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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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, 2004
Commission file number: 000-26689
FOUNDRY NETWORKS, INC.
(Exact name of registrant as specified in its charter)
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Delaware |
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77-0431154 |
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(State or jurisdiction of |
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(I.R.S. Employer |
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incorporation or organization) |
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Identification Number) |
2100 Gold Street
P.O. Box 649100
San Jose, CA 95164-9100
Website: www.foundrynetworks.com
(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
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 þ No o
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. o
Indicate by check mark whether the registrant is an accelerated
filer (as defined in Rule 12b-2 of the
Act). Yes þ No o
The aggregate market value of the registrant’s common
stock, $0.0001 par value per share, held by non-affiliates
of the registrant on June 30, 2004, the last business day
of the registrant’s most recently completed second quarter,
was approximately $1,731,232,640, 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% or 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 138,194,525 shares of the registrant’s
common stock issued and outstanding as of March 7, 2005.
DOCUMENTS INCORPORATED BY REFERENCE
Part III (Items 10-14) incorporates information by
reference from the definitive proxy statement for the 2005
Annual Meeting of Stockholders to be filed hereafter.
FOUNDRY NETWORKS, INC.
TABLE OF CONTENTS
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. 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 the Market Price of Our
Stock.” Readers are cautioned to not 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 “we” or “us” 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 and in other documents
we file from time to time with the Securities and Exchange
Commission, including our Quarterly Reports on Form 10-Q to
be filed in fiscal year 2005. All public reports filed by us
with the Securities and Exchange Commission (SEC) are
available free of charge on our website at
www.foundrynetworks.com or from the SEC at
www.sec.gov as soon as practicable after we file such
reports with the SEC.
Foundry, a Delaware Corporation founded in 1996, is a leading
provider of networking products. We design, develop,
manufacture, market and sell solutions to meet the needs of
high-performance network infrastructures for Layer 2-7 switching
and routing and wired and wireless local area networks (LANs),
metropolitan area networks (MANs), wide area networks (WANs),
and the web. We sell a wide variety of stackable fixed
configuration switches and modular platforms, referred to as
chassis. Our product breadth allows us to offer 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 wireless access points and wiring closets connecting
the desktops together within an 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 data centers and a customer’s network
of web and application servers. 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. 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 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,
transportation, e-commerce, and universities. For enterprises,
we provide a complete end-to-end solution with our
FastIron®, FastIron Edge®, FastIron Workgroup,
IronPointtm,
BigIron®, ServerIron®,
EdgeIrontm,
and
AccessIrontm
product lines. Our enterprise portfolio of products, combined
with our network management and security, meets the needs for
wireless access, wiring closet, data center, WAN access and
campus solutions. Our products support a wide array of
interfaces such as wireless, 10/100 Ethernet, 1 Gigabit
Ethernet (copper and fiber), 10 Gigabit Ethernet, Packet over
SONET and ATM so that our customers can leverage their existing
infrastructures. Our service provider markets include Metro
service providers, Internet service providers, web hosting and
Internet data centers, application service providers, and
Internet exchanges. For service providers, we offer our
high-performance BigIron switches, NetIron® Metro routers,
and ServerIron web switches. Our switching and routing products
can be managed with our IronView® Network Manager products.
We sell our products through a direct sales force, resellers,
and OEM partners. By providing high levels of performance and
intelligence capabilities at competitive price points, we
provide comprehensive solutions to address the growing
enterprise and service provider markets.
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Market Trends and Business Drivers
The Ethernet switching and routing market appears to be poised
for growth. According to the 2005 Ethernet Switch Five Year
Forecast Report, published by an independent research firm,
Dell’Oro, the Ethernet switch market is expected to grow
steadily over the next five years. In addition, Dell’Oro
has projected that 10-Gigabit Ethernet switch port shipments
will double in 2005, 2006, and 2007. Although 10-Gigabit
Ethernet port shipments are expected to double in the coming
years, revenues may grow at a slower rate due to pricing
pressures from increased competition and rapid technological
change.
Foundry Networks was an early leader in bringing 10-Gigabit
Ethernet products to market. Working closely with the Institute
of Electrical and Electronics Engineers standards body for
10-Gigabit Ethernet (IEEE 802.3ae), we delivered what we believe
to be the first Layer 3 10-Gigabit switch in 2001. By focusing
on the more sophisticated features available at Layer 3 of Open
Systems Interconnect (OSI) model for data networking, we
believe we delivered a higher performing 10-GbE solution than
competitors who merely implemented Layer 2 switching. Since the
introduction of our first 10-GbE switch product, we have
continued to bring new 10-GbE products and solutions to market.
Our roster of 10-GbE customers includes banking, university,
manufacturing, motion picture, and service providers across the
globe. In 2004, we successfully brought to market a 10-GbE
switch that implements a 10-GbE WAN physical interface (10-GbE
WAN PHY). The significance of the 10-GbE WAN PHY is that it now
makes pure Ethernet WANs possible. 10-GbE is more than the
highest-speed Ethernet available today. 10-GbE offers the
potential to unify and simplify networking on a global scale
with all the benefits and cost efficiencies of Ethernet.
In addition to the need for high-performance, high-reliability,
and high-availability networking solutions, today’s
enterprises and service providers are facing business drivers
that place new demands on their networks. These drivers include:
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Convergence |
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Mobility |
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Security |
Convergence — Although convergence
primarily refers to using the same network for data, voice, and
video, it also refers to the demands placed on networks that
support mission-critical applications such as accounting, order
fulfillment, and other business processes. As businesses seek to
accommodate network user needs, adding bandwidth alone is not an
adequate solution. Not only have the types of traffic
proliferated, but also different applications have different
needs for levels of network service. This need is addressed by
application switching which is also known as Layer 4-7
switching. Application switches extend their features and
functions by examining data in Layers 4 through 7 of OSI model.
Not only does a Layer 4-7 switch provide benefits such as
optimizing computing resources, it can also provide critical
protection from external threats such as denial of service (DoS)
attacks and address costly nuisances such as unwanted email
solicitations, sometimes called “spam email.” This
business driver fuels demand for additional features and
functions that networks can perform. Supplying these features
and functions has the potential to be a significant
differentiator in the market.
Mobility — Wireless networking is
rapidly gaining acceptance in the market place. Wireless
networking provides many benefits, including coverage of areas
that would be difficult to cable and simplification of changes
when personnel move within an organization. On the horizon,
however, is the larger opportunity of mobility. Whereas wireless
focused on lowering the total cost of ownership, mobility seeks
to enhance return on investment. With advanced features and
functions, mobility will enable businesses to achieve
productivity gains by seamlessly extending productivity tools to
multiple locations. This business driver fuels demand for
integration in wired and wireless networking. A company that has
considerable expertise in switch and routing has a competitive
advantage over providers of wireless devices to the extent that
it can offer a superior integrated solution.
Security — In today’s business
environment, perimeter defenses such as firewalls and intrusion
detection are no longer adequate to address security needs.
Security measures must now take into account internal
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threats, network admission control, anomaly
detection (non-business-related network usage such as music
file sharing), and compliance with policies and regulations.
This business driver fuels demand for secure and highly reliable
networking that can support additional security features and
functions.
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. Key elements of
our strategy include:
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Continue to Deliver Products that Meet the Needs of the
High-End Switching Segment. Our high-performance
Ethernet switches have achieved both commercial success and high
levels of customer satisfaction. We will continue to broaden our
product offerings to meet customer business needs with a full
range of networking products. We will continue to broaden our
high-end enterprise and service provider switch portfolio to
meet the needs for greater bandwidth, more flexible interfaces,
advances in Internet networking protocols, convergence,
mobility, and enhanced security. We intend to continue to offer
value-added feature sets that provide for reliability,
redundancy, ease of use and management of the network, yielding
a higher return on investment with a lower total cost of
ownership. |
We have successfully introduced products that implement
solutions in five strategic areas, and we intend to continue to
enhance our product portfolio in these areas:
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10 Gigabit Ethernet — Our 10GbE solutions have
achieved commercial success in the marketplace and we remain a
leader in 10 Gigabit Ethernet. Our 10GbE customers include
healthcare, government, research, university, and media
organizations. As the boundaries of LANs, MANs and WANs continue
to blur, companies will want to unify networks at a lower cost,
with fewer management and operational requirements. 10GbE is the
logical evolution of Ethernet that delivers the reliability of
optical networks. 10GigE addresses the key concerns facing
businesses today — the continued need for additional
bandwidth while building a reliable network. In 2004, we
expanded the number and types of interface modules available to
the Terathon class of products. These interface modules included
1-Gigabit Ethernet connections and support for Internet Protocol
Verion 6 (IPv6). Also in 2004, we began shipping new 10-Gigabit
Ethernet products in our FastIron Edge and EdgeIron product
lines. Recently in 2005, we announced and began shipping the
FastIron SuperX, a modular switch that provides outstanding port
density in a compact form factor. We also announced that the
FastIron SuperX would be accompanied by BigIron SuperX and
TurboIron SuperX models. These products are designed to
accelerate the adoption of 10-Gigabit Ethernet by offering
attractive price points and high-performance switching and
routing. |
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Mobility — Our wireless product offering, the
IronPoint 200 and IronWare-IP operating system for FastIron Edge
switches, delivers strong security, seamless mobility, enhanced
user policies, centralized management, ease of use, and
integration with our wired networks. The IronPoint 200 offers
enterprises maximum flexibility with optimal controls for
increased productivity and secure deployments. Effective and
efficient management of networking resources is key to cost
containment and reliability. Therefore, we also developed an
IronPoint edition of the IronView Network Manager system to
provide centralized wireless access point management. Our high-
performance FastIron Edge Layer 2/3 switches are wireless LAN
capable. We intend to further develop and support new wireless
networking products. |
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Voice-over-IP (VoIP) — An increasing number of
enterprises are migrating to converged environments in which
voice, video, and data are carried by the same network to take
advantage of valuable business benefits such as reduced costs
and increased productivity. A converged network needs more than
just new devices such as IP telephones or IP video cameras. A
converged environment needs a network foundation that provides
superior performance and high availability. We deliver both the
high-performance networking products in our FastIron Layer 2/3
Enterprise Switches and the tools necessary to configure and
optimize a converged environment with our IronView Network
Manager system. Our adherence to industry and international
standards has been validated by our customers who have
successfully used a wide variety of IP phones and cameras from
different suppliers, including those of our |
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competitors. In 2003, we delivered new FastIron Edge switches
with power-over-Ethernet. This provides customers the technology
needed to power new devices such as IP phones, realize optimal
network performance, and manage network resources. We intend to
further develop and expand our networking and management
offerings for converged environments so that customers will have
more options for efficiencies and productivity. |
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Security — As networking has become an essential part
of nearly all businesses, agencies, and organizations, security
has become an integral part of designing and deploying
today’s networks and data centers. The foundation for our
security model is our reliable, robust, high-performance
security architecture. Our architecture is based on our layered
IronShield Security Model, with advanced device, network, and
service protection features. We intend to evolve IronShield
Security to keep ahead of risks. In the near-term, we intend to
deliver an extension to the IronShield security reference model
that addresses new high-profile security services. Our
IronShield security encompasses network level features that we
have deployed in our full range of Layer 2-7 switches, routers,
and intelligent traffic management devices to implement secure
networks. Since our inception, we have delivered innovative,
effective, and efficient functions and features into our
products to provide network security. We intend to continue our
investment in security and best practices, and to build them
into all of our products. We remain committed to a strategy of
standard-based implementations and product offerings so that our
customers will benefit from ease of use and interoperability. |
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Internet Protocol version 6 (IPv6) — Although interest
in and adoption of IPv6 is gaining momentum in international
markets, the widespread adoption of IPv6 in the
U.S. commercial sector is likely to take several years.
However, the U.S. federal government has made IPv6 a
requirement for its installations. We deliver products that meet
the requirements of IPv6 using a phased approach. In 2004, we
delivered new IPv6 interface modules for the BigIron MG8 and
NetIron 40G. We intend to further develop and deliver IPv6
solutions. |
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Extend Product Offerings with Adjacent Technologies that
Provide High-Value to Customers. In 2004, we introduced
our line of AccessIron WAN aggregation routers. We designed this
solution to meet the needs of businesses and organizations for
T-Carrier, E-Carrier, and T-Carrier-3 interconnection with WAN
services. Such WAN services are typically provided by telephone
carriers. Our AccessIron routers also include Ethernet ports. We
intend to explore additional product offerings in adjacent
technologies that would benefit our installed customer base by
providing ease of management, cost efficiencies, or productivity
gains. |
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Continue to Expand our Metro Router Capabilities to
Address this Growing Market and Deliver a New Level of Price/
Performance. We remain committed to the service provider
and metro provider markets while growing our enterprise
business. As these markets regain momentum and growth, we are
positioned to provide state-of-the-art solutions. We have
product offerings and planned enhancements for Multi-Protocol
Label Switching, Virtual Private LAN Services (VPLS), traffic
engineering (TE) and multiplexing of different services
over Virtual LAN (VLAN). Our superior wire-speed bandwidth and
port density accommodate the most demanding metro area networks
with room for growth. |
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Continue to Leverage our Product Capabilities to Address
Emerging Markets. This includes metropolitan area
networking (MAN), Gigabit Ethernet storage area networking
(SAN), VoIP, and content distribution networks. As noted above,
the key advantages of 1 and 10 Gigabit Ethernet, such as price,
simplicity and ease of use, will allow this technology to
migrate into many new adjacent markets over time. Our strategy
is to position ourself to benefit from acceptance of Gigabit
Ethernet in such environments as 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
focused on network infrastructure and provide complete solutions
to our customers. |
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Continue our Market Leadership Position in Internet
Traffic Management Systems. We believe demand for
Internet traffic management intelligence capabilities will be a
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web-based businesses and Internet service providers and an area
of increasing importance to traditional 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 customers, while
providing a high degree of service reliability. |
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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 a greater worldwide sales
presence. |
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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 on-site hardware repair and replacement,
24-hour, seven days-a-week web and telephone support, parts
depots in strategic global locations, implementation support,
pre-sales service, system software and network management
software updates, and technical documentation updates. |
Sales and Marketing
Our sales strategy includes domestic and international field
sales organizations, domestic and international resellers, OEM
relationships, and marketing programs.
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 works with resellers to assist in
communicating product benefits to end-user customers and
proposing networking solutions. As of December 31, 2004,
our domestic sales organization consisted of 162 sales
representatives and systems engineers.
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. Product fulfillment and first level
support for our international customers are provided by
resellers and integrators. Our international resellers include
Mitsui & Co., Inc., in Japan, Samsung Electronics Co.,
Ltd. in Korea, Shanghai Gentek Corporation, Inc. and Global
Technology Integrator Ltd. in China, and Pervasive Networks Ltd.
and Spot Distribution Ltd. in Europe. Please see “Risk
Factors — Our operations in international markets
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.” As of December 31,
2004, our international field organization consisted of 92 sales
representatives and system engineers who conduct sales,
marketing, and support activities. Our international sales
organization establishes and maintains direct relationships with
resellers, integrators, and end-users. Our export product sales
represented 40% of net product revenues in 2004 and 38% in 2003.
Information on net product sales to customers attributable to
our geographic regions is included in Note 2 of Notes to
Consolidated Financial Statements.
OEM/ Co-Branding. We have an OEM/co-branding relationship
with Hewlett-Packard Company (HP). HP markets and sells our
products on a private label basis through their worldwide sales
forces. Our agreement with HP provides that they may postpone,
cancel, increase or decrease any order prior to shipment without
penalty.
Marketing programs. We have numerous marketing programs
designed to inform existing and potential customers, the press,
industry standard analyst groups, resellers and OEMs, about the
capabilities and benefits of us and our products. Our marketing
efforts also support the sale and distribution of our products
through
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our field organizations and channels. These 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 maintenance of our web site.
Customer Service and Support
Our service and support organization maintains and supports
products sold by our field organization to end-users. We provide
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 provide all customers with our standard one-year hardware and
90-day software warranty. Our standalone switches in the
FastIron Edge, FastIron Workgroup, and EdgeIron product lines
have a five-year hardware warranty. We also have four levels of
customer service offerings to meet specific support needs. Our
Titanium service program provides the most comprehensive support
and includes advance hardware replacement within four hours
delivered by a trained technician for on-site support. Our Gold
service program is targeted towards customers who have trained
internal resources to maintain their network 24x7. Our Gold
program is designed to provide all the tools needed by these
trained resources to maximize the uptime of their network. Our
Silver service program is tailored for customers who typically
purchase spares inventory as part of their overall contingency
plan. Our 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 and
Irvine, California, Boston, Massachusetts, New York City, New
York, Chicago, Illinois, Denver, Colorado, and Herndon,
Virginia. We also have Centers-of-Excellence in London, Hong
Kong, Toronto and Tokyo. These Centers-of-Excellence include
executive briefing centers and serve as major customer
demonstration centers, regional technical support centers, and
equipment depot centers. The Centers-of-Excellence are fully
equipped to demonstrate our product lines. They also support
interoperability testing, provide hands-on training for
customers, and showcase our end-to-end LAN, MAN and WAN
solutions. These Centers-of-Excellence allow us to deliver
superior customer service and expand service offerings to our
rapidly growing worldwide installed base.
Significant Customers
Sales to our ten largest customers accounted for 37% and 44% of
net product revenue for 2004 and 2003, respectively. The loss of
continued orders from any of our more significant customers,
such as the U.S. government or individual agencies within
the U.S. government, Mitsui, or Hewlett Packard, could
cause our revenue and profitability to suffer. Sales to U.S.
government agencies accounted for approximately 27%, 31%, and
15% of our total revenues in 2004, 2003, and 2002, respectively.
Please see “Risk Factors — Although our customer
base has increased, we still depend on large, recurring
purchases from certain significant customers, and a loss,
cancellation or delay in purchases by these customers could
negatively affect our revenue” and “— The
United States government is a significant customer and has been
one key to our financial success. However, government demand is
unpredictable and there is no guarantee of future contract
awards.”
Customers representing 10% or more of net product revenue were
as follows for the years ended December 31:
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Customer A
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Quality Assurance
In 2003, we demonstrated our commitment to quality assurance and
testing by expanding and adding dedicated quality assurance test
labs and facilities. In order to continue to provide the highest
level of customer service, our internal resolution labs were
expanded to approximately twice their previous size.
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Because quality is a priority in all of our operating units, we
have a quality council consisting of interdepartmental leaders
that meet weekly to monitor quality and to drive continuous
improvement. The results of our enhancements are measured by
several metrics, including the number of events reported to
customer support in relation to systems shipped.
Manufacturing
We operate under a modified “turn-key” process,
utilizing strategic manufacturing partners that are ISO 9000
certified and have global manufacturing capabilities. All
designs, documentation, selection of approved suppliers, quality
control, and configuration are performed at our facilities. Our
manufacturing operations consist of quality assurance for
subassemblies and final assembly and test. Our manufacturing
process also includes the configuration of products 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 ensure the quality and reliability of
our products. Our approach to manufacturing provides the
flexibility of outsourcing while maintaining quality control of
products delivered to customers.
We currently have four manufacturing partners. Celestica, Inc.,
located in San Jose, California and Monterey, Mexico, Flash
Electronics, Inc., in Fremont, California, and Proworks Inc,
located in San Jose, California, assemble and test printed
circuit boards. Sanmina-SCI Corp., located in San Jose,
assembles and tests printed circuit boards and our backplane
products. Celestica, Inc., Sanmina-SCI Corp., and Flash
Electronics, Inc. have global manufacturing facilities providing
full back-up capability and local content for foreign sales if
required. We perform all prototype and pre-production
procurement and component qualification with support from our
manufacturing partners. Our agreements with our contract
manufacturers allow them to procure long lead-time component
inventory on our behalf based on a rolling production forecast
provided by us. We may be contractually obligated to purchase
long lead-time component inventory procured by our contract
manufacturers in accordance with our forecasts although we can
generally give notice of order cancellation at least
90 days prior to the delivery date. We also have several
third-party OEMs who manufacture some Foundry-branded products
that we purchase and resell under the Foundry brand.
We design all ASICs, printed circuit boards and sheet metal, and
work closely with semiconductor partners on future component
selection and design support. All materials used in our products
are subject to 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 components from several sources, 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, or subcontracted by, Texas Instruments Inc.,
Fujitsu Ltd., and Broadcom Corp. An alternative supply for these
ASICs would require an extensive development period. Please see
“Risk Factors — We purchase several key
components for our products from sole sources; if these
components are not available, our revenues may 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 businesses. 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.
Our research and development operations involve development
activities that utilize both custom and commercial silicon,
which enables us to quickly bring new products and features to
market. We are currently
9
developing new switching solutions that provide new levels of
performance, scalability, and functionality. We had 197
engineers at the end of 2004, compared to 159 engineers at the
end of 2003. Our research and development expenses were
$43.9 million in 2004, $40.5 million in 2003, and
$34.9 million in 2002, or 11%, 10%, and 12% of net
revenues, respectively.
Competition
We believe the key competitive factors that affect our markets
are technical expertise, pricing, new product innovation,
product features, service and support, brand awareness, and
distribution. Our products have won numerous awards. 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. However, our market
continues to evolve 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, Inc. (Cisco) maintains a dominant position in our
market and several of its products compete directly with ours.
Cisco’s substantial resources and market dominance have
enabled it to reduce prices on its products within a short
period of time following introduction, which reduces 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. We
believe our technology and the purpose-built features of our
products make them unique and allow us to compete effectively
against Cisco and other competitors. Although we believe that we
are currently among the top providers of networking solutions,
there can be no assurance that we will be able to compete
successfully against Cisco, currently the market leader in
network infrastructure solutions.
In addition to Cisco, we compete against Extreme Networks, Inc.,
Juniper Networks, Inc., F5 Networks, Inc., Nortel Networks Ltd.,
Enterasys Networks Inc., 3Com Corp., Huawei Technologies Co.,
Ltd., Force 10 Networks Inc., and Alcatel, among others.
Some 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. As
a result, we anticipate that we will have to continue to adjust
prices on many of our products to stay competitive. Please see
“Risk Factors — Intense competition in the market
for network solutions could prevent us from maintaining or
increasing revenue and sustaining profitability” and
“ — Our gross margins may decline over time and
the average selling prices of our products may decrease as a
result of competitive pressures and other factors.”
Seasonality
General economic conditions have an effect on our business and
financial results. From time to time, the markets in which we
sell our products experience weak economic conditions that may
negatively affect sales. We experience some seasonal trends in
the sale of our products. For example, sales to the
U.S. government are typically stronger in the third
calendar quarter and sales to European customers tend to be
weaker in the summer months.
Backlog
Our backlog generally represents orders for which a purchase
order has been received for product to be shipped within
90 days to customers with approved credit status. Orders
are subject to cancellation, rescheduling or product
specification changes by the customers. Although we believe that
our backlog is firm, orders may be cancelled by the customer
without penalty. For this reason, we believe our backlog at any
given date is not a reliable indicator of future revenues.
10
Intellectual Property
Our success and ability to compete are heavily dependent on our
internally developed technology and know-how. Our proprietary
technology includes our ASICs, our IronCore, JetCore, and
Terathon hardware architecture, our IronWare software, our
IronView network management software, and certain mechanical
designs. Different variations and combinations of these
proprietary technologies are implemented across our product
offerings. We rely on a combination of patent, copyright,
trademark, and trade secret laws, as well as contractual
restrictions on disclosure, to protect our intellectual property
rights in these proprietary technologies.
