UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 000-26041
F5 NETWORKS, INC.
WASHINGTON | 91-1714307 | |
(State or other jurisdiction of
incorporation or organization) |
(I.R.S. Employer Identification No.) |
401 Elliott Avenue West
Seattle, Washington 98119
(Address of principal executive offices and zip code)
(206) 272-5555
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes [X] No [ ].
Indicate the number of shares outstanding of each of the registrants classes of common stock as of the latest practicable date: 25,608,326 shares of common stock, no par value, as of May 6, 2002.
Page 1 of 20 Pages
F5 NETWORKS, INC.
FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2002
Table of Contents
Page | |||
|
|||
PART I. | FINANCIAL INFORMATION | ||
Item 1. | Financial Statements (unaudited) | ||
Condensed Consolidated Statements of Operations | 3 | ||
Condensed Consolidated Balance Sheets | 4 | ||
Condensed Consolidated Statements of Cash Flows | 5 | ||
Notes to Condensed Consolidated Financial Statements | 6 | ||
Item 2. |
Managements Discussion and Analysis of Financial Condition and Results of Operations
|
10 | |
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | 17 | |
PART II. | OTHER INFORMATION | ||
Item 1. | Legal Proceedings | 18 | |
Item 4. | Submission of Matters to a Vote of Security Holders | 19 | |
Item 6. | Exhibits and Reports on Form 8-K | 19 | |
Signatures | 20 |
2
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
F5 NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited, in thousands except per share data)
Three months ended | Six months ended | |||||||||||||||||
March 31, | March 31, | |||||||||||||||||
|
|
|||||||||||||||||
2002 | 2001 | 2002 | 2001 | |||||||||||||||
|
|
|
|
|||||||||||||||
Net revenues:
|
||||||||||||||||||
Products
|
$ | 20,782 | $ | 19,772 | $ | 41,440 | $ | 37,497 | ||||||||||
Services
|
6,319 | 7,295 | 12,686 | 14,303 | ||||||||||||||
|
|
|
|
|||||||||||||||
Total net revenues
|
27,101 | 27,067 | 54,126 | 51,800 | ||||||||||||||
|
|
|
|
|||||||||||||||
Cost of net
revenues:
|
||||||||||||||||||
Products
|
5,151 | 12,663 | 11,114 | 20,749 | ||||||||||||||
Services
|
2,680 | 3,238 | 5,374 | 6,822 | ||||||||||||||
|
|
|
|
|||||||||||||||
Total cost of net revenues
|
7,831 | 15,901 | 16,488 | 27,571 | ||||||||||||||
|
|
|
|
|||||||||||||||
Gross profit
|
19,270 | 11,166 | 37,638 | 24,229 | ||||||||||||||
|
|
|
|
|||||||||||||||
Operating expenses:
|
||||||||||||||||||
Sales and marketing
|
11,823 | 12,797 | 24,263 | 26,248 | ||||||||||||||
Research and
development
|
4,751 | 4,549 | 8,888 | 9,393 | ||||||||||||||
General and
administrative
|
4,524 | 4,194 | 8,569 | 8,882 | ||||||||||||||
Restructuring
charge
|
| (96 | ) | | 975 | |||||||||||||
Amortization of unearned
compensation
|
114 | 1,595 | 247 | 2,171 | ||||||||||||||
|
|
|
|
|||||||||||||||
Total operating expenses
|
21,212 | 23,039 | 41,967 | 47,669 | ||||||||||||||
|
|
|
|
|||||||||||||||
Loss from
operations
|
(1,942 | ) | (11,873 | ) | (4,329 | ) | (23,440 | ) | ||||||||||
Other income, net
|
273 | 871 | 778 | 1,070 | ||||||||||||||
|
|
|
|
|||||||||||||||
Loss before income
taxes
|
(1,669 | ) | (11,002 | ) | (3,551 | ) | (22,370 | ) | ||||||||||
Provision for income
taxes
|
101 | (2,260 | ) | 290 | (4,697 | ) | ||||||||||||
|
|
|
|
|||||||||||||||
Net loss
|
$ | (1,770 | ) | $ | (8,742 | ) | $ | (3,841 | ) | $ | (17,673 | ) | ||||||
|
|
|
|
|||||||||||||||
Net loss per share basic and
diluted
|
$ | (0.07 | ) | $ | (0.40 | ) | $ | (0.15 | ) | $ | (0.81 | ) | ||||||
|
|
|
|
|||||||||||||||
Weighted average shares basic
and diluted
|
25,203 | 21,917 | 25,041 | 21,796 | ||||||||||||||
|
|
|
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
3
F5 NETWORKS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
March 31, | September 30, | ||||||||||
2002 | 2001 | ||||||||||
|
|
||||||||||
(unaudited) | |||||||||||
ASSETS | |||||||||||
Current assets:
|
|||||||||||
Cash and cash
equivalents
|
$ | 28,403 | $ | 18,321 | |||||||
Investments
|
47,063 | 51,462 | |||||||||
Accounts receivable, net of
allowances of $6,339 and $6,245
|
20,649 | 22,628 | |||||||||
Inventories
|
960 | 2,602 | |||||||||
Other current
assets
|
6,012 | 6,885 | |||||||||
|
|
||||||||||
Total current
assets
|
103,087 | 101,898 | |||||||||
|
|
||||||||||
Restricted cash
|
6,000 | 6,000 | |||||||||
Investments
|
1,560 | | |||||||||
Property and equipment,
net
|
14,293 | 15,496 | |||||||||
Other assets, net
|
1,288 | 1,269 | |||||||||
|
|
||||||||||
Total assets
|
$ | 126,228 | $ | 124,663 | |||||||
|
|
||||||||||
LIABILITIES AND SHAREHOLDERS EQUITY | |||||||||||
Current
liabilities:
|
|||||||||||
Accounts payable
|
$ | 4,197 | $ | 4,460 | |||||||
