily due to lower sales in Japan and Asia. We expect international revenues will continue to represent a significant portion of net revenues, although we cannot provide assurance that international revenues as a percentage of total net revenues will remain at current levels.

Sales of our BIG-IP products represented 82.2% and 85.0% of product revenues (excluding service revenues) for the three months ended December 31, 2002 and 2001, respectively. The decreased percentage of BIG-IP revenue is primarily attributed to an increase in the percentage of revenues generated from the sale of additional hardware options such as SSL cards and licenses. We expect to derive a significant portion of our product revenues from sales of BIG-IP in the future.

One of our distributors accounted for 11.7% of our total net revenues and 13.7% of our accounts receivable for the three months ended December 31, 2002. No individual customer represented more than 10% of our total net revenues or accounts receivable for the three months ended December 31, 2001.

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Cost of product revenues. Cost of product revenues decreased by 32.0% to $4.1 million for the three months ended December 31, 2002 from $6.0 million for the same period in the prior year and decreased as a percentage of product revenues to 20.8% from 28.9% for the same periods. The decrease is primarily due to lower manufacturing and warranty costs, component costs, and overall material costs resulting from engineering improvements in the design of our products. Certain of our components are subject to significant price fluctuations based on market supply and demand. In the future component pricing may increase significantly due to limited supply and may have a negative impact on our gross margin.

Cost of service revenues. Cost of service revenues decreased by 19.8% to $2.2 million for the three months ended December 31, 2002 from $2.7 million for the same period in the prior year. Cost of service revenues decreased as a percentage of service revenues to 28.6% from 42.3% for the same periods. The decrease primarily relates to improved operational efficiencies and a decrease in personnel and related costs. In the future we expect to increase our cost of service revenues to support new customers and the increasing install base of our application traffic management products.

Sales and marketing. 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 2.6% to $12.8 million for the three months ended December 31, 2002 from $12.4 million for the same period in the prior year. This increase is primarily due to higher payroll and related personnel costs.

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Research and development. 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 6.2% to $4.4 million for the three months ended December 31, 2002 from $4.1 million for the three months ended December 31, 2001. This increase is primarily due to an increase in payroll and related costs and expenses related to the development of new products. We expect to continue to increase research and development expenses as our future success is dependent on the continued enhancement of our current products and our ability to develop new, technologically advanced products that meet the changing needs of our customers.

General and administrative. General and administrative expenses consist primarily of salaries, benefits and related costs of our executive, finance, information technology, human resource and legal personnel, third-party professional service fees, and an allocation of our facilities and depreciation expenses. General and administrative expenses decreased by 17.2% to $3.4 million for the three months ended December 31, 2002 from $4.0 million for the three months ended December 31, 2001. This decrease is primarily due to reductions in professional service fees, facilities costs, and bad debt expenses, partially offset by increased personnel related costs compared to the same period in the prior year.

Amortization of unearned compensation. We have recorded $8.3 million of stock compensation costs since our inception through December 31, 2002. These compensation costs represent the difference between the exercise price and the deemed fair value of certain stock options granted to our employees and outside directors. These stock options generally vest ratably over a four-year period. We are amortizing these compensation costs using an accelerated method as prescribed by FASB interpretation No. 28 (“FIN No. 28”) and recorded stock compensation charges of $0.1 million for the three months ended December 31, 2002 and 2001. As of December 31, 2002, the remaining balance of unearned compensation totaled approximately $28,000.

Other income, net. Other income, net, consists primarily of interest income and foreign currency transaction gains and losses. Other income, net decreased 8.5% to $462,000 for the three months ended December 31, 2002 from $505,000 for the three months ended December 31, 2001. This decrease is primarily due to lower foreign currency gains realized in the current quarter compared to the same period in the prior year.