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,
imitate, 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 in which the laws may not
protect our proprietary rights as fully as in the United States.
The networking industry is increasingly characterized by the
existence of a large number of patents, frequent claims of
infringement, and related litigation regarding patent and other
intellectual property rights. In addition, leading companies in
the networking market may have extensive patent portfolios. As a
result of the existence of a large number of patents and rapid
rate of issuance of new patents in the networking industry, it
is practically impossible for a company to determine in advance
whether a product or any of its components may infringe
intellectual property rights that may be claimed by others. See
Item 3 “Legal Proceedings” below for pending
litigation related to intellectual property matters and
“Risk Factors — We may be subject to litigation
risks and intellectual property infringement claims that are
costly to defend and could limit our ability to use certain
technologies in the future. Additionally, we may be found to
infringe on intellectual property rights of others.”
Employees
As of December 31, 2004, we had 658 employees, consisting
of 332 in sales, customer service and marketing, 197 in
engineering, 81 in manufacturing, and 48 in general and
administrative. None of our employees is represented by a labor
union, with the exception of several foreign employees who are
required by local country employment laws to have labor union
representation. We have never experienced a work stoppage and
believe our employee relations are good.
Our headquarters for corporate administration, research and
development, sales and marketing, and manufacturing currently
occupy approximately 110,000 square feet of leased space in
San Jose, California. We also lease space in various other
geographic locations, domestically and internationally, for
sales and service personnel. In addition to smaller sales
offices, we have regional offices under lease agreements in the
following locations:
| |
|
|
|
|
| Americas |
|
EMEA |
|
APAC |
| |
|
|
|
|
|
San Jose, California
|
|
London, England |
|
Tokyo, Japan |
|
Irvine, California
|
|
Munich, Germany |
|
Singapore |
|
Salt Lake City, Utah
|
|
Paris, France |
|
Hong Kong |
|
Chicago, Illinois
|
|
Amsterdam, Netherlands |
|
Sydney, Australia |
|
Fort Lauderdale, Florida
|
|
Milan, Italy |
|
Beijing, China |
|
New York City, New York
|
|
|
|
|
|
Herndon, Virginia
|
|
|
|
|
|
Toronto, Canada
|
|
|
|
|
11
We intend to expand our existing facilities during 2005 and
believe that suitable additional or substitute space will be
available as needed to accommodate this expansion and for any
additional sales offices that may be needed. Our principal web
server equipment and operations are maintained in our corporate
headquarters in San Jose, California.
|
|
| Item 3. |
Legal Proceedings |
On October 25, 2004, we entered into a settlement agreement
and patent cross-license (the agreements) covering technologies
that were at issue in litigation with Nortel Networks (Nortel).
The agreements resolved ongoing litigation in both Massachusetts
and California. Pursuant to the agreements, we paid
$35.0 million to Nortel in early November 2004 and, based
on the results of a third-party valuation analysis, we recorded
an operating expense of $30.2 million in the third quarter
of 2004. The remaining $4.8 million paid to Nortel
represents consideration for a four-year cross-license with
Nortel.
Another long-standing litigation matter was resolved on
February 10, 2005, when the Ninth Circuit Court of Appeals
(Court of Appeals) dismissed the plaintiff’s appeal In
re Foundry Networks, Inc. Securities Litigation. The
dismissal was in response to plaintiff’s motion to dismiss
their appeal of the District Court judgment in favor of us. This
litigation began in December 2000, when several similar
stockholder class action lawsuits were filed against us and
certain of our officers in the United States District Court for
the Northern District of California, following our announcement
of our anticipated financial results for the fourth quarter
ended December 31, 2000. The District Court had dismissed
the case with prejudice and entered judgment in our favor, after
which the plaintiffs filed a Notice of Appeal with the Court of
Appeals. Oral argument before the Court of Appeals was scheduled
for February 17, 2005. However, on February 9, 2005,
plaintiffs filed their unopposed motion of dismissal of their
appeal, making the District Court’s judgment final. No
settlement was paid in the action. We believe the dismissal
validates our position that the lawsuit was without merit.
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 our common stock alleging
violations of federal securities laws. The case was designated
as In re Foundry Networks, Inc. Initial Public Offering
Securities Litigation, No. 01-CV-10640 (SAS)
(S.D.N.Y.), related to In re 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 our common stock from September 27, 1999 through
December 6, 2000. The operative amended complaint names as
defendants us and three of our officers (Foundry Defendants),
including our Chief Executive Officer and Chief Financial
Officer; and investment banking firms that served as
underwriters for our initial public offering in September 1999.
The amended complaint alleged 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
registration statement for the initial public offering
(IPO) failed to disclose that (i) the underwriters
agreed to allow certain customers to purchase shares in the IPO
in exchange for excess commissions to be paid to the
underwriters, and (ii) the underwriters arranged for
certain customers to purchase additional shares in the
aftermarket at predetermined prices. The amended complaint also
alleges that false or misleading analyst reports were issued.
Similar allegations were made in lawsuits challenging over 300
other initial public offerings conducted in 1999 and 2000. The
cases were consolidated for pretrial purposes. On
February 19, 2003, the Court ruled on all defendants’
motions to dismiss. In ruling on motions to dismiss, the Court
must treat the allegations in the complaint as if they were true
solely for purposes of deciding the motions. The motion was
denied as to claims under the Securities Act of 1933 in the case
involving us. The same ruling was made in all but 10 of the
other cases. The Court dismissed the claims under
Section 10(b) of the Securities Exchange Act of 1934
against us and one of the individual defendants and dismissed
all of the Section 20(a) “control person”
claims. The Court denied the motion to dismiss the
Section 10(b) claims against our remaining individual
defendants on the basis that those defendants allegedly sold our
stock following the IPO, allegations found sufficient purely for
pleading purposes to allow those claims to move forward. A
similar ruling was made with respect to 62 individual defendants
in the other cases. We have accepted a settlement proposal
presented to all issuer defendants. Under the terms of this
settlement, plaintiffs will dismiss and release all claims
against the Foundry Defendants in exchange for a contingent
payment by the insurance companies collectively responsible for
insuring the issuers in all of the IPO cases and for the
12
assignment or surrender of control of certain claims we may have
against the underwriters. The settlement will require approval
of the Court, which cannot be assured, after class members are
given the opportunity to object to the settlement or opt out of
the settlement.
In May 2003, Lucent Technologies Inc. (Lucent) filed a lawsuit
against us in the United States District Court for the District
of Delaware alleging that certain of our products infringe
several of Lucent’s patents, and seeking injunctive relief,
as well as unspecified damages. Lucent also brought suit on the
same patents (and one additional patent) against one of our
competitors. On February 6, 2004, the District Court
severed the two cases. Fact discovery is now closed. A Markman
claim construction hearing was held on January 14, 2005,
and the parties are awaiting the Court’s claim
construction. On February 28, 2005, the parties filed
summary judgment motions. Trial in the matter is expected to
begin in November 2005. The severed trial, to which we are not a
party, is scheduled to begin April 26, 2005. We have
analyzed the validity of Lucent’s claims and believe that
Lucent’s suit is without merit. We are committed to
vigorously defending ourselves against Lucent’s claims.
On February 13, 2004, we filed a lawsuit against Lucent in
the United States District Court, Eastern District of Texas,
Marshall Division. The lawsuit alleges that certain of
Lucent’s products infringe one of our patents. We are
seeking injunctive relief and damages. On March 22, 2004,
Lucent filed an Answer and Counter Claim seeking a declaration
of invalidity as to our asserted patent. On April 9, 2004,
Lucent filed an Amended Answer and Counter Claim asserting
infringement of U.S. patent #5649131. We have analyzed
the validity of Lucent’s counter claim and believe it is
without merit. Discovery has begun and is scheduled to close on
June 17, 2005. A Markman claims construction hearing is
scheduled for March 24, 2005. Trial is scheduled to begin
August 1, 2005.
From time to time, we are subject to other legal proceedings and
claims in the ordinary course of business, including claims of
alleged infringement of trademarks, copyrights, patents and
other intellectual property rights. From time to time, third
parties assert patent infringement claims against us in the form
of letters, lawsuits and other forms of communication. In
addition, from time to time, we receive notification from
customers claiming that they are entitled to indemnification or
other obligations from us related to infringement claims made
against them by third parties. Regardless of the merits of our
position, litigation is always an expensive and uncertain
proposition. In accordance with SFAS No. 5,
“Accounting for Contingencies” (SFAS 5), we
record a liability when it is both probable that a liability has
been incurred and the amount of the loss can be reasonably
estimated. We review the need for any such liability on a
quarterly basis and record any necessary adjustments to reflect
the effect of ongoing negotiations, settlements, rulings, advice
of legal counsel, and other information and events pertaining to
a particular case in the period they become known. At
December 31, 2004, we have not recorded any such
liabilities in accordance with SFAS 5. We believe we have
valid defenses with respect to the legal matters pending against
us. In the event of a determination adverse to us, we could
incur substantial monetary liability and be required to change
our business practices. Any unfavorable determination could have
a material adverse effect on our 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 2004.
PART II
|
|
| Item 5. |
Market For Registrant’s Common Equity, Related
Stockholder Matters, and Issuer Purchases of Equity
Securities |
Price Range of Common Stock
Foundry’s common stock began trading on the Nasdaq National
Market on September 28, 1999 and is traded under the symbol
“FDRY”. As of December 31, 2004, there were
approximately 356 holders of record
13
of the common stock. The following table sets forth the high and
low closing sale prices of our common stock as reported on the
Nasdaq National Market.
| |
|
|
|
|
|
|
|
|
| |
|
High | |
|
Low | |
| |
|
| |
|
| |
|
2004
|
|
|
|
|
|
|
|
|
|
Fourth quarter
|
|
$ |
13.96 |
|
|
$ |
9.91 |
|
|
Third quarter
|
|
$ |
13.57 |
|
|
$ |
8.50 |
|
|
Second quarter
|
|
$ |
18.84 |
|
|
$ |
11.30 |
|
|
First quarter
|
|
$ |
33.75 |
|
|
$ |
15.80 |
|
|
2003
|
|
|
|
|
|
|
|
|
|
Fourth quarter
|
|
$ |
27.68 |
|
|
$ |
21.88 |
|
|
Third quarter
|
|
$ |
23.77 |
|
|
$ |
15.25 |
|
|
Second quarter
|
|
$ |
16.00 |
|
|
$ |
7.92 |
|
|
First quarter
|
|
$ |
10.13 |
|
|
$ |
7.39 |
|
Dividend Policy
We have never paid cash dividends on our capital stock. We
currently anticipate that we will retain our future earnings, if
any, and therefore do not expect to pay cash dividends in the
foreseeable future.
Unregistered Securities Sold in 2004
We did not sell any unregistered shares of our common stock
during 2004.
Issuer Purchases of Equity Securities
We do not have a stock repurchase program and did not repurchase
any of our equity securities during the quarter ended
December 31, 2004.
|
|
| 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.
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
|
2001 | |
|
2000 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(Dollars in thousands, except per share amounts) | |
|
Consolidated Statement of Operations Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues, net
|
|
$ |
409,104 |
|
|
$ |
399,628 |
|
|
$ |
300,742 |
|
|
$ |
311,176 |
|
|
$ |
377,156 |
|
| |
Gross margin
|
|
|
265,681 |
|
|
|
258,770 |
|
|
|
160,550 |
|
|
|
153,035 |
|
|
|
242,826 |
|
| |
Gross margin percentage
|
|
|
65 |
% |
|
|
65 |
% |
|
|
53 |
% |
|
|
49 |
% |
|
|
64 |
% |
|
Income (loss) from operations(1)
|
|
|
63,365 |
|
|
|
112,057 |
|
|
|
27,171 |
|
|
|
(1,591 |
) |
|
|
130,896 |
|
|
Net income(1)
|
|
|
47,967 |
|
|
|
75,082 |
|
|
|
22,537 |
|
|
|
2,886 |
|
|
|
88,121 |
|
|
Basic net income per share(1)
|
|
$ |
0.35 |
|
|
$ |
0.60 |
|
|
$ |
0.19 |
|
|
$ |
0.02 |
|
|
$ |
0.80 |
|
|
Diluted net income per share(1)
|
|
$ |
0.34 |
|
|
$ |
0.55 |
|
|
$ |
0.18 |
|
|
$ |
0.02 |
|
|
$ |
0.69 |
|
14
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
As of December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
|
2001 | |
|
2000 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(In thousands) | |
|
Consolidated Balance Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash, cash equivalents and investments
|
|
$ |
617,441 |
|
|
$ |
505,684 |
|
|
$ |
326,453 |
|
|
$ |
274,734 |
|
|
$ |
252,245 |
|
|
Working capital
|
|
|
519,144 |
|
|
|
430,038 |
|
|
|
390,543 |
|
|
|
354,054 |
|
|
|
339,369 |
|
|
Total assets
|
|
|
811,192 |
|
|
|
658,144 |
|
|
|
451,535 |
|
|
|
412,138 |
|
|
|
398,466 |
|
|
Long-term liabilities
|
|
|
17,613 |
|
|
|
7,707 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
Total stockholders’ equity
|
|
|
706,338 |
|
|
|
590,495 |
|
|
|
398,099 |
|
|
|
361,832 |
|
|
|
345,016 |
|
|
|
| (1) |
2004 includes an operating expense of $18.7 million, net of
tax, related to our litigation settlement with Nortel in the
third quarter of 2004. |
|
|
| 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
our consolidated 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. Our 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 section entitled
“Management’s Discussion and Analysis of Financial
Condition and Results of Operations — Risk Factors
That May Affect Future Results and the Market Price of Our
Stock.” Readers are cautioned to not place undue reliance
on these forward-looking statements, which reflect
management’s opinions only as of the date hereof. We
undertake 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 we file from time to
time with the SEC. All public reports filed by us with the SEC
are available free of charge on our website at
www.foundrynetworks.com or from the SEC at
www.sec.gov as soon as practicable after we file such
reports with the SEC.
Overview
Founded in 1996, Foundry designs, develops, manufactures,
markets and sells a comprehensive, end-to-end suite of high
performance data networking solutions, including Ethernet Layer
2 and Layer 3 switches, Metro routers, and Internet traffic
management products. Our customers include U.S. government
agencies, universities, e-commerce sites, and enterprises such
as healthcare, financial, manufacturing and entertainment
companies, as well as Internet and Metro service providers.
Over the course of the last several years, we believe the
overall global economy has continued to strengthen, and capital
spending on IT infrastructure, particularly data networking
equipment, has also improved. The overall data networking market
grew over 20% during 2004, with significant growth in market
sectors in which we do not have a heavy concentration. During
2004, we saw the early signs of a broad enterprise network
upgrade cycle as customers began to focus on newer technology,
particularly 10-Gigabit Ethernet. There are also indications
that the global carrier and service provider market is beginning
to increase its investment in data networking infrastructure.
The market for data networking products continues to be
dominated by Cisco Systems, Inc., with over 50% share of the
networking market. We continue to invest in our core market and
adjacent markets in which the competitive landscape looks
attractive and the growth prospects are promising. Although we
expect our revenues to grow modestly in 2005, there is no
assurance that the networking market will continue to improve or
that we will be successful in capitalizing on this improvement.
15
|
|
|
2004 Financial Performance |
|
|
|
| |
• |
2004 marked our sixth consecutive year with net income since we
went public in September 1999. |
| |
| |
• |
Our revenues for 2004 increased to $409.1 million, from
$399.6 million in 2003, due to an increase of
$11.8 million in service revenue. Despite increased sales
volume in 2004, our product revenues were nearly flat as a
result of price erosion and a shift in sales mix to lower-priced
stackable products. Our customer base grew to 7,800 customers at
the end of 2004, from 6,500 customers at the end of 2003. |
| |
| |
• |
In October 2004, we entered into a settlement agreement and
patent cross-license agreement with Nortel, pursuant to which we
paid $35.0 million to Nortel and recorded an operating
expense of $30.2 million in the third quarter of 2004. The
remaining amount paid to Nortel represents consideration for a
four-year patent cross-license with Nortel and is being
amortized ratably to cost of product revenue over the license
term. The litigation settlement reduced net income by
$18.7 million, net of tax. |
| |
| |
• |
Net income in 2004 was $48.0 million, or 12% of total net
revenues, compared to $75.1 million, or 19% of total net
revenues, in 2003. In 2004, we expanded our sales organization
and research and development team. This investment in our
infrastructure, as well as a litigation settlement expense of
$30.2 million and related legal fees, reduced our
profitability in 2004. |
| |
| |
• |
Our balance sheet remains debt-free, with cash and investments
of $617.4 million, an increase of $111.8 million from
2003. During 2004, we generated $81.5 million of cash from
operations and received $38.7 million of cash from employee
stock option exercises. |
Critical Accounting Policies and Estimates
Management’s discussion and analysis of financial condition
and results of operations are based on our consolidated
financial statements, which have been prepared in accordance
with U.S. generally accepted accounting principles. The
preparation of these financial statements 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 its estimates and judgments on historical
experience, market trends, current economic conditions, and
other factors that are believed to be reasonable under the
circumstances. The results of these estimates form the basis for
judgments about the carrying value of assets and liabilities
that are not readily apparent from other sources. Actual results
may differ from these estimates under different assumptions or
conditions. Management believes the following critical
accounting policies reflect the more significant judgments and
estimates that can have a significant effect on our results of
operations and the value of certain assets and liabilities on
our consolidated financial statements. Management has discussed
the development, selection, and disclosure of these estimates
with the Audit Committee of Foundry’s Board of Directors.
These and other significant accounting policies are more fully
described in Note 2 to the consolidated financial
statements included in this Form 10-K.
We generate the majority of our revenue from sales of stackable
and chassis-based networking equipment, with the remainder of
our revenue coming from customer support fees, training and
installation services. We recognize revenue when persuasive
evidence of an arrangement exists, delivery or performance has
occurred, the sales price is fixed or determinable, and
collectibility is reasonably assured.
Product revenue is generally recognized upon transfer of title,
unless an acceptance period or other contingency exists, in
which case revenue is recognized upon the earlier of customer
acceptance or expiration of the acceptance period, or upon
satisfaction of the contingency.
16
Support revenue is recognized ratably over the term of the
support arrangement, in accordance with Financial Accounting
Standards Board (FASB) Technical Bulletin 90-1,
“Accounting for Separately Priced Extended Warranty and
Product Maintenance Contracts.”
When sales arrangements contain multiple elements (e.g.,
hardware and installation), we apply the provisions of Emerging
Issues Task Force Issue No. 00-21, “Revenue
Arrangements with Multiple Deliverables” (EITF 00-21)
to determine the separate units of accounting that exist within
the arrangement. If more than one unit of accounting exists, the
arrangement consideration is allocated to each unit of
accounting using either the relative fair value method or the
residual fair value method as prescribed by EITF 00-21.
Revenue is recognized for each unit of accounting when the
revenue recognition criteria described above have been met for
that unit of accounting. The application of EITF 00-21
involves significant judgment. For example, we use judgment to
determine whether objective and reliable evidence of fair value
exists for undelivered item(s) in an arrangement. The timing of
revenue recognition varies based on this determination.
At the time product revenue is recognized, we estimate the
amount of warranty costs to be incurred and record the amount as
a cost of revenue. Our standard warranty period generally
extends 12 months from the date of sale for hardware and
90 days for software, and our estimate of the amount
necessary to settle warranty claims is based primarily on our
past experience. Although we believe our estimate is adequate
and that the judgment we apply is appropriate, actual warranty
costs could differ materially from our estimate. If actual
warranty costs are greater than initially estimated, our cost of
revenues could increase in the future. We also provide a
provision for estimated customer returns at the time product
revenue is recognized. Our provision is based primarily on
historical sales returns and our return policies. Our resellers
generally do not have a right of return, and our contracts with
original equipment manufacturers only provide for rights of
return in the event our products do not meet specifications or
there is an epidemic failure, as defined in the contracts. If
historical data used by us to calculate estimated sales returns
does not reasonably approximate future returns, revenue in
future periods could be affected.
|
|
|
Allowance for Doubtful Accounts |
Customers are subject to a credit review process, which
evaluates the customer’s financial condition and ability to
pay, and are generally assigned a credit limit that may be
increased only after a successful collection history has been
established. We continually monitor and evaluate the
collectibility of our trade receivables and actively manage our
accounts receivable to minimize credit risk. We record specific
allowances for doubtful accounts 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
significant deterioration in financial condition. We estimate
allowances for doubtful accounts for all other customers based
on factors such as current economic and industry trends, the
extent to which receivables are past due, and historical
collection experience. If circumstances change, estimates
regarding the collectibility of receivables would be adjusted.
We mitigate some collection risk by requiring certain
international customers to provide letters of credit or bank
guarantees prior to placing an order with us. Although we
believe our allowance for doubtful accounts is adequate and that
the judgment we apply is appropriate, our actual amount of bad
debt could differ materially from our estimates.
The networking industry is characterized by rapid technological
change, frequent new product introductions, changes in customer
requirements, and evolving industry standards. Our inventory
purchases and commitments are made based on anticipated demand
for our products, as estimated by management, and our expected
service requirements. We perform an assessment of our inventory
each quarter, which includes a review of, among other factors,
demand requirements, manufacturing lead-times, product life
cycles and development plans, product pricing and quality
issues. Based on this analysis, we estimate the amount of excess
and obsolete inventory on hand and make adjustments to record
inventory at the lower of cost or estimated net realizable
value. Once inventory has been written down to the lower of cost
or estimated net realizable value, it is reflected on our
balance sheet at its new carrying cost until it is sold or
otherwise disposed.
17
We use contract manufacturers to assemble and test our products.
We also utilize third-party OEMs to manufacture certain
Foundry-branded products. In order to reduce manufacturing
lead-times and ensure an adequate supply of inventories, our
agreements with some of these manufacturers allow them to
procure long lead-time component inventory on our behalf based
on rolling production forecasts provided by us. We may be
contractually obligated to purchase long lead-time component
inventory procured by certain manufacturers in accordance with
our forecasts although we can generally give notice of order
cancellation at least 90 days prior to the delivery date.
In addition, we issue purchase orders to our component suppliers
that may not be cancelable at any time. As of December 31,
2004, we had approximately $40.0 million of open purchase
orders with our component suppliers and third-party
manufacturers that may not be cancelable. If actual demand for
our products is below the level assumed in our production
forecasts, we may have excess inventory or a liability as a
result of our purchase commitments.
|
|
|
Deferred Tax Asset Valuation Allowance |
We recognize deferred tax assets based on differences between
the financial statement carrying amounts and the tax bases of
assets. We record a valuation allowance to reduce our deferred
tax assets to the amount that is more likely than not to be
realized. Significant management judgment is required in
determining whether valuation allowances should be recorded
against our deferred tax assets. Management assesses the
likelihood that our deferred tax assets will be realized against
projected future taxable income or our ability to generate
taxable income from specific sources, and to the extent that
realization is not believed to be more likely than not, a
valuation allowance is established. In the event we determine
that we are unable to realize some or all of our deferred tax
assets in the future, an adjustment to our deferred tax assets
would be necessary, resulting in a charge to income in the
period such determination is made. Likewise, if we later
determine that it is more likely than not that our deferred tax
assets would be realized, the previously provided valuation
allowance would be reversed. Our net deferred tax assets as of
December 31, 2004 and 2003 were $42.3 million and
$33.3 million, respectively.