Accrued liabilities
|
12,605 | 11,517 | |||||||||
Deferred revenue
|
11,650 | 11,031 | |||||||||
|
|
||||||||||
Total current liabilities
|
28,452 | 27,008 | |||||||||
|
|
||||||||||
Long-term
liabilities
|
1,373 | 1,167 | |||||||||
|
|
||||||||||
Total liabilities
|
29,825 | 28,175 | |||||||||
|
|
||||||||||
Commitments and
contingencies:
|
|||||||||||
Shareholders
equity:
|
|||||||||||
Preferred stock, no par value; 10,000
shares authorized, no shares outstanding
|
| | |||||||||
Common stock, no par value; 100,000
shares authorized 25,381 and 24,764
shares issued and outstanding
|
126,877 | 123,393 | |||||||||
Accumulated other comprehensive
income
|
598 | 573 | |||||||||
Unearned
compensation
|
(289 | ) | (536 | ) | |||||||
Accumulated deficit
|
(30,783 | ) | (26,942 | ) | |||||||
|
|
||||||||||
Total shareholders
equity
|
96,403 | 96,488 | |||||||||
|
|
||||||||||
Total liabilities and shareholders
equity
|
$ | 126,228 | $ | 124,663 | |||||||
|
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
4
F5 NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(unaudited, in thousands)
Six months ended | ||||||||||||
March 31, | ||||||||||||
|
||||||||||||
2002 | 2001 | |||||||||||
|
|
|||||||||||
CASH FLOWS FROM OPERATING
ACTIVITIES:
|
||||||||||||
Net loss
|
$ | (3,841 | ) | $ | (17,673 | ) | ||||||
Adjustments to reconcile net loss to
net cash provided by (used
in) operating activities:
|
||||||||||||
Restructuring
charges
|
| 975 | ||||||||||
Provision for asset write
downs
|
551 | 378 | ||||||||||
Loss on sale of
assets
|
| 120 | ||||||||||
Provisions for inventory write
downs
|
(13 | ) | 4,910 | |||||||||
Realized loss on sale of
investments
|
95 | | ||||||||||
Amortization of unearned
compensation
|
247 | 2,171 | ||||||||||
Provision for doubtful accounts and
sales returns
|
3,648 | 8,908 | ||||||||||
Depreciation and
amortization
|
2,829 | 2,386 | ||||||||||
Deferred income
taxes
|
| (3,891 | ) | |||||||||
Changes in operating assets and
liabilities:
|
||||||||||||
Accounts receivable
|
(1,679 | ) | 4,245 | |||||||||
Inventories
|
1,670 | (6,631 | ) | |||||||||
Other assets
|
729 | (2,345 | ) | |||||||||
Accounts payable and accrued
liabilities
|
431 | (6,700 | ) | |||||||||
Deferred revenue
|
592 | (2,537 | ) | |||||||||
|
|
|||||||||||
Net cash provided by (used in) operating
activities
|
5,259 | (15,684 | ) | |||||||||
|
|
|||||||||||
CASH FLOWS FROM INVESTING
ACTIVITIES:
|
||||||||||||
Purchase of
investments
|
(41,048 | ) | (27,633 | ) | ||||||||
Sale of investments
|
43,988 | 38,476 | ||||||||||
Proceeds from the sale of property
and equipment
|
| 90 | ||||||||||
Purchases of property and
equipment
|
(1,525 | ) | (7,232 | ) | ||||||||
|
|
|||||||||||
Net cash provided by investing
activities
|
1,415 | 3,701 | ||||||||||
|
|
|||||||||||
CASH FLOWS FROM FINANCING
ACTIVITIES:
|
||||||||||||
Proceeds from the exercise of stock
options and warrants
|
3,485 | 1,183 | ||||||||||
Repurchase of common
stock
|
| (1,082 | ) | |||||||||
|
|
|||||||||||
Net cash provided by financing
activities
|
3,485 | 101 | ||||||||||
|
|
|||||||||||
Net increase (decrease) in cash and cash
equivalents
|
10,159 | (11,882 | ) | |||||||||
Effect of exchange rate changes on
cash and cash equivalents
|
(77 | ) | (34 | ) | ||||||||
|
|
|||||||||||
Cash and cash equivalents at
beginning of period
|
18,321 | 18,536 | ||||||||||
|
|
|||||||||||
Cash and cash equivalents at end of
period
|
$ | 28,403 | $ | 6,620 | ||||||||
|
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
5
F5 NETWORKS, INC.
(unaudited)
1. The Company and Basis of Presentation:
F5 Networks provides integrated products and services to manage, control and optimize Internet traffic and content. The Companys five core products, the BIG-IP® IP Application Switch & Controller, 3-DNS® Controller, GLOBAL-SITE Controller, EDGE-FX® Cache, and the SEE-IT Network Manager, help manage traffic and content to servers and network devices in a way that maximizes availability and throughput. F5s unique iControl Architecture provides integration and interoperability between its products and also allows its customers to develop integration and operability between the Companys products and other third party products. The Companys solutions address many elements required for successful Internet and Intranet business applications, including high availability, high performance, intelligent load balancing, fault tolerance, security, streamlined manageability, and global data management and content control. By enhancing Internet performance availability and content distribution, the Companys solutions enable its customers and partners to maximize the use of the Internet in their business.
