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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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Form 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2000
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to _____________
Commission file number:
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SonicWALL, Inc.
(Exact name of registrant as specified in its charter)
California 7372 77-0270079
(State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer
of incorporation) Classification Code Number) Identification No.)
1160 Bordeaux Drive
Sunnyvale, California 94089
(408) 745-9600
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
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Securities registered pursuant to Section 12 (b) of the Act:
Title of each class Name of Exchange on which registered
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None None
Securities registered pursuant to Section 12 (g) of the Act:
Common Stock (no 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 that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate 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, as of December 31, 2000, was approximately $631,166,943 million
based upon the last sale price reported for December 29, 2000 on the Nasdaq
Stock Market. For purposes of this disclosure, shares of Common Stock held by
persons who hold more than 5% of the outstanding shares of Common Stock and
shares held by officers and directors of the Registrant have been excluded
because such persons may be deemed to be affiliates. This determination is not
necessarily conclusive.
The number of shares of the Registrant's Common Stock outstanding on
December 31, 2000 was 62,646,843.
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PART I
ITEM 1. BUSINESS
You should carefully review the following risks associated with owning our
common stock. Our business, operating results or financial condition could be
materially adversely affected by any of the following risks. The trading price
of our common stock could decline due to any of these risks, and you as an
investor may lose all or part of your investment. You should also refer to the
other information set forth in this report and incorporated by reference
herein, including our financial statements and the related notes. Given these
risks and uncertainties, readers are cautioned not to place undue reliance on
such forward-looking statements.
Overview
SonicWALL, Inc. designs, develops, manufactures and sells Internet security
infrastructure products designed to provide secure Internet access to our
broadband customers and process secure transactions for enterprises and service
providers. We believe our security appliances provide high performance, robust,
reliable, easy-to-use and affordable Internet security and virtual private
network ("VPN") functionalities. We also sell security services including
content filtering services and anti-virus protection on an annual subscription
basis. Our transaction security products provide high performance SSL
acceleration and offloading to enable service providers and enterprises to
deploy e-commerce applications without degrading web site performance. We sell
our products to customers in the small to medium enterprise, e-commerce,
service provider, branch office and telecommuter markets. As of December 31,
2000, we have sold more than 117,000 of our Internet security appliances
worldwide.
Our SonicWALL product line provides our customers with comprehensive
integrated security including firewall, VPN, anti-virus, content filtering and
secure sockets layer ("SSL") encryption and decryption functionality, so users
can enjoy affordable, secure Internet communications and conduct secure
Internet transactions. SonicWALL delivers plug-and-play appliance solutions
that we believe are high performance, easy to install and cost-effective. With
current suggested retail prices ranging from $495 to $6,995, our products are
designed to enable customers to reduce purchase costs and avoid hiring costly
information technology personnel for Internet security. By using an embedded
single purpose operating system and a hardware design without moving parts, our
products maximize reliability and uptime. The SonicWALL access security
products can be used in networks ranging in size from 1 to 1,000 users and are
fully compatible with VPN technology from more expensive enterprise security
solutions offered by, among others, Check Point Software Technologies, Ltd.,
Nortel Networks and Cisco Systems, Inc.
SonicWALL was initially incorporated in California in 1991 as Sonic Systems.
In August 1999, we changed our name to SonicWALL, Inc. References in this
report to "We" "Our" "Us" and "the Company" refer to SonicWALL, Inc. Our
principal executive offices are located at 1160 Bordeaux Drive, Sunnyvale,
California 94089, and our telephone number is (408) 752-9600.
Industry Background
Growth of Internet Usage By Small to Medium Enterprise, Branch Office,
Telecommuter, and Education Markets
Businesses and consumers are increasingly accessing the Internet for a wide
variety of uses including communications, information gathering and commerce.
Because it is an affordable means of achieving global reach and brand
awareness, the Internet is a particularly attractive vehicle for small and
medium size businesses as they endeavor to access and share information with a
large number of geographically dispersed customers, employees and business
partners. For example, of the 87.4 million devices estimated by International
Data Corporation ("IDC"), a market research organization, to have Internet
access in 1998, approximately 60% were used by small businesses and home
offices. IDC estimates that the proportion of small businesses, those with less
than 100 people, accessing the Internet in the United States will increase from
approximately 50% in 1998 to approximately 65% by 2001, to a total of 4.7
million businesses.
Today's large business enterprise is characterized by many branch offices,
mobile workers and telecommuters, all of whom connect electronically to the
corporate office and each other. Because of the confidential nature of business
data, these connections must be secure. VPNs provide secure Internet
connections between the business enterprise and dispersed employees and
business partners. Communicating using VPNs offers significant cost savings
over alternative solutions such as private leased line or frame relay networks.
TeleChoice, a market researcher, estimates that VPNs can cut telecommunication
costs by as much as 90% over private leased line networks, and for this reason,
their use is expected to grow rapidly. Infonetics Research projects worldwide
expenditures on VPNs will grow by 100% per year through 2001, when they are
expected to reach $11.9 billion.
The Internet has also become a vital tool of information access and
communication for schools and libraries. According to the National Center for
Education Statistics, there were over 96,000 K-12 public schools and libraries
in the United States in 1998, of which 89% of schools and 35% of libraries were
connected to the Internet. The growth in Internet connectivity in this market,
combined with the proliferation of objectionable web sites, has created a need
for Internet security products that include content filtering capabilities.
Growth of e-Commerce
The Internet Economy has grown rapidly driven by its cost effectiveness and
ease-of-use as a means of communication, collaboration and coordination between
consumers, businesses and trading partners. What started out as an alternative
marketing channel has quickly turned into a complete economic system consisting
of (i) ubiquitous, low cost communication networks using Internet technologies
and standards, (ii) applications that enable business to be conducted over this
network infrastructure, (iii) interconnected electronic markets that operate
over the network and applications infrastructure, (iv) producers and
intermediaries providing a variety of digital products and services to
facilitate market efficiency and (v) emerging policy and legal frameworks for
conducting business over the Internet. Analysts predict that within the next
ten years the value of Internet-based transactions will account for up to 10%
of the world's consumer sales. Moreover, according to e-Marketer, the business-
to-business e-commerce market will grow from an estimated $226 billion in 2000
to $2.8 trillion in 2004.
Increasing Use of Broadband Access Technologies
Many small to medium enterprises and branch offices have addressed the need
for Internet access by installing a single computer with a dial-up connection
that is shared throughout the office, or by installing a dedicated network data
connection at a significantly greater expense, such as a T-1 line. Recently,
new high-speed technologies have emerged that can better satisfy the bandwidth
requirements of small to medium enterprises at a fraction of the cost of
traditional solutions. These technologies include DSL and cable modems, which
provide access speeds of up to 100 times faster than traditional 28.8 kbps
analog modems. In addition, new generations of Internet-based applications,
such as business to business e-commerce, sales force automation and enterprise
resource planning ("ERP") continue to emerge that require higher bandwidth than
is available through dial-up solutions. As DSL and cable services become more
affordable and widely available, small to medium enterprises, branch offices
and telecommuters are increasingly deploying these technologies as their
Internet access solution. IDC estimates that in the United States, the number
of small businesses using high-speed access is expected to expand from 380,000
in 1998 to 3.3 million in 2003.
Importance of Internet Security
Secure access to the Internet is a growing concern for most Internet users.
Because broadband technologies, including DSL and cable, are always connected
to the Internet, they present greater security issues than dial-up connections
and increase the risk that proprietary data or other sensitive information
might be compromised. These types of Internet connections present ongoing
security issues for small to medium enterprises, branch offices, and
telecommuters and increase the risk that computer hackers, disgruntled
employees, contractors or competitors might successfully access proprietary
data or other sensitive information. In addition, as more web-enabled, mission-
critical business applications are developed and offered by vendors such as
Oracle Corp., PeopleSoft Inc., Siebel Systems, Inc., and SAP AG, the amount of
sensitive data
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transmitted over the Internet increases, leading organizations to look for high
performance, robust solutions to address these security needs.
Increasing Need for Anti-Virus Solutions
In a 2000 survey conducted by ICSA, companies reported an average of 9 virus
infections per 100 personal computers with the most common infections spread
through e-mail messages, floppy disks and Internet downloads. In addition to
lost productivity, corporations must concern themselves with potentially severe
financial losses to themselves and their partners and customers. This has been
highlighted by the rapid infection of many users through widespread virus
outbreaks such as the "ILOVEYOU' and "Melissa' e-mail viruses. As a result,
enterprises are spending rapidly to deploy anti-virus protection solutions
across the enterprise and expending technical resources on an ongoing basis to
keep these solutions updated against the latest virus threats. IDC, a research
organization, expects sales of anti-virus products to increase from $1.2
billion in 1999 to $2.7 billion in 2004.
Increasing Use of SSL to Secure E-Commerce Transactions
Secure Sockets Layer, or SSL, is the most widely used encryption technology
for enabling the secure transmission of confidential data in e-commerce
transactions. Industry analysts believe reliable and affordable SSL solutions
will act as a driver to rapid e-commerce growth. Data encryption provided by
SSL allows e-commerce vendors to build secure systems, and also provides the
basis from which a business can build trust with customers, suppliers, partners
and employees. Netcraft, a market research firm estimates the SSL market will
increase from 726,000 SSL-based web servers in 1999 to more than 5 million by
2001.
Rapid Overall Growth in the Internet Security Market
The market for Internet security products include a variety of applications
to address network vulnerabilities and protect confidential data during
transmission and access. These products include firewalls, VPN access products,
anti-virus solutions, content filtering, intrusion detection technologies and
SSL encryption. According to IDC, the market for Internet security products is
expected to grow at a compounded annual growth rate of 21% to $8.3 billion by
2003. IDC also estimates that the market for firewall appliances priced at less
than $10,000 will grow at a compounded annual growth rate of 88% over the same
period.
Lack of a Cost Effective, High Performance Security Solution for the Access
Security Market
Although the need for Internet security is widespread, security vendors
generally have focused on providing solutions for large enterprises with highly
complex needs and extensive information technology (IT) support organizations.
These solutions have typically involved expensive enterprise firewall software
that runs on a dedicated server or personal computer and requires extensive
support, constant monitoring and regular updates by information technology
personnel to maintain their effectiveness. The expense and complexity of these
solutions, which often require additional products to incorporate VPN, SSL and
anti-virus capabilities, internet protocol address management or content
filtering, are impractical for the majority of small to medium enterprises due
to the more limited resources of such organizations. While there are suppliers
of low cost Internet routers, which may provide limited Internet security
functionality, we believe these products are difficult to install and configure
and provide relatively low performance.
