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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, 2001
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 (I.R.S. Employer
Jurisdiction 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 $664,634,544 as of March 20, 2002, 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 119,935,943 shares of the registrant's common stock issued and
outstanding as of March 20, 2002.
DOCUMENTS INCORPORATED BY REFERENCE
Part III (Items 10-13) incorporates information by reference from the
definitive proxy statement for the 2001 Annual Meeting of Stockholders to be
filed hereafter.
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FOUNDRY NETWORKS, INC.
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.............................................................. 19
Item 7(A). Quantitative and Qualitative Disclosures about Market Risk................ 37
Item 8. Consolidated Financial Statements and Supplementary Data.................. 38
Item 9. Change in and Disagreements with Accountants on Accounting and Financial
Disclosure.............................................................. 60
PART III
Item 10. Directors and Executive Officers of the Registrant........................ 61
Item 11. Executive Compensation.................................................... 61
Item 12. Security Ownership of Certain Beneficial Owners and Management............ 61
Item 13. Certain Relationships and Related Transactions............................ 61
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K........... 62
SIGNATURES........................................................................... 64
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. together with its
consolidated subsidiaries, (collectively 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
2002.
Item 1. Business
Overview
Foundry Networks, founded in 1996, is a leading provider of next-generation
networking products. We provide high-performance, end-to-end switching and
routing devices for enterprises and service providers. We design, develop,
manufacture and market solutions to meet the needs of high-performance network
infrastructures for Layer 2-7 switching and routing and for Local Area Networks
(LANs), Metropolitan Area Networks (MANs), Wide Area Networks (WANs), and the
web. Foundry's 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 Metro 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 and service
providers to build highly available network infrastructures that 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.
Our networking products have been deployed in key enterprise markets that
include automotive, energy, retail, healthcare, banking, trading, insurance,
aerospace, government agencies, technology, motion pictures, video and
animation, E-commerce, and universities. Our service provider markets include
metro service providers, Internet service providers, web hosting and Internet
data centers, application service providers, and Internet exchanges. For
enterprises, Foundry provides a complete end-to-end solution with the FastIron
JetCore product line. FastIron meets the needs for wiring closet, data center,
and campus solutions coupled with Foundry's network management and security.
For service providers, Foundry offers our BigIron JetCore high-performance
switches with integrated Layer 2/3 and Layer 4-7 traffic management for LAN,
MAN, and WAN applications. Foundry's solutions connect enterprises and service
providers with Foundry's Global Ethernet Metro router solutions. Foundry's
products support a wide array of interfaces such as Packet 10 Gigibit Ethernet,
Packet over SONET and ATM so that our customers can leverage their existing
infrastructures. 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.
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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 complexity of information traveling over networks has increased
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 enterprises,
web-based businesses, and Internet service providers demanding networking
solutions with superior performance and intelligence capabilities.
Evolution of Market Needs
Organizations initially 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.
Increasingly, enterprises are "webifying" their businesses. Not only are
mainstream enterprises taking advantage of the Internet to expand through
E-commerce capabilities, enterprises are also using the Internet for
business-to-business transactions, internal process reengineering, and supply
chain management. The increasing reliance on the Internet by businesses,
government agencies, and organizations is increasing the demand for
cost-effective, high performance solutions for both internal networks and
access to the Internet externally.
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, 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--1 and 10 Gigabit Ethernet, capable of data
transmission speeds of 10,000 megabits per second (or 10 Gigabits per second),
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,
using application-specific integrated circuits, or ASICs, that are 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
Two trends continue to drive 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
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increased use of multiple traffic types for many applications, enterprises and
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 service
providers, network intelligence allows them to maintain network reliability and
offer differentiated, fee-based quality of service.
Second, as the Internet has evolved, the traffic crossing the WANs has
shifted from primarily voice traffic to primarily data traffic. Not long ago, a
majority of all wide area traffic was voice traffic. Today, due to the success
of the Internet, most of the wide area traffic is data. Historically, the basic
technology used to move traffic within WANs has been SONET, 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
gaining momentum as the solution for MANs and WANs. This momentum has been
propelled in part by the relative inexpensiveness and availability of
off-the-shelf Ethernet networking equipment and the large pool of qualified
networking specialists that are proficient in Ethernet technology. 10 Gigabit
Ethernet is a key factor in this momentum for MANs and WANs because providers
can quickly build out high-speed networks. The general acceptance and large
volume of Ethernet installations in LANs have, over time, led to improved
performance and significantly reduced prices.
As bandwidth demand increases and bandwidth-intensive applications are being
made available to enterprise and private users, a new class of service provider
is beginning to emerge, the Metro Service Provider (Metro SP). Foundry has had
significant success in providing our Ethernet solutions for MANs across the
globe. Large enterprises (including government agencies) often have multiple
buildings in a local area and even have offices across the globe. Metro SPs
provide the critical intermediary network between enterprises and long-haul
regional networks. 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 LANs across the metro and regional areas to
business and private users. In this application, Gigabit Ethernet provides high
bandwidth, high reliability 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 Metro routers, Gigabit Ethernet Layer 2
and Layer 3 switches, and Layer 4-7 Internet traffic management products for
enterprises, and service providers. Our solutions provide the following
benefits:
Breadth of Product Line. We are one of the few networking companies to
provide a full suite of Metro routers, Gigabit Ethernet Layer 2/3 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 provider edge of a Metro
service provider through to the 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 and 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,
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web-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. Unlike 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
the standard for 10 Gigabit Ethernet. 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 a 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 and service providers. Key elements of our
strategy include:
Continue to Leverage Our Product Breadth to Expand Our Solutions
Offerings. As recently demonstrated with our latest product introductions,
the FastIron 400/800/1500 Enterprise Switches, BigIron 4000/8000/15000
backbone switches, and NetIron 400/800/1500 Metro routers, we will continue
to leverage our comprehensive product breadth to offer solutions to the
enterprise and service provider markets. Our end-to-end network solution
spans the LAN, MAN, and 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, yielding
a higher return on investment coupled with a decreasing total cost of
ownership.
Continue to Expand Our Metro Router Capabilities to Address this Growing
Market and Deliver a New Level of Price/Performance to the Service
Providers. Foundry will continue to bring new features and functionality to
our Metro 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), and VPLS (Virtual Private LAN Services).
We provide a complete Metro solution including Multi-Tenant Unit (MTU),
Provider Edge (PE), Provider Core (PC), and Internet Edge (IE), based on the
NetIron family of Metro Routers, allowing a purpose-built feature set and
optimization. We provide a range of features for both MPLS and Layer 2 Metro
architectures with industry-leading scalability and reliability. We intend
to pursue a MetroLink Interface strategy to embrace SONET and 10-Gigabit
Ethernet technologies with Ethernet-over-SONET (EoSONET) and offer a
consistent feature set and a common management interface.
Continue to Leverage Our Product Capabilities to Address Emerging
Markets. This includes Metropolitan Area Networking (MAN), Gigabit Ethernet
Storage Area Networking (SAN), Voice over IP (VoIP), 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, VoIP, and Content distribution. To
accomplish this, we have added the necessary features and enhancements to
our products to provide an ideal solution for these customers. We work with
select partners when additional non-networking hardware or software is
needed for solutions such as VoIP and SAN. This permits us to remain
entirely focused on network infrastructure while providing complete
solutions to our customers.
Continue Our Market Leadership Position in Internet Traffic Management
Systems. We believe the demand for Internet traffic management intelligence
capabilities will be a very important growth area for web-based businesses
and Internet service providers and an area of increasing importance to
traditional
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enterprise networks. We intend to maintain our 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.
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 new technologies such as 10 Gigabit Ethernet.
Expand Global Sales Organization. We intend to continue the global
expansion of our sales organization utilizing a direct sales organization in
the United States and abroad, strategic channel partners outside the United
States and select original equipment manufacturers. 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, parts depots in strategic
locations globally, implementation support, pre-sales service, 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 and
service providers. During 2001 and first quarter 2002, Foundry launched five
new products to expand and deepen the breadth of our product offerings. These
include:
. 10 Gigabit Ethernet Module
. FastIron 4802--high-capacity Layer 2/3 wiring closet switch based on
JetCore ASICs
. EdgeIron 4802F--high-performance, low cost, Layer 2 wiring closet switch
. FastIron 400/800/1500 and FastIron JetCore Modules
. New Management Modules and Interface Modules based on JetCore for BigIron
systems
. NetIron Metro router with MetroLink Interface Modules
Our product suite can be classified by the solutions each product line
offers.
FastIron Enterprise Switches
The new FastIron(R) 400, 800 and 1500 modular systems, complemented by the
award-winning FastIron 4802, are the first in the industry to provide
enterprise customers with an end-to-end enterprise LAN solution, ranging from
the wiring closet to the LAN backbone, based on a single product family. This
simplifies network operations and maintenance, leading to savings in total cost
of ownership. The new JetCore-based FastIron systems provide advanced Layer 2/3
feature sets with state-of-the-art Ternary Content Addressable Memory (TCAM),
integrated support for IP, IPX and AppleTalk, rich Quality of Service (QoS) and
bandwidth management features for Voice over IP (VoIP), complete Multicast
features and jumbo frame support for scaling server farm throughputs.
Based on Foundry's third generation JetCore ASIC chipsets, the FastIron 4802
provides 48 10/100 ports and two optional Gigabit Ethernet uplink ports, as
well as a comprehensive Layer 2/3 feature set including embedded support for
Bandwidth Provisioning, rich QoS and IP Billing and Accounting.
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EdgeIron Layer 2 Switches
The EdgeIron(TM) 4802F Layer 2 switch delivers wire-speed performance,
superior port density, and a complete standard Layer 2 feature set to address
the needs of Enterprise users. Measuring only one rack unit high and featuring
up to 10.1 million packets per second of wire-speed switching capacity, the
EdgeIron 4802F is an excellent choice for Layer 2 10/100 edge applications in
high-performance local-area networks. With an easy-to-use, industry-standard
Command Line Interface (CLI), Telnet based interface, web based Graphical User
Interface (GUI), standard Simple Network Management Protocol (SNMP) interface,
and RADIUS-based authentication, EdgeIron 4802F is easy and secure to
configure, deploy, and maintain.
NetIron Metro Routers
Purpose-built for metro area and service provider networks, the NetIron
Metro routers provide unparalleled routing performance for both MPLS and Layer
2 Metro networks. NetIron Metro routers provide a complete suite of MPLS
functionality, including the new Virtual Private LAN Segment (VPLS). Foundry's
VPLS implementation allows Metro service providers to build scalable MPLS-based
Metro networks that can offer multi-point-to-multi-point enterprise Virtual
Private Network (VPN) services with on-demand bandwidth provisioning. Foundry's
VPLS implementation accommodates different customer interface points including
10/100 Mbps Ethernet, Gigabit Ethernet, OC-3c ATM, OC-3c SONET, OC-12c SONET or
OC-48c SONET.
Foundry offers two major high availability features purpose-built for Layer
2 Metro networks which offer an alternative to Spanning Tree Protocol (STP)
based Metro designs. First, the Metro Ring Protocol (MRP) offers sub-second
fault-detection, isolation, and fail-over for Metro access rings. Second, the
Virtual Switch Redundancy Protocol (VSRP) offers sub-second fail-over for full
mesh or partial mesh Metro topologies. Together, the MRP and the VSRP
complement the existing Spanning Tree based innovations such as Rapid STP (IEEE
802.1w) and SuperSpan.
BigIron Layer 3 Backbone Switches
BigIron Layer 3 switches provide the industry's highest performance--up to
178 million packets per second and wire speed at every port--with a consistent,
non-blocking switch architecture and rich functionality across the entire
switch family. BigIron systems are optimized for service providers and
enterprise backbones. The BigIron system features carrier-class reliability and
availability with support for redundant management modules with rapid failover,
hot-swappable power supplies, and interface modules. BigIron systems can scale
up to 232 Gigabit Ethernet ports, 14 10-Gigabit Ethernet ports, or 672 10/100
Mbps ports in a single modular system. BigIron systems enable customized,
differentiated service offerings that support voice, video and data on the same
network with Quality of Service (QoS) and multicast capabilities. Other
features include:
. on-demand bandwidth provisioning with wire-speed fine-grain bandwidth
control,
. jumbo frames on Gigabit Ethernet for scalable service throughput and
performance,
. scalable network accounting and billing solution using Layer 2 through 7
information provided by built-in sFlow technology, and
. protection against denial of service attacks using IronShield security
with wire-speed extended access control lists, secure shell, secure copy,
and user authentication that prevent unauthorized network access.
ServerIron Layer 4-7 Traffic Management Switches
The ServerIron(R) family of Internet traffic management switches provides
high-performance Layer 4 through Layer 7 switching with integrated Layer 2/3
functionalities. ServerIron switches enable network managers to control and
manage Web transactions, Web applications, and E-commerce traffic flows.
ServerIron eases escalating Internet traffic overload, reduces the burden of
server farm management, and allows the entire network infrastructure to scale
to its full potential. All ServerIron switches include TrafficWorks IronWare,
Foundry's
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comprehensive suite of Internet traffic management software. The ServerIron
switches forward requests to the right server, cache, firewall, or even the
right data center location based on packet header and content information that
is significantly expanded beyond what is found in traditional Layer 2/3 packet
headers.
IronView Network Manager
The Foundry IronView(R) Network Manager (INM) allows today's networks to run
at maximum efficiency by allowing network managers to effectively track and
perform configuration changes and software updates and to quickly identify and
resolve network failures. IronView Network Manager empowers network managers to
seamlessly control changes to complex network-wide functions such as Access
Control Lists (ACLs), Virtual LANs (VLANs), software and configuration updates,
and network alarm and event controls. INM dramatically simplifies network
provisioning, diagnostics, and resolution, thus reducing total cost of
ownership and increasing our customers' return on investment.