The unaudited condensed consolidated financial statements included herein have been prepared by the Company, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) for interim financial statements. Certain information and footnote disclosures, normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of our financial position as of March 31, 2002, our operating results for the three and six months ended March 31, 2002 and 2001, and our cash flows for the six months ended March 31, 2002 and 2001. The condensed consolidated balance sheet as of September 30, 2001 has been derived from the audited consolidated balance sheet as of that date. These unaudited condensed consolidated financial statements should be read in conjunction with the financial statements and the notes thereto included in the Companys Annual Report on Form 10-K for the fiscal year ended September 30, 2001, filed with the SEC on December 28, 2001.
The results of operations for the interim periods presented are not necessarily indicative of the operating results to be expected for any subsequent interim period or for the full fiscal year or any future periods.
2. Summary of Significant Accounting Policies:
Principles of Consolidation
The consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United Sates of America. The consolidated financial statements include the accounts of the Company and all majority owned subsidiaries. Significant intercompany accounts and transactions have been eliminated in consolidation.
Reclassifications
Certain reclassifications have been made to prior year balances to conform to the current year presentation. These reclassifications had no impact on previously reported net loss, shareholders equity, or total assets. The Company had previously reported cash equivalents and investments on a combined basis, as they are readily convertible to cash without penalty and subject to insignificant risk of change in value. The Company has presented investments separately within current assets and long-term assets based upon maturities and managements intent with regard to those securities.
6
F5 NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Use of Estimates
The preparation of financial statements is in conformity with accounting principles generally accepted in the United States of America and requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Estimates that are particularly susceptible to changes in the near term are the adequacy of allowances for sales returns and bad debt, inventory obsolescence, warranty costs, useful lives of assets and deferred taxes.
Revenue Recognition
The Company recognizes revenue in accordance with the guidance provided under Statement of Financial Accounting Standards (SFAS) No. 48, Revenue Recognition When Right of Return Exists, SEC Staff Accounting Bulleting (SAB) No. 101, Revenue Recognition in Financial Statements, Statement of Position (SOP) No. 97-2, Software Revenue Recognition, and SOP No. 98-9 Modification of SOP No. 97-2, Software Revenue Recognition, with Respect to Certain Transactions.
The Company sells products through resellers, original equipment manufacturers
and other channel partners, as well as directly to end users, under similar
terms. Typically a software license, hardware, installation and customer
support elements are combined into a package with a single bundled price. A
portion of the sales price is allocated to each element of the bundled package
based on their respective fair values when the individual elements are sold
separately. Revenues from the license of software are recognized when the
product has been shipped and the customer is obligated to pay for the product.
When rights of return are present and the Company cannot estimate returns, the
Company recognizes revenue when such rights lapse. Installation revenue is
recognized when the product has been installed at the customers site. Revenues
for customer support are recognized on a straight-line basis over the service
contract term. Sales returns are estimated based on historical experience by
type of product and are recorded at the time revenues are recognized.
Cash Equivalents and Investments
Cash equivalents and short term investments are highly liquid investments,
consisting of investments in money market funds and short-term investments,
which are readily convertible to cash without penalty and subject to
insignificant risk of changes in value. The Companys cash and cash
equivalents and investments balance consists of the following:
March 31,
September 30,
2002
2001
(in thousands)
$
28,403
$
18,321
47,063
51,462
1,560
$
77,026
$
69,783
In December of 2001, the Company purchased, from a third party, approximately 16 million shares of common stock of Artel Solutions Group Holdings Limited (Artel), which represents an approximate 1% ownership percentage. Artel is one of the Companys primary partners in the Asia Pacific Region. The Company paid approximately $1.3 million for the shares, which represented the then fair value of Artels common stock as traded on the Hong Kong Stock Exchange. The Company intends to hold the investment for a period in excess of one year. The investment is considered Available for Sale and is included in the investments in the balance sheet. Subsequent changes in the fair value of the common stock will be reflected as a component of comprehensive income on the balance sheet.
7
F5 NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Concentration of Credit Risk
The Company places its temporary cash investments with five major financial institutions.
The Companys customers are from diverse industries and geographic locations.
The majority of net revenues from international customers are denominated in
U.S. dollars. These international revenues were approximately $9.5 million for
the three months ended March 31, 2002, and $8.9 million for the three months
ended March 31, 2001 and $18.3 million and $16.4 million for the six months
ended March 31, 2002 and March 31, 2001, respectively. One customer
accounted for 9.2% and 4.8% of the Companys accounts receivable balance at
March 31, 2002 and 2001, respectively.
Inventories
Inventories consist of hardware, software and related component parts and are
recorded at the lower of cost or market (as determined by the first-in,
first-out method).
Inventories are comprised of the following:
March 31,
September 30,
2002
2001
(in thousands)
$
1,183
$
3,283
735
1,347
(958
)
(2,028
)
$
960
$
2,602
The Company established an estimated reserve for excess inventory based upon
the Companys forecasted sales projections. Adjustments to this reserve are
reflected as a component of cost of sales.
Comprehensive Loss
The following table sets forth a reconciliation of net loss to comprehensive
loss, net of tax:
Three months ended
Six months ended
March 31,
March 31,
2002
2001
2002
2001
(in thousands)
(in thousands)
$
(1,770
)
$
(8,742
)
$
(3,841
)
$
(17,673
)
145
564
196
(186
)
13
(48
)
(171
)
(162
)
$
(1,612
)
$
(8,226
)
$
(3,816
)
$
(18,021
)
Net Loss Per Share
Basic net loss per share has been computed by dividing the net loss by the weighted average number of common shares outstanding during the period. Diluted net loss per share is computed by dividing net loss by the weighted average number of common and dilutive common stock equivalent shares outstanding during the period. The Company excludes the impact of dilutive common stock equivalent shares from the calculation of diluted net loss per share when the inclusion of such elements would be anti-dilutive.