We are subject to the possibility of loss contingencies in the
normal course of our business, including those related to
intellectual property and securities litigation. A loss
contingency is accrued when it is probable that a liability has
been incurred and the amount of loss can be reasonably
estimated. We continually reassess the likelihood of any adverse
judgments or outcomes to our contingencies, as well as potential
ranges of probable losses, and will recognize a liability, if
any, for these contingencies based on a careful analysis of each
issue with the assistance of outside legal counsel and other
experts.
Recent Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123
(revised 2004), “Share-Based Payment”
(SFAS 123R), which replaces SFAS No. 123,
“Accounting for Stock-Based Compensation”
(SFAS 123) and supercedes APB Opinion No. 25,
“Accounting for Stock Issued to Employees.”
SFAS 123R also amends SFAS No. 95,
“Statement of Cash Flows,” to require that tax
benefits from stock option exercises be classified as a
financing activity, instead of an operating activity, on the
statement of cash flows. SFAS 123R requires all share-based
payments to employees, including grants of employee stock
options, to be recognized in the financial statements based on
their fair values, beginning with the first interim or annual
period after June 15, 2005. The pro forma disclosures
previously permitted under SFAS 123 will no longer be an
alternative to financial statement recognition. We are required
to adopt SFAS 123R in our third quarter of 2005, beginning
July 1, 2005. Under SFAS 123R, we must determine the
appropriate fair value model to be used for valuing share-based
payments, the amortization method for recognizing compensation
cost, and the transition method to be used at the date of
adoption. The transition methods include prospective and
retroactive adoption options. Under the retroactive option,
prior periods may be restated either as of the beginning of the
year of adoption or for all periods presented. The prospective
method requires that compensation expense be recorded for all
unvested stock options and restricted stock at the beginning of
the first quarter of adoption of SFAS 123R, whereas under
the retroactive method we would record compensation
18
expense for all unvested stock options and restricted stock
beginning with the first period restated. We are evaluating the
requirements of SFAS 123R and expect its adoption to have a
material effect on our consolidated results of operations. We
have not yet determined the method of adoption or the effect of
adopting SFAS 123R, nor have we determined whether the
adoption will result in amounts that are similar to the current
pro forma disclosures under SFAS 123.
See Note 2 of the Consolidated Financial Statements in
Item 8 for a description of other recent accounting
pronouncements.
Results of Operations
We offer products in two configuration platforms, a fixed
configuration stackable and a flexible configuration chassis. A
stackable has a fixed configuration that cannot be altered. A
chassis uses a modular platform that can be populated and
reconfigured with various management and line card modules as
frequently as desired by the customer. For example, customers
can use our chassis products at the edge of their network and
then reconfigure the chassis to be used in the backbone or core
of their network. Our selling prices and gross margins on
chassis-based products are generally higher than our stackable
products because of the flexible configuration offered by
chassis-based products.
Net revenue information is as follows (dollars in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year Ended December 31, | |
| |
|
| |
| |
|
|
|
% of Net | |
|
|
|
% of Net | |
|
|
|
% of Net | |
| |
|
2004 | |
|
Revenues | |
|
2003 | |
|
Revenues | |
|
2002 | |
|
Revenues | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
Net revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
$ |
349,019 |
|
|
|
85 |
% |
|
$ |
351,325 |
|
|
|
88 |
% |
|
$ |
264,998 |
|
|
|
88 |
% |
|
Service
|
|
|
60,085 |
|
|
|
15 |
% |
|
|
48,303 |
|
|
|
12 |
% |
|
|
35,744 |
|
|
|
12 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net revenues
|
|
$ |
409,104 |
|
|
|
100 |
% |
|
$ |
399,628 |
|
|
|
100 |
% |
|
$ |
300,742 |
|
|
|
100 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Chassis
|
|
$ |
306,828 |
|
|
|
75 |
% |
|
$ |
315,706 |
|
|
|
79 |
% |
|
$ |
231,571 |
|
|
|
77 |
% |
|
Stackable
|
|
|
102,276 |
|
|
|
25 |
% |
|
|
83,922 |
|
|
|
21 |
% |
|
|
69,171 |
|
|
|
23 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net revenues
|
|
$ |
409,104 |
|
|
|
100 |
% |
|
$ |
399,628 |
|
|
|
100 |
% |
|
$ |
300,742 |
|
|
|
100 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net product revenues in 2004 decreased 1% from 2003, despite
increased sales volume, as a result of lower average selling
prices and a shift in sales mix to lower-priced stackable
products. Although the overall global economy improved in 2004,
the pricing environment remained competitive. As a result, we
experienced an increase in overall port shipments of 15%, but
the decline in average selling prices and a shift to
lower-priced stackable products resulted in flat product
revenues. Our sales volume increased in 2004 primarily due to
sales of our 10-Gigabit Ethernet stackable products, which offer
a similar feature set as our small-end chassis at a lower price
point. Stackable products generated 25% of our total net
revenues in 2004, versus 21% in 2003. Sales to the
U.S. government represented 27% of our total revenues in
2004, down from 31% in 2003, as a result of less Federal funding
for IT projects in 2004. The decrease in sales to the
U.S. government was offset by increased business from our
enterprise customers.
Net product revenues increased 33% from 2002 to 2003 due to an
increase in overall IT spending, increased market share, and
expanded sales coverage. During 2003, we focused our sales
efforts on broadening our customer base, particularly in
non-cyclical customer verticals, such as healthcare, research
enterprises, government agencies, and universities, that
typically demonstrate continued capital spending during slow
economic cycles. Sales to the U.S. government were
particularly strong in 2003, accounting for 31% of our total
revenues, compared to 15% in 2002, due to the government’s
effort to both expand and upgrade their networks. In late 2002,
the federal government certified many of our JetCore-based
products for sale to the Department of Defense (DOD). Once
certified, we generated significant revenue from sales of these
products to the DOD. We also experienced significant revenue
growth in Japan in 2003 due to the establishment of a
19
direct sales force in 2002 to complement our reseller
relationship with Mitsui, one of our largest resellers. In 2003,
our expanded sales coverage in Japan resulted in significant
sales growth in that country.
Service revenues consist primarily of revenue from customer
support contracts, and to a lesser extent, from providing
training and installation services. Service revenues increased
$11.8 million, or 24%, in 2004 and $12.6 million, or
35%, in 2003. The increase in absolute dollars was due to a
larger installed base of our networking equipment each year as
customers purchased new support contracts with their new
equipment purchases and renewed maintenance contracts on
existing equipment. Our customer base grew from
5,200 customers at the end of 2002, to 6,500 customers at
the end of 2003, and to 7,800 customers at the end of 2004.
We manage our business based on four geographic regions: the
Americas (primarily the United States); Europe, the Middle East,
and Africa (EMEA); Japan; and Asia Pacific. We determine
revenues by geographic location based on the physical
destination of our product shipments. Net product revenue by
region as a percentage of net product revenue was as follows for
the years ended December 31:
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Americas
|
|
|
62 |
% |
|
|
63 |
% |
|
|
61 |
% |
|
EMEA
|
|
|
19 |
% |
|
|
14 |
% |
|
|
14 |
% |
|
Japan
|
|
|
11 |
% |
|
|
15 |
% |
|
|
13 |
% |
|
Asia Pacific
|
|
|
8 |
% |
|
|
8 |
% |
|
|
12 |
% |
The shift in product sales from Japan to EMEA in 2004 was due to
large deployments of our products in Europe by the
U.S. government and several other large customers during
2004, compared to large deployments of our products by major
service providers in Japan during 2003.
The following table presents gross margins and gross margin
percentages for product and service revenues (dollars in
thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year Ended December 31, | |
| |
|
| |
| |
|
|
|
Gross | |
|
|
|
Gross | |
|
|
|
Gross | |
| |
|
2004 | |
|
Margin % | |
|
2003 | |
|
Margin % | |
|
2002 | |
|
Margin % | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
Gross margins:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
$ |
219,830 |
|
|
|
63 |
% |
|
$ |
218,213 |
|
|
|
62 |
% |
|
$ |
130,350 |
|
|
|
49 |
% |
|
Service
|
|
|
45,851 |
|
|
|
76 |
% |
|
|
40,557 |
|
|
|
84 |
% |
|
|
30,200 |
|
|
|
84 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gross margin
|
|
$ |
265,681 |
|
|
|
65 |
% |
|
$ |
258,770 |
|
|
|
65 |
% |
|
$ |
160,550 |
|
|
|
53 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Our cost of product revenues consists primarily of materials,
labor, manufacturing overhead, warranty costs, and provisions
for excess and obsolete inventory. Although we experienced an
overall decline in average selling prices in 2004, product gross
margins in 2004 were 1% higher than 2003 as a result of
favorable product mix and lower contract manufacturing and
component costs in 2004, offset somewhat by increased inventory
provisions. Inventory provisions were $13.5 million and
$9.0 million in 2004 and 2003, respectively. Inventory
provisions increased as a result of higher levels of inventory
in 2004 and challenges associated with forecasting demand and
managing supply for our broader product portfolio.
The increase in product gross margin as a percentage of product
revenues in 2003 from 2002 was due primarily to cost
efficiencies associated with increased business volume in 2003
and significant reductions of our component and sub-assembly
costs. Product margins improved to a lesser extent as a result
of increased sales of our high-end, high-margin products in 2003
and lower provisions for excess and obsolete inventory. During
2003, our total port shipments of all products increased by 32%
from 2002, and our shipments of Gigabit Ethernet ports, a higher
gross margin product, grew by 67%. This shift in product mix was
due to our customers’ increasing preference for Gigabit
Ethernet, a Layer 4-7 switching technology and higher gross
margin product, instead of 10/100 Ethernet, a Layer 2/3
technology and lower gross margin product. This product mix
shift contributed to our gross margin improvement in 2003.
During the first nine months of 2003,
20
our component and assembly costs were reduced significantly,
which dramatically improved our gross margins. In the fourth
quarter of 2003, our component and assembly costs stabilized.
Our cost of service revenues consists primarily of costs related
to providing services under customer support contracts,
including maintaining adequate spares inventory levels at
service depots. Service costs include material costs, labor, and
overhead. Service gross margins were 76% in 2004, down from 84%
in both 2003 and 2002. Despite significantly higher service
revenues in 2004 and 2003, our service gross margin percentage
decreased in 2004 and remained unchanged in 2003 from 2002, as a
result of increased service inventory and labor costs associated
with supporting a larger customer base and a broader product
portfolio. As noted above, our customer base grew considerably
between 2002 and 2004. Due to the expansion of our customer base
throughout the world, we continued to increase our investment in
our support infrastructure by opening more service facilities
and supplying them with adequate spares inventory to support our
increasingly broader product offerings. We expect service gross
margins to experience variability over time due to the timing of
technical support initiations and renewals and additional
investments in our customer support infrastructure.
Our gross margins may be adversely affected by increased price
competition, component shortages, increases in material or labor
costs, excess and obsolete inventory charges, changes in
channels of distribution, or customer, product and geographic
mix. See also “Risk Factors — Our gross margins
may decline over time and the average selling prices of our
products may decrease as a result of competitive pressures and
other factors.”
The following table presents research and development, sales and
marketing, and general and administrative expenses for the years
ended December 31, 2004, 2003, and 2002 (dollars in
thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year Ended December 31, | |
| |
|
| |
| |
|
|
|
% of Net | |
|
|
|
% of Net | |
|
|
|
% of Net | |
| |
|
2004 | |
|
Revenues | |
|
2003 | |
|
Revenues | |
|
2002 | |
|
Revenues | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
Research and Development
|
|
$ |
43,905 |
|
|
|
11 |
% |
|
$ |
40,473 |
|
|
|
10 |
% |
|
$ |
34,933 |
|
|
|
12 |
% |
|
Sales and Marketing
|
|
|
98,614 |
|
|
|
24 |
% |
|
|
88,439 |
|
|
|
22 |
% |
|
|
82,924 |
|
|
|
28 |
% |
|
General and Administrative
|
|
|
29,604 |
|
|
|
7 |
% |
|
|
17,570 |
|
|
|
4 |
% |
|
|
14,451 |
|
|
|
5 |
% |
|
Litigation Settlement
|
|
|
30,193 |
|
|
|
7 |
% |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Research and development expenses consist primarily of
salaries and related personnel expenses, prototype materials,
and expenses related to the development of our ASICs, software
development and testing costs, and the depreciation of property
and equipment used in research and development activities.
Research and development expenses in 2004 increased
$3.4 million from 2003 due primarily to higher payroll
costs and depreciation expense. Average headcount increased 13%
in 2004 and depreciation expense increased as a result of
significant purchases of advanced test equipment during the
first half of 2004. The increase in research and development
expenses in 2003 was due primarily to prototype expenses
incurred in connection with development of our terabit-capacity
Ethernet switching products, and, to a lesser extent, an
increase in our average headcount from 147 engineers in 2002 to
159 engineers in 2003. We believe continued investment in
product enhancements and new product development is critical to
achieving our strategic objectives, and, as a result, we expect
research and development expenses to continue to increase in
absolute dollars.
Sales and marketing expenses consist primarily of
salaries, commissions and related expenses for personnel engaged
in marketing, sales and customer support activities, costs
associated with trade shows, advertising, and promotions, and
the cost of facilities. Sales and marketing expenses increased
$10.2 million in 2004, primarily due to increases of
$4.4 million for advertising and trade shows,
$4.2 million for compensation costs, and $3.3 million
of depreciation associated with demonstration and evaluation
equipment. During 2004, we increased our marketing efforts to
introduce our new products such as our Terabit-capacity chassis
and 10-Gigabit stackable products and increased our marketing
and sales force to 332 employees from 308 in 2003. The increase
in absolute dollars of $5.5 million from 2002 to 2003 was
primarily due to higher sales commissions as a result of
increased revenues in 2003, higher travel costs associated with
expanding our sales coverage, and, to a lesser extent, increased
marketing expenses associated with the launch of new products in
2003.
21
General and administrative expenses consist primarily of
salaries and related expenses for executive, finance and
administrative personnel, costs of facilities, bad debt, legal
fees, and other general corporate expenses. General and
administrative expenses increased $12.0 million in 2004,
compared to 2003, primarily due to an increase of
$9.1 million in legal fees related to the Nortel and Lucent
patent infringement cases discussed in Part I, Item 3
“Legal Proceedings,” $1.6 million for consulting
fees related to compliance with Section 404 of the
Sarbanes-Oxley Act, and $0.9 million from reduced bad debt
reserve requirements in 2003, compared to no bad debt reserve
requirements in 2004. General and administrative expenses
increased $3.1 million in 2003, compared to 2002, due to
increases of $3.0 million in legal expenses and
$0.9 million in executive bonuses, offset by a
$1.2 million decrease in bad debt expense as a result of
improved collections effort and credit quality of our customer
base.
Litigation settlement. In October 2004, we entered into a
settlement agreement and patent cross-license agreement with
Nortel. As a result of the agreements, Nortel’s actions for
monetary damages and an injunction against us were dismissed,
and our suit against Nortel was also dismissed. Pursuant to the
agreements, we paid $35.0 million to Nortel and recorded an
operating expense of $30.2 million in the third quarter of
2004. The remaining amount paid to Nortel represents
consideration for a four-year cross-license with Nortel and is
being amortized ratably to cost of product revenue over the
license term.
Amortization of deferred stock compensation. In
connection with the granting 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 the stock options were granted. We
recorded no additional deferred stock compensation after 2000.
Deferred stock compensation was amortized to operations over the
respective vesting periods of the options. We had no remaining
deferred stock compensation to amortize in 2004. We recorded
amortization of deferred stock compensation expense of
approximately $231,000 and $1.1 million in 2003 and 2002,
respectively.
Interest and other income, net. We earn interest income
on funds maintained in interest-bearing money market and
investment accounts. We recorded net interest and other income
of $9.9 million, $5.2 million, and $5.0 million
in 2004, 2003, and 2002, respectively. The increase in 2004 was
primarily due to higher investment balances and higher interest
rates throughout 2004. Our total cash and investments increased
$111.7 million from 2003. Interest income in 2003 remained
nearly unchanged from 2002, despite higher levels of cash and
investments throughout 2003, due to lower average interest rates
in 2003. See Item 7A “Quantitative and Qualitative
Disclosures about Market Risk” for a description of our
investment policy.
Income taxes. The effective tax rate was 35%, 36%, and
30% for the years ended December 31, 2004, 2003, and 2002,
respectively. These rates reflect applicable federal and state
tax rates, offset by research and development tax credits,
export sales incentives, and tax-exempt interest income. The
lower effective tax rate of 30% in 2002 was due to significantly
higher tax-exempt interest income and research and development
credit as a percentage of net income.
Our income taxes payable for federal and state purposes have
been reduced, and stockholders’ equity 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, we receive an income tax benefit
for the difference between the fair market value of the stock
issued at the time of the exercise and the employee’s
option price, tax effected. These benefits are credited directly
to stockholders’ equity and amounted to $29.2 million,
$46.5 million, and $4.8 million for the years ended
December 31, 2004, 2003, and 2002, respectively.
Liquidity and Capital Resources
At December 31, 2004, we had cash and investments of
$617.4 million, an increase of $111.7 million from
$505.7 million at December 31, 2003. The increase was
primarily the result of our pre-tax profitability, which enabled
us to generate $81.5 million of cash from operations, and
the receipt of $38.7 million of cash from issuances of
common stock to employees. During 2004, cash payments for income
taxes, net of refunds
22
received, were $5.3 million. This is low relative to our
pre-tax income as a result of $29.2 million of tax
deductions in 2004 for disqualifying dispositions of employee
stock options.
Cash and investments increased $179.2 million in 2003 from
2002. The increase was primarily the result of increased
profitability in 2003 and proceeds from the exercise of employee
stock options. In 2003, we paid relatively insignificant amounts
of taxes in relation to our income before taxes because we had
significant tax deductions resulting from disqualifying
dispositions of employee stock options of $46.5 million. We
also generated $117.2 million of income before taxes and
received $70.6 million of cash from issuances of common
stock to employees.
Inventories increased $10.7 million from 2003 to
$38.7 million as of December 31, 2004. We
significantly increased our production and service inventory
levels to support a broader product offering and larger
installed customer base, and in anticipation of higher sales
volume in 2005. Annualized inventory turnover was approximately
3.5 and 4.0 for the years ended December 31, 2004 and 2003,
respectively. The decrease in inventory turnover in 2004 was due
to lower product sales in 2004 and higher average inventory
levels during the year.
Accounts receivable, net of allowances, increased
$14.4 million from the end of 2003 to $91.5 million as
of December 31, 2004. Our accounts receivable and days
sales outstanding (DSO) are primarily affected by shipment
linearity, collections performance, and timing of support
contract renewals. DSO, calculated based on annualized revenues
for the most recent quarter ended and net accounts receivable as
of the balance sheet date, increased to 79 days as of
December 31, 2004, from 63 days as of
December 31, 2003. The increase in DSO was primarily due to
the timing of support contract renewals. A significant amount of
annual support contracts were renewed during the fourth quarter
of 2004, with little or no revenue contribution in 2004.
Shipment linearity, as percentage of revenue, remained nearly
unchanged during the fourth quarter of fiscal 2004, compared to
the same period in 2003.
DSO increased from 54 days as of December 31, 2002 to
63 days as of December 31, 2003. The increase in DSO
in 2003 was due to less linear shipments during the fourth
quarter of 2003, in which more than 50% of our revenues shipped
during the last month of the quarter.
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Disclosures about Contractual Obligations and Commercial
Commitments |
The following table aggregates our contractual obligations and
commercial commitments at December 31, 2004, and the effect
such obligations are expected to have on our liquidity and cash
flow in future periods (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
More | |
| |
|
|
|
Less Than | |
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Than | |
| |
|
Total | |
|
1 Year | |
|
1–3 Years | |
|
5 Years | |
| |
|
| |
|
| |
|
| |
|
| |
|
Operating leases of facilities
|
|
$ |
11,747 |
|
|
$ |
4,736 |
|
|
$ |
5,730 |
|
|
$ |
1,281 |
|
|
Purchase commitments with contract manufacturers
|
|
|
40,042 |
|
|
|
40,042 |
|
|
|
— |
|
|
|
— |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total contractual cash obligations
|
|
$ |
51,789 |
|
|
$ |
44,778 |
|
|
$ |
5,730 |
|
|
$ |
1,281 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
For purposes of the above table, contractual obligations for the
purchase of goods or services are defined as agreements that are
enforceable, legally binding on us, and that subject us to
penalties if we cancel the agreement. Our purchase commitments
are based on our short-term manufacturing needs and are
fulfilled by our vendors within short time horizons.
Although it is difficult for us to predict future liquidity
requirements with certainty, we believe our existing cash
balances and anticipated funds from operations in 2005 will
satisfy our cash requirements for at least the next
12 months. Key factors affecting our cash flows include our
ability to effectively manage our working capital, in
particular, inventories and accounts receivable, and future
demand for our products and related pricing. We may incur higher
capital expenditures in the near future to expand our
operations. Although we do not have any current plans or
commitments to do so, we may from time to time consider the
23
acquisition of products or businesses complementary to our
business. Any acquisition or investment may require additional
capital.
|
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Off-Balance Sheet Arrangements |
Other than operating leases of facilities, we do not maintain
any off-balance sheet transactions, arrangements, or obligations
that are reasonably likely to have a material current or future
effect on our financial condition, results of operations,
liquidity, or capital resources.
In the ordinary course of business, we enter into contractual
arrangements under which we may agree to indemnify the
counter-party from losses relating to a breach of
representations and warranties, a failure to perform certain
covenants, or claims and losses arising from certain external
events as outlined within the particular contract, which may
include, for example, losses arising from litigation or claims
relating to past performance. Such indemnification clauses may
not be subject to maximum loss clauses. No amounts are reflected
in our condensed consolidated financial statements as of
December 31, 2004 or 2003 related to these indemnifications
as, historically, payments made related to these
indemnifications have not been material to our financial
position or results of operations.
Risk Factors That May Affect Future Results and the Market
Price of Our Stock
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|
Weak economic and market conditions or geopolitical
turmoil may adversely affect our revenues, gross margins and
expenses. |
Our quarterly revenues and operating results 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.
Additionally, current political turmoil in many parts of the
world, including terrorist and military actions, may weaken the
global economy. If economic conditions in the United States and
globally do not improve, or if they worsen, we may experience
material negative effects on our business, operating results and
financial condition. There can be no assurance that we will be
able to maintain or improve our financial results or that
economic and market conditions will continue to improve and will
not deteriorate.
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Although our customer base has increased, we still depend
on large, recurring purchases from certain significant
customers, and a loss, cancellation or delay in purchases by
these customers could negatively affect our revenue. |
Sales to our ten largest customers accounted for 37% and 44% of
net product revenue for 2004 and 2003, respectively. The loss of
continued orders from any of our more significant customers,
such as the U.S. government or individual agencies within
the U.S. government, Mitsui, or Hewlett Packard, could
cause our revenue and profitability to suffer. Our ability to
attract new customers will depend on a variety of factors,
including the cost-effectiveness, reliability, scalability,
breadth and depth of our products.