Hardware and Software Architecture
JetCore ASIC
Foundry has been a leader in achieving performance breakthroughs with
application-specific integrated circuits (ASICs). In June 2001, we introduced
JetCore, our third generation ASICs, which builds on our previous success with
IronCore I and IronCore II. In 1997, IronCore I was launched as the first Layer
3 ASIC in the industry. This ASIC provided Layer 2, 3, and 4 access control
lists (ACLs) and quality of service (QoS).
From 1997, when we first commenced commercial shipments of our products
through the end of 2001, IronCore was the foundation for all of Foundry's
products allowing us to provide customers with consistent performance,
reliability and features, as well as the ability to leverage their networking
equipment investment. The IronCore chassis architecture consists of a
high-speed data highway that incorporated 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. 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.
JetCore extends Foundry's proven expertise in ASIC design and innovation.
JetCore provides bandwidth management on-demand, advanced Layer 2 and 3
features, enhanced QoS, jumbo frames, and new network management features and
functions. The new JetCore ASIC integrates Hewlett-Packard's patented XRMON
packet sampling technology and sFlow, an Internet Engineering Task Force (IETF)
draft standard for network traffic monitoring and accounting. JetCore is
backward compatible to IronCore.
With JetCore-powered switching and routing products, Foundry delivers
leading network monitoring and traffic accounting capabilities, including:
. Accurate network traffic accounting, from Layer 2 up to Layer 7
. Integration with industry-leading accounting and billing applications
. Intrusion detection and full visibility of any network traffic, regardless
of protocol (e.g., IPv4, IPX, AppleTalk, and IPv6)
. Precise network policing of network traffic everywhere, from the network
edge up to the network core
. Identification of network bottlenecks within a network and complete packet
header decoding from Layer 2 up to Layer 7
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IronWare and Internet IronWare Software
During 2001, Foundry delivered a major release of our IronWare software to
provide enhanced reliability, security and bandwidth management capabilities.
Moreover, we provided two major releases of our IronView Network Management
System to expand its features and functions including velocity management, rate
limiting, and multi-label protocol switching. All of these next-generation
functions fully comply with international standards while taking advantage of
our innovative hardware architecture.
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 assist in
communicating product benefits to end-user customers and proposing networking
solutions.
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, Spot Distribution in the United
Kingdom, and Pan Dacom and GE Compunet in Germany. As of December 31, 2001, our
international field organization included over 75 sales representatives and
system engineers. Foundry's foreign offices conduct sales, marketing, and
support activities. Foundry's export sales represented 15%, 30%, and 35% of net
revenue in 1999, 2000, and 2001, respectively. We intend to expand our
international presence through additional personnel and through the addition of
key resellers and integrators.
OEM/Co-Branding. We have OEM/Co-Branding relationships established with
Hewlett-Packard, Hitachi, Lucent, and NEC. Our OEMs market and sell our
products on a private label basis through their worldwide sales forces and also
purchase our products for use in their own internal networks. The agreements
with our OEMs automatically renew for two additional one-year periods, unless
the agreement is terminated within 60 days prior to the end of any period. The
agreements provide that the OEMs may postpone, cancel, increase or decrease any
order made under the agreement without penalty.
Lease financing program. Since January 2000, Foundry Commercial Credit, a
private-label leasing program, has offered 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 GE Capital, a diversified financial services company wholly
owned by General Electric (NYSE: GE) . Foundry's leasing program is 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, public
seminars and Webcasts, participation in independent third-party product tests,
presentations, and our web site.
10
Customer Service and Support
Throughout the past year, Foundry has maintained its leadership in customer
service by increasing the scope and coverage of its global customer service
offerings, expanding our Centers of Excellence from 8 to 10 locations by
opening facilities in Denver and Hong Kong, and increasing the number of spare
parts depots across the globe. At the beginning of 2001, Foundry was recognized
as the winner of "Best Customer Service" by the editors of Web Hosting Magazine.
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. Our customer service offerings also include parts depots
in strategic locations globally, implementation support, and pre-sales service.
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.
We provide all customers with a one-year hardware and 90-day software
warranty. We also have four levels of customer service offerings to meet
specific support needs called Titanium, Gold, Silver, and Bronze. The Titanium
service program provides the most comprehensive support including advance
hardware replacement within 4 hours delivered by a trained technician for
on-site support. The Gold service program is targeted towards customers who
have trained internal resources to maintain their network 24x7. The program is
designed to provide all the tools needed by these trained resources to maximize
the uptime of their network. The Silver service program is tailored for
customers who typically purchase spares inventory as a part of their overall
contingency plan. The Bronze service program is targeted towards budget
conscious customers who are looking for basic telephone and web-based support
and run a 9 to 5 operation.
We have regional Centers-of-Excellence in San Jose, Boston, New York,
Chicago, Denver, Herndon, Irvine, London, Hong Kong, and Tokyo. These Centers
of Excellence include Executive Briefing Centers (EBC) and serve as major
customer demonstration centers, regional technical support centers, and
equipment depot centers. The Centers of Excellence are fully equipped to
demonstrate Foundry's award-winning, high-performance product lines including
NetIron Metro routers, BigIron Layer 3 switches, FastIron Enterprise switches,
and ServerIron Layer 4-7 traffic management switches. They also support
interoperability testing, provide hands-on training for customers, and showcase
Foundry's end-to-end LAN, MAN and WAN solutions. The centers allow Foundry to
deliver superior customer service to our customers and expand service offering
to the rapidly growing worldwide 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, burn-in, and configuration are performed
at our facilities. Our manufacturing operations consist of quality assurance of
subassemblies and the performance of 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
11
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. Our agreements with Sanmina and Celestica
allow them to procure long lead-time component inventory on our behalf based
upon a rolling production forecast provided by Foundry with lead times of up to
6 months. Foundry is contractually obligated to the purchase of long lead-time
component inventory procured by our contract manufacturers in accordance with
the forecast, unless Foundry gives notice of order cancellation at least 30 to
90 days prior to the delivery date. If actual demand of our products is below
the projections, we may have excess inventory as a result of our purchase
commitments of long lead-time components with our contract manufacturers.
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 of 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 and Fujitsu, Ltd. An alternative supply for these
ASICs would require an extensive development period.
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 ordered by us, the
purchase price of the components, lead time and the shipping arrangements. In
the event one of these suppliers 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. We had 135 engineers at the end
of 2001 compared to 89 in 2000. Our research and development expenses were $9.0
million in 1999, $27.5 million in 2000 and $33.9 million in 2001, or 6.8%, 7.3%
and 10.9% of net revenue.
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. Our products have won many awards.
12
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 and Enterasys Networks as well as other smaller public and
private companies such as Juniper Networks, Extreme Networks, and Riverstone
Networks. 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 WAN solutions to enterprises and
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 and JetCore hardware architecture, and our
IronWare software. Different variations 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 contractual
restrictions on disclosure to protect our intellectual property rights in these
proprietary technologies. Although we have patent applications pending, we do
not currently own any patents.
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 some 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
and trademark 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 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
13
Nortel's patents, and seeking injunctive relief as well as unspecified damages.
Nortel has also brought suit, on the same or similar patents, against a number
of other networking companies. Foundry has analyzed the validity of Nortel's
claims and believes that Nortel's suit is without merit. Foundry is committed
to vigorously defending itself against these claims. Irrespective of the merits
of the Company's position, we may incur substantial expenses in defending
against third party claims. In the event of a determination adverse to the
Company, the Company could incur substantial monetary liability, and be
required to change its business practices. Either of these could have a
material adverse effect on the Company's financial position, results of
operations, or cash flows.
Employees
As of December 31, 2001, we had 595 employees, including 348 in sales and
marketing, 135 in engineering, 63 in manufacturing and 49 in general and
administrative. None of our employees is represented by a labor union or is
subject to a collective bargaining agreement. We have never experienced a work
stoppage and believe our employee relations are good.
Executive Officers
The names and ages of our executive officers as of December 31, 2001 are as
follows:
Name Age Position
---- --- --------
Bobby R. Johnson, Jr........ 45 President, Chief Executive Officer, and Chairman of the Board of
Directors
Lee Chen.................... 48 Vice President, Software Engineering and Quality Assurance
Karl D. Triebes............. 35 Vice President, Hardware Engineering
Ken K. Cheng................ 46 Vice President, Marketing and Product and Program Management
Timothy D. Heffner.......... 52 Vice President, Finance and Administration, Chief Financial Officer
Woody L. Akin............... 53 Vice President of Sales for the Americas
Paul L. Twombly............. 50 Vice President of Customer Support
H. Earl Ferguson............ 63 Chief Technology Officer
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.
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.
Karl D. Triebes has served as Vice President of Hardware Engineering of
Foundry since June 2001. From May 2000 to June 2001, Mr. Triebes was Vice
President of Engineering at Alcatel U.S.A, a telecommunications company. From
December 1999 to May 2000, he was Assistant Vice President of Newbridge
Networks Corp., a
14
networking company subsequently acquired by Alcatel. From January 1997 to
December 1999, he was Vice President of Systems and Software of Stanford
Telecommunications, Inc. Mr. Triebes holds a B.S. from San Diego 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.
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.
Woody L. Akin has served as Vice President of Sales for the Americas of
Foundry since April 2001. From November 2000 to March 2001, Mr. Akin served as
Vice President of Sales Operations of Foundry. From April 1989 to May 1999, Mr.
Akin was Vice President of North American enterprise sales at 3Com Corporation,
a computer networking company. From June 1982 to March 1989, Mr. Akin held
various sales management positions at ROLM/IBM, a telecommunications company.
Mr. Akin holds a B.S. degree from the University of Colorado.
Paul L. Twombly has served as Foundry's Vice President of Customer Support
since April 2001. From October 1999 to May 2001, Mr. Twombly was Senior Vice
President of Global Client Services at Nice Systems Ltd., a major worldwide
provider of CRM systems. From January 1998 to August 1999, Mr. Twombly was Vice
President of Customer Service at Warpspeed Communications, a telecommications
company. From April 1990 to January 1998, Mr. Twombly was Vice President of
Customer Service at Voysys Corporation, an OEM provider of telecommunications
products. Mr. Twombly holds a B.S. degree from Northwestern University.
H. Earl Ferguson co-founded Foundry and has served as Chief Technology
Officer since August 2001. From July 1996 to July 2001 Mr. Ferguson served as
Vice President, Hardware Engineering, and Chief Technical Officer of Foundry.
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.
Item 2. Properties
Our headquarters for corporate administration, research and development,
sales and marketing, and manufacturing occupy approximately 97,000 square feet
of space in San Jose, California. 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, several similar shareholder class action lawsuits were
filed against Foundry and certain of its officers in the United States 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,
15
2000. The lawsuits were subsequently consolidated by the Court, under the
caption In re Foundry Networks, Inc. Securities Litigation, Master File No.
C-00-4823-MMC, lead plaintiffs were selected as required by law and such
plaintiffs filed a consolidated amended complaint which alleged violations of
federal securities laws and purported to seek damages on behalf of a class of
shareholders who purchased Foundry's common stock during the period from
September 7, 2000 to December 19, 2000. On October 26, 2001, the Court granted
the Company's motion to dismiss the consolidated amended complaint without
prejudice to amend. On December 13, 2001, attorneys for lead plaintiffs filed a
second amended complaint. The Company reviewed the second amended complaint and
concluded that it was also without merit. The Company believes the lawsuit is
without merit and intends to defend itself vigorously.
A class action lawsuit was filed on November 27, 2001 in the United States
District Court for the Southern District of New York on behalf of purchasers of
Foundry common stock alleging violations of federal securities laws. Kassin v.
Foundry Networks, Inc. et al., No. 01-CV-10640 (SAS) (S.D.N.Y.), related to
Initial Public Offering Securities Litigation, No. 21 MC 92 (SAS) (S.D.N.Y.).
The case is brought purportedly on behalf of all persons who purchased the
common stock of the Company from September 27, 1999 through December 6, 2000.
The complaint names as defendants, the Company, three of its officers, and
investment banking firms that served as underwriters for the Company's initial
public offering in September 1999. The complaint alleges violations of Sections
11 and 15 of the Securities Act of 1933, and Section 10(b) of the Securities
Exchange Act of 1934, on the grounds that the prospectus incorporated in the
registration statement for the offering failed to disclose, among other things,
that (i) the underwriters had solicited and received excessive and undisclosed
commissions from certain investors in exchange for which the underwriters
allocated to those investors material portions of the shares of the Company's
stock sold in the initial public offering, and (ii) the underwriters had
entered into agreements with customers whereby the underwriters agreed to
allocate shares of the Company's stock sold in the initial public offering to
those customers in exchange for which the customers agreed to purchase
additional shares of the Company's stock in the aftermarket at pre-determined
prices. No specific damages are claimed. We are aware that similar allegations
have been made in lawsuits relating to more than 300 other initial public
offerings conducted in 1999 and 2000. Those cases have been consolidated for
pretrial purposes before the Honorable Judge Shira A. Scheindlin. Defendants'
time to respond to the complaints has been stayed pending plans for further
coordination. Plaintiffs have moved for appointment of lead plaintiff.
Management believes that the allegations in these class action lawsuits
against the Company and its officers are without merit and management intends
to contest them vigorously. However, these litigations are in the preliminary
stage, and their outcome cannot be predicted. The litigation process is
inherently uncertain. If the outcome of the litigation is adverse to the
Company and if, in addition, the Company was required to pay significant
monetary damages in excess of available insurance, its business could be
significantly harmed.
From time to time the Company is subject to legal proceedings and claims in
the ordinary course of business, including claims of alleged infringement of
trademarks, copyrights, patents and other intellectual property rights. In
addition, from time to time, third parties assert patent infringement claims
against the Company in the form of letters, lawsuits and other forms of
communication. 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. Nortel has also
brought suit, on the same or similar patents, against a number of other
networking companies. Foundry has analyzed the validity of Nortel's claims and
believes that Nortel's suit is without merit. Foundry is committed to
vigorously defending itself against these claims. Irrespective of the merits of
the Company's position, we may incur substantial expenses in defending against
third party claims. In the event of a determination adverse to the Company, the
Company could incur substantial monetary liability, and be required to change
its business practices. Either of these could have a material adverse effect on
the Company's financial position, results of operations, or cash flows.
