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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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Form 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2001
Commission file number: 000-26689
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FOUNDRY NETWORKS, INC.
(Exact name of registrant as specified in its charter)
Delaware 77-0431154
(State or other (I.R.S. Employer
Jurisdiction Identification No.)
of Incorporation or
organization)
2100 Gold Street
P.O. Box 649100
San Jose, CA 95164-9100
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code:
(408) 586-1700
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.0001 par value
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period than the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
The aggregate market value of the voting stock held by non-affiliates of the
registrant was approximately $664,634,544 as of March 20, 2002, based upon the
closing sale price on the Nasdaq National Market reported for such date. Shares
of common stock held by each officer and director and by each person who owns
5% of more of the outstanding common stock have been excluded in that such
persons may be deemed to be affiliates. This determination of affiliate status
is not necessarily a conclusive determination for other purposes.
There were 119,935,943 shares of the registrant's common stock issued and
outstanding as of March 20, 2002.
DOCUMENTS INCORPORATED BY REFERENCE
Part III (Items 10-13) incorporates information by reference from the
definitive proxy statement for the 2001 Annual Meeting of Stockholders to be
filed hereafter.
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FOUNDRY NETWORKS, INC.
TABLE OF CONTENTS
Page
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PART I
Item 1. Business.................................................................. 3
Item 2. Properties................................................................ 15
Item 3. Legal Proceedings......................................................... 15
Item 4. Submission of Matters to a Vote of Security Holders....................... 16
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters..... 17
Item 6. Selected Consolidated Financial Data...................................... 18
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations.............................................................. 19
Item 7(A). Quantitative and Qualitative Disclosures about Market Risk................ 37
Item 8. Consolidated Financial Statements and Supplementary Data.................. 38
Item 9. Change in and Disagreements with Accountants on Accounting and Financial
Disclosure.............................................................. 60
PART III
Item 10. Directors and Executive Officers of the Registrant........................ 61
Item 11. Executive Compensation.................................................... 61
Item 12. Security Ownership of Certain Beneficial Owners and Management............ 61
Item 13. Certain Relationships and Related Transactions............................ 61
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K........... 62
SIGNATURES........................................................................... 64
2
PART I
In addition to historical information, this Annual Report on Form 10-K
contains forward-looking statements. These forward-looking statements involve
risks, uncertainties and assumptions. The actual results may differ materially
from those anticipated in these forward-looking statements as a result of many
factors, including but not limited to, those discussed in the sections entitled
"Business--Research and Development," 'Business--Competition,"
"Business--Intellectual Property," and "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Risk Factors That May Affect
Future Results and Market Price of Stock." Readers are cautioned not to place
undue reliance on these forward-looking statements, which reflect management's
opinions only as of the date hereof. Foundry Networks, Inc. together with its
consolidated subsidiaries, (collectively the "Company" or "Foundry") undertakes
no obligation to revise or publicly release the results of any revision to
these forward-looking statements. Readers should carefully review the risk
factors described in this document as well as in other documents the Company
files from time to time with the Securities and Exchange Commission, including
the Quarterly Reports on Form 10-Q to be filed by the Company in fiscal year
2002.
Item 1. Business
Overview
Foundry Networks, founded in 1996, is a leading provider of next-generation
networking products. We provide high-performance, end-to-end switching and
routing devices for enterprises and service providers. We design, develop,
manufacture and market solutions to meet the needs of high-performance network
infrastructures for Layer 2-7 switching and routing and for Local Area Networks
(LANs), Metropolitan Area Networks (MANs), Wide Area Networks (WANs), and the
web. Foundry's combined product breadth allows us to offer global end-to-end
solutions within and throughout a customer's networking infrastructure
regardless of the geographically dispersed nature of the entire organization.
Our products can be found from the wiring closets connecting the desktops
together within the enterprise to the mission critical LAN backbone and data
center. We provide robust and high performance routing solutions from the
Internet core to the edge of the Internet service access network and its
network of web and application servers. Our Metro routers deliver the
capabilities and performance needed to provide efficient and reliable core
routing services to Internet data centers around the world. Our Layer 2 and
Layer 3 switches provide the intelligence, speed and cost effectiveness
required to support the increasing use of bandwidth-intensive and
Internet-based applications. Our high performance Internet traffic management
systems with network intelligence capabilities allow enterprises and service
providers to build highly available network infrastructures that direct traffic
flow efficiently based on client location, application type, and administrative
policies, while allowing service providers to offer their customers
differentiated, fee-based quality of service.
Our networking products have been deployed in key enterprise markets that
include automotive, energy, retail, healthcare, banking, trading, insurance,
aerospace, government agencies, technology, motion pictures, video and
animation, E-commerce, and universities. Our service provider markets include
metro service providers, Internet service providers, web hosting and Internet
data centers, application service providers, and Internet exchanges. For
enterprises, Foundry provides a complete end-to-end solution with the FastIron
JetCore product line. FastIron meets the needs for wiring closet, data center,
and campus solutions coupled with Foundry's network management and security.
For service providers, Foundry offers our BigIron JetCore high-performance
switches with integrated Layer 2/3 and Layer 4-7 traffic management for LAN,
MAN, and WAN applications. Foundry's solutions connect enterprises and service
providers with Foundry's Global Ethernet Metro router solutions. Foundry's
products support a wide array of interfaces such as Packet 10 Gigibit Ethernet,
Packet over SONET and ATM so that our customers can leverage their existing
infrastructures. We sell our products through a direct sales force, resellers,
and OEM partners. By providing high levels of performance and intelligence
capabilities at compelling price points, we provide comprehensive solutions to
address the rapidly growing enterprise and service provider markets.
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Industry Background
The pervasiveness of computing by businesses, organizations and individuals,
and the need to interconnect computing devices to enable widespread
communication, have given rise to the multi-billion dollar computer networking
industry. The complexity of information traveling over networks has increased
with the adoption of bandwidth-intensive applications that include increasing
amounts of data, voice, video and graphics. The increase in users, coupled with
these new bandwidth-intensive applications, has resulted in enterprises,
web-based businesses, and Internet service providers demanding networking
solutions with superior performance and intelligence capabilities.
Evolution of Market Needs
Organizations initially adopted data networks to connect a limited number of
computers within close proximity, allowing users to share simple, common
services, such as file servers and printers. In these networks, called local
area networks or LANs, traffic patterns were predictable because the majority
of traffic resided within the LAN and remained local to a specific part of the
organization. Widespread Internet usage, the proliferation of client-server
applications and the adoption of new bandwidth-intensive applications have
increased traffic loads and created unpredictable traffic patterns. Today, the
majority of traffic traverses the boundaries of the LAN to networks outside of
the LAN. Such communication traditionally required an organization to utilize
costly long distance carrier services that often provided inadequate
performance. As a result of today's traffic flows, enterprises increasingly
require low cost, high performance networking equipment to enable effective
communications across geographically dispersed networks, known as MANs and WANs.
Increasingly, enterprises are "webifying" their businesses. Not only are
mainstream enterprises taking advantage of the Internet to expand through
E-commerce capabilities, enterprises are also using the Internet for
business-to-business transactions, internal process reengineering, and supply
chain management. The increasing reliance on the Internet by businesses,
government agencies, and organizations is increasing the demand for
cost-effective, high performance solutions for both internal networks and
access to the Internet externally.
Evolution of Network Solutions
Early LANs consisted of hubs, which enabled multiple users to share network
resources, and software-based routers, which supported multiple protocols to
move traffic around the network. Increased use of bandwidth-intensive
applications and a larger number of users strained these early network
infrastructures, making it increasingly difficult for them to handle new
applications while still performing at an acceptable speed. Network devices
known as Layer 2 switches replaced hubs to provide dedicated bandwidth to
users, while Fast Ethernet technology was introduced to provide data
transmission speeds of 100 Mbps, ten times faster than original hubs. Despite
these improvements, the installed base of traditional routers, relying on
software to analyze and route network traffic, were unable to accommodate
increased data speeds and changing traffic patterns and became the new network
bottleneck.
Two new technologies--1 and 10 Gigabit Ethernet, capable of data
transmission speeds of 10,000 megabits per second (or 10 Gigabits per second),
and Layer 3 switching--evolved in parallel to handle growing and unpredictable
traffic patterns and address the performance needs of bandwidth-intensive
applications. Gigabit Ethernet-based Layer 3 switches combine Gigabit
transmission speeds with the forwarding capabilities of software-based routers.
In Layer 3 switches, the software forwarding capabilities that enabled early
routers to move traffic around the network perform this function in hardware,
using application-specific integrated circuits, or ASICs, that are built into
the switch. This integration enables manufacturers to develop Layer 3 switches
at lower costs while improving network performance.
Next Generation Needs and Solutions
Two trends continue to drive the network infrastructure market. First, as
enterprises and service providers seek to accommodate network user needs,
adding bandwidth alone is not an adequate solution. Due to the
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increased use of multiple traffic types for many applications, enterprises and
service providers have an acute need for solutions that provide network
intelligence to distinguish among and prioritize network traffic based on types
of traffic, content being requested and the applications deployed. Particularly
for anyone supporting electronic business on the web, including service
providers, network intelligence allows them to maintain network reliability and
offer differentiated, fee-based quality of service.
Second, as the Internet has evolved, the traffic crossing the WANs has
shifted from primarily voice traffic to primarily data traffic. Not long ago, a
majority of all wide area traffic was voice traffic. Today, due to the success
of the Internet, most of the wide area traffic is data. Historically, the basic
technology used to move traffic within WANs has been SONET, which was primarily
designed to carry voice traffic. As the level of wide area traffic has migrated
to data, service providers are looking for a technology that is better suited
to handle data traffic.