Lack of High Performance Solutions to Perform Secure Transactions
The growth of e-commerce on the Internet and the need for secure
transactions has created increased loads on typical web servers, which have
general purpose CPUs. These servers were not designed to handle the extreme
processing requirements of SSL transactions and as a result, their performance,
as measured by the number of transactions per second (or TPS) that can be
processed simultaneously, declines considerably. Studies show that server
performance declines by over 90% when processing SSL transactions versus
ordinary non-encrypted Internet traffic. The need to improve the performance of
servers processing e-commerce
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transactions has typically been addressed by installing an SSL acceleration
board within the server. While these solutions increase performance, because
they continue to utilize the host CPU for a portion of the transaction
processing, they do not fully optimize the server's performance. A more
effective solution is to install a board within the web server that fully
offloads and accelerates the SSL encryption and decryption processes, thus
leaving the server completely free to process the remainder of the transaction
and all other traffic at maximum performance. In addition, as businesses
utilize highly specialized network equipment, such as content switches, load
balancers and caching appliances, to provide maximum performance for high
traffic web sites and Internet applications, they are seeking specialized
products to address SSL encryption and decryption acceleration and offloading
within these network architectures.
The SonicWALL Solution
SonicWALL, Inc. provides Internet security products designed to provide
secure access to customers in the small to medium enterprise, branch office,
telecommuter and education markets. These products are complemented by value-
added security services such as VPN, anti-virus protection and content
filtering. We also provide products to enable high performance processing of
secure transactions for service providers and enterprises that are deploying e-
commerce applications. We believe our security appliances provide high
performance, robust, reliable, easy-to-use and cost-effective Internet
security, while our SSL appliances enable web sites to maintain optimal
performance while processing a growing number of secure transactions. As of
December 31, 2000, we have sold more than 117,000 of our Internet security
appliances worldwide. The SonicWALL product line provides our customers with
the following key benefits:
. High Performance, Robust Access Security. The SonicWALL product family
provides a comprehensive integrated security solution that includes
firewall, VPN, anti-virus and content filtering. Our access security
products protect private networks against Internet-based theft,
destruction or modification of data, and automatically notify customers
if their network is under attack. SonicWALL has been awarded the
internationally recognized International Computer Security Association,
or ICSA, Firewall Certification, the same certification awarded to
significantly more expensive products sold by Check Point Software
Technologies, Ltd. and Cisco Systems, Inc. Our VPN products enable
affordable, secure communications among remote offices, mobile employees
and business partners over the Internet. Our anti-virus service provides
comprehensive virus protection with automatic updates and minimal
administration. Our content filtering service enables businesses, schools
and libraries to restrict access to objectionable or inappropriate web
sites.
. High Performance, Robust Transaction Security. The SonicWALL product
family also includes SSL acceleration and offloading products that allow
enterprises and service providers to secure and accelerate e-commerce
transactions. By accelerating and offloading the processing of secure
e-commerce transactions, our SSL products allow web sites to handle
significantly higher volumes of customer traffic. Unlike competitive SSL
acceleration products, our products completely offload SSL processing,
enabling maximum performance of the server.
. Ease of Installation and Use. The SonicWALL product family delivers a
plug-and-play appliance designed for easy installation and use.
Installation involves simply connecting a SonicWALL device between the
private network and the broadband Internet access device for our access
security products and in front of the e-commerce web server for our
transaction security products. SonicWALL products are easily configured
and managed through a web browser-based interface. No reconfiguration of
any personal computer application is required. Our access security
products are pre-configured to interface with all major Internet access
technologies, including cable, DSL, ISDN, Frame Relay and T-1. Our
transaction security products are compatible with all major web server
and e-commerce software products and are designed to operate in the most
sophisticated and highest traffic network architectures.
. Low Total Cost of Ownership. The SonicWALL product design minimizes the
purchase, installation and maintenance costs of Internet security. The
suggested retail prices of our access security products range from $495
to $4,995, versus enterprise firewall products, which range in price from
approximately
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$5,000 to more than $15,000. The suggested retail prices of our
transaction security products range from $2,495 to $6,995. Our affordable,
easy-to-manage Internet security appliances also enable customers to avoid
the expense of hiring costly IT personnel who may otherwise be required to
implement and maintain an effective Internet security solution.
. Reliability. The SonicWALL product design maximizes reliability and
uptime. Our products use an embedded single purpose operating system and
a hardware design that contains no moving parts. Most competitors'
products consist of software installed on general-purpose host computers
that use the Windows NT or UNIX operating systems. General-purpose
operating systems such as these are designed to run multiple
applications, creating an environment with less security and in which
random system crashes are commonplace. Moreover, since general-purpose
computers contain many moving parts, such as hard disk drives, floppy
drives, fans and switching power supplies, they are more prone to
hardware failures over time. These software and hardware failures can
compromise Internet security.
. Scalability and Compatibility. SonicWALL products are designed to provide
comprehensive Internet security for networks ranging in size from 1 to
1,000 users and for e-commerce applications that handle millions of
secure transactions daily. Our access security products consist of three
separate models designed to serve the specific security needs of our
target markets. Our transaction security products include PCI add-in
boards as well as appliance-based solutions, which can be deployed in the
most sophisticated networks requiring the highest levels of transaction
performance. Our products vary with respect to the number of supported
users, the number of transactions handled, the number of ports and
feature options such as VPN, anti-virus protection or content filtering.
In addition to serving the security needs of the small to medium
enterprise market, SonicWALL access security products are a fully
compatible, perimeter security solution for large, distributed
enterprises and their branch offices and telecommuters. SonicWALL
transaction security products are an ideal solution for enterprises and
service providers who are deploying high performance e-commerce
applications. Our products are designed to interoperate with enterprise
security products offered by, among others, Check Point Software
Technologies, Ltd. and Cisco Systems, Inc.
Strategy
Our goal is to extend our leadership position and become the industry
standard Internet security solution for broadband access and e-commerce users
in our target markets and become the leader in providing high performance
processing solutions for secure transactions. Key elements of our strategy
include:
. Extend Our Leadership Position in Access Security. We believe that we
have established a market leadership position as a provider of Internet
access security products designed for our target markets by offering
robust, reliable, easy-to-use products at attractive prices. We intend to
continue to focus our product development efforts, distribution
strategies and marketing programs to satisfy the growing needs of these
markets. We believe that the current Internet security offerings of most
vendors are comparatively expensive, technically complex and generally
unable to satisfy these target markets.
. Become a Leader in the Transaction Security Market. We believe that we
can establish a leadership position in the fast growing e-commerce
transaction security market. Through our acquisition of Phobos
Corporation in November 2000, we believe we possess the highest
performance, most scaleable, reliable and easy-to-use SSL products in the
market. We intend to utilize our strategic partnerships, distribution
channels and marketing programs to deliver these products to large
enterprises and service providers that are deploying e-business
applications and processing e-commerce transactions.
. Continue to Develop New Products and Reduce Manufacturing Costs. We
intend to use our product design and development expertise to expand our
product offerings and reduce our manufacturing costs. We believe that
these new product offerings, other new products and associated cost
reductions will strengthen our market position and assist us in
penetrating new markets.
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. Strengthen the SonicWALL Brand. We believe that strong brand recognition
in our target markets is important to our long-term success. We intend to
continue to strengthen our SonicWALL brand name through industry trade
shows, our web site, advertising, direct mailings to both our resellers
and our end users, and public relations. Our reputation as a reliable,
high performance, easy-to-use and affordable Internet security vendor
contributes to our resellers' sales efforts.
. Expand Our Indirect Channel. Our target markets are generally served by a
two-tier distribution channel. We have successfully penetrated these
markets with over 7,000 value-added resellers, systems integrators and
distributors who sell our products in over 30 countries, including large
distributors such as Ingram Micro, Inc. and Tech Data Corp.. We have also
established reseller relationships with Alltel Corporation, WebMD Corp.
and myCIO.com, a Network Associates business. We intend to continue to
build and expand our base of indirect channel relationships through
additional marketing programs, hiring additional marketing staff and
increased advertising.
. Develop Strategic Original Equipment Manufacturer Relationships. By
entering into original equipment manufacturer ("OEM") arrangements to
sell our products, we intend to build upon the brand awareness and
worldwide channels of major networking and telecommunications equipment
suppliers to further penetrate our target markets. We presently have OEM
agreements with the following companies: Network Associates, a
manufacturer of security software products, Com21, Inc., a supplier of
cable modems, NetGear, Inc., a manufacturer of networking products for
small office and home office customers, and 3COM Corporation, a provider
of diversified networking products.
. Increase Services Revenue. We intend to continue to develop new services
and add on products to generate additional revenue from our installed
base. For example, we recently announced our integrated, managed anti-
virus service to our customers and had installed over 20,000 clients as
of December 31, 2000. In January 2001, we introduced SonicWALL Total
Secure, which enables our managed service provider partners to offer a
complete security service, using SonicWALL technology, for a fixed price
per user per month. We also offer fee-based customer support services and
training to our customers. We have dedicated marketing personnel and
programs that focus on selling these products and services to our
existing base of customers. We have actively sought registration of our
customers and have experienced a registration rate of nearly 65% to date.
This has enabled us to pursue cost effective, targeted marketing
campaigns to our installed base of registered users. Our Auto Update
feature encourages our customers to register their product by offering
periodic notifications via e-mail of new security threats, bug fixes and
marketing information on new features and products. Each SonicWALL model
is configured to allow end users to easily and conveniently download new
features and products that have been purchased, either through our
resellers or our web site. Such sales could include additional
functionality such as VPN or subscription services such as anti-virus and
content filtering.
Products and Services
SonicWALL provides complete Internet security solutions that include access
security products, value-added security services and transaction security
products. We believe our access security product line provides cost effective
and high performance Internet security for the small and medium size
enterprise, telecommuter, education and government markets. We also offer a
broad range of security services designed to enhance the functionality and
performance of the appliance platforms. Our transaction security products
enable our target enterprise and service provider customers to process large
volumes of secure transactions using SSL technology without compromising the
performance of their e-commerce or e-business applications.
Our Global Management System (GMS) enables distributed enterprises and
service providers to manage and monitor up to 1000 SonicWALL Internet security
appliances and deploy our security services from a central location to reduce
staffing requirements, speed deployment and lower costs. SonicWALL GMS allows
network administrators to administer and monitor security policies across
large, geographically distributed networks.