8
F5 NETWORKS, INC.
The following sets forth the computation of basic and diluted net loss per
share for the three and six months ended March 31, 2002 and 2001 (in thousands,
except per share data):
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Three month ended
Six month ended
March 31,
March 31,
2002
2001
2002
2001
$
(1,770
)
$
(8,742
)
$
(3,841
)
$
(17,673
)
25,203
21,917
25,041
21,796
25,203
21,917
25,041
21,796
$
(0.07
)
$
(0.40
)
$
(0.15
)
$
(0.81
)
2,264
888
2,232
1,432
Recent Accounting Pronouncements
In July of 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 141 Business Combinations which is effective for all business combinations initiated after July 1, 2001. SFAS No. 141, supersedes APB Opinion No. 16, Business Combinations, and FASB Statement No. 38, Accounting for Pre-acquisition Contingencies of Purchased Enterprises and requires that all business combinations be accounted for using the purchase method of accounting. Further, SFAS No. 141 requires certain intangibles to be recognized as assets apart from goodwill if they meet certain criteria and also requires expanded disclosures regarding the primary reasons for consummation of the combination and the allocation of the purchase price paid to the assets acquired and liabilities assumed by major balance sheet caption. We do not believe the standard will have a significant impact on our financial position.
In July of 2001, the FASB issued SFAS No. 142 Goodwill and Other Intangible Assets which is effective for fiscal years beginning after December 15, 2001. SFAS No. 142 supercedes APB Opinion No. 17, Intangible Assets, and addresses financial accounting and reporting for intangible assets acquired individually or with a group of other assets and the accounting and reporting for goodwill and other intangible assets subsequent to their acquisition. Under the model set forth in SFAS No. 142, goodwill is no longer amortized to earnings, but instead be subject to periodic testing for impairment. We do not believe the standard will have a significant impact on our financial position.
In July 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations. FASB 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development, and (or) the normal operation of a long-lived asset, except for certain obligations of lessees. The provisions of FAS 143 will be effective for fiscal years beginning after June 15, 2002, however early application is permitted. We do not believe the standard will have a significant impact on our financial statements.
9
F5 NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
In August 2001, the FASB issued SFAS No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets. This Statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This Statement supersedes FASB Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business. The provisions of FAS 144 will be effective for fiscal years beginning after December 15, 2001. We are currently evaluating the implications of adoption of the standard and anticipate adopting its provisions in fiscal year 2002.
The following Managements Discussion and Analysis of Financial Condition and
Results of Operations should be read in conjunction with our consolidated
financial statements and notes thereto contained in the Companys annual report
on Form-10K filed with the Securities and Exchange Commission on December 28,
2001. Our discussion contains forward-looking statements, within the meaning
of the Private Securities Litigation Reform Act of 1995, based upon current
expectations. These forward-looking statements include, but are not limited
to, statements about our plans, objectives, expectations and intentions and
other statements that are not historical facts. Because these forward-looking
statements involve risks and uncertainties, our actual results and the timing
of certain events could differ materially from those anticipated in these
forward-looking statements as a result of certain factors, including those set
forth under Risk Factors and Business in the Companys Form 10-K for the
fiscal year ended September 30, 2001, and elsewhere in this report.
Overview
F5 Networks, Inc. (F5) is a leading provider of integrated Internet traffic
and content management solutions designed to improve the availability and
performance of Internet-based servers and applications. Our Internet traffic
products monitor and manage local and geographically dispersed servers and
intelligently direct traffic to the server best able to handle a users
request. Our content management products enable network managers to increase
access to content by capturing and storing it at points between production
servers and end-users and ensure that newly published or updated files and
applications are replicated uniformly across all target servers. When combined
with our network management tools, these products help organizations optimize
their network server availability and performance and cost-effectively manage
their Internet infrastructure.
Currently, we derive approximately 65% of our net revenues from sales of the
BIG-IP product line, and we expect to derive a significant portion of our net
revenues from sales of the BIG-IP product line in the future. For the three
months ended March 31, 2002, no individual customer represented more than 10%
of our total net revenues.
Net revenues derived from customers located outside of the United States were
$9.5 million and $9.0 million for the three months ended March 31, 2002 and
2001, respectively. We plan to continue to make significant investments in our
international operations, particularly in the European markets. International
revenues are expected to continue to represent a significant portion of our net
revenues, although we cannot be assured that these revenues as a percentage of
net revenues will remain at their current levels.
We have recorded a total of $8.3 million of stock compensation costs since our
inception through March 31, 2002. These charges represent the difference
between the exercise price and the deemed fair value of certain stock options
granted to our employees and outside directors. These options generally vest
ratably over a four-year period. We are amortizing these costs using an
accelerated method as prescribed by FASB interpretation No. 28 (FIN No. 28)
and have recorded stock compensation amortization of $2.6 million, $2.1
million, and $2.5 million for the years ended
September 30, 2001, 2000, and 1999, respectively and $114,000 and $1.6 million
for the three months ended March 31, 2002 and 2001 respectively.
10
We expect to recognize amortization expense related to unearned compensation of
approximately $443,000, $83,000 and $10,000 during the years ended September
30, 2002, 2003, and 2004, respectively. We cannot guarantee, however, that we
will not accrue additional stock compensation costs in the future.
