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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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Form 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1999
Commission file number: 000-26689
FOUNDRY NETWORKS, INC.
(Exact name of registrant as specified in its charter)
Delaware 77-0431154
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2100 Gold Street
P.O. Box 649100
San Jose, CA 95164-9100
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (408) 586-1700
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.0001 par value
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period than the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
registrant was approximately $12,427,827,281 as of March 10, 2000, based upon
the closing sale price on the Nasdaq National Market reported for such date.
Shares of common stock held by each officer and director and by each person who
owns 5% of more of the outstanding common stock have been excluded in that such
persons may be deemed to be affiliates. This determination of affiliate status
is not necessarily a conclusive determination for other purposes.
There were 114,834,589 shares of the registrant's common stock issued and
outstanding as of March 10, 2000. (1)
DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates information by reference from the definitive proxy
statement for the 1999 Annual Meeting of Stockholders to be filed hereafter.
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(1) All share numbers and share related prices in this Form 10-K, including
shares of common stock outstanding as of March 10, 2000, reflect the two-
for-one forward split of the registrant's outstanding capital stock
effected on January 10, 2000 in the form of a stock dividend.
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TABLE OF CONTENTS
Page
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PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 13
Item 3. Legal Proceedings........................................... 13
Item 4. Submission of Matters to a Vote of Security Holders......... 13
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters........................................ 14
Item 6. Selected Financial Data..................................... 15
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................. 17
Item 7(A). Quantitative and Qualitative Disclosures about Market Risk.. 30
Item 8. Financial Statements and Supplementary Data................. 31
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure................................... 50
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 51
Item 11. Executive Compensation...................................... 51
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................. 51
Item 13. Certain Relationships and Related Transactions.............. 51
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K........................................................ 51
SIGNATURES.............................................................. 53
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PART I
In addition to historical information, this Annual Report on Form 10-K
contains forward-looking statements. These forward-looking statements involve
risks, uncertainties and assumptions. The actual results may differ materially
from those anticipated in these forward-looking statements as a result of many
factors, including but not limited to, those discussed in the section entitled
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Risk Factors That May Affect Future Results and Market Price of
Stock." Readers are cautioned not to place undue reliance on these forward-
looking statements, which reflect management's opinions only as of the date
hereof. Foundry Networks, Inc. (the "Company" or "Foundry") undertakes no
obligation to revise or publicly release the results of any revision to these
forward-looking statements. Readers should carefully review the risk factors
described in this document as well as in other documents the Company files from
time to time with the Securities and Exchange Commission, including the
Quarterly Reports on Form 10-Q to be filed by the Company in fiscal year 2000.
Item 1. BUSINESS
Foundry designs, develops, manufactures and markets a comprehensive, end-to-
end suite of high performance networking products for enterprises, educational
institutions, government agencies, web-hosting companies, Application Service
Providers (ASPs), electronic banking and finance service providers, and
Internet service providers. Our Internet routers, Gigabit Ethernet Layer 2 and
Layer 3 switching routers and Internet traffic management systems enable our
customers to build and maintain efficient, high performance networks. Our
products provide solutions for a full range of networks, including Local Area
Networks (LANs), Metropolitan Area Networks (MANs) and Wide Area Networks
(WANs). This combined product breadth allows us to offer global oriented
solutions within and throughout a customer's networking infrastructure
regardless of the geographically dispersed nature of the entire organization.
Our products can be found in the wiring closets sitting on the floors of the
office connecting the desktops together within the enterprise right down to the
LAN core or data center. We provide an end-to-end solution from deep inside the
core of the Internet right out to the Internet service provider's point of
entry to the WAN to its network of web servers. Our Internet routers deliver
the capabilities and performance needed to deliver Internet services around the
world. Our Layer 2 and Layer 3 switches provide the horsepower required to
support the increasing use of bandwidth-intensive and Internet-based
applications. Our high performance Internet traffic management systems with
network intelligence capabilities allow enterprises, web-based businesses, and
Internet service providers to direct traffic flow more efficiently, based on
client location, application type and end user, while also allowing Internet
service providers to offer their customers differentiated, fee-based quality of
service. We sell our products through a direct sales force, resellers and an
OEM. By providing high levels of performance and network intelligence
capabilities at compelling price points, we provide a comprehensive solution to
address the rapidly growing networking market.
Industry Background
The pervasiveness of computing by businesses, organizations and individuals,
and the need to interconnect computing devices to enable widespread
communication, have given rise to the multi-billion dollar computer networking
industry. The explosive growth of the Internet and corporate internal and
external communications needs are driving the recent growth in enterprise and
Internet service provider networks. The complexity of information traveling
over networks is also rapidly increasing with the adoption of bandwidth-
intensive applications that include increasing amounts of data, voice, video
and graphics. The increase in users, coupled with these new bandwidth-intensive
applications, has resulted in exponential growth in network traffic. This
growth has led to a demand by enterprises, web-based businesses, and Internet
service providers for networking solutions with superior performance and
intelligence capabilities.
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Evolution of Market Needs
Organizations adopted data networks to connect a limited number of computers
within close proximity, allowing users to share simple, common services, such
as file servers and printers. In these networks, called local area networks or
LANs, traffic patterns were predictable because the majority of traffic resided
within the LAN and remained local to a specific part of the organization.
Widespread Internet usage, the proliferation of client-server applications and
the adoption of new bandwidth-intensive applications have increased traffic
loads and created unpredictable traffic patterns. Today, the majority of
traffic traverses the boundaries of the LAN to networks outside of the LAN.
Such communication traditionally required an organization to utilize costly
long distance carrier services that often provided inadequate performance. As a
result of today's traffic flows, enterprises increasingly require low cost,
high performance networking equipment to enable effective communications across
geographically dispersed networks, known as MANs and WANs.
Applying enterprise performance requirements to the growing set of web-based
organizations and Internet service providers magnifies our challenges. As their
customers have increasingly become dependent on Internet access, these new web-
based companies and Internet service providers demand networking solutions that
ensure the highest levels of performance and scalability. Similar to enterprise
needs, web-oriented organizations require low cost, high performance solutions
for both their internal networks and access to the Internet. The exponential
growth of Internet traffic, combined with the business critical nature of the
services that Internet service providers provide, necessitates heightened
requirements for reliability.
Evolution of Network Solutions
Early LANs consisted of hubs, which enabled multiple users to share network
resources, and software-based routers, which supported multiple protocols to
move traffic around the network. Increased use of bandwidth-intensive
applications and a larger number of users strained these early network
infrastructures, making it increasingly difficult for them to handle new
applications while still performing at an acceptable speed. Network devices
known as Layer 2 switches replaced hubs to provide dedicated bandwidth to
users, while Fast Ethernet technology was introduced to provide data
transmission speeds of 100 Mbps, or ten times faster than original hubs.
Despite these improvements, the installed base of traditional routers, relying
on software to analyze network traffic, was unable to accommodate increased
data speeds and changing traffic patterns and became the new network
bottleneck.
Two new technologies, Gigabit Ethernet, capable of data transmission speeds
of 1000 Mbps, and Layer 3 switching, evolved in parallel to handle growing and
unpredictable traffic patterns and address the performance needs of bandwidth-
intensive applications. Gigabit Ethernet-based Layer 3 switches combine Gigabit
transmission speeds with the forwarding capabilities of software-based routers.
In Layer 3 switches, the software forwarding capabilities that enabled early
routers to move traffic around the network perform this function in hardware,
integrated on application-specific integrated circuits, or ASICs, built into
the switch. This integration enables manufacturers to develop Layer 3 switches
at lower costs while improving network performance.
Next Generation Needs and Solutions
As enterprises, web-based businesses, and Internet service providers seek to
accommodate network user needs, adding bandwidth alone is not an adequate
solution. Due to the increased use of multiple traffic types for many
applications, enterprises, web-based businesses, and Internet service providers
have an acute need for solutions that provide network intelligence to
distinguish among and prioritize different types of traffic and regulate the
network response to traffic. Particularly for anyone supporting electronic
business on the web, including Internet service providers, network intelligence
allows them to maintain network reliability and offer differentiated, fee-based
quality of service.
To address these needs for network intelligence, a new class of device,
Internet traffic management systems, also known as Layer 4-7 switches, has
emerged as a complement to the performance capabilities of
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existing Layer 3 switches. These switches provide increased network
intelligence, and therefore greater network efficiency, by utilizing
information about the application and the end user to intelligently direct the
traffic to its intended destination. Both classes of switches are necessary
components of a comprehensive networking solution. Layer 3 switches provide the
bandwidth and routing needed to support new applications while Internet traffic
management systems give enterprises, web-based businesses, and Internet service
providers the intelligence to control information delivery. Key Internet
traffic management capabilities include the ability to:
. enhance server performance and reliability by distributing traffic across
multiple servers that support Internet applications;
. scale server farms infrastructures by using the inherent capabilities of
the load balancing devices to removal of traditional network design
constraints;
. increase network security by detecting, stopping and identifying the
source of a hacker attack;
. improve Internet response time by inspecting an end user's web site
address and sending traffic to a specific server that hosts the desired
content; and
. reduce WAN operating costs and improve Internet response time by
redirecting web traffic destined for remote Internet hosts to a group of
local cache servers.
The challenge to the networking company is to provide cost-effective, higher
bandwidth solutions and the increased intelligence required to meet new network
demands placed on enterprises, web-based businesses, and Internet service
providers. Alternatives to Gigabit Ethernet technology, such as asynchronous
transfer mode, are complex and expensive, and do not utilize existing
networking investments or provide network intelligence capabilities. Although
existing Layer 2 and Layer 3 switches utilize Gigabit Ethernet technology, they
often do not scale to span the entire network or provide the performance
required by today's network users. Existing Layer 3 switches, although
essential to the performance of the network, do not incorporate the Internet
traffic management intelligence or capabilities necessary to provide traffic
direction.
A large market has emerged for a broad range of high performance, cost-
effective switching solutions with network intelligence capabilities that
address the needs of enterprises, web-based businesses, and Internet service
providers. Collaborative Research, an independent research and consulting firm
specializing in the Internet traffic management switching market, estimates in
a February 1999 report that the Internet traffic management switching market
totaled $130 million in 1998 and is expected to grow to $1.0 billion in 2002.
Dell'Oro Group estimates in a March 1999 report that the Layer 3 LAN switching
market totaled $637 million in 1998 and is expected to increase to $3.9 billion
in 2002.