Gigabit Ethernet, which has emerged as the ubiquitous LAN technology, is
gaining momentum as the solution for MANs and WANs. This momentum has been
propelled in part by the relative inexpensiveness and availability of
off-the-shelf Ethernet networking equipment and the large pool of qualified
networking specialists that are proficient in Ethernet technology. 10 Gigabit
Ethernet is a key factor in this momentum for MANs and WANs because providers
can quickly build out high-speed networks. The general acceptance and large
volume of Ethernet installations in LANs have, over time, led to improved
performance and significantly reduced prices.
As bandwidth demand increases and bandwidth-intensive applications are being
made available to enterprise and private users, a new class of service provider
is beginning to emerge, the Metro Service Provider (Metro SP). Foundry has had
significant success in providing our Ethernet solutions for MANs across the
globe. Large enterprises (including government agencies) often have multiple
buildings in a local area and even have offices across the globe. Metro SPs
provide the critical intermediary network between enterprises and long-haul
regional networks. Using Long-Haul Gigabit Ethernet as the enabling technology,
these service providers deliver new services such as broadband Internet access,
bandwidth-on-demand and Virtual LANs across the metro and regional areas to
business and private users. In this application, Gigabit Ethernet provides high
bandwidth, high reliability and high density solutions that enable
multi-services such as Voice-over-IP and Virtual Private Networks to be
delivered over a common backbone.
Solutions
We offer a comprehensive suite of Metro routers, Gigabit Ethernet Layer 2
and Layer 3 switches, and Layer 4-7 Internet traffic management products for
enterprises, and service providers. Our solutions provide the following
benefits:
Breadth of Product Line. We are one of the few networking companies to
provide a full suite of Metro routers, Gigabit Ethernet Layer 2/3 switches
and Layer 4 through 7 Internet traffic management products applicable to
LANs, MANs, WANs and data center service farm connectivity. This product
breadth is attractive to customers who desire a single source for their high
performance networking solutions. Our products allow us to provide solutions
throughout a customer's network, from the wiring closet edge of an
enterprise LAN to the LAN core, and from the provider edge of a Metro
service provider through to the core of Internet communication devices.
Performance. Our products provide a high level of performance and a
non-blocking architecture across multiple types of networks. A non-blocking
architecture allows all users attached to the switch to access the network
simultaneously without any negative impact on performance. We believe we
currently offer the highest-performing, non-blocking switches in the market.
The performance of our products allows enterprises and service providers to
build highly reliable networks that support unpredictable traffic flows,
bandwidth-intensive applications and dynamic end-user needs.
Intelligence. Our products provide the intelligence required to
transport unpredictable traffic and bandwidth-intensive applications,
improving the performance, reliability and manageability of networks. Our
products direct traffic using information about the application and
end-user, enabling enterprises,
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web-based businesses, and Internet service providers to control information
delivery and realize benefits such as increased revenue through application-
or availability-based service fees.
Compelling Price Points. Our products are designed to offer superior
performance and network intelligence capabilities at compelling price
points. Unlike low-priced switches that provide limited functionality, our
products offer customers higher value for their networking equipment
investment by providing a comprehensive feature set while maintaining low
price points.
Flexibility of Architecture. Our products incorporate a uniform hardware
architecture that is compatible with all major existing network products
without any significant loss of performance or functionality. Our
architecture supports all forms of Gigabit Ethernet (fiber and copper) and
the standard for 10 Gigabit Ethernet. As a result, our customers can
integrate our products into their networks without an extensive and
expensive replacement of their existing network components.
Strategy
Our objective is to be a leading provider of next-generation,
high-performance network solutions. We intend to achieve this objective by
providing a broad suite of the most cost-effective, highest-performing network
switching products for enterprises and service providers. Key elements of our
strategy include:
Continue to Leverage Our Product Breadth to Expand Our Solutions
Offerings. As recently demonstrated with our latest product introductions,
the FastIron 400/800/1500 Enterprise Switches, BigIron 4000/8000/15000
backbone switches, and NetIron 400/800/1500 Metro routers, we will continue
to leverage our comprehensive product breadth to offer solutions to the
enterprise and service provider markets. Our end-to-end network solution
spans the LAN, MAN, and WAN with high levels of performance and
functionality. We intend to continue to offer value-added feature sets that
provide for redundancy, ease of use and management of the network, yielding
a higher return on investment coupled with a decreasing total cost of
ownership.
Continue to Expand Our Metro Router Capabilities to Address this Growing
Market and Deliver a New Level of Price/Performance to the Service
Providers. Foundry will continue to bring new features and functionality to
our Metro router platform and add to our product offering by incorporating
leading-edge features. These new enhancements include features such as MPLS
(Multi-Protocol Label Switching), and VPLS (Virtual Private LAN Services).
We provide a complete Metro solution including Multi-Tenant Unit (MTU),
Provider Edge (PE), Provider Core (PC), and Internet Edge (IE), based on the
NetIron family of Metro Routers, allowing a purpose-built feature set and
optimization. We provide a range of features for both MPLS and Layer 2 Metro
architectures with industry-leading scalability and reliability. We intend
to pursue a MetroLink Interface strategy to embrace SONET and 10-Gigabit
Ethernet technologies with Ethernet-over-SONET (EoSONET) and offer a
consistent feature set and a common management interface.
Continue to Leverage Our Product Capabilities to Address Emerging
Markets. This includes Metropolitan Area Networking (MAN), Gigabit Ethernet
Storage Area Networking (SAN), Voice over IP (VoIP), and Content
Distribution Networks. As noted above, the key advantages of Gigabit
Ethernet (price, simplicity, ease of use) will allow this technology to
migrate into many new adjacent markets over time. Foundry's strategy is to
position the company to benefit from the acceptance of Gigabit Ethernet in
such environments as the MAN, SAN, VoIP, and Content distribution. To
accomplish this, we have added the necessary features and enhancements to
our products to provide an ideal solution for these customers. We work with
select partners when additional non-networking hardware or software is
needed for solutions such as VoIP and SAN. This permits us to remain
entirely focused on network infrastructure while providing complete
solutions to our customers.
Continue Our Market Leadership Position in Internet Traffic Management
Systems. We believe the demand for Internet traffic management intelligence
capabilities will be a very important growth area for web-based businesses
and Internet service providers and an area of increasing importance to
traditional
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enterprise networks. We intend to maintain our leadership position in this
market by continually improving the performance and functionality of our
Internet traffic management products. Designed to provide the highest level
of performance and network intelligence capabilities, our products enable
web-based businesses and Internet service providers to rapidly deliver new
revenue-generating applications and services to end-user customers, while
providing a high degree of service reliability.
Provide Superior Technology. We intend to provide superior technology,
based on price, performance and features, through continual enhancements of
existing products and ongoing development of new products that provide
higher levels of performance and intelligence. We also intend to pursue cost
reduction efforts that will allow us to remain highly competitive while
offering customers compelling price points. We intend to ensure that our
hardware and software architectures are flexible and extensible and are
designed to support new technologies such as 10 Gigabit Ethernet.
Expand Global Sales Organization. We intend to continue the global
expansion of our sales organization utilizing a direct sales organization in
the United States and abroad, strategic channel partners outside the United
States and select original equipment manufacturers. We intend to increase
our worldwide sales force and establish additional channel partner
relationships to build greater worldwide sales presence.
Deliver World Class Service and Support. We intend to expand our service
and support infrastructure to meet the needs of our growing customer base.
Our goal is to minimize our customers' network downtime by offering a wide
range of service and support programs to meet individual customer needs,
including prompt onsite hardware repair and replacement, twenty-four hour,
seven days-a-week web and telephone support, parts depots in strategic
locations globally, implementation support, pre-sales service, system
software and network management software upgrades, and technical
documentation updates.
Products
We provide a comprehensive line of networking devices designed to meet the
price, performance, reliability, and feature requirements of enterprises and
service providers. During 2001 and first quarter 2002, Foundry launched five
new products to expand and deepen the breadth of our product offerings. These
include:
. 10 Gigabit Ethernet Module
. FastIron 4802--high-capacity Layer 2/3 wiring closet switch based on
JetCore ASICs
. EdgeIron 4802F--high-performance, low cost, Layer 2 wiring closet switch
. FastIron 400/800/1500 and FastIron JetCore Modules
. New Management Modules and Interface Modules based on JetCore for BigIron
systems
. NetIron Metro router with MetroLink Interface Modules
Our product suite can be classified by the solutions each product line
offers.
FastIron Enterprise Switches
The new FastIron(R) 400, 800 and 1500 modular systems, complemented by the
award-winning FastIron 4802, are the first in the industry to provide
enterprise customers with an end-to-end enterprise LAN solution, ranging from
the wiring closet to the LAN backbone, based on a single product family. This
simplifies network operations and maintenance, leading to savings in total cost
of ownership. The new JetCore-based FastIron systems provide advanced Layer 2/3
feature sets with state-of-the-art Ternary Content Addressable Memory (TCAM),
integrated support for IP, IPX and AppleTalk, rich Quality of Service (QoS) and
bandwidth management features for Voice over IP (VoIP), complete Multicast
features and jumbo frame support for scaling server farm throughputs.
