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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2003

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.

401 Elliott Avenue West
Seattle, Washington 98119
(Address of principal executive offices and zip code)

(206) 272-5555
(Registrant’s telephone number, including area code)

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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No[ ]

The number of shares outstanding of the registrant’s common stock as of April 23, 2003 was 26,369,186.

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F5 NETWORKS, INC.

QUARTERLY REPORT ON FORM 10-Q

For the Quarter Ended March 31, 2003

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PART I — FINANCIAL INFORMATION

Item 1. Financial Statements (unaudited)

F5 NETWORKS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited, in thousands except per share amounts)

The accompanying notes are an integral part of these consolidated financial statements.

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F5 NETWORKS, INC.

CONSOLIDATED BALANCE SHEETS
(unaudited, in thousands)

The accompanying notes are an integral part of these consolidated financial statements.

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F5 NETWORKS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)

The accompanying notes are an integral part of these consolidated financial statements.

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F5 NETWORKS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.     Description of Business

F5 Networks provides integrated products and services to manage, control and optimize Internet traffic. Our core products, the BIG-IP® Controller, 3-DNS® Controller, and the BIG-IP Link Controller, help manage traffic to servers and network devices in a way that maximizes availability and throughput. Our unique iControl™ Architecture integrates our products and also allows our customers to integrate them with other third party products. Our solutions address many elements required for successful Internet and Intranet business applications, including high availability, high performance, intelligent load balancing, fault tolerance, security and streamlined manageability. By enhancing Internet performance and availability, our solutions enable our customers and partners to maximize the use of the Internet in their business.

2.     Basis of Presentation

In the opinion of management, the unaudited consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary for their fair presentation in conformity with accounting principles generally accepted in the United States of America. The consolidated balance sheet as of September 30, 2002 has been derived from the audited consolidated balance sheet as of that date, but does not include all disclosures required by generally accepted accounting principles for complete financial statements. The information included in this Form 10-Q should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2002.

3.     Short-Term and Long-Term Investments

Investments in securities with maturities of less than one year or where management’s intent is to use the investments to fund current operations are classified as short-term investments. We consider our securities as available-for-sale, which are reported at fair value with the related unrealized gains and losses included as a component of shareholders’ equity. Realized gains and losses and declines in value of securities judged to be other than temporary are included in other income (expense). The cost of investments for purposes of computing realized and unrealized gains and losses is based on the specific identification method.

Long-term investments consist of securities with maturities of greater than one year and an investment in Artel Solutions Group Holdings Limited (“Artel.”) All long-term investments are classified as available-for-sale and are carried at fair value, with unrealized gains and losses reflected as a component of comprehensive income based on changes in the fair value of investment. In December of 2001, we purchased, from a third-party, approximately 16 million shares of common stock of Artel, which represents an approximate 1% ownership percentage. At March 31, 2003, the cost basis of our investment in Artel was $1.3 million and the fair market value was $1.2 million.

4.     Inventories

Inventories consist of hardware and related component parts and are recorded at the lower of cost or market (as determined by the first-in, first-out method). We outsource the manufacturing of our pre-configured hardware platforms to a contract manufacturer who assembles each product to our specifications. Our agreement with the contract manufacturer 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. For any product inventory carried by the contract manufacturer beyond 30 days, the contract manufacturer will charge us a monthly carrying fee of 1.5% of the inventory’s carrying value. We have the option to purchase inventory held by the contract manufacturer beyond 30 days to avoid incurring the related carrying charges. As of March 31, 2003, we were committed to purchase approximately $0.8 million of inventory. As protection against component shortages and to provide replacement parts for our service teams, we also stock limited supplies of certain key components for our products.

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F5 NETWORKS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

5.     Comprehensive Income (Loss)

The following reconciles net income (loss) to comprehensive income (loss) (in thousands):

6.     Net Income (Loss) Per Share

Basic net income (loss) per share has been computed by dividing the 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.

The following sets forth the computation of basic and diluted net income (loss) per share (in thousands, except per share data):

For the three months ended March 31, 2003, approximately 3.9 million shares attributable to outstanding stock options were excluded from the calculation of diluted earnings per share because the effect was antidilutive. For the three months ended March 31, 2002, in which we incurred a net loss, dilutive common stock equivalent shares are excluded from the calculation as their impact would have been antidilutive. Diluted earnings per share would have been reduced by the calculated effect of approximately 2.3 million outstanding stock options for the three months ended March 31, 2002.

For the six months ended March 31, 2003, approximately 4.0 million shares attributable to outstanding stock options were excluded from the calculation of diluted earnings per share because the effect was antidilutive. For the six months ended March 31, 2002, in which we incurred a net loss, dilutive common stock equivalent shares are excluded from the calculation as their impact would have been antidilutive. Diluted earnings per share would have been reduced by the calculated effect of approximately 2.2 million outstanding stock options for the six months

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F5 NETWORKS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

ended March 31, 2002.

7.     Stock-Based Compensation

We account 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,” FASB Interpretation No. 44 (“FIN No. 44”) “Accounting for Certain Transactions Involving Stock Compensation,” and related interpretations 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 our 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.

Pro forma information regarding net income (loss) is required by SFAS No. 123, and has been determined as if we had accounted for our stock options under the minimum value method of that statement for all periods prior to us becoming a public entity and fair value method of that statement for all periods subsequent to us becoming a public entity. For purposes of pro forma disclosures, the estimated fair value of the options is amortized over the options’ vesting period. Our net income (loss) and net income (loss) per share would have been adjusted to the pro forma amounts indicated below (in thousands, except per share data):

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F5 NETWORKS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

8.     Restructuring Charge

During the third quarter of fiscal 2002, we recorded restructuring charges of approximately $3.3 million in connection with management’s decision to exit the cache appliance business. As a result of discontinuing this line of business and other changes in the overall business, we wrote-down certain assets, consolidated operations, and terminated 47 employees throughout all divisions of the company. As of September 30, 2002, total cash payments and write-offs of approximately $2.2 million had been recorded. The following summarizes our restructuring charges (in thousands):

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. The adoption of this standard did not have an impact on our financial statements.