Solution
We offer a comprehensive suite of Internet routers, Gigabit Ethernet Layer 2
and Layer 3 switches, and Internet traffic management products for enterprises,
web-based businesses, and Internet service providers. Our solution provides the
following benefits:
Breadth of Product Line. We are one of the few networking companies to
provide a full suite of Internet routers, Gigabit Ethernet Layer 2 and
Layer 3 switches and Internet traffic management products applicable to
LANs, MANs and WANs. This product breadth is attractive to customers who
desire a single source for their high performance networking solutions. Our
products allow us to provide solutions throughout a customer's network,
from the wiring closet edge of an enterprise LAN to the LAN core, and from
the WAN edge of an Internet service provider through to its core of
Internet communication devices.
Performance. Our products provide a high level of performance and a non-
blocking architecture across multiple types of networks. A non-blocking
architecture allows all users attached to the switch to access the network
simultaneously without any negative impact on performance. We believe that
we have set the industry bar for and currently offer the highest-performing
non-blocking switches in the market. The performance of our products allows
enterprises, web-based businesses, and Internet service providers
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to build highly reliable networks that support unpredictable traffic flows,
bandwidth-intensive applications and dynamic end-user needs.
Intelligence. Our products provide the intelligence required to
transport unpredictable traffic and bandwidth-intensive applications,
improving the performance, reliability and manageability of networks. Our
products direct traffic using information about the application and end
user, enabling enterprises, web-based businesses, and Internet service
providers to control information delivery and realize benefits such as
increased revenue through application-or availability-based service fees.
Compelling Price Points. Our products are designed to offer superior
performance and network intelligence capabilities at compelling price
points. According to testing conducted in April 1999 by the Tolly Group, an
independent test firm, and Network World, an independent networking
publication, our BigIron 4000 and 8000 products offer the best cost per
Gigabit of throughput for Layer 3 Gigabit Ethernet switches. Unlike other
low-priced switches that provide limited functionality, our products offer
customers higher value for their networking equipment investment by
providing a comprehensive feature set while maintaining low price points.
Flexibility of Architecture. Our products incorporate a uniform hardware
architecture that is compatible with all major existing network products
without any significant loss of performance or functionality. Our
architecture supports all forms of Gigabit Ethernet (fiber and copper) and
is designed to support the emerging standard for 10 Gigabit Ethernet. We
also plan to support future emerging technologies such as wave division
multiplexing. As a result, our customers can integrate our products into
their networks without an extensive and expensive replacement of their
existing network components.
Strategy
Our objective is to be the leading provider of next generation high
performance network solutions. We intend to achieve this objective by providing
a broad suite of the most cost-effective, highest-performing network switching
products for enterprises, web-based businesses, and Internet service providers.
Key elements of our strategy include:
Continue to Leverage Our Product Breadth to Expand Our Product Line. As
recently demonstrated with our latest product introduction, the
NetIron400/800 Internet router, we will continue to leverage our
comprehensive product breadth to offer solutions to the enterprise, web-
based businesses, and Internet service provider markets. Our end-to-end
network solution spans the LAN, MAN and LAN/WAN with high levels of
performance and functionality. We intend to continue to offer value-added
feature sets that provide for redundancy, ease of use and management of the
network.
Continue Our Market Leadership Position in Internet Traffic Management
Systems. We believe the demand for Internet traffic management intelligent
capabilities will be a very important growth area for web-based businesses
and Internet service providers and an area of increasing importance to
enterprises and anyone entering and participating in the electronic
commerce marketplace. We intend to achieve a leadership position in this
market by continually improving the performance and functionality of our
Internet traffic management products. Designed to provide the highest level
of performance and network intelligence capabilities, our products enable
web-based businesses and Internet service providers to rapidly deliver new
revenue-generating applications and services to end-user customers, while
providing a high degree of service reliability.
Provide Superior Technology. We intend to provide superior technology,
based on price, performance and features, through continual enhancements of
existing products and ongoing development of new products that provide
higher levels of performance and intelligence. We also intend to pursue
cost reduction efforts that will allow us to remain highly competitive
while offering customers compelling price points. We intend to ensure that
our hardware and software architectures are flexible and extensible and are
designed to support emerging technologies such as 10 Gigabit Ethernet and
wave division multiplexing.
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Expand Global Sales Organization. We intend to expand our global sales
presence with our direct sales organization in the United States, strategic
channel partners outside the United States and select original equipment
manufacturers. In addition, we intend to work with resellers in the United
States to penetrate select vertical markets such as web-hosting facilities
and small Internet service providers. We intend to increase our worldwide
sales force and establish additional channel partner relationships to build
greater worldwide sales presence.
Deliver World Class Service and Support. We intend to expand our service
and support infrastructure to meet the needs of our growing customer base.
Our goal is to minimize our customers' network downtime by offering a wide
range of service and support programs to meet individual customer needs,
including prompt onsite hardware repair and replacement, twenty-four hour,
seven days-a-week web and telephone support, system software and network
management software upgrades and technical documentation updates.
Products
We provide a comprehensive line of networking devices designed to meet the
price, performance, reliability and feature requirements of enterprises, web-
based businesses, and Internet service providers. Our product suite includes
Internet core routers, Gigabit Ethernet edge switches, Gigabit Ethernet and
Internet protocol over synchronous optical network (also known as IP over
SONET) core switches and Gigabit Ethernet intelligent network service switches
for server farms. Edge switches connect individuals and groups of workstations
to the network. Core switches are the most critical network component and serve
as the convergence point for the majority of network traffic. Internet traffic
management systems in web-hosting facilities and server farms provide
centralized collection points for server-based applications used by
enterprises, web-based businesses, and Internet service providers.
Area of List Price per
Product/First Deployment/ Port (as of
Date of Shipment Product Type Configuration Options Performance March 15, 2000)
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FastIron
Workgroup LAN edge 24 10/100 Mbps ports 3 Mpps $ 149
May 1997 Layer 2 24 10/100 Mbps ports $ 199
+1 Gigabit Ethernet port $ 240
24 10/100 Mbps ports
+ 2 Gigabit Ethernet ports
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FastIron
II LAN edge 72 10/100 Mbps ports 23 Mpps $ 229
October
1998 Layer 2/3 + 2 Gigabit Ethernet ports
72 10/100 Mbps ports $ 284
+ 4 Gigabit Ethernet ports
72 10/100 Mbps ports $ 367
+ 8 Gigabit Ethernet ports
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FastIron
II Plus LAN edge 144 10/100 Mbps ports 36 Mpps $ 312
October
1998 Layer 2/3 + 2 Gigabit Ethernet ports
+ Expansion slot
144 10/100 Mbps ports $ 340
+ 4 Gigabit Ethernet ports
+ Expansion slot
144 10/100 Mbps ports $ 395
+ 8 Gigabit Ethernet ports
+ Expansion slot
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FastIron
II Plus
GC LAN edge 64 1000Base-T ports 96 Mpps $ 925
August
1999 Layer 2/3
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Area of List Price per
Product/First Deployment/ Port (as of
Date of Shipment Product Type Configuration Options Performance March 15, 2000)
NetIron LAN edge and core 16 10/100 Mbps ports 3 Mpps $ 562
June 1997 Layer 2/3 24 10/100 Mbps ports $ 416
1 Gigabit Ethernet port $ 1,995
2 Gigabit Ethernet ports $ 1,847
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TurboIron/8 LAN edge and core 8 Gigabit Ethernet ports 12 Mpps $ 1,249
July 1998 Layer 2/3/4-7
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BigIron 4000 LAN edge and core 88 10/100 Mbps ports 48 Mpps $ 465
August 1998 LAN/WAN edge 32 Gigabit Ethernet ports $ 2,280
Layer 2/3/4
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BigIron 8000 LAN edge and core, 184 10/100 Mbps ports 96 Mpps $ 450
September 1998 LAN/WAN edge 64 Gigabit Ethernet ports $ 2,296
Layer 2/3/4 2 port OC-3 IP over SONET $ 12,497
4 port OC-3 IP over SONET $ 8,748
2 port OC-12 IP over SONET $ 22,497
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ServerIron LAN server farm 8 10/100 Mbps ports 3 Mpps $ 786
April 1998 Layer 2/4-7 16 10/100 Mbps ports $ 624
24 10/100 Mbps ports $ 791
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ServerIronXL LAN server farm 8 10/100Mbps ports 3 Mpps $ 999
November 1999 Enhanced Performance 16 10/100 Mbps ports $ 719
Expanded Capabilities 24 10/100 Mbps ports $ 625
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ServerIronXL/G LAN server farm 8 Gigabit Ethernet ports 12 Mpps $ 1,875
November 1999 Layer 2/4-7
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NetIron400 Internet edge and core Chassis plus management 47 Mpps Starts at
April 2000 LAN/WAN edge Configuration varies by $ 27,995
Layer 2/3/4 requirement
1000Base-SX GBIC $ 500
1000Base-LX GBIC $ 1,500
2 port OC-3 IP over SONET $ 12,497
4 port OC-3 IP over SONET $ 8,748
2port OC-12 IP over SONET $ 22,247
2-port OC-48 IP over SONET $ 32,500
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NetIron800 Internet edge and core Chassis plus management 90 Mpps Starts at
April 2000 LAN/WAN edge Configuration varies by $ 33,995
Layer 2/3/4 requirement
1000Base-SX GBIC $ 500
1000Base-LX GBIC $ 1,500
2 port OC-3 IP over SONET $ 12,497
4 port OC-3 IP over SONET $ 8,748
2port OC-12 IP over SONET $ 22,247
2-port OC-48 IP over SONET $ 32,500
Foundry Edge Switching Solutions
FastIron. The FastIron workgroup switch provides Fast Ethernet and Gigabit
Ethernet switching. Designed to accelerate workgroup and server performance in
enterprises, the FastIron workgroup switch offers redundancy, bandwidth
management for delay-intensive applications and complete network management
support.
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FastIron II and FastIron II Plus. The FastIron II product family is a
redundant, chassis-based wiring closet switch that offers non-blocking Fast
Ethernet and Gigabit Ethernet performance of up to 96 million packets per
second. FastIron II product families offer full Layer 2 and basic Layer 3
switching for all port configurations as well as support for all major industry
standard routing protocols. This protocol support is necessary to ensure
interoperability with installed enterprise applications and equipment.