Although 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:
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• |
our reseller agreements generally do not require minimum
purchases; |
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| |
• |
our customers can stop purchasing and our resellers can stop
marketing our products at any time; and |
| |
| |
• |
our reseller agreements generally are not exclusive and are for
one-year terms, with no obligation of the resellers to renew the
agreements. |
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
24
number of customers. In addition, a change in the mix of our
customers, or a change in the mix of direct and indirect sales,
could adversely affect our revenues and gross margins.
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The United States government is a significant customer and
has been one key to our financial success. However, government
demand is unpredictable and there is no guarantee of future
contract awards. |
As part of the changing economic environment, the United States
government has become an important customer for the networking
industry, and for us in particular. The process of becoming a
qualified government vendor, especially for high-security
projects, takes considerable time and effort, and the timing of
contract awards and deployment of our products are hard to
predict. Typically, six to twelve months may elapse between the
initial evaluation of our systems by governmental agencies and
the execution of a contract. The revenue stream from these
contracts is hard to predict and may be materially uneven
between quarters. Government agency contracts are frequently
awarded only after formal competitive bidding processes, which
are often protracted and may contain provisions that permit
cancellation in the event funds are unavailable to the
government agency. Even if we are awarded contracts, substantial
delays or cancellations of purchases could result from protests
initiated by losing bidders. In addition, government agencies
are subject to budgetary processes and expenditure constraints
that could lead to delays or decreased capital expenditures in
certain areas. If we fail to win significant government contract
awards, if the government or individual agencies within the
government terminate or reduce the scope and value of our
existing contracts, or if the government fails to reduce the
budget deficit, our financial results may be harmed.
Additionally, government orders may be subject to priority
requirements that may affect scheduled shipments to our other
customers.
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Because our financial results are difficult to predict and
may fluctuate significantly, we may not meet quarterly financial
expectations, which could cause our stock price to
decline. |
Our quarterly revenues and operating results are difficult to
predict and may fluctuate significantly from quarter to quarter.
Our quarterly revenue and earnings per share guidance is our
best estimate at the time we provide guidance. Delays in
generating or recognizing forecasted revenues could cause our
quarterly operating results to be below our expectations and
those of public market analysts or investors, which could cause
the price of our common stock to fall.
We may experience a delay in generating or recognizing revenue
for a number of reasons. Unfulfilled orders at the beginning of
each quarter are typically substantially less than our expected
revenue for that quarter. Therefore, we depend on obtaining
orders in a quarter for shipment in that quarter to achieve our
revenue objectives. In addition, our reseller agreements
typically allow the reseller to delay scheduled delivery dates
without penalty. Moreover, demand for our products may fluctuate
as a result of seasonality. For example, sales to the
U.S. government are typically stronger in the third
calendar quarter and demand from European customers is generally
weaker in the summer months.
Orders are generally cancelable at any time prior to shipment.
Reasons for cancellation could include our inability to deliver
products within the customer’s specified timeframe due to
component shortages or high priority government orders that take
precedence to commercial enterprise orders, as well as other
reasons.
Our revenues for a particular period may also be difficult to
predict and may be adversely affected if we experience a
non-linear (back-end loaded) sales pattern during the period. We
typically experience significantly higher levels of sales
towards the end of a period as a result of customers submitting
their orders late in the period or as a result of manufacturing
issues or component shortages which may delay shipments. Such
non-linearity in shipments can increase costs, as irregular
shipment patterns result in periods of underutilized capacity
and additional costs associated with higher inventory levels,
inventory planning and management. Furthermore, orders received
towards the end of the period may not ship within the period due
to our manufacturing lead times.
In addition, we may incur increased costs and expenses related
to sales and marketing, including expansion of our direct sales
operations and distribution channels, product marketing,
customer support, expansion of our corporate infrastructure,
legal matters, and facilities expansion. We base our operating
expenses on anticipated revenue levels, and a high percentage of
our expenses are fixed in the short-term. As a
25
result, any significant shortfall in revenue relative to our
expectations could cause a significant decline in our quarterly
operating results.
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 may
not be able to rely on prior results for any period as an
indication of future performance. In the future, our revenue may
remain the same, decrease or increase, and we may not be able to
sustain or increase profitability on a quarterly or annual
basis. As a consequence, operating results for a particular
quarter are extremely difficult to predict.
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Intense competition in the market for network solutions
could prevent us from maintaining or 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. 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 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.
Although we are currently among the top providers of network
infrastructure solutions, we cannot assure you that we will be
able to compete successfully against Cisco, currently the
leading provider in the networking market.
We also compete with other companies, such as Extreme Networks,
Juniper Networks, F5 Networks, Inc., Nortel Networks, Enterasys
Networks, 3Com, Huawei Technologies, Force 10 Networks, and
Alcatel. 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. Furthermore, a number of these competitors may merge
or form strategic relationships that would enable them to apply
greater resources and sales coverage than we can, and to offer,
or bring to market earlier, products that are superior to ours
in terms of features, quality, pricing or a combination of these
and 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,
enhance our current products and maintain customer satisfaction.
In addition, we must make certain our sales and marketing
capabilities allow us to compete effectively against our
competitors. If we fail to do so, our products may not compete
favorably with those of our competitors and our revenues and
profitability could suffer.
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We must continue to introduce new products with superior
performance and features in a timely manner in order to sustain
and increase our revenue, and if we fail to predict and respond
to emerging technological trends and customers’ changing
needs, our operating results may suffer. |
The networking industry is characterized by rapid technological
change, frequent new product introductions, changes in customer
requirements, and evolving industry standards. Therefore, in
order to remain competitive, we must 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. Even if these objectives are accomplished, new products
may not be successful in the marketplace, or may take more time
than anticipated to start generating meaningful revenue. 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 the market will accept. After a product is developed,
we must be able to forecast sales volumes and
26
quickly manufacture a sufficient volume of products and mix of
configurations that meet customer requirements, all at low costs.
The current life cycle of our products is typically 18 to
24 months. The introduction of new products or product
enhancements may shorten the life cycle of our existing products
or 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
and in achieving volume manufacturing for such new products.
This has led to, and may in the future lead to, delayed sales,
increased expenses and lower quarterly revenues 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.
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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
on our internally developed technology and know-how. Our
proprietary technology includes our ASICs, our IronCore,
JetCore, and Terathon hardware architecture, our IronWare
software, our IronView network management software, and certain
mechanical designs. We rely on a combination of patent,
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, 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 in which the laws may not protect our
proprietary rights as fully as in the United States.
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We may be subject to litigation risks and intellectual
property infringement claims that are costly to defend and could
limit our ability to use certain technologies in the future.
Additionally, we may be found to infringe on intellectual
property rights of others. |
The networking industry is subject to claims and related
litigation regarding patent and other intellectual property
rights. In particular, some companies in the networking industry
claim extensive patent portfolios. As a result of the existence
of a large number of patents and rate of issuance of new patents
in the networking industry, it is practically impossible for a
company to determine in advance whether a product or any of its
components may infringe upon intellectual property rights that
may be claimed by 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.
Third parties may in the future assert claims or initiate
litigation against us or our manufacturers, suppliers or
customers alleging infringement of their intellectual property
rights with respect to our existing or future products. We are
committed to vigorously defending ourselves against such claims.
Regardless of the merits of our position, we have in the past
and may in the future incur substantial expenses in defending
against third party claims. In the event of a determination
adverse to us, we could incur substantial monetary liability,
and be required to change our business practices. Either of
these could have a material adverse effect on our financial
position, results of operations, or cash flows.
Some companies have attempted to realize revenues from their
patent portfolios by using licensing programs. Some of these
companies have contacted us regarding a license. We carefully
review all license requests, but are unwilling to license
technology not required for our product portfolio. However, any
asserted
27
license demand can require considerable effort and expense to
review and respond. Moreover, a refusal by us to a license
request could result in threats of litigation or actual
litigation, which, if initiated, could harm our business.
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 Part I, Item 3 “Legal
Proceedings,” and we are vigorously contesting these
allegations. Responding to the allegations has been, and
probably will continue to be, expensive and time-consuming for
us. An unfavorable resolution of the lawsuits could adversely
affect our business, results of operations, or financial
condition.
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Our ability to increase our revenues depends on expanding
our direct sales operations and reseller distribution channels
and continuing to provide excellent customer support. |
If we are unable to effectively develop 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. Additionally, if our resellers and
system integrators are not successful in their sales efforts,
sales of our products may decrease and our operating results
could suffer. Some of our resellers also sell products that
compete with our products. Resellers and system integrators
typically sell directly to end-users and often provide system
installation, technical support, professional services, and
other support services in addition to network equipment sales.
System integrators also typically integrate our products into an
overall solution, and a number of resellers and service
providers are also system integrators. 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.
Additionally, if we do not manage distribution of our products
and services effectively, or if our resellers’ financial
conditions or operations weaken, our revenues and gross margins
could be adversely affected.
In an effort to gain market share and support our customers, we
may need to expand our direct sales operations and customer
service staff to support new and existing customers. The timing
and extent of any such expansion are uncertain. We currently
outsource our technical support to a third-party provider in
Australia to support our customers in that continent. In the
future, we may utilize third-party contractors in other regions
of the world as part of our expansion effort. Expansion of our
direct sales operations, reseller channels, and customer service
operations may not be successfully implemented and the cost of
any expansion may exceed the revenues generated.
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Our gross margins 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 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 have decreased in the
past 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
occasionally 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 adversely 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 provisions for excess and obsolete
inventory. Additionally, our gross margins may be negatively
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 an end user
28
than on sales through resellers or to our OEMs. As a result, any
significant shift in revenues through resellers or to our OEMs
could harm our gross margins. If product or related warranty
costs associated with our products are greater than we have
experienced, our gross margins may also be adversely affected.
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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 on our
ability to identify, attract and retain highly-skilled
managerial, engineering, sales and marketing, finance and
manufacturing personnel. Competition for these personnel can be
intense, especially in the San Francisco Bay Area, and we
may experience some difficulty hiring employees in the timeframe
we desire, particularly engineering and sales personnel.
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. In order to improve
productivity, we have historically used stock options to
motivate and retain our employees. The recent decision by the
accounting standard setting body regarding the accounting
treatment of stock options as compensation expense could limit
our ability to continue to use stock options as an incentive and
retention tool. 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 on 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 may depend 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 for any of our personnel.
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Our operations in international markets 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
Pervasive Networks and Spot Distribution in Europe, Mitsui in
Japan, Shanghai Gentek and GTI in China, and Samsung in Korea.
The failure of our international resellers to sell our products
would limit our ability to sustain and grow our revenue. In
particular, our revenue from Japan depends primarily on
Mitsui’s ability to sell our products and on the strength
of the Japanese economy. There are a number of additional risks
arising from our international business, including:
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potential recessions in economies outside the United States; |
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longer accounts receivable collection cycles; |
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• |
seasonal reductions in business activity; |
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• |
higher costs of doing business in foreign countries; |
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• |
infringement claims on foreign patents, copyrights, or trademark
rights; |
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• |
difficulties in managing operations across disparate geographic
areas; |
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| |
• |
difficulties associated with enforcing agreements through
foreign legal systems; |
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| |
• |
political instability and export restrictions; |
| |
| |
• |
potential adverse tax consequences; |
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| |
• |
unexpected changes in regulatory requirements; |
29
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| |
• |
military conflict and terrorist activities; and |
| |
| |
• |
natural disasters and widespread medical epidemics, such as SARS. |
The factors described above could also disrupt our product and
component manufacturers and key suppliers located outside of the
United States. One or more of such factors may have a material
adverse effect on our future international operations and,
consequently, on our 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. See also Item 7A
“Quantitative and Qualitative Disclosures About Market
Risk — Foreign currency exchange rate risk” for a
review of certain risks associated with foreign exchange rates.
|
|
|
We purchase several key components for our products from
sole sources; if these components are not available, our
revenues may be harmed. |
We purchase several key components used in our products from
sole sources, and depend on supply from these sources to meet
our needs. The inability of any supplier to provide us with an
adequate supply 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. Lead-times for various components have
lengthened recently as a result of limits on IT spending and the
economic uncertainty, which has made certain components scarce.
As component demand increases and lead-times become longer, our
suppliers may increase component costs. If component costs
increase, our gross margins may also decline.
Our principal limited or sole-sourced components include
high-speed dynamic and static random access memories, commonly
known as DRAMs and SRAMs, ASICs, printed circuit boards, optical
components, packet processors, switching fabrics,
microprocessors and power supplies. We acquire these components
through purchase orders and have no long-term commitments
regarding supply or pricing 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 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 insufficient 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 subcontract substantially all of our manufacturing to
companies that assemble and test our products. In addition, some
Foundry-branded products are manufactured by third party OEMs.
Our agreements with some of these companies allow them to
procure long lead-time component inventory on our behalf based
on a rolling production forecast provided by us. We may be
contractually obligated to purchase long lead-time component
inventory procured by certain suppliers and third-party
manufacturers in accordance with our forecasts although we can
generally give notice of order cancellation at least
90 days prior to the delivery date. If actual demand for
our products is below our projections, we may have excess
inventory as a result of our purchase commitments. We do not
have long-term contracts with these suppliers and third-party
manufacturers.
30
We have experienced delays in product shipments from our
contract manufacturers, which in turn delayed product shipments
to our customers. In addition, certain of our products require a
long manufacturing lead-time, which may result in delayed
shipments. 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 or OEMs to provide us
with adequate supplies of high-quality products, the loss of any
of our third-party manufacturers, or the inability to obtain
components and raw materials, could cause a delay in our ability
to fulfill orders. Additionally, from time to time, we
transition, via our contract manufacturers, to different
manufacturing locations, including lower-cost foreign countries.
Such transitions are inherently risky and could cause a delay in
our ability to fulfill orders or a deterioration in product
quality.
|
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|
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 fail to meet 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, 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 certain customers for a particular quarter are
not realized in that quarter, we may not meet our revenue
expectations.
|
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|
If we do not adequately manage and evolve our financial
reporting and managerial systems and processes, our ability to
manage and grow our business may be harmed. |
Our ability to successfully implement our business plan and
comply with regulations requires an effective planning and
management process. We expect that we will need to continue to
improve existing, and implement new, operational and financial
systems, procedures and controls to manage our business
effectively in the future. 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.
|
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|
Recent legislation requires us to undertake an annual
evaluation of our internal controls over financial reporting
that may identify internal control weaknesses requiring
remediation, which could harm our reputation. |
We have recently completed our evaluation of our internal
controls over financial reporting as required by
Section 404 of the Sarbanes-Oxley Act of 2002. Although our
assessment, testing and evaluation resulted in our conclusion
that as of December 31, 2004, our internal controls over
financial reporting were effective, we cannot predict the
outcome of our testing in future periods. If our internal
controls are found to be ineffective in future periods, our
reputation could be harmed. We may incur additional expenses and
commitment of management’s time in connection with further
evaluations, either of which could materially increase our
operating expenses and accordingly reduce our net income.
|
|
|
Beginning July 1, 2005, we will be required to record
compensation expense for stock options. As a result, our
profitability will be reduced significantly. |
FASB has recently issued an accounting standard that will
require the fair value of all equity-based awards granted to
employees be recognized in the statement of operations as
compensation expense, beginning in the third quarter of 2005.
The various methods for determining the fair value of stock
options are based on, among other things, the volatility of the
underlying stock. As noted above, our stock price has
historically been
31
volatile. Therefore, the adoption of this accounting standard
will negatively affect our profitability and may adversely
affect our stock price. Such adoption could also limit our
ability to continue to use stock options as an incentive and
retention tool, which could, in turn, hurt our ability to
recruit employees and retain existing employees.
|
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|
The timing of the adoption of industry standards may
negatively affect 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 or delay of an industry
standard related to a specific technology may prevent market
acceptance of products using the technology. We intend to
develop products using new technological advancements 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, if the adoption of industry standards moves
too quickly, we may develop products that do not comply with a
later-adopted 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 on widespread market acceptance of their
underlying technologies. At least one networking equipment
standards body has reportedly stopped all work on a standard in
response to assertions by Nortel that it controls the patent
rights to certain industry standards. Attempts by third parties
to impose licensing fees on industry standards could undermine
the adoption of such standards and decrease industry
opportunities.
|
|
|
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:
|
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| |
• |
negative customer reactions; |
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| |
• |
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 defects or errors. |
|
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|
We may incur liabilities that are not subject to maximum
loss clauses. |
In the ordinary course of business, we enter into purchase
orders, sales contracts, and other similar contractual
arrangements relating to the marketing, sale, manufacture,
distribution, or use of our products and services. We may incur
liabilities relating to our failure to address certain
liabilities or inability to perform certain covenants or
obligations under such agreements, or which result from claims
and losses arising from certain external events as outlined
within the particular contract. Such agreements may not contain,
or be subject to, maximum loss clauses, and liabilities arising
from them may result in significant adverse changes to our
financial position or results of operations.
32
|
|
|
Our products may not continue to comply with the
regulations governing their sale, which may 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 those of certain international
bodies. Although we believe our products are currently in
compliance with domestic and international standards and
regulations in countries in which we currently sell, there can
be 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 certification, we may not be able to sell our
products where these standards or regulations apply, which may
prevent us from sustaining our revenues or maintaining
profitability. Additionally, future changes in tariffs, or their
application, by regulatory agencies could affect the sales of
some of our products.
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|
We may engage in acquisitions that could result in the
dilution of our stockholders, disrupt our operations, cause us
to incur substantial expenses and harm our business if we cannot
successfully integrate the acquired business, products,
technologies or personnel. |
Although we focus on internal product development and growth, we
may learn of acquisition prospects that would complement our
existing business or enhance our technological capabilities. Any
acquisition by us could result in large and immediate
write-offs, the incurrence of debt and contingent liabilities,
or amortization expenses related to amortizable intangible
assets, any of which could negatively affect our results of
operations. Furthermore, acquisitions involve numerous risks and
uncertainties, including:
|
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• |
difficulties in the assimilation of products, operations,
personnel and technologies of the acquired companies; |
| |
| |
• |
diversion of management’s attention from other business
concerns; |
| |
| |
• |
disruptions to our operations, including potential difficulties
in completing ongoing projects in a timely manner; |
| |
| |
• |
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, and our failure to do so could harm our business.
|
|
|
Our stock price has been volatile historically, which may
make it more difficult to sell shares when needed at attractive
prices. |
The trading price of our common stock has been, and may continue
to be, subject to wide fluctuations. Our stock price may
fluctuate in response to a number of events and factors, such as
quarterly variations in operating results, announcements of
technological innovations or new products 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, speculation in the press or investment community,
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.
33
|
|
|
Anti-takeover provisions could make it more difficult for
a third party to acquire us. |
Our board of directors has the authority to issue up to
5,000,000 shares of preferred stock and to determine the
price, rights, preferences, privileges and restrictions,
including voting rights, of those shares without any further
vote or action by the stockholders. The rights of the holders of
common stock may be subject to, and may be adversely affected
by, the rights of the holders of any preferred stock that may be
issued in the future. The issuance of preferred stock may have
the effect of delaying, deferring or preventing a change of
control of Foundry without further action by the stockholders
and may adversely affect the voting and other rights of the
holders of common stock. We have no present plans to issue
shares of preferred stock. Further, certain provisions of our
charter documents, including provisions eliminating the ability
of stockholders to take action by written consent and limiting
the ability of stockholders to raise matters at a meeting of
stockholders without giving advance notice, may have the effect
of delaying or preventing changes in control or management of
Foundry, which could have an adverse effect on the market price
of our stock. In addition, our charter documents do not permit
cumulative voting, which may make it more difficult for a third
party to gain control of our board of directors.
|
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|
Our operations could be significantly hindered by the
occurrence of a natural disaster, terrorist acts or other
catastrophic events. |
Our operations are susceptible to outages due to fire, floods,
power loss, power shortages, telecommunications failures,
break-ins and similar events. In addition, certain of our local
and foreign offices, OEMs, and contract manufacturers are
located in areas susceptible to earthquakes and acts of
terrorism, which could cause a material disruption in our
operations. For example, we procure critical components from
countries such as Japan and Taiwan, which periodically
experience earthquakes and typhoons. 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 insurance to compensate us
for losses that may occur as a result of any of these events.
Any such event could have a material adverse effect on our
business, operating results, and financial condition.
|
|
| Item 7A. |
Quantitative and Qualitative Disclosures about Market
Risk. |
Our investments are made in accordance with an investment policy
approved by our Board of Directors. The primary objective of our
investment activities is to preserve capital while maximizing
yields without significantly increasing risk. Our exposure to
interest rate risk relates to our investment portfolio. We do
not use interest rate swaps in our investment portfolio. We
place our investments with high-credit quality issuers and, by
policy, limit the amount of credit exposure with any one issuer
or fund. For liquidity purposes, our investment policy requires
that we maintain a minimum of $75 million in money market
accounts of suitable credit quality.
Our investment portfolio is classified as held-to-maturity and
is recorded at amortized cost, and includes only securities with
original maturities of less than two years and with secondary or
resale markets to ensure portfolio liquidity. Since we hold our
investments to maturity, we are exposed to risk in the event an
issuer is not able to meet its obligations at maturity. To
mitigate this risk, our investment policy does not allow us to
invest more than $15 million with any one issuer. We do not
have any investments denominated in foreign country currencies,
and therefore are not subject to foreign currency risk on such
investments.
We have performed a hypothetical sensitivity analysis assuming
an immediate parallel shift in the yield curve of plus or minus
50 basis points for the entire year, while all other
variables remain constant. A hypothetical 50 basis point
decline in interest rates as of December 31, 2004 would
reduce our annualized interest income by approximately
$2.5 million.
34
|
|
|
Foreign currency exchange rate risk |
Currently, 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. 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. For most currencies, we are a net payer of foreign
currencies and, therefore, benefit from a stronger
U.S. dollar and are adversely affected by a weaker
U.S. dollar relative to those foreign currencies.
We have performed a sensitivity analysis as of December 31,
2004 and 2003 using a modeling technique that measures the
change in fair values arising from a hypothetical 10% adverse
movement in foreign currency exchange rates relative to the
U.S. dollar, with all other variables held constant.
Foreign currency exchange rates used were based on market rates
in effect at December 31, 2004 and 2003. The sensitivity
analysis indicated that a hypothetical 10% adverse movement in
foreign currency exchange rates would not result in a material
loss in the fair values of foreign currency denominated assets
and liabilities at December 31, 2004 and 2003.
35
|
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| Item 8. |
Financial Statements And Supplementary Data |
FOUNDRY NETWORKS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
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36
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL
REPORTING
Management is responsible for establishing and maintaining an
adequate a system of internal controls over financial reporting.
The system contains monitoring mechanisms, and actions deemed
appropriate by management are taken to address deficiencies. The
Audit Committee, which is composed entirely of directors who are
not officers or employees of the Company, provides oversight to
the financial reporting process. Even an effective internal
control system, no matter how well designed, has inherent
limitations — including the possibility of human error
and the circumvention or overriding of controls — and
therefore can only provide reasonable assurance that financial
statements are free of material errors. Further, because of
changes in conditions, the effectiveness of the system of
internal controls may vary over time and no projections can be
made to future periods.
Management assessed the effectiveness of our internal control
system over financial reporting as of December 31, 2004
using criteria described in “Internal Control -Integrated
Framework” issued by the Committee of Sponsoring
Organizations (COSO). Based on this assessment, management
believes that as of December 31, 2004, our system of
internal controls over financial reporting met those criteria.