Critical Accounting Policies and Estimates
F5 Networks discussion and analysis of its financial condition and results of
operations are based upon F5 Networks consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States of America. The preparation of these financial statements
requires the Company to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosure
of contingent assets and liabilities. On an on-going basis, we evaluate our
estimates, including those related to product returns, bad debts, inventories,
investments, intangible assets, income taxes, financing operations, warranty
obligations, contingencies and litigation. We base our estimates on historical
experience and on various other assumptions that are believed to be reasonable
under the circumstances. This analysis then forms the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
We have identified the following as critical accounting policies to our
company: revenue recognition, valuation allowances, warranties, and impairment
of long-lived assets and valuation of deferred tax assets.
Revenue Recognition.
We recognize product revenue upon shipment, net of
estimated returns, provided that collection is determined to be probable and no
significant obligations remain. In some instances, product revenue from
distributors is subject to agreements allowing limited rights of return,
rebates, and price protection. Accordingly, we reduce revenue recognized for
estimated future returns, price protection, and rebates, at the time the
related revenue is recorded. The estimates for returns are adjusted
periodically based upon changes in historical rates of returns, inventory
levels in the distribution channel, and other related factors. The estimates
and reserves for rebates and price protection are based on historical rates.
Accordingly, it is possible that these estimates will change in the future or
that the actual amounts could vary from our estimates and that the amounts of
such changes could seriously harm our business.
We license products with post-contract customer support (PCS). PCS includes
rights to upgrades, when and if available, a limited period of telephone
support, updates, and bug fixes. Statement of Position 97-2 (SOP 97-2),
Software Revenue Recognition, as amended, generally requires revenue earned
on software arrangements involving multiple elements to be allocated to each
element based on the relative fair value of the elements. Typically a software
license, hardware, installation and customer support elements are combined into
a package with a single bundled price. A portion of the sales price is
allocated to each element of the bundled package based on their respective fair
values when the individual elements are sold separately. Revenues from the
license of software, net of an allowance for estimated returns, are recognized
when the product has been shipped and the customer is obligated to pay for the
product. When rights of return are present and the Company cannot estimate
returns, the Company recognizes revenue when such rights lapse. Installation
revenue is recognized when the product has been installed at the customers
site. Revenues for customer support are recognized on a straight-line basis
over the service contract term.
Revenues for customer support are recognized on a straight-line basis over the
service contract term. Consulting services are customarily billed at fixed
rates, plus out-of-pocket expenses, and revenues are recognized when the
consulting has been completed. Training revenue is recognized when the training
has been completed.
Our ordinary payment terms to our domestic customers are net 30 days. Our
ordinary payment terms to our international customers are net 60 days. We have
offered extended payment terms beyond ordinary terms to some customers. For
these arrangements, revenue is recognized when payments become due.
We perform ongoing credit evaluations of our customers financial condition and
generally do not require any collateral. We maintain allowances for potential
credit losses and such losses have been within our expectations.
11
Valuation of Accounts Receivable and Inventories.
Reserve for Doubtful Accounts.
Estimates are used in determining our allowance
for bad debts and are based on our historical collection experience, current
trends, credit policy, specific identification and a percentage of our accounts
receivable by aging category. In determining these percentages, we evaluate
historical write-offs of our receivables, current trends in the credit quality
of our customer base as well as changes in the credit policies.
Reserve for Obsolete/Excess Inventory.
We currently reduce the carrying value
of inventory for estimated obsolescence or unmarketable inventory equal to the
difference between the cost of inventory and the estimated market value based
upon assumptions about future demand and market conditions. If actual market
conditions are less favorable than those projected by management, additional
inventory write-downs may be required.
Warranties.
The Company generally offers warranties for 90 days and one year
depending on whether it relates to hardware or software. Estimated future
warranty obligations related to products are provided by charges to operations
in the period in which the related revenue is recognized. These estimates are
based on historical warranty experience and other relevant information of which
the Company is aware. Our standard warranties require us to repair or replace
defective product returned to us during such warranty period at no cost to the
customer. We record that estimate at the time of sale. While our warranty costs
have historically been within our expectations and the provisions established,
we cannot guarantee that we will continue to experience the same warranty
return rates or repair costs that we have in the past. A significant increase
in product return rates, or a significant increase in the costs to repair our
products, could have a material adverse impact on our operating results for the
period.
Impairment of long-lived assets and valuation of deferred tax assets
. The
Companys long-lived assets include long-term investments and other intangible
assets. At March 31, 2002, the Company had $1.6 million of long-term
investments. The fair value of the long-term investments is dependant on the
performance of the company in which we have invested, as well as volatility
inherent in the external markets for this investment.
As of September 30, 2001, our deferred tax asset of $20.9 million was offset by
a full valuation allowance. Management evaluates the realizability of the
deferred tax assets quarterly and assesses the need for valuation allowances
quarterly. We intend to maintain a full valuation allowance until we reach
sustainable profitability and it is more likely that not that the companys
deferred tax asset will be realized.
Results of Operations (in thousands, except percentages):
Net revenues
. Net revenues consist of sales of our products, which include
software licenses, appliances, and services. Service revenues include revenue
from installation services, service and support agreements provided as
part of the initial product sale, sales of extended and renewed service and
support contracts, consulting services, and training.
12
International net revenues totaled $9.5 million for the three months ended
March 31, 2002 and $9.0 million for the three months ended March 31, 2001.