Based on Foundry's third generation JetCore ASIC chipsets, the FastIron 4802
provides 48 10/100 ports and two optional Gigabit Ethernet uplink ports, as
well as a comprehensive Layer 2/3 feature set including embedded support for
Bandwidth Provisioning, rich QoS and IP Billing and Accounting.
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EdgeIron Layer 2 Switches
The EdgeIron(TM) 4802F Layer 2 switch delivers wire-speed performance,
superior port density, and a complete standard Layer 2 feature set to address
the needs of Enterprise users. Measuring only one rack unit high and featuring
up to 10.1 million packets per second of wire-speed switching capacity, the
EdgeIron 4802F is an excellent choice for Layer 2 10/100 edge applications in
high-performance local-area networks. With an easy-to-use, industry-standard
Command Line Interface (CLI), Telnet based interface, web based Graphical User
Interface (GUI), standard Simple Network Management Protocol (SNMP) interface,
and RADIUS-based authentication, EdgeIron 4802F is easy and secure to
configure, deploy, and maintain.
NetIron Metro Routers
Purpose-built for metro area and service provider networks, the NetIron
Metro routers provide unparalleled routing performance for both MPLS and Layer
2 Metro networks. NetIron Metro routers provide a complete suite of MPLS
functionality, including the new Virtual Private LAN Segment (VPLS). Foundry's
VPLS implementation allows Metro service providers to build scalable MPLS-based
Metro networks that can offer multi-point-to-multi-point enterprise Virtual
Private Network (VPN) services with on-demand bandwidth provisioning. Foundry's
VPLS implementation accommodates different customer interface points including
10/100 Mbps Ethernet, Gigabit Ethernet, OC-3c ATM, OC-3c SONET, OC-12c SONET or
OC-48c SONET.
Foundry offers two major high availability features purpose-built for Layer
2 Metro networks which offer an alternative to Spanning Tree Protocol (STP)
based Metro designs. First, the Metro Ring Protocol (MRP) offers sub-second
fault-detection, isolation, and fail-over for Metro access rings. Second, the
Virtual Switch Redundancy Protocol (VSRP) offers sub-second fail-over for full
mesh or partial mesh Metro topologies. Together, the MRP and the VSRP
complement the existing Spanning Tree based innovations such as Rapid STP (IEEE
802.1w) and SuperSpan.
BigIron Layer 3 Backbone Switches
BigIron Layer 3 switches provide the industry's highest performance--up to
178 million packets per second and wire speed at every port--with a consistent,
non-blocking switch architecture and rich functionality across the entire
switch family. BigIron systems are optimized for service providers and
enterprise backbones. The BigIron system features carrier-class reliability and
availability with support for redundant management modules with rapid failover,
hot-swappable power supplies, and interface modules. BigIron systems can scale
up to 232 Gigabit Ethernet ports, 14 10-Gigabit Ethernet ports, or 672 10/100
Mbps ports in a single modular system. BigIron systems enable customized,
differentiated service offerings that support voice, video and data on the same
network with Quality of Service (QoS) and multicast capabilities. Other
features include:
. on-demand bandwidth provisioning with wire-speed fine-grain bandwidth
control,
. jumbo frames on Gigabit Ethernet for scalable service throughput and
performance,
. scalable network accounting and billing solution using Layer 2 through 7
information provided by built-in sFlow technology, and
. protection against denial of service attacks using IronShield security
with wire-speed extended access control lists, secure shell, secure copy,
and user authentication that prevent unauthorized network access.
ServerIron Layer 4-7 Traffic Management Switches
The ServerIron(R) family of Internet traffic management switches provides
high-performance Layer 4 through Layer 7 switching with integrated Layer 2/3
functionalities. ServerIron switches enable network managers to control and
manage Web transactions, Web applications, and E-commerce traffic flows.
ServerIron eases escalating Internet traffic overload, reduces the burden of
server farm management, and allows the entire network infrastructure to scale
to its full potential. All ServerIron switches include TrafficWorks IronWare,
Foundry's
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comprehensive suite of Internet traffic management software. The ServerIron
switches forward requests to the right server, cache, firewall, or even the
right data center location based on packet header and content information that
is significantly expanded beyond what is found in traditional Layer 2/3 packet
headers.
IronView Network Manager
The Foundry IronView(R) Network Manager (INM) allows today's networks to run
at maximum efficiency by allowing network managers to effectively track and
perform configuration changes and software updates and to quickly identify and
resolve network failures. IronView Network Manager empowers network managers to
seamlessly control changes to complex network-wide functions such as Access
Control Lists (ACLs), Virtual LANs (VLANs), software and configuration updates,
and network alarm and event controls. INM dramatically simplifies network
provisioning, diagnostics, and resolution, thus reducing total cost of
ownership and increasing our customers' return on investment.
Hardware and Software Architecture
JetCore ASIC
Foundry has been a leader in achieving performance breakthroughs with
application-specific integrated circuits (ASICs). In June 2001, we introduced
JetCore, our third generation ASICs, which builds on our previous success with
IronCore I and IronCore II. In 1997, IronCore I was launched as the first Layer
3 ASIC in the industry. This ASIC provided Layer 2, 3, and 4 access control
lists (ACLs) and quality of service (QoS).
From 1997, when we first commenced commercial shipments of our products
through the end of 2001, IronCore was the foundation for all of Foundry's
products allowing us to provide customers with consistent performance,
reliability and features, as well as the ability to leverage their networking
equipment investment. The IronCore chassis architecture consists of a
high-speed data highway that incorporated a backplane and crosspoint switching
fabric and supports up to fifteen interface modules. The crosspoint switching
fabric allows all lines of communication to intersect with one another. Our
implementation of the crosspoint switching fabric includes custom-designed,
high speed ASICs that provide throughput of up to 480 Gigabits and 178 million
packets per second. This amount of throughput allows each module connected to
the switch to support simultaneous communication among all workstations
connected to the switch, while all workstations connected to the switch can
operate at maximum performance. These features of IronCore allow enterprises,
web-based businesses, and Internet service providers to have dedicated access
to the network at any time, using any application at the maximum speed.
JetCore extends Foundry's proven expertise in ASIC design and innovation.
JetCore provides bandwidth management on-demand, advanced Layer 2 and 3
features, enhanced QoS, jumbo frames, and new network management features and
functions. The new JetCore ASIC integrates Hewlett-Packard's patented XRMON
packet sampling technology and sFlow, an Internet Engineering Task Force (IETF)
draft standard for network traffic monitoring and accounting. JetCore is
backward compatible to IronCore.
With JetCore-powered switching and routing products, Foundry delivers
leading network monitoring and traffic accounting capabilities, including:
. Accurate network traffic accounting, from Layer 2 up to Layer 7
. Integration with industry-leading accounting and billing applications
. Intrusion detection and full visibility of any network traffic, regardless
of protocol (e.g., IPv4, IPX, AppleTalk, and IPv6)
. Precise network policing of network traffic everywhere, from the network
edge up to the network core
. Identification of network bottlenecks within a network and complete packet
header decoding from Layer 2 up to Layer 7
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IronWare and Internet IronWare Software
During 2001, Foundry delivered a major release of our IronWare software to
provide enhanced reliability, security and bandwidth management capabilities.
Moreover, we provided two major releases of our IronView Network Management
System to expand its features and functions including velocity management, rate
limiting, and multi-label protocol switching. All of these next-generation
functions fully comply with international standards while taking advantage of
our innovative hardware architecture.
Sales and Marketing
Our sales strategy includes a domestic and international field sales
organization, domestic and international resellers, a lease financing program
and OEM relationships.
Domestic field sales. Our domestic field sales organization establishes and
maintains direct relationships with key accounts and strategic customers. To a
lesser extent, our field organization also works with resellers to assist in
communicating product benefits to end-user customers and proposing networking
solutions.
Domestic resellers. Our domestic resellers include regional networking
system resellers and vertical resellers who focus on specific markets, such as
small Internet service providers. We provide sales and marketing assistance and
training to our resellers, who in turn provide first level support to end-user
customers. We intend to leverage our relationship with key resellers to
penetrate select vertical markets.
International sales. Internationally, product fulfillment and first level
support is provided by resellers and integrators. Our international resellers
include Mitsui in Japan, Samsung in Korea, Spot Distribution in the United
Kingdom, and Pan Dacom and GE Compunet in Germany. As of December 31, 2001, our
international field organization included over 75 sales representatives and
system engineers. Foundry's foreign offices conduct sales, marketing, and
support activities. Foundry's export sales represented 15%, 30%, and 35% of net
revenue in 1999, 2000, and 2001, respectively. We intend to expand our
international presence through additional personnel and through the addition of
key resellers and integrators.
OEM/Co-Branding. We have OEM/Co-Branding relationships established with
Hewlett-Packard, Hitachi, Lucent, and NEC. Our OEMs market and sell our
products on a private label basis through their worldwide sales forces and also
purchase our products for use in their own internal networks. The agreements
with our OEMs automatically renew for two additional one-year periods, unless
the agreement is terminated within 60 days prior to the end of any period. The
agreements provide that the OEMs may postpone, cancel, increase or decrease any
order made under the agreement without penalty.
Lease financing program. Since January 2000, Foundry Commercial Credit, a
private-label leasing program, has offered our customers standardized solution
packages that combine Foundry's high performance end-to-end switching solutions
with innovative lease financing options. Foundry Commercial Credit is being
administered by GE Capital, a diversified financial services company wholly
owned by General Electric (NYSE: GE) . Foundry's leasing program is marketed
through a direct sales force and authorized resellers in the United States and
other key markets in Europe, Latin America and Asia Pacific.