Foundry Switching Solutions for the Network Core
NetIron and TurboIron/8. Our NetIron and TurboIron/8 switches allow small
and medium-sized enterprises to increase performance at their network core with
multi-protocol Layer 3 switching. NetIron provides Ethernet, Fast Ethernet and
Gigabit Ethernet connectivity, while TurboIron/8 offers all Gigabit Ethernet
Layer 2 and Layer 3 switching and Internet traffic management systems. Both
products support a full suite of industry standard routing protocols. We also
offer multi-layer switching that enables NetIron and TurboIron/8 switches to
transparently perform processing-intensive Internet protocol and Internet
protocol exchange (IPX) traffic forwarding, freeing existing routers to handle
non-IP and IPX traffic and to manage and communicate with other routers. This
capability reduces the workload of routers and the need for costly upgrades,
and improves the overall network performance.
BigIron 4000 and BigIron 8000. Our BigIron 4000 and BigIron 8000 switches
are designed for the core of large enterprises, web-based businesses, and
Internet service providers. BigIron switches can be deployed in collapsed
backbone data centers and server farms of local area and metropolitan area
networks. BigIron also can be used as a high performance local and wide area
network router. BigIron provides Ethernet, Fast Ethernet and Gigabit Ethernet
Layer 2 and Layer 3 switching and Internet traffic management systems, multi-
protocol support and Packet over SONET on a single platform. We believe our
BigIron switches provide the industry's highest non-blocking Gigabit Ethernet
port density and performance with up to 64 Gigabit Ethernet ports and 96
million packets per second performance. In addition to supporting the full
range of industry standard routing protocols, BigIron supports BGP4, a
necessary protocol for Internet service providers that require high performance
connectivity to the Internet.
Foundry Solutions for the Internet Edge and Core
NetIron400 and NetIron800. The NetIron400 and NetIron800 Internet Core
Router provide high-performance switching capacity, scalability, control, and
functionality. With interfaces ranging from 10 Mbps to 10 Gbps, NetIron400 and
NetIron800 are designed to meet the expanding bandwidth and control
requirements faced by Internet Service Providers (ISPs) today. Foundry's key
differentiators include reliability, switching capacity, Internet and LAN
integration, compactness, long haul links (up to 150 kilometers), and the
industry leading price/performance returns. The NetIron 400 and NetIron 800
utilize Foundry's ASIC architectures along with experienced routing software
development to deliver Internet scaleable routing protocol that delivers the
performance needed to create the nucleus of the Internet.
Foundry Intelligent Network Service Switching Solutions for the Server Farm
ServerIron. The ServerIron product family of switches provide Internet
service providers and enterprises with high performance Internet traffic
management that improves the availability, performance and scalability of
Internet services such as content publishing, web hosting and e-commerce.
ServerIron is compatible with all major server vendors and operating systems
and requires no special server agent software. ServerIron, as a switch-based
product provides high performance, high port density, scalable capacity and
multiple levels of redundancy required by users of mission critical Internet
applications. Foundry Networks recently enhanced the ServerIron product
offering due to the changing Internet market space and evolving web-based
ECommerce requirements. ServerIronXL includes a more powerful processor as well
as enhance Internet IronWare Internet traffic management software that adds the
following capabilities to the entire ServerIron product family: Firewall load
balancing, Full Network Address Translation, Expanded security features (to
protect against malicious hacker attacks), as well as URL-, Cookie-, and SSL-
Session ID switching.
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IronView Network Management Solutions
IronView. Our IronView network management solution provides a comprehensive
set of easy-to-use tools to simplify management of our switches. A command line
interface streamlines local and remote management and configuration. Industry
standard simple network management protocol and configuration applications are
available on major platforms for graphical user interface management, including
HP OpenView for Sun Solaris, Windows NT and stand-alone Windows NT. Our
switches also include a user-friendly web interface. Industry standard remote
monitoring simplifies network monitoring and a mirror port is included for
network tracing and troubleshooting.
Hardware and Software Architecture
IronCore
All of our products are based on the IronCore hardware architecture. We
believe that IronCore allows us to provide customers with consistent
performance, reliability and features, as well as the ability to leverage their
networking equipment investment. We also believe that the IronCore architecture
allows us to quickly bring new products to market that meet customer needs and
interoperate with existing networking equipment.
The IronCore architecture reflects our expertise in custom designed
programmable ASICs. These ASICs are designed to provide high performance and
integrated Layer 2, Layer 3 and Layer 4 switching capabilities. We believe this
programmable design allows us to offer customers the flexibility of field-
upgradeable software features without compromising performance. We have
developed 13 custom ASICs used throughout our product portfolio.
The IronCore chassis architecture consists of a high-speed data highway that
incorporates a backplane and crosspoint switching fabric and supports up to
eight interface modules. The crosspoint switching fabric allows all lines of
communication to intersect with one another. Our implementation of the
crosspoint switching fabric includes custom designed, high speed ASICs that
provide throughput of up to 128 Gigabits and 96 million packets per second.
This amount of throughput allows each module connected to the switch to support
simultaneous communication among all workstations connected to the switch,
while all workstations connected to the switch can operate at maximum
performance. We believe these features of IronCore allow enterprises, web-based
businesses, and Internet service providers to have dedicated access to the
network at any time, using any application at the maximum speed.
IronWare and Internet IronWare Software
Our IronWare and Internet IronWare software work with the IronCore hardware
architecture to provide high performance switching. IronWare, which is pre-
installed on our Layer 2 and Layer 3 products, provides network design
flexibility, multiple levels of redundancy for reliability and support for
current and future applications. We believe our Internet IronWare software
provides superior intelligent switching capabilities, such as server load-
balancing and transparent cache switching, for our Internet traffic management
products.
Sales and Marketing
Our sales strategy includes a domestic and international field sales
organization, domestic and international resellers, lease financing program and
an OEM relationship.
Domestic field sales. Our domestic field organization establishes and
maintains direct relationships with key accounts and strategic customers. To a
lesser extent, our field organization also works with resellers to assist in
communicating product benefits to end user customers and proposing networking
solutions. As of December 31, 1999, our field organization included over 95
sales representatives and system engineers. In addition, as of December 31,
1999, we maintained field offices in 35 major metropolitan areas in the United
States.
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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 are
provided by resellers and integrators. Our international resellers include
Mitsui in Japan, Samsung in Korea, Mitech in the United Kingdom, Boreal in
France and Pan Dacom in Germany. We also provide field support in key Canadian,
European and Asia Pacific locations including Toronto, London, Paris,
Frankfurt, Munich and Taipei. We intend to expand our international presence
through additional sales and engineering personnel and through the addition of
key resellers and integrators. For fiscal 1999, domestic sales in the U.S.
accounted for 82% of our revenue. No other country accounted for greater than
or equal to 10% of our revenue.
OEM. We established an OEM relationship with Hewlett-Packard in January
1999. Pursuant to our agreement, Hewlett-Packard markets and sells our products
on a private label basis through its worldwide sales force. Hewlett-Packard
also purchases our products for use in its internal networks. For fiscal 1999,
sales to Hewlett-Packard accounted for 14% of our revenue. Our agreement with
Hewlett-Packard continues until May 18, 2000, unless terminated earlier for a
material breach by either party. The agreement automatically renews for two
additional one year periods, unless the agreement is terminated within 60 days
prior to the end of any period. This agreement provides that Hewlett-Packard
may postpone, cancel, increase or decrease any order made under the agreement
without penalty.
Lease financing program. In January 2000, we established Foundry Commercial
Credit, a private-label leasing program, to offer our customers standardized
solution packages that combine Foundry's high performance end-to-end switching
solutions with innovative lease financing options. Foundry Commercial Credit is
being administered by Heller Financial, Inc. (NYSE: HF), a worldwide commercial
finance company. Foundry's leasing program will be marketed through a direct
sales force and authorized resellers in the United States and other key markets
in Europe, Latin America and Asia Pacific.
Marketing programs. We have numerous marketing programs designed to inform
existing and potential customers, as well as resellers and OEMs, about the
capabilities and benefits of our company and products. Our marketing efforts
also support the sale and distribution of our products through our field
organizations and channels. Our marketing efforts include advertising, public
relations, participation in industry trade shows and conferences, participation
in independent third-party product tests, presentations and our web site. We
have begun an e-commerce initiative directed at existing customers and
resellers.
Customer Service and Support
Our service and support organization maintains and supports our products
sold by our field organization to end users. Customer service revenue was 1.0%
and 1.7% of our revenue for 1998 and 1999, respectively. Our resellers and OEM
are responsible for installation, maintenance and support services to their
customers. We may offer limited assistance to our resellers and OEM in
providing service and support to their end user customers.
TechNet, our comprehensive suite of service and support options, provides
customers with a variety of programs to meet specific support needs. TechNet
Gold gives customer network operations the highest level of priority and our
full range of services. TechNet Silver provides customers with all the tools
needed to optimize network performance and uptime. TechNet Bronze extends
warranty support with software updates and telephone and online support.
In December 1999, we opened our regional Centers-of-Excellence in Reston,
Virginia; Irvine, California; and Bracknell, Berkshire in the United Kingdom.
Foundry's Centers-of-Excellence locations are fully equipped to demonstrate
Foundry's award-winning high performance LAN and LAN/WAN products and to
support interoperability testing and hands-on training for customers. These
regional centers also include executive briefing centers and serve as regional
technical support centers, with Foundry sparing depots. The centers allow
Foundry to continue to deliver superior customer service and quality products
to its customers while increasing the variety of support programs to their
rapidly growing installed base.
9
Manufacturing
We operate under a modified "turn key" process utilizing strategic
manufacturing partners that are ISO 9000 certified and have global
manufacturing capabilities. We maintain control and procurement responsibility
for all proprietary components. All designs, documentation, selection of
approved suppliers, quality control and repairs are performed at our
facilities. In 1999, we transitioned our assembly and testing functions from
our Sunnyvale facility to our manufacturing partners in order to realize lower
costs and higher volume efficiencies. Our approach to manufacturing provides
the flexibility of outsourcing while maintaining quality control of delivered
products to customers. We have selected this approach to ensure our ability to
respond to rapid growth and sudden market shifts.