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 2001.
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, 2001, there
were approximately 471 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
------- -------
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
2001
First quarter.. $ 23.50 $ 7.50
Second quarter. $ 22.05 $ 6.19
Third quarter.. $ 21.14 $ 5.80
Fourth quarter. $ 11.59 $ 6.21
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 2001
The Company did not make any unregistered sales of the Company's common
stock during fiscal 2001.
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, 2001 and the consolidated
balance sheet data as of December 31, 2000 and 2001 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 years ended
December 31, 1997 and 1998 and the balance sheet data as of December 31, 1997,
1998 and 1999 are derived from audited financial statements not included herein.
Year Ended December 31,
--------------------------------------------
1997 1998 1999 2000 2001
------- ------- -------- -------- --------
(In thousands, except per share data)
(Note 1)
Consolidated Statement of Operations Data:
Revenue, net................................... $ 3,381 $17,039 $133,522 $377,156 $311,176
Cost of revenue................................ 1,835 8,433 56,612 134,330 158,141
------- ------- -------- -------- --------
Gross profit................................ 1,546 8,606 76,910 242,826 153,035
------- ------- -------- -------- --------
Operating expenses:
Research and development.................... 5,403 8,797 9,037 27,499 33,947
Sales and marketing......................... 3,419 7,258 23,142 67,753 90,786
General and administrative.................. 1,853 1,589 4,532 10,493 27,185
Amortization of deferred stock compensation. -- 727 9,463 6,185 2,708
------- ------- -------- -------- --------
Total operating expenses................ 10,675 18,371 46,174 111,930 154,626
------- ------- -------- -------- --------
Income (loss) from operations.................. (9,129) (9,765) 30,736 130,896 (1,591)
Interest income................................ 122 413 1,886 11,235 8,746
Write-down of minority investment.............. -- -- -- -- 2,500
------- ------- -------- -------- --------
Income (loss) before provision for income taxes (9,007) (9,352) 32,622 142,131 4,655
Provision for income taxes..................... -- -- 9,750 54,010 1,769
------- ------- -------- -------- --------
Net income (loss).............................. $(9,007) $(9,352) $ 22,872 $ 88,121 $ 2,886
======= ======= ======== ======== ========
Basic net income (loss) per share.............. $ (0.67) $ (0.35) $ 0.42 $ 0.80 $ 0.02
Diluted net income (loss) per share............ $ (0.67) $ (0.35) $ 0.20 $ 0.69 $ 0.02
Weighted average shares--basic................. 13,570 26,976 54,929 110,141 117,360
Weighted average shares--diluted............... 13,570 26,976 114,835 127,131 125,521
December 31,
----------------------------------------------
1997 1998 1999 2000 2001
-------- -------- -------- -------- --------
Consolidated Balance Sheet Data:
Cash and cash equivalents........... $ 3,182 $ 4,567 $120,378 $168,429 $ 98,210
Short-term investments.............. -- -- 39,789 83,816 176,524
Working capital..................... 4,076 10,663 180,508 339,369 354,054
Total assets........................ 6,988 19,238 213,498 398,466 412,138
Long-term obligations............... 178 -- -- -- --
Total stockholders' equity (deficit) (10,509) (18,926) 181,604 345,016 361,832
- --------
(Note 1) On October 1, 1999, Foundry completed its initial public offering.
See also Note 6 of the Notes to Consolidated Financial Statements.
18
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 2002.
Overview
Founded in 1996, Foundry designs, develops, manufactures and markets a
comprehensive, end-to-end suite of high performance Metro routers, Gigabit
Ethernet Layer 2 and Layer 3 switches, and Internet traffic management 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 product suite includes
the NetIron family of Metro routers, FastIron family of Ethernet edge switches,
EdgeIron layer 2 Ethernet switches, BigIron family of Gigabit Ethernet core
switches and ServerIron family of Ethernet Layer 4-7 Internet traffic
management switches. In June 2001, we introduced the JetCore ASIC chipset
family which consists of different ASICs that provide various combinations of
10/100 or Gigabit Ethernet ports to deliver advanced switching and routing
functionalities. Built on 0.18 micron technology, the JetCore chipset
represents the third major ASIC development from Foundry in a four year span.
Purpose-built to meet the feature, performance and scalability needs of the
high-bandwidth enterprise, Metro and Internet networks, Foundry's JetCore
chipset is the foundation of Foundry's next-generation switching and routing
platforms. We expect to incorporate JetCore into our next generation product
lines by the end of June 2002.
We generated net income of $88.1 million and $2.9 million for the years
ended December 31, 2000 and 2001, respectively. As of December 31, 2001, we had
retained earnings of $93.5 million. For the fourth quarter ended December 31,
2001, we incurred a net loss of $10.7 million. This is the first quarterly loss
we have incurred since the quarter ended December 31, 1998. The net loss for
the quarter was due to a sequential decrease in revenue as a result of a
combination of factors, including an overall reduction in capital spending by
our existing and potential customers, unfavorable economic conditions, and the
transition to JetCore products which caused some customers to place orders for
the new JetCore-based products to be delivered in the first half of 2002. As a
result of the challenging economic environment, we have and may continue to
experience reduced demand for our products and heightened pricing pressure from
our competitors. During the fourth quarter of 2001, we recorded certain
one-time charges totaling $18.7 million as a result of these unfavorable
economic conditions. These charges were comprised of $9.3 million provision for
excess and obsolete inventories specifically associated with the major product
transition to JetCore-based products, $2.8 million for the write-down of a note
receivable from a stockholder, $2.5 million for the write-down of a minority
investment for an other than temporary decline in value, $1.1 million for
facilities abandonment, $1.8 million bad debt expense related to one specific
customer, and $1.2 million of other one-time charges. Our gross margin for
fiscal 2001 was adversely impacted by a decrease in revenue and increase in the
provision for excess and obsolete inventories as a result of the product
transition and challenging economic environment. Additionally, due to a number
of factors which are discussed in more detail below, our selling prices and
gross margins have and may continue to decrease as a result of macro-economic
factors and our efforts to compete aggressively, reduce our inventory levels
and maintain sales levels.
19
Market and economic conditions continue to be challenging. We have observed
effects of the economic downturn in many areas of our business. The current
recession has had a material adverse effect on our business and on some of our
existing and prospective customers, with a number of such customers
substantially delaying or reducing their network expansion plans, restructuring
or consolidating in order to remain competitive. One such proposed merger
currently in process may have significant implications for Foundry. Our largest
OEM, Hewlett Packard has proposed a merger with Compaq Computer Corp. to
restructure itself to focus on certain market sectors. Sales to Hewlett Packard
accounted for 14%, 4% and 6% of our net revenue for 1999, 2000 and 2001,
respectively. If this merger is approved by shareholders and if Hewlett Packard
chooses to eliminate its networking division as it realigns its business,
Hewlett Packard may discontinue its OEM relationship with Foundry, which will
negatively impact our revenue. Irrespective of the merger, if Hewlett Packard
chooses to reduce or terminate its relationship with Foundry, our revenue and
ability to market and sell our products to potential customers will be harmed.
The global economic slowdown has also caused varying decreases in revenue from
certain geographic regions. As a result, sales to certain countries or regions
may continue to fluctuate. We have also experienced some gross margin
deterioration, asset impairments and increased inventory and accounts
receivable provisions as a result of the economic downturn. In response to the
slowdown, the Company has and continues to increase its efforts to reduce
inventories and operating costs. However, the uncertainty about the severity
and duration of the current recession continues to impair the Company's ability
to project its revenue in the near future. If economic conditions in the United
States and globally do not improve, or if we experience a worsening in economic
conditions, we may continue to experience material adverse effects on our
business, operating results, and financial condition. In order to be profitable
we must maintain reasonable cost and expense levels while generating and
sustaining higher revenue to cover costs and achieve profitability.
Critical Accounting Policies and Estimates
Our significant accounting policies are more fully described in Note 2 to
the consolidated financial statements included in this Form 10-K. The
preparation of our consolidated financial statements in accordance with
generally accepted accounting principles requires us to make estimates and
judgments that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements, and the reported amounts of revenue and expenses during
the period reported. By their nature, these estimates and judgments are subject
to an inherent degree of uncertainty. Management bases their estimates and
judgments on historical experience, market trends, and other factors that are
believed to be reasonable under the circumstances. Actual results may differ
from these estimates under different assumptions or conditions. Management
believes the following critical accounting policies, among others, affect its
more significant judgments and estimates used in the preparation of its
consolidated financial statements.
Revenue Recognition
In past years and for fiscal 2001, we derived 90% or more of our revenue
from sales of our stackable and chassis-based networking equipment, with the
remaining revenue generated from customer support fees, training and
installation services. Foundry's revenue recognition policy follows SEC Staff
Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial
Statements." Specifically, Foundry recognizes revenue when persuasive evidence
of an arrangement exists, delivery has occurred, the sales price is fixed or
determinable and collectibility is reasonably assured. Product revenue is
generally recorded at the time of shipment when title and risk of loss passes
to the customer, unless we have future obligations for installation or have to
obtain customer acceptance, in which case revenue is not recorded until such
obligations have been satisfied or customer acceptance has been received. For
example, revenue is not recognized when the customer has a right of return or
when undelivered products or services are essential to the functionality of
delivered products.
At the time revenue is recognized, Foundry establishes an accrual for
estimated warranty expenses associated with its sales, recorded as a component
of cost of revenue. Foundry's standard warranty period extends 12 months from
the date of sale and our warranty accrual represents our best estimate of the
amounts necessary to settle future and existing claims on products sold as of
the balance sheet date. While we believe that our warranty accrual is adequate
and that the judgment applied is appropriate, such amounts estimated to be due
and payable could differ materially from what will actually transpire in the
future. Foundry also provides a
20
reserve for estimated customer returns. In 1999, 2000 and 2001, Foundry
recorded a provision for sales returns equal to $1.2 million, $3.7 million and
$3.6 million, respectively, which has been netted against revenue in the
accompanying consolidated statements of income. This provision is based on our
historical returns, analysis of credit memo data and return policies. Sales to
Foundry's resellers do not provide for rights of return and the contracts with
Foundry's original equipment manufacturers do 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 agreements. If the historical data
used by the Company to calculate the estimated sales returns and allowances
does not properly reflect future returns, revenue could be overstated. In
addition, if the Company's actual warranty costs are greater than the accrual,
cost of revenues will increase in the future.
Revenue from customer support services is recognized ratably over the
contractual period, generally one year. Amounts invoiced to customers in excess
of revenue recognized on support contracts are recorded as deferred revenue
until the revenue recognition criteria are met. Revenue from customer support
services accounted for 1.7%, 3.9% and 9.1% for the years ended December 31,
1999, 2000 and 2001, respectively. Revenue for training and installation
services is recognized as services are rendered. Revenue from software,
training and installation services, combined, accounts for less than 1% of
total revenue for 1999, 2000, and 2001.
Inventories
The networking industry is characterized by rapid technological change,
frequent new product introductions, changes in customer requirements, and
evolving industry standards. We regularly monitor inventory quantities on hand
and record a provision for excess and obsolete inventories based primarily on
our estimated forecast of product demand and production requirements for the
next three months. In recent quarters, demand for our products has been
adversely affected as a result of the current recession and reduced
telecommunications and infrastructure capital spending, particularly in the
United States. As demonstrated during fiscal 2001, a significant decrease in
demand could result in an increase in the amount of excess inventory quantities
on hand. Consequently, provisions for excess and obsolete inventory in the
amounts of $3.8 million, $13.6 million, and $24.9 million were recorded for the
years ended December 31, 1999, 2000, and 2001, respectively. Inventory
write-offs were approximately $1.6 million in 1999, $4.4 million in 2000, and
$8.9 million in 2001. Although we make every effort to ensure the accuracy of
our forecasts of future product demand, any significant unanticipated changes
in demand or technological developments would significantly impact the value of
our inventory and our reported operating results. Our estimates of future
product demand may prove to be inaccurate, in which case we may have
understated or overstated the provision required for excess and obsolete
inventory. In the future, if our inventory is determined to be overvalued, we
would be required to recognize such costs in our cost of revenue at the time of
such determination. If our inventory is determined to be undervalued, we may
have overstated our cost of revenue in previous periods and would be required
to recognize additional operating income at the time of sale.
Accounts Receivable
We continually monitor and evaluate the collectibility of our trade
receivables based on a combination of factors. We record specific allowances
for bad debts when we become aware of a specific customer's inability to meet
its financial obligation to us such as in the case of bankruptcy filings or
deterioration of financial position. Estimates are used in determining our
allowances for all other customers based on factors such as current trends, the
length of time the receivables are past due and historical collection
experience. In determining our allowance for doubtful accounts, we also
consider our agreement with GE Capital (formerly Heller Financial Corp.), our
third party leasing partner, which allows GE Capital a right of recourse
against Foundry for defaults by customers financed through GE Capital based on
certain criteria. We mitigate some collection risk by requiring most of our
customers in the Asian region to secure lines of credit prior to placing an
order with us. During the year ended December 31, 2001, Foundry provided
approximately $9.1 million to increase its allowance for doubtful accounts to a
level deemed necessary by management to provide for potential uncollectible
amounts. While we believe that our allowance for doubtful accounts receivable
is adequate and that the judgment applied
21
is appropriate, such amounts estimated could differ materially from what will
actually transpire in the future. If the historical data used by the Company to
calculate the estimated allowance for doubtful accounts does not properly
reflect future bad debts, net income could be overstated.
Deferred Tax Asset Valuation Allowance
We recognize deferred tax assets and liabilities based on the differences
between the financial statement carrying amounts and the tax bases of assets
and liabilities. Significant management judgment is required in determining our
deferred tax assets and liabilities and any valuation allowance recorded
against our net deferred tax assets. Management makes an assessment of the
likelihood that our deferred tax assets will be recovered from future taxable
income, and to the extent that recovery is not believed to be likely, a
valuation allowance must be established. For fiscal 2000 and 2001, we did not
record a valuation allowance to reduce our deferred tax assets because we
believe the amount is more likely than not to be realized. In the event Foundry
is unable to realize some or all of its deferred tax assets in the future, an
adjustment to the deferred tax assets would be charged to income in the period
such determination was made. Our net deferred tax assets as of December 31,
2001 were $29.7 million.
