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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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Form 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2000
Commission file number: 000-26689
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FOUNDRY NETWORKS, INC.
(Exact name of registrant as specified in its charter)
Delaware 77-0431154
(State or other Jurisdiction (I.R.S. Employer Identification No.)
of Incorporation or organization)
2100 Gold Street
P.O. Box 649100
San Jose, CA 95164-9100
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code:
(408) 586-1700
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.0001 par value
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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 than 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 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. [_]
The aggregate market value of the voting stock held by non-affiliates of the
registrant was approximately $775,225,067 as of March 16, 2001, based upon the
closing sale price on the Nasdaq National Market reported for such date. Shares
of common stock held by each officer and director and by each person who owns
5% of more of the outstanding common stock have been excluded in that such
persons may be deemed to be affiliates. This determination of affiliate status
is not necessarily a conclusive determination for other purposes.
There were 119,914,766 shares of the registrant's common stock issued and
outstanding as of March 16, 2001.
DOCUMENTS INCORPORATED BY REFERENCE
Part III (Items 10-13) incorporates information by reference from the
definitive proxy statement for the 2000 Annual Meeting of Stockholders to be
filed hereafter.
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TABLE OF CONTENTS
Page
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PART I
Item 1. Business.................................................... 3
Item 2. Properties.................................................. 15
Item 3. Legal Proceedings........................................... 15
Item 4. Submission of Matters to a Vote of Security Holders......... 16
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 17
Item 6. Selected Consolidated Financial Data........................ 18
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................. 20
Item 7(A). Quantitative and Qualitative Disclosures about Market Risk.. 35
Item 8. Consolidated Financial Statements and Supplementary Data.... 36
Item 9. Change in and Disagreements with Accountants on Accounting
and Financial Disclosure................................... 56
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 57
Item 11. Executive Compensation...................................... 57
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 57
Item 13. Certain Relationships and Related Transactions.............. 57
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 58
SIGNATURES ............................................................ 59
2
PART I
In addition to historical information, this Annual Report on Form 10-K
contains forward-looking statements. These forward-looking statements involve
risks, uncertainties and assumptions. The actual results may differ materially
from those anticipated in these forward-looking statements as a result of many
factors, including but not limited to, those discussed in the sections entitled
"Business--Research and Development," "Business--Competition," "Business--
Intellectual Property," and "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Risk Factors That May Affect Future
Results and Market Price of Stock." Readers are cautioned not to place undue
reliance on these forward-looking statements, which reflect management's
opinions only as of the date hereof. Foundry Networks, Inc. (the "Company" or
"Foundry") undertakes no obligation to revise or publicly release the results
of any revision to these forward-looking statements. Readers should carefully
review the risk factors described in this document as well as in other
documents the Company files from time to time with the Securities and Exchange
Commission, including the Quarterly Reports on Form 10-Q to be filed by the
Company in fiscal year 2001.
Item 1. Business
Overview
Foundry designs, develops, manufactures and markets a comprehensive, end-to-
end suite of high performance networking products for enterprises, educational
institutions, government agencies, web-hosting companies, Application Service
Providers (ASPs), electronic banking and finance service providers, and
Internet service providers. Our Internet routers, Gigabit Ethernet Layer 2 and
Layer 3 switching routers and Internet traffic management systems enable our
customers to build and maintain efficient, high performance networks. Our
products provide solutions for a full range of networks, including Local Area
Networks (LANs), Metropolitan Area Networks (MANs) and Wide Area Networks
(WANs). This combined product breadth allows us to offer global end-to-end
solutions within and throughout a customer's networking infrastructure
regardless of the geographically dispersed nature of the entire organization.
Our products can be found from the wiring closets connecting the desktops
together within the enterprise to the mission critical LAN backbone and data
center. We provide robust and high performance routing solutions from the
Internet core to the edge of the Internet service access network and its
network of web and application servers. Our Internet routers deliver the
capabilities and performance needed to provide efficient and reliable core
routing services to Internet data centers around the world. Our Layer 2 and
Layer 3 switches provide the intelligence, speed and cost effectiveness
required to support the increasing use of bandwidth-intensive and Internet-
based applications. Our high performance Internet traffic management systems
with network intelligence capabilities allow enterprises, web-based businesses,
and Internet service providers to build highly available web infrastructures
which direct traffic flow efficiently based on client location, application
type and administrative policies, while allowing service providers to offer
their customers differentiated, fee-based quality of service. We sell our
products through a direct sales force, resellers and OEM partners. By providing
high levels of performance and intelligence capabilities at compelling price
points, we provide comprehensive solutions to address the rapidly growing
enterprise and service provider markets.
Industry Background
The pervasiveness of computing by businesses, organizations and individuals,
and the need to interconnect computing devices to enable widespread
communication, have given rise to the multi-billion dollar computer networking
industry. The explosive growth of the Internet and corporate internal and
external communications needs are driving the recent growth in enterprise and
Internet service provider networks. The complexity of information traveling
over networks is also rapidly increasing with the adoption of bandwidth-
intensive applications that include increasing amounts of data, voice, video
and graphics. The increase in users, coupled with these new bandwidth-intensive
applications, has resulted in exponential growth in network traffic. This
growth has led to a demand by enterprises, web-based businesses, and Internet
service providers for networking solutions with superior performance and
intelligence capabilities.
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Evolution of Market Needs
Organizations adopted data networks to connect a limited number of computers
within close proximity, allowing users to share simple, common services, such
as file servers and printers. In these networks, called local area networks or
LANs, traffic patterns were predictable because the majority of traffic resided
within the LAN and remained local to a specific part of the organization.
Widespread Internet usage, the proliferation of client-server applications and
the adoption of new bandwidth-intensive applications have increased traffic
loads and created unpredictable traffic patterns. Today, the majority of
traffic traverses the boundaries of the LAN to networks outside of the LAN.
Such communication traditionally required an organization to utilize costly
long distance carrier services that often provided inadequate performance. As a
result of today's traffic flows, enterprises increasingly require low cost,
high performance networking equipment to enable effective communications across
geographically dispersed networks, known as MANs and WANs.
Applying enterprise performance requirements to the growing set of web-based
organizations and Internet service providers magnifies our challenges. As their
customers have increasingly become dependent on Internet access, these new web-
based companies and Internet service providers demand networking solutions that
ensure the highest levels of performance and scalability. Similar to enterprise
needs, web-oriented organizations require low cost, high performance solutions
for both their internal networks and access to the Internet. The exponential
growth of Internet traffic, combined with the business critical nature of the
services that Internet service providers provide, necessitates heightened
requirements for reliability.
Evolution of Network Solutions
Early LANs consisted of hubs, which enabled multiple users to share network
resources, and software-based routers, which supported multiple protocols to
move traffic around the network. Increased use of bandwidth-intensive
applications and a larger number of users strained these early network
infrastructures, making it increasingly difficult for them to handle new
applications while still performing at an acceptable speed. Network devices
known as Layer 2 switches replaced hubs to provide dedicated bandwidth to
users, while Fast Ethernet technology was introduced to provide data
transmission speeds of 100 Mbps, or ten times faster than original hubs.
Despite these improvements, the installed base of traditional routers, relying
on software to analyze and route network traffic, were unable to accommodate
increased data speeds and changing traffic patterns and became the new network
bottleneck.
Two new technologies, Gigabit Ethernet, capable of data transmission speeds
of 1000 Mbps, and Layer 3 switching, evolved in parallel to handle growing and
unpredictable traffic patterns and address the performance needs of bandwidth-
intensive applications. Gigabit Ethernet-based Layer 3 switches combine Gigabit
transmission speeds with the forwarding capabilities of software-based routers.
In Layer 3 switches, the software forwarding capabilities that enabled early
routers to move traffic around the network perform this function in hardware,
integrated on application-specific integrated circuits, or ASICs, built into
the switch. This integration enables manufacturers to develop Layer 3 switches
at lower costs while improving network performance.
Next Generation Needs and Solutions
Over the last two years, two main trends have emerged within the network
infrastructure market. First, as enterprises and service providers seek to
accommodate network user needs, adding bandwidth alone is not an adequate
solution. Due to the increased use of multiple traffic types for many
applications, enterprises, web-based businesses, and Internet service providers
have an acute need for solutions that provide network intelligence to
distinguish among and prioritize network traffic based on types of traffic,
content being requested and the applications deployed. Particularly for anyone
supporting electronic business on the web, including Internet service
providers, network intelligence allows them to maintain network reliability and
offer differentiated, fee-based quality of service.
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To address these needs for network intelligence, a new class of device,
Internet traffic management systems, also known as Layer 4-7 web switches, has
emerged as a complement to the performance capabilities of existing Layer 3
switches. These switches provide increased network intelligence, and therefore
greater network efficiency, by utilizing information about the application and
the end user to intelligently direct the traffic to its intended destination.
Both classes of switches are necessary components of a comprehensive networking
solution. Layer 3 switches running Gigabit Ethernet provide the bandwidth and
routing needed to support new applications while Internet traffic management
systems give enterprises, web-based businesses, and Internet service providers
the intelligence to control information delivery.
Second, as the Internet has evolved, the traffic crossing the Wide Area
Networks has shifted from primarily voice traffic to primarily data traffic.
Not long ago, eighty percent of all wide area traffic was voice traffic. Today,
due to the success of the Internet, eighty percent of all wide area traffic is
data. Historically, the basic technology used to move traffic within Wide Area
Networks has been SONET (Synchronous Optical Networking), which was primarily
designed to carry voice traffic. As the level of wide area traffic has migrated
to data, service providers are looking for a technology that is better suited
to handle data traffic.
Gigabit Ethernet, which has emerged as the ubiquitous LAN technology, is a
potential solution. The general acceptance and large volume of Ethernet
installations in LANs have, over time, led to improved performance and
significantly reduced prices. These improvements have created an environment
where Gigabit Ethernet, traditionally a LAN technology, is gaining acceptance
in the wide area as service providers look for cost effective methods of
delivering the necessary bandwidth to their customers.
As bandwidth demand increases and bandwidth intense applications are being
made available to enterprise and private users, a new class of service provider
is beginning to emerge, the Metro Service Provider. Using Long-Haul Gigabit
Ethernet as the enabling technology, these service providers deliver new
services such as broadband Internet access, bandwidth-on-demand and Virtual
Local Area Networks across the metro and regional areas to business and private
users. In this application, Gigabit Ethernet provides very high bandwidth,
highly reliable and high density solutions that enable multi-services such as
Voice-over-IP and Virtual Private Networks to be delivered over a common
backbone.
Solutions
We offer a comprehensive suite of Internet routers, Gigabit Ethernet Layer 2
and Layer 3 switches, and Internet traffic management products for enterprises,
web-based businesses, and Internet service providers. Our solution provides the
following benefits:
Breadth of Product Line. We are one of the few networking companies to
provide a full suite of Internet routers, Gigabit Ethernet Layer 2 / Layer
3 switches and Layer 4 through 7 Internet traffic management products
applicable to LANs, MANs, WANs and data center service farm connectivity.
This product breadth is attractive to customers who desire a single source
for their high performance networking solutions. Our products allow us to
provide solutions throughout a customer's network, from the wiring closet
edge of an enterprise LAN to the LAN core, and from the WAN edge of an
Internet service provider through to its core of Internet communication
devices.
Performance. Our products provide a high level of performance and a non-
blocking architecture across multiple types of networks. A non-blocking
architecture allows all users attached to the switch to access the network
simultaneously without any negative impact on performance. We believe we
currently offer the highest-performing non-blocking switches in the market.
The performance of our products allows enterprises, web-based businesses,
and Internet service providers to build highly reliable networks that
support unpredictable traffic flows, bandwidth-intensive applications and
dynamic end-user needs.
Intelligence. Our products provide the intelligence required to
transport unpredictable traffic and bandwidth-intensive applications,
improving the performance, reliability and manageability of networks. Our
products direct traffic using information about the application and end
user, enabling enterprises, web-
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based businesses, and Internet service providers to control information
delivery and realize benefits such as increased revenue through
application-or availability-based service fees.
Compelling Price Points. Our products are designed to offer superior
performance and network intelligence capabilities at compelling price
points. According to testing conducted in November 2000 by Network World,
an independent networking publication, our BigIron 4000 and 8000 products
offer the best cost per Gigabit of throughput for Layer 3 Gigabit Ethernet
switches. Unlike other low-priced switches that provide limited
functionality, our products offer customers higher value for their
networking equipment investment by providing a comprehensive feature set
while maintaining low price points.
Flexibility of Architecture. Our products incorporate a uniform hardware
architecture that is compatible with all major existing network products
without any significant loss of performance or functionality. Our
architecture supports all forms of Gigabit Ethernet (fiber and copper) and
is designed to support the emerging standard for 10 Gigabit Ethernet. We
also plan to support future emerging technologies such as wave division
multiplexing. As a result, our customers can integrate our products into
their networks without an extensive and expensive replacement of their
existing network components.
Strategy
Our objective is to be the leading provider of next generation high
performance network solutions. We intend to achieve this objective by providing
a broad suite of the most cost-effective, highest-performing network switching
products for enterprises, web-based businesses, and Internet service providers.
Key elements of our strategy include:
Continue to Leverage Our Product Breadth to Expand Our Product Line. As
recently demonstrated with our latest product introduction, the
NetIron400/800/15000 Internet router, we will continue to leverage our
comprehensive product breadth to offer solutions to the enterprise, web-
based businesses, and Internet service provider markets. Our end-to-end
network solution spans the LAN, MAN and LAN/WAN with high levels of
performance and functionality. We intend to continue to offer value-added
feature sets that provide for redundancy, ease of use and management of the
network.
Continue to Expand Our Internet Router Capabilities to Address this
Growing Market and Deliver a New Level of Price/Performance to the Internet
Core Service Providers. Foundry will continue to bring new features and
functionality to our Internet Router platform and add to our product
offering by incorporating leading-edge features. These new enhancements
include features such as MPLS (Multi-Protocol Label Switching), an
emerging wide area protocol.
Continue to Leverage Our Product Capabilities to Address Emerging
Markets. This includes Metropolitan Area Networking (MAN), Gigabit Ethernet
Storage Area Networking (SAN) and Content Distribution Networks. As noted
above, the key advantages of Gigabit Ethernet (price, simplicity, ease of
use) will allow this technology to migrate into many new adjacent markets
over time. Foundry's strategy is to position the company to benefit from
the acceptance of Gigabit Ethernet in such environments as the MAN, SAN and
Content distribution. To accomplish this, we plan to add the necessary
features and enhancements to our products to ensure an ideal solution for
these customers.
Continue Our Market Leadership Position in Internet Traffic Management
Systems. We believe the demand for Internet traffic management intelligent
capabilities will be a very important growth area for web-based businesses
and Internet service providers and an area of increasing importance to
traditional enterprise networks. We intend to achieve a leadership position
in this market by continually improving the performance and functionality
of our Internet traffic management products. Designed to provide the
highest level of performance and network intelligence capabilities, our
products enable web-based businesses and Internet service providers to
rapidly deliver new revenue-generating applications and services to end-
user customers, while providing a high degree of service reliability.
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Provide Superior Technology. We intend to provide superior technology,
based on price, performance and features, through continual enhancements of
existing products and ongoing development of new products that provide
higher levels of performance and intelligence. We also intend to pursue
cost reduction efforts that will allow us to remain highly competitive
while offering customers compelling price points. We intend to ensure that
our hardware and software architectures are flexible and extensible and are
designed to support emerging technologies such as 10 Gigabit Ethernet and
wave division multiplexing.
Expand Global Sales Organization. We intend to continue the global
expansion of our sales organization utilizing a direct sales organization
in the United States, strategic channel partners outside the United States
and select original equipment manufacturers. In addition, we intend to work
with resellers in the United States to penetrate select vertical markets
such as web-hosting facilities and small Internet service providers. We
intend to increase our worldwide sales force and establish additional
channel partner relationships to build greater worldwide sales presence.
Deliver World Class Service and Support. We intend to expand our service
and support infrastructure to meet the needs of our growing customer base.
Our goal is to minimize our customers' network downtime by offering a wide
range of service and support programs to meet individual customer needs,
including prompt onsite hardware repair and replacement, twenty-four hour,
seven days-a-week web and telephone support, system software and network
management software upgrades and technical documentation updates.
Products
We provide a comprehensive line of networking devices designed to meet the
price, performance, reliability and feature requirements of enterprises, web-
based businesses, and Internet service providers. Our product suite includes
Internet core routers, Gigabit Ethernet edge switches, Gigabit core switches
and Gigabit Ethernet intelligent network service switches for server farms.
Edge switches connect individuals and groups of workstations to the network.
Core switches are the most critical network component and serve as the
convergence point for the majority of network traffic. Internet traffic
management systems in web-hosting facilities and server farms provide
centralized collection points for server-based applications used by
enterprises, web-based businesses, and Internet service providers.
Foundry Edge Switching Solutions
FastIron. The FastIron workgroup switch provides Fast Ethernet and Gigabit
Ethernet switching. Designed to accelerate workgroup and server performance in
enterprise networks, the FastIron workgroup switch offers redundancy, bandwidth
management for delay-intensive applications and complete network management
support.
FastIron II and FastIron II Plus. The FastIron II product family is a
redundant, chassis-based wiring closet switch that offers non-blocking Fast
Ethernet and Gigabit Ethernet performance of up to 96 million packets per
second. FastIron II product families offer full Layer 2 and basic Layer 3
switching for all port configurations as well as support for all major industry
standard routing protocols. This protocol support is necessary to ensure
interoperability with installed enterprise applications and equipment.
FastIron III. Foundry's FastIron III, a new member of our FastIron family,
delivers cost effective, high-performance, full-featured Layer 2 or Layer 3 LAN
switch for Enterprise and Service Provider networks. Cost conscience network
administrators can consolidate their backbone and distribution networks into a
FastIron III, allowing for both savings and enhancement of the overall
performance of network infrastructures. Foundry's FastIron III provides up to
336-ports of non-blocking 10/100Base-TX connectivity or up to 120-ports of
Gigabit Ethernet. FastIron III is ideally suited for enterprises and service
providers who require very high density and highly reliable edge connectivity
solutions.
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Foundry Switching Solutions for the Network Core
NetIron and TurboIron/8 Fixed Configuration Layer 3 Switches. Our NetIron
and TurboIron/8 fixed configuration switches allow small and medium-sized
enterprises to increase performance in their network core with multi-protocol
Layer 3 switching. NetIron provides Ethernet, Fast Ethernet and Gigabit
Ethernet connectivity, while TurboIron/8 offers all Gigabit Ethernet Layer 2
and Layer 3 switching and Internet traffic management systems. Both products
support a full suite of industry standard routing protocols. We also offer
multi-layer switching that enables NetIron and TurboIron/8 switches to
transparently perform processing-intensive Internet protocol and Internet
protocol exchange (IPX) traffic forwarding, freeing existing routers to handle
non-IP and IPX traffic and to manage and communicate with other routers. This
capability reduces the workload of routers and the need for costly upgrades,
and improves the overall network performance.
BigIron 4000, BigIron 8000 and BigIron 15000. Our BigIron 4000, BigIron 8000
and BigIron 15000 switches are designed for the LAN/MAN Gigabit Ethernet
backbone of large enterprises, web-based businesses, and Internet service
providers. BigIron switches can be deployed in collapsed backbone, data centers
and server farms of local area and metropolitan area networks. BigIron provides
Ethernet, Fast Ethernet and Gigabit Ethernet Layer 2 and Layer 3 switching, IP
only or multi-protocol support and Packet over SONET on a single platform. We
believe our BigIron switches provide the industry's highest non-blocking
Gigabit Ethernet port density and performance with up to 120 Gigabit Ethernet
ports and 178 million packets per second performance. The BigIron Layer 3
switches support a robust set of standard-based routing protocols including
RIP, OSPF and BGP4 which is the routing protocol of choice in the Internet
core.