We currently have two primary manufacturing partners. One partner,
Celestica, located in San Jose, California, assembles and tests our printed
circuit boards. The other partner, Hadco, located in Santa Clara, California,
assembles and tests our backplane products. Both companies are ISO certified
and have global manufacturing facilities providing full back-up capability and
local content for foreign sales if required. We perform all prototype and pre-
production procurement and component qualification with support from our
manufacturing partners. Any interruptions in the operations of either of these
manufacturing partners or delays in their shipment of products would negatively
impact our ability to meet scheduled product deliveries to our customers. We
design all ASICs, printed circuit boards and sheet metal while working closely
with semiconductor partners on future component selection and design support.
All materials used in our products are processed through a full qualification
cycle and controlled by use of an "Approved Vendor Listing" that must be
followed by our sources. We perform extensive testing of all our products
including in-circuit testing of all printed circuit board assemblies, full
functional testing, elevated temperature burn-in and power cycling at maximum
and minimum configuration levels. Please see "Risk Factors--Our reliance on
third-party manufacturing vendors to manufacture our products may cause a delay
in our ability to fill orders" on page 26 for a review of certain risks
associated with our manufacturing operations.
We currently purchase several components from a single source, including
certain integrated circuits, power supplies and long-range optics, which we
believe are readily available from other suppliers. Our proprietary ASICs,
which provide key functionality in our products, are fabricated in foundries
operated by Texas Instruments. An alternative supply for these ASICs could not
be readily obtained.
We acquire these components through purchase orders and have no long-term
commitments regarding supply or price from these suppliers. The material terms
of these orders typically involve the quantity of supply ordered by us, the
purchase price of the components, lead time and the shipping arrangements. In
the event one of these suppliers, in particular, Texas Instruments, materially
delays its supply to us or one of them terminates its relationship with us, we
may not be able to find an alternate supplier on a timely basis and, as a
result, our business could be harmed.
Research and Development
Our future success depends on our ability to enhance existing products and
develop new products that incorporate the latest technological developments. We
work with customers and prospects, as well as partners and industry research
organizations, to identify and implement new solutions that meet the current
and future needs of enterprises, web-based businesses, and Internet service
providers. Whenever possible, our products are based on industry standards to
ensure interoperability. We intend to continue to support emerging industry
standards integral to our product strategy.
We use a uniform architecture across our product line, including
programmable ASICs, and system and network management software. This enables us
to quickly bring new products and features to market. For example, we shipped
the industry's first Gigabit Ethernet Layer 2 and Layer 3 switch in June 1997.
We are currently developing new switching solutions that provide new levels of
performance, scalability and functionality for the LAN, MAN and LAN/WAN. We
also have engineering efforts focused on cost reduction.
10
As of December 31, 1999, we had an engineering staff of 43 responsible for
hardware design and development, architecture and software development,
documentation and quality assurance. Our research and development expenses
totaled $9.0 million in 1999, $8.8 million in 1998 and $5.4 million in 1997.
Competition
We believe that we compete favorably in the key competitive factors that
impact our markets, including technical expertise, price points, new product
innovation, product features, service and support, brand awareness and
distribution. We intend to remain competitive through ongoing investment in
research and development efforts to enhance existing products and introduce new
products. We will seek to expand our market presence through aggressive
marketing and sales efforts and through the continued implementation of cost
reduction efforts. However, our market is still evolving and we may not be able
to compete successfully against current and future competitors.
The market in which we operate is highly competitive. Cisco Systems
maintains a dominant position in this market and several of its products
compete directly with our products. Cisco's substantial resources and market
dominance have enabled it to reduce prices on its products within a short
period of time following the introduction of these products, which reduces the
margins and profitability of its competitors. Purchasers of networking
solutions may choose Cisco's products because of its longer operating history,
broad product line and strong reputation in the networking market. In addition,
Cisco may have developed or could in the future develop new technologies that
directly compete with our products or render our products obsolete.
In addition to Cisco, we compete with other large public companies, such as
3Com and Nortel Networks, as well as other smaller public and private
companies. Many of our current and potential competitors have longer operating
histories and substantially greater financial, technical, sales, marketing and
other resources, as well as greater name recognition and larger installed
customer bases than we do. Furthermore, companies that do not offer a directly
competitive product to our products could develop new products or enter into
agreements with other networking companies to provide a product that competes
with our products or provides a more complete solution than we can offer.
Additionally, we may face competition from unknown companies and emerging
technologies that may offer new LAN, MAN and LAN/WAN solutions to enterprises,
web-based businesses, and Internet service providers.
Intellectual Property
Our success and ability to compete are substantially dependent upon our
internally developed technology and know-how. Our proprietary technology
includes our ASICs, our IronCore hardware architecture, and our IronWare and
Internet IronWare software. Different versions and combinations of these
proprietary technologies are implemented across our product offerings. We rely
on a combination of copyright, trademark and trade secret laws and restrictions
on disclosure to protect our intellectual property rights in these proprietary
technologies. We do not own any patents nor do we have any patent applications
pending. We may not have taken actions that adequately protect our intellectual
property rights.
We provide software to customers under license agreements included in the
packaged software. These agreements are not negotiated with or signed by the
licensee, and thus may not be enforceable in some jurisdictions. Despite our
efforts to protect our proprietary rights through confidentiality and license
agreements, unauthorized parties may attempt to copy or otherwise obtain and
use our products or technology. These precautions may not prevent
misappropriation or infringement of our intellectual property. Monitoring
unauthorized use of our products is difficult and the steps we have taken may
not prevent misappropriation of our technology, particularly in foreign
countries where the laws may not protect our proprietary rights as fully as in
the United States.
Our industry is characterized by the existence of a large number of patents
and frequent claims and related litigation regarding patent and other
intellectual property rights. In particular, leading companies in the
networking markets have extensive patent portfolios with respect to networking
technology, while we do not currently own any patents or have any patent
applications pending. In July 1999, we received a letter from
11
Resonate, Inc., alleging that our ServerIron products infringe one of its
patents. Based on the advice of our patent counsel, we do not believe that our
current ServerIron products infringe Resonate's patent. We have and intend to
continue to contest this claim vigorously. Although we have had no
communication with Resonate on this issue since December 1999, these kinds of
disputes are subject to inherent uncertainties and, therefore, we cannot assure
you that we will prevail in our objection to this claim, nor can we assure you
that this dispute will not result in litigation or that an adverse result or
judgment will not adversely affect our financial condition.
From time to time, other third parties, including leading companies, have
asserted against others and may assert against us exclusive patent, copyright,
trademark and other intellectual property rights to technologies and related
standards that are important to us. Third parties may assert claims or initiate
litigation against us or our manufacturers, suppliers or customers alleging
infringement of their proprietary rights with respect to our existing or future
products. Any of these claims, with or without merit, could be time-consuming,
result in costly litigation and diversion of technical and management
personnel, or require us to develop non-infringing technology or enter into
royalty or license agreements. These royalty or license agreements, if
required, may not be available on acceptable terms, if at all. If there is a
successful claim of infringement or if we fail to develop non-infringing
technology or license the proprietary rights on a timely basis, our business
would be harmed.
Employees
As of December 31, 1999, we had 222 employees, including 123 in sales and
marketing, 43 in engineering, 35 in manufacturing and 21 in general and
administrative functions. We are not subject to any collective bargaining
agreements and believe our employee relations are good.
Executive Officers
The names and ages of our executive officers as of December 31, 1999 are as
follows:
Name Age Position
---- --- --------
Bobby R. Johnson, Jr. .. 43 President, Chief Executive Officer, and Chairman
of the Board of Directors
H. Earl Ferguson........ 61 Vice President, Hardware Engineering
Vice President, Finance and Administration, Chief
Timothy D. Heffner...... 50 Financial Officer
Vice President, Marketing and Product and Program
Ken K. Cheng............ 44 Management
Wilburn W. McGill....... 57 Vice President, Manufacturing
Robert W. Shackleton.... 49 Vice President, North American Sales
William S. Kallaos...... 52 Vice President, International Sales
Vice President, Software Engineering and Quality
Lee Chen ............... 45 Assurance
Bobby R. Johnson, Jr. co-founded Foundry and has served as President, Chief
Executive Officer and Chairman of the board of directors of Foundry since its
inception in May 1996. From August 1993 to October 1995, Mr. Johnson co-founded
and served as President, Chief Executive Officer and Chairman of the board of
directors of Centillion Networks, Inc., a provider of local area network
switches. From September 1991 to February 1993, Mr. Johnson was Vice President
and General Manager of Internetworking Hardware for Network Equipment
Technologies, a wide area networking company. Mr. Johnson holds a B.S. with
honors from North Carolina State University.
H. Earl Ferguson co-founded Foundry and has served as Vice President,
Hardware Engineering, and chief technical officer of Foundry since July 1996.
From August 1993 to February 1996, Mr. Ferguson was co-founder and Vice
President of Engineering of Centillion Networks and the Vice President of
Engineering for the Centillion Business Unit of Bay Networks. From December
1991 to February 1993, Mr. Ferguson was Director of Internetworking Hardware
for Network Equipment Technologies. Mr. Ferguson holds six patents in
internetworking technologies. Mr. Ferguson holds a B.S. from the University of
Washington and M.S. from the University of Michigan.
12
Timothy D. Heffner has served as Vice President, Finance and Administration
and Chief Financial Officer of Foundry since November 1996. From September 1994
to November 1996, Mr. Heffner was Director of Finance for Centillion Networks
and for the Centillion Business Unit of Bay Networks. From January 1994 to
September 1994, Mr. Heffner was Chief Financial Officer of Digital Generation
Systems, a network services company. Mr. Heffner holds a B.S. from San Jose
State University.
Ken K. Cheng has served as Vice President of Marketing of Foundry since
December 1999 and as Vice President of Product and Program Management of
Foundry since July 1998. From December 1993 to July 1998, Mr. Cheng was Senior
Vice President and Chief Operating Officer of Digital Generation Systems, a
network services company. From December 1988 to December 1993, Mr. Cheng was
Director of LAN/WAN Internetworking Hardware for Network Equipment
Technologies. Mr. Cheng holds a B.S. from Queen's University and an M.B.A. from
Santa Clara University.
Wilburn W. McGill has served as Vice President of Manufacturing of Foundry
since February 1997. From March 1996 to February 1997, Mr. McGill was the Vice
President of Operations at Ancot Corporation, a networking analyzer company.
From May 1995 to March 1996, Mr. McGill was Vice President of Engineering and
Operations for DTC Data Technology Corporation, a network interface card
company. From January 1990 to February 1994, Mr. McGill was General Manager for
the Research and Development Division of Centera Ltd., a networking solutions
company.