Purchase Commitments
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. Our agreements with Sanmina and Celestica allow them to
procure long lead-time component inventory on our behalf based upon a rolling
production forecast provided by Foundry with lead times of up to 6 months.
Foundry is contractually obligated to the purchase of long lead-time component
inventory procured by our contract manufacturers in accordance with the
forecast, unless Foundry gives notice of order cancellation at least 30 to 90
days prior to the delivery date. As of December 31, 2001, the Company was
committed to purchase approximately $35.4 million of such inventory over the
next four months. If actual demand of our products is below the projections, we
may have excess inventory as a result of our purchase commitments of long
lead-time components with our contract manufacturers. This would be recorded as
additional provisions for excess inventory as a component of cost of revenue.
Litigation
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 lawsuits pending against us as indicated
in Item 1 "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.
22
Results of Operations
The following table sets forth selected items from our consolidated
statement of income as a percentage of revenue for the periods indicated:
Year Ended December 31,
----------------------
1999 2000 2001
----- ----- -----
Revenue, net................................... 100.0% 100.0% 100.0%
Cost of revenue................................ 42.4 35.6 50.8
----- ----- -----
Gross profit................................ 57.6 64.4 49.2
----- ----- -----
Operating expenses:
Research and development.................... 6.8 7.3 10.9
Sales and marketing......................... 17.3 18.0 29.2
General and administrative.................. 3.4 2.8 8.7
Amortization of deferred stock compensation. 7.1 1.6 0.9
----- ----- -----
Total operating expenses................ 34.6 29.7 49.7
----- ----- -----
Income (loss) from operations.................. 23.0 34.7 (0.5)
Interest income................................ 1.4 3.0 2.9
Write-down of minority investment.............. -- -- 0.8
----- ----- -----
Income before provision for income taxes....... 24.4 37.7 1.6
Provision for income taxes..................... 7.3 14.3 0.6
----- ----- -----
Net income..................................... 17.1% 23.4% 1.0%
===== ===== =====
Revenue. Net revenue was $133.5 million, $377.2 million, and $311.2 million
in fiscal 1999, 2000, and 2001, respectively, representing an increase of 183%
from fiscal 1999 to 2000 and a decrease of 17% from 2000 to 2001. The increase
from 1999 to 2000 was due to a strong market demand for Internet infrastructure
equipment, increased acceptance of Foundry's product offerings, and a
significant increase in Foundry's sales and marketing organizations, all of
which contributed to higher revenues in 2000. The decline in revenue in 2001
reflected the effects of the global economic slowdown,a reduction in capital
spending by our existing and potential customers and, to a lesser extent, the
product transition to JetCore ASICs which caused some of our customers to place
orders for new JetCore-based products to be delivered in the first half of
2002. For the year ended December 31, 1999, sales to America Online and Hewlett
Packard accounted for 11% and 14% of our revenue, respectively. For the years
ended December 31, 2000 and 2001, no customer accounted for greater than 10% of
our revenue.
Customer support revenue was 1.7%, 3.9% and 9.1% of our net revenue for
1999, 2000 and 2001, respectively. Revenue from support contracts are
recognized ratably over the contractual period, generally 12 months. The
increases in support revenue were due to the associated increase in product
sales in 2000 and our increased customer base, resulting in new customer
support contracts in addition to support contract renewals by existing
customers.
Cost of revenue. Cost of revenue consists primarily of material, labor,
manufacturing overhead, warranty costs and the provision for excess and
obsolete inventories. Cost of revenue was $56.6 million, $134.3 million, and
$158.1 million in fiscal 1999, 2000, and 2001 or 42.4%, 35.6%, and 50.8% of
revenue, respectively. The decrease in cost of revenue as a percentage of
revenue from 1999 to 2000 was primarily a result of shifts in product mix and
lower manufacturing overhead costs due to higher sales volume. The increase in
cost of revenue as a percentage of revenue from 2000 to 2001 was due to a
decline in sales volume and average selling prices resulting from the global
economic slowdown, and increased inventory provision in response to the
deteriorating economic environment and a major product line transition in the
fourth quarter of 2001. The provision for excess and obsolete inventories
increased from $13.6 million in 2000 to $24.9 million in 2001, of which $9.3
million
23
was recorded in fourth quarter 2001 to specifically reserve for excess
inventories as a result of our product realignment and transition from our
IronCore ASICs-based product lines to the new and more powerful products
incorporating our next generation JetCore ASICs.
Our gross margin has been and may continue to be adversely affected by
heightened price competition, component shortages, increases in material or
labor costs, 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 $9.0 million,
$27.5 million and $33.9 million in fiscal 1999, 2000 and 2001 or 6.8%, 7.3%,
and 10.9% of revenue, respectively. The increases were primarily due to the
addition of engineering personnel from 43 in 1999 to 89 in 2000 to 135 in 2001
and increased expenditures on the design and development of new products,
particularly the development of our next generation JetCore ASICs in 2001.
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 $23.1 million, $67.8 million and $90.8 million in fiscal 1999, 2000 and
2001 or 17.3%, 18.0% and 29.2% of revenue, respectively. The increase from 1999
to 2000 was 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. The increase from 2000
to 2001 was primarily due to increases in the average size of our direct sales
force from 205 in 2000 to 289 in 2001, and increased marketing and advertising
investments associated with the introduction of new products.
General and administrative. General and administrative expenses consist
primarily of salaries and related expenses for executive, finance and
administrative personnel, facilities, bad debt, legal, and other general
corporate expenses. General and administrative expenses were $4.5 million,
$10.5 million and $27.2 million in fiscal 1999, 2000 and 2001 or 3.4%, 2.8% and
8.7% of revenue, respectively. The increase in absolute dollars from 1999 to
2000 was primarily due to an increase in headcount from 21 to 47 and an
increase in general corporate expenses consistent with the increased scale of
operations and revenue growth. General and administrative expenses increased in
absolute dollars from 2000 to 2001 primarily due to certain charges such as
$2.8 million for the write-down of a note receivable from a stockholder and
$1.1 million of costs related to facilities consolidation, an increase in the
provision for doubtful accounts receivable from $4.7 million in 2000 to
$9.1 million in 2001 as a result of the impact of the deteriorating economy on
our customer base, and an increase in general corporate expenses such as legal
and facilities costs.
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 $17.3 million in 1999, and $0.3 million
in 2000, representing the difference between the exercise price and the deemed
fair market value of our common stock on the date these stock options were
granted. We recorded no additional deferred stock compensation in 2001.
Deferred stock compensation is reflected within stockholders' equity and is
being
24
amortized to operations over the respective vesting periods. We recorded
amortization of deferred stock compensation expense of approximately $9.5
million, $6.2 million and $2.7 million for fiscal 1999, 2000 and 2001,
respectively. At December 31, 2001, we had approximately $1.3 million remaining
to be amortized in 2002 and 2003.
Interest income. Interest income is earned on funds we keep on deposit in
interest bearing money market and short-term investment accounts. Foundry had
interest income of $1.9 million, $11.2 million and $8.7 million in 1999, 2000
and 2001, respectively. Interest income increased significantly from 1999 to
2000 due to higher cash balances resulting from the proceeds from our initial
public offering on October 1, 1999. Interest income decreased from 2000 to 2001
due to lower interest rates during 2001.
Write-down of minority investment. In February 2001, Foundry made a $2.5
million minority investment in a development stage private company, who is also
a customer. In December 2001, the Company determined that the investment
declined in fair market value on an other than temporary basis based on certain
factors such as the value of the most recent round of financing, market and
industry conditions and financial condition of and business outlook for the
company. Accordingly, Foundry wrote-down the minority investment in its
entirety in the accompanying consolidated statement of income for the year
ended December 31, 2001.
Income taxes. The Company generated significant taxable income in 1999,
2000, and 2001. 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, 2000, and 2001.
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 $0.9
million, $57.9 million and $10.5 million for the years ended December 31, 1999,
2000, and 2001, respectively. Benefits reducing taxes payable amounted to
approximately $55.2 million and $8.1 million for the years ended December 31,
2000 and 2001, respectively. Benefits increasing gross deferred tax assets
amounted to $2.7 million and $2.4 million for the years ended December 31, 2000
and 2001, respectively.
Liquidity and Capital Resources
At December 31, 2001, Foundry had cash and cash equivalents and short-term
investments totaling $274.7 million as compared to $252.2 million at December
31, 2000, an increase of $22.5 million.
Cash provided by operating activities was $19.6 million, $86.0 million and
$32.6 million for the years ended December 31, 1999, 2000 and 2001,
respectively. The increase from 1999 to 2000 was due primarily to the
significant increase in net income combined with an income tax benefit realized
from stock option exercises totaling $57.9 million, offset by purchases of
inventories and increase in accounts receivables. Cash provided by operating
activities decreased to $32.6 million for 2001 as a result of significantly
lower net income in 2001, lower tax benefit from stock option exercises, a
significant increase in deferred tax assets offset by increases in the
provisions for doubtful accounts and excess and obsolete inventories.
Cash utilized in investing activities was $40.8 million, $49.2 million, and
$100.5 million for the years ended December 31, 1999, 2000, and 2001,
respectively. The increases were primarily due to purchases of short-term
investments offset by proceeds received from the maturities of held-to-maturity
investments.
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
25
exercises and, to a lesser extent, the collection of stockholder promissory
notes. During 2001, we utilized $2.6 million for financing activities, which
comprised primarily of $15.0 million used for the repurchase of Foundry common
stock in the open market offset by $12.4 million of proceeds from stock option
exercises and sale of common stock under the Employee Stock Purchase Plan.
As of December 31, 2001, we had inventory purchase commitments to our
contract manufacturers totaling $35.4 million and operating lease commitments
totaling $25.6 million. We may incur higher capital expenditures in the near
future, when market conditions improve and if we expand our operations.
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 our existing cash balances and
anticipated funds from operations, will satisfy our cash requirements for at
least the next 12 months. Key factors impacting our cash flows include our
ability to effectively manage our working capital, in particular inventory and
accounts receivable, as well as future demand for our products and related
pricing.
Recently Issued Accounting Standards
See Note 2 of Notes to Consolidated Financial Statements for recently
adopted and issued accounting standards.
26
Risk Factors That May Affect Future Results and Market Price of Stock
We may not be able to maintain profitability in the future.
We generated net income of $88.1 million and $2.9 million for the year ended
December 31, 2000 and 2001 on revenues of $377.2 million and $311.2 million,
respectively. As of December 31, 2001, we had retained earnings of $93.5
million. Although we have been profitable on an annual basis for the last three
consecutive years, we incurred a net loss of $10.7 million for the fourth
quarter ended December 31, 2001. This is our first quarterly operating loss
since the quarter ended December 31, 1998. When economic conditions improve, we
may incur increased costs and expenses related to sales and marketing,
including expansion of our direct sales operation and distribution channels,
product development, customer support, expansion of our corporate
infrastructure, and facilities expansion. 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 significant shortfall in revenue relative to
our expectations could cause a significant decline in our quarterly operating
results. In order to be profitable, we must 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.
The current economic downturn may continue to adversely affect our revenues,
gross margins and expenses.
Our quarterly revenue and operating results have and may continue to
fluctuate due to the effects of general economic conditions in the United
States and globally, and, in particular, market conditions in the
communications and networking industries. In recent quarters, our operating
results have been adversely affected as a result of the current recession and
reduced capital spending, particularly in the United States. The downturn has
also contributed to declines in revenue during 2001. We have also experienced
gross margin declines, reflecting the effect of competitive pressures as well
as writedowns for inventories and other asset impairments as a result of the
downturn. Our general and administrative expenses were higher than expected due
in part to an increase in the provision for doubtful accounts and write-down of
a note receivable from a stockholder. We are uncertain about the extent,
severity, and length of the economic downturn. If the economic conditions in
the United States and globally do not improve, or if we experience a worsening
in the global economic slowdown, we may continue to experience material
negative effects on our business, operating results, and financial condition.
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,
especially in recent periods, 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.
In addition, demand for our products may fluctuate as a result of seasonality,
particularly in Europe.
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.
Terrorist acts and acts of war may harm our business and operating results.
The terrorist attacks in New York and Washington D.C. on September 11, 2001
have disrupted commerce throughout the world and have intensified the
uncertainty of the U.S. and global economies. The long-term effects on our
business from these attacks are unknown. The continued threat of terrorism and
heightened
27
security and military action in response to this threat may cause further
disruption to the economy. To the extent that such disruptions result in delays
or cancellations of customer orders, the manufacture or shipment of our
products, our business and results of operations could be materially and
adversely affected.
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 negatively impact our revenue.
For the years ended December 31, 2000 and 2001, 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.
While our financial performance may depend on large, recurring orders from
certain customers and resellers, we do not generally have binding commitments
from 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
. 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 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 economic environment and 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
remain flat, decrease or grow at a slower rate. As a consequence, operating
results for a particular quarter are extremely difficult to predict. We expect
that our operating expenses will increase if we expand our sales and marketing
operations and as we 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.
28
We also compete with other large public companies, such as Nortel Networks
and Enterasys Networks as well as other smaller public and private companies
such as Juniper Networks, Extreme Networks and Riverstone Networks. 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.
Our ability to increase our revenue depends on expanding our 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 sales and
support staff or establish and cultivate relationships with our indirect
distribution channels, our ability to grow and increase revenue could be harmed
or if our resellers are not successful in their sales efforts, sales of our
products may decrease and our operating results would suffer. Some of our
resellers also sell products that compete with our products. As a result, we
cannot assure you that our resellers will market our products effectively or
continue to devote the resources necessary to provide us with adequate sales,
marketing and technical support.