Ernst and Young, LLP, the registered public accounting firm that
audited our financial statements included in this Annual Report
on Form 10-K, has issued an attestation report on
management’s assessment of our internal control over
financial reporting.
| |
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| |
/s/ Bobby R. Johnson,
Jr.
Bobby
R. Johnson, Jr.
Chief Executive Officer and President
March 11, 2005 |
|
/s/ Timothy D. Heffner
--------------------------------------------
Timothy D. Heffner
Chief Financial Officer,
Vice President Finance and Administration
March 11, 2005 |
37
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Foundry Networks, Inc.:
We have audited management’s assessment, included in the
accompanying Management’s Report on Internal Control Over
Financial Reporting, that Foundry Networks, Inc. maintained
effective internal control over financial reporting as of
December 31, 2004, based on criteria established in
Internal Control — Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission
(the COSO criteria). Foundry Networks, Inc.’s management is
responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness
of internal control over financial reporting. Our responsibility
is to express an opinion on management’s assessment and an
opinion on the effectiveness of the company’s internal
control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control
over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of
internal control over financial reporting, evaluating
management’s assessment, testing and evaluating the design
and operating effectiveness of internal control, and performing
such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable
basis for our opinion.
A company’s internal control over financial reporting is a
process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with
generally accepted accounting principles. A company’s
internal control over financial reporting includes those
policies and procedures that (1) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions
are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of
management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the
company’s assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that Foundry
Networks, Inc. maintained effective internal control over
financial reporting as of December 31, 2004 is fairly
stated, in all material respects, based on the COSO criteria.
Also, in our opinion, Foundry Networks, Inc. maintained, in all
material respects, effective internal control over financial
reporting as of December 31, 2004, based on the COSO
criteria.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
consolidated balance sheets as of December 31, 2004 and
2003, and the related consolidated statements of income,
stockholders’ equity, and cash flows for each of the three
years in the period ended December 31, 2004 of Foundry
Networks, Inc. and our report dated March 9, 2005 expressed
an unqualified opinion thereon.
Palo Alto, CA
March 9, 2005
38
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Foundry Networks, Inc.:
We have audited the accompanying consolidated balance sheets of
Foundry Networks, Inc. as of December 31, 2004 and 2003,
and the related consolidated statements of income,
stockholders’ equity, and cash flows for each of the three
years in the period ended December 31, 2004. Our audits
also included the financial statement schedule listed in the
Index at Item 15(a)(2) for the years ended
December 31, 2004 and 2003. These financial statements and
schedule 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 the standards of the
Public Company Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by
management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the consolidated
financial position of Foundry Networks, Inc. at
December 31, 2004 and 2003, and the consolidated results of
its operations and its cash flows for each of the three years in
the period ended December 31, 2004, in conformity with
U.S. generally accepted accounting principles. Also, in our
opinion, the related financial statement schedule for the years
ended December 31, 2004 and 2003, when considered in
relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set
forth therein.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
effectiveness of Foundry Networks, Inc. internal control over
financial reporting as of December 31, 2004, based on
criteria established in Internal Control — Integrated
Framework issued by the Committee of Sponsoring Organizations of
the Treadway Commission and our report dated March 9, 2005
expressed an unqualified opinion thereon.
Palo Alto, California
March 9, 2005
39
FOUNDRY NETWORKS, INC.
CONSOLIDATED BALANCE SHEETS
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December 31, | |
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2004 | |
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2003 | |
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(In thousands, except per | |
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share amounts) | |
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ASSETS |
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Current assets:
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Cash and cash equivalents
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$ |
112,274 |
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$ |
161,718 |
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Short-term investments
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331,202 |
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184,859 |
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Accounts receivable, net of allowances for doubtful accounts of
$3,117 and $4,151 and sales returns of $1,627 and $2,020 at
December 31, 2004 and 2003, respectively
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91,502 |
|
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77,077 |
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| |
Inventories
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|
38,743 |
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28,017 |
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| |
Deferred tax assets
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25,799 |
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33,308 |
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Prepaid expenses and other assets
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6,865 |
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5,001 |
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|
|
|
| |
|
Total current assets
|
|
|
606,385 |
|
|
|
489,980 |
|
|
Property and equipment, net
|
|
|
8,852 |
|
|
|
7,866 |
|
|
Investments
|
|
|
173,965 |
|
|
|
159,107 |
|
|
Deferred tax assets
|
|
|
16,479 |
|
|
|
— |
|
|
Other assets
|
|
|
5,511 |
|
|
|
1,191 |
|
| |
|
|
|
|
|
|
| |
|
Total assets
|
|
$ |
811,192 |
|
|
$ |
658,144 |
|
| |
|
|
|
|
|
|
| |
|
LIABILITIES AND STOCKHOLDERS’ EQUITY |
|
Current liabilities:
|
|
|
|
|
|
|
|
|
| |
Accounts payable
|
|
$ |
18,238 |
|
|
$ |
10,080 |
|
| |
Accrued payroll and related expenses
|
|
|
21,682 |
|
|
|
16,650 |
|
| |
Other accrued expenses
|
|
|
8,700 |
|
|
|
5,804 |
|
| |
Deferred support revenue
|
|
|
38,621 |
|
|
|
27,408 |
|
| |
|
|
|
|
|
|
| |
|
Total current liabilities
|
|
|
87,241 |
|
|
|
59,942 |
|
|
Deferred support revenue
|
|
|
17,613 |
|
|
|
7,707 |
|
| |
|
|
|
|
|
|
| |
|
Total liabilities
|
|
|
104,854 |
|
|
|
67,649 |
|
| |
|
|
|
|
|
|
|
Commitments and contingencies (Note 3)
|
|
|
|
|
|
|
|
|
|
Stockholders’ equity:
|
|
|
|
|
|
|
|
|
| |
Preferred stock, $0.0001 par value:
|
|
|
|
|
|
|
|
|
| |
Authorized — 5,000 shares at December 31,
2004 and 2003; None issued and outstanding as of
December 31, 2004 and 2003
|
|
|
— |
|
|
|
— |
|
| |
Common stock, $0.0001 par value:
|
|
|
|
|
|
|
|
|
| |
Authorized — 300,000 shares at December 31,
2004 and 2003:
|
|
|
|
|
|
|
|
|
| |
|
Issued and outstanding — 137,226 and
131,623 shares at December 31, 2004 and 2003,
respectively
|
|
|
14 |
|
|
|
13 |
|
| |
Additional paid-in capital
|
|
|
467,682 |
|
|
|
399,789 |
|
| |
Note receivable from stockholder
|
|
|
— |
|
|
|
(480 |
) |
| |
Accumulated other comprehensive income (loss)
|
|
|
(451 |
) |
|
|
47 |
|
| |
Retained earnings
|
|
|
239,093 |
|
|
|
191,126 |
|
| |
|
|
|
|
|
|
| |
|
Total stockholders’ equity
|
|
|
706,338 |
|
|
|
590,495 |
|
| |
|
|
|
|
|
|
| |
|
Total liabilities and stockholders’ equity
|
|
$ |
811,192 |
|
|
$ |
658,144 |
|
| |
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
40
FOUNDRY NETWORKS, INC.
CONSOLIDATED STATEMENTS OF INCOME
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
(In thousands, except per share data) | |
|
Net revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Product
|
|
$ |
349,019 |
|
|
$ |
351,325 |
|
|
$ |
264,998 |
|
| |
Service
|
|
|
60,085 |
|
|
|
48,303 |
|
|
|
35,744 |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
Total net revenues
|
|
|
409,104 |
|
|
|
399,628 |
|
|
|
300,742 |
|
| |
|
|
|
|
|
|
|
|
|
|
Cost of revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Product
|
|
|
129,189 |
|
|
|
133,112 |
|
|
|
134,648 |
|
| |
Service
|
|
|
14,234 |
|
|
|
7,746 |
|
|
|
5,544 |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
Total cost of revenues
|
|
|
143,423 |
|
|
|
140,858 |
|
|
|
140,192 |
|
| |
|
|
|
|
|
|
|
|
|
| |
Gross margin
|
|
|
265,681 |
|
|
|
258,770 |
|
|
|
160,550 |
|
| |
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Research and development
|
|
|
43,905 |
|
|
|
40,473 |
|
|
|
34,933 |
|
| |
Sales and marketing
|
|
|
98,614 |
|
|
|
88,439 |
|
|
|
82,924 |
|
| |
General and administrative
|
|
|
29,604 |
|
|
|
17,570 |
|
|
|
14,451 |
|
| |
Litigation settlement
|
|
|
30,193 |
|
|
|
— |
|
|
|
— |
|
| |
Amortization of deferred stock compensation
|
|
|
— |
|
|
|
231 |
|
|
|
1,071 |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
Total operating expenses
|
|
|
202,316 |
|
|
|
146,713 |
|
|
|
133,379 |
|
| |
|
|
|
|
|
|
|
|
|
|
Income from operations
|
|
|
63,365 |
|
|
|
112,057 |
|
|
|
27,171 |
|
|
Interest and other income, net
|
|
|
9,868 |
|
|
|
5,168 |
|
|
|
5,025 |
|
| |
|
|
|
|
|
|
|
|
|
|
Income before provision for income taxes
|
|
|
73,233 |
|
|
|
117,225 |
|
|
|
32,196 |
|
|
Provision for income taxes
|
|
|
25,266 |
|
|
|
42,143 |
|
|
|
9,659 |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
Net income
|
|
$ |
47,967 |
|
|
$ |
75,082 |
|
|
$ |
22,537 |
|
| |
|
|
|
|
|
|
|
|
|
|
Basic net income per share
|
|
$ |
0.35 |
|
|
$ |
0.60 |
|
|
$ |
0.19 |
|
| |
|
|
|
|
|
|
|
|
|
|
Weighted average shares used in computing basic net income per
share
|
|
|
135,445 |
|
|
|
125,133 |
|
|
|
119,482 |
|
| |
|
|
|
|
|
|
|
|
|
|
Diluted net income per share
|
|
$ |
0.34 |
|
|
$ |
0.55 |
|
|
$ |
0.18 |
|
| |
|
|
|
|
|
|
|
|
|
|
Weighted average shares used in computing diluted net income per
share
|
|
|
143,118 |
|
|
|
135,631 |
|
|
|
123,780 |
|
| |
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
41
FOUNDRY NETWORKS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
Note | |
|
|
|
Accumulated | |
|
|
|
|
|
|
| |
|
Common Stock | |
|
Treasury Stock | |
|
Additional | |
|
Receivable | |
|
Deferred | |
|
Other | |
|
|
|
Total | |
|
|
| |
|
| |
|
| |
|
Paid-In | |
|
From | |
|
Stock | |
|
Comprehensive | |
|
Retained | |
|
Stockholders’ | |
|
Comprehensive | |
| |
|
Shares | |
|
Amount | |
|
Shares | |
|
Amount | |
|
Capital | |
|
Stockholder | |
|
Compensation | |
|
Income | |
|
Earnings | |
|
Equity | |
|
Income | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(In thousands) | |
|
BALANCES AT DECEMBER 31, 2001
|
|
|
119,299 |
|
|
$ |
12 |
|
|
|
1,522 |
|
|
$ |
(14,996 |
) |
|
$ |
284,740 |
|
|
$ |
(480 |
) |
|
$ |
(1,302 |
) |
|
$ |
351 |
|
|
$ |
93,507 |
|
|
$ |
361,832 |
|
|
|
|
|
| |
Issuances of common stock under stock plans
|
|
|
2,067 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
8,253 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
8,253 |
|
|
|
|
|
| |
Repurchases of common stock from terminated employees
|
|
|
(37 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(106 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(106 |
) |
|
|
|
|
| |
Issuances of stock repurchased from open market
|
|
|
— |
|
|
|
— |
|
|
|
(1,522 |
) |
|
|
14,996 |
|
|
|
(14,996 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
| |
Amortization of deferred stock compensation
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
1,071 |
|
|
|
— |
|
|
|
— |
|
|
|
1,071 |
|
|
|
|
|
| |
Tax benefit from stock option exercises
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
4,808 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
4,808 |
|
|
|
|
|
| |
Foreign currency translation adjustments
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(296 |
) |
|
|
— |
|
|
|
(296 |
) |
|
|
(296 |
) |
| |
Net income
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
22,537 |
|
|
|
22,537 |
|
|
|
22,537 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BALANCES AT DECEMBER 31, 2002
|
|
|
121,329 |
|
|
|
12 |
|
|
|
— |
|
|
|
— |
|
|
|
282,699 |
|
|
|
(480 |
) |
|
|
(231 |
) |
|
|
55 |
|
|
|
116,044 |
|
|
|
398,099 |
|
|
|
22,241 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Issuances of common stock under stock plans
|
|
|
10,295 |
|
|
|
1 |
|
|
|
— |
|
|
|
— |
|
|
|
70,625 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
70,626 |
|
|
|
|
|
| |
Repurchase of common stock from terminated employee
|
|
|
(1 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(17 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(17 |
) |
|
|
|
|
| |
Amortization of deferred stock compensation
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
231 |
|
|
|
— |
|
|
|
— |
|
|
|
231 |
|
|
|
|
|
| |
Tax benefit from stock option exercises
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
46,482 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
46,482 |
|
|
|
|
|
| |
Foreign currency translation adjustments
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(8 |
) |
|
|
— |
|
|
|
(8 |
) |
|
|
(8 |
) |
| |
Net income
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
75,082 |
|
|
|
75,082 |
|
|
|
75,082 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BALANCES AT DECEMBER 31, 2003
|
|
|
131,623 |
|
|
|
13 |
|
|
|
— |
|
|
|
— |
|
|
|
399,789 |
|
|
|
(480 |
) |
|
|
— |
|
|
|
47 |
|
|
|
191,126 |
|
|
|
590,495 |
|
|
|
75,074 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Issuances of common stock under stock plans
|
|
|
5,603 |
|
|
|
1 |
|
|
|
— |
|
|
|
— |
|
|
|
38,675 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
38,676 |
|
|
|
|
|
| |
Tax benefit from stock option exercises
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
29,218 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
29,218 |
|
|
|
|
|
| |
Repayment of note receivable from stockholder
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
480 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
480 |
|
|
|
|
|
| |
Foreign currency translation adjustments
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(498 |
) |
|
|
— |
|
|
|
(498 |
) |
|
|
(498 |
) |
| |
Net income
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
47,967 |
|
|
|
47,967 |
|
|
|
47,967 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BALANCES AT DECEMBER 31, 2004
|
|
|
137,226 |
|
|
$ |
14 |
|
|
|
— |
|
|
$ |
— |
|
|
$ |
467,682 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
(451 |
) |
|
$ |
239,093 |
|
|
$ |
706,338 |
|
|
$ |
47,469 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
42
FOUNDRY NETWORKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
(In thousands) | |
|
CASH FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$ |
47,967 |
|
|
$ |
75,082 |
|
|
$ |
22,537 |
|
|
Adjustments to reconcile net income to net cash provided by
operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Depreciation and amortization
|
|
|
7,439 |
|
|
|
5,333 |
|
|
|
4,936 |
|
| |
Amortization of deferred stock compensation
|
|
|
— |
|
|
|
231 |
|
|
|
1,071 |
|
| |
(Reduction of) provision for doubtful accounts
|
|
|
— |
|
|
|
(862 |
) |
|
|
344 |
|
| |
Provision for sales returns
|
|
|
2,080 |
|
|
|
3,709 |
|
|
|
1,527 |
|
| |
Inventory provisions
|
|
|
13,485 |
|
|
|
9,007 |
|
|
|
16,445 |
|
| |
Deferred tax assets
|
|
|
(8,970 |
) |
|
|
(4,748 |
) |
|
|
1,096 |
|
| |
Tax benefit from stock option exercises
|
|
|
29,218 |
|
|
|
46,482 |
|
|
|
4,808 |
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Accounts receivable
|
|
|
(16,505 |
) |
|
|
(28,028 |
) |
|
|
(1,937 |
) |
| |
Inventories
|
|
|
(24,211 |
) |
|
|
(3,545 |
) |
|
|
(6,647 |
) |
| |
Prepaid expenses and other assets
|
|
|
(6,184 |
) |
|
|
(1,425 |
) |
|
|
1,558 |
|
| |
Accounts payable
|
|
|
8,158 |
|
|
|
(1,604 |
) |
|
|
(3,616 |
) |
| |
Accrued payroll and related expenses
|
|
|
5,032 |
|
|
|
4,902 |
|
|
|
816 |
|
| |
Other accrued expenses
|
|
|
2,896 |
|
|
|
(3,966 |
) |
|
|
1,477 |
|
| |
Deferred support revenue
|
|
|
21,119 |
|
|
|
14,881 |
|
|
|
4,453 |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
Net cash provided by operating activities
|
|
|
81,524 |
|
|
|
115,449 |
|
|
|
48,868 |
|
| |
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Purchases of investments
|
|
|
(599,027 |
) |
|
|
(461,339 |
) |
|
|
(295,267 |
) |
| |
Maturities of investments
|
|
|
437,826 |
|
|
|
256,107 |
|
|
|
333,057 |
|
| |
Purchases of property and equipment, net
|
|
|
(8,425 |
) |
|
|
(6,819 |
) |
|
|
(5,000 |
) |
| |
|
|
|
|
|
|
|
|
|
| |
|
Net cash (used)/ provided by investing activities
|
|
|
(169,626 |
) |
|
|
(212,051 |
) |
|
|
32,790 |
|
| |
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Proceeds from issuances of common stock
|
|
|
38,676 |
|
|
|
70,626 |
|
|
|
8,253 |
|
| |
Repayment of note receivable from stockholder
|
|
|
480 |
|
|
|
— |
|
|
|
— |
|
| |
Repurchases of common stock
|
|
|
— |
|
|
|
(17 |
) |
|
|
(106 |
) |
| |
|
|
|
|
|
|
|
|
|
| |
|
Net cash provided by financing activities
|
|
|
39,156 |
|
|
|
70,609 |
|
|
|
8,147 |
|
| |
|
|
|
|
|
|
|
|
|
|
(DECREASE)/ INCREASE IN CASH AND CASH EQUIVALENTS
|
|
|
(48,946 |
) |
|
|
(25,993 |
) |
|
|
89,805 |
|
| |
Effect of exchange rate changes on cash
|
|
|
(498 |
) |
|
|
(8 |
) |
|
|
(296 |
) |
|
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR
|
|
|
161,718 |
|
|
|
187,719 |
|
|
|
98,210 |
|
| |
|
|
|
|
|
|
|
|
|
|
CASH AND CASH EQUIVALENTS, END OF YEAR
|
|
$ |
112,274 |
|
|
$ |
161,718 |
|
|
$ |
187,719 |
|
| |
|
|
|
|
|
|
|
|
|
|
SUPPLEMENTAL CASH FLOW INFORMATION:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Cash paid for income taxes, net of refunds
|
|
$ |
5,321 |
|
|
$ |
4,202 |
|
|
$ |
976 |
|
The accompanying notes are an integral part of these
consolidated financial statements.
43
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|
|
| 1. |
DESCRIPTION OF BUSINESS |
Founded in 1996, Foundry designs, develops, manufactures,
markets and sells a comprehensive, end-to-end suite of high
performance data networking solutions, including Ethernet Layer
2 and Layer 3 switches, Metro routers, and Internet traffic
management products. Our customers include U.S. government
agencies, universities, e-commerce sites, and enterprises such
as healthcare, financial, manufacturing and entertainment
companies, as well as Internet and Metro service providers.
|
|
| 2. |
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES |
Principles of Consolidation and Foreign Currency
Translation
Our consolidated financial statements reflect the operations of
Foundry and our wholly-owned subsidiaries. All intercompany
transactions and balances have been eliminated. The functional
currency of our foreign subsidiaries is deemed to be the local
country’s currency. Assets and liabilities of foreign
operations are translated into U.S. dollars at the exchange
rate in effect at the applicable balance sheet date, and
revenues and expenses are translated into U.S. dollars
using average exchange rates prevailing during that period.
Translation adjustments have not been material to date and are
included as a component of accumulated other comprehensive
income or loss within stockholders’ equity.
Reclassifications
Certain prior period consolidated balance sheet items have been
reclassified to conform to the December 31, 2004
presentation.
Use of Estimates
The preparation of financial statements in conformity with
U.S. generally accepted accounting principles requires
management to make estimates, judgments, and assumptions that
affect the amounts reported in the financial statements and
accompanying footnotes. Actual results could differ from those
estimates. Estimates, judgments and assumptions are used in the
recognition of revenue, accounting for allowances for doubtful
accounts and sales returns, inventory provisions, product
warranty liability, income taxes, deferred tax assets,
contingencies and similar items. Estimates, judgments and
assumptions are reviewed periodically by management and the
effects of revisions are reflected in the consolidated financial
statements in the period in which they are made.
Cash Equivalents and Investments
We consider all investments with original maturities of
90 days or less to be cash equivalents. Cash and cash
equivalents consist of corporate and government debt securities,
and cash deposited in checking and money market accounts. Our
investment portfolio includes only marketable securities with
original maturities of less than two years and with secondary or
resale markets.
Investments with original maturities greater than 90 days
that mature less than one year from the consolidated balance
sheet date are classified as short-term investments. Investments
with maturities greater than one year from the consolidated
balance sheet date are classified as long-term investments. All
of our investments are stated at amortized cost and classified
as held-to-maturity.
We monitor our investments for impairment on a quarterly basis
and determine whether a decline in fair value is
other-than-temporary by considering factors such as current
economic and market conditions, the credit rating of the
security’s issuer, the length of time an investment’s
fair value has been below our carrying value, and our ability
and intent to hold investments to maturity. If an
investment’s decline in fair value, caused by factors other
than changes in interest rates, is deemed to be
other-than-temporary, we would reduce
44
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
its carrying value to its estimated fair value, as determined
based on quoted market prices or liquidation values. Declines in
value judged to be other-than-temporary, if any, are recorded in
operations as incurred. We do not have any investments as of
December 31, 2004 that have been in a continuous unrealized
loss position for 12 months or longer.