Foundry Solutions for the Internet Edge and Core
NetIron400, NetIron800 and NetIron 1500. The NetIron400, NetIron800 and
NetIron 1500 Internet Core Router provide high-performance switching capacity,
scalability, control, and functionality. With interfaces ranging from 10 Mbps
to 2.5 Gbps, our NetIron products are designed to meet the expanding bandwidth
and control requirements faced by Internet Service Providers today. Foundry's
key differentiators include reliability, switching capacity, Internet and LAN
integration, compactness, long haul links Gigabit Ethernet (up to 150
kilometers), and the industry leading price/performance metric. Our NetIron
products utilize Foundry's ASIC architectures along with experienced routing
software development to deliver Internet scaleable routing protocol that
delivers the performance needed to create the nucleus of the Internet.
Foundry's NetIron400 4-slot, NetIron800 8-slot and NetIron1500 15-slot modular
chassis dramatically reduce performance bottlenecks with wire-speed IP routing.
NetIron delivers up to 480 Gbps of superior backplane switching capacity and is
aimed specifically at satisfying the exploding bandwidth requirements
encountered by growth oriented ISPs. NetIron chassis-based routers deliver up
to 172,000,000 packets per second per chassis for reliable packet delivery even
under the heaviest of Internet traffic loads. Designed to meet the expanding
bandwidth and control requirements faced by ISPs today, the chassis-based
Internet routers offer interfaces including OC-3c, OC-12c, and OC-48c Packet
over SONET/SDH, OC-3 ATM, and Gigabit Ethernet.
Foundry Intelligent Network Service Switching Solutions for the Server Farm
ServerIron. The ServerIron product family of switches provide Internet
service providers and enterprises with high performance Internet traffic
management that improves the availability, performance and scalability of
Internet services such as content publishing, web hosting and e-commerce.
ServerIron is compatible with all major server vendors and operating systems
and requires no special server agent software. ServerIron, as a switch-based
product provides high performance, high port density, scalable capacity and
multiple levels of redundancy required by users of mission critical Internet
applications. Foundry's ServerIron products are available in a fixed
configuration (ServerIron, ServerIronXL) or chassis-based solution (ServerIron
400 and 800). Foundry recently enhanced the ServerIron family of products due
to the changing Internet market space and evolving web-based ECommerce
requirements. These enhancements include a more powerful processor as well as
enhanced Internet IronWare Internet traffic management software that adds the
following capabilities to the entire ServerIron product family: Firewall load
balancing, Full Network Address Translation, Expanded
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security features to protect against malicious hacker attacks, as well as URL-,
Cookie-, and SSL-Session ID switching.
IronView Network Management Solutions
IronView. Our IronView network management solution provides a comprehensive
set of easy-to-use tools to simplify management of our switches. A command line
interface streamlines local and remote management and configuration. Industry
standard simple network management protocol and configuration applications are
available on major platforms for graphical user interface management, including
HP OpenView for Sun Solaris, Windows NT and stand-alone Windows NT. Our
switches also include a user-friendly web interface allowing all Foundry
devices within a network to be managed from a single terminal. In addition,
industry standard remote monitoring simplifies network monitoring and a mirror
port is included for network tracing and troubleshooting.
Hardware and Software Architecture
IronCore
All of our products are based on the IronCore hardware architecture. We
believe that IronCore allows us to provide customers with consistent
performance, reliability and features, as well as the ability to leverage their
networking equipment investment. We also believe that the IronCore architecture
allows us to quickly bring new products to market that meet customer needs and
interoperate with existing networking equipment.
The IronCore architecture reflects our expertise in custom designed
programmable ASICs. These ASICs are designed to provide high performance and
integrated Layer 2, Layer 3 and Layer 4 switching capabilities. We believe this
programmable design allows us to offer customers the flexibility of field-
upgradeable software features without compromising performance. We have
developed over a dozen custom ASICs used throughout our product portfolio.
The IronCore chassis architecture consists of a high-speed data highway that
incorporates a backplane and crosspoint switching fabric and supports up to
fifteen interface modules. The crosspoint switching fabric allows all lines of
communication to intersect with one another. Our implementation of the
crosspoint switching fabric includes custom designed, high speed ASICs that
provide throughput of up to 480 Gigabits and 178 million packets per second.
This amount of throughput allows each module connected to the switch to support
simultaneous communication among all workstations connected to the switch,
while all workstations connected to the switch can operate at maximum
performance. We believe these features of IronCore allow enterprises, web-based
businesses, and Internet service providers to have dedicated access to the
network at any time, using any application at the maximum speed.
IronWare and Internet IronWare Software
Our IronWare and Internet IronWare software work with the IronCore hardware
architecture to provide high performance switching. IronWare, which is pre-
installed on our Layer 2 and Layer 3 products, provides network design
flexibility, multiple levels of redundancy for reliability and support for
current and future applications. We believe our Internet IronWare software
provides superior intelligent switching capabilities, such as server load-
balancing and transparent cache switching, for our Internet traffic management
products.
Sales and Marketing
Our sales strategy includes a domestic and international field sales
organization, domestic and international resellers, a lease financing program
and OEM relationships.
Domestic field sales. Our domestic field sales organization establishes and
maintains direct relationships with key accounts and strategic customers. To a
lesser extent, our field organization also works with resellers to
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assist in communicating product benefits to end user customers and proposing
networking solutions. As of December 31, 2000, our domestic field organization
included approximately 220 sales representatives and system engineers. In
addition, as of December 31, 2000, we maintained field offices in over 40 major
metropolitan areas in the United States.
Domestic resellers. Our domestic resellers include regional networking
system resellers and vertical resellers who focus on specific markets such as
small Internet service providers. We provide sales and marketing assistance and
training to our resellers, who in turn provide first level support to end-user
customers. We intend to leverage our relationship with key resellers to
penetrate select vertical markets.
International sales. Internationally, product fulfillment and first level
support is provided by resellers and integrators. Our international resellers
include Mitsui in Japan, Samsung in Korea, Mitech in the United Kingdom, and
Deutsche Telekom in Germany. We also provide field support in key Canadian,
European and Asia Pacific locations including Toronto, London, Paris,
Frankfurt, Munich and Taipei. As of December 31, 2000, our international field
organization included approximately 79 sales representatives and system
engineers. We intend to expand our international presence through additional
personnel and through the addition of key resellers and integrators. For fiscal
2000, domestic sales in the U.S. accounted for 70% of our revenue. No other
country accounted for greater than or equal to 10% of our revenue in fiscal
2000.
OEMs. Our most significant OEM relationship was established with Hewlett-
Packard in January 1999. Pursuant to our agreement, Hewlett-Packard markets and
sells our products on a private label basis through its worldwide sales force.
Hewlett-Packard also purchases our products for use in its own internal
networks. For fiscal 2000, sales to Hewlett-Packard accounted for 4.4% of
revenue. Our agreement with Hewlett-Packard continues until May 18, 2001,
unless terminated earlier for a material breach by either party. The agreement
automatically renews for two additional one year periods, unless the agreement
is terminated within 60 days prior to the end of any period. This agreement
provides that Hewlett-Packard may postpone, cancel, increase or decrease any
order made under the agreement without penalty. In addition, we signed OEM/Co-
branding agreements with both UTStarcom and Lucent Technologies to OEM and co-
brand our products in 2000.
Lease financing program. In January 2000, we established Foundry Commercial
Credit, a private-label leasing program, to offer our customers standardized
solution packages that combine Foundry's high performance end-to-end switching
solutions with innovative lease financing options. Foundry Commercial Credit is
being administered by Heller Financial, Inc. (NYSE: HF), a worldwide commercial
finance company. Foundry's leasing program will be marketed through a direct
sales force and authorized resellers in the United States and other key markets
in Europe, Latin America and Asia Pacific.
Marketing programs. We have numerous marketing programs designed to inform
existing and potential customers, as well as resellers and OEMs, about the
capabilities and benefits of our company and products. Our marketing efforts
also support the sale and distribution of our products through our field
organizations and channels. Our marketing efforts include advertising, public
relations, participation in industry trade shows and conferences, participation
in independent third-party product tests, presentations and our web site. We
also have an e-commerce initiative directed at existing customers and
resellers.
Customer Service and Support
Our service and support organization maintains and supports our products
sold by our field organization to end-users. Our service and support
organization provides 24-hour assistance, including telephone, Internet and
worldwide web support. Customer service revenue was 1.0%, 1.7% and 3.9% of our
net revenue for 1998, 1999 and 2000, respectively. Our resellers and OEMs are
responsible for installation, maintenance and support services to their
customers. We may offer limited assistance to our resellers and OEMs in
providing service and support to their end user customers.
10
We provide all customers with a one-year hardware and 90-day software
warranty. We also offer maintenance programs under TechNet, our comprehensive
suite of service and support options, which provides customers with a variety
of programs to meet specific support needs. TechNet Titanium gives customer
network operations the highest level of priority by providing for a same day,
four-hour hardware replacement. TechNet Gold extends hardware warranty and
gives customers a full range of other services. TechNet Silver provides
customers with all the tools needed to optimize network performance and uptime.
TechNet Bronze extends warranty support with software updates and telephone and
online support.
We have regional Centers-of-Excellence in San Jose, California; Reston,
Virginia; Irvine, California; New York, New York; Chicago, Illinois; Tokyo,
Japan; and Bracknell in the United Kingdom. Foundry's Centers-of-Excellence
locations are fully equipped to demonstrate Foundry's award-winning high
performance LAN and LAN/WAN products and to support interoperability testing
and hands-on training for customers. These regional centers also include
executive briefing centers and serve as regional technical support centers,
with Foundry sparing depots. The centers allow Foundry to continue to deliver
superior customer service and quality products to its customers while
increasing the variety of support programs to their rapidly growing installed
base.
Manufacturing
We operate under a modified "turn key" process utilizing strategic
manufacturing partners that are ISO 9000 certified and have global
manufacturing capabilities. We maintain control and procurement responsibility
for all proprietary components. All designs, documentation, selection of
approved suppliers, quality control and repairs are performed at our
facilities. Our manufacturing operations consist of quality assurance of
materials, components, subassemblies, and performing final assembly and test.
Our manufacturing process also includes the configuration of hardware and
software in unique combinations to meet a wide variety of individual customer
requirements. We use automated testing equipment and "burn-in" procedures, as
well as comprehensive inspection and testing to assure the quality and
reliability of our products. Our approach to manufacturing provides the
flexibility of outsourcing while maintaining quality control of delivered
products to customers. We have selected this approach to ensure our ability to
respond to rapid growth and sudden market shifts.
We currently have two primary manufacturing partners. One partner,
Celestica, located in San Jose, California, assembles and tests our printed
circuit boards. The other partner, Sanmina, also located in San Jose,
California, assembles and tests our backplane products. Both companies are ISO
certified and have global manufacturing facilities providing full back-up
capability and local content for foreign sales if required. We perform all
prototype and pre-production procurement and component qualification with
support from our manufacturing partners. Any interruptions in the operations of
either of these manufacturing partners or delays in their shipment of products
could negatively impact our ability to meet scheduled product deliveries to our
customers. We design all ASICs, printed circuit boards and sheet metal while
working closely with semiconductor partners on future component selection and
design support. All materials used in our products are processed through a full
qualification cycle and controlled by use of an "Approved Vendor Listing" that
must be followed by our sources. We perform extensive testing of all our
products including in-circuit testing of all printed circuit board assemblies,
full functional testing, elevated temperature burn-in and power cycling at
maximum and minimum configuration levels. Please see "Risk Factors--Our
reliance on third-party manufacturing vendors to manufacture our products may
cause a delay in our ability to fill orders" for a review of certain risks
associated with our manufacturing operations.
We currently purchase several components from a single source, including
certain integrated circuits, power supplies and long-range optics, which we
believe are readily available from other suppliers. Our proprietary ASICs,
which provide key functionality in our products, are fabricated in foundries
operated by Texas Instruments. An alternative supply for these ASICs could not
be readily obtained.
We acquire these components through purchase orders and have no long-term
commitments regarding supply or price from these suppliers. The material terms
of these orders typically involve the quantity of supply
11
ordered by us, the purchase price of the components, lead time and the shipping
arrangements. In the event one of these suppliers, in particular, Texas
Instruments, materially delays its supply to us or one of them terminates its
relationship with us, we may not be able to find an alternate supplier on a
timely basis and, as a result, our business could be harmed.
Research and Development
Our future success depends on our ability to enhance existing products and
develop new products that incorporate the latest technological developments. We
work with customers and prospects, as well as partners and industry research
organizations, to identify and implement new solutions that meet the current
and future needs of enterprises, web-based businesses, and Internet service
providers. Whenever possible, our products are based on industry standards to
ensure interoperability. We intend to continue to support emerging industry
standards integral to our product strategy.
We use a uniform architecture across our product line, including
programmable ASICs, and system and network management software. This enables us
to quickly bring new products and features to market. We are currently
developing new switching solutions that provide new levels of performance,
scalability and functionality for the LAN, MAN and LAN/WAN. We also have
engineering efforts focused on cost reduction.
The industry in which Foundry competes in is subject to rapid technological
developments, evolving industry standards, changes in customer requirements,
and frequent new product introductions and enhancements. As a result, Foundry's
success, in part, depends upon its ability to continue to enhance its existing
solutions and to develop and introduce new products that improve network
performance at a cost-effective and timely basis. There can be no assurance
that Foundry will be able to successfully develop new products to address new
customer requirements and technological changes, or that such products will
achieve market acceptance.
As of December 31, 2000, we had an engineering staff of 89 responsible for
hardware design and development, architecture and software development,
documentation and quality assurance. Our research and development expenses
totaled $8.8 million, $9.0 million and $27.5 million in 1998, 1999 and 2000,
respectively.
Competition
We believe that we perform favorably in the key competitive factors that
impact our markets, including technical expertise, pricing, new product
innovation, product features, service and support, brand awareness and
distribution. We intend to remain competitive through ongoing investment in
research and development efforts to enhance existing products and introduce new
products. We will seek to expand our market presence through aggressive
marketing and sales efforts and through the continued implementation of cost
reduction efforts. However, our market is still evolving and we may not be able
to compete successfully against current and future competitors.
The market in which we operate is highly competitive. Cisco Systems
maintains a dominant position in this market and several of its products
compete directly with our products. Cisco's substantial resources and market
dominance have enabled it to reduce prices on its products within a short
period of time following the introduction of these products, which reduces the
margins and therefore, the profitability of its competitors. Purchasers of
networking solutions may choose Cisco's products because of its longer
operating history, broader product line and strong reputation in the networking
market. In addition, Cisco may have developed or could in the future develop
new technologies that directly compete with our products or render our products
obsolete.
In addition to Cisco, we compete with other large public companies, such as
Nortel Networks, Lucent Technologies, Juniper Networks and Extreme Networks as
well as other smaller public and private companies.
12
Many of our current and potential competitors have longer operating histories
and substantially greater financial, technical, sales, marketing and other
resources, as well as greater name recognition and larger installed customer
bases than we do. Furthermore, companies that do not offer a directly
competitive product to our products could develop new products or enter into
agreements with other networking companies to provide a product that competes
with our products or provides a more complete solution than we can offer.
Additionally, we may face competition from unknown companies and emerging
technologies that may offer new LAN, MAN and LAN/WAN solutions to enterprises,
web-based businesses, and Internet service providers.
Intellectual Property
Our success and ability to compete are substantially dependent upon our
internally developed technology and know-how. Our proprietary technology
includes our ASICs, our IronCore hardware architecture, and our IronWare and
Internet IronWare software. Different versions and combinations of these
proprietary technologies are implemented across our product offerings. We rely
on a combination of copyright, trademark and trade secret laws and restrictions
on disclosure to protect our intellectual property rights in these proprietary
technologies. We do not currently own any patents, although we have patent
applications pending. We may not have taken actions that adequately protect our
intellectual property rights.
We provide software to customers under license agreements included in the
packaged software. These agreements are not negotiated with or signed by the
licensee, and thus may not be enforceable in some jurisdictions. Despite our
efforts to protect our proprietary rights through confidentiality and license
agreements, unauthorized parties may attempt to copy or otherwise obtain and
use our products or technology. These precautions may not prevent
misappropriation or infringement of our intellectual property. Monitoring
unauthorized use of our products is difficult and the steps we have taken may
not 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.
Our industry is characterized by the existence of a large number of patents
and frequent claims and related litigation regarding patent and other
intellectual property rights. In particular, leading companies in the
networking markets have extensive patent portfolios with respect to networking
technology.
From time to time third parties have asserted exclusive patent, copyright,
trademark and other intellectual property rights to technologies and related
standards that are important to us. Such third parties may assert claims or
initiate litigation against us or our manufacturers, suppliers or customers
alleging infringement of their proprietary rights with respect to our existing
or future products. In fiscal 2000, we received letters from both IBM and
Nortel alleging that certain of our products that operate on industry standards
may infringe one or more of their patents. In March 2001, Nortel filed a
lawsuit against Foundry in the United States District Court for the District of
Massachusetts alleging that certain of our products infringe several of
Nortel's patents and seeking injunctive relief as well as unspecified damages.
We are currently analyzing the validity of these claims and exploring potential
courses of action. Regardless of the merit of these claims, our investigation
could be time-consuming, result in costly litigation and diversion of technical
management personnel, or require us to develop non-infringing technology or
enter into royalty or license agreements. If there is a successful claim of
infringement by any third party, or if we fail to develop non-infringing
technology or license the proprietary rights, our business could be harmed.
Employees
As of December 31, 2000, we had 572 employees, including 361 in sales and
marketing, 89 in engineering, 75 in manufacturing and 47 in general and
administrative. We are not subject to any collective bargaining agreements and
believe our employee relations are good.
13
Executive Officers
The names and ages of our executive officers as of December 31, 2000 are as
follows:
Name Age Position
---- --- --------
Bobby R. Johnson, Jr.... 44 President, Chief Executive Officer, and Chairman of the
Board of Directors
H. Earl Ferguson........ 63 Vice President, Hardware Engineering
Timothy D. Heffner...... 51 Vice President, Finance and Administration, Chief Financial Officer
Ken K. Cheng............ 45 Vice President, Marketing and Product and Program Management
Wilburn W. McGill....... 58 Vice President, Manufacturing
Robert W. Shackleton.... 50 Vice President, North American Sales
William S. Kallaos...... 53 Vice President, International Sales
Lee Chen................ 46 Vice President, Software Engineering and Quality Assurance
Norma J. Barrera ....... 46 Vice President, Human Resources
Bobby R. Johnson, Jr. co-founded Foundry and has served as President, Chief
Executive Officer and Chairman of the board of directors of Foundry since its
inception in May 1996. From August 1993 to October 1995, Mr. Johnson co-founded
and served as President, Chief Executive Officer and Chairman of the board of
directors of Centillion Networks, Inc., a provider of local area network
switches. From September 1991 to February 1993, Mr. Johnson was Vice President
and General Manager of Internetworking Hardware for Network Equipment
Technologies, a wide area networking company. Mr. Johnson holds a B.S. with
honors from North Carolina State University.
H. Earl Ferguson co-founded Foundry and has served as Vice President,
Hardware Engineering, and chief technical officer of Foundry since July 1996.
From August 1993 to February 1996, Mr. Ferguson was co-founder and Vice
President of Engineering of Centillion Networks and the Vice President of
Engineering for the Centillion Business Unit of Bay Networks. From December
1991 to February 1993, Mr. Ferguson was Director of Internetworking Hardware
for Network Equipment Technologies. Mr. Ferguson holds six patents in
internetworking technologies. Mr. Ferguson holds a B.S. from the University of
Washington and M.S. from the University of Michigan.
Timothy D. Heffner has served as Vice President, Finance and Administration
and Chief Financial Officer of Foundry since November 1996. From September 1994
to November 1996, Mr. Heffner was Director of Finance for Centillion Networks
and for the Centillion Business Unit of Bay Networks. From January 1994 to
September 1994, Mr. Heffner was Chief Financial Officer of Digital Generation
Systems, a network services company. Mr. Heffner holds a B.S. from San Jose
State University.