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Access Security Products:
SonicWALL access security products include high performance, solid-state
Internet security appliances that provide integrated security to meet the needs
of the individual telecommuter through the large distributed enterprise.
SonicWALL Internet security appliances share a common set of Internet security
features that have been tailored to meet the needs of our target markets:
Firewall Security. Our firewall technology protects private networks against
Internet-based theft, destruction or modification of data, and automatically
notifies customers if their networks are under attack. SonicWALL has been
awarded the internationally recognized ICSA Firewall Certification, the same
certification awarded to significantly more expensive products sold by Check
Point Software Technologies, Ltd. and Cisco Systems, Inc. In addition,
SonicWALL is pre-configured to automatically detect and thwart Denial of
Service attacks such as Ping of Death, SYN Flood, LAN Attack, and Internet
Protocol Spoofing.
Internet Protocol Address Management. SonicWALL products also include
Network Address Translation, or NAT, which allows a customer to connect
multiple users on their private network to the Internet using a single public
internet protocol, or IP, address and Dynamic Host Configuration Protocol, or
DHCP, Client and Server capabilities. DHCP Client allows the appliance to
automatically acquire its IP address settings from the Internet Service
Provider, or ISP. DHCP Server allows computers on the private network to
automatically acquire IP address settings from the appliance, simplifying
client personal computer configuration.
Web Browser-Based Management. SonicWALL appliances are easily and securely
configured and managed through a web browser-based interface. The SonicWALL
interface effectively insulates the user from the underlying complexity of
Internet security, while providing enough flexibility to meet the diverse needs
of our customers.
Logging and Reporting. SonicWALL appliances maintain an event log of
potential security concerns, which can be viewed with a web browser or
automatically sent to any e-mail address on a periodic basis. SonicWALL
appliances notify the administrator of high-priority security issues, such as
an attack on a server, by immediately sending an alert message to a priority e-
mail account such as an e-mail pager. SonicWALL also provides pre-defined
reports that show different views of Internet usage, such as the most commonly
accessed web sites.
Internet Security Appliances
Our SonicWALL line of Internet security appliances vary with respect to the
number of supported users, the number of ports, product features, processor
speed and scalability. They include:
SonicWALL TELE2. This Internet security appliance provides affordable,
complete Internet security and high performance integrated virtual private
networking (VPN) functionality for telecommuters and small offices with up to 5
users. As a complement to the SonicWALL PRO and SonicWALL PRO-VX, the SonicWALL
TELE2 allows businesses to provide cost-effective firewall security and VPN
connectivity to their branch offices and remote workers.
SonicWALL SOHO2. This Internet security appliance is a comprehensive and
affordable Internet security solution for smaller networks using broadband
connections to the Internet. SonicWALL SOHO2 is available in 10-user and 50-
user models and can be upgraded to support unlimited users.
SonicWALL XPRS2. This Internet security appliance protects an unlimited
number of users from Internet security threats and includes a De-Militarized
Zone (DMZ) port for customers with public web servers. With the DMZ port,
public web and e-commerce servers on the local network can be accessed from the
Internet without exposing the private network to Internet-based attacks.
Publicly accessible servers connected to the DMZ are also protected against
Denial of Service (DoS) attacks.
SonicWALL PRO. This Internet security appliance meets the security demands
of medium to large networks and supports up to 100 simultaneous VPN connections
to remote offices or workers. The SonicWALL PRO allows companies to increase
productivity by establishing secure VPN connections with business partners,
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branch offices, telecommuters and mobile users. The SonicWALL High Availability
upgrade can be added to eliminate network downtime by allowing two SonicWALL
PROs to act as a redundant pair.
SonicWALL PRO-VX. This is a high-performance, scalable security and remote
access solution for the enterprise that can support up to 1000 remote offices
or workers. The SonicWALL PRO-VX includes hardware VPN acceleration to support
larger networks. It also includes our High Availability feature to eliminate
network downtime by allowing two SonicWALL PRO-VXs to act as a redundant pair.
Coupled with the SonicWALL Global Management System (GMS), the SonicWALL PRO-VX
cost effectively extends security policies across large distributed networks of
enterprises and service providers.
Security Services:
SonicWALL Internet security appliances integrate seamlessly with a
comprehensive and expanding line of value-added security services to provide
complete Internet security. With SonicWALL's integrated security services,
companies avoid the integration and maintenance problems that often result from
sourcing, installing, and maintaining security products and services from
multiple vendors.
SonicWALL Anti-Virus. Our anti-virus subscription service eliminates the
challenges of installing and maintaining anti-virus protection throughout a
business and across a distributed network. This SonicWALL service integrates
with our security appliances to deploy and maintain anti-virus software for
each user on the network without the need for desktop-by-desktop installation,
configuration and maintenance. Automatic virus updates ensure all network nodes
are protected from new virus outbreaks.
SonicWALL IPSec VPN. Our virtual private networking capabilities enable
affordable and secure communications over the Internet between geographically
dispersed offices, workers and partners. SonicWALL virtual private networking
uses the industry standard IPSec protocol to deliver state-of-the-art security
and interoperability with other virtual private networking products such as
Check Point Software Technologies, Ltd.'s Firewall-1 and Nortel Network's
Contivity VPN Switch.
Content Filtering. Our content filtering service enables businesses,
families, schools and libraries to control access to objectionable or
inappropriate web sites. SonicWALL can filter Internet content by URL, keyword
or application type. We offer a content filter subscription service that
provides a list of objectionable web sites that is automatically updated on a
weekly basis.
SonicWALL TotalSecure. Introduced in January 2001, our comprehensive
security service for small and medium-sized enterprises is offered through
Managed Service Providers (MSPs) and other service providers. TotalSecure
offers customers 24/7 Internet security, virtual private networking (VPN) and
"always current" protection against viruses, hackers and web-site attacks.
TotalSecure is provided for a monthly, per user fee, with no up-front equipment
purchase.
Transaction Security Products:
Our transaction security products utilize SSL technology and high
performance ASIC designs to ensure the highest levels of performance and
security for businesses and service providers. SonicWALL SSL products boost e-
commerce web site performance up to 50 times by completely offloading the
processing burden of SSL transactions. SonicWALL's SSL products deliver
industry-leading price/performance and guarantee transaction security for the
enterprise, e-commerce and service provider markets.
SonicWALL SSL-PCI. This cost-effective, plug-and-play SSL accelerator board
installs directly into any web server to offload all encryption and decryption
processes from the server, freeing it to perform its applications. Storing up
to 256 keys and certificates, the SonicWALL SSL-PCI ensures complete web server
independence for secure processing.
SonicWALL SSL Appliances. Our SSL appliances easily install in front of any
web server or cluster tasked with secure transaction processing, and support up
to 200 new SSL connections per second and up to
8
900 sustained SSL connections per second for high-demand SSL processing. The
SSL appliances store up to 256 keys and certificates to ensure web server
independence and eliminate configuring secure processing properties on the host
application. The SSL appliances include redundant power supplies and a fail-
over port for high availability SSL processing.
Customers
We sell over 98% of our products through distributors and original equipment
manufacturers. As of December 31, 2000, we have sold more than 117,000 Internet
security appliances. The following lists our top international and domestic
distributors based on revenues in the year ended December 31, 2000, and all of
our current original equipment manufacturers.
Top Domestic and International Distributors Original Equipment Manufacturers
. Ingram Micro, Inc. . Forval Creative, Inc. . 3COM Corp.
. Tech Data Corp. . ComputerLinks (Germany) . Com21, Inc.
. Westcon . Sumitomo Metal Systems (Japan) . Netgear, Inc.
. Access Networks AG . Tek Data (England) . Network Associates
(Switzerland) . Marubeni Solutions
. Telectronic SA
End Users
The following is a representative list of end users in each of our target
markets who have deployed one or more SonicWALL products. These include the
small to medium enterprise, the branch offices of large corporations,
telecommuter, and the education and public institution markets.
Small to Medium Branch Offices Telecommuter Education and Public Institutions
Enterprises
. BDO Seidman LLP . American Express . Compaq Computer . Albany County School District
. Becks Beer . Bank of Nova Scotia Corporation . City of Santa Cruz
. Charlotte Hornets . Centurion/Bank of Ireland . Lucent Technologies . Comision Federal de Electricidad
. Fila Sports . Commercial Bank of . Microsoft Corporation . Duke University
. Pixar Animation San Francisco . NEC . Johns Hopkins University
Studios, Inc. . Wells Fargo . PricewaterhouseCoopers LLP . Santa Clara County
. Sun Microsystems, Inc. . California Library
Sales and Marketing
Our sales and marketing efforts focus on successfully penetrating the small
to medium enterprise, branch office, telecommuter and education markets. Our
marketing programs promote SonicWALL brand awareness and reputation as a
reliable, high performance, easy-to-use, and affordable Internet security
appliance. We try to strengthen our brand through a variety of marketing
programs which include on-going public relations, our web site, advertising,
direct mail, industry and regional trade shows and seminars. We intend to
rapidly expand our indirect channel relationships through additional marketing
programs, additional marketing staff and increased advertising.
We believe that SonicWALL products are ideally suited for the indirect
channel where it is not economically efficient for us to sell directly to the
end users of our products. We primarily market and sell our products in this
indirect channel through a two-tiered distribution structure consisting of
distributors and resellers, in the United States and over 30 other countries.
Distributors accounted for approximately 84% of our total revenue for the year
ended December 31, 2000. Resellers, which include systems integrators, Internet
Service Providers, or ISPs, dealers, mail order catalogs and online catalogs,
generally purchase our products from our distributors and then sell our
products to end-users in our target markets. Except for our SonicWALL Preferred
Partner level resellers described below, we do not have purchase agreements
with or sell directly to our resellers. Our distributor and reseller agreements
are non-exclusive.
9
We divide our sales organization regionally into three areas: the United
States and Canada; the Pacific Rim and Latin America; and Europe, the Middle
East and Africa. Regional sales representatives manage our relationships with
our network of distributors, value-added resellers and customers, help our
value-added reseller network sell and support key customer accounts, and act as
a liaison between our value-added reseller network and our marketing
organization. The regional sales representative's primary responsibility is to
help the indirect channel succeed and grow within the territory. We also have
an internal sales staff that supports the indirect channel, and a dedicated
business development organization whose primary responsibilities are
identifying, promoting and managing strategic relationships to sell our
products with ISPs, industry leaders and original equipment manufacturers, as
well as to obtain technology for incorporation in our product line.