International revenues represented $18.3 million for the six months ended March
31, 2002 and $16.4 million for the six months ended March 31, 2001. We expect
international sales will continue to represent a significant portion of net
revenues, although we cannot assure you that international sales as a
percentage of net revenues will remain at current levels.
In the future, our average selling prices may decrease as we leverage our
channel model with a greater percentage of sales through resellers and
distributors and, to a lesser extent, due to increased competition. This
decrease in average selling price may have a negative impact on our gross
margin.
Product revenues
. Product revenues increased by 5.1% to $20.8 million for the
three months ended March 31, 2002 from $19.8 million for the same period in the
prior year. Product revenues for the six months ended March 31, 2002 increased
by 10.5% to $41.4 million from $37.5 million for the six months ended March 31,
2001. These increases in revenues were primarily due to a larger quantity of
our products sold through our international indirect sales channels and
additional software revenue. These increases reflect new customers, as well as
repeat sales to existing customers.
Service revenues
. Service revenues decreased by 13.4% to $6.3 million for the
three months ended March 31, 2002 from $7.3 million for the three months ended
March 31, 2001. Service revenues for the six months ended March 31, 2002
decreased by 11.3% to $12.7 million from $14.3 million for the six months ended
March 31, 2001. This decrease was a result of a reduction in maintenance
revenue due to a larger percentage of our international resellers, rather than
F5, providing service and installation to end-users.
Gross Margin (in thousands, except percentages):
Cost of net revenues.
Cost of net revenues consists primarily of hardware
components and outsourced and internal manufacturing costs, fees for
third-party software products integrated into our products, service and support
personnel and an allocation of our facilities and depreciation expenses.
13
Cost of product revenues
. Cost of product revenues decreased by 59.3% to $5.2
million for the three months ended March 31, 2002 from $12.7 million for the
three months ended March 31, 2001 and decreased as a percentage of product
revenues to 24.8% from 64.0% for the same periods. For the six months ended
March 31, 2002, cost of product revenues decreased by 46.4% to $11.1 million
from $20.7 million for the six months ended March 31, 2001 and decreased as a
percentage of product revenues to 26.8% from 55.3% for the same periods. This
decrease for the three and six months ended March 31, 2002 is primarily due to
a $4.9 million charge related to excess inventory recorded in the quarter ended
March 31, 2001 in addition to a decline in component costs and a decrease in
headcount from 19 at March 31, 2001 to 12 at March 31, 2002 due to
manufacturing efficiencies. Certain of our components are subject to
significant price fluctuations based on market supply and demand. In the
future component pricing may increase significantly due to limited supply and
may have a negative impact on our gross margin.
Cost of service revenues
. Cost of service revenues decreased by 17.2% to $2.7
million for the three months ended March 31, 2002 from $3.2 million for the
same period in the prior year. Cost of service revenues decreased as a
percentage of service revenues to 42.4% from 44.4% for the same periods. For
the six months ended March 31, 2002, cost of service revenues decreased by
21.2% to $5.4 million from $6.8 million for the six months ended March 31, 2001
and as a percentage of service revenues to 42.4% from 47.7% for the same
periods. This decrease for the three and six months ended March 31, 2002 is
primarily the result of a decrease in headcount to 83 at March 31, 2002 from 95
at March 31, 2001 due to a larger percentage of our international resellers,
rather than F5, providing service and installation to end-users as well as
improved efficiency.
Operating expenses (in thousands, except percentages):
Sales and marketing
. Our sales and marketing expenses consist primarily of
salaries, commissions and related benefits of our sales and marketing staff,
costs of our marketing programs, including public relations, advertising and
trade shows and an allocation of our facilities and depreciation expenses.
Sales and marketing expenses decreased by 7.6% to $11.8 million for the three
months ended March 31, 2002 from $12.8 million for the same period in the prior
year. For the six months ended March 31, 2002, sales and marketing expenses
decreased by 7.6% to $24.3 million
from $26.2 million for the six months ended March 31, 2001. This decrease was
due primarily to a decrease in marketing co-op and trade show activities. We
have also implemented cost control measures in travel, advertising, general
marketing, and allocated facilities expenses, as well as other discretionary
spending areas.
14
Research and development
. Our research and development expenses consist
primarily of salaries and related benefits for our product development
personnel and an allocation of our facilities and depreciation expenses.
Research and development expenses increased by 4.4% to $4.8 million for the
three months ended March 31, 2002 from $4.5 million for the three months ended
March 31, 2001. This increase was primarily due to an increase in headcount to
142 at March 31, 2002 from 115 at March 31, 2001 related to the development of
new software products. For the six months ended March 31, 2002, research and
development expenses decreased by 5.4% to $8.9 million from $9.4 million for
the six months ended March 31, 2001. This decrease was primarily due to a
reduction in facilities cost based on occupation of a smaller space in the
quarter ended March 31, 2002 than in the same quarter of the prior year. These
decreases were offset by an increase in salaries and benefits expenses related
to the increase in headcount. Our future success is dependent in a large part
on the continued enhancement of our current products and our ability to develop
new, technologically advanced products that meet the sophisticated needs of our
customers. We expect research and development expenses to remain consistent as
a percentage of net revenue in the foreseeable future.
General and administrative
. Our general and administrative expenses consist
primarily of salaries, benefits and related costs of our executive, finance,
information technology, human resource and legal personnel, third-party
professional service fees, and an allocation of our facilities and depreciation
expenses. General and administrative expenses increased by 7.9% to $4.5 million
for the three months ended March 31, 2002 from $4.2 million for the three
months ended March 31, 2001. This increase is primarily due to professional
fees related to defending patents. For the six months ended March 31, 2002,
general and administrative expenses decreased by 3.5% to $8.6 million from $8.9
million for the six months ended March 31, 2001. This decrease was due
primarily to a decrease in facilities expense due to the sublease of one of our
buildings and a decrease in executive salaries.