Ken K. Cheng has served as Vice President of Marketing of Foundry since
December 1999 and as Vice President of Product and Program Management of
Foundry since July 1998. From December 1993 to July 1998, Mr. Cheng was Senior
Vice President and Chief Operating Officer of Digital Generation Systems, a
network services company. From December 1988 to December 1993, Mr. Cheng was
Director of LAN/WAN Internetworking Hardware for Network Equipment
Technologies. Mr. Cheng holds a B.S. from Queen's University and an M.B.A. from
Santa Clara University.
Wilburn W. McGill has served as Vice President of Manufacturing of Foundry
since February 1997. From March 1996 to February 1997, Mr. McGill was the Vice
President of Operations at Ancot Corporation, a networking analyzer company.
From May 1995 to March 1996, Mr. McGill was Vice President of Engineering and
Operations for DTC Data Technology Corporation, a network interface card
company. From January 1990 to February 1994, Mr. McGill was General Manager for
the Research and Development Division of Centera Ltd., a networking solutions
company.
14
Robert W. Shackleton has served as Vice President of North American Sales of
Foundry since April 1997. From March 1989 to March 1997, Mr. Shackleton was
with Network Equipment Technologies where he served as Senior Director of
United States Distribution and Sales. From October 1973 to February 1989, he
worked for IBM where he held a variety of sales and management responsibilities
in the U.S. Mr. Shackleton holds a B.A. with honors from the University of
Colorado and attended Stanford University's Business School Executive
Management Program.
William S. Kallaos has served as Vice President of International Sales of
Foundry since April 1997. From September 1984 to February 1997, Mr. Kallaos
worked for UB Networks in a variety of positions, most recently as Vice
President of United States Sales. Mr. Kallaos holds a B.A. with honors from the
University of Missouri.
Lee Chen has served as Vice President, Software Engineering and Quality
Assurance since October 1999. From June 1996 to September 1999, Mr. Chen served
as Director of Software Engineering for Foundry. From January 1995 to February
1996, Mr. Chen was the Vice President of Engineering of OTS, a software
consulting company. From August 1993 to December 1995, Mr. Chen was co-founder
of Centillion Networks. Mr. Chen holds a M.S. from San Jose State University.
Norma J. Barrera has served as vice president, Human Resources since
December 2000. From November 1999 to December 2000 Ms. Barrera was Senior
Director at Telocity, a broadband Internet company. Prior to Telocity, Ms.
Barrera held senior HR positions at Silicon Graphics from June 1996 to November
1999 and Apple Computer from February 1995 to July 1996. She was also vice
president of HR and Administration for Kaiser Permanente from October 1988 to
February 1995. Ms. Barrera holds an MPA and a BS in Human Resources and
Organizational Development from the University of San Francisco.
Item 2. Properties
Our headquarters for corporate administration, research and development,
sales and marketing, and manufacturing occupy approximately 71,000 square feet
of space in San Jose, California which we moved to in February 2000. In
December 2000, we leased 19,800 square feet of additional office space located
within a mile from our headquarters to accommodate our sales and marketing
personnel. We also lease space in various other geographic locations
domestically and internationally for sales and service personnel. We believe
that our existing facilities are adequate to meet current requirements, and
that suitable additional or substitute space will be available as needed to
accommodate any further physical expansion of corporate operations and for any
additional sales offices. The Company's principal Web server equipment and
operations are maintained in our corporate headquarters in San Jose,
California.
Item 3. Legal Proceedings.
In December 2000, a shareholder class action lawsuit was filed against
Foundry and certain of its officers in the United States District Court for the
Northern District of California, following Foundry's announcement in December
2000, of its anticipated financial results for the fourth quarter ended
December 31, 2000. The lawsuit alleges violation of federal securities laws and
purports to seek damages on behalf of a class of shareholders who purchased
Foundry common stock during the period from October 18, 2000 to December 19,
2000. Following the filing of the lawsuit, several virtually identical lawsuits
were filed making essentially the same allegations. Foundry expects that all of
the lawsuits will be consolidated by the court. Foundry has reviewed the
lawsuits, believes them to be without merit and intends to seek dismissal of
the lawsuits at its first opportunity.
In addition, the Company is a party to various legal proceedings arising
from the ordinary course of its business and/or third-party claims alleging
infringement of proprietary rights with respect to our existing or future
products. In fiscal 2000, we received letters from both IBM and Nortel alleging
that certain of our
15
products that operate on industry standards may infringe one or more of their
patents. In March 2001, Nortel filed a lawsuit against Foundry in the United
States District Court for the District of Massachusetts alleging that certain
of the Company's products infringe several of Nortel's patents and seeking
injunctive relief as well as unspecified damages. See also the sections
entitled "Business--Intellectual Property" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Risk Factors That
May Affect Future Results and Market Price of Stock."
Item 4. Submission Of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth
quarter of fiscal 2000.
16
PART II
Item 5. Market For Registrant's Common Equity and Related Stockholder Matters
Price Range of Common Stock
The Company's common stock commenced trading on the Nasdaq National Market
on September 28, 1999 and is traded under the symbol "FDRY". Prior to this
time, there was no public market for our stock. As of December 31, 2000, there
were approximately 434 holders of record of the common stock. The following
table sets forth for the periods indicated, the high and low closing sale
prices for the common stock as reported on the Nasdaq National Market.
High Low
------- -------
1999
Fourth quarter............................................. $161.19 $ 63.00
2000
First quarter.............................................. $207.56 $106.88
Second quarter............................................. $124.94 $ 54.50
Third quarter.............................................. $131.00 $ 58.50
Fourth quarter............................................. $ 89.00 $ 13.00
Dividend Policy
The Company has never paid cash dividends on its capital stock. The Company
currently anticipates that it will retain its future earnings, if any, to fund
the development and growth of its business and, therefore, does not anticipate
paying cash dividends in the foreseeable future.
Unregistered Securities Sold in 2000
The Company did not make any unregistered sales of the Company's common
stock during fiscal 2000.
17
Item 6. Selected Consolidated Financial Data
The selected consolidated financial data set forth below should be read
together with the consolidated financial statements and related notes,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," and the other information contained in this Form 10-K.
The consolidated statement of operations data set forth below for each of
the years in the three-year period ended December 31, 2000 and the consolidated
balance sheet data as of December 31, 1999 and 2000 are derived from, and
qualified by reference to, our audited financial statements appearing elsewhere
in this Form 10-K. The statement of operations data for the period from
inception on May 22, 1996 to December 31, 1996 and the year ended December 31,
1997 and the balance sheet data as of December 31, 1996 and 1997 are derived
from audited financial statements not included herein.
Period from
May 22, 1996
(Inception) to Year Ended December 31,
December 31, -----------------------------------
1996 1997 1998 1999 2000
-------------- ------- ------- -------- --------
(in thousands, except per share data)
Consolidated Statement
of Operations Data:
Revenue, net............ $ -- $ 3,381 $17,039 $133,522 $377,156
Cost of revenue......... -- 1,835 8,433 56,612 134,330
------- ------- ------- -------- --------
Gross profit.......... -- 1,546 8,606 76,910 242,826
------- ------- ------- -------- --------
Operating expenses:
Research and
development.......... 1,914 5,403 8,797 9,037 27,499
Sales and marketing... -- 3,419 7,258 23,142 67,753
General and
administrative....... 226 1,853 1,589 4,532 10,493
Amortization of
deferred stock
compensation......... -- -- 727 9,463 6,185
------- ------- ------- -------- --------
Total operating
expenses........... 2,140 10,675 18,371 46,174 111,930
------- ------- ------- -------- --------
Income (loss) from
operations............. (2,140) (9,129) (9,765) 30,736 130,896
Interest income, net.... 127 122 413 1,886 11,235
------- ------- ------- -------- --------
Income (loss) before
provision for income
taxes.................. (2,013) (9,007) (9,352) 32,622 142,131
Provision for income
taxes.................. -- -- -- 9,750 54,010
------- ------- ------- -------- -------- ---
Net income (loss)....... $(2,013) $(9,007) $(9,352) $ 22,872 $ 88,121
======= ======= ======= ======== ========
Basic net income (loss)
per share.............. $ (0.50) $ (0.67) $ (0.35) $ 0.42 $ 0.80
Diluted net income
(loss) per share....... $ (0.50) $ (0.67) $ (0.35) $ 0.20 $ 0.69
Weighted average
shares--basic(a)....... 4,048 13,570 26,976 54,929 110,141
Weighted average
shares--diluted(a)..... 4,048 13,570 26,976 114,835 127,131
December 31,
--------------------------------------------------
1996 1997 1998 1999 2000
-------------- ------- ------- -------- --------
Consolidated Balance
Sheet Data:
Cash and cash
equivalents............ $ 3,823 $ 3,182 $ 4,567 $120,378 $168,429
Working capital......... 3,505 4,076 10,663 180,508 340,150
Total assets............ 4,557 6,988 19,238 213,498 398,466
Long term obligations,
less current portion... 344 178 -- -- --
Total stockholders'
equity (deficit)....... (1,903) (10,509) (18,926) 181,604 345,016
- --------
(a) See Note 2 of the Notes to Consolidated Financial Statements beginning on
page 42 for an explanation of the determination of the number of shares and
share equivalents used in computing per share amounts.
18
Unaudited Quarterly Results of Operations
The following tables set forth our consolidated statement of operations data
for each of the eight quarters ended December 31, 2000, including such amounts
expressed as a percentage of net revenue. This unaudited quarterly information
has been prepared on the same basis as our audited financial statements and, in
the opinion of management, reflects all adjustments, consisting only of normal
recurring entries, necessary for a fair presentation of the information for the
periods presented. The operating results for any quarter are not necessarily
indicative of results for any future period.
Quarter Ended
------------------------------------------------------------------------------
Mar. 31, Jun. 30, Sep. 30, Dec. 31, Mar. 31, Jun. 30, Sep. 30, Dec. 31,
1999 1999 1999 1999 2000 2000 2000 2000
-------- -------- -------- -------- -------- -------- -------- --------
(in thousands)
Statement of Operations
Data (unaudited):
Revenue, net............ $15,425 $24,062 $38,896 $55,139 $70,014 $88,790 $113,241 $105,111
Cost of revenue......... 7,570 10,421 17,274 21,347 24,843 30,472 39,538 39,477
------- ------- ------- ------- ------- ------- -------- --------
Gross profit......... 7,855 13,641 21,622 33,792 45,171 58,318 73,703 65,634
Operating expenses:
Research and
development........... 1,746 1,879 2,199 3,213 3,941 6,393 9,194 7,971
Sales and marketing.... 2,717 4,256 6,654 9,515 10,093 15,028 19,566 23,066
General and
administrative........ 670 985 1,025 1,852 1,818 2,070 2,977 3,628
Amortization of
deferred stock
compensation.......... 1,054 3,848 2,248 2,313 1,953 1,581 1,382 1,269
------- ------- ------- ------- ------- ------- -------- --------
Total operating
expenses............ 6,187 10,968 12,126 16,893 17,805 25,072 33,119 35,934
------- ------- ------- ------- ------- ------- -------- --------
Income from operations.. 1,668 2,673 9,496 16,899 27,366 33,246 40,584 29,700
Interest income, net.... 24 -- 47 1,815 2,041 2,700 3,283 3,211
------- ------- ------- ------- ------- ------- -------- --------
Income before provision
for income taxes....... 1,692 2,673 9,543 18,714 29,407 35,946 43,867 32,911
Provision for income
taxes.................. 423 668 3,737 4,922 11,321 13,492 16,641 12,556
------- ------- ------- ------- ------- ------- -------- --------
Net income.............. $ 1,269 $ 2,005 $ 5,806 $13,792 $18,086 $22,454 $ 27,226 $ 20,355
======= ======= ======= ======= ======= ======= ======== ========
Basic net income per
share.................. $ 0.04 $ 0.05 $ 0.14 $ 0.14 $ 0.17 $ 0.21 $ 0.24 $ 0.18
======= ======= ======= ======= ======= ======= ======== ========
Diluted net income per
share.................. $ 0.01 $ 0.02 $ 0.05 $ 0.11 $ 0.14 $ 0.18 $ 0.21 $ 0.16
======= ======= ======= ======= ======= ======= ======== ========
Mar. 31, Jun. 30, Sep. 30, Dec. 31, Mar. 31, Jun. 30, Sep. 30, Dec. 31,
1999 1999 1999 1999 2000 2000 2000 2000
-------- -------- -------- -------- -------- -------- -------- --------
Percentage of Revenue
(unaudited):
Revenue, net............ 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenue......... 49.1 43.3 44.4 38.7 35.5 34.3 34.9 37.6
------- ------- ------- ------- ------- ------- -------- --------
Gross profit......... 50.9 56.7 55.6 61.3 64.5 65.7 65.1 62.4
Operating expenses:
Research and
development........... 11.3 7.8 5.7 5.8 5.6 7.2 8.1 7.6
Sales and marketing.... 17.6 17.7 17.1 17.3 14.4 16.9 17.4 21.9
General and
administrative........ 4.4 4.1 2.6 3.4 2.6 2.3 2.6 3.5
Amortization of
deferred stock
compensation.......... 6.8 16.0 5.8 4.2 2.8 1.8 1.2 1.2
------- ------- ------- ------- ------- ------- -------- --------
Total operating
expenses............ 40.1 45.6 31.2 30.7 25.4 28.2 29.3 34.2
------- ------- ------- ------- ------- ------- -------- --------
Income from operations.. 10.8 11.1 24.4 30.6 39.1 37.5 35.8 28.2
Interest income, net.... 0.2 -- 0.1 3.3 2.9 3.0 2.9 3.1
------- ------- ------- ------- ------- ------- -------- --------
Income before provision
for income taxes....... 11.0 11.1 24.5 33.9 42.0 40.5 38.7 31.3
Provision for income
taxes.................. 2.8 2.8 9.6 8.9 16.2 15.2 14.7 11.9
------- ------- ------- ------- ------- ------- -------- --------
Net income ............. 8.2% 8.3% 14.9% 25.0% 25.8% 25.3% 24.0% 19.4%
======= ======= ======= ======= ======= ======= ======== ========
19
Item 7. Management's Discussion and Analysis of Financial Condition and Results
Of Operations
The following discussion and analysis of our financial condition and results
of operations should be read together with "Selected Financial Data" and our
financial statements and related notes appearing elsewhere in this Form 10-K.
This discussion and analysis contains forward-looking statements that involve
risks, uncertainties and assumptions. The actual results may differ materially
from those anticipated in these forward-looking statements as a result of many
factors, including but not limited to those discussed in the sections entitled
"Business--Research and Development," "Business--Competition," "Business--
Intellectual Property," and "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Risk Factors That May Affect Future
Results and Market Price of Stock." Readers are cautioned not to place undue
reliance on these forward-looking statements, which reflect management's
opinions only as of the date hereof. The Company undertakes no obligation to
revise or publicly release the results of any revision to these forward-looking
statements. Readers should carefully review the risk factors described in this
document as well as in other documents the Company files from time to time with
the Securities and Exchange Commission, including the Quarterly Reports on Form
10-Q to be filed by the Company in fiscal year 2001.
Overview
Foundry designs, develops, manufactures and markets a comprehensive, end-to-
end suite of high performance networking products for enterprises, educational
institutions, government agencies, web-hosting companies, Application Service
Providers (ASPs), electronic banking and finance service providers, and
Internet Service Providers. From our inception in May 1996 through December
1997, our operating activities related primarily to developing, building and
testing prototype products; building our engineering and manufacturing
infrastructure, commencing the staffing of our marketing, sales and technical
support organizations; and establishing relationships with customers. We
commenced commercial shipments of our FastIron workgroup Layer 2 switch in May
1997, the initial product released in our family of stackable products. We
shipped NetIron, our first generation Layer 3 switch, in June 1997. During the
second quarter of 1998, we shipped the first products in our Layer 4-7
ServerIron family. We shipped BigIron, our second generation of midsize and
large-scale chassis-based products, in the third quarter of 1998. In May 2000,
we began shipping our new product line of high-performance Internet backbone
routers, NetIron400 and NetIron800.
We derive our revenue substantially from sales of our stackable and chassis-
based products, including fees for customer support services related to our
products. Foundry's revenue recognition policy follows Securities and Exchange
Commission Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial
Statements." Specifically, Foundry recognizes product revenue when persuasive
evidence of an arrangement exists, delivery has occurred, the sales price is
fixed or determinable and collectibility is probable. In general, this results
in revenue being recorded at the time of shipment, unless we have future
obligations for installation or have to obtain customer acceptance, in which
case revenue is deferred until such obligations have been satisfied or customer
acceptance has been received. Revenue from customer support services is
deferred and recognized on a straight-line basis over the contractual period,
generally one year. At shipment date, Foundry establishes an accrual for
estimated warranty expenses associated with its sales. Foundry's warranty
period extends 12 months from the date of sale. In 1999 and 2000, Foundry
recorded a provision for sales returns equal to $1.2 million and $3.7 million,
respectively, which has been netted against revenue in the accompanying
consolidated statements of operations. Returns related to 1998 revenue were
insignificant. This provision is based on our historical returns. Sales to
Foundry's resellers do not provide for rights of return and the contract with
Foundry's original equipment manufacturer does not provide for rights of return
except in the event Foundry's products do not meet specifications or there has
been an epidemic failure, as defined in the agreement.
Our cost of revenue consists primarily of material, labor, manufacturing
overhead and warranty costs. We market and sell our products primarily through
a direct sales and marketing organization and, to a lesser extent, through
resellers and through our OEM/Co-branding relationships with Hewlett-Packard,
Lucent Technologies
20
and UTstarcom. We have sales representatives in the United States, Singapore,
Italy, Canada, France, United Kingdom, Sweden, China, Mexico, Brazil,
Netherlands, Germany, Australia, New Zealand, Dubai, Hong Kong, South Korea,
and Taiwan. We have made significant investments to expand our international
operations and expect international revenue to increase as a percentage of
total revenue.
We generated net income of $22.9 million and $88.1 million for the years
ended December 31, 1999 and 2000, respectively. As of December 31, 2000, we had
retained earnings of $90.6 million. Although we have been profitable in each
quarter since the first quarter of fiscal 1999, our ability to remain
profitable depends on our ability to generate and sustain substantially higher
revenue while maintaining reasonable cost and expense levels. In addition, our
results will fluctuate from quarter to quarter due to factors in our industry
and the broad macro-economic arena that are outside of our control, including
the recent economic downturn. We received a lower than anticipated amount of
product orders in the last few weeks of the fourth quarter of 2000 and continue
to receive a lower than anticipated amount of product orders for the first
quarter of 2001 as a result of decreased or delayed capital spending by
existing and prospective customers and the slowing U.S. economy. Due to a
number of factors which are discussed in more detail below, we expect our
selling prices and gross margins to decrease as a result of our increased
efforts to compete aggressively and maintain sales levels. As a result, we may
not be able to sustain or increase profitability on a quarterly or annual basis
in the future.
In 2000, we also expanded our board of directors. At a meeting of our board
of directors on October 18, 2000, the board approved an amendment to our Bylaws
increasing our authorized number of directors from three (3) members to seven
(7) members and unanimously appointed the following persons to the board:
Alfred J. Amoroso, C. Nicholas Keating, Jr. and J. Steven Young.
Results of Operations
The following table sets forth selected items from our consolidated
statement of operations as a percentage of revenue for the periods indicated:
Year Ended December 31,
--------------------------
1998 1999 2000
------- ------- -------
Revenue, net....................................... 100.0% 100.0% 100.0%
Cost of revenue.................................... 49.5 42.4 35.6
------- ------- -------
Gross profit..................................... 50.5 57.6 64.4
------- ------- -------
Operating expenses:
Research and development......................... 51.6 6.8 7.3
Sales and marketing.............................. 42.6 17.3 18.0
General and administrative....................... 9.3 3.4 2.8
Amortization of deferred stock compensation...... 4.3 7.1 1.6
------- ------- -------
Total operating expenses....................... 107.8 34.6 29.7
------- ------- -------
Income (loss) from operations...................... (57.3) 23.0 34.7
Interest income, net............................... 2.4 1.4 3.0
------- ------- -------
Income (loss) before provision for income taxes.... (54.9) 24.4 37.7
Provision for income taxes......................... -- 7.3 14.3
------- ------- -------
Net income (loss).................................. (54.9)% 17.1% 23.4%
======= ======= =======
Revenue. Net revenue was $17.0 million, $133.5 million and $377.2 million in
fiscal 1998, 1999 and 2000, respectively, representing increases of 685% from
fiscal 1998 to 1999, and 183% from fiscal 1999 to 2000. These increases were
due to the market's increased demand for Internet infrastructure equipment,
growing acceptance of Foundry's product offerings, and a significant increase
in Foundry's sales and marketing organizations, all of which led to increases
in the amount of our equipment sold. In addition, we introduced our
21
BigIron Layer 3 products in the third quarter of 1998, our ServerIron Layer 4-7
products in the second quarter of 1998, and our NetIron Internet routers in the
second quarter of 2000. These additional product offerings also resulted in
increased revenues.