Domestic Channel. In the United States, the primary distributors of our
products to resellers are Ingram Micro, Inc. and Tech Data Corp.. Ingram Micro,
Inc. accounted for 34% of our revenue in 1998 and 1999 and 32% in 2000. Tech
Data Corp. began distributing our Internet security products in February 1999,
and in the year ended December 31, 2000, accounted for approximately 20% of
total revenue.
Domestic resellers receive various benefits and product discounts depending
on the level of purchases that the reseller commits to or achieves. The basic
program is the SonicWALL Reseller, which offers access to privileged
information and sales and marketing materials. Next, we offer a SonicWALL
Select Partner, which extends those benefits by adding access to an expanded
set of sales and marketing tools, as well as priority technical support. The
top level is SonicWALL Preferred Partner, where additional benefits such as
sales leads, access to additional discounted demonstration units and market
development funds are available. SonicWALL Reseller and Select Partner sellers
all source our products through a distributor. We sell directly to SonicWALL
Preferred Partner level resellers.
International Channel. We believe there is a strong international market for
our products. International sales represented 34% of our revenue in 1999 and
approximately 32% of revenue in 2000. Sales to Japan accounted for 11% of total
revenue in the year ended December 31, 2000.
We direct all of our international resellers to the appropriate distributor
in each territory. We support our international distributors by offering
customizable marketing materials, sales tools, leads, co-operative marketing
funds, joint advertising, discounted demonstration units and training. We also
participate in regional press tours, trade shows and seminars. Additional key
international distributors include Access Networks AG in Switzerland, Tek Data
Distribution in England, DataWorld in Hong Kong and ComputerLinks in Germany.
Original Equipment Manufacturer Channel. We enter into select original
equipment manufacturer relationships in order to take advantage of the channels
of well-established companies that sell into our target markets. We believe
these channels expand our overall market while having a minor impact on our own
indirect channel sales. We currently have agreements to sell our products or
services through several original equipment manufacturers. Com21, Inc., a
supplier of cable modems, is licensed to incorporate our technology in its
access products. Network Associates, Inc., a provider of security and anti-
virus software products, sells our firewall appliances and upgrade services
under its own name. NetGear, Inc., a provider of networking equipment for small
and medium businesses, is licensed to incorporate certain components of our
technology into its router and switching products. 3COM Corporation, a provider
of diversified networking and telecommunications equipment, resells certain
products that we manufacture and design under its own name. In addition, we
have signed agreements with myCIO.com, a Network Associates business, and All
Bases Covered(TM), a provider of outsourced information technology services, to
offer our TotalSecure security service under their own brands. The terms of our
agreements with these customers are variable and can generally be cancelled
under certain conditions. In the year ended December 31, 2000, our original
equipment manufacturer revenue accounted for approximately 15% of total
revenue.
Customer Service and Technical Support
We offer our customers a comprehensive range of support programs through a
customer service and technical support organization that provides product
maintenance and technical support services on a worldwide
10
basis. Our technical support staff is located in Sunnyvale, California. In
addition to standard support, we offer premium support services that an end
user customer located in the United States can purchase from us or our channel
partners.
Standard Support. Included during the warranty period, standard support is a
unique web-based technical support mechanism whereby distributors, channel
partners and end users can use our extensive on-line technical support resource
database. If the resource database does not answer a question, the user can
immediately enter a query or "trouble ticket" on-line and our customer service
organization will then generate a response via phone, fax or e-mail.
Per Incident Support. This support program provides priority technical
support for the duration of a single technical support issue. This program has
been designed for customers who have a single problem that they would like
resolved promptly, thereby avoiding or minimizing network down time.
Premium Support. Available for purchase only in the continental United
States, our annual, subscription-based Premium Support program offers extended
benefits to the Standard Support offering that include expedited response time,
overnight equipment replacement, and more. Premium Support is designed for
customers who rely heavily on network/Internet connectivity and cannot afford
to have network downtime.
Our products include a standard one-year warranty that can be extended at
additional cost. The warranty provides access to our standard technical support
services along with repair or replacement guarantees for units with product
defects.
Technology
We have designed our SonicWALL products using a unique combination of
proprietary hardware and software that delivers comprehensive Internet security
with what we believe is exceptional ease-of-use and industry-leading
price/performance.
Access Security Products
Our access security product line currently has two base hardware
configurations. The SonicWALL TELE2, SOHO2 and XPRS2 use the Toshiba TX3927
RISC microprocessor. The SonicWALL TELE2 and SOHO2 include two 10/100 Mbps Fast
Ethernet ports, while the XPRS2 includes three 10/100 Mbps Fast Ethernet ports.
The SonicWALL PRO and PRO-VX use Intel Corporation's 233MHz StrongARM RISC
microprocessor. They include three 10/100 Mbps Fast Ethernet ports.
Additionally, the PRO-VX incorporates custom hardware to accelerate VPN
performance up to 45 Mbps 3DES.
In addition, our global management system, SonicWALL GMS, is an enterprise
software application that enables service providers and distributed enterprises
to centrally manage all of their SonicWALL appliances from a single location.
SonicWALL GMS is available to use in Windows NT or Sun Solaris operating
environments.
The SonicWALL product line consists of the following core features:
. Firewall. The core technology is the stateful packet inspection firewall
software, which is widely accepted as the most advanced and secure method
of implementing an Internet firewall. It examines all layers of the
packet (from the physical layer up to application layer) and determines
whether to accept or reject the requested communication based on state
information derived from previous communications and the applications in
use. Stateful packet inspection dynamically adjusts based on the changing
state of the communication running across the firewall and is invisible
to users on the protected network. It therefore requires no client
personal computer reconfiguration. Our SonicWALL firewall protects
against a known set of security threats.
. IP Address Management. We have developed tools to hide the complexity of
IP addressing. Network Access Transmission, or NAT, allows networks to
share a small number of valid public Internet
11
Protocol, or IP, addresses with an equal or larger number of client
computers on the LAN. This is a common challenge in new broadband-
connected networks. Our DHCP Client and Server tools allow both the
firewall and the client computers behind it to obtain their respective IP
addresses dynamically from a server and thereby eliminate the need for
manual configuration.
. Web Browser-Based Management Interface. We believe our products have an
intuitive and easy-to-use web-based management interface for rapid
installation, configuration and maintenance, without the need for a
dedicated information technology staff to install and maintain the
solution. This interface can be easily accessed from any web browser on
the internal, private network. This interface can also be accessed
remotely in a secure manner using the virtual private networking feature
described above.
. Logging and Reporting. SonicWALL maintains an event log of potential
security concerns, which can be viewed with a web browser or
automatically sent to any e-mail address on a periodic basis. SonicWALL
notifies the administrator of high-priority security issues, such as an
attack on a server, by immediately sending an alert message to a priority
e-mail account such as an e-mail pager. SonicWALL also provides pre-
defined reports that show different views of Internet usage, such as the
most commonly accessed web sites.
Security Services
SonicWALL Internet Security Appliances integrate seamlessly with a
comprehensive and expanding line of value-added security services to provide
complete Internet security. With SonicWALL's integrated security services,
companies avoid the integration and maintenance problems that often result from
sourcing, installing, and maintaining security products from multiple vendors.
Our security services are easily enabled on the base hardware platform via a
software key.
. Anti-Virus. Our anti-virus subscription service eliminates the challenges
of installing and maintaining anti-virus protection throughout a business
and across a distributed network. This SonicWALL service integrates with
our security appliances to deploy and maintain anti-virus software for
each user on the network--without the need for desktop-by-desktop
installation, configuration and maintenance. Automatic virus updates
ensure all network nodes are protected from new virus outbreaks.
. Virtual Private Networking. We developed virtual private networking
support for the SonicWALL products to provide a means for our customers
to use the Internet for secure communication between LANs, and from
remote clients to LANs. SonicWALL virtual private networking complies
with the Internet Protocol Security (IPSec) standard and supports three
data encryption methods: 56 bit Data Encryption Standard (DES); 168 bit
Data Encryption Standard (Triple-DES); and 56 bit ARCFour (ARC4). By
building our virtual private networking technology on industry
standards--IPSec, DES and Triple-DES--we have been able to establish
virtual private networking interoperability with other leading virtual
private networking solutions from companies such as Check Point Software
Technologies, Ltd., Nortel Networks Corp. and Cisco Systems, Inc.
. Content Filtering. Our Internet content filter blocks objectionable
content using a list of forbidden URLs and keywords as well as cookies,
Java and ActiveX scripts. We license the widely respected CyberNOT list
of URLs and adapt it for our products. Each SonicWALL appliance can
automatically download an updated URL list weekly to keep pace with the
dynamic nature of Internet content by subscribing to the SonicWALL
Internet Content Filtering subscription.
Transaction Security Products
SonicWALL transaction security products boost web site performance by
completely offloading all SSL processing from the web servers to a device
optimized for handling SSL transactions. SonicWALL SSL products use a powerful
onboard processor with SonicWALL's proprietary embedded operating system to
deliver a complete end-to-end security system. Our SSL products boost e-
commerce web site performance up
12
to 50 times at a fraction of the cost of installing new web servers. Storing up
to 256 keys and certificates, SonicWALL SSL products ensure complete web server
independence for secure processing.
Our product line has the following hardware configurations:
. SonicWALL SSL-PCI. This cost effective plug-and-play SSL board installs
directly into any web server to offload all encryption, decryption and
secure processes from the server, freeing it to perform its essential web
site tasks. It supports up to 200 new SSL connections per second and up
to 900 sustained SSL connections per second for high-demand SSL
processing. In addition to performing the crypto functions, the SonicWALL
SSL-PCI can function as a 10/100 Mbps Fast Ethernet Network Interface
Card (NIC).
. SonicWALL SSL Appliances. These rack mount or appliance form factor
products are designed for data centers, e-commerce web hosting
environments and enterprise networks. The SonicWALL SSL appliances have
two 10/100 Mbps Fast Ethernet ports--one for network traffic and one for
server traffic, and support up to 200 new SSL connections per second and
up to 900 sustained SSL connections per second for high-demand SSL
processing. They also include a fail-over port and redundant power supply
for high availability SSL processing.
Research and Development
We believe that our future success will depend in large part on our ability
to develop new and enhanced Internet security solutions and our ability to meet
the rapidly changing needs of our target customers who have broadband access to
the Internet. We focus our research and development on evolving Internet
security needs. In addition, we have made substantial investments in hardware
and ASIC technologies, which are critical to drive product cost reductions and
higher performance solutions.