In an effort to gain market share and support our customers, we may expand
our direct sales operation and customer service staff to support new and
existing customers. The timing and extent of any such expansion is uncertain in
light of the current economic environment. Expansion of our direct sales
operation and reseller distribution channels may not be successfully
implemented and the cost of any expansion may exceed the revenue generated.
We must continue to introduce new products with superior performance in a
timely manner in order to sustain and increase our revenue.
The networking industry is characterized by rapid technological change,
frequent new product introductions, changes in customer requirements, and
evolving industry standards. Therefore, 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 to remain
competitive. The process of developing new technology is complex and uncertain,
and if we fail to develop or obtain important intellectual property and
accurately predict customers' changing needs and emerging technological trends,
our business could be harmed. We must commit significant resources to develop
new products before knowing whether our investments will eventually result in
products that the market will accept. After a product is developed, we must be
able to forecast sales volumes and quickly manufacture a sufficient mix of
products and configurations that meet customer requirements, all at low costs.
The current life cycle of our products is typically 18 to 24 months. In June
2001, we introduced JetCore, our third generation of ASICs which will be
incorporated within our existing product lines by the end of March 2002. The
introduction of new products or product enhancements may shorten the life cycle
of our existing products, replace sales of some of our current products,
thereby offsetting the benefit of even a successful product introduction, and
may cause customers to defer purchasing our existing products in anticipation
of the new 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. In addition, we have experienced, and may in the
future experience, delays in developing and releasing new products and product
enhancements. This has led
29
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.
Some of our customers depend on the continued growth of the Internet for all or
substantially all of their revenue. If the Internet does not expand as
expected, our business will be adversely affected.
A substantial portion of our business and revenue depends on the continued
growth of the Internet and on the deployment of our products by customers that
depend on the growth of the Internet. Spending on Internet infrastructure has
increased significantly over the past several years based upon the growth of
the Internet. There can be no assurance that spending on Internet
infrastructure will continue at these historical rates. As a result of the
recent economic decline, spending on Internet infrastructure has decreased
significantly, which has had a material adverse effect on our business. To the
extent that the economic slowdown and reduction in capital spending continue to
adversely affect spending on Internet infrastructure or 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 be harmed.
Our revenue may be adversely affected by a reduction in outside financing made
available to our emerging company customers.
Our customer base includes emerging enterprise, telecommunications and
Internet companies who rely on venture capital firms, banks and other similar
financing sources to fund their operations and growth. Due to the slowdown of
the economy and other factors, many of these customers have and may experience
cash flow problems and are finding it increasingly difficult to obtain
financing on attractive terms, if at all. Some of these companies have been
unable to raise adequate capital and have reduced or ceased their purchases of
our products and some have been unable to pay or have delayed payment for
products they had previously purchased. The inability of some of our existing
and prospective customers to pay us for our products may adversely affect the
timing of revenue recognition and such reductions in spending or payment
defaults by this segment of our customer base have had and may have an adverse
effect on our operating results and stock price.
Our gross margin may 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 and macroeconomic
pressures and rapid technological change. The average selling prices of our
products has decreased and may continue to 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, as a
result of the recent disruption in the technology sector coupled with more
broad macro-economic factors, both we and our competitors may pursue more
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
manufacturing costs and effectively manage our inventory levels. Although
management continues to closely monitor inventory levels, declines in demand
for our products could result in additional provision for excess and obsolete
inventories. 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. If
product or related warranty costs associated with our products are greater than
we have experienced, gross margin may also be adversely affected.
30
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. In spite of the economic
downturn, competition for these personnel is intense, especially in the San
Francisco Bay Area, and we have experienced some 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.
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, Shanghai Gentek, GTI and UTStarcom in China 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 Japan 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;
. 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.
31
We purchase several key components for our 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, Samsung and QCS
Limited. The inability of our suppliers to provide us with adequate supplies of
key components or the loss of any of our suppliers may cause a delay in our
ability to fulfill orders and may have a material adverse effect on our
business and financial condition.
Our principal limited-sourced components include dynamic and static random
access memories, commonly known as DRAMs and SRAMs, ASICs, printed circuit
boards, optical components, microprocessors and power supplies. 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. Our agreements with Sanmina and Celestica allow them to
procure long lead-time component inventory on our behalf based upon a rolling
production forecast provided by Foundry with lead times of up to 6 months.
Foundry is contractually obligated to the purchase of long lead-time component
inventory procured by our contract manufacturers in accordance with the
forecast, unless Foundry gives notice of order cancellation at least 30 to 90
days prior to the delivery date. If actual demand of our products is below the
projections, we may have excess inventory as a result of our purchase
commitments of long lead-time components with our contract manufacturers. 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
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.
32
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 a customer. The decision by customers
to purchase our products is often based on their internal budgets and
procedures involving rigorous evaluation, testing, implementation and
acceptance of new technologies. 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, MPLS Draft-Martini, 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.
If we do not manage our growth effectively, our business will be harmed.
We experienced rapid growth from 1999 to 2000 which placed a significant
strain on our resources. Our revenue increased significantly during those
years, and our headcount increased from 222 employees in 1999 to
33
572 in 2000. Our headcount grew, at a much slower rate, to 600 employees in
2001. 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; 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. During the second quarter of 2001,
we completed the implementation of an Enterprise Resource Planning system to
meet the 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.
Although Foundry continues to focus on internal product development and
growth, we may review acquisition prospects that would complement our existing
business or enhance our technological capabilities as part of our business
strategy. 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 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.
34
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. Our proprietary technology
includes our ASICs, our IronCore and JetCore hardware architecture, and our
IronWare software. We rely on a combination of copyright, trademark and trade
secret laws and contractual restrictions on disclosure to protect our
intellectual property rights in these proprietary technologies. We do not own
any patents although we do have patent applications pending. There can be no
assurance that patents will be issued from pending applications, or that claims
allowed on any future patents will be sufficiently broad to protect our
technology.
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 some 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.
As a result of the existence of a large number and rapid rate of issuance of
new patents in the networking industry, it is not economically practical for a
company of our size to determine in advance whether a product or any of its
components infringe patent rights of others.
From time to time third parties have asserted exclusive patent, copyright
and trademark 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 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. Nortel has also brought suit, on the same or
similar patents, against a number of other networking companies. Foundry has
analyzed the validity of Nortel's claims and believes that Nortel's suit is
without merit. Foundry is committed to vigorously defending itself against
these claims. Irrespective of the merits of the Company's position, we may
35
incur substantial expenses in defending against third party claims. In the
event of a determination adverse to the Company, the Company could incur
substantial monetary liability, and be required to change its business
practices. Either of these could have a material adverse effect on the
Company's financial position, results of operations, or cash flows.
Our stock price has been volatile historically, which may make it more
difficult to resell shares when needed at attractive prices.
The trading price of our common stock has been and may continue to be
subject to wide fluctuations. During the year ended December 31, 2000, the
closing sale prices of our common stock on the Nasdaq Stock Market ranged from
$13.00 to $207.56. During the year ended December 31, 2001, the closing sale
prices of our common stock ranged from $5.80 to $23.50. 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 lawsuits pending against us as indicated
in Item 1 "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 23.5% 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
23.5% of our outstanding common stock as of December 31, 2001. 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's directors
and executive officers, or the prospect of these sales, could adversely affect
the market price of Foundry's 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
36
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.
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 and contract manufacturers are located in Northern
California, an area susceptible to earthquakes. In recent years, the western
United States (and California in particular) has experienced repeated episodes
of diminished electrical power supply. As a result of these episodes, our
contractors' facilities and certain of our operations or facilities may be
subject to "rolling blackouts" or other unscheduled interruptions of electrical
power. As a result of this energy crisis, these contractors may be unable to
manufacture sufficient quantities of our products or they may increase their
service fees. The prospect of such unscheduled interruptions may continue for
the foreseeable 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.
Our independent auditor, Arthur Andersen LLP, has been indicted by the United
States Department of Justice, creating uncertainties for the Company in making
its SEC filings.
On March 14, 2002, the United States Department of Justice obtained an
indictment against Arthur Andersen LLP, the Company's auditors. The indictment
raises a number of uncertainties for the Company. The SEC has announced that it
will continue to accept financial statements audited by Andersen in its SEC
filings, as long as companies obtain certain financial representations from
Andersen concerning audit quality controls for audit reports issued after March
14, 2002. However, if Andersen is convicted, the SEC may bar Andersen from
doing public company audit work, or may refuse to accept financial statements
audited by Andersen in future SEC filings. If financial statements audited by
Andersen are no longer accepted by the SEC, we would have to seek another
auditing firm. The number of auditing firms in the United States with staffing
and capabilities similar to Andersen's is limited. If financial statements
audited by Andersen are no longer accepted by the SEC, it is likely that many
public companies will be seeking alternative auditors at the same time. We may
experience difficulties in obtaining a satisfactory alternative auditor, and
the cost of obtaining the annual audit may increase.
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. A hypothetical 100
basis point decline in short-term interest rates would reduce the annualized
earnings on our $274.7 million of cash equivalents and short-term investments
at December 31, 2001 by approximately $2.7 million. With the exception of a
high-risk $2.5 million minority 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
37
secondary or resale markets to ensure portfolio liquidity. In December 2001,
the Company wrote-off the minority investment as it was determined that the
investment had declined in value and that the decline was other-than temporary.
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's operations denominated in Canadian dollars, 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.
37.1
Item 8. Consolidated Financial Statements And Supplementary Data
FOUNDRY NETWORKS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Report of Independent Public Accountants............................................................... 39
Consolidated Balance Sheets as of December 31, 2000 and 2001........................................... 40
Consolidated Statements of Income for the Years Ended December 31, 1999, 2000 and 2001................. 41
Consolidated Statements of Redeemable Convertible Preferred Stock and Stockholders' Equity (Deficit) as
of December 31, 1999, 2000 and 2001.................................................................. 42
Consolidated Statements of Cash Flows for the Years Ended December 31, 1999, 2000 and 2001............. 43
Notes to Consolidated Financial Statements............................................................. 44
38
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,
2000 and 2001, and the related consolidated statements of income, redeemable
convertible preferred stock and stockholders' equity and cash flows for each of
the three years in the period ended December 31, 2001. 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 of America. 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 financial position of Foundry Networks, Inc. and
subsidiaries as of December 31, 2000 and 2001, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001 in conformity with accounting principles generally accepted
in the United States of America.
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.
/S/ ARTHUR ANDERSEN LLP
San Jose, California
January 21, 2002
39
FOUNDRY NETWORKS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
December 31,
------------------
2000 2001
-------- --------
A S S E T S
Current assets:
Cash and cash equivalents..................................................................... $168,429 $ 98,210
Short-term investments........................................................................ 83,816 176,524
Accounts receivable, net of allowances for doubtful accounts of $4,261 and $6,648 and sales
returns of $1,501 and $1,501 at December 31, 2000 and 2001, respectively..................... 64,573 51,830
Inventories................................................................................... 51,593 43,277
Deferred tax assets........................................................................... 13,715 29,656
Prepaid expenses and other current assets..................................................... 10,693 4,863
-------- --------
Total current assets....................................................................... 392,819 404,360
-------- --------
Property and equipment:
Computers and related equipment............................................................... 6,451 11,493
Leasehold improvements........................................................................ 922 1,477
Furniture and fixtures........................................................................ 503 214
-------- --------
7,876 13,184
Less: Accumulated depreciation................................................................ (3,010) (6,868)
-------- --------
Net property and equipment................................................................. 4,866 6,316
-------- --------
Other long-term assets............................................................................ 781 1,462
-------- --------
Total assets............................................................................... $398,466 $412,138
======== ========
L I A B I L I T I E S A N D S T O C K H O L D E R S' E Q U I T Y
Current liabilities:
Accounts payable.............................................................................. $ 20,432 $ 15,300
Accrued payroll and related expenses.......................................................... 11,130 10,932
Warranty accrual.............................................................................. 2,841 2,499
Other accrued expenses........................................................................ 5,642 4,601
Income taxes payable.......................................................................... -- 1,193
Deferred revenue.............................................................................. 13,405 15,781
-------- --------
Total current liabilities.................................................................. 53,450 50,306
-------- --------
Commitments and contingencies (Note 3)............................................................
Stockholders' equity:
Common stock, $0.0001 par value:
Authorized--300,000,000 shares at December 31, 2001:
Issued and outstanding--118,076,155 and 119,298,814 shares at December 31, 2000 and
2001, respectively.......................................................................... 12 12
Treasury stock................................................................................ (4) (14,996)
Additional paid-in capital.................................................................... 263,176 284,740
Note receivable from stockholder.............................................................. (3,270) (480)
Deferred stock compensation................................................................... (5,580) (1,302)
Cumulative translation adjustment............................................................. 61 351
Retained earnings............................................................................. 90,621 93,507
-------- --------
Total stockholders' equity................................................................. 345,016 361,832
-------- --------
Total liabilities and stockholders' equity................................................. $398,466 $412,138
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
40
FOUNDRY NETWORKS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data)
Year Ended December 31,
--------------------------
1999 2000 2001
-------- -------- --------
Revenue, net.......................................................... $133,522 $377,156 $311,176
Cost of revenue....................................................... 56,612 134,330 158,141
-------- -------- --------
Gross profit....................................................... 76,910 242,826 153,035
-------- -------- --------
Operating expenses:
Research and development........................................... 9,037 27,499 33,947
Sales and marketing................................................ 23,142 67,753 90,786
General and administrative......................................... 4,532 10,493 27,185
Amortization of deferred stock compensation........................ 9,463 6,185 2,708
-------- -------- --------
Total operating expenses....................................... 46,174 111,930 154,626
-------- -------- --------
Income (loss) from operations......................................... 30,736 130,896 (1,591)
Interest income....................................................... 1,886 11,235 8,746
Write-down of minority investment..................................... -- -- 2,500
-------- -------- --------
Income before provision for income taxes.............................. 32,622 142,131 4,655
Provision for income taxes............................................ 9,750 54,010 1,769
-------- -------- --------
Net income............................................................ $ 22,872 $ 88,121 $ 2,886
======== ======== ========
Basic net income per share............................................ $ 0.42 $ 0.80 $ 0.02
======== ======== ========
Weighted average shares used in computing basic net income per share.. 54,929 110,141 117,360
======== ======== ========
Diluted net income per share.......................................... $ 0.20 $ 0.69 $ 0.02
======== ======== ========
Weighted average shares used in computing diluted net income per share 114,835 127,131 125,521
======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
41
FOUNDRY NETWORKS, INC.
CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED
STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
(in thousands)
Redeemable
Convertible
Preferred Notes
Stock Common Stock Treasury Stock Additional Receivable
----------------- --------------- ---------------- Paid-in From
Shares Amount Shares Amount Shares Amount Capital Stockholders
------- -------- ------- ------ ------ -------- ---------- ------------
BALANCES AT DECEMBER 31, 1998....................... 44,975 $ 30,085 55,832 $ 5 -- $ -- $ 6,118 $ (713)
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 from employees........ -- -- (455) -- -- -- (19) 19
Deferred stock compensation...................... -- -- -- -- -- -- 17,270 --
Amortization of deferred stock compensation...... -- -- -- -- -- -- -- --
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)
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 from employees........ -- -- (326) -- -- -- (121) --
Deferred stock compensation...................... -- -- -- -- -- -- 300 --
Amortization of deferred stock compensation...... -- -- -- -- -- -- -- --
Reduction in deferred stock compensation......... -- -- -- -- -- -- (306) --
Tax benefit from stock option exercises.......... -- -- -- -- -- -- 57,858 --
Foreign currency translation adjustments......... -- -- -- -- -- -- -- --
Net income....................................... -- -- -- -- -- -- -- --
------- -------- ------- --- ------ -------- -------- -------
BALANCES AT DECEMBER 31, 2000....................... -- -- 118,076 12 1,200 (4) 263,176 (3,270)
Exercise of stock options for cash............... -- -- 2,525 -- -- -- 6,557 --
Non-cash compensation expense for terminated
Employee........................................ -- -- -- -- -- -- 265 --
Repurchase of common stock from employees........ -- -- (230) -- -- -- (45) --
Common stock issued under Employee Stock
Purchase Plan................................... -- -- 450 -- -- -- 5,856 --
Repurchase of common stock in open market........ -- -- (1,522) -- 1,522 (14,996) -- --
Issuance of stock repurchased from founder....... -- -- -- -- (1,200) 4 -- --
Amortization of deferred stock compensation...... -- -- -- -- -- -- -- --
Reduction in deferred stock compensation......... -- -- -- -- -- -- (1,570) --
Write-down of note receivable from
stockholder..................................... -- -- -- -- -- -- -- 2,790
Tax benefit from stock option exercises.......... -- -- -- -- -- -- 10,501 --
Foreign currency translation adjustments......... -- -- -- -- -- -- -- --
Net income....................................... -- -- -- -- -- -- -- --
------- -------- ------- --- ------ -------- -------- -------
BALANCES AT DECEMBER 31, 2001....................... -- $ -- 119,299 $12 1,522 $(14,996) $284,740 $ (480)
======= ======== ======= === ====== ======== ======== =======
Accumulated Retained Total
Deferred Other Earnings Stockholders'
Stock Comprehensive (Accumulated Equity
Compensation Income Deficit) (Deficit)
------------ ------------- ------------ -------------
BALANCES AT DECEMBER 31, 1998....................... $ (3,964) $ -- $(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 from employees........ -- -- -- --
Deferred stock compensation...................... (17,270) -- -- --
Amortization of deferred stock compensation...... 9,463 -- -- 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....................... (11,771) -- 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 from employees........ -- -- -- (121)
Deferred stock compensation...................... (300) -- -- --
Amortization of deferred stock compensation...... 6,185 -- -- 6,185
Reduction in deferred stock compensation......... 306 -- -- --
Tax benefit from stock option exercises.......... -- -- -- 57,858
Foreign currency translation adjustments......... -- 61 -- 61
Net income....................................... -- -- 88,121 88,121
-------- ----- -------- --------
BALANCES AT DECEMBER 31, 2000....................... (5,580) 61 90,621 345,016
Exercise of stock options for cash............... -- -- -- 6,557
Non-cash compensation expense for terminated
Employee........................................ -- -- -- 265
Repurchase of common stock from employees........ -- -- -- (45)
Common stock issued under Employee Stock
Purchase Plan................................... -- -- -- 5,856
Repurchase of common stock in open market........ -- -- -- (14,996)
Issuance of stock repurchased from founder....... -- -- -- 4
Amortization of deferred stock compensation...... 2,708 -- -- 2,708
Reduction in deferred stock compensation......... 1,570 -- -- --
Write-down of note receivable from
stockholder..................................... -- -- -- 2,790
Tax benefit from stock option exercises.......... -- -- -- 10,501
Foreign currency translation adjustments......... -- 290 -- 290
Net income....................................... -- -- 2,886 2,886
-------- ----- -------- --------
BALANCES AT DECEMBER 31, 2001....................... $ (1,302) $ 351 $ 93,507 $361,832
======== ===== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
42
FOUNDRY NETWORKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended December 31,
------------------------------
1999 2000 2001
-------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income........................................................................ $ 22,872 $ 88,121 $ 2,886
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation..................................................................... 445 1,378 3,858
Amortization of deferred stock compensation...................................... 9,463 6,185 2,708
Provision for allowance for doubtful accounts.................................... 1,269 4,698 9,061
Provision for allowance for sales returns........................................ 1,187 3,734 3,595
Provision for excess and obsolete inventories.................................... 3,827 13,558 24,864
Deferred tax assets.............................................................. (5,220) (5,981) (13,537)
Write-down of minority investment................................................ -- -- 2,500
Write-down of note receivable from stockholder................................... -- -- 2,790
Non-cash compensation expense.................................................... -- -- 265
Tax benefit from stock option exercises.......................................... 866 55,344 8,097
Change in operating assets and liabilities:
Accounts receivable........................................................... (24,781) (44,073) 87
Inventories................................................................... (13,369) (48,408) (16,548)
Prepaid expenses and other assets............................................. (973) (10,134) 5,149
Accounts payable.............................................................. 1,498 12,875 (5,132)
Accrued payroll and related expenses.......................................... 3,201 6,992 (198)
Warranty accrual.............................................................. 1,737 749 (342)
Other accrued expenses........................................................ 3,834 1,629 (1,041)
Income taxes payable.......................................................... 9,925 (9,925) 1,193
Deferred revenue.............................................................. 3,798 9,236 2,376
-------- --------- ---------
Net cash provided by operating activities.................................. 19,579 85,978 32,631
-------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of minority investment................................................... -- -- (2,500)
Purchases of short-term investments............................................... (39,789) (190,486) (354,383)
Maturities of short-term investments.............................................. -- 146,459 261,675
Purchases of property and equipment............................................... (1,045) (5,148) (5,308)
-------- --------- ---------
Net cash used by investing activities...................................... (40,834) (49,175) (100,516)
-------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on capital lease obligations................................... (178) -- --
Proceeds from issuance of common stock............................................ 136,163 10,553 12,417
Repurchases of common stock....................................................... (4) (121) (15,041)
Repayment of notes receivable..................................................... 85 755 --
Net proceeds from issuance of redeemable convertible preferred stock.............. 1,000 -- --
-------- --------- ---------
Net cash provided (used) by financing activities........................... 137,066 11,187 (2,624)
-------- --------- ---------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS.................................... 115,811 47,990 (70,509)
Effect of exchange rate changes on cash........................................... -- 61 290
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR........................................ 4,567 120,378 168,429
-------- --------- ---------
CASH AND CASH EQUIVALENTS, END OF YEAR.............................................. $120,378 $ 168,429 $ 98,210
======== ========= =========
SUPPLEMENTAL CASH FLOW INFORMATION:
Issuance of common stock for notes receivable..................................... $ 146 $ 3,270 $ --
Issuance of common stock in net exercise settlement of warrants................... 30 -- --
Conversion of redeemable convertible preferred stock upon initial public offering. 31,085 -- --
Repurchase of common stock and cancellation of corresponding note receivable...... 19 -- --
Reduction in deferred stock compensation due to employee terminations............. -- 306 1,570
Cash paid for interest............................................................ 166 -- --
Cash paid for income taxes, net of refunds........................................ 4,182 12,169 1,418
The accompanying notes are an integral part of these consolidated financial
statements.
43
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION OF THE COMPANY:
Foundry Networks, Inc. (together with its subsidiaries, collectively the
Company or 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 and Foreign Currency Translation
The Company's consolidated financial statements reflect the operations of
the Company and its wholly-owned subsidiaries in the United States, Barbados,
Brazil, France, Canada, Germany, the Netherlands, United Kingdom, Singapore,
Japan 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. Translation adjustments have not been material
to date and are included as a separate component of stockholders' equity.
Reclassifications
Certain items previously reported in specific financial statement captions
have been reclassified to conform with the December 31, 2001 presentation.
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, minority investment, 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 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.
44
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Foundry accounts for its investments under the provisions 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
2000 and 2001, Foundry's short-term investments, which were stated at amortized
cost and classified as held-to-maturity, consisted of corporate and investment
grade U.S. debt securities and 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
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair 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, 2001
------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
--------- ---------- ---------- ----------
Money market funds.......................... $ 33,135 $ -- $ -- $ 33,135
Commercial paper............................ 58,807 -- -- 58,807
Government securities....................... 149,583 127 (27) 149,683
-------- ---- ---- --------
$241,525 $127 $(27) $241,625
======== ==== ==== ========
Included in cash and cash equivalents....... $ 65,001 $ -- $ -- $ 65,001
Included in short-term investments.......... 176,524 127 (27) 176,624
-------- ---- ---- --------
$241,525 $127 $(27) $241,625
======== ==== ==== ========
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,
---------------
2000 2001
------- -------
Purchased parts............................. $31,975 $20,305
Work-in-process............................. 16,935 22,706
Finished goods.............................. 2,683 266
------- -------
$51,593 $43,277
======= =======
45
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The networking industry is characterized by rapid technological change,
frequent new product introductions, changes in customer requirements, and
evolving industry standards. We regularly monitor inventory quantities on hand
and record a provision for excess and obsolete inventories based primarily on
our estimated forecast of product demand and production requirements for the
next three months. In recent quarters, demand for our products has been
adversely affected as a result of the current recession and reduced
telecommunications and infrastructure capital spending, particularly in the
United States. Consequently, provisions for excess and obsolete inventory in
the amounts of $3.8 million, $13.6 million, and $24.9 million were recorded for
the years ended December 31, 1999, 2000, and 2001, respectively. Inventory
write-offs were approximately $1.6 million in 1999, $4.4 million in 2000, and
$8.9 million in 2001. Approximately $7.8 million and $5.2 million of the
Company's work-in-process inventories were consigned to contract manufacturers'
sites as of December 31, 2000 and 2001, 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 customer credit risk is controlled through credit approvals, credit
limits, continuous monitoring procedures and establishment of an allowance for
potential doubtful accounts when deemed necessary. We record specific
allowances for bad debts when we become aware of a specific customer's
inability to meet its financial obligation to us such as in the case of
bankruptcy filings or deterioration of financial position. Estimates are used
in determining our allowances for all other customers based on factors such as
current trends, the length of time the receivables are past due and historical
collection experience. In determining our allowance for doubtful accounts, we
also consider our agreement with GE Capital, our third party leasing partner,
which allows GE Capital a right of recourse against Foundry for defaults by
customers financed through GE Capital based on certain criteria. We mitigate
some collection risk by requiring most of our customers in the Asian region to
secure lines of credit prior to placing an order with us. During the year ended
December 31, 2001, Foundry provided approximately $9.1 million to increase its
allowance for doubtful accounts receivable to a level deemed necessary by
management to provide for potential uncollectible amounts. Foundry's top ten
customers accounted for 38% and 40% of trade receivables as of December 31,
2000 and 2001, 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
lease term.
Minority Investment
In February 2001, Foundry made a $2.5 million minority investment in a
development stage private company, who is also a customer. Sales to this
customer during 2000 and 2001 were insignificant. Foundry's
46
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
interest in the company is significantly less than 20% and, as such, the
Company does not have the ability to exercise significant influence. In
December 2001, the Company determined that the investment declined in fair
value on an other than temporary basis based on a number of factors including
the value of the most recent round of financing, general market and industry
conditions and the financial condition of and business outlook for the company.
Accordingly, Foundry wrote-down the entire minority investment and recorded the
expense in the accompanying consolidated statement of income for the year ended
December 31, 2001.
Impairment of Long-Lived Assets
The Company accounts for the impairment of long-lived assets pursuant to
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of." Long-lived assets to be held and used are
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of such assets may not be recoverable. Determination
of recoverability is based on an estimate of undiscounted future cash flows
resulting from the use of the asset and its eventual disposition. Measurement
of an impairment loss for long-lived assets that management expects to hold and
use is based on the fair value of the asset. Long-lived assets to be disposed
of are reported at the lower of carrying amount or fair value less costs to
sell. To date, charges recorded by the Company for the impairment of long-lived
assets have not been significant.
Revenue Recognition
General. Foundry's revenue recognition policy follows SEC Staff Accounting
Bulletin (SAB) No. 101, "Revenue Recognition in Financial Statements."
Specifically, Foundry recognizes revenue when persuasive evidence of an
arrangement exists, delivery has occurred, the sales price is fixed or
determinable and collectibility is reasonably assured.
Products. Revenue is generally recorded at the time of shipment when title
and risk of loss passes to the customer, unless we have future obligations for
installation or have to obtain customer acceptance, in which case revenue is
not recorded until such obligations have been satisfied or customer acceptance
has been received. For example, revenue is not recognized when undelivered
products or services are essential to the functionality of delivered products.