Income taxes. The provision for income tax of $210,000 and $189,000 for the three months ended December 31, 2002 and 2001, respectively, primarily relates to foreign income taxes associated with our international operations. The Company has a valuation allowance to offset U.S. deferred tax assets in accordance with the provisions of FAS 109. The Company reported net income during the first quarter of fiscal 2003. In the event the Company maintains profitability in future reporting periods management will continue to evaluate the realizability of the Company’s U.S. deferred tax assets. If it is determined that it is more likely than not that the U.S. deferred tax assets are recoverable, the valuation allowance will be reversed in a future reporting period.

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Financial Condition

Cash and cash equivalents, short-term investments and long-term investments totaled $85.2 million as of December 31, 2002. Working capital was $55.3 million and $74.5 million for the three months ended December 31, 2002 and 2001, respectively. This decrease in working capital was the result of a transfer of cash and short-term investments to long-term investments. In December 2002, we invested approximately $22.0 million in securities with maturities greater than one year, which are classified as long-term investments. Consistent with our investment policy the average maturity of our investments is less than one year with no individual security having a maturity exceeding two years.

Cash flow from operations was $2.7 million for the three months ended December 31, 2002 compared to $3.3 million for the three months ended December 31, 2001. Cash flow from operations in the first quarter of fiscal 2002 resulted primarily from net income from operations combined with changes in operating assets and liabilities, as adjusted for various non-cash changes including a provision for doubtful accounts, and depreciation and amortization charges. Cash used in investing activities was $15.8 million for the three months ended December 31, 2002 compared to $9.2 million for the same period in the prior year. Cash used in each of the quarterly periods were primarily due to the purchase of investments and property and equipment, partially offset by the sale of investments. Cash provided by financing activities for the three months ended December 31, 2002 was $1.8 million compared to $1.3 million for the same period in the prior year. Our financing activities relate to cash received from the exercise of employee stock options and stock purchase plan. We believe that our existing cash and investment balances together with cash generated from operations should be sufficient to meet our operating requirements.

In 2001, we entered into a Common Stock and Warrant Purchase Agreement with Nokia Finance International B.V. (“NFI”). Under this Agreement, we issued and sold to NFI (i) 2,466,421 shares of Common Stock and (ii) warrants (the “Warrants”) to purchase additional shares of common stock. The Warrants allowed NFI to purchase additional shares of common stock to increase its ownership percentage in the Company (up to a maximum of one share less than 20%) during three ten business day periods beginning on December 31, 2001, June 30, 2002 and December 31, 2002, at an exercise price equal to the average 10-day closing price before the start of each period. NFI did not purchase additional shares and the Warrants have expired.

As of December 31, 2002, our principal commitments consisted of obligations outstanding under operating leases. In 2000, we entered into lease agreements on two buildings for our corporate headquarters. The lease agreements expire in 2012 with an option for renewal. The lease for the second building has been fully subleased through 2012. We established a restricted escrow account in connection with this lease agreement. Under the terms of this lease, a $6.0 million certificate of deposit is required through November 2012, unless the lease is terminated before then. This amount has been included on our balance sheet as a component of restricted cash. Contractual obligations reflected in the following table are net of anticipated sublease income.

Payments Due by Period (in thousands)

We outsource the manufacturing of our pre-configured hardware platforms to a contract manufacturer, Solectron, who assembles each product to our specifications. Our agreement with Solectron allows them to procure component inventory on our behalf based upon a rolling production forecast. We are contractually obligated to purchase the component inventory in accordance with the forecast, unless we give notice of order cancellation outside of applicable lead times. As of December 31, 2002, we were committed to purchase approximately $0.9 million of such inventory.

Critical Accounting Policies and Estimates

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The following critical accounting policies relate to the more significant judgments and estimates used in the preparation of our consolidated financial statements.