Other Income and Taxes (in thousands, except percentages):
Other income, net.
Other income, net, consists primarily of interest income,
interest expense, and foreign currency exchange gains and losses. Other
income, net was $273,000 for the three months ended March 31, 2002 and $871,000
for the three months ended March 31, 2001. This decrease is primarily due to
declining interest rates and investment income. For the six months ended March
31, 2002 other income, net totaled $778,000 as compared to $1.1 million for the
six months ended March 31, 2001. This decrease in other income, net, is
primarily due to a
decrease in interest income related to a decrease in interest rates and a
foreign currency gain for the six months ended March 31, 2002 of $218,000
compared to a foreign currency loss of $124,000 for the six months ended March
31, 2001.
15
Income taxes
. Income tax expense of $101,000 and $290,000 for the three and
six months ended March 31, 2002 primarily relates to foreign income taxes
associated with our international operations.
The income tax benefits of $2.3 million and $4.7 million for the three and six
months ended March 31, 2001 reflected the then expected annual effective income
tax rate for the year ended September 30, 2001.
In the fourth quarter of fiscal 2001, however, the changes in the economic
environment caused us to re-evaluate whether it is more likely than not that
the Companys deferred tax asset will be realized. Based upon the weight of
all of the available positive and negative evidence, we recorded a full
valuation allowance to completely offset our deferred tax assets.
Liquidity and Capital Resources (in thousands):
Cash and cash equivalents increased to $28.4 million at March 31, 2002 from
$6.6 million at March 31, 2001, an increase of $21.8 million. Cash provided by
operating activities was $5.3 million for the six months ended March 31, 2002
compared to cash used in operating activities of $15.7 million for the six
months ended March 31, 2001. This increase is primarily the result of reduced
operating loss and accounts receivable and inventory management. Inventory
management remains an area of focus as we balance the need to maintain
strategic inventory levels with the need to ensure competitive lead times. We
expect our cash provided by operating activities may fluctuate in future
periods as a result of fluctuations in our operating results, accounts
receivable collections, inventory management, and the timing of payments, among
other causes.
Cash provided by investing activities was $1.4 million for the three months
ended March 31, 2002 compared to $3.7 million for the same period in the prior
year. The decrease in cash provided by investing activities was primarily due
to the result of cash investment purchases, including the $1.3 million
investment in Artel during December 2001. Cash provided by financing activities
for the three months ended March 31, 2002 was $3.5 million due to stock option
exercises as compared to cash provided by financing activities of $101,000 for
the same period last year.
We expect that our existing cash balances and cash from operations will be
sufficient to meet our anticipated working capital and capital expenditures for
the foreseeable future.
As of March 31, 2002, our principal commitments consisted of obligations
outstanding under operating leases. In April 2000, we entered into a lease
agreement on two buildings for a new corporate headquarters. The lease
commenced in July 2000 on the first building; and the lease on the second
building commenced in October 2000. The lease for both buildings expires in
2012 with an option for renewal. We established a restricted escrow account in
connection with this lease agreement. Under the term of the lease, a $6.0
million irrevocable standby letter of credit is required through November 2012,
unless the lease is terminated before then. This amount has been included
on our balance sheet as of March 31, 2002 as a component of restricted cash.
We have surplus office space of approximately 14,000 square feet, which is
subleased until 2003 and approximately 110,000 square feet, which is subleased
until 2012.
16
Payments Due by Period (in thousands):
Payments Due by Period (in thousands):
Item 2.
Managements Discussion and Analysis of Financial Condition and Results of Operations
Table of Contents
Table of Contents
Three months ended
Six months ended
March 31,
March 31,
2002
2001
2002
2001
(unaudited)
(unaudited)
$
20,782
$
19,772
$
41,440
$
37,497
6,319
7,295
12,686
14,303
$
27,101
$
27,067
$
54,126
$
51,800
76.7
%
73.0
%
76.6
%
72.4
%
23.3
27.0
23.4
27.6
100.0
%
100.0
%
100.0
%
100.0
%
Table of Contents
Three months ended
Six months ended
March 31,
March 31,
2002
2001
2002
2001
(unaudited)
(unaudited)
$
5,151
$
12,663
$
11,114
$
20,749
2,680
3,238
5,374
6,822
$
7,831
$
15,901
$
16,488
$
27,571
$
15,631
$
7,109
$
30,326
$
16,748
$
3,639
$
4,057
$
7,312
$
7,481
24.8
%
64.0
%
26.8
%
55.3
%
42.4
44.4
42.4
47.7
28.9
58.7
30.5
53.2
75.2
36.0
73.2
44.7
57.6
%
55.6
%
57.6
%
52.3
%
Table of Contents
Three months ended
Six months ended
March 31,
March 31,
2002
2001
2002
2001
(unaudited)
(unaudited)
$
11,823
$
12,797
$
24,263
$
26,248
4,751
4,549
8,888
9,393
4,524
4,194
8,569
8,882
(96
)
975
114
1,595
247
2,171
$
21,212
$
23,039
$
41,967
$
47,669
43.6
%
47.3
%
44.8
%
50.7
%
17.5
16.8
16.4
18.1
16.7
15.5
15.8
17.1
(0.4
)
1.9
0.4
5.9
0.5
4.2
78.2
%
85.1
%
77.5
%
92.0
%
Table of Contents
Three months ended
Six months ended
March 31,
March 31,
2002
2001
2002
2001
(unaudited)
(unaudited)
$
(1,942
)
$
(11,873
)
$
(4,329
)
(23,440
)
273
871
778
1,070
(1,669
)
(11,002
)
(3,551
)
(22,370
)
101
(2,260
)
290
(4,697
)
$
(1,770
)
$
(8,742
)
$
(3,841