For the year ended December 31, 2000, no customer accounted for greater than
10% of our revenue.
Cost of revenue. Cost of revenue consists primarily of material, labor,
manufacturing overhead and warranty costs. Cost of revenue was $8.4 million,
$56.6 million and $134.3 million in fiscal 1998, 1999 and 2000, or 49.5%, 42.4%
and 35.6% of revenue, respectively. The decrease in cost of revenue as a
percentage of revenue was primarily a result of shifts in product mix and lower
manufacturing overhead costs due to increased production volume. We expect our
gross margin may be adversely affected by increases in material or labor costs,
heightened price competition, component shortages, changes in channels of
distribution, product and geographic mix, as well as the mix of configurations
within each product group. Downward pressures on our gross margins may be
further impacted by increased percentage of revenue from service market
providers, international purchasers or through our OEMs, all of which may have
lower margins, or an increase in product costs. See also "Risk Factors That May
Affect Future Results and Market Price of Stock -- We expect our gross margin
to decline over time and the average selling prices of our products may
decrease as a result of competitive pressures and other factors."
Research and development. Research and development expenses consist
primarily of salaries and related personnel expenses, prototype expenses
related to the development of our ASICs, software development and testing
costs, and the depreciation of property and equipment related to research and
development activities. Research and development expenses were $8.8 million,
$9.0 million and $27.5 million in fiscal 1998, 1999 and 2000, or 51.6%, 6.8%
and 7.3% of revenue, respectively. The increases were primarily due to the
addition of engineering personnel, higher expenditures on prototypes and
depreciation on additional lab equipment. Research and development costs are
expensed as incurred. We believe continued investment in product enhancements
and new product development is critical to attaining our strategic objectives,
and as a result, we expect research and development expenses to continue to
increase in absolute dollars.
Sales and marketing. Sales and marketing expenses consist primarily of
salaries, commissions and related expenses for personnel engaged in marketing,
sales and customer support functions, as well as trade shows, advertising,
promotional expenses and the cost of facilities. Sales and marketing expenses
were $7.3 million, $23.1 million and $67.8 million in fiscal 1998, 1999 and
2000 or 42.6%, 17.3% and 18.0% of revenue, respectively. The increases were
primarily due to significant increases in the size of our direct sales force
and related commissions, additional marketing and advertising investments
associated with the introduction of new products, the expansion of distribution
channels, and general corporate branding. We expect these expenses to increase
in absolute dollars as we continue to build our field sales and support
organizations and expand sales and marketing activities in the future.
General and administrative. General and administrative expenses consist
primarily of salaries and related expenses for executive, finance and
administrative personnel, facilities expenses and other general corporate
expenses. General and administrative expenses were $1.6 million, $4.5 million
and $10.5 million in fiscal 1998, 1999 and 2000 or 9.3%, 3.4% and 2.8% of
revenue, respectively. The increase in absolute dollars was primarily due to an
additional provision for doubtful accounts receivable of $4.7 million to
increase our reserve for potential uncollectible accounts due to the impact of
the softening economy on our customer base. In addition, we have added
personnel to support the increase in revenue and general corporate expenses
consistent with the increased scale of operations. We expect general and
administrative expenses to continue to increase in absolute dollars as we
continue to build the infrastructure necessary to support the growth of our
business.
Amortization of deferred stock compensation. In connection with the grant of
stock options to employees and a director, we recorded deferred stock
compensation in the aggregate amount of $4.7 million in 1998, $17.3 million in
1999, and $300,000 in 2000, representing the difference between the exercise
price and the
22
deemed fair market value of our common stock on the date these stock options
were granted. This amount is reflected within stockholders' equity and is being
amortized to operations over the respective vesting periods. We recorded
amortization of deferred stock compensation expense of approximately $727,000,
$9.5 million and $6.2 million for fiscal 1998, 1999 and 2000, respectively. At
December 31, 2000, we had approximately $5.6 million remaining to be amortized
over the corresponding vesting period of each respective option, generally four
years from the date of grant.
Interest income. Interest income is the net result of the interest earned on
the funds we keep on deposit in interest bearing money market and short-term
investment accounts less any interest expense incurred on our revolving bank
line of credit and capital lease obligations. Foundry had net interest income
of $413,000, $1.9 million and $11.2 million in 1998, 1999 and 2000,
respectively. During 1998, we had cash balances in an interest bearing account
resulting from the proceeds of our private financing in March 1998. During
1999, interest income increased significantly due to higher cash balances
resulting from the proceeds from our initial public offering on October 1,
1999. During 2000, our interest income increased to $11.2 million as a result
of significantly higher cash balances provided by operations and from the
proceeds of our 1999 initial public offering.
Income taxes. Foundry did not provide for state or federal income taxes in
fiscal 1998 due to operating losses incurred during the year. A valuation
allowance was provided for the entire deferred tax asset as of December 31,
1998 due to the limited operating history of the Company, the lack of
profitability and the uncertainty of future profitability at that time. The
Company generated significant taxable income in 1999 and 2000. Management
believes that the Company will likely generate sufficient taxable income in the
future to ensure the realization of the tax benefits arising from its existing
deferred tax assets. Therefore, no valuation allowance was required as of
December 31, 1999 and 2000.
The Company's income taxes payable for federal and state purposes have been
reduced, and the deferred tax assets increased, by the tax benefits associated
with taxable dispositions of employee stock options. When an employee exercises
a stock option issued under a nonqualified plan or has a disqualifying
disposition related to a qualified plan, the Company receives an income tax
benefit calculated as the difference between the fair market value of the stock
issued at the time of the exercise and the option price, tax effected. These
benefits were credited directly to stockholders' equity and amounted to
$866,000 and $57.9 million for the years ended December 31, 1999 and 2000,
respectively. Benefits reducing taxes payable amounted to approximately
$900,000 and $55.2 million for the years ended December 31, 1999 and 2000,
respectively. Benefits increasing gross deferred tax assets amounted to $40,000
and $2.7 million for the years ended December 31, 1999 and 2000, respectively.
Net income. Net income increased to $88.1 million for 2000 from $22.9
million for 1999 and from a net loss of $9.4 million for 1998. These increases
were the result of significantly higher sales of the Company's new product
offerings in each of the years, offset by the Company's operating expenses
which grew at a relatively slower pace compared to our revenue growth.
Liquidity and Capital Resources
On October 1, 1999, we completed our initial public offering in which we
raised net proceeds of approximately $131.8 million from the sale of 11,500,000
shares of our common stock. Prior to our initial public offering, Foundry
financed operations primarily through the private sales of common and preferred
stock and, to a lesser extent, from a capital equipment lease line. At December
31, 2000, Foundry had cash and cash equivalents of $168.4 million and short-
term investments of $83.8 million. Cash equivalents consisted of commercial
paper and cash deposited in money market accounts with original maturities of
less than three months. Short-term investments was comprised of investment
grade corporate and U.S. debt securities and commercial paper with original
maturities greater than three months but less than one year.
23
Cash provided by operating activities was $19.6 million and $86.0 million
for the years ended December 31, 1999 and 2000, respectively. Cash utilized in
operating activities was $13.2 million in 1998. The increase from 1999 to 2000
was due to the income tax benefit realized from exercises of nonqualified stock
options and disqualified dispositions of incentive stock options totaling $57.9
million combined with increased net income offset by increases in accounts
receivable and inventories. The cash utilized in 1998 was due to net losses, as
well as working capital required to fund our growth in operations, including
accounts receivable and inventories. We expect that accounts receivable will
continue to increase to the extent our revenue continues to rise. We also
expect that our inventory levels will increase due to new product introductions
and increased purchases to secure the supply of certain components. As a
result, such increases will reduce our cash and short-term investments.
Cash utilized in investing activities was $414,000, $40.8 million and $49.2
million for the years ended December 31, 1998, 1999, and 2000, respectively.
The cash utilized in 1998 represented purchases of computers and electronic
test equipment. In 1999 and 2000 we used cash to purchase short-term
investments and, to a lesser extent, property and equipment.
Financing activities in 1998 provided $15.0 million primarily from an equity
financing and the exercise of stock options, offset by principal repayments on
capital lease obligations. Financing activities in 1999 provided $137.1
million, arising primarily from proceeds from our initial public offering on
October 1, 1999. Financing activities in 2000 provided $11.2 million primarily
from stock option exercises and, to a lesser extent, the collection of
stockholder promissory notes.
On September 28, 1999, we entered into a lease for approximately 71,000
square feet to serve as our headquarters and manufacturing facility in San
Jose, California. Our lease commenced on February 1, 2000 and will expire on
January 31, 2006. The related rent expense is $131,000 per month. In December
2000, we entered into an agreement to sublease 19,800 square feet of office
space near our corporate headquarters to accommodate our growth in headcount.
This lease is for a term of twelve months expiring on December 31, 2001. Under
the terms of the lease, we prepaid rent for the entire lease term totaling $1.8
million.
As of December 31, 2000, we did not have any material commitments for
capital expenditures other than those under operating lease agreements. We
expect to incur capital expenditures as we expand our operations in the near
future. Although we do not have any current plans or commitments to do so, from
time to time, we may also consider the acquisition of products and businesses
complementary to our business. Any acquisition or investments may require
additional capital. Although it is difficult for us to predict future liquidity
requirements with certainty, we believe that the net proceeds from our initial
public offering, together with our existing cash balances and anticipated funds
from operations, will satisfy our cash requirements for at least the next 12
months.
Recently Issued Accounting Standards
See Note 2 of Notes to Consolidated Financial Statements for recently
adopted and recently issued accounting standards.
Risk Factors That May Affect Future Results and Market Price of Stock
Although we have been profitable since first quarter 1999, we may not be able
to maintain profitability in the future.
We generated net income of $22.9 million and $88.1 million for the years
ended December 31, 1999 and 2000, respectively. As of December 31, 2000, we had
retained earnings of $90.6 million. We expect to incur increased costs and
expenses related to:
. sales and marketing, including expansion of our direct sales operation
and distribution channels;
24
. product development;
. customer support;
. expansion of our corporate infrastructure; and
. facilities expansion.
With increased levels of spending, an inability to meet expected revenue
levels in a particular quarter could have a material, negative impact on our
operating results for that period as we will not be able to react quickly
enough to scale back operations. Although we have been profitable in each
quarter since the first quarter of fiscal 1999, our ability to remain
profitable depends on our ability to generate and sustain substantially higher
revenue while maintaining reasonable cost and expense levels. We may not be
able to sustain or increase profitability on a quarterly or annual basis in the
future.
We may not meet quarterly financial expectations, which could cause our stock
price to decline.
Our quarterly revenue and operating results are difficult to predict and may
fluctuate significantly from quarter to quarter. Delays in generating or
recognizing forecasted revenue could cause our quarterly operating results to
be below the expectations of public market analysts or investors, which could
cause the price of our common stock to fall.
We may experience a delay in generating or recognizing revenue for a number
of reasons. Orders at the beginning of each quarter typically do not equal
expected revenue for that quarter and are generally cancelable at any time.
Therefore, we depend on obtaining orders in a quarter for shipment in that
quarter to achieve our revenue objectives. In addition, the failure to ship
products by the end of a quarter may negatively affect our operating results.
Our reseller agreements typically provide that the reseller may delay scheduled
delivery dates without penalty. Further, our customer purchase orders and
reseller agreements sometimes provide that the customer or reseller may cancel
orders within specified time frames without significant penalty.
We also plan to increase our operating expenses to expand our sales and
marketing efforts, expand our customer support capabilities, finance increased
levels of research and development and build our operational and administrative
infrastructure. We base our operating expenses on anticipated revenue trends
and a high percentage of our expenses are fixed in the short term. As a result,
any shortfall in revenue relative to our expectations could cause a significant
decline in our quarterly operating results.
Although our customer base has increased substantially, we still depend on
large, recurring purchases from certain customers, and any loss, cancellation
or delay in purchases by these customers could cause a shortfall in revenue.
Prior to fiscal 2000, a limited number of customers and resellers accounted
for a significant portion of our revenue. For the fourth quarter and year ended
December 31, 2000, no customers accounted for greater than 10% of our net
revenue. This may not necessarily be indicative of future customer
concentrations. Although our customer base has become less concentrated, the
loss of continued orders from our more significant customers could cause our
revenue and profitability to suffer. For example, in 2000, sales to Hewlett-
Packard and America Online accounted for 4.4% and 6.3% of revenues,
respectively.
While our financial performance may depend on large, recurring orders from
certain customers and resellers, we do not have binding commitments from any of
them. For example:
. our reseller agreements generally do not require minimum purchases;
. our customers can stop purchasing and our resellers can stop marketing
our products at any time;
. our reseller agreements generally are not exclusive and are for one year
terms, with no obligation of the resellers to renew the agreements; and
25
. our reseller agreements provide for discounts based on expected or actual
volumes of products purchased or resold by the reseller in a given
period.
Because our expenses are based on our revenue forecasts, a substantial
reduction or delay in sales of our products to, or unexpected returns from
customers and resellers, or the loss of any significant customer or reseller
could harm our business. Although our largest customers may vary from period to
period, we anticipate that our operating results for any given period will
continue to depend to a significant extent on large orders from a small number
of customers.
Financial results for any particular period will not predict results for future
periods.
Because of the uncertain nature of the rapidly changing market we serve,
period-to-period comparisons of operating results may not be meaningful. In
addition, you should not rely on the results for any period as an indication of
future performance. In the future, our revenue may grow at a slower rate or not
at all and on a quarter-to-quarter basis may be significantly lower than our
historical quarterly growth rate. As a consequence, operating results for a
particular quarter are extremely difficult to predict. We currently expect that
our operating expenses will continue to increase significantly as we expand our
sales and marketing operations and continue to develop new products. Further,
we are subject to employer payroll taxes when our employees exercise their non-
qualified stock options. The employer payroll taxes are assessed on each
employee's gain, which is the difference between the price of our common stock
on the date of exercise and the exercise price. During a particular period,
these payroll taxes could be material depending on the number of stock options
exercised and the fair market value of our common stock during such period.
These employer payroll taxes would be recorded as a charge to operations in the
period such options are exercised based on actual gains realized by employees.
In addition to the net proceeds we would receive upon the exercise of stock
options, we would receive tax deductions for gains realized by employees on the
exercise of non-qualified stock options for which the benefit is recorded as
additional paid-in capital. However, because we are unable to predict our
future stock price and the number of optionees who may exercise during any
particular period, we cannot predict what, if any, expense will be recorded in
a future period and the impact on our future financial results.
Intense competition in the market for network solutions could prevent us from
increasing revenue and sustaining profitability.
The market for network solutions is intensely competitive. In particular,
Cisco Systems Inc. maintains a dominant position in this market and several of
its products compete directly with our products.
We also compete with other large public companies, such as Nortel Networks,
Lucent Technologies, Juniper Networks and Extreme Networks as well as other
smaller public and private companies. Some of our current and potential
competitors have greater market leverage, longer operating histories, greater
financial, technical, sales, marketing and other resources, more name
recognition and larger installed customer bases. Additionally, we may face
competition from unknown companies and emerging technologies that may offer new
LAN, MAN and LAN/WAN solutions to enterprises and ISPs. Furthermore, a number
of these competitors may merge or form strategic relationships that would
enable them to offer, or bring to market earlier, products that are superior to
ours in terms of features, quality, pricing or other factors.
In order to remain competitive, we must, among other things, invest
significant resources in developing new products with superior performance at
lower prices than our competitors. We must also enhance our current products
and maintain customer satisfaction. If we fail to do so, our products may not
compete favorably with those of our competitors and our revenue and
profitability could suffer.
26
Our ability to increase our revenue depends on expanding our North American
direct sales operation and reseller distribution channels and continuing to
provide excellent customer support.
If we are unable to effectively expand, train and retain our domestic sales
and support staff or establish our indirect distribution channels, our ability
to grow and increase revenue could be harmed. Our expansion of our direct sales
operation may not be successfully completed and the cost of our expansion may
exceed the revenue generated.
If we are unable to develop relationships with significant resellers, or if
these resellers are not successful in their sales efforts, sales of our
products may decrease and our operating results would suffer.
We need to increase our customer service and support staff to support new
and existing customers and resellers. The design and installation of networking
products can be complex and our customers, particularly our ISP customers,
require a high level of sophisticated support and services. Hiring highly
trained customer service and 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.
We must continue to introduce new products with superior performance in a
timely manner in order to sustain and increase our revenue.
The current life cycle of our products is typically 18 to 24 months. To
remain competitive, we need to introduce new products in a timely manner that
offer substantially greater performance and support a greater number of users
per device, all at lower price points. We have experienced, and may in the
future experience, delays in developing and releasing new products and product
enhancements. This has led to, and may in the future lead to, delayed sales,
increased expenses and lower quarterly revenue than anticipated. During the
development of our products, we have also experienced delays in the prototyping
of our ASICs, which in turn has led to delays in product introductions. In
addition, when we announce new products or product enhancements that have the
potential to replace or shorten the life cycle of our existing products,
customers may defer purchasing our existing products. This could harm our
operating results by decreasing sales, increasing our inventory levels of older
products and exposing us to greater risk of product obsolescence.
We sell to Internet Service Providers, whose unpredictable demands,
requirements and business models subject us to potential adverse revenue
fluctuations.
We have introduced products specifically targeted at the ISP market and
currently have under development other products to address their requirements.
As a result, our success depends on increased sales to ISPs. We believe that
there are a number of risks arising from doing business with ISPs which may not
arise in our relationships with our other customers, including:
. ISPs demonstrate a low level of brand loyalty and may switch to another
supplier which provides superior performance;
. any failure of an ISP's service to its customers, particularly in the
case of our largest ISP customer, America Online, that is correctly or
incorrectly attributed to our products could lead to substantial negative
publicity and undermine our efforts to increase our sales in both this
market and other markets;
. we may lose ISP customers if they fail due to the highly competitive
nature of their business or if they do not survive as a result of mergers
and acquisitions in the ISP industry; and
. if the Internet does not continue to expand as a widespread
communications medium and commercial marketplace, the growth of the
market for Internet infrastructure equipment may not continue and the
demand for our products could decline.
27
Due to these factors, we may not successfully increase our penetration of
the ISP market or maintain our current level of sales in this market.
Our revenue may be adversely affected by a reduction in outside financing made
available to many of our customers.
Our customer base includes emerging enterprise, telecommunications and
Internet companies who rely on venture capital firms and other similar
financing sources to fund their operations and growth. Many of these customers
are finding it increasingly difficult to obtain such financing on attractive
terms, if at all. If these companies are unable to raise adequate capital, they
may significantly reduce or even cease their purchases of our products or may
be unable to pay or delay payment for products they had previously purchased.
Such reductions in spending or payment defaults could have a material adverse
effect on our operating results, which could cause our stock price to decline.
Some of our revenue may be derived through vendor financing programs which may
be difficult to administer and may expose us to increased credit risks.
Our existing and potential customers may increasingly demand vendor
financing programs through which they can finance their purchase of networking
equipment. We currently have one such program in place, but only on a limited
basis. Several of our large competitors, in contrast, currently offer vendor
financing programs on a broad basis. In the future we may also offer them on a
broad basis in order to meet increased demand and remain competitive. Although
vendor financing programs can increase customer opportunities, they can also be
difficult and costly to administer and may be utilized by customers who carry
heightened credit risk. If we are unable to effectively administer vendor
financing programs on a broad basis, or if we incur material losses due to
customer defaults under the programs, our business could be harmed which could
cause our stock price to decline.