Cash equivalents and investments consist of the following (in
thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
December 31, 2004 | |
| |
|
| |
| |
|
|
|
Gross | |
|
Gross | |
|
|
| |
|
Amortized | |
|
Unrealized | |
|
Unrealized | |
|
Estimated | |
| |
|
Cost | |
|
Gains | |
|
Losses | |
|
Fair Value | |
| |
|
| |
|
| |
|
| |
|
| |
|
Money market funds
|
|
$ |
72,203 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
72,203 |
|
|
Municipal bonds
|
|
|
288,232 |
|
|
|
5 |
|
|
|
(157 |
) |
|
|
288,080 |
|
|
Corporate bonds
|
|
|
11,941 |
|
|
|
— |
|
|
|
(58 |
) |
|
|
11,883 |
|
|
Government-sponsored enterprise securities
|
|
|
204,994 |
|
|
|
2 |
|
|
|
(1,443 |
) |
|
|
203,553 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
$ |
577,370 |
|
|
$ |
7 |
|
|
$ |
(1,658 |
) |
|
$ |
575,719 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash equivalents
|
|
$ |
72,203 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
72,203 |
|
|
Short-term investments
|
|
|
331,202 |
|
|
|
3 |
|
|
|
(588 |
) |
|
|
330,617 |
|
|
Long-term investments
|
|
|
173,965 |
|
|
|
4 |
|
|
|
(1,070 |
) |
|
|
172,899 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
$ |
577,370 |
|
|
$ |
7 |
|
|
$ |
(1,658 |
) |
|
$ |
575,719 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
December 31, 2003 | |
| |
|
| |
| |
|
|
|
Gross | |
|
Gross | |
|
|
| |
|
Amortized | |
|
Unrealized | |
|
Unrealized | |
|
Estimated | |
| |
|
Cost | |
|
Gains | |
|
Losses | |
|
Fair Value | |
| |
|
| |
|
| |
|
| |
|
| |
|
Money market funds
|
|
$ |
84,952 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
84,952 |
|
|
Corporate securities
|
|
|
14,388 |
|
|
|
4 |
|
|
|
— |
|
|
|
14,392 |
|
|
Corporate commercial paper
|
|
|
21,983 |
|
|
|
— |
|
|
|
— |
|
|
|
21,983 |
|
|
Government securities
|
|
|
338,741 |
|
|
|
293 |
|
|
|
(56 |
) |
|
|
338,978 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
$ |
460,064 |
|
|
$ |
297 |
|
|
$ |
(56 |
) |
|
$ |
460,305 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash equivalents
|
|
$ |
116,098 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
116,098 |
|
|
Short-term investments
|
|
|
184,859 |
|
|
|
1 |
|
|
|
(34 |
) |
|
|
184,826 |
|
|
Long-term investments
|
|
|
159,107 |
|
|
|
296 |
|
|
|
(22 |
) |
|
|
159,381 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
$ |
460,064 |
|
|
$ |
297 |
|
|
$ |
(56 |
) |
|
$ |
460,305 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
Municipal and corporate bonds. Unrealized losses as of
December 31, 2004 on our investments in municipal and
corporate bonds were caused by interest rate increases. The
contractual terms of the debentures do not permit the issuer to
settle the securities at a price less than the amortized cost of
the investment. The issuers of our municipal bonds have a credit
rating of AAA, and the issuers of our corporate bonds have a
credit rating of AA (Moody’s and S&P).
Government-sponsored enterprise securities (GSEs).
Unrealized losses as of December 31, 2004 on our
investments in fixed income housing GSEs (i.e., Federal National
Mortgage Association and Federal Home Loan Mortgage Corp.) were
caused by interest rate increases. The contractual terms of the
investments do not permit the issuer to settle the securities at
a price less than the amortized cost of the investment. The
issuers of our GSEs have a credit rating of AAA.
45
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Because the decline in the market value of our investments is
attributable to changes in interest rates and not credit
quality, and because we have the ability and intent to hold
these investments until a recovery of our amortized cost, which
will be at maturity, we do not consider these investments to be
other-than-temporarily impaired at December 31, 2004.
Allowance for Doubtful Accounts
We record an allowance for doubtful accounts to ensure trade
receivables are not overstated due to uncollectibility. Accounts
receivable are not sold or factored. Exposure to credit risk is
controlled through credit approvals, credit limits, and
continuous monitoring procedures. Customers are subject to a
credit review process that evaluates their financial position
and ability to pay. Specific allowances for bad debts are
recorded when we become aware of a customer’s inability to
meet its financial obligation to us, such as in the case of
bankruptcy filings or a significant deterioration in financial
position. Estimates are used in determining allowances for all
other customers based on factors such as current economic and
industry trends, the extent to which receivables are past due
and historical collection experience. Accounts are deemed past
due once they exceed the due date on the invoice. We mitigate
some collection risk by requiring certain international
customers to secure letters of credit or bank guarantees prior
to placing an order with us. If circumstances change, estimates
regarding the collectibility of receivables would be adjusted.
Inventories
Inventories are stated on a first-in, first-out basis at the
lower of cost or estimated net realizable value, and include
purchased parts, labor and manufacturing overhead. Inventories
consist of the following (in thousands):
| |
|
|
|
|
|
|
|
|
| |
|
December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
|
Purchased parts
|
|
$ |
11,713 |
|
|
$ |
9,495 |
|
|
Work-in-process
|
|
|
19,795 |
|
|
|
13,528 |
|
|
Finished goods
|
|
|
7,235 |
|
|
|
4,994 |
|
| |
|
|
|
|
|
|
| |
|
$ |
38,743 |
|
|
$ |
28,017 |
|
| |
|
|
|
|
|
|
The networking industry is characterized by rapid technological
change, frequent new product introductions, changes in customer
requirements, and evolving industry standards. Our inventory
purchases and commitments are made based on anticipated demand
for our products, as estimated by management, and our expected
service requirements. We perform an assessment of our inventory
each quarter, which includes a review of, among other factors,
demand requirements, manufacturing lead-times, product life
cycles and development plans, product pricing and quality
issues. Based on this analysis, we estimate the amount of excess
and obsolete inventory on hand and make adjustments to record
inventory at the lower of cost or estimated net realizable
value. Once inventory has been written down to the lower of cost
or estimated net realizable value, it is reflected on our
balance sheet at its new carrying value until it is sold or
otherwise disposed. Inventory provisions of $13.5 million,
$9.0 million and $16.4 million were recorded for the
years ended December 31, 2004, 2003, and 2002, respectively.
Concentrations
Financial instruments that potentially subject us to a
concentration of credit risk consist principally of cash
equivalents, short and long-term investments, and accounts
receivable. We seek to reduce credit risk on financial
instruments by investing in high-quality debt issuances and, by
policy, we limit the amount of credit exposure with any one
issuer or fund. Additionally, we grant credit only to customers
deemed credit worthy in
46
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
the judgment of management. As of December 31, 2004 and
2003, ten customers accounted for approximately 41% and 55%,
respectively, of our net outstanding trade receivables.
Proprietary ASICs used in the manufacture of our products are
purchased from sole sources. Our custom-designed ASICs may not
be readily available from other suppliers as the development
period required to fabricate our ASICs can be lengthy. The
inability of an ASIC supplier to fulfill our production
requirements, or the time required for us to identify new
suppliers if a relationship is terminated, could negatively
affect our future results of operations.
Property and Equipment
Property and equipment are stated at cost. Depreciation expense
is recorded using the straight-line method over the estimated
useful lives of the assets, which are two years for software and
equipment and three years for furniture and fixtures. Leasehold
improvements are amortized over the shorter of their estimated
useful life or the lease term.
Property and equipment consisted of the following (in thousands):
| |
|
|
|
|
|
|
|
|
| |
|
December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
|
Computers and equipment
|
|
$ |
31,259 |
|
|
$ |
22,927 |
|
|
Leasehold improvements
|
|
|
2,060 |
|
|
|
1,967 |
|
|
Furniture and fixtures
|
|
|
109 |
|
|
|
109 |
|
| |
|
|
|
|
|
|
| |
|
|
33,428 |
|
|
|
25,003 |
|
|
Less accumulated depreciation
|
|
|
(24,576 |
) |
|
|
(17,137 |
) |
| |
|
|
|
|
|
|
|
Property and equipment, net
|
|
$ |
8,852 |
|
|
$ |
7,866 |
|
| |
|
|
|
|
|
|
Revenue Recognition
General. We generally sell our products through
our direct sales force to domestic customers and through
reseller channels to international customers. We generate the
majority of our revenue from sales of chassis and
stackable-based networking equipment, with the remainder of our
revenue coming from customer support fees, training and
installation services. We recognize revenue when persuasive
evidence of an arrangement exists, delivery or performance has
occurred, the sales price is fixed or determinable and
collectibility is reasonably assured. Evidence of an arrangement
generally consists of customer purchase orders and, in certain
instances, sales contracts or agreements. Shipping terms and
related documents, or written evidence of customer acceptance,
when applicable, are used to verify delivery or performance. We
assess whether the sales price is fixed or determinable based on
payment terms and whether the sales price is subject to refund
or adjustment. We assess collectibility based on the
creditworthiness of the customer as determined by our credit
checks and the customer’s payment history with us.
When sales arrangements contain multiple elements (e.g.,
hardware and installation), we apply the provisions of Emerging
Issues Task Force Issue No. 00-21, “Revenue
Arrangements with Multiple Deliverables” (EITF 00-21)
to determine the separate units of accounting that exist within
the arrangement. If more than one unit of accounting exists, the
arrangement consideration is allocated to each unit of
accounting using either the relative fair value method or the
residual fair value method as prescribed by EITF 00-21.
Revenue is recognized for each unit of accounting when the
revenue recognition criteria described in the preceding
paragraph have been met for that unit of accounting.
EITF 00-21 was effective for revenue arrangements entered
into in fiscal periods beginning after June 15, 2003. We
adopted EITF 00-21 in the third quarter of 2003, and its
adoption did not have a material effect on our results of
operations or financial position.
47
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Product. Product revenue is generally recognized
upon transfer of title, unless an acceptance period or other
contingency exists, in which case revenue is recognized upon the
earlier of customer acceptance or expiration of the acceptance
period, or upon satisfaction of the contingency. Shipping
charges billed to customers are included in product revenue and
the related shipping costs are included in cost of product
revenues.
At the time product revenue is recognized, we estimate the
amount of warranty costs to be incurred and record the amount as
a cost of product revenue. Our standard warranty period
generally extends 12 months from the date of sale, and our
estimate of the amount necessary to settle warranty claims is
based primarily on our past experience. We also provide for
estimated sales returns at the time product revenue is
recognized and record that amount as a reduction to product
revenue. Our sales return provision is based primarily on
historical sales returns and our return policies. Our resellers
generally do not have a right of return and our contracts with
original equipment manufacturers only provide for rights of
return in the event our products do not meet our published
specifications or there is an epidemic failure, as defined in
the contracts.
Services. Service revenues consist primarily of
fees for customer support services and, to a lesser extent,
training and installation services. Our suite of customer
support programs provides customers access to technical
assistance, unspecified software updates on a when-and-if
available basis, hardware repair and replacement parts.
Support services are offered under renewable, fee-based
contracts. Revenue from customer support contracts is deferred
and recognized ratably over the contractual support period, in
accordance with FASB Technical Bulletin 90-1,
“Accounting for Separately Priced Extended Warranty and
Product Maintenance Contracts.” Support contracts generally
range from one to five years.
Revenue from training and installation services is recognized
when services have been performed, and represented less than 1%
of total revenues for all periods presented.
Segment and Geographic Information
Operating segments are defined as components of an enterprise
for which separate financial information is available and
evaluated regularly by the chief operating decision-maker, or
decision-making group, in deciding how to allocate resources and
in assessing performance. We are organized as, and operate in,
one reportable segment: the design, development, manufacturing,
marketing and sale of a comprehensive, end-to-end suite of
high-performance data networking solutions, including Ethernet
Layer 2 and Layer 3 switches, Metro routers and Internet traffic
management products. Our chief operating decision-making group
reviews consolidated financial information, accompanied by
information about revenues by geographic region and
configuration type. We do not assess the performance of our
geographic regions on other measures of income or expense, such
as depreciation and amortization, gross margin or net income. In
addition, our assets are primarily located in our corporate
office in the United States and not allocated to any specific
region. Therefore, geographic information is presented only for
net product revenue.
We manage our business based on four geographic regions: the
Americas (primarily the United States); Europe, the Middle East,
and Africa (EMEA); Japan; and Asia Pacific. Our foreign offices
conduct sales, marketing and support activities. We determine
revenues by geographic location based on the physical
48
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
destination of our product shipments. Net product revenue by
region as a percentage of net product revenue was as follows for
the years ended December 31:
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Americas
|
|
|
62 |
% |
|
|
63 |
% |
|
|
61 |
% |
|
EMEA
|
|
|
19 |
% |
|
|
14 |
% |
|
|
14 |
% |
|
Japan
|
|
|
11 |
% |
|
|
15 |
% |
|
|
13 |
% |
|
Asia Pacific
|
|
|
8 |
% |
|
|
8 |
% |
|
|
12 |
% |
Sales to the U.S. federal government accounted for
approximately 27%, 31%, and 15% of our total revenues in 2004,
2003, and 2002, respectively.
Net product revenue from customers representing 10% or more of
net product revenue was as follows for the years ended
December 31:
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Customer A
|
|
|
<10 |
% |
|
|
14 |
% |
|
|
12 |
% |
|
Customer B
|
|
|
<10 |
% |
|
|
12 |
% |
|
|
<10 |
% |
Advertising Costs
We expense advertising costs as incurred. Advertising expenses
for the years ended December 31, 2004, 2003, and 2002 were
$7.9 million, $3.5 million, and $3.8 million,
respectively.
Computation of Per Share Amounts
Basic earnings per share (EPS) has been calculated using
the weighted-average number of shares of common stock
outstanding during the period, less shares subject to
repurchase. Diluted EPS has been calculated using the
weighted-average number of shares of common stock outstanding
during the period, less shares subject to repurchase and
potentially dilutive weighted-average common stock equivalents.
Weighted-average common stock equivalents include the
potentially dilutive effect of in-the-money stock options,
determined based on the average share price for each period
using the treasury stock method. Under the treasury stock
method, the tax-effected proceeds that would be received
assuming the exercise of all in-the-money stock options are
assumed to be used to repurchase shares in the open market.
Certain common stock equivalents were excluded from the
calculation of diluted EPS because the exercise price of these
common stock equivalents was greater than the average market
price of the common stock for the respective period and,
therefore, their inclusion would have been anti-dilutive. There
were 8.5 million, 1.9 million, and 15.7 million
anti-dilutive common stock equivalents for the years ended
December 31, 2004, 2003, and 2002, respectively.
49
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
(In thousands, except per share data) | |
|
Net income
|
|
$ |
47,967 |
|
|
$ |
75,082 |
|
|
$ |
22,537 |
|
| |
|
|
|
|
|
|
|
|
|
|
Basic:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Weighted average shares outstanding
|
|
|
135,445 |
|
|
|
125,133 |
|
|
|
119,861 |
|
| |
Less: Weighted average shares subject to repurchase
|
|
|
— |
|
|
|
— |
|
|
|
(379 |
) |
| |
|
|
|
|
|
|
|
|
|
| |
Weighted average shares used in computing basic EPS
|
|
|
135,445 |
|
|
|
125,133 |
|
|
|
119,482 |
|
| |
|
|
|
|
|
|
|
|
|
|
Basic EPS
|
|
$ |
0.35 |
|
|
$ |
0.60 |
|
|
$ |
0.19 |
|
| |
|
|
|
|
|
|
|
|
|
|
Diluted:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Weighted average shares outstanding
|
|
|
135,445 |
|
|
|
125,133 |
|
|
|
119,861 |
|
| |
Add: Weighted average dilutive potential shares
|
|
|
7,673 |
|
|
|
10,498 |
|
|
|
3,919 |
|
| |
|
|
|
|
|
|
|
|
|
| |
Weighted average shares used in computing diluted EPS
|
|
|
143,118 |
|
|
|
135,631 |
|
|
|
123,780 |
|
| |
|
|
|
|
|
|
|
|
|
|
Diluted EPS
|
|
$ |
0.34 |
|
|
$ |
0.55 |
|
|
$ |
0.18 |
|
| |
|
|
|
|
|
|
|
|
|
Accounting for Stock-Based Compensation
As permitted by Statement of Financial Accounting Standards
No. 123, “Accounting for Stock-Based
Compensation” (SFAS 123), we follow the intrinsic
value method of accounting for employee stock options as
prescribed by Accounting Principles Board Opinion No. 25,
“Accounting for Stock Issued to Employees.”
Accordingly, we recognize compensation expense if options are
granted with an exercise price below fair market value at the
date of grant or if in-the-money options are modified subsequent
to the date of grant. Any resulting compensation expense is
recognized either ratably over the vesting period or using
variable accounting over the period from the date of
modification to exercise or cancellation of the award.
We currently grant stock options under several stock option
plans that allow for the granting of non-qualified and incentive
stock options to our employees and directors. Stock options
generally vest ratably over two to five years from the date of
grant and have a term of ten years. We also have an employee
stock purchase plan that allows eligible employees to purchase
shares of our common stock at 85% of the lower of the fair
market value of the common stock at the beginning of each
offering period or at the end of each purchase period through
payroll deductions that may not exceed 20% of an employee’s
compensation.
50
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The following table illustrates the effect on reported net
income and earnings per share had we accounted for our employee
stock options and employee stock purchase plan under the fair
value method prescribed by SFAS 123.
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
(In thousands, except per share | |
| |
|
amounts) | |
|
Net income as reported
|
|
$ |
47,967 |
|
|
$ |
75,082 |
|
|
$ |
22,537 |
|
|
Add: Total stock-based compensation expense included in reported
net income, net of tax effect
|
|
|
— |
|
|
|
150 |
|
|
|
750 |
|
|
Deduct: Total stock-based compensation expense determined using
the fair value method for all awards, net of related tax effect
|
|
|
(42,206 |
) |
|
|
(32,962 |
) |
|
|
(78,677 |
) |
| |
|
|
|
|
|
|
|
|
|
|
Pro forma net income (loss)
|
|
$ |
5,761 |
|
|
$ |
42,270 |
|
|
$ |
(55,390 |
) |
| |
|
|
|
|
|
|
|
|
|
|
Basic net income (loss) per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
As reported
|
|
$ |
0.35 |
|
|
$ |
0.60 |
|
|
$ |
0.19 |
|
| |
Pro forma
|
|
$ |
0.04 |
|
|
$ |
0.34 |
|
|
$ |
(0.46 |
) |
|
Diluted net income (loss) per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
As reported
|
|
$ |
0.34 |
|
|
$ |
0.55 |
|
|
$ |
0.18 |
|
| |
Pro forma
|
|
$ |
0.04 |
|
|
$ |
0.31 |
|
|
$ |
(0.46 |
) |
The weighted average fair value of stock options granted under
all plans during 2004, 2003, and 2002 was $8.17, $6.15, and
$3.41 per share, respectively. We estimate the fair value
of our stock options using the Black-Scholes option pricing
model, which is the most commonly used model for purposes of
disclosure pursuant to SFAS 123. The Black-Scholes
option-pricing model includes assumptions regarding expected
volatility, lives, dividend yields, and risk-free interest
rates. These assumptions reflect our best estimates, but these
items involve uncertainties based on market conditions generally
outside of our control. The following weighted-average
assumptions were used to estimate the fair value of option
grants and employee stock purchase plan purchase rights:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Stock Option Plan | |
|
Employee Stock Purchase Plan | |
| |
|
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
Average risk free interest rate
|
|
|
2.93% |
|
|
|
2.16% |
|
|
|
3.15% |
|
|
|
2.12% |
|
|
|
1.88% |
|
|
|
2.23% |
|
|
Average expected life of the options
|
|
|
3.5 years |
|
|
|
3.8 years |
|
|
|
3.6 years |
|
|
|
1.4 years |
|
|
|
2.0 years |
|
|
|
0.5 years |
|
|
Dividend yield
|
|
|
0% |
|
|
|
0% |
|
|
|
0% |
|
|
|
0% |
|
|
|
0% |
|
|
|
0% |
|
|
Volatility of common stock
|
|
|
71.9% |
|
|
|
75.0% |
|
|
|
75.0% |
|
|
|
67.1% |
|
|
|
73.7% |
|
|
|
81.1% |
|
Recent Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board
(FASB) issued SFAS No. 123 (revised 2004),
“Share-Based Payment” (SFAS 123R), which replaces
SFAS No. 123, “Accounting for Stock-Based
Compensation” (SFAS 123) and supercedes APB Opinion
No. 25, “Accounting for Stock Issued to
Employees.” SFAS 123R also amends
SFAS No. 95, “Statement of Cash Flows,” to
require that tax benefits from stock option exercises be
classified as a financing activity, instead of an operating
activity, on the statement of cash flows. SFAS 123R
requires all share-based payments to employees, including grants
of employee stock options, to be recognized in the financial
statements based on their fair values, beginning with
51
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
the first interim or annual period after June 15, 2005. The
pro forma disclosures previously permitted under SFAS 123
will no longer be an alternative to financial statement
recognition. We are required to adopt SFAS 123R in our
third quarter of 2005, beginning July 1, 2005. Under
SFAS 123R, we must determine the appropriate fair value
model to be used for valuing share-based payments, the
amortization method for recognizing compensation cost and the
transition method to be used at the date of adoption. The
transition methods include prospective and retroactive adoption
options. Under the retroactive option, prior periods may be
restated either as of the beginning of the year of adoption or
for all periods presented. The prospective method requires that
compensation expense be recorded for all unvested stock options
and restricted stock at the beginning of the first quarter of
adoption of SFAS 123R, whereas under the retroactive method
we would record compensation expense for all unvested stock
options and restricted stock beginning with the first period
restated. We are evaluating the requirements of SFAS 123R
and expect its adoption to have a material effect on our
consolidated results of operations. We have not yet determined
the method of adoption or the effect of adopting SFAS 123R,
nor have we determined whether the adoption will result in
amounts that are similar to the current pro forma disclosures
under SFAS 123.
In November 2004, the FASB issued SFAS No. 151,
“Inventory Costs — An Amendment of ARB
No. 43, Chapter 4” (SFAS 151). SFAS 151
amends the guidance in ARB No. 43, Chapter 4,
“Inventory Pricing,” to clarify the types of costs
that should be expensed rather than capitalized as inventory.
Among other provisions, the new rule requires that items such as
idle facility expense, excessive spoilage, double freight, and
rehandling costs be recognized as current-period charges
regardless of whether they meet the criterion of “so
abnormal” as stated in ARB No. 43. Additionally,
SFAS 151 requires that the allocation of fixed production
overhead to the costs of conversion be based on the normal
capacity of the production facilities. SFAS 151 is
effective for fiscal years beginning after June 15, 2005.
We will be required to adopt SFAS 151 in the first quarter
of fiscal 2006, beginning on January 1, 2006. We are
currently evaluating the effect that the adoption of
SFAS 151 will have on our consolidated results of
operations and financial condition, but we do not expect the
adoption of SFAS 151 to have a material effect.
In March 2004, the Emerging Issues Task Force (EITF) of the
FASB reached a consensus on Issue No. 03-01, “The
Meaning of Other-Than-Temporary Impairment and Its Application
to Certain Investments” (EITF 03-01). EITF 03-01
provides guidance for identifying other-than-temporarily
impaired investments. In September 2004, the FASB issued a FASB
Staff Position EITF 03-1-1 that delays the effective date
of the recognition and measurement provisions of EITF 03-01
until further notice. The disclosure requirements were effective
for annual financial statements for fiscal years ending after
June 15, 2004. We do not expect the adoption of the
accounting provisions of EITF 03-01 to have a material
effect on our results of operations and financial condition.
|
|
| 3. |
COMMITMENTS AND CONTINGENCIES |
Guarantees and Product Warranties
FASB Interpretation No. 45, “Guarantor’s
Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others”
(FIN 45), requires that upon issuance of a guarantee, the
guarantor must disclose and record a liability for the fair
value of the obligation it assumes under that guarantee.
FIN 45 is applicable to our product warranty liability and
indemnification obligations contained in commercial agreements,
including customary intellectual property indemnifications for
our products contained in agreements with our resellers and
end-users.
52
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
We generally provide customers with a standard one-year hardware
and 90-day software warranty. Customers can upgrade and/or
extend the warranty for up to five years by purchasing one of
our customer support programs. Our warranty accrual represents
our best estimate of the amount necessary to settle future and
existing claims as of the balance sheet date. We periodically
assess the adequacy of our warranty accrual and adjust the
amount as considered necessary.