Robert W. Shackleton has served as Vice President of North American Sales of
Foundry since April 1997. From March 1989 to March 1997, Mr. Shackleton was
Senior Director of United States Distribution and Sales for Network Equipment
Technologies. Mr. Shackleton holds a B.A. with honors from the University of
Colorado and attended Stanford University's Business School Executive
Management Program.
William S. Kallaos has served as Vice President of International Sales of
Foundry since April 1997. From September 1984 to February 1997, Mr. Kallaos
worked for UB Networks in a variety of positions, most recently as Vice
President of United States Sales. Mr. Kallaos holds a B.A. with honors from the
University of Missouri.
Lee Chen has served as Vice President, Software Engineering and Quality
Assurance since October 1999. From June 1996 to September 1999, Mr. Chen served
as Director of Software Engineering for Foundry. From January 1995 to February
1996, Mr. Chen was the Vice President of Engineering of OTS, a software
consulting company. From August 1993 to December 1995, Mr. Chen was co-founder
of Centillion Networks. Mr. Chen holds a M.S. from San Jose State University.
Item 2. PROPERTIES
Our headquarters for corporate administration, research and development,
sales and marketing, and manufacturing occupy approximately 71,000 square feet
of space in San Jose, California which we moved to in February 2000. We also
lease space in various other geographic locations domestically and
internationally for sales and service personnel. We believe that our existing
facilities are adequate for our needs through at least the end of year 2000. We
may need additional space at that time and there can be no assurance that such
additional space will be available on commercially reasonable terms, if at all.
Item 3. LEGAL PROCEEDINGS.
The Company is not currently subject to any material legal proceedings. The
Company may from time to time become a party to various legal proceedings
arising from the ordinary course of its business. See also "Management's
Discussion and Analysis of Financial Condition and Results of Operations--Risk
Factors That May Affect Future Results and Market Price of Stock."
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
13
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Price Range of Common Stock
The Company's common stock commenced trading on the Nasdaq National Market
on September 28, 1999 and is traded under the symbol "FDRY". Prior to this
time, there was no public market for our stock. As of December 31, 1999, there
were approximately 256 holders of record of the common stock. The following
table sets forth for the periods indicated, the high and low closing sale
prices for the common stock as reported on the Nasdaq National Market.
High Low
------- ------
Fourth quarter............................................. $161.19 $63.00
Dividend Policy
The Company has never paid cash dividends on its capital stock. The Company
currently anticipates that it will retain all available funds for use in its
business and does not anticipate paying cash dividends in the foreseeable
future.
Unregistered Securities Sold in 1999
In 1999, we issued 2,923,072 shares of common stock pursuant to the exercise
of stock options at exercise prices ranging from $0.03 to $11.50 per share.
These stock options were granted under our 1996 Stock Plan prior to our initial
public offering. Our issuance of these shares of common stock was exempt from
registration under the Securities Act of 1933, as amended (the "Securities
Act") in reliance on Rule 701 promulgated under the Securities Act.
In June 1999, we issued 375,000 shares of Series C preferred stock to one
investor, a family trust of which Andrew K. Ludwick, a director of Foundry, is
trustee, for an aggregate cash consideration of $1,000,000. Our issuance of
this stock was exempt from registration under the Securities Act in reliance on
Section 4(2) of the Securities Act.
In September 1999, we issued 150,000 shares of common stock pursuant to the
exercise of a nonstatutory stock option at an exercise price of $0.83 per
share. This stock option was granted to a key executive outside of the 1996
Stock Plan prior to our initial public offering. Our issuance of this stock was
exempt from registration under the Securities Act in reliance on Rule 701
promulgated under the Securities Act.
In November 1999, we issued 89,640 shares of common stock to an equipment
lessor upon the exercise of a warrant based on an exercise price of $0.33 per
share. Our issuance of this stock was exempt from registration under the
Securities Act in reliance on Section 4(2) of the Securities Act.
Use of Proceeds from Sales of Registered Securities
On September 27, 1999, in connection with our initial public offering, a
Registration Statement on Form S-1 (No. 333-82577) was declared effective by
the Securities and Exchange Commission. The offering commenced on September 28,
1999 and 11,500,000 shares of our common stock were offered and sold for our
account at a price of $12.50 per share, generating gross offering proceeds of
$143,750,000. After deducting approximately $10,062,500 in underwriting
discounts and $1,856,700 in other related expenses, the net proceeds of the
offering were approximately $131,830,800.
We expect to use the net proceeds of the offering for working capital and
general corporate purposes, including increased spending on sales and
marketing, customer support, research and development, expansion of our
operational and administrative infrastructure, and the leasing of additional
facilities. Specific amounts for these purposes have not been determined. In
addition, we may use a portion of our cash and short-term investments to
acquire or invest in complementary businesses, technologies, product lines or
products.
14
However, we have no current plans, agreements or commitments with respect to
any such acquisition, and we are not currently engaged in any negotiations with
respect to any such transaction. We are currently investing our cash in short-
term, interest-bearing, investment grade securities.
Item 6. SELECTED FINANCIAL DATA
The selected financial data set forth below should be read together with the
financial statements and related notes, "Management's Discussion and Analysis
of Financial Condition and Results of Operations," and the other information
contained in this Form 10-K.
The statement of operations data set forth below for each of the years in
the three-year period ended December 31, 1999 and the balance sheet data as of
December 31, 1998 and 1999 are derived from, and qualified by reference to, our
audited financial statements appearing elsewhere in this Form 10-K. The
statement of operations data for the period from inception on May 22, 1996 to
December 31, 1996 and the balance sheet data as of December 31, 1996 and 1997
are derived from audited financial statements not included herein.
Period from
May 22, 1996 Year Ended
(Inception) to December 31,
December 31, ----------------------------
1996 1997 1998 1999
-------------- ------- -------- ---------
(in thousands, except per share data)
Statement of Operations Data:
Revenue, net...................... $ -- $ 3,381 $ 17,039 $ 133,522
Cost of revenue................... -- 1,835 8,433 56,612
------- ------- -------- ---------
Gross profit.................... -- 1,546 8,606 76,910
------- ------- -------- ---------
Operating expenses:
Research and development........ 1,914 5,403 8,797 9,037
Sales and marketing............. -- 3,419 7,258 23,142
General and administrative...... 226 1,853 1,589 4,532
Amortization of deferred stock
compensation................... -- -- 727 9,463
------- ------- -------- ---------
Total operating expenses...... 2,140 10,675 18,371 46,174
------- ------- -------- ---------
Income (loss) from operations..... (2,140) (9,129) (9,765) 30,736
Interest income, net.............. 127 122 413 1,886
------- ------- -------- ---------
Income (loss) before provision for
income taxes..................... (2,013) (9,007) (9,352) 32,622
Provision for income taxes........ -- -- -- 9,750
------- ------- -------- ---------
Net income (loss)................. $(2,013) $(9,007) $ (9,352) $ 22,872
======= ======= ======== =========
Basic net income (loss) per
share............................ $ (0.50) $ (0.67) $ (0.35) $ 0.42
Diluted net income (loss) per
share............................ $ (0.50) $ (0.67) $ (0.35) $ 0.20
Weighted average shares--
basic(a)......................... 4,048 13,570 26,976 54,929
Weighted average shares--
diluted(a)....................... 4,048 13,570 26,976 114,835
Pro forma basic net income (loss)
per share........................ $ (0.24) $ (0.14) $ 0.26
Weighted average shares--pro forma
basic(a)......................... 37,134 68,646 88,859
December 31,
--------------------------------------
1996 1997 1998 1999
------- -------- -------- ---------
Balance Sheet Data:
Cash and cash equivalents.............. $ 3,823 $ 3,182 $ 4,567 $ 120,378
Working capital........................ 3,505 4,076 10,663 180,508
Total assets........................... 4,557 6,988 19,238 213,498
Long term obligations, less current
portion............................... 344 178 -- --
Total stockholders' equity (deficit)... (1,903) (10,509) (18,926) 181,604
- --------
(a) See Note 2 of the Notes to Financial Statements beginning on page 40 for an
explanation of the determination of the number of shares and share
equivalents used in computing per share amounts.
15
Quarterly Results of Operations
The following tables set forth our statement of operations data for each of
the eight quarters ended December 31, 1999, including these amounts expressed
as a percentage of total revenue. This unaudited quarterly information has been
prepared on the same basis as our audited financial statements and, in the
opinion of management, reflects all adjustments, consisting only of normal
recurring entries, necessary for a fair presentation of the information for the
periods presented. The operating results for any quarter are not necessarily
indicative of results for any future period.