Marketing programs. We have numerous marketing programs designed to inform
existing and potential customers, as well as resellers and OEMs, about the
capabilities and benefits of our company and products. Our marketing efforts
also support the sale and distribution of our products through our field
organizations and channels. Our marketing efforts include advertising, public
relations, participation in industry trade shows and conferences, public
seminars and Webcasts, participation in independent third-party product tests,
presentations, and our web site.
10
Customer Service and Support
Throughout the past year, Foundry has maintained its leadership in customer
service by increasing the scope and coverage of its global customer service
offerings, expanding our Centers of Excellence from 8 to 10 locations by
opening facilities in Denver and Hong Kong, and increasing the number of spare
parts depots across the globe. At the beginning of 2001, Foundry was recognized
as the winner of "Best Customer Service" by the editors of Web Hosting Magazine.
Our service and support organization maintains and supports our products
sold by our field organization to end-users. Our service and support
organization provides 24-hour assistance, including telephone, Internet and
worldwide web support. Our customer service offerings also include parts depots
in strategic locations globally, implementation support, and pre-sales service.
Our resellers and OEMs are responsible for installation, maintenance and
support services to their customers. We may offer limited assistance to our
resellers and OEMs in providing service and support to their end-user customers.
We provide all customers with a one-year hardware and 90-day software
warranty. We also have four levels of customer service offerings to meet
specific support needs called Titanium, Gold, Silver, and Bronze. The Titanium
service program provides the most comprehensive support including advance
hardware replacement within 4 hours delivered by a trained technician for
on-site support. The Gold service program is targeted towards customers who
have trained internal resources to maintain their network 24x7. The program is
designed to provide all the tools needed by these trained resources to maximize
the uptime of their network. The Silver service program is tailored for
customers who typically purchase spares inventory as a part of their overall
contingency plan. The Bronze service program is targeted towards budget
conscious customers who are looking for basic telephone and web-based support
and run a 9 to 5 operation.
We have regional Centers-of-Excellence in San Jose, Boston, New York,
Chicago, Denver, Herndon, Irvine, London, Hong Kong, and Tokyo. These Centers
of Excellence include Executive Briefing Centers (EBC) and serve as major
customer demonstration centers, regional technical support centers, and
equipment depot centers. The Centers of Excellence are fully equipped to
demonstrate Foundry's award-winning, high-performance product lines including
NetIron Metro routers, BigIron Layer 3 switches, FastIron Enterprise switches,
and ServerIron Layer 4-7 traffic management switches. They also support
interoperability testing, provide hands-on training for customers, and showcase
Foundry's end-to-end LAN, MAN and WAN solutions. The centers allow Foundry to
deliver superior customer service to our customers and expand service offering
to the rapidly growing worldwide installed base.
Manufacturing
We operate under a modified "turn key" process utilizing strategic
manufacturing partners that are ISO 9000 certified and have global
manufacturing capabilities. We maintain control and procurement responsibility
for all proprietary components. All designs, documentation, selection of
approved suppliers, quality control, burn-in, and configuration are performed
at our facilities. Our manufacturing operations consist of quality assurance of
subassemblies and the performance of final assembly and test. Our manufacturing
process also includes the configuration of hardware and software in unique
combinations to meet a wide variety of individual customer requirements. We use
automated testing equipment and "burn-in" procedures, as well as comprehensive
inspection and testing to assure the quality and reliability of our products.
Our approach to manufacturing provides the flexibility of outsourcing while
maintaining quality control of delivered products to customers. We have
selected this approach to ensure our ability to respond to rapid growth and
sudden market shifts.
We currently have two primary manufacturing partners. One partner,
Celestica, located in San Jose, California, assembles and tests our printed
circuit boards. The other partner, Sanmina, also located in San Jose,
California, assembles and tests our backplane products. Both companies are ISO
certified and have global manufacturing facilities providing full back-up
capability and local content for foreign sales if required. We
11
perform all prototype and pre-production procurement and component
qualification with support from our manufacturing partners. Any interruptions
in the operations of either of these manufacturing partners or delays in their
shipment of products could negatively impact our ability to meet scheduled
product deliveries to our customers. Our agreements with Sanmina and Celestica
allow them to procure long lead-time component inventory on our behalf based
upon a rolling production forecast provided by Foundry with lead times of up to
6 months. Foundry is contractually obligated to the purchase of long lead-time
component inventory procured by our contract manufacturers in accordance with
the forecast, unless Foundry gives notice of order cancellation at least 30 to
90 days prior to the delivery date. If actual demand of our products is below
the projections, we may have excess inventory as a result of our purchase
commitments of long lead-time components with our contract manufacturers.
We design all ASICs, printed circuit boards and sheet metal while working
closely with semiconductor partners on future component selection and design
support. All materials used in our products are processed through a full
qualification cycle and controlled by use of an "Approved Vendor Listing" that
must be followed by our sources. We perform extensive testing of all of our
products including in-circuit testing of all printed circuit board assemblies,
full functional testing, elevated temperature burn-in and power cycling at
maximum and minimum configuration levels. Please see "Risk Factors--Our
reliance on third-party manufacturing vendors to manufacture our products may
cause a delay in our ability to fill orders" for a review of certain risks
associated with our manufacturing operations.
We currently purchase several components from a single source, including
certain integrated circuits, power supplies and long-range optics, which we
believe are readily available from other suppliers. Our proprietary ASICs,
which provide key functionality in our products, are fabricated in foundries
operated by Texas Instruments and Fujitsu, Ltd. An alternative supply for these
ASICs would require an extensive development period.
We acquire these components through purchase orders and have no long-term
commitments regarding supply or price from these suppliers. The material terms
of these orders typically involve the quantity of supply ordered by us, the
purchase price of the components, lead time and the shipping arrangements. In
the event one of these suppliers materially delays its supply to us or one of
them terminates its relationship with us, we may not be able to find an
alternate supplier on a timely basis and, as a result, our business could be
harmed.
Research and Development
Our future success depends on our ability to enhance existing products and
develop new products that incorporate the latest technological developments. We
work with customers and prospects, as well as partners and industry research
organizations, to identify and implement new solutions that meet the current
and future needs of enterprises, web-based businesses, and Internet service
providers. Whenever possible, our products are based on industry standards to
ensure interoperability. We intend to continue to support emerging industry
standards integral to our product strategy.
We use a uniform architecture across our product line, including
programmable ASICs, and system and network management software. This enables us
to quickly bring new products and features to market. We are currently
developing new switching solutions that provide new levels of performance,
scalability and functionality for the LAN, MAN and LAN/WAN. We also have
engineering efforts focused on cost reduction. We had 135 engineers at the end
of 2001 compared to 89 in 2000. Our research and development expenses were $9.0
million in 1999, $27.5 million in 2000 and $33.9 million in 2001, or 6.8%, 7.3%
and 10.9% of net revenue.
Competition
We believe that we perform favorably in the key competitive factors that
impact our markets, including technical expertise, pricing, new product
innovation, product features, service and support, brand awareness and
distribution. Our products have won many awards.
12
We intend to remain competitive through ongoing investment in research and
development efforts to enhance existing products and introduce new products. We
will seek to expand our market presence through aggressive marketing and sales
efforts and through the continued implementation of cost reduction efforts.
However, our market is still evolving and we may not be able to compete
successfully against current and future competitors.
The market in which we operate is highly competitive. Cisco Systems
maintains a dominant position in this market and several of its products
compete directly with our products. Cisco's substantial resources and market
dominance have enabled it to reduce prices on its products within a short
period of time following the introduction of these products, which reduces the
margins and therefore, the profitability of its competitors. Purchasers of
networking solutions may choose Cisco's products because of its longer
operating history, broader product line and strong reputation in the networking
market. In addition, Cisco may have developed or could in the future develop
new technologies that directly compete with our products or render our products
obsolete.
In addition to Cisco, we compete with other large public companies, such as
Nortel Networks and Enterasys Networks as well as other smaller public and
private companies such as Juniper Networks, Extreme Networks, and Riverstone
Networks. Many of our current and potential competitors have longer operating
histories and substantially greater financial, technical, sales, marketing and
other resources, as well as greater name recognition and larger installed
customer bases than we do. Furthermore, companies that do not offer a directly
competitive product to our products could develop new products or enter into
agreements with other networking companies to provide a product that competes
with our products or provides a more complete solution than we can offer.
Additionally, we may face competition from unknown companies and emerging
technologies that may offer new LAN, MAN and WAN solutions to enterprises and
service providers.
Intellectual Property
Our success and ability to compete are substantially dependent upon our
internally developed technology and know-how. Our proprietary technology
includes our ASICs, our IronCore and JetCore hardware architecture, and our
IronWare software. Different variations and combinations of these proprietary
technologies are implemented across our product offerings. We rely on a
combination of copyright, trademark and trade secret laws and contractual
restrictions on disclosure to protect our intellectual property rights in these
proprietary technologies. Although we have patent applications pending, we do
not currently own any patents.
We provide software to customers under license agreements included in the
packaged software. These agreements are not negotiated with or signed by the
licensee, and thus may not be enforceable in some jurisdictions. Despite our
efforts to protect our proprietary rights through confidentiality and license
agreements, unauthorized parties may attempt to copy or otherwise obtain and
use our products or technology. These precautions may not prevent
misappropriation or infringement of our intellectual property. Monitoring
unauthorized use of our products is difficult and the steps we have taken may
not prevent misappropriation of our technology, particularly in some foreign
countries where the laws may not protect our proprietary rights as fully as in
the United States.