Revenue Recognition. We recognize revenue in accordance with the guidance provided under Statement of Financial Accounting Standards (SFAS) No. 48, “Revenue Recognition When Right of Return Exists,” SEC Staff Accounting Bulleting (SAB) No. 101, “Revenue Recognition in Financial Statements,” Statement of Position (“SOP”) No. 97-2, “Software Revenue Recognition,” and SOP No. 98-9 “Modification of SOP No. 97-2, Software Revenue Recognition, with Respect to Certain Transactions.”

We sell products through resellers, original equipment manufacturers (“OEM”) and other channel partners, as well as directly to end users, under similar terms. We recognize product revenue upon shipment, net of estimated returns, provided that collection is determined to be probable and no significant obligations remain. Product revenues from OEM agreements are recognized based on reporting of sales from the OEM partner. Whenever a software license, hardware, installation and post-contract customer support (“PCS”) elements are combined into a package with a single “bundled” price, a portion of the sales price is allocated to each element of the bundled package based on their respective fair values as determined when the individual elements are sold separately. Revenues from the license of software are recognized when the software has been shipped and the customer is obligated to pay for the software. When rights of return are present and we cannot estimate returns, we recognize revenue when such rights lapse. Revenues for PCS are recognized on a straight-line basis over the service contract term. PCS includes rights to upgrades, when and if available, a limited period of telephone support, updates, and bug fixes. Installation revenue is recognized when the product has been installed at the customer’s site. Consulting services are customarily billed at fixed rates, plus out-of-pocket expenses, and revenues are recognized when the consulting has been completed. Training revenue is recognized when the training has been completed.

Our ordinary payment terms to our domestic customers are net 30 days. Our ordinary payment terms to our international customers are net 30 to 90 days based on normal and customary trade practices in the individual markets. We have offered extended payment terms beyond ordinary terms to some customers. For these arrangements, revenue is recognized when payments become due.

Reserve for Doubtful Accounts. Estimates are used in determining our allowance for bad debts and are based on our historical collection experience, current trends, credit policy, specific identification and a percentage of our accounts receivable by aging category. In determining these percentages, we evaluate historical write-offs of our receivables, current trends in the credit quality of our customer base, as well as changes in the credit policies. We perform ongoing credit evaluations of our customers’ financial condition and generally do not require any collateral. If there is a deterioration of a major customer’s credit worthiness or actual defaults are higher than our historical experience, the recoverability of amounts due could be adversely affected.

Reserve for Product Returns. Sales returns are estimated based on historical experience by type of product and are recorded at the time revenues are recognized. In some instances, product revenue from distributors is subject to agreements allowing limited rights of return. Accordingly, we reduce revenue recognized for estimated future returns at the time the related revenue is recorded. When rights of return are present and we cannot estimate returns, revenue is recognized when such rights lapse. The estimates for returns are adjusted periodically based upon changes in historical rates of returns, inventory in the distribution channel, and other related factors. It is possible that these estimates will change in the future or that the actual amounts could vary from our estimates and that the amounts of such changes could seriously harm our business.

Reserve for Obsolete/Excess Inventory. We currently reduce the carrying value of inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required.

Reserve for Warranties. Our warranty reserve is established based on our historical experience and an estimate of the amounts necessary to settle future and existing claims on products sold as of the balance sheet date. While we believe that our warranty reserve is adequate and that the judgment applied is appropriate, such amounts estimated to

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be due and payable could differ materially from what will actually transpire in the future.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk. The primary objective of our investment activities is to preserve principal, while at the same time maximize the income we receive from our investments without significantly increasing risk. Some of the securities that we have invested in may be subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. For example, if we hold a security that was issued with a fixed interest rate at the then-prevailing rate and the prevailing interest rate later rises, the principal amount of our investment will probably decline. To minimize this risk, we maintain our portfolio of cash equivalents and investments in a variety of securities, including commercial paper, government securities and money market funds. The following table presents the amounts of our cash equivalents, short-term investments and long-term investments that are subject to market risk by range of expected maturity and weighted-average interest rates as of December 31, 2002.