)
$
(17,673
)
(7.2
)%
(43.9
)%
(8.0
)%
(45.3
)%
1.0
3.2
1.4
2.1
(6.2
)
(40.7
)
(6.6
)
(43.2
)
0.4
(8.3
)
0.5
(9.1
)
(6.6
)%
(32.4
)%
(7.1
)%
(34.1
)%
Table of Contents
Six months ended
March 31,
2002
2001
$
74,635
$
45,305
28,403
6,620
5,259
(15,684
)
1,415
3,701
3,485
101
Table of Contents
Contractual
Less than
1-3
4-5
After 5
Obligations
Total
1 year
Years
Years
years
$
23,448
$
3,648
$
4,672
$
3,542
$
11,586
Other Commercial
Less than
1-3
4-5
After 5
Commitments
Total
1 year
Years
Years
years
$
6,000
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Interest Rate Risk. We do not hold derivative financial instruments in our investment portfolio. The Board of Directors authorized one transaction to purchase and sell publicly traded company options in fiscal 2001. Our cash equivalents consist of high-quality securities, as specified in our investment policy guidelines. The policy limits the amount of credit exposure to any one issue or issuer to a maximum of 20% of the total portfolio with the exception of treasury securities, commercial paper and money market funds, which are exempt from size limitation. The policy limits all short-term investments to mature in two years or less, with the average maturity being one year or less. These securities are subject to interest rate risk and a decrease in interest rates could have an adverse impact on earnings for our investment portfolio. We do not currently hedge against these interest rate exposures.
As of March 31, 2002, our cash equivalents mature within three months and our short-term investments mature, on average, within one year. Therefore, as of March 31, 2002, we believe the reported amounts of cash equivalents and investments to be reasonable approximations of fair value and the market risk arising from our holdings to be minimal. We maintain investment portfolio holdings of various issuers, types, and maturities, the majority of which are corporate bonds and government securities. These securities are generally classified as available for sale and, consequently, are recorded on the balance sheet at fair value with unrealized gains or losses reported as a separate component of accumulated other comprehensive income.
17
Maturing in
Three months or
Three months to
Greater than
March 31, 2002:
less
one year
one year
Total
Fair value
(in thousands)
$
13,193
$
13,193
$
13,193
1.820
%
$
18,350
$
28,713
$
47,063
$
47,063
2.065
%
3.301
%
The following sensitivity analysis presents hypothetical changes of our
investment in Artel Solutions Group Holdings Limited (Artel), classified as
Available for Sale as of March 31, 2002. This modeling technique measures
the hypothetical change in fair values arising from selected hypothetical
changes in the stock price of Artel. We selected stock price fluctuations of
plus or minus 15%, 35%, and 50% based on the historical fluctuation of the
common stock.
Valuation of Security Give X% Increase
Valuation of Security Give X% Decrease in
in Securities Price
Securities Price
Fair Value at
(in thousands)
(in thousands)
3/31/2002
Security
(in thousands)
15%
35%
50%
15%
35%
50%
$
1,560
$
1,794
$
2,106
$
2,340
$
1,326
$
1,014
$
780
Foreign Currency Risk. The majority of our sales and expenses are denominated in U.S. dollars and as a result, we have not experienced significant foreign exchange gains and losses to date. While we have conducted some transactions in foreign currencies during the fiscal year ended September 31, 2001 and the three months ended March 31,2002 and expect to continue to do so, we do not anticipate that foreign exchange gains and losses will be significant. We have not engaged in foreign currency hedging to date, however we may do so in the future.
The Artel investment is considered Available for Sale and is included in investments on the balance sheet. Subsequent changes in the fair value of the common stock will be reflected as a component of comprehensive income in the balance sheet. This investment is subject to foreign currency exchange rate risk.
PART II OTHER INFORMATION
Item 1. Legal Proceedings
The Company is subject to legal proceedings, claims, and litigation arising in the ordinary course of business. While the outcome of these matters is currently not determinable, management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on the Companys consolidated financial position, results of operations, or cash flows.
Reference is made to Item 3, Legal Proceedings in our Annual Report on Form 10-K for the year ended September 30, 2001, filed December 28, 2001 for descriptions of our legal proceedings. We continue to believe that the resolution of these legal proceedings will not have a material, adverse effect on us and there have been no material developments since our 10-K filing.
18
Item 4. Submission of Matters to a vote of Security Holders
The Company held its Annual Meeting of Shareholders on March 7, 2002 to elect
two class III directors. At the Annual Meeting, the following nominees were
elected as follows:
Votes
For
Withheld
19,409,464
1,789,968
20,871,165
328,267
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
(1) Incorporated by reference from Registration Statement on
Form S-1,
File No. 333-75817.
3.1
Second Amended and Restated Articles of Incorporation of the Registration (1)
3.2
Amended and Restated Bylaws of the Registrant (1)
(b) Reports on Form 8-K:
No reports on Form 8-K were filed during the second quarter of fiscal 2002.
19
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on this 8th day of May, 2002.
F5 Networks, Inc.
(Registrant) |
||
|
||
By | ||
/s/ STEVEN COBURN | ||
|
||
Steven Coburn
Chief Financial Officer (Duly Authorized Officer and Principal Financial and Accounting Officer) |
20