Our industry is characterized by the existence of a large number of patents
and frequent claims and related litigation regarding patent and other
intellectual property rights. In particular, leading companies in the
networking markets have extensive patent portfolios with respect to networking
technology.
From time to time third parties have asserted exclusive patent, copyright
and trademark rights to technologies and related standards that are important
to us. Such third parties may assert claims or initiate litigation against us
or our manufacturers, suppliers or customers alleging infringement of their
proprietary rights with respect to our existing or future products. In March
2001, Nortel filed a lawsuit against Foundry in the United States District
Court for the District of Massachusetts alleging that certain of the Company's
products infringe several of
13
Nortel's patents, and seeking injunctive relief as well as unspecified damages.
Nortel has also brought suit, on the same or similar patents, against a number
of other networking companies. Foundry has analyzed the validity of Nortel's
claims and believes that Nortel's suit is without merit. Foundry is committed
to vigorously defending itself against these claims. Irrespective of the merits
of the Company's position, we may incur substantial expenses in defending
against third party claims. In the event of a determination adverse to the
Company, the Company could incur substantial monetary liability, and be
required to change its business practices. Either of these could have a
material adverse effect on the Company's financial position, results of
operations, or cash flows.
Employees
As of December 31, 2001, we had 595 employees, including 348 in sales and
marketing, 135 in engineering, 63 in manufacturing and 49 in general and
administrative. None of our employees is represented by a labor union or is
subject to a collective bargaining agreement. We have never experienced a work
stoppage and believe our employee relations are good.
Executive Officers
The names and ages of our executive officers as of December 31, 2001 are as
follows:
Name Age Position
---- --- --------
Bobby R. Johnson, Jr........ 45 President, Chief Executive Officer, and Chairman of the Board of
Directors
Lee Chen.................... 48 Vice President, Software Engineering and Quality Assurance
Karl D. Triebes............. 35 Vice President, Hardware Engineering
Ken K. Cheng................ 46 Vice President, Marketing and Product and Program Management
Timothy D. Heffner.......... 52 Vice President, Finance and Administration, Chief Financial Officer
Woody L. Akin............... 53 Vice President of Sales for the Americas
Paul L. Twombly............. 50 Vice President of Customer Support
H. Earl Ferguson............ 63 Chief Technology Officer
Bobby R. Johnson, Jr. co-founded Foundry and has served as President, Chief
Executive Officer and Chairman of the board of directors of Foundry since its
inception in May 1996. From August 1993 to October 1995, Mr. Johnson co-founded
and served as President, Chief Executive Officer and Chairman of the board of
directors of Centillion Networks, Inc., a provider of local area network
switches. From September 1991 to February 1993, Mr. Johnson was Vice President
and General Manager of Internetworking Hardware for Network Equipment
Technologies, a wide area networking company. Mr. Johnson holds a B.S. with
honors from North Carolina State University.
Lee Chen has served as Vice President, Software Engineering and Quality
Assurance since October 1999. From June 1996 to September 1999, Mr. Chen served
as Director of Software Engineering for Foundry. From January 1995 to February
1996, Mr. Chen was the Vice President of Engineering of OTS, a software
consulting company. From August 1993 to December 1995, Mr. Chen was co-founder
of Centillion Networks. Mr. Chen holds a M.S. from San Jose State University.
Karl D. Triebes has served as Vice President of Hardware Engineering of
Foundry since June 2001. From May 2000 to June 2001, Mr. Triebes was Vice
President of Engineering at Alcatel U.S.A, a telecommunications company. From
December 1999 to May 2000, he was Assistant Vice President of Newbridge
Networks Corp., a
14
networking company subsequently acquired by Alcatel. From January 1997 to
December 1999, he was Vice President of Systems and Software of Stanford
Telecommunications, Inc. Mr. Triebes holds a B.S. from San Diego State
University.
Ken K. Cheng has served as Vice President of Marketing of Foundry since
December 1999 and as Vice President of Product and Program Management of
Foundry since July 1998. From December 1993 to July 1998, Mr. Cheng was Senior
Vice President and Chief Operating Officer of Digital Generation Systems, a
network services company. From December 1988 to December 1993, Mr. Cheng was
Director of LAN/WAN Internetworking Hardware for Network Equipment
Technologies. Mr. Cheng holds a B.S. from Queen's University and an M.B.A. from
Santa Clara University.
Timothy D. Heffner has served as Vice President, Finance and Administration
and Chief Financial Officer of Foundry since November 1996. From September 1994
to November 1996, Mr. Heffner was Director of Finance for Centillion Networks
and for the Centillion Business Unit of Bay Networks. From January 1994 to
September 1994, Mr. Heffner was Chief Financial Officer of Digital Generation
Systems, a network services company. Mr. Heffner holds a B.S. from San Jose
State University.
Woody L. Akin has served as Vice President of Sales for the Americas of
Foundry since April 2001. From November 2000 to March 2001, Mr. Akin served as
Vice President of Sales Operations of Foundry. From April 1989 to May 1999, Mr.
Akin was Vice President of North American enterprise sales at 3Com Corporation,
a computer networking company. From June 1982 to March 1989, Mr. Akin held
various sales management positions at ROLM/IBM, a telecommunications company.
Mr. Akin holds a B.S. degree from the University of Colorado.
Paul L. Twombly has served as Foundry's Vice President of Customer Support
since April 2001. From October 1999 to May 2001, Mr. Twombly was Senior Vice
President of Global Client Services at Nice Systems Ltd., a major worldwide
provider of CRM systems. From January 1998 to August 1999, Mr. Twombly was Vice
President of Customer Service at Warpspeed Communications, a telecommications
company. From April 1990 to January 1998, Mr. Twombly was Vice President of
Customer Service at Voysys Corporation, an OEM provider of telecommunications
products. Mr. Twombly holds a B.S. degree from Northwestern University.
H. Earl Ferguson co-founded Foundry and has served as Chief Technology
Officer since August 2001. From July 1996 to July 2001 Mr. Ferguson served as
Vice President, Hardware Engineering, and Chief Technical Officer of Foundry.
From August 1993 to February 1996, Mr. Ferguson was co-founder and Vice
President of Engineering of Centillion Networks and the Vice President of
Engineering for the Centillion Business Unit of Bay Networks. From December
1991 to February 1993, Mr. Ferguson was Director of Internetworking Hardware
for Network Equipment Technologies. Mr. Ferguson holds six patents in
internetworking technologies. Mr. Ferguson holds a B.S. from the University of
Washington and M.S. from the University of Michigan.
Item 2. Properties
Our headquarters for corporate administration, research and development,
sales and marketing, and manufacturing occupy approximately 97,000 square feet
of space in San Jose, California. We also lease space in various other
geographic locations domestically and internationally for sales and service
personnel. We believe that our existing facilities are adequate to meet current
requirements, and that suitable additional or substitute space will be
available as needed to accommodate any further physical expansion of corporate
operations and for any additional sales offices. The Company's principal Web
server equipment and operations are maintained in our corporate headquarters in
San Jose, California.
Item 3. Legal Proceedings.
In December 2000, several similar shareholder class action lawsuits were
filed against Foundry and certain of its officers in the United States Court
for the Northern District of California, following Foundry's announcement in
December 2000 of its anticipated financial results for the fourth quarter ended
December 31,
15
2000. The lawsuits were subsequently consolidated by the Court, under the
caption In re Foundry Networks, Inc. Securities Litigation, Master File No.
C-00-4823-MMC, lead plaintiffs were selected as required by law and such
plaintiffs filed a consolidated amended complaint which alleged violations of
federal securities laws and purported to seek damages on behalf of a class of
shareholders who purchased Foundry's common stock during the period from
September 7, 2000 to December 19, 2000. On October 26, 2001, the Court granted
the Company's motion to dismiss the consolidated amended complaint without
prejudice to amend. On December 13, 2001, attorneys for lead plaintiffs filed a
second amended complaint. The Company reviewed the second amended complaint and
concluded that it was also without merit. The Company believes the lawsuit is
without merit and intends to defend itself vigorously.
A class action lawsuit was filed on November 27, 2001 in the United States
District Court for the Southern District of New York on behalf of purchasers of
Foundry common stock alleging violations of federal securities laws. Kassin v.
Foundry Networks, Inc. et al., No. 01-CV-10640 (SAS) (S.D.N.Y.), related to
Initial Public Offering Securities Litigation, No. 21 MC 92 (SAS) (S.D.N.Y.).
The case is brought purportedly on behalf of all persons who purchased the
common stock of the Company from September 27, 1999 through December 6, 2000.
The complaint names as defendants, the Company, three of its officers, and
investment banking firms that served as underwriters for the Company's initial
public offering in September 1999. The complaint alleges violations of Sections
11 and 15 of the Securities Act of 1933, and Section 10(b) of the Securities
Exchange Act of 1934, on the grounds that the prospectus incorporated in the
registration statement for the offering failed to disclose, among other things,
that (i) the underwriters had solicited and received excessive and undisclosed
commissions from certain investors in exchange for which the underwriters
allocated to those investors material portions of the shares of the Company's
stock sold in the initial public offering, and (ii) the underwriters had
entered into agreements with customers whereby the underwriters agreed to
allocate shares of the Company's stock sold in the initial public offering to
those customers in exchange for which the customers agreed to purchase
additional shares of the Company's stock in the aftermarket at pre-determined
prices. No specific damages are claimed. We are aware that similar allegations
have been made in lawsuits relating to more than 300 other initial public
offerings conducted in 1999 and 2000. Those cases have been consolidated for
pretrial purposes before the Honorable Judge Shira A. Scheindlin. Defendants'
time to respond to the complaints has been stayed pending plans for further
coordination. Plaintiffs have moved for appointment of lead plaintiff.