Quarter Ended
----------------------------------------------------------------------------------
Mar. 31, Jun. 30, Sep. 30, Dec. 31, Mar. 31, Jun. 30, Sep. 30, Dec. 31,
1998 1998 1998 1998 1999 1999 1999 1999
-------- -------- -------- -------- -------- -------- -------- --------
(in thousands)
Statement of Operations
Data:
Revenue, net............ $ 1,842 $ 2,361 $ 4,030 $ 8,806 $15,425 $24,062 $38,896 $55,139
Cost of revenue......... 915 1,167 1,918 4,433 7,570 10,421 17,274 21,347
------- ------- ------- ------- ------- ------- ------- -------
Gross profit........... 927 1,194 2,112 4,373 7,855 13,641 21,622 33,792
Operating expenses:
Research and
development........... 1,383 1,867 3,705 1,842 1,746 1,879 2,199 3,213
Sales and marketing.... 1,209 1,536 1,887 2,626 2,717 4,256 6,654 9,515
General and
administrative........ 251 318 365 655 670 985 1,025 1,852
Amortization of
deferred stock
compensation.......... -- -- 233 494 1,054 3,848 2,248 2,313
------- ------- ------- ------- ------- ------- ------- -------
Total operating
expenses.............. 2,843 3,721 6,190 5,617 6,187 10,968 12,126 16,893
------- ------- ------- ------- ------- ------- ------- -------
Income (loss) from
operations............. (1,916) (2,527) (4,078) (1,244) 1,668 2,673 9,496 16,899
Interest income, net.... 40 173 135 65 24 -- 47 1,815
------- ------- ------- ------- ------- ------- ------- -------
Income (loss) before
provision for income
taxes (1,876) (2,354) (3,943) (1,179) 1,692 2,673 9,543 18,714
Provision for income
taxes.................. -- -- -- -- 423 668 3,737 4,922
------- ------- ------- ------- ------- ------- ------- -------
Net income (loss)....... $(1,876) $(2,354) $(3,943) $(1,179) $ 1,269 $ 2,005 $ 5,806 $13,792
======= ======= ======= ======= ======= ======= ======= =======
Mar. 31, Jun. 30, Sep. 30, Dec. 31, Mar. 31, Jun. 30, Sep. 30, Dec. 31,
1998 1998 1998 1998 1999 1999 1999 1999
-------- -------- -------- -------- -------- -------- -------- --------
Percentage of Revenue:
Revenue, net............ 100.0 % 100.0 % 100.0 % 100.0 % 100.0% 100.0% 100.0% 100.0%
Cost of revenue......... 49.7 49.4 47.6 50.3 49.1 43.3 44.4 38.7
------- ------- ------- ------- ------- ------- ------- -------
Gross profit........... 50.3 50.6 52.4 49.7 50.9 56.7 55.6 61.3
Operating expenses:
Research and
development........... 75.1 79.1 91.9 20.9 11.3 7.8 5.7 5.8
Sales and marketing.... 65.6 65.1 46.8 29.8 17.6 17.7 17.1 17.3
General and
administrative........ 13.6 13.4 9.1 7.5 4.4 4.1 2.6 3.4
Amortization of
deferred stock
compensation.......... -- -- 5.8 5.6 6.8 16.0 5.8 4.2
------- ------- ------- ------- ------- ------- ------- -------
Total operating
expenses.............. 154.3 157.6 153.6 63.8 40.1 45.6 31.2 30.7
------- ------- ------- ------- ------- ------- ------- -------
Income (loss) from
operations............. (104.0) (107.0) (101.2) (14.1) 10.8 11.1 24.4 30.6
Interest income, net.... 2.2 7.3 3.4 0.7 0.2 -- 0.1 3.3
------- ------- ------- ------- ------- ------- ------- -------
Income (loss) before
provision for income
taxes.................. (101.8) (99.7) (97.8) (13.4) 11.0 11.1 24.5 33.9
Provision for income
taxes.................. -- -- -- -- 2.8 2.8 9.6 8.9
------- ------- ------- ------- ------- ------- ------- -------
Net income (loss)....... (101.8)% (99.7)% (97.8)% (13.4)% 8.2% 8.3% 14.9% 25.0%
======= ======= ======= ======= ======= ======= ======= =======
16
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of our financial condition and results
of operations should be read together with "Selected Financial Data" and our
financial statements and related notes appearing elsewhere in this Form 10-K.
This discussion and analysis contains forward-looking statements that involve
risks, uncertainties and assumptions. The actual results may differ materially
from those anticipated in these forward-looking statements as a result of many
factors, including but not limited to those discussed in the section entitled
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Risk Factors That May Affect Future Results and Market Price of
Stock." Readers are cautioned not to place undue reliance on these forward-
looking statements, which reflect management's opinions only as of the date
hereof. The Company undertakes no obligation to revise or publicly release the
results of any revision to these forward-looking statements. Readers should
carefully review the risk factors described in this document as well as in
other documents the Company files from time to time with the Securities and
Exchange Commission, including the Quarterly Reports on Form 10-Q to be filed
by the Company in fiscal year 2000.
Overview
Foundry designs, develops, manufactures and markets a comprehensive, end-to-
end suite of high performance networking products for enterprises, educational
institutions, government agencies, web-hosting companies, Application Service
Providers (ASPs), electronic banking and finance service providers, and
Internet service providers. From our inception in May 1996 through April 1997,
we were engaged primarily in research and development activities and did not
generate any revenue. A substantial portion of our operating expenses during
this period was related to the design and development of our custom ASICs,
software development and testing prototype designs. We commenced commercial
shipments of our FastIron workgroup Layer 2 switch in May 1997, the initial
product released in our family of stackable products. We shipped NetIron, our
first generation Layer 3 switch, in June 1997. During the second quarter of
1998, we shipped the first products in our Layer 4-7 ServerIron family. We
shipped BigIron, our second generation of midsize and large-scale chassis-based
products, in the third quarter of 1998. Since the first quarter of 1998, our
revenue has increased every quarter, and we were profitable in each quarter of
1999, although we cannot assure you that these results will be indicative of
future performance.
We derive our revenue substantially from sales of our stackable and chassis-
based products, including fees for customer support services related to our
products. We market and sell our products primarily through a direct sales and
marketing organization and, to a lesser extent through resellers and through
our OEM relationship with Hewlett-Packard. We have sales representatives in the
United States, Singapore, Italy, Canada, France, Sweden, China, Netherlands,
Germany, Taiwan and the United Kingdom. We have made significant investments to
expand our international operations and expect international revenue to
increase as a percentage of total revenue. Currently, a majority of our
international sales are denominated in U.S. dollars. We generally recognize
product revenue upon shipment to customers. Revenue from customer support
services is deferred and recognized on a straight-line basis over the
contractual period.
We expect the average selling price of our products to decline due to a
number of factors, including competitive pricing pressures and rapid
technological changes. Our gross margins may be affected by price declines if
we are unable to reduce costs. Furthermore, our gross margins may be affected
by fluctuations in manufacturing volumes, component costs, the mix of product
configurations sold and the mix of distribution channels through which our
products are sold. We generally realize higher gross margins on direct sales to
the end user than on sales through resellers or our OEM. Any significant shift
in revenue through resellers or our OEM, or the loss of any large customer,
reseller or our OEM, could harm our gross margins, operating results and
financial condition.
We rely on two third-party manufacturing vendors that produce different
assemblies for our products. Prior to the first quarter of 1999, we performed
final assembly, testing, quality assurance, manufacturing,
17
engineering, documentation control and repairs of our products at our Sunnyvale
facility. In 1999, we transitioned assembly and testing functions from our
Sunnyvale facility to our manufacturing partners. We realized lower costs and
higher volume efficiencies as a result of this transition in 1999.
In connection with the grant of stock options to employees, we recorded
deferred stock compensation of $4.7 million in 1998 and $17.3 million in 1999,
representing the difference between the exercise price and the deemed fair
market value of our common stock on the date these stock options were granted.
This amount is reflected within stockholders' equity and is being amortized to
operations ratably over the respective vesting periods. We recorded
amortization of deferred stock compensation expense of approximately $727,000
and $9.5 million for the years ended December 31, 1998 and 1999, respectively.
At December 31, 1999, we had approximately $11.8 million remaining to be
amortized over the corresponding vesting period of each respective option,
generally four years. The amortization expense relates to options granted to
employees and directors.
Results of Operations
The following table sets forth selected items from our statement of
operations as a percentage of revenue for the periods indicated:
Year Ended December 31,
----------------------------
1997 1998 1999
-------- ------- -------
Revenue, net................................. 100.0 % 100.0 % 100.0%
Cost of revenue.............................. 54.3 49.5 42.4
-------- ------- -------
Gross profit............................... 45.7 50.5 57.6
-------- ------- -------
Operating expenses:
Research and development................... 159.8 51.6 6.8
Sales and marketing........................ 101.1 42.6 17.3
General and administrative................. 54.8 9.3 3.4
Amortization of deferred stock
compensation.............................. -- 4.3 7.1
-------- ------- -------
Total operating expenses................. 315.7 107.8 34.6
-------- ------- -------
Income (loss) from operations................ (270.0) (57.3) 23.0
Interest income, net......................... 3.6 2.4 1.4
-------- ------- -------
Income (loss) before provision for income
taxes....................................... (266.4) (54.9) 24.4
Provision for income taxes................... -- -- 7.3
-------- ------- -------
Net income (loss)............................ (266.4)% (54.9)% 17.1%
======== ======= =======
Revenue. Revenue was $3.4 million, $17.0 million and $133.5 million in
fiscal 1997, 1998 and 1999, respectively, representing increases of 400% from
fiscal 1997 to 1998, and 685% from fiscal 1998 to 1999. These increases were
due to the market's growing acceptance of Foundry's product offerings, and a
significant increase in Foundry's sales and marketing organizations. We
introduced our BigIron products in the third quarter of 1998 and our ServerIron
products in the second quarter of 1998. Our product introductions coincided
with broad market acceptance of Gigabit Ethernet technology resulting from the
adoption of the Gigabit Ethernet standard in June 1998.
For the year ended December 31, 1999, sales to America Online and Hewlett-
Packard accounted for 11% and 14% of revenue, respectively. Hewlett-Packard is
both an OEM and an end user.
Cost of revenue. Cost of revenue consists primarily of material, labor,
overhead and warranty costs. Cost of revenue was $1.8 million, $8.4 million and
$56.6 million in fiscal 1997, 1998 and 1999, or 54%, 50% and 42% of revenue,
respectively. The decrease as a percentage of revenue was primarily a result of
lower overhead costs due to increased production volume.
18
Research and development. Research and development expenses consist
primarily of salaries and related personnel expenses, prototype expenses
related to the development of our ASICs, software development and testing
costs, and the depreciation of property and equipment related to research and
development activities. Research and development expenses were $5.4 million,
$8.8 million and $9.0 million in fiscal 1997, 1998 and 1999, or 160%, 52% and
7% of revenue, respectively. The increase in absolute dollars was primarily due
to the addition of engineering personnel and related costs. Research and
development costs are expensed as incurred. As a percentage of revenue,
research and development decreased because of the significant increase in
revenue. We believe continued investment in product enhancements and new
product development is critical to attaining our strategic objectives, and as a
result, we expect research and development expenses to continue to increase in
absolute dollars.
Sales and marketing. Sales and marketing expenses consist primarily of
salaries, commissions and related expenses for personnel engaged in marketing,
sales and customer support functions, as well as trade shows, advertising,
promotional expenses and the cost of facilities. Sales and marketing expenses
were $3.4 million, $7.3 million and $23.1 million in fiscal 1997, 1998 and 1999
or 101%, 43% and 17% of revenue, respectively. The increase in absolute dollars
was primarily due to the addition of sales and marketing personnel and
increased commission expenses resulting from significantly higher sales. As a
percentage of revenue, sales and marketing expenses decreased because of the
significant increase in revenue. We expect these expenses to increase in
absolute dollars as we continue to build our field sales and support
organizations and expand sales and marketing activities in the future.