In December 2002, the FASB issued SFAS No. 148 “Accounting for Stock-Based Compensation—Transition and Disclosure,” which provides guidance for transition to the fair value based method of accounting for stock-based employee compensation and the required financial statement disclosure. The adoption of SFAS No. 148 did not have a material impact on our financial statements and the additional disclosures required are included in the notes to the consolidated 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 may contain 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 increased by 3.4% to $28.0 million for the three months ended March 31, 2003 from $27.1 million for the same period in the prior year. Total net revenues increased by 1.7% to $55.1 million for the six months ended March 31, 2003 from $54.1 million for the same period in the prior year. The overall increase for the three and six months ended March 31, 2003, is primarily due to the growth in service revenues partially offset by lower product revenues.

Product revenues decreased by 2.1% to $20.3 million for the three months ended March 31, 2003 from $20.8 million for the same period in the prior year. For the six months ended March 31, 2003, product revenues decreased by 3.9% to $39.8 million from $41.4 million for the same period in the prior year. The decrease in product revenues for the three and six months ended March 31, 2003, is primarily due to weakness in the Japan and Asia markets.

Services revenues increased by 21.5% to $7.7 million for the three months ended March 31, 2003 from $6.3 million for the same period in the prior year. For the six months ended March 31, 2003, services revenues increased by 20.1% to $15.2 million from $12.7 million for the same period in the prior year. The increase in service revenues for the three and six months ended March 31, 2003, is primarily due to growth in the number of customers renewing their original service maintenance contracts. We expect services revenues will continue to represent a significant portion of total net revenues.

International revenues represented 37.4% and 39.5% of total net revenues for the three months ended March 31, 2003 and 2002, respectively and 33.9% and 37.2% of total net revenues for the six months ended March 31, 2003 and 2002, respectively. The decrease in international revenues is primarily due to lower sales in the Japan and Asia markets. 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 82.9% and 85.0% of product revenues (excluding service revenues) for the three months ended March 31, 2003 and 2002, respectively and 82.6% and 85.0% of product revenues for the six months ended March 31, 2003 and 2002, 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.

Our BIG-IP products are currently manufactured on two lines of systems: server appliances and IP application switches. Server appliances were our original products and as of the end of fiscal year 2002, accounted for a little more than half of our systems revenues. However, with the introduction of our new IP application switch based products including the BIG-IP 5100 and the BIG-IP 2400, the percentage of revenues derived from IP application switches has increased to well over half of total systems revenue for the three and six months ended

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March 31, 2003. Going forward, we expect the percentage of BIG-IP sales derived from IP application switches to continue to increase as a percentage of total systems sales.

One of our distributors accounted for 11.7% of our total net revenues and 14.8% of our accounts receivable for the three months ended March 31, 2003. For the six months ended March 31, 2003, this customer accounted for 12.0% of our total net revenues. No individual customer represented more than 10% of our total net revenues or accounts receivable for the three and six month periods ended March 31, 2002.

Cost of product revenues. Cost of product revenues decreased by 18.4% to $4.2 million for the three months ended March 31, 2003 from $5.2 million for the same period in the prior year and decreased as a percentage of product revenues to 20.7% from 24.8% for the same periods. For the six months ended March 31, 2003, cost of product revenues decreased by 25.7% to $8.3 million from $11.1 million for the same period in the prior year and decreased as a percentage of product revenues to 20.7% from 26.8% for the same periods. The decrease in cost of product revenues 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 15.1% to $2.3 million for the three months ended March 31, 2003, from $2.7 million for the same period in the prior year. Cost of service revenues decreased as a percentage of service revenues to 29.6% from 42.4% for the same periods. For the six months ended March 31, 2003, cost of service revenues decreased by 17.5% to $4.4 million from $5.4 million for the same period in the prior year. Cost of service revenues decreased as a percentage of service revenues to 29.1% from 42.4% for the same periods. The decrease in cost of service revenues is primarily the result of improved operational efficiencies and a reduction 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.

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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 10.5% to $13.1 million for the three months ended March 31, 2003, from $11.8 million for the same period in the prior year. For the six months ended March 31, 2003, sales and marketing expenses increased by 6.4% to $25.8 million from $24.3 million for the same period in the prior year. The increase in sales and marketing expenses is primarily due to higher payroll and related personnel costs.

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 2.8% to $4.9 million for the three months ended March 31, 2003, from $4.8 million for the same period in the prior year. For the six months ended March 31, 2003, research and development expenses increased by 4.4% to $9.3 million from $8.9 million for the same period in the prior year. The increase in research and development expenses 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, bad debt charges, and an allocation of our facilities and depreciation expenses. General and administrative expenses decreased by 35.9% to $2.9 million for the three months ended March 31, 2003, from $4.5 million for the same period in the prior year. For the six months ended March 31, 2003, general and administrative expenses decreased by 27.1% to $6.3 million from $8.6 million for the same period in the prior year. The decrease in general and administrative expenses 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 March 31, 2003. 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 $71,000 for the six months ended March 31, 2003 and $247,000 for the same period in the prior year. As of March 31, 2003, the remaining balance of unearned compensation totaled approximately $22,000.

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