Changes in our product warranty liability for the year ended
December 31, 2004 were as follows (in thousands):
| |
|
|
|
|
|
|
Balance, December 31, 2003
|
|
$ |
1,781 |
|
| |
Liabilities accrued for warranties issued during the period
|
|
|
1,008 |
|
| |
Warranty claims settled during the period
|
|
|
(710 |
) |
| |
Changes in liabilities for pre-existing warranties during the
period, including changes in estimates
|
|
|
(581 |
) |
| |
|
|
|
|
Balance, December 31, 2004
|
|
$ |
1,498 |
|
| |
|
|
|
We offer our customers renewable support arrangements, including
extended warranties, that generally range from one to five
years. We do not separate extended warranty revenues from
routine support service revenues, as it is not practical to do
so. The change in our deferred support revenue balance was as
follows for the year ended December 31, 2004 (in thousands):
| |
|
|
|
|
|
|
Deferred support revenue at December 31, 2003
|
|
$ |
35,115 |
|
| |
New support arrangements
|
|
|
79,874 |
|
| |
Recognition of support revenue
|
|
|
(58,755 |
) |
| |
|
|
|
|
Ending balance at December 31, 2004
|
|
$ |
56,234 |
|
| |
|
|
|
In the ordinary course of business, we enter into contractual
arrangements under which we may agree to indemnify the
counter-party from losses relating to a breach of
representations and warranties, a failure to perform certain
covenants, or claims and losses arising from certain external
events as outlined within the particular contract, which may
include, for example, losses arising from litigation or claims
relating to past performance. Such indemnification clauses may
not be subject to maximum loss clauses. No amounts are reflected
in our consolidated financial statements as of December 31,
2004 or 2003 related to these indemnifications as, historically,
payments made related to these indemnifications have not been
material to our consolidated financial position or results of
operations.
Leases
We lease our facilities and office buildings under operating
leases that expire at various dates through April 2011. Most of
our leases contain renewal options. Our headquarters for
corporate administration, research and development, sales and
marketing, and manufacturing occupy approximately
110,000 square feet of space in San Jose, California.
Rent expense under operating leases was $5.4 million in
2004 and $5.3 million in 2003 and 2002. At
December 31, 2004, future minimum lease payments under all
noncancelable operating leases were as follows (in thousands):
| |
|
|
|
|
| |
|
Operating | |
| |
|
Leases | |
| |
|
| |
|
2005
|
|
$ |
4,736 |
|
|
2006
|
|
|
2,337 |
|
|
2007
|
|
|
2,138 |
|
|
2008
|
|
|
1,255 |
|
|
2009
|
|
|
576 |
|
|
Thereafter
|
|
|
705 |
|
| |
|
|
|
|
Total lease payments
|
|
$ |
11,747 |
|
| |
|
|
|
53
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Purchase Commitments with Suppliers and Third-Party
Manufacturers
We use contract manufacturers to assemble and test our products.
We also utilize third-party OEMs to manufacture certain
Foundry-branded products. In order to reduce manufacturing
lead-times and ensure an adequate supply of inventories, our
agreements with some of these manufacturers allow them to
procure long lead-time component inventory on our behalf based
on a rolling production forecast provided by us. We may be
contractually obligated to purchase long lead-time component
inventory procured by certain manufacturers in accordance with
our forecasts although we can generally give notice of order
cancellation at least 90 days prior to the delivery date.
In addition, we issue purchase orders to our component suppliers
and third-party manufacturers that may not be cancelable at any
time. As of December 31, 2004, we had approximately
$40.0 million of open purchase orders with our component
suppliers and third-party manufacturers that may not be
cancelable.
Litigation
On October 25, 2004, we entered into a settlement agreement
and patent cross-license (the agreements) covering technologies
that were at issue in litigation with Nortel. The agreements
resolved the ongoing litigation in both Massachusetts and
California. Pursuant to the agreements, we paid
$35.0 million to Nortel in early November 2004 and, based
on the results of a third-party valuation analysis, we recorded
an operating expense of $30.2 million in the third quarter
of 2004. The remaining $4.8 million paid to Nortel
represents consideration for a four-year cross-license with
Nortel.
Another long-standing litigation matter was resolved on
February 10, 2005, when the Ninth Circuit Court of Appeals
(Court of Appeals) dismissed the plaintiff’s appeal In
re Foundry Networks, Inc. Securities Litigation. The
dismissal was in response to plaintiff’s motion to dismiss
their appeal of the District Court judgment in favor of us. This
litigation began in December 2000, when several similar
stockholder class action lawsuits were filed against us and
certain of our officers in the United States District Court for
the Northern District of California, following our announcement
of our anticipated financial results for the fourth quarter
ended December 31, 2000. The District Court had dismissed
the case with prejudice and entered judgment in our favor, after
which the plaintiffs filed a Notice of Appeal with the Court of
Appeals. Oral argument before the Court of Appeals was scheduled
for February 17, 2005. However, on February 9, 2005,
plaintiffs filed their unopposed motion of dismissal of their
appeal, making the District Court’s judgment final. No
settlement was paid in the action. We believe the dismissal
validates our position that the lawsuit was without merit.
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 our common stock alleging
violations of federal securities laws. The case was designated
as In re Foundry Networks, Inc. Initial Public Offering
Securities Litigation, No. 01-CV-10640 (SAS)
(S.D.N.Y.), related to In re 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 our common stock from September 27, 1999 through
December 6, 2000. The operative amended complaint names as
defendants us and three of our officers (Foundry Defendants),
including our Chief Executive Officer and Chief Financial
Officer; and investment banking firms that served as
underwriters for our initial public offering in September 1999.
The amended complaint alleged 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
registration statement for the initial public offering
(IPO) failed to disclose that (i) the underwriters
agreed to allow certain customers to purchase shares in the IPO
in exchange for excess commissions to be paid to the
underwriters, and (ii) the underwriters arranged for
certain customers to purchase additional shares in the
aftermarket at predetermined prices. The amended complaint also
alleges that false or misleading analyst reports were issued.
Similar allegations were made in lawsuits challenging over 300
other initial public offerings conducted in 1999 and 2000. The
cases were consolidated for pretrial purposes. On
February 19, 2003, the Court ruled on all defendants’
motions to dismiss. In ruling on motions to dismiss, the Court
must
54
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
treat the allegations in the complaint as if they were true
solely for purposes of deciding the motions. The motion was
denied as to claims under the Securities Act of 1933 in the case
involving us. The same ruling was made in all but 10 of the
other cases. The Court dismissed the claims under
Section 10(b) of the Securities Exchange Act of 1934
against us and one of the individual defendants and dismissed
all of the Section 20(a) “control person”
claims. The Court denied the motion to dismiss the
Section 10(b) claims against our remaining individual
defendants on the basis that those defendants allegedly sold our
stock following the IPO, allegations found sufficient purely for
pleading purposes to allow those claims to move forward. A
similar ruling was made with respect to 62 individual defendants
in the other cases. We have accepted a settlement proposal
presented to all issuer defendants. Under the terms of this
settlement, plaintiffs will dismiss and release all claims
against the Foundry Defendants in exchange for a contingent
payment by the insurance companies collectively responsible for
insuring the issuers in all of the IPO cases and for the
assignment or surrender of control of certain claims we may have
against the underwriters. The settlement will require approval
of the Court, which cannot be assured, after class members are
given the opportunity to object to the settlement or opt out of
the settlement.
In May 2003, Lucent Technologies Inc. (Lucent) filed a lawsuit
against us in the United States District Court for the District
of Delaware alleging that certain of our products infringe
several of Lucent’s patents, and seeking injunctive relief,
as well as unspecified damages. Lucent also brought suit on the
same patents (and one additional patent) against one of our
competitors. On February 6, 2004, the District Court
severed the two cases. Fact discovery is now closed. A Markman
claim construction hearing was held on January 14, 2005,
and the parties are awaiting the Court’s claim
construction. On February 28, 2005, the parties filed
summary judgment motions. Trial in the matter is expected to
begin in November 2005. The severed trial, to which we are not a
party, is scheduled to begin April 26, 2005. We have
analyzed the validity of Lucent’s claims and believe that
Lucent’s suit is without merit. We are committed to
vigorously defending ourselves against Lucent’s claims.
On February 13, 2004, we filed a lawsuit against Lucent in
the United States District Court, Eastern District of Texas,
Marshall Division. The lawsuit alleges that certain of
Lucent’s products infringe one of our patents. We are
seeking injunctive relief and damages. On March 22, 2004,
Lucent filed an Answer and Counter Claim seeking a declaration
of invalidity as to our asserted patent. On April 9, 2004,
Lucent filed an Amended Answer and Counter Claim asserting
infringement of U.S. patent #5649131. We have analyzed
the validity of Lucent’s counter claim and believe it is
without merit. Discovery has begun and is scheduled to close on
June 17, 2005. A Markman claims construction hearing is
scheduled for March 24, 2005. Trial is scheduled to begin
August 1, 2005.
From time to time, we are subject to other legal proceedings and
claims in the ordinary course of business, including claims of
alleged infringement of trademarks, copyrights, patents and
other intellectual property rights. From time to time, third
parties assert patent infringement claims against us in the form
of letters, lawsuits and other forms of communication. In
addition, from time to time, we receive notification from
customers claiming that they are entitled to indemnification or
other obligations from us related to infringement claims made
against them by third parties. Regardless of the merits of our
position, litigation is always an expensive and uncertain
proposition. In accordance with SFAS No. 5,
“Accounting for Contingencies” (SFAS 5), we
record a liability when it is both probable that a liability has
been incurred and the amount of the loss can be reasonably
estimated. We review the need for any such liability on a
quarterly basis and record any necessary adjustments to reflect
the effect of ongoing negotiations, settlements, rulings, advice
of legal counsel, and other information and events pertaining to
a particular case in the period they become known. At
December 31 2004, we have not recorded any such liabilities
in accordance with SFAS 5. We believe we have valid
defenses with respect to the legal matters pending against us.
In the event of a determination adverse to us, we could incur
substantial monetary liability and be required to change our
business practices. Any unfavorable determination could have a
material adverse effect on our financial position, results of
operations, or cash flows.
55
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
We account for income taxes pursuant to SFAS No. 109,
“Accounting for Income Taxes” (SFAS 109).
SFAS 109 provides for an asset and liability approach to
accounting for income taxes, under which deferred tax assets and
liabilities are recognized for the estimated future tax
consequences attributable to tax credit carryforwards and to
differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted
tax rates in effect for the year in which those temporary
differences are expected to be recovered or settled. Components
of our deferred tax assets were as follows at December 31
(in thousands):
| |
|
|
|
|
|
|
|
|
|
|
| |
|
December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
|
Deferred Tax Assets:
|
|
|
|
|
|
|
|
|
| |
Accrued payroll and related expenses
|
|
$ |
3,580 |
|
|
$ |
2,135 |
|
| |
Inventory valuation reserve
|
|
|
13,844 |
|
|
|
12,090 |
|
| |
Accrued warranty
|
|
|
597 |
|
|
|
715 |
|
| |
Allowance for doubtful accounts
|
|
|
1,243 |
|
|
|
1,665 |
|
| |
Write-down of minority interest
|
|
|
997 |
|
|
|
2,120 |
|
| |
Depreciation
|
|
|
1,229 |
|
|
|
1,491 |
|
| |
Research and development credits
|
|
|
18,482 |
|
|
|
11,635 |
|
| |
Deferred support revenue
|
|
|
2,255 |
|
|
|
— |
|
| |
Litigation settlement tax liability
|
|
|
(1,795 |
) |
|
|
— |
|
| |
Other temporary differences
|
|
|
2,843 |
|
|
|
2,460 |
|
| |
|
|
|
|
|
|
| |
|
Total deferred tax assets
|
|
|
43,275 |
|
|
|
34,311 |
|
| |
|
Valuation allowance
|
|
|
(997 |
) |
|
|
(1,003 |
) |
| |
|
|
|
|
|
|
| |
|
Net deferred tax assets
|
|
$ |
42,278 |
|
|
$ |
33,308 |
|
| |
|
|
|
|
|
|
We believe that we will likely generate sufficient taxable
income in future periods to realize the tax benefits arising
from our existing deferred tax assets. As of December 31,
2004, we had a Federal research and development tax credit
carryforward of $10.3 million, a portion of which will
expire beginning in 2021. We also had state tax credit
carryforwards of $8.2 million, of which $7.7 million
can be carried forward indefinitely and $0.5 million will
expire beginning in 2009.
Our provision for income taxes consisted of the following for
the years ended December 31 (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Current:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Federal
|
|
$ |
24,432 |
|
|
$ |
40,934 |
|
|
$ |
7,801 |
|
| |
Foreign
|
|
|
165 |
|
|
|
464 |
|
|
|
189 |
|
| |
State
|
|
|
3,496 |
|
|
|
5,493 |
|
|
|
560 |
|
| |
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
28,093 |
|
|
|
46,891 |
|
|
|
8,550 |
|
| |
|
|
|
|
|
|
|
|
|
|
Deferred:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Federal
|
|
|
(2,600 |
) |
|
|
(2,830 |
) |
|
|
1,201 |
|
| |
State
|
|
|
(227 |
) |
|
|
(1,918 |
) |
|
|
(92 |
) |
| |
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
(2,827 |
) |
|
|
(4,748 |
) |
|
|
1,109 |
|
| |
|
|
|
|
|
|
|
|
|
|
Total provision
|
|
$ |
25,266 |
|
|
$ |
42,143 |
|
|
$ |
9,659 |
|
| |
|
|
|
|
|
|
|
|
|
56
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Our provision for income taxes and effective tax rate differs
from the statutory U.S. federal income tax rate as follows
for the years ended December 31 (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Provision at U.S. statutory rate of 35%
|
|
$ |
25,632 |
|
|
|
35.0 |
% |
|
$ |
41,029 |
|
|
|
35.0 |
% |
|
$ |
11,269 |
|
|
|
35.0 |
% |
|
State income taxes, net of federal benefit
|
|
|
3,587 |
|
|
|
4.9 |
% |
|
|
6,044 |
|
|
|
5.2 |
% |
|
|
1,657 |
|
|
|
5.1 |
% |
|
Federal and state research and development credits
|
|
|
(2,248 |
) |
|
|
(3.1 |
)% |
|
|
(2,118 |
) |
|
|
(1.8 |
)% |
|
|
(1,895 |
) |
|
|
(5.9 |
)% |
|
Nondeductible deferred stock compensation
|
|
|
— |
|
|
|
— |
|
|
|
92 |
|
|
|
0.0 |
% |
|
|
424 |
|
|
|
1.3 |
% |
|
Export sales incentive
|
|
|
(1,413 |
) |
|
|
(1.9 |
)% |
|
|
(1,884 |
) |
|
|
(1.6 |
)% |
|
|
(620 |
) |
|
|
(1.9 |
)% |
|
Tax-exempt interest
|
|
|
(1,185 |
) |
|
|
(1.6 |
)% |
|
|
(616 |
) |
|
|
(0.5 |
)% |
|
|
(1,126 |
) |
|
|
(3.5 |
)% |
|
Valuation allowance
|
|
|
— |
|
|
|
— |
|
|
|
1,003 |
|
|
|
0.9 |
% |
|
|
— |
|
|
|
— |
|
|
Other
|
|
|
893 |
|
|
|
1.2 |
% |
|
|
(1,407 |
) |
|
|
(1.2 |
)% |
|
|
(50 |
) |
|
|
(0.1 |
)% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
25,266 |
|
|
|
34.5 |
% |
|
$ |
42,143 |
|
|
|
36.0 |
% |
|
$ |
9,659 |
|
|
|
30.0 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Our income taxes payable have been reduced by the tax benefits
associated with certain 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, we receive an income tax benefit for the
difference between the fair market value of the stock issued at
the time of the exercise and the employee’s option price,
tax effected. These benefits are credited directly to
stockholders’ equity and amounted to $29.2 million,
$46.5 million, and $4.8 million for the years ended
December 31, 2004, 2003, and 2002, respectively.
Preferred Stock
We are authorized to issue up to 5,000,000 shares of
preferred stock, with a par value of $0.0001 per share.
Preferred stock may be issued from time to time in one or more
series. Our board of directors is authorized to determine the
rights, preferences, privileges and restrictions on these
shares. No shares of preferred stock were outstanding as of
December 31, 2004 and 2003.
Stock Option Exchange Program
On August 21, 2002, we filed a Tender Offer Statement with
the Securities and Exchange Commission related to a voluntary
stock option exchange program for our employees. Our executive
officers and directors were not eligible to participate in this
program. Under the exchange program, employees were given the
opportunity to voluntarily cancel unexercised vested and
unvested stock options previously granted to them in exchange
for a stock option grant on or about March 21, 2003 equal
to one-half the number of tendered options. However,
participants who elected to exchange options were also required
to exchange other options granted to them in the previous six
months. On September 20, 2002, we accepted for exchange
options to purchase 5,744,500 shares of our common
stock. The cancelled options were exchanged for 2,757,100
replacement stock options on March 24, 2003 at an exercise
price of $7.76 per share, which was the fair value of the
shares on that date. In order to receive a replacement stock
option grant, an employee was required to remain employed with
us or one of our subsidiaries until March 24, 2003. The
replacement options vest over a three-year period. The stock
option exchange program did not result in stock compensation
expense or variable accounting for replacement awards.
57
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Common Stock
We had 137,225,812 and 131,622,730 shares of common stock
issued and outstanding at December 31, 2004 and 2003,
respectively.
The following shares of common stock have been reserved for
future issuance as of December 31, 2004:
| |
|
|
|
|
|
|
1996 Stock Plan
|
|
|
26,362,685 |
|
|
1999 Directors’ Stock Option Plan
|
|
|
3,280,000 |
|
|
1999 Employee Stock Purchase Plan
|
|
|
5,692,990 |
|
|
2000 Non-Executive Stock Option Plan
|
|
|
2,536,734 |
|
| |
|
|
|
| |
Total
|
|
|
37,872,409 |
|
| |
|
|
|
1996 Stock Plan
Under our 1996 Stock Plan (the Plan), the board of directors
authorized the issuance of 73,235,683 shares of common
stock to employees and consultants as of December 31, 2004,
of which 26,362,685 shares are available for future
issuance. Nonstatutory options granted under the Plan must be
issued at a price equal to at least 85% of the fair market value
of our common stock on 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 our common stock on the
date of grant. In 2004 and 2003, all option grants under the
Plan were granted at a price equal to the fair market value of
our common stock on 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 two to five
years. The number of shares available for issuance under the
Plan will be increased on the first day of each fiscal year
through 2006 by the lesser of (i) 5,000,000 shares;
(ii) five percent (5%) of the shares outstanding on the
last day of the immediately preceding fiscal year; or
(iii) such lesser amount of shares as determined by the
board of directors.
1999 Directors’ Stock Option Plan
Under the 1999 Directors’ Stock Option Plan
(Directors’ Plan), each non-employee director who becomes a
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 2004, our five non-employee directors received
annual grants totaling 300,000 stock options at an exercise
price of $13.50 per share. As of December 31, 2004,
1,910,000 options were outstanding with a weighted-average
exercise price of $35.75 per share.
2000 Non-Executive Stock Option Plan
Under the 2000 Non-Executive Stock Option Plan (Non-Executive
Plan), we may issue non-qualified options to purchase common
stock to employees and external consultants other than officers
and directors. As of December 31, 2004,
2,427,548 shares were outstanding with a weighted average
exercise price of $12.34 per share.
58
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The following table summarizes stock option activity under all
stock option plans during the three years ended
December 31, 2004:
| |
|
|
|
|
|
|
|
|
|
| |
|
|
|
Weighted | |
| |
|
|
|
Average | |
| |
|
Options | |
|
Exercise | |
| |
|
Outstanding | |
|
Price($) | |
| |
|
| |
|
| |
|
Balance, December 31, 2001
|
|
|
25,460,623 |
|
|
|
30.44 |
|
| |
Granted
|
|
|
12,496,950 |
|
|
|
6.24 |
|
| |
Exercised
|
|
|
(1,472,887 |
) |
|
|
3.00 |
|
| |
Cancelled
|
|
|
(9,273,434 |
) |
|
|
57.14 |
|
| |
|
|
|
|
|
|
|
Balance, December 31, 2002
|
|
|
27,211,252 |
|
|
|
11.72 |
|
| |
Granted
|
|
|
9,945,464 |
|
|
|
11.23 |
|
| |
Exercised
|
|
|
(9,477,396 |
) |
|
|
6.92 |
|
| |
Cancelled
|
|
|
(1,162,761 |
) |
|
|
18.55 |
|
| |
|
|
|
|
|
|
|
Balance, December 31, 2003
|
|
|
26,516,559 |
|
|
|
12.96 |
|
| |
Granted
|
|
|
11,358,800 |
|
|
|
15.30 |
|
| |
Exercised
|
|
|
(4,483,154 |
) |
|
|
7.00 |
|
| |
Cancelled
|
|
|
(3,353,693 |
) |
|
|
19.53 |
|
| |
|
|
|
|
|
|
|
Balance, December 31, 2004
|
|
|
30,038,512 |
|
|
|
14.00 |
|
| |
|
|
|
|
|
|
As of December 31, 2004, an aggregate of
4,405,446 shares were available for future option grants to
our employees.
The following table presents information about stock options
outstanding and exercisable at December 31, 2004:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Stock Options Outstanding | |
|
|
| |
|
| |
|
Stock Options Exercisable | |
| |
|
|
|
Weighted- | |
|
|
|
| |
| |
|
|
|
Average | |
|
Weighted- | |
|
|
|
Weighted- | |
| |
|
|
|
Remaining | |
|
Average | |
|
|
|
Average | |
| |
|
Shares | |
|
Contractual | |
|
Exercise | |
|
Shares | |
|
Exercise | |
| Range of Exercise Prices |
|
Outstanding | |
|
Life (years) | |
|
Price $ | |
|
Exercisable | |
|
Price $ | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
$0.03–$6.14
|
|
|
4,791,398 |
|
|
|
6.23 |
|
|
|
4.92 |
|
|
|
4,051,232 |
|
|
|
4.82 |
|
|
$6.30–$7.76
|
|
|
5,203,294 |
|
|
|
7.74 |
|
|
|
7.34 |
|
|
|
2,731,351 |
|
|
|
7.33 |
|
|
$7.94–$9.71
|
|
|
5,051,440 |
|
|
|
8.92 |
|
|
|
8.96 |
|
|
|
894,639 |
|
|
|
8.10 |
|
|
$9.76–$13.16
|
|
|
4,608,372 |
|
|
|
7.68 |
|
|
|
11.24 |
|
|
|
2,502,692 |
|
|
|
11.23 |
|
|
$13.35–$18.06
|
|
|
4,332,078 |
|
|
|
8.83 |
|
|
|
15.13 |
|
|
|
1,221,248 |
|
|
|
15.44 |
|
|
$18.88–$23.89
|
|
|
4,524,530 |
|
|
|
8.89 |
|
|
|
21.80 |
|
|
|
486,856 |
|
|
|
21.04 |
|
|
$26.21–$108.13
|
|
|
1,527,400 |
|
|
|
5.99 |
|
|
|
63.75 |
|
|
|
1,415,063 |
|
|
|
66.67 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Total
|
|
|
30,038,512 |
|
|
|
7.93 |
|
|
|
14.00 |
|
|
|
13,303,081 |
|
|
|
14.91 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
59
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The following table sets forth a comparison, as of
December 31, 2004, of the number of stock options
outstanding with exercise prices at or below the closing price
of our common stock on December 31, 2004 (In-the-Money
options) to those with exercise prices greater than the closing
price of our common stock on such date (Out-of-the-Money
options). The closing price of our common stock was $13.16 on
December 31, 2004.