All of our research and development activities are conducted at our
principal facilities in Sunnyvale, California and in Salt Lake City, Utah. In
1998, 1999 and 2000 we incurred expenses of $2,051,000, $3,643,000 and
$11,359,000, respectively, on research and development.
Competition
The market for Internet security products is worldwide and highly
competitive, and we expect competition to intensify in the future. There are
few substantial barriers to entry, and additional competition from existing
competitors and new market entrants will occur in the future. Current and
potential competitors in our markets include, but are not limited to the
following, all of whom sell worldwide or have a presence in most of the major
markets for such products:
. enterprise firewall software vendors such as Check Point Software
Technologies, Ltd. and Symantec Corporation;
. network equipment manufacturers such as Cisco Systems, Inc., Lucent
Technologies, Nortel Networks Corp. and Nokia Corp.;
. encryption processing equipment manufacturers such as nCipher Corporation
and Rainbow Technologies;
. computer or network component manufacturers such as Intel Corporation;
. operating system software vendors such as Microsoft Corporation, Novell,
Inc. and Sun Microsystems, Inc.;
. security appliance suppliers such as WatchGuard Technologies, Inc.; and
. low cost Internet router suppliers which may include limited Internet
security functionality.
13
Many of our competitors to date have generally targeted large enterprises'
security needs with firewall products that are typically very complex and
expensive, ranging in price from approximately $5,000 to more than $15,000.
While there are suppliers of low cost Internet routers which may provide
limited Internet security functionality, we believe these products are
difficult to install and configure and provide relatively low performance. At
any time, any of these competitors may adapt existing products for our target
markets. Many of our current or potential competitors have longer operating
histories, greater name recognition, larger customer bases and significantly
greater financial, technical, marketing and other resources than we do. Nothing
prevents or hinders these actual or potential competitors from entering our
target markets at any time. In addition, our competitors may bundle products
competitive to ours with other products that they may sell to our current or
potential customers. These customers may accept these bundled products rather
than separately purchasing our products. If these companies were to use their
greater financial, technical and marketing resources in our target markets, it
could adversely affect our business.
Proprietary Rights
We currently rely on a combination of copyright and trademark laws, trade
secrets, confidentiality provisions and other contractual provisions to protect
our proprietary rights. Despite our efforts to protect our proprietary rights,
unauthorized parties may misappropriate or infringe on our trade secrets,
copyrights, trademarks, service marks and similar proprietary rights. Although
we are currently investigating patent protection for some of our proprietary
technology, we have not yet received any patent protection for our technology
or products. Even if we obtain such patents, that will not guarantee that our
patent rights will be valuable, create a competitive barrier, or will be free
from infringement. We face additional risk when conducting business in
countries that have poorly developed or inadequately enforced intellectual
property laws. In any event, competitors may independently develop similar or
superior technologies or duplicate the technologies we have developed, which
could substantially limit the value of our intellectual property.
U.S. Government Export Regulation Compliance
Our products are subject to federal export restrictions on encryption
strength. Recent federal legislation, however, has increased exportable
encryption strength and allows the export of any-strength encryption to
designated business sectors overseas, including U.S. subsidiaries, banks,
financial institutions, insurance companies and health and medical end users.
In addition, we have obtained a federal export license that allows us to export
encryption technology to commercial entities in approved countries. With these
expanded export rights, we may export strong encryption to a wide range of
foreign end-users, subject to limitations and record-keeping requirements. To
comply with these constraints, we obtain from our distributors and resellers
detailed information about each foreign end-user customer that will obtain
strong encryption.
Manufacturing
We currently outsource our manufacturing to one contract manufacturer, Flash
Electronics, under an agreement that may be cancelled upon 180 days prior
notice by either party. Outsourcing our manufacturing enables us to reduce
fixed overhead and personnel costs and to provide flexibility in meeting market
demand.
We design and develop all the key components of our products, including
printed circuit boards and software. In addition, we determine the components
that are incorporated in our products and select the appropriate suppliers of
these components. Product testing and burn-in is performed by our contract
manufacturers using tests that we specify.
Employees
As of January 31, 2001, we had 268 employees. Of these, 105 were employed in
sales and marketing, 42 in finance and administration, 97 in research and
development and 24 in operations. We are not party to any collective bargaining
agreements with our employees and we have not experienced any work stoppages.
We believe we have excellent relations with our employees.
14
RISK FACTORS
You should carefully review the following risks associated with owning our
common stock. Our business, operating results or financial condition could be
materially adversely affected by any of the following risks. The trading price
of our common stock could decline due to any of these risks, and you as an
investor may lose all or part of your investment. You should also refer to the
other information set forth in this report and incorporated by reference
herein, including our financial statements and the related notes. Given these
risks and uncertainties, readers are cautioned not to place undue reliance on
such forward-looking statements.
Company Risks
We have recently entered the emerging market for broadband Internet security
appliances, and we do not know if we will be successful in marketing our
products to our target customers.
We believe that many potential customers in our target markets are not fully
aware of the need for Internet security products and services. Historically,
only enterprises having substantial resources developed or purchased Internet
security solutions. Also, there is a perception that Internet security is
costly and difficult to implement. Therefore, we will not succeed unless we can
educate our target markets about the need for Internet security and convince
potential customers of our ability to provide this security in a cost-effective
and easy-to-use manner. Although we have spent, and will continue to spend,
considerable resources educating potential customers about the need for
Internet security and the benefits of our products and services, our efforts
may be unsuccessful.
Even if we convince our target markets about the importance of the need for
Internet security, we do not know if this will result in the sale of our
products. We currently expect that almost all of our future revenue will be
generated through sales of our SonicWALL products, including related services
such as subscription and license fees. Our success depends on market acceptance
of our products and services.
From inception through 1996, we derived substantially all of our revenue
from the sale of Ethernet products for Apple Macintosh computers. In October
1997, we introduced our SonicWALL line of products, and in 1998 we made a
strategic decision to concentrate our resources in the Internet security
market. As a result, we stopped shipment of Ethernet products during December
1999. In 1997, 1998 and 1999 our Ethernet revenue was $9,092,000, $5,166,000
and $1,644,000 and represented approximately 97%, 69% and 8% respectively, of
our total revenue.
Failure to successfully integrate our recent acquisition of Phobos Corporation
could harm our business.
We acquired Phobos Corporation on November 14, 2000. Our failure to
successfully address the risks associated with our acquisition of this company
could have a material adverse affect on our ability to develop and market
products based on the acquired technology. The success of this acquisition will
depend on our ability to:
. Successfully integrate and manage their operations;
. Retain their key employees; and
. Develop and market products based on the acquired technology.
We may be unable to manage our growth, and if we cannot do so, it could have a
material adverse effect on our business.
Our business has grown rapidly in the last year. As of December 31, 1999, we
had 73 employees. As of January 31, 2000, we had 268 employees, an increase of
approximately 267%. In addition, we have experienced expansion in our
manufacturing and shipping requirements, our product line, our customer base
and our end user installed base. This rapid expansion has placed significant
strain on our administrative,
15
operational and financial resources and has resulted in ever-increasing
responsibilities for our management personnel. These changes have increased the
complexity of managing SonicWALL, Inc. If we continue to experience significant
growth, our current systems, management and resources will be inadequate, and
our organization will need to grow rapidly in order to meet the demands placed
on our business. If we cannot manage our growth effectively, our business
prospects will be materially adversely affected.
We do not know if we will be able to maintain profitability in the future.
We incurred losses of $467,000 in 1997 and $1,461,000 in 1998, which
represented 5.0% and 19.5%, respectively, of total revenue. In the year ended
December 31, 1999, we reported net income of $158,000, and we reported
$8,747,000 in net income, or approximately 12.6% of revenue, for the year ended
December 31, 2000. We do not know if we will be able to maintain profitability
in the future. If we are not able to maintain profitability, your investment in
our common stock may decline in value.
Because we recently introduced our Internet security products, we cannot
predict our future operating results or our future revenues from these
products.
Because from 1996-1998 our business focus was selling Ethernet products for
Macintosh computers, and in November 2000 we expanded our operations through
the acquisition of Phobos Corporation, our historical financial information is
of limited value in projecting future operating results. We believe that
comparing different periods of our operating results is not meaningful and you
should not rely on the results for any period as an indication of our future
performance.
Our limited three-year history of selling Internet security products is one
of many factors underlying our inability to predict our revenue for a given
period. We base our spending levels for product development, sales and
marketing, and other operating expenses largely on our expected future revenue.
A large proportion of our expenses is fixed for a particular quarter or year,
and therefore, we may be unable to decrease our spending in time to compensate
for any unexpected quarterly or annual shortfall in revenue. As a result, any
shortfall in revenue could adversely affect our operating results.
We depend on two major distributors for a significant amount of our revenue,
and if they or others cancel or delay purchase orders, our revenue may decline
and the price of our stock may fall.
To date, sales to a limited number of distributors have accounted for a
significant portion of our revenue. In 1999, Ingram Micro, Inc. and Tech Data
Corporation, both of which are global computer equipment and accessory
distributors, account for approximately 34% and 12% of our revenue,
respectively. In 2000, approximately 84% of our sales were to distributors, and
Ingram Micro, Inc. and Tech Data Corp. accounted for approximately 32% and 20%
of our revenue, respectively. We cannot assure you that either of these
existing customers will continue to place orders with us, that orders by these
existing customers will continue at the levels of previous periods or that we
will be able to obtain large orders from new customers.
We anticipate that sales of our products to relatively few customers will
continue to account for a significant portion of our revenue. If any of our
major distributors stops or delays its purchase of our products, our revenue
and profitability would be adversely affected. In addition, as of December 31,
2000, Ingram Micro, Inc. and Tech Data Corp. represented $5.2 million and $3.1
million, respectively, of our account receivable, constituting 39% and 24%,
respectively, of total receivables on such date. The failure of any of these
distributors to pay us in a timely manner could adversely affect our payments
to suppliers and our creditworthiness, which could make it more difficult to
conduct business.
Although we have limited one-year agreements with Ingram Micro, Inc. and
Tech Data Corp., these contracts are subject to termination at any time, and we
do not know if these customers will continue to place orders for our products.
16
If an original equipment manufacturer customer cancels, reduces or delays
purchases, our revenue may decline and our business could be adversely
affected.