At the time revenue is recognized, Foundry establishes an accrual for estimated
warranty expenses associated with its sales, recorded as a component of cost of
revenues. Foundry's standard warranty period extends 12 months from the date of
sale and our warranty accrual represents our best estimate of the amount
necessary to settle future and existing claims on products sold as of the
balance sheet date. Foundry also provides a reserve for estimated customer
returns. In 1999, 2000 and 2001, Foundry recorded a provision for sales returns
equal to $1.2 million, $3.7 million and $3.6 million, respectively, which has
been netted against revenue in the accompanying consolidated statements of
income. This provision is based on our historical returns, analysis of credit
memo data and return policies. Sales to Foundry's resellers do not provide for
rights of return and the contracts with Foundry's original equipment
manufacturers do 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 agreements.
Services. Revenue from customer support services is recognized ratably
over the contractual period, generally one year. Amounts invoiced to customers
in excess of revenue recognized on support contracts are recorded as deferred
revenue until the revenue recognition criteria are met. Revenue from customer
support services accounted for 1.7%, 3.9% and 9.1% for the years ended December
31, 1999, 2000 and 2001, respectively. Revenue for training and installation
services are recognized as services are rendered. Revenue from training and
installation services accounted for less than 1% of total revenue for 1999,
2000 and 2001.
47
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Segment Reporting
SFAS No. 131, "Disclosures About Segments of an Enterprise and Related
Information" was adopted by Foundry in 1997 and 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.
For the year ended December 31, 1999, one customer accounted for 11% of our
net revenue and another customer accounted for 14%. For the years ended
December 31, 2000 and 2001, no customer individually accounted for greater than
10% of our net revenue.
Foundry sells to various countries in North and South America, Europe, Asia,
and Australia. Foundry's foreign offices conduct sales, marketing and support
activities. Foundry's export sales represented 15%, 30% and 35% of net revenue
in 1999, 2000 and 2001, respectively. Sales to individual countries outside of
the United States each represented less than 10% of revenue in 1999, 2000 and
2001.
Advertising Costs
Foundry expenses all advertising costs as incurred. Advertising expenses for
the years ended December 31, 1999, 2000 and 2001 were $2.5 million, $7.7
million and $8.3 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, 1999, 2000 and 2001 and, accordingly, all software development
costs have been charged to research and development expense in the accompanying
statements of income.
Computation of Per Share Amounts
Basic net income per common share and diluted net income per common share
are presented in conformity with SFAS No. 128, "Earnings Per Share" for all
periods presented. Pursuant to SAB No. 98, 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 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.
48
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In accordance with SFAS No. 128, basic net income 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 years
ended December 31, 1999, 2000 and 2001, diluted net income per common share has
been calculated assuming the conversion of all dilutive potential common stock
using the treasury stock method. Certain common stock equivalent shares were
excluded from the calculation of diluted net earnings per share because the
exercise price of these options was greater than the average market price of
the common shares and therefore, the effect would have been anti-dilutive. The
common equivalent shares which were anti-dilutive and therefore, excluded from
the diluted earnings per share computation for the years ended December 31,
2000 and 2001 were 942,000 and 10.4 million shares, respectively. No shares
were excluded from the calculation for 1999.
Year Ended December 31,
------------------------------------
1999 2000 2001
-------- -------- --------
(In thousands, except per share data
Net income ......................................................... $ 22,872 $ 88,121 $ 2,886
Basic:
Weighted average shares of common stock outstanding.............. 71,563 116,259 119,331
Less: Weighted average shares subject to repurchase.............. (16,634) (6,118) (1,971)
-------- -------- --------
Weighted average shares used in computing basic net income per
common share................................................... 54,929 110,141 117,360
======== ======== ========
Basic net income per common share................................... $0.42 $0.80 $0.02
======== ======== ========
Diluted:
Weighted average shares of common stock outstanding.............. 71,563 116,259 119,331
Add: Weighted average dilutive potential common stock............ 43,272 10,872 6,190
-------- -------- --------
Weighted average shares used in computing diluted net income per
common share................................................... 114,835 127,131 125,521
======== ======== ========
Diluted net income per common share................................. $0.20 $0.69 $0.02
======== ======== ========
Stock-Based Compensation
In October 1995, the Financial Accounting Standards Board (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 July 2001, the FASB issued SFAS No. 141, "Business Combinations," and
SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 provides new
guidance on the accounting for a business combination at the date a business
combination is completed. Specifically, it requires use of the purchase method
of accounting for all business combinations initiated after June 30, 2001,
thereby eliminating use of the pooling-of-interests method. SFAS No. 142
establishes new guidance on how to account for goodwill and intangible assets
after a business combination is completed. Among other things, it requires that
goodwill and certain other
49
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
intangible assets with indefinite lives no longer be amortized and will be
tested for impairment at least annually and written down only when impaired.
The Company will follow the requirements of SFAS No. 141 for any future
business acquisitions. The adoption of SFAS No. 142 will not have a material
impact on the Company's financial position, results of operations, or cash
flows.
In October 2001, the FASB issued SFAS No. 144 "Accounting for the Impairment
or Disposal of Long-Lived Assets." SFAS No. 144 supercedes SFAS No. 121 by
requiring that one accounting model be used for long-lived assets to be
disposed of by sale, whether previously held and used or newly acquired and by
broadening the presentation of discontinued operations to include more disposal
transactions. The Statement will be effective for fiscal years beginning after
December 15, 2001. The adoption of SFAS No. 144 will not have a material impact
on the Company's financial position or results of operations.
In April 2001, the Emerging Issues Task Force ("EITF") reached a consensus
on Issue No. 00-25, "Vendor Income Statement Characterization of Consideration
Paid to a Reseller of the Vendor's Products." This issue concluded that certain
consumer and trade sales promotion expenses are presumed to be a reduction of
the selling prices of the vendor's products and therefore, should be
characterized as a reduction of revenue when recognized in the vendor's income
statement. The provisions of this pronouncement are required to be applied
starting with fiscal years beginning after December 15, 2001. The Company will
adopt this pronouncement on January 1, 2002. The adoption of EITF 00-25 will
not have a material impact on operating income, net income, or earnings per
share.
3. COMMITMENTS AND CONTINGENCIES:
Rent expense under operating leases was $0.4 million, $2.5 million and $7.6
million for the years ended December 31, 1999, 2000 and 2001, respectively. At
December 31, 2001, future minimum lease payments under all noncancelable
operating leases are as follows (in thousands):
Operating
Leases
---------
2002................ $ 4,455
2003................ 4,186
2004................ 4,203
2005................ 4,239
2006................ 2,485
Thereafter.......... 6,001
-------
Total lease payments $25,569
=======
50
Litigation
In December 2000, several similar shareholder class action lawsuits were
filed against Foundry and certain of its officers in the United States 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 lawsuits were subsequently consolidated by the Court,
under the caption In re Foundry Networks, Inc. Securities Litigation, Master
File No. C-00-4823-MMC, lead plaintiffs were selected as required by law and
they filed a consolidated amended complaint which alleged violations of federal
securities laws and purported to seek damages on behalf of a class of
shareholders who purchased Foundry's common stock during the period from
September 7, 2000 to December 19, 2000. On October 26, 2001, the Court granted
the Company's motion to dismiss the consolidated amended complaint without
prejudice to amend. On December 13, 2001, attorneys for lead plaintiffs filed a
second amended complaint. The Company has reviewed the second amended complaint
and concluded that it was also without merit. The Company believes the lawsuit
is without merit and intends to defend itself vigorously.
A class action lawsuit was filed on November 27, 2001 in the United States
District Court for the Southern District of New York on behalf of purchasers of
Foundry common stock alleging violations of federal securities laws. Kassin v.
Foundry Networks, Inc. et al., No. 01-CV-10640 (SAS) (S.D.N.Y.), related to
Initial Public Offering Securities Litigation, No. 21 MC 92 (SAS) (S.D.N.Y.).
The case is brought purportedly on behalf of all persons who purchased the
common stock of the Company from September 27, 1999 through December 6, 2000.
The complaint names as defendants, the Company, three of its officers, and
investment banking firms that served as underwriters for the Company's initial
public offering in September 1999. The complaint alleges violations of Sections
11 and 15 of the Securities Act of 1933, and Section 10(b) of the Securities
Exchange Act of 1934, on the grounds that the prospectus incorporated in the
registration statement for the offering failed to disclose, among other things,
that (i) the underwriters had solicited and received excessive and undisclosed
commissions from certain investors in exchange for which the underwriters
allocated to those investors material portions of the shares of the Company's
stock sold in the initial public offering, and (ii) the underwriters had
entered into agreements with customers whereby the underwriters agreed to
allocate shares of the Company's stock sold in the initial public offering to
those customers in exchange for which the customers agreed to purchase
additional shares of the Company's stock in the aftermarket at pre-determined
prices. No specific damages are claimed. We are aware that similar allegations
have been made in lawsuits relating to more than 300 other initial public
offerings conducted in 1999 and 2000. Those cases have been consolidated for
pretrial purposes before the Honorable Judge Shira A. Scheindlin. Defendants'
time to respond to the complaints has been stayed pending plans for further
coordination. Plaintiffs have moved for appointment of lead plaintiff.
Management believes that the allegations in these class action lawsuits
against the Company and its officers are without merit and management intends
to contest them vigorously. However, these litigations are in the preliminary
stage, and their outcome cannot be predicted. The litigation process is
inherently uncertain. If the outcome of the litigation is adverse to the
Company and if, in addition, the Company was required to pay significant
monetary damages in excess of available insurance, its business could be
significantly harmed.
From time to time the Company is subject to legal proceedings and claims in
the ordinary course of business, including claims of alleged infringement of
trademarks, copyrights, patents and other intellectual property rights. In
addition, from time to time, third parties assert patent infringement claims
against the Company in the form of letters, lawsuits and other forms of
communication. 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. Nortel has also
brought suit, on the same or similar patents, against a number of other
networking companies. Foundry has analyzed the validity of Nortel's claims and
believes that Nortel's suit is without merit. Foundry is committed to
vigorously defending itself against these claims. Irrespective of the merits of
the Company's position, we may incur substantial expenses in defending against
third party claims. In the event of a determination adverse to the Company, the
Company could incur substantial monetary liability, and be required
51
to change its business practices. Either of these could have a material adverse
effect on the Company's financial position, results of operations, or cash
flows.
Purchase Commitments
The Company uses two primary contract manufacturers to assemble and test our
circuit boards and backplane products. During the normal course of business, in
order to reduce manufacturing lead times and ensure adequate inventories, the
Company's agreements with these contract manufacturers allow them to procure
long lead-time component inventory on our behalf based upon a rolling
production forecast provided by Foundry with lead times of up to 6 months.
Foundry is contractually obligated to the purchase of long lead-time component
inventory procured by our contract manufacturers in accordance with the
forecast, unless Foundry gives notice of order cancellation at least 30 to 90
days prior to the delivery date. As of December 31, 2001, the Company was
committed to purchase approximately $35.4 million of such inventory over the
next four months. Included in the provision for excess and obsolete inventory
for the year ended December 31, 2001 was $2.1 million related to uncancelable
purchase commitments for excess inventories.
4. COMPREHENSIVE INCOME
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 the changes in equity of
an enterprise except those resulting from stockholder transactions.
Comprehensive income for the year ended December 31, 1999 approximated net
income. Comprehensive income for the years ended December 31, 2000 and 2001 was
$88.2 million and $3.2 million, respectively, including the effects of foreign
currency translation adjustments.
5. 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, 2000 and 2001, components of the Company's
net deferred income tax assets (all current) were as follows (in thousands):
December 31,
---------------
2000 2001
------- -------
Deferred Tax Assets:
Capitalized start-up and organizational costs. $ 269 $ 69
Accrued vacation pay.......................... 766 1,163
Inventories valuation......................... 5,147 12,217
Warranty...................................... 1,534 999
Accounts receivable valuation................. 1,260 5,299
Research and development credits.............. 3,045 4,525
Other temporary differences................... 1,694 5,384
------- -------
Total deferred tax assets................. $13,715 $29,656
======= =======
As of December 31, 2001, the Company's state tax credit carryforwards for
income tax purposes were approximately $4.5 million. If not utilized, the state
tax credit can be carried over to succeeding years until exhausted.
As of December 31, 2000 and 2001, Foundry had no significant deferred tax
liabilities.
52
The provision for income taxes consists of the following components for the
years ended December 31 (in thousands):
1999 2000 2001
------- ------- --------
Current
Federal........... $12,733 $49,069 $ 13,814
Foreign........... -- 108 218
State............. 2,237 10,814 1,274
------- ------- --------
Total......... 14,970 59,991 15,306
Deferred
Federal........... (4,551) (5,302) (11,938)
Foreign and State. (669) (679) (1,599)
------- ------- --------
Total......... (5,220) (5,981) (13,537)
------- ------- --------
Total provision... $ 9,750 $54,010 $ 1,769
======= ======= ========
Income (loss) before provision for income taxes consisted of the following
(in thousands):
December 31,
-----------------------
1999 2000 2001
------- -------- ------
United States $32,622 $141,819 $4,135
International -- 312 520
------- -------- ------
Total..... $32,622 $142,131 $4,655
======= ======== ======
The actual provision (benefit) 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):
1999 2000 2001
-------------- ------------- --------------
Provision at U.S. statutory rate of 35%... $11,418 35.0% $49,746 35.0% $ 1,629 35.0%
State income taxes, net of federal benefit 1,709 5.2% 6,997 4.9% (211) (4.5)%
Change in valuation allowance............. (9,185) (28.2)% -- -- -- --
Research and development credits.......... (893) (2.7)% (2,155) (1.5)% (1,669) (35.9)%
Nondeductible deferred stock compensation. 3,808 11.7% 1,757 1.2% 1,176 25.3%
Foreign Sales Corporation benefit......... (28) -- (2,318) (1.6)% (482) (10.4)%
Other..................................... 2,921 9.0% (17) -- 1,326 28.5%
------- ----- ------- ---- ------- -----
Total.................................. $ 9,750 30.0% $54,010 38.0% $ 1,769 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, $57.9 million and $10.5 million for the years ended December 31,
1999, 2000 and 2001, respectively. Benefits reducing taxes payable amounted to
approximately $55.2 million and $8.1 million for the years ended December 31,
2000 and 2001, respectively. Benefits increasing gross deferred tax assets
amounted to $2.7 million and $2.4 million in the years ended December 31, 2000
and 2001, respectively. 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, 2000 and 2001.