Hewlett-Packard is a major customer and our most significant OEM, and our
business could be harmed if our relationship with Hewlett-Packard is
terminated.
Hewlett-Packard, currently our most significant OEM, accounted for
approximately 4.4% of our revenue in 2000 and 14% of our revenue in 1999. We
anticipate that it will continue to be a major customer. In addition to
providing revenue through sales of our products to Hewlett-Packard, we believe
that this relationship is important to facilitate broad market acceptance of
our products and enhance our sales, marketing and distribution capabilities.
Therefore, in addition to directly affecting our revenue, the cancellation of
our agreement with Hewlett-Packard could harm our ability to market and sell
our products to potential customers.
In addition, if we were to default under conditions specified in the
agreement, Hewlett-Packard could use our source code to develop and manufacture
competing products. This could harm our performance and ability to compete.
This agreement creates the potential that we and Hewlett-Packard may compete
for sales to the same customer. If this situation occurs, it could harm our
relationship with Hewlett-Packard and also harm our business.
We expect our gross margin to decline over time and the average selling prices
of our products may decrease as a result of competitive pressures and other
factors.
Our industry has experienced rapid erosion of average product selling prices
due to a number of factors, particularly competitive pressures and rapid
technological change. We anticipate that the average selling prices of our
products will decrease in response to competitive pressures, increased sales
discounts, new product introductions by our competitors or other factors. Both
we and our competitors sometimes lower sales prices in order to gain market
share or create more demand. Furthermore, with the recent disruption in the
technology sector coupled with more broad macro-economic factors, both we and
our competitors may pursue more
28
aggressive pricing strategies in an effort to maintain sales levels. Such
intense pricing competition could cause our gross margins to decline and may
adversely affect our business, operating results, or financial condition.
Our gross margins may be further affected if we are unable to reduce costs
and effectively manage our inventory levels. Additionally, our gross margins
may be affected by fluctuations in manufacturing volumes, component costs, the
mix of product configurations sold and the mix of distribution channels through
which our products are sold. For example, we generally realize higher gross
margins on direct sales to the end user than on sales through resellers or our
OEMs. As a result, any significant shift in revenue through resellers or our
OEMs could harm our gross margins.
We need additional qualified personnel to maintain and expand our business. If
we are unable to promptly attract and retain qualified personnel, our business
may be harmed.
We believe our future success will depend in large part upon our ability to
identify, attract and retain highly skilled managerial, engineering, sales and
marketing, finance and manufacturing personnel. Competition for these personnel
is intense, especially in the San Francisco Bay Area, and we have had
difficulty hiring employees in the timeframe we desire, particularly engineers.
Volatility or lack of positive performance in our stock price may also
adversely affect our ability to retain key employees, all of whom have been
granted stock options. We may not succeed in identifying, attracting and
retaining personnel. The loss of the services of any of our key personnel, the
inability to identify, attract or retain qualified personnel in the future or
delays in hiring required personnel, particularly engineers and sales
personnel, could make it difficult for us to manage our business and meet key
objectives, such as timely product introductions. In addition, companies in the
networking industry whose employees accept positions with competitors
frequently claim that competitors have engaged in unfair hiring practices. We
have received one claim like this from another company and we may receive
additional claims in the future. We could incur substantial costs in defending
ourselves against any such claims, regardless of the merits of such claims.
Our success also depends to a significant degree upon the continued
contributions of our key management, engineering, sales and marketing, finance
and manufacturing personnel, many of whom would be difficult to replace. In
particular, we believe that our future success depends on Bobby R. Johnson,
Jr., President, Chief Executive Officer and Chairman of the Board. We do not
have employment contracts or key person life insurance covering any of our
personnel.
Our expansion in international markets will involve inherent risks that we may
not be able to control. As a result, our business may be harmed if we are
unable to successfully address these risks.
Our success will depend, in part, on increasing international sales and
expanding our international operations. Our international sales primarily
depend on our resellers, including Pan Dacom and Total Network Solutions in
Europe, Mitsui in Japan, Bell Canada in Canada and Samsung in Korea. Although
we expect international revenue to increase as a percentage of our total
revenue, the failure of our resellers to sell our products internationally
would limit our ability to sustain and grow our revenue. In particular, our
revenue from international sales depends on Mitsui's ability to sell our
products and on the strength of the Japanese economy which has been weak in
recent years.
There are a number of risks arising from our international business,
including:
. potential recessions in economies outside the United States;
. longer accounts receivable collection cycles;
. seasonal reductions in business activity;
29
. higher costs of doing business in foreign countries;
. difficulties in managing operations across disparate geographic areas;
. difficulties associated with enforcing agreements through foreign legal
systems;
. political instability and export restrictions;
. potential adverse tax consequences; and
. unexpected changes in regulatory requirements.
One or more of such factors may have a material adverse effect on the
Company's future international operations and, consequently, on its business,
operating results and financial condition.
Generally, our international sales are denominated in U.S. dollars. As a
result, an increase in the value of the U.S. dollar relative to foreign
currencies could make our products less competitive on a price basis in
international markets. In the future, we may elect to invoice some of our
international customers in local currency, which could subject us to
fluctuations in exchange rates between the U.S. dollar and the local currency.
We purchase several key components for products from single or limited sources;
if these components are not available, our revenues may be harmed.
We currently purchase several key components used in our products from
single or limited sources and depend on supply from these sources to meet our
needs. Our principal suppliers of key components include Celestica, Texas
Instruments, Sanmina, Finisar, Hewlett-Packard, Intel, Fujitsu and Samsung. Our
principal limited-sourced components include dynamic and static random access
memories, commonly known as DRAMs and SRAMs, ASICs, printed circuit boards,
optical components and microprocessors. We acquire these components through
purchase orders and have no long-term commitments regarding supply or price
from these suppliers. From time to time, we have experienced shortages in
allocations of components, resulting in delays in filling orders. We may
encounter shortages and delays in obtaining components in the future which
could impede our ability to meet customer orders.
We depend on anticipated product orders to determine our material
requirements. Lead times for single- or limited-sourced materials and
components can be as long as six months, vary significantly and depend on
factors such as the specific supplier, contract terms and demand for a
component at a given time. Inventory management remains an area of focus as we
balance the need to maintain strategic inventory levels to ensure competitive
lead times with the risk of inventory obsolescence due to rapidly changing
technology and customer requirements. If orders do not match forecasts or if we
do not manage inventory effectively, we may have either excess or inadequate
inventory of materials and components, which could negatively affect our
operating results and financial condition.
Our reliance on third-party manufacturing vendors to manufacture our products
may cause a delay in our ability to fill orders.
We currently subcontract substantially all of our manufacturing to two
companies located in San Jose, California. Celestica assembles and tests our
printed circuit boards, and Sanmina Corporation assembles and tests our
backplane products. We do not have long-term contracts with either of these
manufacturers. We have experienced delays in product shipments from our
contract manufacturers, which in turn delayed product shipments to our
customers. We may in the future experience similar delays or other problems,
such as inferior quality and insufficient quantity of product, any of which
could harm our business and operating results. We intend to regularly introduce
new products and product enhancements, which will require us to rapidly achieve
volume production by coordinating our efforts with our suppliers and contract
manufacturers. We attempt to increase our material purchases, contract
manufacturing capacity and internal test and quality functions to meet
30
anticipated demand. The inability of our contract manufacturers to provide us
with adequate supplies of high-quality products, the loss of either of our
contract manufacturers, or the ability to obtain raw materials, could cause a
delay in our ability to fulfill orders.
Due to the lengthy sales cycles of some of our products, the timing of our
revenue is difficult to predict and may cause us to miss our revenue
expectations.
Some of our products have a relatively high sales price, and often represent
a significant and strategic decision by an enterprise or Internet service
provider. As a result, the length of our sales cycle in these situations can be
as long as 12 months and may vary substantially from customer to customer.
While our customers are evaluating our products and before they may place an
order with us, we may incur substantial sales and marketing expenses and expend
significant management effort. Consequently, if sales forecasted from a
specific customer for a particular quarter are not realized in that quarter, we
may not meet our revenue expectations.
The timing of the adoption of industry standards may negatively impact
widespread market acceptance of our products.
Our success depends in part on both the adoption of industry standards for
new technologies in our market and our products' compliance with industry
standards. Many technological developments occur prior to the adoption of the
related industry standard. The absence of an industry standard related to a
specific technology may prevent market acceptance of products using the
technology. For example, we introduced Gigabit Ethernet products in May 1997,
over a year prior to the adoption of the industry standard for this technology.
We intend to develop products using other technological advancements, such as
10 Gigabit Ethernet, and may develop these products prior to the adoption of
industry standards related to these technologies. As a result, we may incur
significant expenses and losses due to lack of customer demand, unusable
purchased components for these products and the diversion of our engineers from
future product development efforts. Further, we may develop products that do
not comply with the eventual industry standard, which could hurt our ability to
sell these products. If the industry evolves to new standards, we may not be
able to successfully design and manufacture new products in a timely fashion
that meet these new standards. Even after industry standards are adopted, the
future success of our products depends upon widespread market acceptance of
their underlying technologies.
If our products contain undetected software or hardware errors, we could incur
significant unexpected expenses and lost sales and be subject to product
liability claims.
Our products are complex and may contain undetected defects or errors,
particularly when first introduced or as new enhancements and versions are
released. Despite our testing procedures, these defects and errors may be found
after commencement of commercial shipments. Any defects or errors in our
products discovered in the future or failures of our customers' networks,
whether caused by our products or another vendors' products could result in:
. negative customer reactions;
. product liability claims;
. negative publicity regarding us and our products;
. delays in or loss of market acceptance of our products;
. product returns;
. lost sales; and
. unexpected expenses to remedy errors.
31
If we do not manage our growth effectively, our business will be harmed.
We have experienced rapid growth which has placed, and continues to place, a
significant strain on our resources. Our revenue increased significantly during
2000 and our headcount increased from 222 to 572 employees. Our management team
has relatively limited experience managing rapidly growing companies. As a
result, we may make mistakes in operating our business, such as inaccurately
forecasting our sales, which may result in unanticipated fluctuations in our
operating results. To accommodate anticipated growth, we must:
. improve existing and implement new operational and financial systems,
procedures and controls;
. hire, train and manage additional qualified personnel, including in the
near future, a significant number of new sales personnel; and
. effectively manage multiple relationships with our customers, suppliers
and other third parties.
Our current or planned personnel systems, procedures and controls may not be
adequate to support our future operations. In October 2000, we began
implementation of an Enterprise Resource Planning (ERP) system to meet the
increasing needs associated with the growth of our operations. As our
international operations grow, we will need to expand our support and
communications infrastructure overseas as well. Any delay in the implementation
of or disruption in the transition to new or enhanced systems, procedures or
controls, could harm our ability to accurately forecast sales demand, manage
our supply chain and record and report financial and management information on
a timely and accurate basis.
Our products may not meet the legal foreign and international standards
required for their sale, which will harm our business.
In the United States, our products must comply with various regulations and
standards defined by the Federal Communications Commission and Underwriters
Laboratories. Internationally, products that we develop may be required to
comply with standards established by telecommunications authorities in various
countries as well as with recommendations of the International
Telecommunication Union. Although our products are currently in compliance with
domestic and international standards and regulations in countries we currently
sell to, there is no assurance that our existing and future product offerings
will continue to comply with evolving standards and regulations. If we fail to
obtain timely domestic or foreign regulatory approvals or certificates, we
would not be able to sell our products where these standards or regulations
apply, which may prevent us from sustaining our revenue or maintaining
profitability.
We may engage in future acquisitions that could result in the dilution of our
stockholders, cause us to incur substantial expenses and harm our business if
we cannot successfully integrate the acquired business, products, technologies
or personnel.
As part of our business strategy, we may review acquisition prospects that
would complement our existing business or enhance our technological
capabilities. Future acquisitions by us could result in large and immediate
write-offs, the incurrence of debt and contingent liabilities or amortization
expenses related to goodwill and other intangible assets, any of which could
negatively affect our results of operations. Furthermore, acquisitions involve
numerous risks and uncertainties, including:
. difficulties in the assimilation of products, operations, personnel and
technologies of the acquired companies;
. diversion of management's attention from other business concerns;
. risks of entering geographic and business markets in which we have no or
limited prior experience; and
. potential loss of key employees of acquired organizations.
Although we do not currently have any agreements or plans with respect to
any material acquisitions, we may make acquisitions of complementary
businesses, products or technologies in the future. We may not be
32
able to successfully integrate any businesses, products, technologies or
personnel that might be acquired in the future, and our failure to do so could
harm our business.
We may need to raise more capital, but the availability of additional financing
is uncertain.
We believe that our existing working capital and cash from future operations
will enable us to meet our working capital requirements for at least the next
12 months. However, if cash from future operations is insufficient, or if cash
is used for acquisitions or other currently unanticipated uses, we could be
required to raise substantial additional capital. Additional capital, if
required, may not be available on acceptable terms, or at all. If we are unable
to obtain additional capital, we may be required to reduce the scope of our
planned product development and marketing efforts, which could harm our
business, financial condition and operating results. To the extent that we
raise additional capital through the sale of equity or convertible debt
securities, the issuance of such securities could result in dilution to our
existing stockholders and could cause our stock price to decline. If additional
funds are raised through the issuance of debt securities, these securities
would have rights, preferences and privileges senior to holders of common
stock. The terms of debt securities could impose restrictions on our operations
and could cause our stock price to decline.
If we fail to protect our intellectual property, our business and ability to
compete could suffer.
Our success and ability to compete are substantially dependent upon our
internally developed technology and know-how. We do not own any patents
although we do have patent applications pending. We may not have taken actions
that adequately protect our intellectual property rights.
We provide software to customers under license agreements included in the
packaged software. These agreements are not negotiated with or signed by the
licensee, and thus may not be enforceable in some jurisdictions. Despite our
efforts to protect our proprietary rights through confidentiality and license
agreements, unauthorized parties may attempt to copy or otherwise obtain and
use our products or technology. These precautions may not prevent
misappropriation or infringement of our intellectual property. Monitoring
unauthorized use of our products is difficult and the steps we have taken may
not 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.
We may be subject to intellectual property infringement claims that are costly
to defend and could limit our ability to use certain technologies in the
future.
Our industry is characterized by the existence of a large number of patents
and frequent claims and related litigation regarding patent and other
intellectual property rights. In particular, some companies in the networking
markets have extensive patent portfolios with respect to networking technology.
We do not currently own any patents, although we have patent applications
pending.
From time to time third parties have asserted exclusive patent, copyright,
trademark and other intellectual property rights to technologies and related
standards that are important to us. Such third parties may assert claims or
initiate litigation against us or our manufacturers, suppliers or customers
alleging infringement of their proprietary rights with respect to our existing
or future products. In fiscal 2000, we received letters from both IBM and
Nortel alleging that certain of our products that operate on industry standards
may infringe one or more of their patents. In March 2001, Nortel filed a
lawsuit against Foundry in the United States District Court for the District of
Massachusetts alleging that certain of the Company's products infringe several
of Nortel's patents and seeking injunctive relief as well as unspecified
damages. We are currently analyzing the validity of these claims and exploring
potential courses of action. Regardless of the merit of these claims, our
investigation could be time-consuming, result in costly litigation and
diversion of technical management personnel, or require us to develop non-
infringing technology or enter into royalty or license agreements. If there is
a successful claim of infringement by any third party, or if we fail to develop
non-infringing technology or license the proprietary rights, our business could
be harmed.
33
Our stock price has been volatile historically, which may make it more
difficult for you to resell shares when you want at prices you find attractive.
The trading price of our common stock has been and may continue to be
subject to wide fluctuations. During the year, the closing sale prices of our
common stock on the Nasdaq Stock Market (taking into consideration any stock
splits) ranged from $13.00 to $207.56. The trading price of our common stock
has been and may continue to be subject to wide fluctuations. Our stock price
may fluctuate in response to a number of events and factors, such as quarterly
variations in operating results, announcements of technological innovations or
new products and media properties by us or our competitors, changes in
financial estimates and recommendations by securities analysts, the operating
and stock price performance of other companies that investors may deem
comparable, and news reports relating to trends in our markets. In addition,
the stock market in general, and technology companies in particular, have
experienced extreme volatility that often has been unrelated to the operating
performance of such companies. These broad market and industry fluctuations may
adversely affect the price of our stock, regardless of our operating
performance. Additionally, volatility or lack of positive performance in our
stock price may adversely affect our ability to retain key employees, all of
whom have been granted stock options.
We face litigation risks
We are a party to lawsuits in the normal course of our business. Litigation
in general, and intellectual property and securities litigation in particular,
can be expensive, lengthy and disruptive to normal business operations.
Moreover, the results of complex legal proceedings are difficult to predict. We
believe that we have defenses in the class action lawsuits pending against us
as indicated in Item 3 "Legal Proceedings," and we are vigorously contesting
these allegations. Responding to the allegations has been, and probably will
be, expensive and time-consuming for us. An unfavorable resolution of the
lawsuits could adversely affect our business, results of operations, or
financial condition.
Management beneficially owns approximately 27.7% of our stock; their interests
could conflict with yours; significant sales of stock held by them could have a
negative effect on Foundry's stock price.
Foundry's directors and executive officers beneficially own approximately
27.7% of our outstanding common stock as of December 31, 2000. As a result of
their ownership and positions, our directors and executive officers
collectively are able to significantly influence all matters requiring
stockholder approval, including the election of directors and approval of
significant corporate transactions. Such concentration of ownership may also
have the effect of delaying or preventing a change in control of Foundry. In
addition, sales of significant amounts of shares held by Foundry and its
directors and executive officers, or the prospect of these sales, could
adversely affect the market price of Foundry common stock.
Anti-takeover provisions could make it more difficult for a third party to
acquire us.
Our board of directors has the authority to issue up to 5,000,000 shares of
preferred stock and to determine the price, rights, preferences, privileges and
restrictions, including voting rights, of those shares without any further vote
or action by the stockholders. The rights of the holders of common stock may be
subject to, and may be adversely affected by, the rights of the holders of any
preferred stock that may be issued in the future. The issuance of preferred
stock may have the effect of delaying, deferring or preventing a change of
control of Foundry without further action by the stockholders and may adversely
affect the voting and other rights of the holders of common stock. We have no
present plans to issue shares of preferred stock. Further, certain provisions
of our charter documents, including provisions eliminating the ability of
stockholders to take action by written consent and limiting the ability of
stockholders to raise matters at a meeting of stockholders without giving
advance notice, may have the effect of delaying or preventing changes in
control or management of Foundry, which could have an adverse effect on the
market price of our stock. In addition, our charter documents do not permit
cumulative voting, which may make it more difficult for a third party to gain
control of our board of directors.
34
Our operations could be significantly hindered by the occurrence of a natural
disaster, other catastrophic event, or power shortages.
Our operations are susceptible to outages due to fire, floods, power loss,
power shortages, telecommunications failures, break-ins and similar events. In
addition, our headquarters are located in Northern California, an area
susceptible to earthquakes. In recent months, the western United States (and
California in particular) has experienced repeated episodes of diminished
electrical power supply. As a result of these episodes, certain of our
operations or facilities may be subject to "rolling blackouts" or other
unscheduled interruptions of electrical power. The prospect of such unscheduled
interruptions may continue for the forseeable future and we are unable to
predict either their occurrence, duration or cessation. We do not have multiple
site capacity for all of our services in the event of any such occurrence.
Despite our implementation of network security measures, our servers are
vulnerable to computer viruses, break-ins, and similar disruptions from
unauthorized tampering with our computer systems. We may not carry sufficient
business interruption insurance to compensate us for losses that may occur as a
result of any of these events. Any such event could have a material adverse
effect on our business, operating results, and financial condition.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.