We currently have formed original equipment manufacturer relationships with
four original equipment manufacturers including, 3Com Corporation, Com21,
Netgear, Inc., and Network Associates, Inc. If we fail to sell to such OEMs in
the quantities expected, or if any OEM terminates our relationship, this could
adversely affect our reputation, the perception of our products and technology
in the marketplace or the growth of our business, and your investment in our
common stock may decline in value.
Our sales are usually done on a purchase order basis and we have no binding
purchase commitments from our distributors or original equipment manufacturers,
which could result in a lack of sales.
We sell our products to end users through distributors, resellers and
original equipment manufacturers. Our success depends in large part on their
performance. These customers:
. Are not obligated to purchase or market our products and can stop doing
so at any time; and
. Have no exclusive arrangements with us, and are not obligated to renew
their agreements with us.
Average selling prices of our products may decrease, which may reduce our gross
margins.
The average selling prices for our products may decline as a result of
competitive pricing pressures, promotional programs and customers who negotiate
price reductions in exchange for longer term purchase commitments. The pricing
of products depends on the specific features and functions of the products,
purchase volumes and the level of sales and service support. We expect
competition to increase in the future. As we experience pricing pressure, we
anticipate that the average selling prices and gross margins for our products
will decrease over product life cycles. We cannot assure you that we will be
successful in developing and introducing on a timely basis new products with
enhanced features, or that these products, if introduced, will enable us to
maintain our average selling prices and gross margins at current levels. The
Company's gross margin has and will continue to be affected by a variety of
factors, including competition; the mix and average selling prices of products;
new product introductions and enhancements and the cost of components and
manufacturing labor. We must manage each of these factors effectively for our
gross margins to remain at current levels.
We offer retroactive price protection to our major distributors and if we fail
to balance their inventory with end user demand for our products, our allowance
for price protection may be inadequate. This could adversely affect our results
of operations.
We provide our major distributors with price protection rights for
inventories of our products held by them. If we reduce the list price of our
products, our major distributors receive refunds or credits from us that reduce
the price of such products held in their inventory based upon the new list
price. As of December 31, 2000, we estimate that approximately $6.3 million of
our products in our distributors' inventory are subject to price protection.
This amount represented approximately 9.1% of our revenue for the year ended
December 31, 2000. We have provided less than $100,000 of credits under our
price protection policies in the past three fiscal years. Future credits for
price protection will depend on the percentage of our price reductions for the
products in inventory and our ability to manage the level of our major
distributors' inventory. New product introductions or price reductions by us or
our competitors could result in significant product price adjustments. If
future price protection adjustments are higher than expected, our future
results of operation could be materially adversely affected.
Potential future acquisitions could be difficult to integrate, disrupt our
business, dilute shareholder value and adversely affect our operating results.
In November 2000, we completed the acquisition of Phobos Corporation.
Although we have no current plans, agreements or commitments with respect to
any material acquisition, we may make additional acquisitions or investments in
other companies, products or technologies in the future. We are currently in
the process of integrating the operations, products and personnel of the former
Phobos Corporation. If we acquire other businesses in the future, we will be
required to integrate operations, train, retain and motivate the
17
personnel of these entities as well. We may be unable to maintain uniform
standards, controls, procedures and policies if we fail in these efforts.
Similarly, acquisitions may cause disruptions in our operations and divert
management's attention from day-to-day operations, which could impair our
relationships with our current employees, customers and strategic partners.
We may have to incur debt or issue equity securities to pay for any future
acquisitions. The issuance of equity securities for any acquisition could be
substantially dilutive to our stockholders. In addition, our profitability has
suffered because of acquisition-related costs or amortization costs for
acquired goodwill and other intangible assets.
We are dependent on international sales for a substantial amount of our
revenue. We face the risk of international business and associated currency
fluctuations, which might adversely affect our operation results.
International revenue represented 32% of total revenue in 1998, 34% of total
revenue in 1999 and 32% of total revenue in 2000. For the year ended December
31, 2000, revenue from Japan represented 11% of our total revenue, and revenue
from all other international regions collectively represented approximately 21%
of our total revenue. We expect that international revenue will continue to
represent a substantial portion of our total revenue in the foreseeable future.
Our risks of doing business abroad include our ability to maintain distribution
relationships on favorable terms. To the extent we are unable to favorably
renew our distribution agreements or make alternative arrangements, revenue may
decrease from our international operations. We also face risks associated with
general economic conditions and regulatory uncertainties associated with our
international sales. Because our sales are denominated in United States
dollars, the weakness of the foreign country's currency against the dollar
could increase the price of our products in such country and reduce our product
unit sales by making our products more expensive in the local currency.
We are subject to the risks of conducting business internationally,
including potential foreign government regulation of our technology, general
geopolitical risks associated with political and economic instability, changes
in diplomatic and trade relationships, and foreign counties' laws affecting the
Internet generally.
Delays in deliveries from our component suppliers could cause our revenue to
decline and adversely affect our results of operations.
We outsource all of our hardware manufacturing and assembly from security
appliances to a single manufacturer. Our SonicWALL products incorporate certain
components or technologies that are only available from single or limited
sources of supply. Specifically, our products rely upon microprocessors from
Motorola, Inc. and Intel Corporation and incorporate software products from
third-party vendors. We do not have long-term supply arrangements with any
vendor, and this may adversely affect our ability to obtain necessary
components or technology for our products. If we are unable to purchase such
components or maintain licenses from these suppliers, this may delay or prevent
product shipments and result in a loss of sales. This could cause a loss of
revenue that would adversely affect our results of operations. We may not be
able to replace any of these supply sources on economically advantageous terms.
In addition, our products utilize components that have in the past been subject
to market shortages and price fluctuations. If we experience price increases in
our product components, we will experience declines in our gross margin.
We may have to defend lawsuits or pay damages in connection with any alleged or
actual failure of our products and services.
Because our products and services provide and monitor Internet security and
may protect valuable information, we may face claims for product liability,
tort or breach of warranty. Anyone who circumvents our security measures could
misappropriate the confidential information or other property of end users
using our
18
products and services or interrupt their operations. If that happens, affected
end users or others may sue us. In addition, we may face liability for breaches
caused by faulty installation of our products by resellers or end users.
Although we attempt to reduce the risk of losses from claims through
contractual warranty disclaimers and liability limitations, these provisions
may be unenforceable. Some courts, for example, have found contractual
limitations of liability in standard computer and software contracts to be
unenforceable in some circumstances. Defending a lawsuit, regardless of its
merit, could be costly and could divert management attention. Although we
currently maintain business liability insurance, this coverage may be
inadequate or may be unavailable in the future on acceptable terms, if at all.
Our business liability insurance has no specific provisions for potential
liability for Internet security breaches.
A security breach of our internal systems or those of our customers could harm
our business.
Because we provide Internet security, we may become a greater target for
attacks by computer hackers. We will not succeed unless the marketplace is
confident that we provide effective Internet security protection. Networks
protected by our products may be vulnerable to electronic break-ins. Because
the techniques used by computer hackers to access or sabotage networks change
frequently and generally are not recognized until launched against a target, we
may be unable to anticipate these techniques. Although we have not experienced
any act of sabotage or unauthorized access by a third party of our internal
network to date, if an actual or perceived breach of Internet security occurs
in our internal systems or those of our end-user customers, regardless of
whether we cause the breach, it could adversely affect the market perception of
our products and services. This could cause us to lose current and potential
customers, resellers, distributors or other business partners.
We rely primarily on one contract manufacturer for all of our product
manufacturing and assembly, and if we cannot obtain its services, we may not be
able to ship products.
We outsource all of our hardware manufacturing and assembly primarily to one
third-party manufacturer and assembly house; Flash Electronics, Inc. We do not
have a long-term manufacturing contract with this vendor. Flash Electronics has
produced products with acceptable quality, quantify and cost in the past, but
it may be unable or unwilling to meet our future demands. Our operations could
be disrupted if we have to switch to a replacement vendor or if our hardware
supply is interrupted for an extended period. This could result in loss of
customer orders and revenue.
We may be unable to adequately protect our proprietary rights, which may limit
our ability to compete effectively.
Unauthorized parties may misappropriate or infringe our trade secrets,
copyrights, trademarks and similar proprietary rights. We have not received any
patent protection for our technology or products. Even if we obtain such
patents, that will not guarantee that our patent rights will be valuable,
create a competitive barrier, or will be free from infringement. We face
additional risk when conducting business in countries that have poorly
developed or inadequately enforced intellectual property laws. In any event,
competitors may independently develop similar or superior technologies or
duplicate the technologies we have developed, which could substantially limit
the value of our intellectual property.
Potential intellectual property claims and litigation could subject us to
significant liability for damages and invalidation of our proprietary rights.
In the future, we may have to resort to litigation to protect our
intellectual property rights or trade secrets or to determine the validity and
scope of the proprietary rights of others. Any litigation, regardless of its
success, would probably be costly and require significant time and attention of
our key management and technical personnel. Litigation could also force us to:
. stop or delay selling, incorporating or using products that incorporate
the challenged intellectual property;
19
. pay damages;
. enter into licensing or royalty agreements, which may be unavailable on
acceptable terms; or
. redesign products or services that incorporate infringing technology.
We may face infringement claims from third parties in the future. The
computer industry has seen frequent litigation over intellectual property
rights. We expect that infringement claims will be more frequent for Internet
participants as the number of products, services and competitors grows and
functionality of products and services overlaps.
Undetected product errors or defects could result in loss of revenue, delayed
market acceptance and claims against us.
We offer a one-year warranty on all of our products, allowing the end user
to receive a repaired or replacement product for any defective unit.
Historically, refunds based on product warranty claims have been insignificant.
Although we have discovered few errors or defects in our products, our products
may contain undetected errors or defects. If there is a product failure, we may
have to replace all affected products without being able to book revenue for
such replacement units, or we may have to refund the purchase price for such
units. Because of our recent introduction if Internet security products, we
have little experience in gauging the risk of unexpected product failures or
defects. Despite extensive testing, some errors are discovered only after a
product has been installed and used by customers. Any errors discovered after
commercial release could result in loss of revenue and claims against us. In
the year ended December 31, 2000, refunds attributable to errors or defects in
products amounted to less than 2% of total revenue for the period.
If we do not retain our key employees and attract new employees, our ability to
execute our business strategy will be impaired.
We compete for employees in California's Silicon Valley, one of the most
difficult employer environments in the United States. Our future success will
depend largely on the efforts and abilities of our current senior management
and our ability to attract and retain additional key development, technical,
operations, information systems, customer support and sales and marketing
personnel. We do not have employment contracts with any of our key employees,
who may leave us at any time. Specifically, the services of Sreekanth Ravi,
President and Chief Executive Officer, Sudhakar Ravi, Chief Technical Officer,
and Michael Sheridan, Chief Operating Officer, would be difficult to replace.