Management believes that the allegations in these class action lawsuits
against the Company and its officers are without merit and management intends
to contest them vigorously. However, these litigations are in the preliminary
stage, and their outcome cannot be predicted. The litigation process is
inherently uncertain. If the outcome of the litigation is adverse to the
Company and if, in addition, the Company was required to pay significant
monetary damages in excess of available insurance, its business could be
significantly harmed.
From time to time the Company is subject to legal proceedings and claims in
the ordinary course of business, including claims of alleged infringement of
trademarks, copyrights, patents and other intellectual property rights. In
addition, from time to time, third parties assert patent infringement claims
against the Company in the form of letters, lawsuits and other forms of
communication. In March 2001, Nortel filed a lawsuit against Foundry in the
United States District Court for the District of Massachusetts alleging that
certain of the Company's products infringe several of Nortel's patents and
seeking injunctive relief as well as unspecified damages. Nortel has also
brought suit, on the same or similar patents, against a number of other
networking companies. Foundry has analyzed the validity of Nortel's claims and
believes that Nortel's suit is without merit. Foundry is committed to
vigorously defending itself against these claims. Irrespective of the merits of
the Company's position, we may incur substantial expenses in defending against
third party claims. In the event of a determination adverse to the Company, the
Company could incur substantial monetary liability, and be required to change
its business practices. Either of these could have a material adverse effect on
the Company's financial position, results of operations, or cash flows.
Item 4. Submission Of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth
quarter of fiscal 2001.
16
PART II
Item 5. Market For Registrant's Common Equity and Related Stockholder Matters
Price Range of Common Stock
The Company's common stock commenced trading on the Nasdaq National Market
on September 28, 1999 and is traded under the symbol "FDRY". Prior to this
time, there was no public market for our stock. As of December 31, 2001, there
were approximately 471 holders of record of the common stock. The following
table sets forth for the periods indicated, the high and low closing sale
prices for the common stock as reported on the Nasdaq National Market.
High Low
------- -------
2000
First quarter.. $207.56 $106.88
Second quarter. $124.94 $ 54.50
Third quarter.. $131.00 $ 58.50
Fourth quarter. $ 89.00 $ 13.00
2001
First quarter.. $ 23.50 $ 7.50
Second quarter. $ 22.05 $ 6.19
Third quarter.. $ 21.14 $ 5.80
Fourth quarter. $ 11.59 $ 6.21
Dividend Policy
The Company has never paid cash dividends on its capital stock. The Company
currently anticipates that it will retain its future earnings, if any, to fund
the development and growth of its business and, therefore, does not anticipate
paying cash dividends in the foreseeable future.
Unregistered Securities Sold in 2001
The Company did not make any unregistered sales of the Company's common
stock during fiscal 2001.
17
Item 6. Selected Consolidated Financial Data
The selected consolidated financial data set forth below should be read
together with the consolidated financial statements and related notes,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," and the other information contained in this Form 10-K.
The consolidated statement of operations data set forth below for each of
the years in the three-year period ended December 31, 2001 and the consolidated
balance sheet data as of December 31, 2000 and 2001 are derived from, and
qualified by reference to, our audited financial statements appearing elsewhere
in this Form 10-K. The statement of operations data for the years ended
December 31, 1997 and 1998 and the balance sheet data as of December 31, 1997,
1998 and 1999 are derived from audited financial statements not included herein.
Year Ended December 31,
--------------------------------------------
1997 1998 1999 2000 2001
------- ------- -------- -------- --------
(In thousands, except per share data)
(Note 1)
Consolidated Statement of Operations Data:
Revenue, net................................... $ 3,381 $17,039 $133,522 $377,156 $311,176
Cost of revenue................................ 1,835 8,433 56,612 134,330 158,141
------- ------- -------- -------- --------
Gross profit................................ 1,546 8,606 76,910 242,826 153,035
------- ------- -------- -------- --------
Operating expenses:
Research and development.................... 5,403 8,797 9,037 27,499 33,947
Sales and marketing......................... 3,419 7,258 23,142 67,753 90,786
General and administrative.................. 1,853 1,589 4,532 10,493 27,185
Amortization of deferred stock compensation. -- 727 9,463 6,185 2,708
------- ------- -------- -------- --------
Total operating expenses................ 10,675 18,371 46,174 111,930 154,626
------- ------- -------- -------- --------
Income (loss) from operations.................. (9,129) (9,765) 30,736 130,896 (1,591)
Interest income................................ 122 413 1,886 11,235 8,746
Write-down of minority investment.............. -- -- -- -- 2,500
------- ------- -------- -------- --------
Income (loss) before provision for income taxes (9,007) (9,352) 32,622 142,131 4,655
Provision for income taxes..................... -- -- 9,750 54,010 1,769
------- ------- -------- -------- --------
Net income (loss).............................. $(9,007) $(9,352) $ 22,872 $ 88,121 $ 2,886
======= ======= ======== ======== ========
Basic net income (loss) per share.............. $ (0.67) $ (0.35) $ 0.42 $ 0.80 $ 0.02
Diluted net income (loss) per share............ $ (0.67) $ (0.35) $ 0.20 $ 0.69 $ 0.02
Weighted average shares--basic................. 13,570 26,976 54,929 110,141 117,360
Weighted average shares--diluted............... 13,570 26,976 114,835 127,131 125,521
December 31,
----------------------------------------------
1997 1998 1999 2000 2001
-------- -------- -------- -------- --------
Consolidated Balance Sheet Data:
Cash and cash equivalents........... $ 3,182 $ 4,567 $120,378 $168,429 $ 98,210
Short-term investments.............. -- -- 39,789 83,816 176,524
Working capital..................... 4,076 10,663 180,508 339,369 354,054
Total assets........................ 6,988 19,238 213,498 398,466 412,138
Long-term obligations............... 178 -- -- -- --
Total stockholders' equity (deficit) (10,509) (18,926) 181,604 345,016 361,832
- --------
(Note 1) On October 1, 1999, Foundry completed its initial public offering.
See also Note 6 of the Notes to Consolidated Financial Statements.
18
Item 7. Management's Discussion and Analysis of Financial Condition and
Results Of Operations
The following discussion and analysis of our financial condition and results
of operations should be read together with "Selected Financial Data" and our
financial statements and related notes appearing elsewhere in this Form 10-K.
This discussion and analysis contains forward-looking statements that involve
risks, uncertainties and assumptions. The actual results may differ materially
from those anticipated in these forward-looking statements as a result of many
factors, including but not limited to those discussed in the sections entitled
"Business--Research and Development," "Business--Competition,"
"Business--Intellectual Property," and "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Risk Factors That May Affect
Future Results and Market Price of Stock." Readers are cautioned not to place
undue reliance on these forward-looking statements, which reflect management's
opinions only as of the date hereof. The Company undertakes no obligation to
revise or publicly release the results of any revision to these forward-looking
statements. Readers should carefully review the risk factors described in this
document as well as in other documents the Company files from time to time with
the Securities and Exchange Commission, including the Quarterly Reports on Form
10-Q to be filed by the Company in fiscal year 2002.
Overview
Founded in 1996, Foundry designs, develops, manufactures and markets a
comprehensive, end-to-end suite of high performance Metro routers, Gigabit
Ethernet Layer 2 and Layer 3 switches, and Internet traffic management products
for enterprises, educational institutions, government agencies, web-hosting
companies, Application Service Providers (ASPs), electronic banking and finance
service providers, and Internet Service Providers. Our product suite includes
the NetIron family of Metro routers, FastIron family of Ethernet edge switches,
EdgeIron layer 2 Ethernet switches, BigIron family of Gigabit Ethernet core
switches and ServerIron family of Ethernet Layer 4-7 Internet traffic
management switches. In June 2001, we introduced the JetCore ASIC chipset
family which consists of different ASICs that provide various combinations of
10/100 or Gigabit Ethernet ports to deliver advanced switching and routing
functionalities. Built on 0.18 micron technology, the JetCore chipset
represents the third major ASIC development from Foundry in a four year span.
Purpose-built to meet the feature, performance and scalability needs of the
high-bandwidth enterprise, Metro and Internet networks, Foundry's JetCore
chipset is the foundation of Foundry's next-generation switching and routing
platforms. We expect to incorporate JetCore into our next generation product
lines by the end of June 2002.
We generated net income of $88.1 million and $2.9 million for the years
ended December 31, 2000 and 2001, respectively. As of December 31, 2001, we had
retained earnings of $93.5 million. For the fourth quarter ended December 31,
2001, we incurred a net loss of $10.7 million. This is the first quarterly loss
we have incurred since the quarter ended December 31, 1998. The net loss for
the quarter was due to a sequential decrease in revenue as a result of a
combination of factors, including an overall reduction in capital spending by
our existing and potential customers, unfavorable economic conditions, and the
transition to JetCore products which caused some customers to place orders for
the new JetCore-based products to be delivered in the first half of 2002. As a
result of the challenging economic environment, we have and may continue to
experience reduced demand for our products and heightened pricing pressure from
our competitors. During the fourth quarter of 2001, we recorded certain
one-time charges totaling $18.7 million as a result of these unfavorable
economic conditions. These charges were comprised of $9.3 million provision for
excess and obsolete inventories specifically associated with the major product
transition to JetCore-based products, $2.8 million for the write-down of a note
receivable from a stockholder, $2.5 million for the write-down of a minority
investment for an other than temporary decline in value, $1.1 million for
facilities abandonment, $1.8 million bad debt expense related to one specific
customer, and $1.2 million of other one-time charges. Our gross margin for
fiscal 2001 was adversely impacted by a decrease in revenue and increase in the
provision for excess and obsolete inventories as a result of the product
transition and challenging economic environment. Additionally, due to a number
of factors which are discussed in more detail below, our selling prices and
gross margins have and may continue to decrease as a result of macro-economic
factors and our efforts to compete aggressively, reduce our inventory levels
and maintain sales levels.