Foundry's investments are made in accordance with an investment policy
approved by the Board of Directors. The primary objective of the Company's
investment activities is to preserve capital while maximizing yields without
significantly increasing risk. Our exposure to market risk for changes in
interest rates relates primarily to our investment portfolio. We do not use
derivative financial instruments in our investment portfolio. We generally
place our investments with high credit quality issuers and, by policy, limit
the amount of credit exposure to any one issuer or fund. With the exception of
a high-risk $2.5 million investment made in a development stage private
company, who is also our customer, in February 2001, our investment portfolio
includes only marketable securities with original maturities of less than one
year and with active secondary or resale markets to ensure portfolio liquidity.
A hypothetical 100 basis point decline in short-term interest rates would
reduce the annualized earnings on our $202.4 million of cash equivalents and
short-term investments at December 31, 2000 by approximately $2.0 million.
We have no investments denominated in foreign country currencies and
therefore are not subject to foreign currency risk on such investments. Due to
the nature of our short-term investments, we have concluded that there is no
material market risk exposure. Therefore, no quantitative tabular disclosures
are required.
Currently, all of our sales and expenses are denominated in U.S. dollars,
with the exception of Canada, and, as a result, we have not experienced
significant foreign exchange gains and losses to date. We do not currently
enter into forward exchange contracts to hedge exposures denominated in foreign
currencies or any other derivative financial instruments for trading or
speculative purposes. However, in the event our exposure to foreign currency
risk increases, we may choose to hedge those exposures.
35
Item 8. Consolidated Financial Statements And Supplementary Data
FOUNDRY NETWORKS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Report of Independent Public Accountants.................................. 37
Consolidated Balance Sheets as of December 31, 1999 and 2000.............. 38
Consolidated Statements of Operations for the Years Ended December 31,
1998, 1999 and 2000...................................................... 39
Consolidated Statements of Redeemable Convertible Preferred Stock and
Stockholders' Equity (Deficit) as of December 31, 1998, 1999 and 2000.... 40
Consolidated Statements of Cash Flows for the Years Ended December 31,
1998, 1999 and 2000...................................................... 41
Notes to Consolidated Financial Statements ............................... 42
36
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Foundry Networks, Inc.:
We have audited the accompanying consolidated balance sheets of Foundry
Networks, Inc. (a Delaware corporation) and subsidiaries as of December 31,
1999 and 2000, and the related consolidated statements of operations,
redeemable convertible preferred stock and stockholders' equity (deficit) and
cash flows for each of the three years in the period ended December 31, 2000.
These financial statements and the schedule referred to below are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards 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. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Foundry
Networks, Inc. and subsidiaries as of December 31, 1999 and 2000, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 2000 in conformity with accounting
principles generally accepted in the United States.
Our audit was made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in Item 14(a)(2) is
presented for purposes of complying with the Securities and Exchange
Commission's rules and is not part of the basic financial statements. This
schedule has been subjected to the auditing procedures applied in the audit of
the basic financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
Arthur Andersen LLP
San Jose, California
January 12, 2001
37
FOUNDRY NETWORKS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
December 31,
------------------
1999 2000
-------- --------
ASSETS
Current assets:
Cash and cash equivalents................................ $120,378 $168,429
Short-term investments................................... 39,789 83,816
Accounts receivable, net of allowances for doubtful
accounts and sales returns of $1,969 and $5,762 at
December 31, 1999 and 2000, respectively................ 28,932 64,573
Inventories.............................................. 16,743 51,593
Deferred tax assets...................................... 5,220 13,715
Prepaid expenses and other current assets................ 1,340 11,474
-------- --------
Total current assets................................... 212,402 393,600
-------- --------
Property and equipment:
Computers and related equipment.......................... 2,621 6,451
Leasehold improvements................................... -- 922
Furniture and fixtures................................... 107 503
-------- --------
2,728 7,876
Less: Accumulated depreciation........................... (1,632) (3,010)
-------- --------
Net property and equipment............................. 1,096 4,866
-------- --------
$213,498 $398,466
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable......................................... $ 7,557 $ 20,432
Accrued payroll and related expenses..................... 4,138 11,130
Warranty accrual......................................... 2,092 2,841
Other accrued expenses................................... 4,013 5,642
Income taxes payable..................................... 9,925 --
Deferred revenue......................................... 4,169 13,405
-------- --------
Total current liabilities.............................. 31,894 53,450
-------- --------
Commitments and contingencies (Note 3)
Stockholders' equity:
Common stock, $0.0001 par value:
Authorized--300,000,000 shares at December 31, 2000:
Issued and outstanding-- 114,189,450 and 118,076,155
shares at December 31, 1999 and 2000, respectively...... 11 12
Treasury stock........................................... (4) (4)
Additional paid-in capital............................... 191,623 263,176
Notes receivable from stockholders....................... (755) (3,270)
Deferred stock compensation.............................. (11,771) (5,580)
Cumulative translation adjustment........................ -- 61
Retained earnings........................................ 2,500 90,621
-------- --------
Total stockholders' equity............................. 181,604 345,016
-------- --------
$213,498 $398,466
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
38
FOUNDRY NETWORKS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Year Ended December 31,
---------------------------
1998 1999 2000
------- -------- --------
Revenue, net...................................... $17,039 $133,522 $377,156
Cost of revenue................................... 8,433 56,612 134,330
------- -------- --------
Gross profit.................................... 8,606 76,910 242,826
------- -------- --------
Operating expenses:
Research and development........................ 8,797 9,037 27,499
Sales and marketing............................. 7,258 23,142 67,753
General and administrative...................... 1,589 4,532 10,493
Amortization of deferred stock compensation..... 727 9,463 6,185
------- -------- --------
Total operating expenses...................... 18,371 46,174 111,930
------- -------- --------
Income (loss) from operations..................... (9,765) 30,736 130,896
Interest income................................... 431 2,092 11,235
Interest expense.................................. (18) (206) --
------- -------- --------
Income (loss) before provision for income taxes... (9,352) 32,622 142,131
Provision for income taxes........................ -- 9,750 54,010
------- -------- --------
Net income (loss)................................. $(9,352) $ 22,872 $ 88,121
======= ======== ========
Basic net income (loss) per share................. $ (0.35) $ 0.42 $ 0.80
======= ======== ========
Weighted average shares used in computing basic
net income (loss) per share...................... 26,976 54,929 110,141
======= ======== ========
Diluted net income (loss) per share............... $ (0.35) $ 0.20 $ 0.69
======= ======== ========
Weighted average shares used in computing diluted
net income (loss) per share...................... 26,976 114,835 127,131
======= ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
39
FOUNDRY NETWORKS, INC.
CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK AND
STOCKHOLDERS' EQUITY (DEFICIT)
(in thousands)
Redeemable
Convertible Treasury Notes Accumulated
Preferred Stock Common Stock Stock Additional Receivable Deferred Other
------------------ --------------- ------------- Paid-in From Stock Comprehensive
Shares Amount Shares Amount Shares Amount Capital Stockholders Compensation Income
-------- -------- ------- ------ ------ ------ ---------- ------------ ------------ -------------
BALANCES AT
DECEMBER 31,
1997............ 29,511 $ 15,119 52,544 $ 5 -- $ -- $ 766 $ (260) $ -- $ --
Exercise of
stock options
for cash........ -- -- 1,100 -- -- -- 212 -- -- --
Exercise of
stock options
for notes
receivable...... -- -- 2,954 -- -- -- 474 (474) -- --
Issuance of
Series C
redeemable
convertible
preferred stock,
net............. 15,464 14,966 -- -- -- -- -- -- -- --
Deferred stock
compensation.... -- -- -- -- -- -- 4,691 -- (4,691) --
Amortization of
deferred stock
compensation.... -- -- -- -- -- -- -- -- 727 --
Repurchase of
common stock.... -- -- (766) -- -- -- (25) -- -- --
Cancellation of
notes receivable
from
stockholders.... -- -- -- -- -- -- -- 21 -- --
Net loss........ -- -- -- -- -- -- -- -- -- --
-------- -------- ------- --- ----- ----- -------- ------- -------- -----
BALANCES AT
DECEMBER 31,
1998............ 44,975 30,085 55,832 5 -- -- 6,118 (713) (3,964) --
Issuance of
Series C
redeemable
convertible
preferred stock,
net............. 375 1,000 -- -- -- -- -- -- -- --
Issuance of
common stock in
connection with
initial public
offering, net of
offering costs.. -- -- 11,500 1 -- -- 131,831 -- -- --
Conversion of
preferred stock
into common
stock........... (45,350) (31,085) 45,350 5 -- -- 31,080 -- -- --
Exercise of
stock options
for cash........ -- -- 2,917 -- -- -- 4,331 -- -- --
Exercise of
stock options
for notes
receivable...... -- -- 246 -- -- -- 146 (146) -- --
Repayment of
notes
receivable...... -- -- -- -- -- -- -- 85 -- --
Repurchase of
common stock.... -- -- (455) -- -- -- (19) 19 -- --
Deferred stock
compensation.... -- -- -- -- -- -- 17,270 -- (17,270) --
Amortization of
deferred stock
compensation.... -- -- -- -- -- -- -- -- 9,463 --
Repurchase of
common stock
from a founder.. -- -- (1,200) -- 1,200 (4) -- -- -- --
Tax benefit from
stock option
exercises....... -- -- -- -- -- -- 866 -- -- --
Net income...... -- -- -- -- -- -- -- -- -- --
-------- -------- ------- --- ----- ----- -------- ------- -------- -----
BALANCES AT
DECEMBER 31,
1999............ -- -- 114,190 11 1,200 (4) 191,623 (755) (11,771) --
Exercise of
stock options
for cash........ -- -- 3,827 1 -- -- 6,935 -- -- --
Exercise of
stock options
for notes
receivable...... -- -- 60 -- -- -- 3,270 (3,270) -- --
Common stock
issued under
Employee Stock
Purchase Plan... -- -- 325 -- -- -- 3,617 -- -- --
Repayment of
notes
receivable...... -- -- -- -- -- -- -- 755 -- --
Repurchase of
common stock.... -- -- (326) -- -- -- (121) -- -- --
Deferred stock
compensation.... -- -- -- -- -- -- 300 -- (300) --
Amortization of
deferred stock
compensation.... -- -- -- -- -- -- -- -- 6,315 --
Reduction in
deferred stock
compensation.... -- -- -- -- -- -- (306) -- 176 --
Tax benefit from
stock option
exercises....... -- -- -- -- -- -- 57,858 -- -- --
Foreign currency
translation
adjustments..... -- -- -- -- -- -- -- -- -- 61
Net income...... -- -- -- -- -- -- -- -- -- --
-------- -------- ------- --- ----- ----- -------- ------- -------- -----
BALANCES AT
DECEMBER 31,
2000............ -- $ -- 118,076 $12 1,200 $ (4) $263,176 $(3,270) $ (5,580) $ 61
======== ======== ======= === ===== ===== ======== ======= ======== =====
Retained Total
Earnings Stockholders'
(Accumulated Equity
Deficit) (Deficit)
------------ -------------
BALANCES AT
DECEMBER 31,
1997............ $(11,020) $(10,509)
Exercise of
stock options
for cash........ -- 212
Exercise of
stock options
for notes
receivable...... -- --
Issuance of
Series C
redeemable
convertible
preferred stock,
net............. -- --
Deferred stock
compensation.... -- --
Amortization of
deferred stock
compensation.... -- 727
Repurchase of
common stock.... -- (25)
Cancellation of
notes receivable
from
stockholders.... -- 21
Net loss........ (9,352) (9,352)
------------ -------------
BALANCES AT
DECEMBER 31,
1998............ (20,372) (18,926)
Issuance of
Series C
redeemable
convertible
preferred stock,
net............. -- --
Issuance of
common stock in
connection with
initial public
offering, net of
offering costs.. -- 131,832
Conversion of
preferred stock
into common
stock........... -- 31,085
Exercise of
stock options
for cash........ -- 4,331
Exercise of
stock options
for notes
receivable...... -- --
Repayment of
notes
receivable...... -- 85
Repurchase of
common stock.... -- --
Deferred stock
compensation.... -- --
Amortization of
deferred stock
compensation.... -- 9,463
Repurchase of
common stock
from a founder.. -- (4)
Tax benefit from
stock option
exercises....... -- 866
Net income...... 22,872 22,872
------------ -------------
BALANCES AT
DECEMBER 31,
1999............ 2,500 181,604
Exercise of
stock options
for cash........ -- 6,936
Exercise of
stock options
for notes
receivable...... -- --
Common stock
issued under
Employee Stock
Purchase Plan... -- 3,617
Repayment of
notes
receivable...... -- 755
Repurchase of
common stock.... -- (121)
Deferred stock
compensation.... -- --
Amortization of
deferred stock
compensation.... -- 6,315
Reduction in
deferred stock
compensation.... -- (130)
Tax benefit from
stock option
exercises....... -- 57,858
Foreign currency
translation
adjustments..... -- 61
Net income...... 88,121 88,121
------------ -------------
BALANCES AT
DECEMBER 31,
2000............ $ 90,621 $345,016
============ =============
The accompanying notes are an integral part of these consolidated financial
statements.
40
FOUNDRY NETWORKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended December 31,
---------------------------
1998 1999 2000
------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)................................ $(9,352) $ 22,872 $ 88,121
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation..................................... 630 445 1,378
Amortization of deferred stock compensation...... 727 9,463 6,185
Cancellation of notes receivable from
stockholders.................................... 21 -- --
Provision for allowance for doubtful accounts.... 389 1,269 4,698
Provision for allowance for sales returns........ -- 1,187 3,734
Provision for excess and obsolete inventories.... 1,012 3,827 13,558
Deferred tax assets.............................. -- (5,220) (8,495)
Tax benefit from stock option exercises.......... -- 866 57,858
Change in operating assets and liabilities:
Accounts receivable............................ (5,762) (24,781) (44,073)
Inventories.................................... (6,716) (13,369) (48,408)
Prepaid expenses and other current assets...... (4) (973) (10,134)
Accounts payable............................... 4,654 1,498 12,875
Accrued payroll and related expenses........... 444 3,201 6,992
Warranty accrual............................... 331 1,737 749
Other accrued expenses......................... 90 3,834 1,629
Income taxes payable........................... -- 9,925 (9,925)
Deferred revenue............................... 348 3,798 9,236
------- -------- --------
Net cash provided by (used in) operating
activities.................................. (13,188) 19,579 85,978
------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of short-term investments.............. -- (39,789) (190,486)
Maturities of short-term investments............. -- -- 146,459
Purchases of property and equipment.............. (414) (1,045) (5,148)
------- -------- --------
Net cash used by investing activities........ (414) (40,834) (49,175)
------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on capital lease obligations.. (166) (178) --
Proceeds from issuance of common stock........... 212 136,163 10,553
Repurchase of common stock....................... (25) (4) (121)
Repayment of notes receivable.................... -- 85 755
Net proceeds from issuance of redeemable
convertible preferred stock..................... 14,966 1,000 --
------- -------- --------
Net cash provided by financing activities.... 14,987 137,066 11,187
------- -------- --------
INCREASE IN CASH AND CASH EQUIVALENTS............. 1,385 115,811 47,990
Effect of exchange rate changes on cash.......... -- -- 61
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR...... 3,182 4,567 120,378
------- -------- --------
CASH AND CASH EQUIVALENTS, END OF YEAR............ $ 4,567 $120,378 $168,429
======= ======== ========
SUPPLEMENTAL CASH FLOW INFORMATION:
Issuance of common stock for notes receivable.... $ 474 $ 146 $ 3,270
Issuance of common stock in net exercise
settlement of warrants.......................... -- 30 --
Increase in treasury stock on repurchase of
common stock.................................... -- 4 --
Conversion of redeemable convertible preferred
stock upon initial public offering.............. -- 31,085 --
Repurchase of common stock and cancellation of
corresponding note receivable................... -- 19 13
Cash paid for interest........................... 18 166 --
Cash paid for income taxes....................... 1 4,182 12,169
The accompanying notes are an integral part of these consolidated financial
statements.
41
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION OF THE COMPANY:
Foundry Networks, Inc. (the Company or Foundry) incorporated in Delaware on
May 22, 1996 under the name Perennium Networks, Inc., changed its name to
StarRidge Networks, Inc. on June 5, 1996 and then to Foundry Networks, Inc. on
January 22, 1997. Foundry designs, develops, manufactures and markets a
comprehensive, end-to-end suite of high performance networking products for
enterprises, educational institutions, government agencies, web hosting
companies, Application Service Providers (ASPs), electronic banking and finance
service providers, and Internet service providers.
2. SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation
The Company's consolidated financial statements reflect the operations of
the Company and its wholly-owned subsidiaries in the United States, Barbados,
France, Canada, Germany, the Netherlands, United Kingdom, Singapore and Italy.
All significant intercompany transactions and balances have been eliminated.
Assets and liabilities of foreign operations are translated to U.S. dollars at
the exchange rate in effect at the applicable balance sheet date, and revenues
and expenses are translated using average exchange rates prevailing during that
period. Foreign currency transaction gains and losses have not been material to
date. Translation adjustments have not been material to date and are included
as a separate component of stockholders' equity.
Use of Estimates in Preparation of Financial Statements
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 the
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenue and expenses during the period
reported. Actual results could differ from those estimates. Estimates are used
in accounting for, but not limited to, the accounting for excess and obsolete
inventory, product warranty, allowances for doubtful accounts, sales returns,
income taxes, and depreciation. Estimates and assumptions are reviewed
periodically and the effects of revisions are reflected in the consolidated
financial statements in the period they are determined.
Stock Splits
In July 1999, Foundry's board of directors approved a three-for-two stock
split of its outstanding common and preferred stock. In November 1999,
Foundry's board of directors approved a two-for-one stock split of its
outstanding common stock. All share and per share information included in these
financial statements have been retroactively adjusted to reflect the stock
splits.
Cash, Cash Equivalents and Short-Term Investments
Foundry considers all highly liquid investments with original maturities of
three months or less to be cash equivalents. Cash and cash equivalents consist
of commercial paper, government debt securities and cash deposited in checking
and money market accounts.
Foundry accounts for its investments under the provision of Statement of
Financial Accounting Standards (SFAS) No. 115,"Accounting for Certain
Investments in Debt and Equity Securities." Investments in highly liquid
financial instruments with original maturities greater than three months but
less than one year are classified as short-term investments. As of December 31,
1999 and 2000, Foundry's short-term investments, which were stated at amortized
cost and classified as held-to-maturity, consisted of corporate and investment
42
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
grade U.S. debt securities. As of December 31, 2000, short-term investments
also consisted of commercial paper.
Cash equivalents and short-term investments are all due within one year and
consist of the following (in thousands):
December 31, 2000
-----------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
Money market funds............... $ 9,844 $-- $-- $ 9,844
Commercial paper................. 91,779 -- (19) 91,760
Government securities............ 97,648 28 -- 97,676
Corporate debt securities........ 3,080 -- -- 3,080
-------- ---- ---- --------
$202,351 $ 28 $(19) $202,360
======== ==== ==== ========
Included in cash and cash
equivalents..................... $118,535 $-- $ (6) $118,529
Included in short-term
investments..................... 83,816 28 (13) 83,831
-------- ---- ---- --------
$202,351 $ 28 $(19) $202,360
======== ==== ==== ========
December 31, 1999
-----------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
Money market funds............... $ 22,136 $-- $-- $ 22,136
Commercial paper................. 78,597 -- (14) 78,583
Government securities............ 43,444 -- -- 43,444
Corporate debt securities........ 11,511 -- (12) 11,499
-------- ---- ---- --------
$155,688 $-- $(26) $155,662
======== ==== ==== ========
Included in cash and cash
equivalents..................... $115,899 $-- $ (6) $115,893
Included in short-term
investments..................... 39,789 -- (20) 39,769
-------- ---- ---- --------
$155,688 $-- $(26) $155,662
======== ==== ==== ========
Inventories
Inventories are stated on a first-in, first-out basis at the lower of cost
or market, and include purchased parts, labor and manufacturing overhead.