We do not maintain life insurance for any of our key personnel.
If we are unable to meet our future capital requirements, our business will be
harmed.
We expect our cash on hand, cash equivalents and commercial credit
facilities to meet our working capital and capital expenditure needs for at
least the next 12 months. After that time, we may need to raise additional
funds and we cannot be certain that we would be able to obtain additional
financing on favorable terms, if at all. Further, if we issue equity
securities, shareholders may experience additional dilution or the new equity
securities may have rights, preferences or privileges senior to those of
existing holders of common stock. If we cannot raise funds, if needed, on
acceptable terms, we may not be able to develop or enhance our products, take
advantage of future opportunities or respond to competitive pressures or
unanticipated requirements, which could have a material adverse effect on our
business, operating results and financial condition.
20
Industry Risks
Our revenue growth is dependent on the continued growth of broadband access
services, which are currently in early stages of development, and if such
services are not widely adopted or we are unable to address the issues
associated with the development of such services, our sales will be adversely
affected.
Sales of our products depend on the increased use and widespread adoption of
broadband access services, such as cable, DSL, Integrated Services Digital
Network, or ISDN, Frame Relay and T-1. These broadband access services
typically are more expensive in terms of required equipment and ongoing access
charges than is the case with Internet dial-up access providers. Our business,
prospects, results of operations and financial condition would be adversely
affected if the use of broadband access services does not increase as
anticipated or if our customers' access to broadband services is limited.
Critical issues concerning use of broadband access services are unresolved and
will likely affect the use of broadband access services. These issues include:
. security;
. reliability;
. bandwidth;
. congestion;
. cost;
. ease of access; and
. quality of service.
Even if these are resolved, if the market for products that provide
broadband access to the Internet fails to develop, or develops at a slower pace
than we anticipate, our business, prospects, results of operations and
financial condition would be materially adversely affected.
The broadband access services market is new and is characterized by rapid
technological change, frequent enhancements to existing products and new
product introduction, changes in customer requirements and evolving industry
standards. We may be unable to respond quickly or effectively to these
developments. The introduction of new products by competitors, market
acceptance of products based on new or alternative technologies, or the
emergence of new industry standards, could render our existing or future
products obsolete, which would materially adversely affect our business,
prospects, results of operations and financial condition.
The emergence of new industry standards might require us to redesign our
products. If our products fail to comply with widely adopted industry
standards, our customers and potential customers may not purchase our products.
This would have a material adverse effect on our business, prospects, results
of operation and financial condition.
If we are unable to compete successfully in the highly competitive market for
internet security products and services, our business will fail.
The market for Internet security products is worldwide and highly
competitive, and we expect competition to intensify in the future. There are
few substantial barriers to entry, and additional competition from existing
competitors and new market entrants will likely occur in the future. Current
and potential competitors in our markets include, but are not limited to the
following, all of whom sell worldwide or have a presence in most of the major
markets for such products:
. enterprise firewall software vendors such as Check Point Software
Technologies, Ltd. and Symantec Corp.
. network equipment manufacturers such as Cisco Systems, Inc., Lucent
Technologies, Nortel Networks Corp. and Nokia Corp.;
21
. encryption processing equipment manufacturers such as nCypher
Corporation and Rainbow Technologies;
. computer or network component manufacturers such as Intel Corporation;
. operating system software vendors such as Microsoft Corporation, Novell,
Inc. and Sun Microsystems, Inc.;
. security appliance and PCI card suppliers such as WatchGuard
Technologies, Inc.; and
. low cost Internet router suppliers which may include limited Internet
security functionality.
Most of our competitors to date have generally targeted large enterprises'
security needs with firewall and Secure Socket Layer (SSL) products that range
in price from approximately $5,000 to more than $15,000, which may increase
competitive pressure on some of our products, resulting in both lower prices
and gross margins. Recently, some of our competitors have introduced products
priced at less than $1,000. Many of our current or potential competitors have
longer operating histories, greater name recognition, larger customer bases and
significantly greater financial, technical, marketing and other resources than
we do. Nothing prevents or hinders these actual or potential competitors from
entering our target markets at any time. In addition, our competitors may
bundle products competitive to ours with other products that they may sell to
our current or potential customers. These customers may accept these bundled
products rather than separately purchasing our products. If these companies
were to use their greater financial, technical and marketing resources in our
target markets, it could adversely affect our business.
Rapid changes in technology and industry standards could render our products
and services unmarketable or obsolete, and we may be unable to successfully
introduce new products and services.
To succeed, we must continually change and improve our products in response
to rapid technological developments and changes in operating systems, broadband
Internet access, application and networking software, computer and
communications hardware, programming tools, computer language technology and
other security threats. We may be unable to develop new products and services
or achieve and maintain market acceptance of them once they have come to
market. Product development for Internet security appliances requires
substantial engineering time and testing. Releasing new products and services
prematurely may result in quality problems, and delays may result in loss of
customer confidence and market share. In the past, we have on occasion
experienced delays in the schedule introduction of new and enhanced products
and services, and we may experience delays in the future. When we do introduce
new or enhanced products and services, we may be unable to manage the
transition from the older products and services to minimize disruption in
customer ordering patterns avoid excessive inventories of older products and
deliver enough new products and services to meet customer demand.
Governmental regulations affecting internet security could affect our revenue.
Any additional governmental regulation of imports or exports or failure to
obtain required export approval of our encryption technologies could adversely
affect our international and domestic sales. The United States and various
foreign governments have imposed controls, export license requirements and
restrictions on the import or export of some technologies, especially
encryption technology. In addition, from time to time governmental agencies
have proposed additional regulation of encryption technology, such as requiring
the escrow and governmental recovery of private encryption keys. Additional
regulation of encryption technology could delay or prevent the acceptance and
use of encryption products and public networks for secure communications. This,
in turn, could decrease demand for our products and services.
In addition, some foreign competitors are subject to less stringent controls
on exporting their encryption technologies. As a result, they may be able to
compete more effectively than we can in the United States and international
Internet security market.
22
Recently, political attention has resulted in legislative efforts to make
the Internet safe for children at schools and other educational institutions
receiving federal assistance by linking the receipt of federal funds to the
existence of content filtering and security software for such institutions'
Internet connections. Some have questioned the constitutionality or other
legality of such efforts. We believe that any government controls or attempts
to regulate the Internet could have a material adverse effect on our business.
For example, legislation requiring Internet security for schools receiving
federal funds would encourage purchases of our SonicWALL products; a court
ruling invalidating such legislation might reduce sales to these market
segments.
Investment Risks
Because they own approximately 38% of our stock ownership, our officers,
directors and their affiliates can significantly influence all matters
requiring shareholder approval.
As of December 31, 2000, our executive officers, directors, and entities
affiliated with them, in the aggregate, beneficially owned approximately 38% of
our outstanding common stock. These shareholders, if acting together, would be
able to significantly influence all matters requiring shareholder approval,
including the election of directors, mergers or other forms of business
combinations.
Our stock price may be volatile.
The market price of our common stock has been highly volatile and has
fluctuated significantly in the past. We believe that it may continue to
fluctuate significantly in the future in response to the following factors,
some of which are beyond our control:
. Variations in quarterly operating results;
. Changes in financial estimates by securities analysts;
. Changes in market valuations of technology and Internet infrastructure
companies;
. Announcements by us of significant contracts, acquisitions, strategic
partnerships, joint ventures or capital commitments;
. Loss of a major client or failure to complete significant license
transactions;
. Additions or departures of key personnel;
. Sales of common stock in the future; and
. Fluctuations in stock market price and volume, which are particularly
common among highly volatile securities of Internet-related companies.
Our business may be adversely affected by class action litigation due to stock
price volatility.
In the past, securities class action litigation has often been brought
against companies following periods of volatility in the market price of its
securities. We may in the future be the target of similar litigation.
Securities litigation could result in substantial costs and divert management's
attention and resources, which could have a material adverse effect on our
business, operating results and financial condition.
Charter and bylaw provisions limit the authority of our shareholders, and
therefore minority shareholders may not be able to significantly influence
Sonicwall, Inc.'s governance or affairs.
Our board of directors has the authority to issue shares of preferred stock
and to determine the price, rights, preferences, privileges, and restrictions,
including voting rights, of those shares without any further vote or action by
shareholders. The rights of the holders of common stock will be subject to, and
may be adversely affected by, the rights of the holders of any preferred stock
that may be issued in the future. The issuance of preferred stock, while
providing flexibility in connection with possible acquisitions and other
corporate purposes, could have the effect of making it more difficult for a
third party to acquire a majority of our outstanding voting stock.
23
Our charter documents also provide for limitation on the ability of
shareholders to call special meetings and act by written consent and prohibit
cumulative voting for directors. As a result, minority shareholder
representation on the board of directors may be difficult to establish. The
charter documents also limit the persons who may call special meetings of the
shareholders, prohibit shareholder actions by written consent and establish
advance notice requirements for nominations for election to the board of
directors or for proposing matters that can be acted on by shareholders at
shareholder meeting.
ITEM 2. PROPERTIES
Our headquarters are located in approximately 32,000 square feet of office
space in Sunnyvale, California under a lease that expires in October 2004. The
Company also leases approximately 34,000 square feet of office space in Salt
Lake City, Utah under a lease that expires in April 2005. Additional sales and
support offices are leased in the Netherlands, the United Kingdom, Japan and
Hong Kong. We believe that our existing facilities are adequate for our current
needs and that additional space will be available as needed.
ITEM 3. LEGAL PROCEEDINGS
We are party to routine litigation incident to our business. Management
believes that none of these legal proceedings will have a material adverse
effect on our consolidated financial statements taken as a whole or our results
of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Annual Meeting of Shareholders held on December 15, 2000, (the
"December Stockholders Meeting") the stockholders of the Company voted on and
approved the following proposals:
Proposal 1. To elect six directors to the Board of Directors;
Proposal 2. To approve an amendment to the 1999 Employee Stock Purchase
Plan to increase the number of shares of Common Stock reserved
for issuance by 200,000 shares of Common Stock to an aggregate
of 700,000 shares;
Proposal 3. To approve an amendment to the 1998 Stock Option Plan to
increase the number of shares of Common Stock reserved for
issuance thereunder to 12,610,678; and
Proposal 4. To ratify the selection of PricewaterhouseCoopers LLP as
independent accountants of the Company's financial statements
for the year ending December 31, 2000.