19
Market and economic conditions continue to be challenging. We have observed
effects of the economic downturn in many areas of our business. The current
recession has had a material adverse effect on our business and on some of our
existing and prospective customers, with a number of such customers
substantially delaying or reducing their network expansion plans, restructuring
or consolidating in order to remain competitive. One such proposed merger
currently in process may have significant implications for Foundry. Our largest
OEM, Hewlett Packard has proposed a merger with Compaq Computer Corp. to
restructure itself to focus on certain market sectors. Sales to Hewlett Packard
accounted for 14%, 4% and 6% of our net revenue for 1999, 2000 and 2001,
respectively. If this merger is approved by shareholders and if Hewlett Packard
chooses to eliminate its networking division as it realigns its business,
Hewlett Packard may discontinue its OEM relationship with Foundry, which will
negatively impact our revenue. Irrespective of the merger, if Hewlett Packard
chooses to reduce or terminate its relationship with Foundry, our revenue and
ability to market and sell our products to potential customers will be harmed.
The global economic slowdown has also caused varying decreases in revenue from
certain geographic regions. As a result, sales to certain countries or regions
may continue to fluctuate. We have also experienced some gross margin
deterioration, asset impairments and increased inventory and accounts
receivable provisions as a result of the economic downturn. In response to the
slowdown, the Company has and continues to increase its efforts to reduce
inventories and operating costs. However, the uncertainty about the severity
and duration of the current recession continues to impair the Company's ability
to project its revenue in the near future. If economic conditions in the United
States and globally do not improve, or if we experience a worsening in economic
conditions, we may continue to experience material adverse effects on our
business, operating results, and financial condition. In order to be profitable
we must maintain reasonable cost and expense levels while generating and
sustaining higher revenue to cover costs and achieve profitability.
Critical Accounting Policies and Estimates
Our significant accounting policies are more fully described in Note 2 to
the consolidated financial statements included in this Form 10-K. The
preparation of our consolidated financial statements in accordance with
generally accepted accounting principles requires us to make estimates and
judgments that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements, and the reported amounts of revenue and expenses during
the period reported. By their nature, these estimates and judgments are subject
to an inherent degree of uncertainty. Management bases their estimates and
judgments on historical experience, market trends, and other factors that are
believed to be reasonable under the circumstances. Actual results may differ
from these estimates under different assumptions or conditions. Management
believes the following critical accounting policies, among others, affect its
more significant judgments and estimates used in the preparation of its
consolidated financial statements.
Revenue Recognition
In past years and for fiscal 2001, we derived 90% or more of our revenue
from sales of our stackable and chassis-based networking equipment, with the
remaining revenue generated from customer support fees, training and
installation services. Foundry's revenue recognition policy follows SEC Staff
Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial
Statements." Specifically, Foundry recognizes revenue when persuasive evidence
of an arrangement exists, delivery has occurred, the sales price is fixed or
determinable and collectibility is reasonably assured. Product revenue is
generally recorded at the time of shipment when title and risk of loss passes
to the customer, unless we have future obligations for installation or have to
obtain customer acceptance, in which case revenue is not recorded until such
obligations have been satisfied or customer acceptance has been received. For
example, revenue is not recognized when the customer has a right of return or
when undelivered products or services are essential to the functionality of
delivered products.
At the time revenue is recognized, Foundry establishes an accrual for
estimated warranty expenses associated with its sales, recorded as a component
of cost of revenue. Foundry's standard warranty period extends 12 months from
the date of sale and our warranty accrual represents our best estimate of the
amounts necessary to settle future and existing claims on products sold as of
the balance sheet date. While we believe that our warranty accrual is adequate
and that the judgment applied is appropriate, such amounts estimated to be due
and payable could differ materially from what will actually transpire in the
future. Foundry also provides a
20
reserve for estimated customer returns. In 1999, 2000 and 2001, Foundry
recorded a provision for sales returns equal to $1.2 million, $3.7 million and
$3.6 million, respectively, which has been netted against revenue in the
accompanying consolidated statements of income. This provision is based on our
historical returns, analysis of credit memo data and return policies. Sales to
Foundry's resellers do not provide for rights of return and the contracts with
Foundry's original equipment manufacturers do not provide for rights of return
except in the event Foundry's products do not meet specifications or there has
been an epidemic failure, as defined in the agreements. If the historical data
used by the Company to calculate the estimated sales returns and allowances
does not properly reflect future returns, revenue could be overstated. In
addition, if the Company's actual warranty costs are greater than the accrual,
cost of revenues will increase in the future.
Revenue from customer support services is recognized ratably over the
contractual period, generally one year. Amounts invoiced to customers in excess
of revenue recognized on support contracts are recorded as deferred revenue
until the revenue recognition criteria are met. Revenue from customer support
services accounted for 1.7%, 3.9% and 9.1% for the years ended December 31,
1999, 2000 and 2001, respectively. Revenue for training and installation
services is recognized as services are rendered. Revenue from software,
training and installation services, combined, accounts for less than 1% of
total revenue for 1999, 2000, and 2001.
Inventories
The networking industry is characterized by rapid technological change,
frequent new product introductions, changes in customer requirements, and
evolving industry standards. We regularly monitor inventory quantities on hand
and record a provision for excess and obsolete inventories based primarily on
our estimated forecast of product demand and production requirements for the
next three months. In recent quarters, demand for our products has been
adversely affected as a result of the current recession and reduced
telecommunications and infrastructure capital spending, particularly in the
United States. As demonstrated during fiscal 2001, a significant decrease in
demand could result in an increase in the amount of excess inventory quantities
on hand. Consequently, provisions for excess and obsolete inventory in the
amounts of $3.8 million, $13.6 million, and $24.9 million were recorded for the
years ended December 31, 1999, 2000, and 2001, respectively. Inventory
write-offs were approximately $1.6 million in 1999, $4.4 million in 2000, and
$8.9 million in 2001. Although we make every effort to ensure the accuracy of
our forecasts of future product demand, any significant unanticipated changes
in demand or technological developments would significantly impact the value of
our inventory and our reported operating results. Our estimates of future
product demand may prove to be inaccurate, in which case we may have
understated or overstated the provision required for excess and obsolete
inventory. In the future, if our inventory is determined to be overvalued, we
would be required to recognize such costs in our cost of revenue at the time of
such determination. If our inventory is determined to be undervalued, we may
have overstated our cost of revenue in previous periods and would be required
to recognize additional operating income at the time of sale.
Accounts Receivable
We continually monitor and evaluate the collectibility of our trade
receivables based on a combination of factors. We record specific allowances
for bad debts when we become aware of a specific customer's inability to meet
its financial obligation to us such as in the case of bankruptcy filings or
deterioration of financial position. Estimates are used in determining our
allowances for all other customers based on factors such as current trends, the
length of time the receivables are past due and historical collection
experience. In determining our allowance for doubtful accounts, we also
consider our agreement with GE Capital (formerly Heller Financial Corp.), our
third party leasing partner, which allows GE Capital a right of recourse
against Foundry for defaults by customers financed through GE Capital based on
certain criteria. We mitigate some collection risk by requiring most of our
customers in the Asian region to secure lines of credit prior to placing an
order with us. During the year ended December 31, 2001, Foundry provided
approximately $9.1 million to increase its allowance for doubtful accounts to a
level deemed necessary by management to provide for potential uncollectible
amounts. While we believe that our allowance for doubtful accounts receivable
is adequate and that the judgment applied
21
is appropriate, such amounts estimated could differ materially from what will
actually transpire in the future. If the historical data used by the Company to
calculate the estimated allowance for doubtful accounts does not properly
reflect future bad debts, net income could be overstated.
Deferred Tax Asset Valuation Allowance
We recognize deferred tax assets and liabilities based on the differences
between the financial statement carrying amounts and the tax bases of assets
and liabilities. Significant management judgment is required in determining our
deferred tax assets and liabilities and any valuation allowance recorded
against our net deferred tax assets. Management makes an assessment of the
likelihood that our deferred tax assets will be recovered from future taxable
income, and to the extent that recovery is not believed to be likely, a
valuation allowance must be established. For fiscal 2000 and 2001, we did not
record a valuation allowance to reduce our deferred tax assets because we
believe the amount is more likely than not to be realized. In the event Foundry
is unable to realize some or all of its deferred tax assets in the future, an
adjustment to the deferred tax assets would be charged to income in the period
such determination was made. Our net deferred tax assets as of December 31,
2001 were $29.7 million.
Purchase Commitments
We currently subcontract substantially all of our manufacturing to two
companies located in San Jose, California. Celestica assembles and tests our
printed circuit boards, and Sanmina Corporation assembles and tests our
backplane products. Our agreements with Sanmina and Celestica allow them to
procure long lead-time component inventory on our behalf based upon a rolling
production forecast provided by Foundry with lead times of up to 6 months.