Inventories consist of the following (in thousands):
December 31,
---------------
1999 2000
------- -------
Purchased parts............................................ $12,176 $31,975
Work-in-process............................................ 2,700 16,935
Finished goods............................................. 1,867 2,683
------- -------
$16,743 $51,593
======= =======
Provisions for excess and obsolete inventory in the amounts of $1.0 million,
$3.8 million, and $13.6 million were recorded for the years ended December 31,
1998, 1999 and 2000, respectively. Inventory write-offs were approximately
$47,000 in 1998, $1.6 million in 1999, and $4.4 million in 2000. Approximately
43
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
$3.4 million and $7.8 million of the Company's work-in-process inventories were
consigned to contract manufacturers' sites as of December 31, 1999 and 2000,
respectively.
Concentrations
Financial instruments that potentially subject Foundry to a concentration of
credit risk principally consist of cash equivalents, short-term investments and
accounts receivable. Foundry seeks to reduce credit risk on financial
instruments by investing almost exclusively in high credit quality issuers and,
by policy, limits the amount of credit exposure to any one issuer or fund.
Exposure to credit risk is controlled through credit approvals, credit
limits, continuous monitoring procedures and establishment of an allowance for
potential doubtful accounts when deemed necessary. During the year ended
December 31, 2000, Foundry provided approximately $4.7 million to increase its
allowance for doubtful accounts to a level deemed necessary by management to
provide for potential uncollectible amounts. Foundry's top ten customers
accounted for 62% and 38% of trade receivables as of December 31, 1999 and
2000, respectively.
Foundry purchases several key components used in the manufacture of products
from single or limited sources and depends on supply from these sources to meet
its needs. In addition, Foundry depends on contract manufacturers for major
portions of the manufacturing requirements. The inability of the suppliers or
manufacturers to fulfill the production requirements of Foundry could
negatively impact future results.
Property and Equipment
Property and equipment are stated at cost. Depreciation is computed using
the straight-line method over estimated useful lives of the assets. Estimated
useful lives of 2 years are used on computer equipment and related software and
production and engineering equipment. Estimated useful lives of 3 years are
used on furniture and fixtures. Leasehold improvements are amortized over the
remaining lease term.
Revenue Recognition
Foundry's revenue recognition policy follows Securities and Exchange
Commission (SEC) Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition
in Financial Statements." Specifically, Foundry recognizes product revenue when
persuasive evidence of an arrangement exists, delivery has occurred, the sales
price is fixed or determinable and collectibility is probable. In general, this
results in revenue being recorded at the time of shipment, unless we have
future obligations for installation or have to obtain customer acceptance, in
which case revenue is deferred until such obligations have been satisfied or
customer acceptance has been received. Revenue from customer support services
is deferred and recognized on a straight-line basis over the contractual
period, generally one year. At shipment date, Foundry establishes an accrual
for estimated warranty expenses associated with its sales. Foundry's warranty
period extends 12 months from the date of sale. In 1999 and 2000, Foundry
recorded a provision for sales returns equal to $1.2 million and $3.7 million,
respectively, which has been netted against revenue in the accompanying
consolidated statements of operations. Returns related to 1998 revenue were
insignificant. This provision is based on our historical returns. Sales to
Foundry's resellers do not provide for rights of return and the contract with
Foundry's original equipment manufacturer does not provide for rights of return
except in the event Foundry's products do not meet specifications or there has
been an epidemic failure, as defined in the agreement.
During 1998, 1999 and 2000, approximately 99%, 98% and 96%, respectively, of
Foundry's net revenue was derived from product sales. For the year-ended 2000,
no customers individually accounted for greater than
44
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
10% of our net revenue. For the years ended December 31, 1998 and 1999, the
percentages of revenue to significant customers were as follows:
Year Ended
December 31,
------------
1998 1999
------ ------
Customer A............................................... 21% --
Customer B............................................... -- 11%
Customer C............................................... -- 14%
Foundry sells to various countries in North America, Europe, Asia, South
America and Australia. Foundry's foreign offices conduct sales, marketing and
support activities. Foundry's export sales represented 31%, 15% and 30% of net
revenue in 1998, 1999 and 2000, respectively. Sales in significant markets
representing greater than 10% of net revenue were as follows:
Year Ended
December 31,
----------------
1998 1999 2000
---- ---- ----
United States............................................. 69% 85% 70%
Japan..................................................... 21% -- --
Segment Reporting
In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS
No. 131, "Disclosures About Segments of an Enterprise and Related Information."
SFAS No. 131 was adopted by Foundry in 1997. SFAS No. 131 establishes standards
for disclosures about operating segments, products and services, geographic
areas and major customers. Foundry is organized and operates as one operating
segment, the design, development, manufacturing and marketing of high
performance Gigabit Ethernet switches, switching routers, server load balancing
and transparent caching switches. Management uses one measurement for
evaluating profitability and does not disaggregate its business for internal
reporting.
Advertising Costs
Foundry expenses all advertising costs as incurred. Advertising expenses for
the years ended December 31, 1998, 1999 and 2000 were $596,000, $2.5 million
and $7.7 million, respectively.
Software Development Costs
Foundry accounts for internally generated software development costs in
accordance with SFAS No. 86, "Accounting for the Costs of Computer Software to
be Sold, Leased or Otherwise Marketed." Capitalization of eligible product
development costs begins upon the establishment of technological feasibility,
which Foundry has defined as completion of a working model. Internally
generated costs which were eligible for capitalization, after consideration of
factors such as realizable value, were not material for the years ended
December 31, 1998, 1999 and 2000 and, accordingly, all software development
costs have been charged to research and development expense in the accompanying
statements of operations.
Computation of Per Share Amounts
Basic net income (loss) per common share and diluted net income (loss) per
common share are presented in conformity with SFAS No. 128, "Earnings Per
Share" for all periods presented. Pursuant to SAB No. 98,
45
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
common stock and convertible preferred stock issued or granted for nominal
consideration prior to the anticipated effective date of the initial public
offering must be included in the calculation of basic and diluted net income
(loss) per common share as if such stock had been outstanding for all periods
presented. To date, Foundry has not had any issuances or grants for nominal
consideration.
In accordance with SFAS No. 128, basic net income (loss) per common share
has been calculated using the weighted-average number of shares of common stock
outstanding during the period, less shares subject to repurchase. For the year
ended December 31, 1998, Foundry excluded 52,002,570 shares of convertible
preferred stock, outstanding stock options and shares subject to repurchase
from the calculation of diluted net loss per common share because all such
securities are anti-dilutive for the year. No shares were excluded from the
calculation for 1999. For the year ended December 31, 2000, Foundry excluded
942,000 outstanding stock options from the calculation of diluted net income
per share because the shares are anti-dilutive for the year. For the years
ended December 31, 1999 and 2000, diluted net income per common share has been
calculated assuming the conversion of all dilutive potential common stock using
the treasury stock method.
Year Ended December 31,
----------------------------
1998 1999 2000
-------- -------- --------
(In thousands, except per
share data)
Net income (loss)................................ $ (9,352) $ 22,872 $ 88,121
Basic:
Weighted average shares of common stock
outstanding................................... 53,398 71,563 116,259
Less: Weighted average shares subject to
repurchase.................................... (26,422) (16,634) (6,118)
-------- -------- --------
Weighted average shares used in computing basic
net income (loss) per common share............ 26,976 54,929 110,141
======== ======== ========
Basic net income (loss) per common share......... $ (0.35) $ 0.42 $ 0.80
======== ======== ========
Diluted:
Weighted average shares of common stock
outstanding................................... 71,563 116,259
Add: Weighted average dilutive potential common
stock......................................... 43,272 10,872
-------- --------
Weighted average shares used in computing
diluted net income (loss) per common share.... 26,976 114,835 127,131
======== ======== ========
Diluted net income (loss) per common share....... $ (0.35) $ 0.20 $ 0.69
======== ======== ========
Stock-Based Compensation
In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation." This accounting standard permits the use of either a fair value
based method or the method defined in Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" (APB Opinion 25) to account for
stock-based compensation arrangements. Companies that elect to employ the
valuation method provided in APB Opinion 25 are required to disclose the pro
forma net income (loss) that would have resulted from the use of the fair value
based method. Foundry has elected to determine the value of stock-based
compensation arrangements under the provisions of APB Opinion 25, and
accordingly, the pro forma disclosures required under SFAS No. 123 have been
included in Note 6.
Recent Accounting Pronouncements
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards requiring that every derivative
46
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
instrument be recorded in the balance sheet as either an asset or liability
measured at its fair value. SFAS No. 133, as recently amended, is effective for
fiscal years beginning after June 15, 2000. Management believes that the
adoption of SFAS No. 133 will not have a material effect on Foundry's financial
position or results of operations.
Foundry adopted SFAS No. 130, "Reporting Comprehensive Income" in 1998. SFAS
No. 130 establishes standards for reporting and presentation of comprehensive
income. This standard defines comprehensive income as those changes in equity
of an enterprise not resulting from transactions with stockholders. Other
components of comprehensive income for the years ended December 31, 1998, 1999
and 2000 were immaterial and comprised only of foreign currency translation
adjustments.
In December 1999, the SEC issued SAB No. 101. SAB No. 101 and related
interpretations summarize the SEC's view in applying generally accepted
accounting principles to selected revenue recognition issues. Foundry was
required to apply the guidance in SAB No. 101 to their consolidated financial
statements in the fourth quarter of fiscal 2000. The adoption of SAB No. 101
has not had a material impact on Foundry's financial position, revenue
recognition policy or results of operations.
In March 2000, the FASB issued FASB Interpretation No. 44 (FIN 44),
"Accounting for Certain Transactions involving Stock Compensation--an
Interpretation of APB Opinion No. 25." FIN 44 is effective July 1, 2000. The
interpretation clarifies the application of APB Opinion 25 for certain issues,
specifically, (a) the definition of an employee, (b) the criteria for
determining whether a plan qualifies as a noncompensatory plan, (c) the
accounting consequence of various modifications to the terms of a previously
fixed stock option or award, and (d) the accounting for an exchange or stock
compensation awards in a business combination. Foundry adopted FIN 44 in the
quarter ended September 30, 2000 and the adoption did not have a material
impact on its financial position or the results of its operations.
3. COMMITMENTS AND CONTINGENCIES:
In September 1999, Foundry entered into a noncancellable operating lease for
approximately 71,000 square feet to serve as its new headquarters and
manufacturing facility in San Jose, California. The lease commenced on February
1, 2000 and will expire on January 31, 2006. Straight-line rent expense for
this new building is $131,000 per month. In December 2000, Foundry entered into
a noncancellable sublease for 19,800 square feet of additional office space
near its headquarters. The sublease term is one year, commencing on January 1,
2001. Under the terms of the sublease, Foundry prepaid rent for the entire
sublease term totaling $1.8 million. Foundry has entered into other
noncancellable operating leases for its sales offices in the United States,
Canada, Europe and Asia which have expiration dates ranging from 2000-2006.
Rent expense was approximately $263,000, $409,000 and $2.5 million for the
years ended December 31, 1998, 1999 and 2000, respectively.
Future payments, net of the sublease, on operating leases as of December 31,
2000 were as follows (in thousands):
Operating
Leases
---------
2001............................................................ $ 2,252
2002............................................................ 1,979
2003............................................................ 1,966
2004............................................................ 1,970
2005............................................................ 1,842
Thereafter...................................................... 268
-------
Total lease payments............................................ $10,277
=======
47
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In December 2000, a shareholder class action lawsuit was filed against
Foundry and certain of its officers in the United States District Court for the
Northern District of California, following Foundry's announcement in December
2000, of its anticipated financial results for the fourth quarter ended
December 31, 2000. The lawsuit alleges violation of federal securities laws and
purports to seek damages on behalf of a class of shareholders who purchased
Foundry's common stock during the period from October 18, 2000 to December 19,
2000. Following the filing of the lawsuit, several virtually identical lawsuits
were filed making essentially the same allegations. Foundry expects that all of
the lawsuits will be consolidated by the court. Foundry has reviewed the
lawsuits, believes them to be without merit and intends to seek dismissal of
the lawsuits at its first opportunity.
In addition, the Company from time to time is a party to various legal
proceedings arising from the ordinary course of its business and/or third-party
claims alleging infringement of proprietary rights with respect to Foundry's
existing or future products. In fiscal 2000, Foundry received letters from both
IBM and Nortel alleging that certain of Foundry's products that operate on
industry standards may infringe one or more of their patents. Foundry is
currently analyzing the validity of these claims and exploring potential
courses of action.
4. INCOME TAXES:
Foundry accounts for income taxes pursuant to SFAS No. 109, "Accounting for
Income Taxes." SFAS No. 109 provides for an asset and liability approach to
accounting for income taxes under which deferred income taxes are provided
based upon enacted tax laws and rates applicable to the periods in which taxes
become payable. As of December 31, 1999 and 2000, components of the Company's
net deferred income tax assets (all current) were as follows (in thousands):
December 31,
--------------
1999 2000
------ -------
Deferred Tax Assets:
Capitalized start-up and organizational costs.............. $ 422 $ 269
Accrued vacation pay....................................... 327 766
Inventories valuation...................................... 1,773 5,147
Warranty................................................... 842 1,534
Accounts receivable valuation.............................. 671 1,260
Research and development credits........................... -- 3,045
Other temporary differences................................ 1,185 1,694
------ -------
Total deferred tax assets.............................. $5,220 $13,715
====== =======
As of December 31, 2000, the Company's federal and state tax credit
carryforwards for income tax purposes were approximately $900,000 and $2.1
million, respectively. If not utilized, the federal and state tax credit
carryforwards will begin to expire in fiscal 2020.
As of December 31, 1999 and 2000, Foundry had no significant deferred tax
liabilities.
48
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Foundry did not provide for state or federal income taxes in fiscal 1998 due
to operating losses incurred during the year. The provision for income taxes
consists of the following components for the years ended December 31 (in
thousands):
1999 2000
------- -------
Current
Federal.................................................. $12,733 $49,069
Foreign.................................................. -- 108
State.................................................... 2,237 10,814
------- -------
Total.................................................. 14,970 59,991
Deferred
Federal.................................................. (4,551) (5,302)
Foreign and State........................................ (669) (679)
------- -------
Total.................................................. (5,220) (5,981)
------- -------
Total provision.......................................... $ 9,750 $54,010
======= =======
Income (loss) before provision for income taxes consisted of the following
(in thousands):
December 31,
-------------------------
1998 1999 2000
------- ------- --------
United States...................................... $(9,352) $32,622 $141,819
International...................................... -- -- 312
------- ------- --------
$(9,352) $32,622 $142,131
======= ======= ========
The actual provision for income taxes and the corresponding rate differs
from the statutory U.S. federal income tax rate as follows for the years ended
December 31 (in thousands):
1998 1999 2000
-------------- --------------- -------------
Provision at U.S. statutory
rate of 35%............... $(3,273) (35.0)% $11,418 35.0 % $49,746 35.0 %
State income taxes, net of
federal benefit........... (185) (2.0)% 1,709 5.2 % 6,997 4.9 %
Change in valuation
allowance................. 4,267 45.7 % (9,185) (28.2)% -- --
Research and development
credits................... -- -- (893) (2.7)% (2,155) (1.5)%
Nondeductible deferred
stock compensation........ -- -- 3,808 11.7 % 1,757 1.2 %
Foreign Sales Corporation
benefit................... -- -- (28) -- (2,318) (1.6)%
Other...................... (809) (8.7)% 2,921 9.0 % (17) --
------- ----- ------- ------ ------- ----
Total.................... $ -- -- $ 9,750 30.0 % $54,010 38.0 %
======= ===== ======= ====== ======= ====
The Company's income taxes payable for federal and state purposes have been
reduced, and the deferred tax assets increased, by the tax benefits associated
with taxable dispositions of employee stock options. When an employee exercises
a stock option issued under a nonqualified plan or has a disqualifying
disposition related to a qualified plan, the Company receives an income tax
benefit calculated as the difference between the fair market value of the stock
issued at the time of the exercise and the option price, tax effected. These
benefits were credited directly to stockholders' equity and amounted to
$866,000 and $57.9 million for the years ended December 31, 1999 and 2000,
respectively. Benefits reducing taxes payable amounted to approximately
$900,000 and $55.2 million for the years ended December 31, 1999 and 2000,
respectively. Benefits increasing gross deferred tax assets amounted to $40,000
and $2.7 million in the years ended December 31, 1999 and 2000, respectively.
49
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
5. INITIAL PUBLIC OFFERING:
On September 28, 1999, Foundry commenced trading of its common stock on the
Nasdaq National Market in an initial public offering with the sale of
11,500,000 shares of common stock (including the exercise of the over-
allotment option of 1,500,000 shares) at $12.50 per share and realized net
proceeds of $131.8 million.
6. STOCKHOLDERS' EQUITY:
Redeemable Convertible Preferred Stock
In June 1996, Foundry issued 17,250,000 shares of Series A redeemable
convertible preferred stock (Series A) at $0.33 per share. In June to December
1997, Foundry issued 12,260,850 shares of Series B redeemable convertible
preferred stock (Series B) at $0.77 per share. In March 1998, Foundry issued
15,463,920 shares of Series C redeemable convertible preferred stock (Series
C) at $0.97 per share. In June 1999, Foundry issued 375,000 shares of Series C
at $2.67 per share to a family trust, of which an appointed director of
Foundry is a trustee.
Concurrent with the closing of the Company's initial public offering on
October 1, 1999, 45,349,770 shares of redeemable convertible preferred stock
were converted into an equivalent number of shares of common stock.
Preferred Stock
Foundry is authorized to issue up to 5,000,000 shares of preferred stock,
each with a par value of $0.0001 per share. The preferred stock may be issued
from time to time in one or more series. The board of directors is authorized
to determine the rights, preferences, privileges and restrictions on these
shares. As of December 31, 2000, no shares of preferred stock were
outstanding.
Common Stock
Foundry had 114,189,450 and 118,076,155 shares of common stock issued and
outstanding at December 31, 1999 and 2000, respectively. Included in such
outstanding shares are 32,940,000 shares issued to Foundry's founders in 1996
(the Founders Shares). The Founders Shares vest out of the repurchase option
25 percent upon issuance, with the balance vesting ratably each month for the
48 months after issuance. As of December 31, 2000, all Founders Shares were
fully vested. In June 1999, the Company repurchased 1,200,000 unvested shares
from a founder at $0.003 per share. The repurchase has been recorded as
treasury stock on the accompanying balance sheet.
In January 1999, Foundry granted 1,059,000 nonstatutory stock options to
certain key employees outside of the 1996 Stock Plan at an exercise price of
$0.83 per share. The options vest over a four-year period and expire in
January 2009. During fiscal 1999, 150,000 shares were exercised and 68,250
shares were cancelled. During fiscal 2000, 74,415 of these shares were
exercised. The weighted average remaining contractual life of the options was
8.0 years as of December 31, 2000.
The following shares of common stock have been reserved for future issuance
as of December 31, 2000:
1996 Stock Plan................................................... 20,392,676
1999 Directors' Stock Option Plan................................. 1,350,000
1999 Employee Stock Purchase Plan................................. 2,674,347
Nonstatutory stock options to key employees....................... 834,585
2000 Non-Executive Stock Option Plan.............................. 1,996,188
----------
27,247,796
==========
50
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Note Receivable from Stockholder
In May 2000, Foundry allowed an employee to exercise stock options in
exchange for a secured promissory note of $3.27 million. The recourse note
bears interest at a rate of 6.42% per annum and is due on the earlier of (i)
May 25, 2003, (ii) the date of sale of the shares or (iii) termination of
employment. The note is classified as a reduction of stockholders' equity.
1999 Employee Stock Purchase Plan
The 1999 Employee Stock Purchase Plan (the Purchase Plan) was adopted by the
board of directors in July 1999. As of December 31, 2000, a total of 2,674,347
shares of common stock were reserved for issuance under the Purchase Plan. The
number of shares reserved for issuance under the Purchase Plan will be
increased on the first day of each fiscal year from 2000 through 2009 by the
lesser of (i) 1,500,000 shares, (ii) 2% of Foundry's outstanding common stock
on the last day of the immediately preceding fiscal year or (iii) the number of
shares determined by the board of directors.