Information on the Board of Directors.
The following directors were elected at the December Stockholders Meeting:
- Sreekanth Ravi, Chairman
- Sudhakar Ravi
- Charles D. Kissner
- David A. Shrigley
- Ronald E. Heinz
- Robert M. Williams
24
December Stockholders Meeting Results.
Proposal 1. Election of Directors
Broker
Director In favor Withheld non-votes
-------- -------- -------- ---------
Sreekanth Ravi................................. 47,840,272 297,441 n/a
Sudhakar Ravi.................................. 47,840,272 297,441 n/a
Charles D. Kissner............................. 47,908,719 228,994 n/a
David A. Shrigley.............................. 47,909,174 228,539 n/a
Ronald E. Heinz................................ 47,748,665 389,048 n/a
Robert M. Williams............................. 47,909,174 228,539 n/a
Proposal 2. Amendment to 1999 Employee Stock Purchase Plan
Broker
For Against Withheld non-votes
--- ------- -------- ---------
47,340,126 723,271 74,316 0
Proposal 3. Amendment to the 1998 Stock Option Plan
Broker
For Against Withheld non-votes
--- ------- -------- ---------
38,442,552 9,618,143 77,018 0
Proposal 4. Ratification of Independent Public Accountants
Broker
For Against Withheld non-votes
--- ------- -------- ---------
48,064,952 11,686 61,075 0
25
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock commenced trading on the Nasdaq National Market on November
11, 1999 and is traded under the symbol "SNWL". As of December 31, 2000, there
were approximately 174 holders of record of the common stock. The high and low
sale prices for the common stock as reported on the Nasdaq National Market
were:
High Low
-------- --------
Fiscal 1999
Fourth Quarter*.......................................... $ 21.75 $ 12.125
Fiscal 2000
First Quarter............................................ $ 66.25 $17.6875
Second Quarter........................................... $ 46.625 $22.0625
Third Quarter............................................ $54.3125 $26.8125
Fourth Quarter........................................... $ 24.375 $ 12.00
- --------
* Commencing November 11, 1999
We have never paid a cash dividend on our capital stock. We currently
anticipate that we will retain all available funds for use in our business and
we do not anticipate paying any cash dividends.
In March 2000, the Company completed a secondary offering of 7,000,000
shares of its common stock at a price of $50 per share, of which 3,500,000
shares were sold by the Company and 3,500,000 shares were sold by selling
shareholders. The Company received approximately $166 million in net proceeds
after deducting underwriting discounts and commissions and offering expenses.
The Company expects to use the proceeds from the offering to support growth,
working capital and potential acquisitions of complementary products and
technologies.
In September 2000, the Company effected a two-for-one stock split effective
September 15, 2000. All share and per share amounts have been adjusted
accordingly throughout this document to reflect the stock split.
In November 2000, the Company issued approximately 9,906,000 shares of its
common stock in connection with the acquisition of Phobos Corporation.
26
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with our consolidated financial statements and related notes
thereto and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" included in this Form 10-K. The consolidated statements
of operations data for each of the years in the three-year period ended
December 31, 2000, and the balance sheet data at December 31, 2000 and 1999 are
derived from the audited consolidated financial statements included elsewhere
in this Form 10-K. The consolidated statement of operations data for the years
ended December 31, 1997 and 1996 and the balance sheet data at December 31,
1998, 1997 and 1996 are derived from audited financial statements which are not
included in this Form 10-K. Prior year revenue balances have been reclassified
to be consistent with the current year presentation. The historical results are
not necessarily indicative of the operating results to be expected in the
future.
Year Ended December 31,
------------------------------------------
1996 1997 1998 1999 2000
------ ------ ------- ------- --------
(in thousands, except per share data)
Statement of Operations Data:
Revenue
Product......................... $9,356 $9,342 $ 7,480 $19,130 $ 60,101
License and subscription........ -- -- 35 1,917 9,347
------ ------ ------- ------- --------
Total revenue................. 9,356 9,342 7,515 21,047 69,448
------ ------ ------- ------- --------
Cost of revenue...................
Product......................... 5,915 4,842 3307 5,884 17,310
License and subscription........ -- -- 1 77 262
------ ------ ------- ------- --------
Total cost of revenue......... 5,915 4,842 3,308 5,961 17,572
------ ------ ------- ------- --------
Gross margin...................... 3,441 4,500 4,207 15,086 51,876
------ ------ ------- ------- --------
Operating expenses
Research and development........ 1,048 1,983 2,051 3,634 11,359
Sales and marketing............. 1,665 2,468 2,870 5,342 15,662
General and administrative...... 432 644 753 1,761 5,745
In-process research and
development.................... -- -- -- -- 2,300
Amortization of goodwill and
intangibles.................... -- -- -- -- 4,961
Deferred stock compensation..... -- -- 42 2,895 3,315
------ ------ ------- ------- --------
Total operating expenses...... 3,145 5,095 5,716 13,632 43,342
------ ------ ------- ------- --------
Income (loss) from operations..... 296 (595) (1,509) 1,454 8,534
Interest income and other expense,
net.............................. 22 29 54 536 10,136
------ ------ ------- ------- --------
Income (loss) before income
taxes............................ 318 (566) (1,455) 1,990 18,670
Benefit from (provision for)
income taxes..................... (350) 99 (6) (1,832) (9,923)
------ ------ ------- ------- --------
Net income (loss)................. $ (32) $ (467) $(1,461) $ 158 $ 8,747
====== ====== ======= ======= ========
Basic net income (loss) per
share............................ $(0.00) $(0.03) $ (0.06) $ 0.00 $ 0.16
====== ====== ======= ======= ========
Diluted net income (loss) per
share............................ $(0.00) $(0.03) $ (0.06) $ 0.00 $ 0.14
====== ====== ======= ======= ========
Shares used in calculation of
basic net income (loss) per
share............................ 16,920 16,922 22,502 34,668 54,879
====== ====== ======= ======= ========
Shares used in calculation of
diluted net income (loss) per
share............................ 16,920 16,922 22,502 42,392 60,496
====== ====== ======= ======= ========
As of December 31,
------------------------------------------
1996 1997 1998 1999 2000
------ ------ ------- ------- --------
(in thousands)
Consolidated Balance Sheet Data:
Cash and cash equivalents......... $1,036 $ 787 $ 1,051 $62,589 $140,287
Short term investments............ -- -- -- -- 79,257
Total assets...................... 3,448 2,374 4,751 71,239 488,117
Total shareholders' equity........ 932 465 1,488 60,750 435,758
27
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following commentary should be read in conjunction with the financial
statements and related notes contained elsewhere in this Form 10-K. The
discussion contains forward-looking statements that involve risks and
uncertainties. These statements relate to future events or our future financial
performance. In many cases, you can identify forward-looking statements by
terminology such as "may," "will," "should," "expect," "plan," "anticipate,"
"believe," "estimate," "predict," "potential," "intend" or "continue," or the
negative of such terms and other comparable terminology. These statements are
only predictions. Our actual results may differ materially from those
anticipated in these forward-looking statements as a result of a variety of
factors, including, but not limited to, those set forth under "Risk Factors"
and elsewhere in this documents.
Overview
From inception through 1996, we derived substantially all of our revenue
from the development and marketing of networking products for Apple Macintosh
computers. These products enabled Apple Macintosh computers to connect to
computer networks using Ethernet communications standards. The Ethernet
standard was developed in the 1970s by Xerox Corporation and is the most widely
used technology to facilitate communication between computers on local area
networks. The Ethernet standard is defined by the Institute of Electrical and
Electronics Engineers and specifies the speed and other characteristics of a
computer network. In 1998, we made a strategic business decision to concentrate
our resources in the Internet security market due to our belief that this
market had better long-term growth prospects. As a result, we stopped shipments
of our Ethernet product line during December 1999. In October 1997, we
introduced our first Internet security appliance, the SonicWALL DMZ, and began
volume shipments in 1998. In 1998, we began offering content filtering
subscriptions to our SonicWALL customers. Customers can purchase subscriptions
for one to four years, and they receive weekly updated lists of objectionable
web site addresses to which they can block access. We now focus all our
development, marketing and sales efforts on the Internet security appliance
market. Our shift to selling Internet security products has not required any
significant restructuring of our personnel, facilities, manufacturing or
operations. We have not experienced, and do not expect, any significant charges
related to our Ethernet product inventories or warranty obligations. In 1999,
our Internet security products represented approximately 92% of our total
revenue and in 2000 they represented 100% of our total revenue. In 1999, our
Ethernet products represented 8% of our total revenue and in 2000, Ethernet
products are no longer being sold.
Our SonicWALL products are sold primarily through distributors who then
resell our products to resellers and selected retail outlets. These resellers
then sell our products to end-users. Two of our distributors, Ingram Micro,
Inc. and Tech Data Corp., both of which are global computer equipment and
accessory distributors, account for approximately 46% and 52% of our revenue in
1999 and 2000, respectively. In 1999, sales to Ingram Micro, Inc. and Tech Data
Corp. accounted for 34% and 12% of our revenue, respectively. In 2000, sales to
Ingram Micro, Inc. and Tech Data Corp. accounted for 32% and 20% of our
revenue, respectively.
Our revenue consists of product sales and license and subscription revenue.
License and subscription fees include virtual private networking ("VPN"),
global management system, content filtering services, anti-virus and extended
warranty contract fees. Product sales comprised approximately 87% of total
revenue for the year ended December 31, 2000. Product revenue is generally
recognized at the time of shipment if collectibility is probable and no
significant obligations remain. Revenue from software products is recognized in
accordance with SOP 97-2. Specifically, revenue is generally recognized when
delivery of the software has occurred, persuasive evidence of an arrangement
exists, collectibility of the fee is probable and the fee is fixed and
determinable. Revenue from extended warranty programs, premium technical
assistance, and subscriptions to content filtering and anti-virus services is
recognized ratably over the term of the contract or subscription. Ingram Micro,
Inc.'s right to return or rotate its stock on-hand is unlimited, and therefore
we recognize revenue for product sales to Ingram Micro, Inc. when it has sold
the product to its customers. Ingram Micro, Inc. does not have the right to
return non-defective products to us if a customer of Ingram Micro, Inc. returns
such a
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product to Ingram Micro, Inc. For all other distributors, the value of stock
that can be rotated is generally limited to 15% of the prior quarter's
purchases. Co-op advertisin