General and administrative. General and administrative expenses consist
primarily of salaries and related expenses for executive, finance and
administrative personnel, facilities expenses and other general corporate
expenses. General and administrative expenses were $1.9 million, $1.6 million
and $4.5 million in fiscal 1997, 1998 and 1999 or 55%, 9% and 3% of revenue,
respectively. The increase in absolute dollars was primarily due to an increase
in the allowance for doubtful accounts, the addition of personnel necessary to
support the increase in revenue and general corporate expenses consistent with
the increased scale of operations. We expect general and administrative
expenses to continue to increase in absolute dollars as we continue to build
the infrastructure necessary to support the growth of our business and operate
as a public company.
Interest income. Interest income is the net result of the interest earned on
the funds we keep on deposit in interest bearing money market and short-term
investment accounts less any interest expense incurred on our revolving bank
line of credit and capital lease obligations. Foundry had net interest income
of $122,000, $413,000 and $1.9 million in 1997, 1998 and 1999, respectively.
During 1998, we had cash balances in an interest bearing account resulting from
the proceeds of our financing in March 1998. During 1999, interest income
increased significantly due to higher cash balances resulting from the proceeds
from our initial public offering.
Income taxes. Foundry did not incur state or federal income taxes in fiscal
1997 and 1998 due to operating losses incurred during those periods. Foundry
recorded income tax expense for fiscal 1999 of $9.8 million. The provision for
1999 results in an effective tax rate of 30% which reflects the application of
the benefit from cumulative net operating loss carryforwards and accumulated
research credits. As of December 31, 1997 and 1998, Foundry recorded valuation
allowances for the total net deferred tax assets as a result of uncertainties
regarding realization of the assets based upon the limited operating history of
Foundry, the lack of profitability and the uncertainty of future profitability
during those periods.
Net income. Net income increased to $22.9 million for 1999 from a net loss
of $9.3 million for 1998. This increase was due to significantly higher
revenue.
Our operating results have varied significantly in the past and revenue and
operating results may vary significantly in the future due to a number of
factors, including: fluctuations in demand for our products and services,
particularly in Europe and Asia; the cancellation or rescheduling of
significant orders; our ability to develop, introduce, ship and support new
products and product enhancements and manage product transitions;
19
announcements and introductions of new products by our competitors and us; our
ability to build infrastructure to support increased growth; our ability to
achieve required cost reductions; our ability to obtain sufficient supplies of
limited-sourced components for our products; increases in the prices of the
components we purchase; our ability to attain and maintain production volumes
and quality levels for our products; the mix of products sold and the mix of
distribution channels through which they are sold; and costs relating to
possible acquisitions and integration of technologies or businesses. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Risk Factors That May Affect Future Results and Market Price of
Stock--We may not meet quarterly financial expectations, which could cause our
stock price to decline" for a discussion of the risk of fluctuations in
operating results.
Liquidity and Capital Resources
On October 1, 1999, we completed our initial public offering in which we
raised gross proceeds of approximately $143.8 million from the sale of
11,500,000 shares of common stock. Prior to our initial public offering,
Foundry financed operations primarily through the private sales of common and
preferred stock for net proceeds of approximately $33.4 million and, to a
lesser extent, from a capital equipment lease line. At December 31, 1999,
Foundry had cash and cash equivalents of $120.4 million and short-term
investments of $39.8 million. Cash equivalents consisted of commercial paper
and cash deposited in money market accounts with original maturities of less
than three months. Short-term investments was comprised of corporate and U.S.
debt securities with original maturities greater than three months but less
than one year.
Cash provided by operating activities was $18.7 million for the year ended
December 31, 1999. Cash utilized in operating activities was $13.2 million in
1998 and $9.8 million in 1997. The cash utilized in 1998 and 1997 was due to
net losses, as well as working capital required to fund our growth in
operations, including accounts receivable and inventory.
Cash utilized in investing activities was $40.8 million for the year ended
December 31, 1999, $414,000 in 1998 and $526,000 in 1997. The cash utilized in
1998 and 1997 represented purchases of property and equipment, specifically
computers and electronic test equipment. In 1999 we used cash of $39.8 million
to purchase short-term investments and $1.0 million for property and equipment.
Financing activities provided $137.9 million in cash for the year ended
December 31, 1999, consisting primarily of proceeds from our initial public
offering, and to a lesser extent, from the exercise of stock options and
proceeds from the sale of preferred stock. In 1998, we generated $15.0 million
of cash and in 1997, we generated $9.6 million of cash, in each case primarily
from an equity financing and the exercise of stock options, offset by principal
repayments on capital lease obligations.
In December 1999 through March 2000, Foundry established subsidiaries in
foreign countries, including the United Kingdom, France, Canada, Netherlands,
Germany and Singapore, which function primarily as sales offices in those
locations. We have also established sales branch offices in Taiwan, Hong Kong,
Italy, Sweden and Ireland.
On September 28, 1999, we entered into a lease for approximately 71,000
square feet to serve as our new headquarters and manufacturing facility in San
Jose, California. Our lease commenced on February 1, 2000 and will expire on
January 31, 2006. The related rent expense is $131,000 per month.
As of December 31, 1999, we did not have any material commitments for
capital expenditures. However, we expect to incur capital expenditures as we
expand our operations in the near future. Although we do not have any current
plans or commitments to do so, from time to time, we may also consider the
acquisition of, or evaluate investments in, products and businesses
complementary to our business. Any acquisition or investment may require
additional capital. Although it is difficult for us to predict future liquidity
requirements with certainty, we believe that the net proceeds from our initial
public offering, together with our existing cash balances and anticipated funds
from operations, will satisfy our cash requirements for at least the next 12
months.
20
Recently Issued Accounting Standards
See Note 2 of Notes to Financial Statements for recently adopted and
recently issued accounting standards.
Risk Factors That May Affect Future Results and Market Price of Stock
We have incurred losses in the past and may not be able to maintain
profitability in the future.
We incurred net losses of $2.0 million from inception through December 31,
1996, $9.0 million in 1997 and $9.4 million in 1998. We generated net income
of $22.9 million for the year ended December 31, 1999. As of December 31,
1999, we had retained earnings of $2.5 million. We expect to incur increased
costs and expenses related to:
. sales and marketing, including expansion of our direct sales operation
and distribution channels;
. product development;
. customer support;
. expansion of our corporate infrastructure; and
. facilities expansion.
Although we were profitable in each of the four quarters of fiscal 1999,
our ability to remain profitable depends on our ability to generate and
sustain substantially higher revenue while maintaining reasonable cost and
expense levels. We may not be able to sustain or increase profitability on a
quarterly or annual basis in the future.
We may not meet quarterly financial expectations, which could cause our stock
price to decline.
Our quarterly revenue and operating results are difficult to predict and
may fluctuate significantly from quarter to quarter. Delays in generating or
recognizing forecasted revenue could cause our quarterly operating results to
be below the expectations of public market analysts or investors, which could
cause the price of our common stock to fall.
We may experience a delay in generating or recognizing revenue for a number
of reasons. Orders at the beginning of each quarter typically do not equal
expected revenue for that quarter and are generally cancelable at any time.
Therefore, we depend on obtaining orders in a quarter for shipment in that
quarter to achieve our revenue objectives. In addition, the failure to ship
products by the end of a quarter may negatively affect our operating results.
Our reseller agreements typically provide that the reseller may delay
scheduled delivery dates without penalty. Further, our customer purchase
orders and reseller agreements sometimes provide that the customer or reseller
may cancel orders within specified time frames without significant penalty.
We also plan to significantly increase our operating expenses to expand our
sales and marketing efforts, expand our customer support capabilities, finance
increased levels of research and development and build our operational and
administrative infrastructure. We base our operating expenses on anticipated
revenue trends and a high percentage of our expenses are fixed in the short
term. As a result, any shortfall in revenue relative to our expectations could
cause a significant decline in our quarterly operating results.
Intense competition in the market for network solutions could prevent us from
increasing revenue and sustaining profitability.
The market for network solutions is intensely competitive. In particular,
Cisco maintains a dominant position in this market and several of its products
compete directly with our products.
We also compete with other large public companies, such as 3Com and Nortel
Networks, as well as other smaller public and private companies. Many of our
current and potential competitors have longer operating
21
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. Additionally, we may face competition from unknown
companies and emerging technologies that may offer new LAN, MAN and LAN/WAN
solutions to enterprises and Internet service providers.
In order to remain competitive, we must, among other things, invest
significant resources in developing new products with superior performance at
lower prices than our competitors. We must also enhance our current products
and maintain customer satisfaction. If we fail to do so, our products may not
compete favorably with those of our competitors and our revenue and
profitability could suffer.
Our ability to increase our revenue depends on expanding our North American
direct sales operation and reseller distribution channels and continuing to
provide excellent customer support.
Our inability to effectively expand, train and retain our domestic sales and
support staff or establish our indirect distribution channels could harm our
ability to grow and increase revenue. Our expansion of our direct sales
operation may not be successfully completed and the cost of our expansion may
exceed the revenue generated. In addition, we have recently increased our sales
force in advance of sales, and if this increase does not result in an increase
in sales, our business may suffer.
If we fail to develop relationships with significant resellers, or if these
resellers are not successful in their sales efforts, sales of our products may
decrease and our operating results would suffer.
We need to increase our customer service and support staff to support new
and existing customers and resellers. The design and installation of networking
products can be complex and our customers, particularly our Internet service
provider customers, require a high level of sophisticated support and services.
Hiring highly trained customer service and support personnel is very
competitive in our industry due to the limited number of people available with
the necessary technical skills and understanding of our products.
If we fail to introduce new products with superior performance in a timely
manner, our ability to sustain and increase our revenue could suffer.
The current life cycle of our products is typically 18 to 24 months. To
remain competitive, we need to introduce new products in a timely manner that
offer substantially greater performance and support a greater number of users
per device, all at lower price points. We have experienced, and may in the
future experience, delays in developing and releasing new products and product
enhancements. This has led to, and may in the future lead to, delayed sales,
increased expenses and lower quarterly revenue than anticipated. During the
development of our products, we have also experienced delays in the prototyping
of our ASICs, which in turn has led to delays in product introductions. In
addition, when we announce new products or product enhancements that have the
potential to replace or shorten the life cycle of our existing products,
customers may defer purchasing our existing products. This could harm our
operating results by decreasing sales, increasing our inventory levels of older
products and exposing us to greater risk of product obsolescence.