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
Percentage of Total | |
| |
|
|
|
|
|
|
|
Options | |
| |
|
Exercisable | |
|
Unexercisable | |
|
Total | |
|
Outstanding | |
| |
|
| |
|
| |
|
| |
|
| |
|
In-the-Money
|
|
|
10,179,914 |
|
|
|
9,474,590 |
|
|
|
19,654,504 |
|
|
|
65 |
% |
|
Out-of-the-Money
|
|
|
3,123,167 |
|
|
|
7,260,841 |
|
|
|
10,384,008 |
|
|
|
35 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Options Outstanding
|
|
|
13,303,081 |
|
|
|
16,735,431 |
|
|
|
30,038,512 |
|
|
|
100 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
1999 Employee Stock Purchase Plan
Under the 1999 Employee Stock Purchase Plan (the Purchase Plan),
a total of 5,692,990 shares of common stock were reserved
for issuance as of December 31, 2004. The number of shares
reserved for issuance under the Purchase Plan will be increased
on the first day of each fiscal year through 2009 by the lesser
of (i) 1,500,000 shares, (ii) 2% of our
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 allows eligible employees to purchase common
stock through payroll deductions, which cannot exceed 20% of an
employee’s compensation, at a price equal to the lower of
85% of the fair market value of our common stock at the
beginning of each offering period or at the end of each purchase
period. During the two purchase periods in 2004, a total of
1,119,928 shares were issued under the Purchase Plan at an
average price of $6.52 per share.
Deferred Stock Compensation
In connection with grants of stock options to employees and a
director, we recorded deferred stock compensation in the
aggregate amount of $17.6 million in 1999 and 2000,
representing the difference between the exercise price of the
option 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 after 2000. Deferred
stock compensation was reflected within stockholders’
equity and was amortized to expense over the respective vesting
periods of the options. We had no remaining deferred stock
compensation to amortize in 2004. We recorded amortization
expense of approximately $231,000 and $1.1 million in 2003
and 2002, respectively. Amortization expense relates to options
granted to employees in all operating expense categories, but
has not been separately allocated to these categories.
We provide a tax-qualified employee savings and retirement plan
that entitles eligible employees to make tax-deferred
contributions. Under the 401(k) Plan, U.S.-based employees may
elect to reduce their current annual compensation up to the
lesser of 20% or the statutorily prescribed limit, which was
$13,000 in calendar year 2004. Employees age 50 or over may
elect to contribute an additional $1,000. The 401(k) Plan
provides for discretionary contributions as determined by our
board of directors each year. In January 2003, the board of
directors approved a matching contribution program whereby we
match dollar for dollar contributions made by each employee up
to $1,250 per year for each employee. Our matching
contributions to the 401(k) Plan totaled $517,000 and $474,000
in 2004 and 2003, respectively.
60
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
FOUNDRY NETWORKS, INC.
Quarterly Summary (Unaudited)
The following tables set forth our consolidated statement of
operations data for each of the eight quarters ended
December 31, 2004, including such amounts expressed as a
percentage of net revenues. This unaudited quarterly information
has been prepared on the same basis as our audited consolidated
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. 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, | |
| |
|
2003 | |
|
2003 | |
|
2003 | |
|
2003 | |
|
2004 | |
|
2004 | |
|
2004 | |
|
2004 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(In thousands, except per share amounts) | |
|
Statement of Operations Data (unaudited):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Product
|
|
$ |
81,013 |
|
|
$ |
83,444 |
|
|
$ |
89,450 |
|
|
$ |
97,418 |
|
|
$ |
89,300 |
|
|
$ |
83,489 |
|
|
$ |
87,450 |
|
|
$ |
88,780 |
|
| |
Service
|
|
|
10,125 |
|
|
|
12,268 |
|
|
|
12,233 |
|
|
|
13,677 |
|
|
|
14,716 |
|
|
|
14,338 |
|
|
|
15,061 |
|
|
|
15,970 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Total net revenues
|
|
|
91,138 |
|
|
|
95,712 |
|
|
|
101,683 |
|
|
|
111,095 |
|
|
|
104,016 |
|
|
|
97,827 |
|
|
|
102,511 |
|
|
|
104,750 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Product
|
|
|
35,442 |
|
|
|
32,428 |
|
|
|
31,754 |
|
|
|
33,488 |
|
|
|
31,994 |
|
|
|
30,442 |
|
|
|
33,194 |
|
|
|
33,559 |
|
| |
Service
|
|
|
2,061 |
|
|
|
2,196 |
|
|
|
1,688 |
|
|
|
1,801 |
|
|
|
3,126 |
|
|
|
3,566 |
|
|
|
3,785 |
|
|
|
3,757 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Total cost of revenues
|
|
|
37,503 |
|
|
|
34,624 |
|
|
|
33,442 |
|
|
|
35,289 |
|
|
|
35,120 |
|
|
|
34,008 |
|
|
|
36,979 |
|
|
|
37,316 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Gross margin
|
|
|
53,635 |
|
|
|
61,088 |
|
|
|
68,241 |
|
|
|
75,806 |
|
|
|
68,896 |
|
|
|
63,819 |
|
|
|
65,532 |
|
|
|
67,434 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Research and development
|
|
|
9,921 |
|
|
|
10,045 |
|
|
|
10,432 |
|
|
|
10,075 |
|
|
|
10,012 |
|
|
|
10,003 |
|
|
|
11,686 |
|
|
|
12,204 |
|
| |
Sales and marketing
|
|
|
19,981 |
|
|
|
23,415 |
|
|
|
21,428 |
|
|
|
23,615 |
|
|
|
23,168 |
|
|
|
25,094 |
|
|
|
23,228 |
|
|
|
27,124 |
|
| |
General and administrative
|
|
|
3,999 |
|
|
|
2,948 |
|
|
|
4,852 |
|
|
|
5,771 |
|
|
|
5,425 |
|
|
|
6,268 |
|
|
|
10,204 |
|
|
|
7,707 |
|
| |
Litigation settlement
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
30,193 |
|
|
|
— |
|
| |
Amortization of deferred stock compensation
|
|
|
122 |
|
|
|
72 |
|
|
|
21 |
|
|
|
16 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Total operating expenses
|
|
|
34,023 |
|
|
|
36,480 |
|
|
|
36,733 |
|
|
|
39,477 |
|
|
|
38,605 |
|
|
|
41,365 |
|
|
|
75,311 |
|
|
|
47,035 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations
|
|
|
19,612 |
|
|
|
24,608 |
|
|
|
31,508 |
|
|
|
36,329 |
|
|
|
30,291 |
|
|
|
22,454 |
|
|
|
(9,779 |
) |
|
|
20,399 |
|
|
Interest income
|
|
|
1,065 |
|
|
|
1,229 |
|
|
|
1,475 |
|
|
|
1,399 |
|
|
|
1,807 |
|
|
|
1,720 |
|
|
|
2,568 |
|
|
|
3,773 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before provision for income taxes
|
|
|
20,677 |
|
|
|
25,837 |
|
|
|
32,983 |
|
|
|
37,728 |
|
|
|
32,098 |
|
|
|
24,174 |
|
|
|
(7,211 |
) |
|
|
24,172 |
|
|
Provision (benefit) for income taxes
|
|
|
7,237 |
|
|
|
9,043 |
|
|
|
12,204 |
|
|
|
13,659 |
|
|
|
12,197 |
|
|
|
9,186 |
|
|
|
(3,593 |
) |
|
|
7,476 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$ |
13,440 |
|
|
$ |
16,794 |
|
|
$ |
20,779 |
|
|
$ |
24,069 |
|
|
$ |
19,901 |
|
|
$ |
14,988 |
|
|
$ |
(3,618 |
) |
|
$ |
16,696 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic net income (loss) per share
|
|
$ |
0.11 |
|
|
$ |
0.14 |
|
|
$ |
0.16 |
|
|
$ |
0.18 |
|
|
$ |
0.15 |
|
|
$ |
0.11 |
|
|
$ |
(0.03 |
) |
|
$ |
0.12 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted net income (loss) per share
|
|
$ |
0.11 |
|
|
$ |
0.13 |
|
|
$ |
0.15 |
|
|
$ |
0.17 |
|
|
$ |
0.14 |
|
|
$ |
0.11 |
|
|
$ |
(0.03 |
) |
|
$ |
0.12 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
61
FOUNDRY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Quarter Ended | |
| |
|
| |
| |
|
Mar. 31, | |
|
Jun. 30, | |
|
Sep. 30, | |
|
Dec. 31, | |
|
Mar. 31, | |
|
Jun. 30, | |
|
Sep. 30, | |
|
Dec. 31, | |
| |
|
2003 | |
|
2003 | |
|
2003 | |
|
2003 | |
|
2004 | |
|
2004 | |
|
2004 | |
|
2004 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(In thousands, except per share amounts) | |
|
Percentage of Revenue (unaudited):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Product
|
|
|
88.9 |
% |
|
|
87.2 |
% |
|
|
88.0 |
% |
|
|
87.7 |
% |
|
|
85.9 |
% |
|
|
85.3 |
% |
|
|
85.3 |
% |
|
|
84.8 |
% |
| |
Service
|
|
|
11.1 |
|
|
|
12.8 |
|
|
|
12.0 |
|
|
|
12.3 |
|
|
|
14.1 |
|
|
|
14.7 |
|
|
|
14.7 |
|
|
|
15.2 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Total net revenues
|
|
|
100.0 |
|
|
|
100.0 |
|
|
|
100.0 |
|
|
|
100.0 |
|
|
|
100.0 |
|
|
|
100.0 |
|
|
|
100.0 |
|
|
|
100.0 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Product
|
|
|
38.9 |
|
|
|
33.9 |
|
|
|
31.2 |
|
|
|
30.2 |
|
|
|
30.8 |
|
|
|
31.1 |
|
|
|
32.4 |
|
|
|
32.0 |
|
| |
Service
|
|
|
2.3 |
|
|
|
2.3 |
|
|
|
1.7 |
|
|
|
1.6 |
|
|
|
3.0 |
|
|
|
3.7 |
|
|
|
3.7 |
|
|
|
3.6 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Total cost of revenues
|
|
|
41.2 |
|
|
|
36.2 |
|
|
|
32.9 |
|
|
|
31.8 |
|
|
|
33.8 |
|
|
|
34.8 |
|
|
|
36.1 |
|
|
|
35.6 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Gross margin
|
|
|
58.8 |
|
|
|
63.8 |
|
|
|
67.1 |
|
|
|
68.2 |
|
|
|
66.2 |
|
|
|
65.2 |
|
|
|
63.9 |
|
|
|
64.4 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Research and development
|
|
|
10.9 |
|
|
|
10.5 |
|
|
|
10.2 |
|
|
|
9.0 |
|
|
|
9.6 |
|
|
|
10.2 |
|
|
|
11.4 |
|
|
|
11.6 |
|
| |
Sales and marketing
|
|
|
21.9 |
|
|
|
24.4 |
|
|
|
21.1 |
|
|
|
21.3 |
|
|
|
22.3 |
|
|
|
25.6 |
|
|
|
22.6 |
|
|
|
25.9 |
|
| |
General and administrative
|
|
|
4.4 |
|
|
|
3.1 |
|
|
|
4.8 |
|
|
|
5.2 |
|
|
|
5.2 |
|
|
|
6.4 |
|
|
|
10.0 |
|
|
|
7.4 |
|
| |
Litigation settlement
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
29.4 |
|
|
|
— |
|
| |
Amortization of deferred stock compensation
|
|
|
0.1 |
|
|
|
0.1 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Total operating expenses
|
|
|
37.3 |
|
|
|
38.1 |
|
|
|
36.1 |
|
|
|
35.5 |
|
|
|
37.1 |
|
|
|
42.2 |
|
|
|
73.4 |
|
|
|
44.9 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations
|
|
|
21.5 |
|
|
|
25.7 |
|
|
|
31.0 |
|
|
|
32.7 |
|
|
|
29.1 |
|
|
|
23.0 |
|
|
|
(9.5 |
) |
|
|
19.5 |
|
|
Interest income
|
|
|
1.1 |
|
|
|
1.3 |
|
|
|
1.4 |
|
|
|
1.3 |
|
|
|
1.7 |
|
|
|
1.7 |
|
|
|
2.5 |
|
|
|
3.6 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before provision for income taxes
|
|
|
22.6 |
|
|
|
27.0 |
|
|
|
32.4 |
|
|
|
34.0 |
|
|
|
30.8 |
|
|
|
24.7 |
|
|
|
(7.0 |
) |
|
|
23.1 |
|
|
Provision (benefit) for income taxes
|
|
|
7.9 |
|
|
|
9.4 |
|
|
|
12.0 |
|
|
|
12.3 |
|
|
|
11.7 |
|
|
|
9.4 |
|
|
|
(3.5 |
) |
|
|
7.2 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
|
14.7 |
% |
|
|
17.6 |
% |
|
|
20.4 |
% |
|
|
21.7 |
% |
|
|
19.1 |
% |
|
|
15.3 |
% |
|
|
(3.5 |
)% |
|
|
15.9 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
62
FOUNDRY NETWORKS, INC.
SCHEDULE II — VALUATION AND QUALIFYING
ACCOUNTS
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Balance at | |
|
Charged to | |
|
|
|
Balance at | |
| |
|
Beginning | |
|
Costs and | |
|
|
|
End of | |
| Description |
|
of Period | |
|
Expenses | |
|
Deductions(1) | |
|
Period | |
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(In thousands of dollars) | |
|
Year ended December 31, 2002:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for doubtful accounts
|
|
$ |
6,648 |
|
|
$ |
344 |
|
|
$ |
1,159 |
|
|
$ |
5,833 |
|
|
Allowance for sales returns
|
|
|
1,501 |
|
|
|
1,527 |
|
|
|
1,444 |
|
|
|
1,584 |
|
|
Year ended December 31, 2003:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for doubtful accounts
|
|
|
5,833 |
|
|
|
(862 |
) |
|
|
820 |
|
|
|
4,151 |
|
|
Allowance for sales returns
|
|
|
1,584 |
|
|
|
3,709 |
|
|
|
3,273 |
|
|
|
2,020 |
|
|
Year ended December 31, 2004:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for doubtful accounts
|
|
|
4,151 |
|
|
|
— |
|
|
|
1,034 |
|
|
|
3,117 |
|
|
Allowance for sales returns
|
|
|
2,020 |
|
|
|
2,080 |
|
|
|
2,473 |
|
|
|
1,627 |
|
|
|
| (1) |
Deductions for allowance for doubtful accounts refer to
write-offs and deductions for allowance for sales returns refer
to actual returns. |
63
|
|
| Item 9. |
Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure |
None.
|
|
| Item 9A. |
Controls and Procedures |
Based on an evaluation as of December 31, 2004, our Chief
Executive Officer and Chief Financial Officer have concluded
that the disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange
Act of 1934, as amended) were effective to provide reasonable
assurance that information required to be disclosed in this
Annual Report on Form 10-K was recorded, processed,
summarized and reported within the time periods specified in the
SEC’s rules and instructions for Form 10-K.
Management’s report on the Company’s internal control
over financial reporting and the related report of our
independent public accounting firm are included in this
Form 10-K on pages 37 and 38.
There were no significant changes to our internal controls
during the quarter ended December 31, 2004 that have
materially affected, or are reasonably likely to materially
affect, our internal controls over financial reporting.
Item 9B. Other
Information
None.
PART III
|
|
| Item 10. |
Directors and Executive Officers of the Registrant |
Certain information concerning our directors and executive
officers required by this Item is incorporated by reference from
the information contained under the caption “Executive
Officers and Directors,” and “Section 16(a)
Beneficial Ownership Reporting Compliance” in the
Company’s Proxy Statement for its 2005 Annual Meeting of
Stockholders.
Certain information concerning our Audit Committee, Audit
Committee Financial Expert(s) and Code of Ethics is incorporated
by reference from information contained in the Company’s
Proxy Statement for its 2005 Annual Meeting of Stockholders.
|
|
| 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,” and “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,” “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.
64
|
|
| Item 14. |
Principal Auditor Fees and Services |
Incorporated by reference from the information under the caption
“Principal Auditor Fees and Services” in the Proxy
Statement.
PART IV
|
|
| Item 15. |
Exhibits and Financial Statement Schedules |
(a) The following documents are filed as part of this
Form 10-K:
|
|
| |
(1) Consolidated Financial Statements and Reports of
Independent Registered Public Accounting Firm |
| |
| |
(2) Financial Statement Schedules |
See “Item 8. Financial Statements and Supplementary
Data — Schedule II-Valuation and Qualifying
Accounts.” Other schedules are omitted either 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.*(1) |
| |
| |
10 |
.2 |
|
Form of Stock Option Agreement under the registrant’s 1996
Stock Plan.*(1) |
| |
| |
10 |
.3 |
|
1999 Employee Stock Purchase Plan.*(2) |
| |
| |
10 |
.4 |
|
1999 Directors’ Stock Option Plan.*(3) |
| |
| |
10 |
.5 |
|
Form of Stock Option Agreement under the registrant’s
1999 Directors’ Stock Option Plan.*(3) |
| |
| |
10 |
.6 |
|
Form of Indemnification Agreement.(2) |
| |
| |
10 |
.7 |
|
OEM Purchase Agreement dated January 6, 1999 between
Foundry Networks, Inc. and Hewlett-Packard Company, Workgroup
Networks Division.(4) |
| |
| |
10 |
.8 |
|
Reseller Agreement dated July 1, 1997 between Foundry
Networks, Inc. and Mitsui & Co., Ltd.(4) |
| |
| |
10 |
.9 |
|
2000 Non-Executive Stock Option Plan.*(5) |
| |
| |
10 |
.10 |
|
Form of Stock Option Agreement under the registrant’s 2000
Non-Executive Stock Option Plan.*(5) |
| |
| |
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.(6) |
| |
| |
10 |
.12 |
|
Confidential Settlement Agreement and Release, effective
October 25, 2004, by and between Nortel Networks Limited,
Nortel Networks, Inc., Foundry Networks, Inc., Bobby R.
Johnson, Jr., H. Earl Ferguson, deceased, and Jeffrey
Prince. |
| |
| |
21 |
.1 |
|
List of Subsidiaries |
| |
| |
23 |
.1 |
|
Consent of Independent Registered Public Accounting Firm |
| |
| |
31 |
.1 |
|
Rule 13a-14(a) Certification (CEO) |
| |
| |
31 |
.2 |
|
Rule 13a-14(a) Certification (CFO) |
65
| |
|
|
|
|
| Number | |
|
Description |
| | |
|
|
| |
| |
32 |
.1 |
|
Section 1350 Certification (CEO) |
| |
32 |
.2 |
|
Section 1350 Certification (CFO) |
|
|
| * |
Indicates management contract or compensatory plan or
arrangement. |
| |
| (1) |
Copy of original 1996 Stock Plan and related form of Stock
Option Agreement 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). Copy of 1996 Stock Plan
reflecting the amendments for approval at the 2002 Annual
Meeting of Stockholders incorporated by reference to the
Company’s Definitive Proxy Statement for such meeting
(Commission File No. 000-26689). |
| |
| (2) |
Incorporated herein by reference to the exhibit filed with the
Company’s Registration Statement on Form S-1
(Commission File No. 333-82577). |
| |
| (3) |
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 Directors’
Plan reflecting the amendment for approval at the 2002 Annual
Meeting of Stockholders incorporated by reference to the
Company’s Definitive Proxy Statement for such meeting
(Commission File No. 000-26689). |
| |
| (4) |
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. |
| |
| (5) |
Incorporated herein by reference to the exhibit filed with the
Company’s Registration Statement on Form S-8 filed on
October 25, 2000 (Commission File No. 333-48560). |
| |
| (6) |
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). |
| |
| (7) |
Incorporated by reference from the Company’s Report on
Form 8-K filed on July 3, 2002. |
66
SIGNATURES
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.
|
|
| |
Foundry Networks, Inc. |
| |
(Registrant) |
|
|
|
| |
By: |
/s/ Timothy D. Heffner |
|
|
| |
|
| |
Timothy D. Heffner |
| |
Vice President, Finance & Administration, |
| |
Chief Financial Officer |
| |
(Principal Financial and Accounting Officer) |
Date: March 11, 2005
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose
signature appears below constitutes and appoints Bobby R.
Johnson Jr. and Timothy D. Heffner, jointly and severally, his
attorneys-in-fact, each with the power of substitution, for him
in any and all capacities, to sign any amendments to this Annual
Report on Form 10-K, and to file the same, with exhibits
thereto and other documents in connection therewith with the
Securities and Exchange Commission, hereby ratifying and
confirming all that each of said attorneys-in-fact, or his
substitute or substitutes may do or cause to be done by virtue
hereof.
Pursuant to the requirements of the Securities Exchange Act
of 1934, this report has been signed below by the following
persons on behalf of the registrant and in the capacities and on
the dates indicated.
| |
|
|
|
|
|
|
| Signature |
|
Title |
|
Date |
| |
|
|
|
|
| |
/s/ Bobby R. Johnson, Jr.
(Bobby R. Johnson, Jr.) |
|
President, Chief Executive Officer and Chairman of the Board of
Directors (Principal Executive Officer) |
|
March 11, 2005 |
| |
/s/ Timothy D. Heffner
(Timothy D. Heffner) |
|
Vice President, Finance & Administration, Chief
Financial Officer (Principal Financial and Accounting Officer) |
|
March 11, 2005 |
| |
/s/ Andrew K. Ludwick
(Andrew K. Ludwick) |
|
Director |
|
March 11, 2005 |
| |
/s/ Alfred J. Amoroso
(Alfred J. Amoroso) |
|
Director |
|
March 11, 2005 |
| |
/s/ C. Nicholas Keating
(C. Nicholas Keating) |
|
Director |
|
March 11, 2005 |
| |
/s/ J. Steven Young
(J. Steven Young) |
|
Director |
|
March 11, 2005 |
| |
/s/ Alan L. Earhart
(Alan L. Earhart) |
|
Director |
|
March 11, 2005 |
67
INDEX TO EXHIBITS
| |
|
|
|
|
| Number |
|
Description |
| |
|
|
| |
10 |
.12 |
|
Confidential Settlement Agreement and Release, effective
October 25, 2004, by and between Nortel Networks
Limited, Nortel Networks, Inc., Foundry Networks, Inc., Bobby R.
Johnson, Jr., H. Earl Ferguson , deceased, and Jeffrey
Prince |
| |
21 |
.1 |
|
List of Subsidiaries |
| |
23 |
.1 |
|
Consent of Independent Registered Public Accounting Firm |
| |
31 |
.1 |
|
Rule 13a-14(a) Certification (CEO) |
| |
31 |
.2 |
|
Rule 13a-14(a) Certification (CFO) |
| |
32 |
.1 |
|
Section 1350 Certification (CEO) |
| |
32 |
.2 |
|
Section 1350 Certification (CFO) |
68