The Purchase Plan enables eligible employees to purchase common stock
through payroll deductions, which in any event may not exceed 20% of an
employee's compensation, at a price equal to the lower of 85% of the fair
market value of the Company's common stock at the beginning of each offering
period or at the end of each purchase period. During the two purchase periods
in 2000, 325,653 shares had been purchased under the Purchase Plan.
1996 Stock Plan
Under Foundry's 1996 Stock Plan (the Plan), the board of directors
authorized the issuance of 51,235,683 shares of common stock to employees and
consultants as of December 31, 2000, including those issued as of that date.
Nonstatutory options granted under the Plan must be issued at a price equal to
at least 85% of the fair market value of Foundry's common stock at the date of
grant. Incentive stock options granted under the Plan must be issued at a price
at least equal to the fair market value of Foundry's common stock at the date
of grant. Options under the Plan have a term of ten years and vest over a
vesting schedule determined by the board of directors, generally four years for
non-executive officer employees.
1999 Directors' Stock Option Plan
The 1999 Directors' Stock Option Plan (the Directors' Plan) was adopted by
the board of directors in July 1999. As of December 31, 2000, a total of
1,350,000 shares of common stock has been reserved for issuance under the
Directors' Plan.
Under the Directors' Plan, each non-employee director who becomes a non-
employee director after the effective date of the plan will receive an
automatic initial grant of an option to purchase 225,000 shares of common stock
upon appointment or election and annual grants to purchase 60,000 shares of
common stock. Options granted under the plan will vest at the rate of 1/4th of
the total number of shares subject to the options twelve months after the date
of grant and 1/48th of the total number of shares subject to the options each
month thereafter. The exercise price of all stock options granted under the
Directors' Plan shall be equal to the fair market value of a share of common
stock on the date of grant of the option. Options granted under this plan have
a term of ten years. During fiscal 2000, 795,000 options were granted under the
Directors' Plan.
2000 Non-Executive Stock Option Plan
The 2000 Non-Executive Stock Option Plan (the Non-Executive Plan) was
adopted by the board of directors in October 2000. Under the Non-Executive
Plan, the Company may issue non-qualified options to
51
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
purchase common stock to employees and external consultants other than officers
and directors. As of December 31, 2000, a total of 1,996,188 shares of common
stock has been reserved under the Non-Executive Plan and no options had been
issued under it.
The following table summarizes stock option activity under all plans during
the three years ended December 31, 2000:
Weighted
Options Average
Outstanding Exercise Price
----------- --------------
Balance, December 31, 1997....................... 3,626,624 $ 0.07
Granted........................................ 8,167,500 $ 0.21
Exercised...................................... (4,053,842) $ 0.17
Cancelled...................................... (802,500) $ 0.09
-----------
Balance, December 31, 1998....................... 6,937,782 $ 0.17
-----------
Granted........................................ 12,041,004 $ 5.62
Exercised...................................... (3,073,076) $ 1.46
Cancelled...................................... (429,002) $ 0.99
-----------
Balance, December 31, 1999....................... 15,476,708 $ 4.13
-----------
Granted........................................ 10,858,400 $72.45
Exercised...................................... (3,887,378) $ 2.63
Cancelled...................................... (661,187) $28.73
-----------
Balance, December 31, 2000....................... 21,786,543 $37.71
===========
As of December 31, 2000, Foundry had issued an aggregate of 64,007,422
shares of common stock to its employees, including 32,940,000 shares issued to
Foundry's four founders. Of the 64,007,422 shares of common stock issued under
all of the Company's stock option plans, 3,092,235 shares are subject to
repurchase rights at the option of Foundry at $0.03-$54.50 per share upon
cessation of the employees' employment. In 1999 and 2000, Foundry repurchased
455,000 and 326,188 shares, respectively, of unvested common stock from
employees at $0.03-$4.50 per share. As of December 31, 2000, an aggregate of
2,786,906 shares were available for future option grants under all plans.
52
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table summarizes information about stock options outstanding
and exercisable at December 31, 2000:
Options Outstanding Options Exercisable
--------------------------------- ---------------------
Weighted-
Average Weighted- Weighted-
Remaining Average Average
Number Contractual Exercise Number Exercise
Exercise Prices Outstanding Life Price Exercisable Price
- --------------- ----------- ----------- --------- ----------- ---------
$0.03................... 912,532 6.00 $ 0.03 912,532 $ 0.03
$0.10................... 100,661 6.91 $ 0.10 100,661 $ 0.10
$0.17................... 1,432,974 7.53 $ 0.17 1,432,974 $ 0.17
$0.33................... 523,517 7.87 $ 0.33 523,517 $ 0.33
$0.83................... 854,511 8.07 $ 0.83 854,511 $ 0.83
$1.33................... 819,413 8.19 $ 1.33 819,413 $ 1.33
$2.67-$4.00............. 1,869,919 8.42 $ 2.73 1,869,919 $ 2.73
$4.50-$6.30............. 2,759,827 8.60 $ 5.08 2,759,827 $ 5.13
$7.50................... 842,034 8.70 $ 7.50 842,034 $ 7.50
$11.50-$12.50........... 945,734 8.73 $11.50 945,734 $ 1.50
$36.88.................. 1,487,000 9.91 $36.88 698 $ 36.88
$56.90-$85.25........... 7,895,421 9.52 $72.52 69,908 $ 64.07
$91.00-$131.00.......... 1,343,000 9.25 $15.77 82,330 $121.31
---------- ----------
$0.03-$131.00........... 21,786,543 8.81 $37.71 11,214,058 $ 4.75
========== ==========
The following table summarizes information about stock options outstanding
and exercisable at December 31, 1999:
Options Outstanding Options Exercisable
--------------------------------- ---------------------
Weighted-
Average Weighted- Weighted-
Remaining Average Average
Number Contractual Exercise Number Exercise
Exercise Prices Outstanding Life Price Exercisable Price
- --------------- ----------- ----------- --------- ----------- ---------
$0.03................... 1,499,532 7.02 $ 0.03 1,499,532 $ 0.03
$0.10................... 273,500 7.90 $ 0.10 273,500 $ 0.10
$0.17................... 2,310,750 8.54 $ 0.17 2,310,750 $ 0.17
$0.33................... 1,145,624 8.85 $ 0.33 1,145,624 $ 0.33
$0.83................... 244,502 9.07 $ 0.83 244,502 $ 0.83
$1.33................... 1,116,410 9.19 $ 1.33 1,116,410 $ 1.33
$2.67-$4.00............. 2,487,750 9.42 $ 2.73 2,487,750 $ 2.73
$4.50-$6.30............. 3,341,056 9.60 $ 5.06 3,341,056 $ 5.06
$7.50................... 897,834 9.70 $ 7.50 897,834 $ 7.50
$11.50-$12.50........... 1,170,000 9.73 $ 11.50 1,170,000 $ 11.50
$93.63-$131.00.......... 151,000 9.91 $115.91 151,000 $115.91
---------- ----------
$0.03-$131.00........... 14,637,958 9.02 $ 4.37 14,637,958 $ 4.37
========== ==========
Foundry accounts for stock options issued to employees under APB Opinion 25
whereby the difference between the exercise price and the fair value at the
date of grant is recognized as compensation expense. However, Foundry is
required under SFAS No. 123 to disclose pro forma information regarding option
grants made to its employees based on specified valuation techniques that
produce estimated compensation charges.
53
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
These amounts have not been reflected in Foundry's statements of operations
because no compensation charge arises when the price of the employees' stock
options equals the market value of the underlying stock at the grant date, as
in the case of most options granted to Foundry's employees. Had compensation
expense been determined consistent with SFAS No. 123, net income would have
decreased and losses would have increased to the following pro forma amounts
(in thousands, except per share data):
Year Ended December 31,
------------------------
1998 1999 2000
------- ------- -------
Net income (loss) as reported...................... $(9,352) $22,872 $88,121
Pro forma net income (loss)........................ (9,483) 19,448 10,360
Basic net income (loss) per share as reported...... (0.35) 0.42 0.80
Pro forma net income (loss) per share.............. (0.35) 0.35 0.09
Diluted net income (loss) per share as reported.... (0.35) 0.20 0.69
Pro forma diluted net income (loss) per share...... (0.35) 0.17 0.08
The weighted average fair value of stock options granted under all plans
during 1998, 1999 and 2000 was $0.04, $2.70 and $23.61, respectively. Pursuant
to the provisions of SFAS No. 123, the compensation cost associated with
options granted in 1998, 1999 and 2000 was estimated on the grant date using
the Black-Scholes model. The Black-Scholes option pricing model requires the
input of highly subjective assumptions including the expected stock price
volatility. Because Foundry's employee stock options have characteristics
significantly different from those of traded shares, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of the options. The following weighted-average
assumptions were used to estimate fair value:
Employee Stock Purchase
Stock Option Plan Plan
------------------------- -------------------------
1998 1999 2000 1998 1999 2000
------- ------- ------- ---- --------- ---------
Average risk free
interest rate.......... 5.98% 5.56% 6.23% -- 5.21% 5.41%
Average expected life of
option................. 4 years 4 years 4 years -- 1.8 years 1.9 years
Dividend yield.......... 0% 0% 0% -- 0% 0%
Volatility of common
stock.................. 0.01% 55.0% 80.0% -- 80.0% 80.0%
The weighted-average fair value of shares issued under the 1999 Employee
Stock Purchase Plan for 1999 and 2000 were $7.21 and $14.92 per share,
respectively.
In connection with the issuance of certain stock options to employees,
Foundry has recorded deferred stock compensation in the aggregate amount of
approximately $4.7 million, $17.3 million, and $300,000 in 1998, 1999, and
2000, respectively, representing the difference between the deemed fair value
of Foundry's common stock for accounting purposes and the exercise price of
stock options at the date of grant. Foundry is amortizing the deferred stock
compensation expense over the vesting period, generally four years. For the
years ended December 31, 1998, 1999 and 2000, amortization expense was
approximately $727,000, $9.5 million and $6.2 million, respectively. At
December 31, 2000, the remaining deferred stock compensation of approximately
$5.6 million will be amortized as follows: $3.6 million in 2001, $1.6 million
in 2002 and $400,000 in 2003. The amortization expense relates to options
granted to employees in all operating expense categories. The amortization of
deferred stock compensation has not been separately allocated to these
categories. The amount of deferred stock compensation expense to be recorded in
future periods could decrease if options for which accrued but unvested
compensation has been recorded are forfeited. Approximately $306,000 of future
compensation expense was recaptured in 2000 as a result of employee
terminations.
54
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
7. 401(k) PLAN:
Foundry provides a tax-qualified employee savings and retirement plan which
entitles eligible employees to make tax-deferred contributions. Under the
401(k) Plan, employees may elect to reduce their current annual compensation up
to the lesser of 20% or the statutorily prescribed limit, which is $10,000 in
calendar year 2000. Foundry may, at its discretion, make matching or
discretionary contributions to the 401(k) Plan. Foundry has made no matching or
discretionary contributions to date.
8. SUBSEQUENT EVENTS (unaudited):
In January 2001, the number of common shares reserved for issuance under the
1996 Stock Plan increased from 51,235,683 to 56,235,683 shares in accordance
with the automatic annual share increase provision stated in the 1996 Stock
Plan. The Company also granted options to purchase 3,888,050 and 1,982,000
shares of common stock under the 1996 Stock Option Plan and the 2000 Non-
Executive Stock Option Plan, respectively.
In January 2001, the number of common shares reserved for issuance under the
1999 Employee Stock Purchase Plan increased from 3,000,000 to 4,500,000 shares
in accordance with the automatic annual share increase provision stated in the
1999 Employee Stock Purchase Plan.
In January 2001, the Board of Directors authorized the Company to establish
a stock repurchase program pursuant to which up to 5,000,000 shares of its
common stock may be repurchased in the open market or in private transactions
from time to time until January 1, 2002 using available cash reserves. Such
repurchases may be used to partially offset the dilution caused by the issuance
of additional shares under the Company's stock plans. The Company currently
anticipates that repurchased shares will be retired and returned to the status
of authorized but unissued common stock.
In February 2001, the Company invested $2.5 million in a privately-held
company which is also a customer. The Company's investment in the company is
significantly less than 20% and, as such, the Company will not have the ability
to exercise significant influence. Accordingly, this investment will be carried
at the lesser of cost or estimated realizable value.
In March 2001, Nortel filed a lawsuit against Foundry in the United States
District Court for the District of Massachusetts alleging that certain of our
products infringe several of Nortel's patents and seeking injunctive relief as
well as unspecified damages. Foundry is currently analyzing the validity of
these claims and exploring potential courses of action.
55
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
Column A Column B Column C Column D Column E
-------- ------------ ---------- ---------- ----------
Balance at Charged to Balance at
Beginning of Costs and End of
Description Period Expenses Deductions Period
----------- ------------ ---------- ---------- ----------
Year ended December 31, 1998:
Allowance for doubtful
accounts....................... 10,000 389,000 -- 399,000
Allowance for sales returns..... -- -- -- --
Reserve for excess and obsolete
inventory...................... 106,000 1,012,000 47,000 1,071,000
Warranty accrual................ 24,000 331,000 -- 355,000
Year ended December 31, 1999:
Allowance for doubtful
accounts....................... 399,000 1,269,000 314,000 1,354,000
Allowance for sales returns..... -- 1,187,000 572,000 615,000
Reserve for excess and obsolete
inventory...................... 1,071,000 3,827,000 1,619,000 3,279,000
Warranty accrual................ 355,000 3,200,000 1,463,000 2,092,000
Year ended December 31, 2000:
Allowance for doubtful
accounts....................... 1,354,000 4,698,000 1,791,000 4,261,000
Allowance for sales returns..... 615,000 3,734,000 2,848,000 1,501,000
Reserve for excess and obsolete
inventory...................... 3,279,000 13,558,000 4,379,000 12,458,000
Warranty accrual................ 2,092,000 2,240,000 1,491,000 2,841,000
Item 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
56
PART III
Item 10. Directors and Executive Officers of the Registrant
The information regarding the Company's executive officers is set forth
above in Item 1 under the caption "Business--Executive Officers." The
information regarding the Company's directors is incorporated by reference from
the information under the caption "Proposal No. 1--Election of Directors" in
the Company's Proxy Statement for its 2001 Annual Meeting of Stockholders (the
"Proxy Statement"). This item also incorporates by reference the information
contained under the caption "Section 16(a) Beneficial Ownership Reporting
Compliance" in the Proxy Statement.
Item 11. Executive Compensation
Incorporated by reference from the information under the captions "Proposal
No. 1--Election of Directors," "Compensation of Executive Officers," "Option
Grants in Last Fiscal Year," "Aggregated Option Exercise in Last Fiscal Year
and Fiscal Year-End Option Values," "Change of Control Agreements with Named
Executive Officers," "Compensation Committee Report on Executive Compensation,"
"Transactions with Management," and "Performance Graph" in the Proxy Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Incorporated by reference from the information under the captions "Record
Date; Voting Securities," "Common Stock Ownership of Certain Beneficial Owners
and Management" and "Change of Control Agreements with Named Executive
Officers" in the Proxy Statement.
Item 13. Certain Relationships and Related Transactions
Incorporated by reference from the information under the caption
"Transactions with Management" in the Proxy Statement.
57
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) The following documents are filed as part of this Form 10-K:
(1) Consolidated Financial Statements and Report of Independent Public
Accountants
(2) Financial Statement Schedules
See "Item 8. Financial Statements and Supplementary Data--Schedule II--
Valuation and Qualifying Accounts." Other schedules are omitted because they
are not applicable, or because the information is included in the Financial
Statements or the Notes thereto.
(3) Exhibits (numbered in accordance with Item 601 of Regulation S-K)
Number Description
------ -----------
3.1 Amended and Restated Certificate of Incorporation of Foundry Networks,
Inc. (Amended and Restated Certificate of Incorporation filed as
Exhibit 3.2 to Registrant's Registration Statement on Form S-1
(Commission File No. 333-82577) and incorporated herein by reference;
Certificate of Amendment to the foregoing filed as Exhibit 3.1 to
Registrant's Quarterly Report on Form 10-Q for the quarter ended June
30, 2000 and incorporated herein by reference.)
3.2 Amended and Restated Bylaws of Foundry Networks, Inc. (Filed as Exhibit
3.2 to Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2000 and incorporated herein by reference.)
10.1 1996 Stock Plan *
10.2 1999 Employee Stock Purchase Plan **
10.3 1999 Directors' Stock Option Plan **
10.5 OEM Purchase Agreement dated January 6, 1999 between Foundry Networks,
Inc. and Hewlett-Packard Company, Workgroup Networks Division. ***
10.6 Reseller Agreement dated July 1, 1997 between Foundry Networks, Inc.
and Mitsui & Co., Ltd. ***
10.11 Lease agreement dated September 28, 1999, between Foundry Networks,
Inc., and Legacy Partners Commercial Inc., for offices located at 2100
Gold Street, San Jose, CA 95002. ****
21.1 List of Subsidiaries
23.1 Consent of Arthur Andersen LLP, Independent Public Accountants
24.1 Power of Attorney. (appears on the signature page of this report)
- --------
* Copy of original 1996 Stock Plan incorporated herein by reference to the
exhibit filed with the Company's Registration Statement on Form S-1
(Commission File No. 333-82577). Copy of 1996 Stock Plan reflecting the
amendments approved at the 2000 Annual Meeting of Stockholders
incorporated by reference to the Company's Definitive Proxy Statement for
such meeting (Commission File No. 000-26689).
** Incorporated herein by reference to the exhibit filed with the Company's
Registration Statement on Form S-1 (Commission File No. 333-82577).
*** Incorporated herein by reference to the exhibit filed with the Company's
Registration Statement on Form S-1 (Commission File No. 333-82577);
Confidential treatment has been granted by the Securities and Exchange
Commission with respect to this exhibit.
**** Incorporated herein by reference to the exhibit filed with the Company's
Form 10-Q for the quarter ended September 30, 1999 (Commission File No.
000-26689).
(b) The Company filed no Current Reports on Form 8-K during the quarter
ended December 31, 2000.
58
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Foundry Networks, Inc.
/s/ Timothy D. Heffner
By: _________________________________
Timothy D. Heffner
Vice President, Finance &
Administration, Chief Financial
Officer
Date: March 29, 2000
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Bobby R. Johnson Jr. and Timothy D. Heffner,
jointly and severally, his or her attorneys-in-fact, each with the power of
substitution, for him or her in any and all capacities, to sign any amendments
to this Report on Form 10-K, and to file the same, with exhibits thereto and
other documents in connection therewith with the Securities and Exchange
Commission, hereby ratifying and confirming all that each of said attorneys-in-
fact, or his or her substitute or substitutes may do or cause to be done by
virtue hereof.
Pursuant to the requirements of the Securities Exchange 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
--------- ----- ----
/s/ Bobby R. Johnson, Jr. President. Chief Executive March 29, 2001
______________________________________ Officer and Chairman of
(Bobby R. Johnson, Jr.) the Board of Directors
(Principal Executive
Officer)
/s/ Timothy D. Heffner Vice President, Finance & March 29, 2001
______________________________________ Administration, Chief
(Timothy D. Heffner) Financial Officer
(Principal Financial and
Accounting Officer)
/s/ Seth D. Neiman Director March 29, 2001
______________________________________
(Seth D. Neiman)
/s/ Andrew K. Ludwick Director March 29, 2001
______________________________________
(Andrew K. Ludwick)
/s/ Alfred J. Amoroso Director March 29, 2001
______________________________________
(Alfred J. Amoroso)
/s/ C. Nicholas Keating Director March 29, 2001
______________________________________
(C. Nicholas Keating)
/s/ J. Steven Young Director March 29, 2001
______________________________________
(J. Steven Young)
59
Index to Exhibits
Number Description
------ -----------
21.1 List of Subsidiaries
23.1 Consent of Arthur Andersen LLP, Independent Public Accountants
60