53
6. STOCKHOLDERS' EQUITY:
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.
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, 2001 and 2000, no shares of preferred stock were
outstanding.
Stock Repurchase Program
In January 2001, the Board of Directors authorized a stock repurchase
program to acquire up to a total of 5.0 million shares of its outstanding
common stock in the open market from time to time until January 2002. In
October 2001 Foundry repurchased and retired approximately 1,522,000 shares of
its common stock for an aggregate purchase price of approximately $15.0
million. Foundry has completed its repurchase program and intends to grant the
1,522,000 shares as stock options to employees in the first quarter of 2002.
Common Stock
Foundry had 118,076,155 and 119,298,814 shares of common stock issued and
outstanding at December 31, 2000 and 2001, 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% upon issuance, with the balance vesting ratably each month for the 48
months after issuance. As of December 31, 2000 and 2001, 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.
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 2000 and 2001, 74,415 and 172,585 shares were exercised,
respectively. As of December 31, 2001, 450,000 shares were outstanding.
54
The following shares of common stock have been reserved for future issuance
as of December 31, 2001:
1996 Stock Plan............................ 23,346,063
1999 Directors' Stock Option Plan.......... 1,350,000
1999 Employee Stock Purchase Plan.......... 3,724,769
Nonstatutory stock options to key employees 662,000
2000 Non-Executive Stock Option Plan....... 1,920,305
----------
31,003,137
==========
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. In December 2001, the Company wrote-down the note by $2.8 million
to reflect the adverse impact of the significant decline in the Company's stock
price on the employee's ability to sell the vested stock options at a price at
or above the exercise price as well as general concerns over the collectibility
of the note. The Company determined the fair value of the note was $480,000
based on the fair market value of the Company's stock in December 2001.
Accordingly, the Company recorded compensation expense of $2.8 million on the
accompanying consolidated statement of income for fiscal 2001. The note is
classified as a reduction of stockholders' equity.
1996 Stock Plan
Under Foundry's 1996 Stock Plan (the Plan), the board of directors
authorized the issuance of 56,235,683 shares of common stock to employees and
consultants as of December 31, 2001, 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, 2001, a total of
1,350,000 shares of common stock have 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. In June 2001, the directors received their annual grants
totaling 300,000 stock options at an exercise price of $18.88 per share. As of
December 31, 2001, 975,000 options were outstanding at a weighted average
exercise price of $57.34 per share.
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 purchase
55
common stock to employees and external consultants other than officers and
directors. As of December 31, 2001, a total of 1,920,305 shares of common stock
have been reserved for future issuance, of which 1,833,561 shares were
outstanding at a weighted average exercise price of $11.08 per share.
The following table summarizes stock option activity under all plans during
the three years ended December 31, 2001:
Weighted
Average
Options Exercise
Outstanding Price
----------- --------
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
==========
Granted................. 10,505,050 11.43
Exercised............... (2,525,213) 2.60
Cancelled............... (4,305,757) 37.09
----------
Balance, December 31, 2001. 25,460,623 30.44
==========
As of December 31, 2001, Foundry had issued an aggregate of 66,532,635
shares of common stock to its employees, including 32,940,000 shares issued to
Foundry's four founders. Of the 66,532,635 shares of common stock issued under
all of the Company's stock option plans, 946,285 shares are subject to
repurchase rights at the option of Foundry at $0.10-$54.50 per share upon
cessation of the employees' employment. In 1999, 2000 and 2001, Foundry
repurchased 455,000, 326,188 and 230,132 shares, respectively, of unvested
common stock from employees at $0.03-$4.50 per share. As of December 31, 2001,
an aggregate of 1,578,613 shares were available for future option grants under
all plans.
56
The following table summarizes information about stock options outstanding
and exercisable at December 31, 2001:
Options
Options Outstanding Exercisable
--------------------------------- ----------- ---------
Weighted-
Average Weighted- Weighted-
Remaining Average Average
Number Contractual Exercise Number Exercise
Exercise Prices Outstanding Life Price Exercisable Price
--------------- ----------- ----------- --------- ----------- ---------
$0.03.......... 517,532 4.96 $ 0.03 517,532 $ 0.03
$0.10.......... 63,361 5.91 0.10 63,049 0.10
$0.17.......... 570,311 6.49 0.17 376,719 0.17
$0.33.......... 237,674 6.87 0.33 64,176 0.33
$0.83.......... 531,520 7.07 0.83 369,427 0.83
$1.33.......... 593,150 7.19 1.33 313,422 1.33
$2.67-$4.00.... 1,596,715 7.42 2.70 712,193 2.71
$4.50-$6.30.... 2,547,739 8.00 5.30 1,104,107 5.21
$7.50-$10.95... 2,818,969 9.03 8.31 775,044 7.52
$11.38-$14.85.. 6,277,375 8.89 11.47 3,654,172 11.40
$17.55-$23.50.. 964,000 9.43 20.34 11,458 19.98
$36.88......... 1,067,249 8.91 36.88 321,485 36.88
$56.90-$81.81.. 4,530,278 8.62 66.25 2,151,788 64.68
$85.25-$118.50. 2,719,875 8.32 90.82 1,011,833 91.24
$128.00-$131.00 424,875 8.04 128.30 219,846 128.29
---------- ----------
$0.03-$131.00.. 25,460,623 8.39 30.45 11,666,251 28.09
========== ==========
As of December 31, 1999, there were 14,637,958 options exercisable at a
weighted average exercise price of $4.37 and as of December 31, 2000, there
were 11,214,058 options exercisable at a weighted average exercise price of
$4.75.
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, 2001, a total of 3,724,769
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 2001, 449,578 shares had been purchased under the Purchase Plan at an
average price of $13.03 per share.
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.
These amounts have not been reflected in Foundry's statements of income
because no compensation charge arises when the price of the employees' stock
options equals the market value of the underlying stock at the grant
57
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,
-------------------------
1999 2000 2001
------- ------- ---------
Net income as reported........................ $22,872 $88,121 $ 2,886
Pro forma net income (loss)................... 19,448 10,360 (166,049)
Basic net income per share as reported........ 0.42 0.80 0.02
Pro forma basic net income (loss) per share... 0.35 0.09 (1.41)
Diluted net income per share as reported...... 0.20 0.69 0.02
Pro forma diluted net income (loss) per share. 0.17 0.08 (1.41)
The weighted average fair value of stock options granted under all plans
during 1999, 2000 and 2001 was $2.70, $45.41 and $8.61 per share, respectively.
Pursuant to the provisions of SFAS No. 123, the compensation cost associated
with options granted in 1999, 2000 and 2001 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:
Stock Option Plan Employee Stock Purchase Plan
------------------------- -------------------------------
1999 2000 2001 1999 2000 2001
------- ------- ------- --------- --------- ---------
Average risk free interest rate 5.56% 6.23% 3.84% 5.21% 5.41% 3.36%
Average expected life of option 4 years 4 years 4 years 1.8 years 1.9 years 1.3 years
Dividend yield................. 0% 0% 0% 0% 0% 0%
Volatility of common stock..... 55.0% 80.0% 111.0% 80.0% 80.0% 111.0%
The weighted-average fair value of shares issued under the 1999 Employee
Stock Purchase Plan for 1999, 2000 and 2001 were $7.21, $14.92 and $10.63 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 $17.3 million and $0.3 million in 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. We recorded no additional deferred stock compensation in 2001.
Foundry is amortizing the deferred stock compensation expense over the vesting
period, generally four years. For the years ended December 31, 1999, 2000 and
2001, amortization expense was approximately $9.5 million, $6.2 million and
$2.7 million, respectively. At December 31, 2001, the remaining deferred stock
compensation of approximately $1.3 million will be amortized as follows: $1.1
million in 2002 and $0.2 million 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 $1.6
million of future compensation expense was recaptured in 2001 as a result of
employee terminations.
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 $10,500 in
calendar year 2001. 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.
58
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Supplementary Financial Data (Unaudited)
The following tables set forth our consolidated statement of operations data
for each of the eight quarters ended December 31, 2001, 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,
2000 2000 2000 2000 2001 2001 2001 2001
-------- -------- -------- -------- -------- -------- -------- --------
(in thousands)
Statement of Operations Data
(unaudited):
Revenue, net....................... $ 70,014 $ 88,790 $113,241 $105,111 $82,551 $88,569 $74,654 $ 65,403
Cost of revenue.................... 24,843 30,472 39,538 39,477 38,888 41,318 37,152 40,784
-------- -------- -------- -------- ------- ------- ------- --------
Gross profit................. 45,171 58,318 73,703 65,634 43,663 47,251 37,502 24,619
Operating expenses:................
Research and development........ 3,941 6,393 9,194 7,971 7,900 8,251 8,436 9,360
Sales and marketing............. 10,093 15,028 19,566 23,066 24,817 23,266 22,130 20,573
General and administrative...... 1,818 2,070 2,977 3,628 5,947 5,095 5,290 10,854
Amortization of deferred stock
compensation................... 1,953 1,581 1,382 1,269 1,135 833 592 147
-------- -------- -------- -------- ------- ------- ------- --------
Total operating expenses..... 17,805 25,072 33,119 35,934 39,799 37,445 36,448 40,934
-------- -------- -------- -------- ------- ------- ------- --------
Income (loss) from operations...... 27,366 33,246 40,584 29,700 3,864 9,806 1,054 (16,315)
Interest income.................... 2,041 2,700 3,283 3,211 2,865 2,304 2,023 1,555
Write-down of minority investment.. -- -- -- -- -- -- -- 2,500
-------- -------- -------- -------- ------- ------- ------- --------
Income (loss) before provision for
income taxes...................... 29,407 35,946 43,867 32,911 6,729 12,110 3,077 (17,260)
Income tax (expense) benefit....... (11,321) (13,492) (16,641) (12,556) (2,557) (4,602) (1,169) 6,559
-------- -------- -------- -------- ------- ------- ------- --------
Net income (loss).................. $ 18,086 $ 22,454 $ 27,226 $ 20,355 $ 4,172 $ 7,508 $ 1,908 $(10,701)
======== ======== ======== ======== ======= ======= ======= ========
Basic net income (loss) per share.. $ 0.17 $ 0.21 $ 0.24 $ 0.18 $ 0.04 $ 0.06 $ 0.02 $ (0.09)
======== ======== ======== ======== ======= ======= ======= ========
Diluted net income (loss) per share $ 0.14 $ 0.18 $ 0.21 $ 0.16 $ 0.03 $ 0.06 $ 0.02 $ (0.09)
======== ======== ======== ======== ======= ======= ======= ========
Mar. 31, Jun. 30, Sep. 30, Dec. 31, Mar. 31, Jun. 30, Sep. 30, Dec. 31,
2000 2000 2000 2000 2001 2001 2001 2001
-------- -------- -------- -------- -------- -------- -------- --------
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.......................... 35.5 34.3 34.9 37.6 47.1 46.7 49.8 62.4
----- ----- ----- ----- ----- ----- ----- -----
Gross profit....................... 64.5 65.7 65.1 62.4 52.9 53.3 50.2 37.6
----- ----- ----- ----- ----- ----- ----- -----
Operating expenses:......................
Research and development.............. 5.6 7.2 8.1 7.6 9.6 9.3 11.3 14.3
Sales and marketing................... 14.4 16.9 17.4 21.9 30.0 26.3 29.6 31.5
General and administrative............ 2.6 2.3 2.6 3.5 7.2 5.8 7.1 16.6
Amortization of deferred stock
compensation......................... 2.8 1.8 1.2 1.2 1.4 0.9 0.8 0.2
----- ----- ----- ----- ----- ----- ----- -----
Total operating expenses........... 25.4 28.2 29.3 34.2 48.2 42.3 48.8 62.6
----- ----- ----- ----- ----- ----- ----- -----
Income (loss) from operations............ 39.1 37.5 35.8 28.2 4.7 11.0 1.4 (25.0)
Interest income.......................... 2.9 3.0 2.9 3.1 3.5 2.6 2.7 2.4
Write-down of minority investment........ -- -- -- -- -- -- -- 3.8
----- ----- ----- ----- ----- ----- ----- -----
Income (loss) before provision for income
taxes................................... 42.0 40.5 38.7 31.3 8.2 13.6 4.1 (26.4)
Income tax (expense) benefit............. (16.2) (15.2) (14.7) (11.9) (3.1) (5.2) (1.6) 10.0
----- ----- ----- ----- ----- ----- ----- -----
Net income (loss) ....................... 25.8% 25.3% 24.0% 19.4% 5.1% 8.4% 2.5% (16.4)%
===== ===== ===== ===== ===== ===== ===== =====
59
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(1) Period
----------- ------------ ---------- ------------- ----------
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
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
Year ended December 31, 2001:
Allowance for doubtful accounts 4,261,000 9,061,000 6,674,000 6,648,000
Allowance for sales returns.... 1,501,000 3,595,000 3,595,000 1,501,000
- --------
(1) Deductions for allowance for doubtful accounts refers to write-offs and
deductions for allowance for sales returns refers to actual returns.
Item 9. Change in and Disagreements With Accountants on Accounting and
Financial Disclosure
None.
60
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 2002 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.
61
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. ***
10.7 2000 Non-Executive Stock Option Plan****
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)
99 Audit Representation Letter to the SEC
- --------
* 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.
62
**** Incorporated herein by reference to the exhibit filed with the Company's
Form 10-Q for the quarter ended September 30, 2001 (Commission File No.
000-26689).
***** 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, 2001.
63
INDEX TO EXHIBITS
Number Description
------ -----------
21.1 List of Subsidiaries
23.1 Consent of Arthur Andersen LLP, Independent Public Accountants
99 Audit Representation letter to the SEC