We depend on large purchases from a few significant customers, and any loss,
cancellation or delay in purchases by these customers could cause a shortfall
in revenue.
To date, a limited number of customers and resellers have accounted for a
significant portion of our revenue. If any of these customers stop or delay
purchases, our revenue and profitability could suffer. In 1998, Mitsui & Co.
(U.S.A.) accounted for 21% of our revenue. In 1999, sales to Mitsui accounted
for less than 10% and sales to Hewlett-Packard and America Online accounted for
14% and 11% of our revenue, respectively.
While our financial performance depends on large orders from a few
significant customers and resellers, we do not have binding commitments from
any of them. For example:
. our reseller agreements generally do not require minimum purchases;
22
. our customers can stop purchasing and our resellers can stop marketing
our products at any time;
. our reseller agreements generally are not exclusive and are for one year
terms, with no obligation of the resellers to renew the agreements; and
. our reseller agreements provide for discounts based on expected or actual
volumes of products purchased or resold by the reseller in a given
period.
Because our expenses are based on our revenue forecasts, a substantial
reduction or delay in sales of our products to, or unexpected returns from
customers and resellers, or the loss of any significant customer or reseller
could harm our business. Although our largest customers may vary from period-
to-period, we anticipate that our operating results for any given period will
continue to depend to a significant extent on large orders from a small number
of customers.
Our success depends upon sales to Internet service providers, whose
unpredictable demands, requirements and business models subject us to potential
adverse revenue fluctuations.
We have introduced products specifically targeted at the Internet service
provider market and currently have under development other products to address
their requirements. As a result, our success depends on increased sales to
Internet service providers. Although we expect these sales to increase, we
believe that there are a number of risks arising from doing business with
Internet service providers which may not arise in our relationships with our
other customers, including:
. Internet service providers demonstrate a low level of brand loyalty and
may switch to another supplier which provides superior performance;
. any failure of an Internet service provider's service to its customers,
particularly in the case of our largest Internet service provider
customer, America Online, that is correctly or incorrectly attributed to
our products could lead to substantial negative publicity and undermine
our efforts to increase our sales in both this market and other markets;
. we may lose Internet service provider customers if they fail due to the
highly competitive nature of their business or if they do not survive as
a result of mergers and acquisitions in the Internet service provider
industry; and
. if the Internet does not continue to expand as a widespread
communications medium and commercial marketplace, the growth of the
market for Internet infrastructure equipment may not continue and the
demand for our products could decline.
Due to these factors, we may not successfully increase our penetration of
the Internet service provider market or maintain our current level of sales in
this market.
Hewlett-Packard is a major customer and our sole OEM, and the termination of
our relationship with Hewlett-Packard could harm our business.
Hewlett-Packard, currently our sole OEM, accounted for 14% of our revenue in
1999, and we anticipate that it will continue to account for a significant
percentage of our revenue. In addition to providing revenue through sales of
our products to Hewlett-Packard, we believe that this relationship is important
to facilitate broad market acceptance of our products and enhance our sales,
marketing and distribution capabilities. Therefore, in addition to directly
affecting our revenue, the cancellation of our agreement with Hewlett-Packard
could harm our ability to market and sell our products to potential customers.
In addition, if we were to default under conditions specified in the
agreement, Hewlett-Packard could use our source code to develop and manufacture
competing products. This could harm our performance and ability to compete.
23
This agreement creates the potential that we and Hewlett-Packard may compete
for sales to the same customer. If this situation occurs, it could harm our
relationship with Hewlett-Packard and also harm our business.
We expect the average selling prices of our products to decrease which may
reduce gross margins or revenue.
Our industry has experienced rapid erosion of average product selling prices
due to a number of factors, particularly competitive pressures and rapid
technological change. We may experience substantial period-to-period
fluctuations in future operating results due to the erosion of our average
selling prices. We also anticipate that the average selling prices of our
products will decrease in response to competitive pressures, increased sales
discounts, new product introductions by our competitors or other factors.
If we are unable to hire additional qualified personnel as necessary or if we
lose key personnel, we may not be able to successfully manage our business or
achieve our objectives.
We believe our future success will depend in large part upon our ability to
identify, attract and retain highly skilled managerial, engineering, sales and
marketing, finance and manufacturing personnel. Competition for these personnel
is intense, especially in the San Francisco Bay Area, and we have had
difficulty hiring employees in the timeframe we desire, particularly engineers.
We may not succeed in identifying, attracting and retaining personnel. The loss
of the services of any of our key personnel, the inability to identify, attract
or retain qualified personnel in the future or delays in hiring required
personnel, particularly engineers and sales personnel, could make it difficult
for us to manage our business and meet key objectives, such as timely product
introductions. In addition, companies in the networking industry whose
employees accept positions with competitors frequently claim that competitors
have engaged in unfair hiring practices. We have received one claim like this
from another company and we may receive additional claims in the future. We
could incur substantial costs in defending ourselves against any such claims,
regardless of the merits of such claims.
Our success also depends to a significant degree upon the continued
contributions of our key management, engineering, sales and marketing, finance
and manufacturing personnel, many of whom would be difficult to replace. In
particular, we believe that our future success depends on Bobby R. Johnson,
Jr., President, Chief Executive Officer and Chairman of the Board, and H. Earl
Ferguson, Vice President, Hardware Engineering. We do not have employment
contracts or key person life insurance covering any of our personnel.
Our ability to increase our international sales is subject to a number of risks
we do not control.
Our success will depend, in part, on increasing international sales and
expanding our international operations. Our international sales primarily
depend on our resellers, including Boreal and Mitech in Europe, Mitsui in
Japan, Bell Canada in Canada, and Samsung in Korea. Although we expect
international revenue to increase as a percentage of our total revenue, the
failure of our resellers to sell our products internationally would limit our
ability to sustain and grow our revenue. In particular, our revenue from
international sales depends on Mitsui's ability to sell our products and on the
strength of the Japanese economy which has been weak in recent years.
There are a number of risks arising from our international business,
including:
. potential recessions in economies outside the United States, such as
Japan;
. longer accounts receivable collection cycles;
. difficulties in managing operations across disparate geographic areas;
. difficulties associated with enforcing agreements through foreign legal
systems;
. import or export licensing requirements;
24
. potential adverse tax consequences; and
. unexpected changes in regulatory requirements.
Generally, our international sales currently 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.
In January 1999, the new "Euro" currency was introduced in European
countries that are part of the European Monetary Union ("EMU"). During 2002,
all EMU countries are expected to completely replace their national currencies
with the Euro. Because a significant amount of uncertainty exists as to the
effect the Euro will have on the marketplace and because all of the final rules
and regulations have not yet been defined and finalized by the European
Commission regarding the Euro currency, we cannot determine the effect this
will have on our business.
Our reliance on single or limited sources for key components may inhibit our
ability to meet customer demand.
We currently purchase several key components used in our products from
single or limited sources and depend on supply from these sources to meet our
needs. Our principal suppliers of key components include Celestica, Texas
Instruments, Toshiba, Hewlett-Packard, Molex and Intel. We acquire these
components through purchase orders and have no long-term commitments regarding
supply or price from these suppliers. We may encounter shortages and delays in
obtaining components in the future which could impede our ability to meet
customer orders. Our principal limited-sourced components include:
. dynamic and static random access memories, commonly known as DRAMs and
SRAMs;
. printed circuit boards; and
. microprocessors.
We depend on anticipated product orders to determine our material
requirements. Lead times for single- or limited-sourced materials and
components can be as long as six months, vary significantly and depend on
factors such as the specific supplier, contract terms and demand for a
component at a given time. If orders do not match forecasts, we may have either
excess or inadequate inventory of materials and components, which could
negatively affect our operating results and financial condition. From time to
time, we have experienced shortages in allocations of components, resulting in
delays in filling orders.
Our reliance on third-party manufacturing vendors to manufacture our products
may cause a delay in our ability to fill orders.
We currently subcontract substantially all of our manufacturing to two
companies, Celestica-Asia, located in San Jose, California, which assembles and
tests our printed circuit boards, and Hadco Corporation, located in Santa
Clara, California, which assembles and tests our backplane products. We do not
have long-term contracts with either of these manufacturers. We have
experienced delays in product shipments from our contract manufacturers, which
in turn delayed product shipments to our customers. We may in the future
experience similar delays or other problems, such as inferior quality and
insufficient quantity of product, any of which could harm our business and
operating results. We intend to regularly introduce new products and product
enhancements, which will require us to rapidly achieve volume production by
coordinating our efforts with those of our suppliers and contract
manufacturers. We attempt to increase our material purchases, contract
manufacturing capacity and internal test and quality functions to meet
anticipated demand. The inability of our contract manufacturers to provide us
with adequate supplies of high-quality products or the loss of either of our
contract manufacturers, or the ability to obtain raw materials, could cause a
delay in our ability to fulfill orders.
25
Due to the lengthy sales cycles of some of our products, the timing of our
revenue is difficult to predict and may cause us to miss our revenue
expectations.
Some of our products have a relatively high sales price, and often represent
a significant and strategic decision by an enterprise or Internet service
provider. As a result, the length of our sales cycle in these situations can be
as long as 12 months and may vary substantially from customer to customer.
While our customers are evaluating our products and before they may place an
order with us, we may incur substantial sales and marketing expenses and expend
significant management effort. Consequently, if sales forecasted from a
specific customer for a particular quarter are not realized in that quarter, we
may not meet our revenue expectations.
The timing of the adoption of industry standards may negatively impact
widespread market acceptance of our products.
Our success depends in part on both the adoption of industry standards for
new technologies in our market and our products' compliance with industry
standards. Many technological developments occur prior to the adoption of the
related industry standard. The absence of an industry standard related to a
specific technology may prevent market acceptance of products using the
technology. For example, we introduced Gigabit Ethernet products in May 1997,
over a year prior to the adoption of the industry standard for this technology.
We intend to develop products using other technological advancements, such as
10 Gigabit Ethernet, and may develop these products prior to the adoption of
industry standards related to these technologies. As a result, we may incur
significant expenses and losses due to lack of customer demand, unusable
purchased components for these products and the diversion of our engineers from
future product development efforts. Further, we may develop products that do
not comply with the eventual industry standard, which could hurt our ability to
sell these products. If the industry evolves to new standards, we may not be
able to successfully design and manufacture new products in a timely fashion
that meet these new standards. Even after industr