Foundry is contractually obligated to the purchase of long lead-time component
inventory procured by our contract manufacturers in accordance with the
forecast, unless Foundry gives notice of order cancellation at least 30 to 90
days prior to the delivery date. As of December 31, 2001, the Company was
committed to purchase approximately $35.4 million of such inventory over the
next four months. If actual demand of our products is below the projections, we
may have excess inventory as a result of our purchase commitments of long
lead-time components with our contract manufacturers. This would be recorded as
additional provisions for excess inventory as a component of cost of revenue.
Litigation
We are a party to lawsuits in the normal course of our business. Litigation
in general, and intellectual property and securities litigation in particular,
can be expensive, lengthy and disruptive to normal business operations.
Moreover, the results of complex legal proceedings are difficult to predict. We
believe that we have defenses in the lawsuits pending against us as indicated
in Item 1 "Legal Proceedings," and we are vigorously contesting these
allegations. Responding to the allegations has been, and probably will be,
expensive and time-consuming for us. An unfavorable resolution of the lawsuits
could adversely affect our business, results of operations, or financial
condition.
22
Results of Operations
The following table sets forth selected items from our consolidated
statement of income as a percentage of revenue for the periods indicated:
Year Ended December 31,
----------------------
1999 2000 2001
----- ----- -----
Revenue, net................................... 100.0% 100.0% 100.0%
Cost of revenue................................ 42.4 35.6 50.8
----- ----- -----
Gross profit................................ 57.6 64.4 49.2
----- ----- -----
Operating expenses:
Research and development.................... 6.8 7.3 10.9
Sales and marketing......................... 17.3 18.0 29.2
General and administrative.................. 3.4 2.8 8.7
Amortization of deferred stock compensation. 7.1 1.6 0.9
----- ----- -----
Total operating expenses................ 34.6 29.7 49.7
----- ----- -----
Income (loss) from operations.................. 23.0 34.7 (0.5)
Interest income................................ 1.4 3.0 2.9
Write-down of minority investment.............. -- -- 0.8
----- ----- -----
Income before provision for income taxes....... 24.4 37.7 1.6
Provision for income taxes..................... 7.3 14.3 0.6
----- ----- -----
Net income..................................... 17.1% 23.4% 1.0%
===== ===== =====
Revenue. Net revenue was $133.5 million, $377.2 million, and $311.2 million
in fiscal 1999, 2000, and 2001, respectively, representing an increase of 183%
from fiscal 1999 to 2000 and a decrease of 17% from 2000 to 2001. The increase
from 1999 to 2000 was due to a strong market demand for Internet infrastructure
equipment, increased acceptance of Foundry's product offerings, and a
significant increase in Foundry's sales and marketing organizations, all of
which contributed to higher revenues in 2000. The decline in revenue in 2001
reflected the effects of the global economic slowdown,a reduction in capital
spending by our existing and potential customers and, to a lesser extent, the
product transition to JetCore ASICs which caused some of our customers to place
orders for new JetCore-based products to be delivered in the first half of
2002. For the year ended December 31, 1999, sales to America Online and Hewlett
Packard accounted for 11% and 14% of our revenue, respectively. For the years
ended December 31, 2000 and 2001, no customer accounted for greater than 10% of
our revenue.
Customer support revenue was 1.7%, 3.9% and 9.1% of our net revenue for
1999, 2000 and 2001, respectively. Revenue from support contracts are
recognized ratably over the contractual period, generally 12 months. The
increases in support revenue were due to the associated increase in product
sales in 2000 and our increased customer base, resulting in new customer
support contracts in addition to support contract renewals by existing
customers.
Cost of revenue. Cost of revenue consists primarily of material, labor,
manufacturing overhead, warranty costs and the provision for excess and
obsolete inventories. Cost of revenue was $56.6 million, $134.3 million, and
$158.1 million in fiscal 1999, 2000, and 2001 or 42.4%, 35.6%, and 50.8% of
revenue, respectively. The decrease in cost of revenue as a percentage of
revenue from 1999 to 2000 was primarily a result of shifts in product mix and
lower manufacturing overhead costs due to higher sales volume. The increase in
cost of revenue as a percentage of revenue from 2000 to 2001 was due to a
decline in sales volume and average selling prices resulting from the global
economic slowdown, and increased inventory provision in response to the
deteriorating economic environment and a major product line transition in the
fourth quarter of 2001. The provision for excess and obsolete inventories
increased from $13.6 million in 2000 to $24.9 million in 2001, of which $9.3
million
23
was recorded in fourth quarter 2001 to specifically reserve for excess
inventories as a result of our product realignment and transition from our
IronCore ASICs-based product lines to the new and more powerful products
incorporating our next generation JetCore ASICs.
Our gross margin has been and may continue to be adversely affected by
heightened price competition, component shortages, increases in material or
labor costs, changes in channels of distribution, product and geographic mix,
as well as the mix of configurations within each product group. Downward
pressures on our gross margins may be further impacted by increased percentage
of revenue from service market providers, international purchasers or through
our OEMs, all of which may have lower margins, or an increase in product costs.
See also "Risk Factors That May Affect Future Results and Market Price of Stock
- -- We expect our gross margin to decline over time and the average selling
prices of our products may decrease as a result of competitive pressures and
other factors."
Research and development. Research and development expenses consist
primarily of salaries and related personnel expenses, prototype expenses
related to the development of our ASICs, software development and testing
costs, and the depreciation of property and equipment related to research and
development activities. Research and development expenses were $9.0 million,
$27.5 million and $33.9 million in fiscal 1999, 2000 and 2001 or 6.8%, 7.3%,
and 10.9% of revenue, respectively. The increases were primarily due to the
addition of engineering personnel from 43 in 1999 to 89 in 2000 to 135 in 2001
and increased expenditures on the design and development of new products,
particularly the development of our next generation JetCore ASICs in 2001.
Research and development costs are expensed as incurred. We believe continued
investment in product enhancements and new product development is critical to
attaining our strategic objectives, and as a result, we expect research and
development expenses to continue to increase in absolute dollars.
Sales and marketing. Sales and marketing expenses consist primarily of
salaries, commissions and related expenses for personnel engaged in marketing,
sales and customer support functions, as well as trade shows, advertising,
promotional expenses and the cost of facilities. Sales and marketing expenses
were $23.1 million, $67.8 million and $90.8 million in fiscal 1999, 2000 and
2001 or 17.3%, 18.0% and 29.2% of revenue, respectively. The increase from 1999
to 2000 was primarily due to significant increases in the size of our direct
sales force and related commissions, additional marketing and advertising
investments associated with the introduction of new products, the expansion of
distribution channels, and general corporate branding. The increase from 2000
to 2001 was primarily due to increases in the average size of our direct sales
force from 205 in 2000 to 289 in 2001, and increased marketing and advertising
investments associated with the introduction of new products.
General and administrative. General and administrative expenses consist
primarily of salaries and related expenses for executive, finance and
administrative personnel, facilities, bad debt, legal, and other general
corporate expenses. General and administrative expenses were $4.5 million,
$10.5 million and $27.2 million in fiscal 1999, 2000 and 2001 or 3.4%, 2.8% and
8.7% of revenue, respectively. The increase in absolute dollars from 1999 to
2000 was primarily due to an increase in headcount from 21 to 47 and an
increase in general corporate expenses consistent with the increased scale of
operations and revenue growth. General and administrative expenses increased in
absolute dollars from 2000 to 2001 primarily due to certain charges such as
$2.8 million for the write-down of a note receivable from a stockholder and
$1.1 million of costs related to facilities consolidation, an increase in the
provision for doubtful accounts receivable from $4.7 million in 2000 to
$9.1 million in 2001 as a result of the impact of the deteriorating economy on
our customer base, and an increase in general corporate expenses such as legal
and facilities costs.
Amortization of deferred stock compensation. In connection with the grant
of stock options to employees and a director, we recorded deferred stock
compensation in the aggregate amount of $17.3 million in 1999, and $0.3 million
in 2000, representing the difference between the exercise price and the deemed
fair market value of our common stock on the date these stock options were
granted. We recorded no additional deferred stock compensation in 2001.
Deferred stock compensation is reflected within stockholders' equity and is
being
24
amortized to operations over the respective vesting periods. We recorded
amortization of deferred stock compensation expense of approximately $9.5
million, $6.2 million and $2.7 million for fiscal 1999, 2000 and 2001,
respectively. At December 31, 2001, we had approximately $1.3 million remaining
to be amortized in 2002 and 2003.
Interest income. Interest income is earned on funds we keep on deposit in
interest bearing money market and short-term investment accounts. Foundry had
interest income of $1.9 million, $11.2 million and $8.7 million in 1999, 2000
and 2001, respectively. Interest income increased significantly from 1999 to
2000 due to higher cash balances resulting from the proceeds from our initial
public offering on October 1, 1999. Interest income decreased from 2000 to 2001
due to lower interest rates during 2001.
Write-down of minority investment. In February 2001, Foundry made a $2.5
million minority investment in a development stage private company, who is also
a customer. In December 2001, the Company determined that the investment
declined in fair market value on an other than temporary basis based on certain
factors such as the value of the most recent round of financing, market and
industry conditions and financial condition of and business outlook for the
company. Accordingly, Foundry wrote-down the minority investment in its
entirety in the accompanying consolidated statement of income for the year
ended December 31, 2001.
Income taxes. The Company generated significant taxable income in 1999,
2000, and 2001. Management believes that the Company will likely generate
sufficient taxable income in the future to ensure the realization of the tax
benefits arising from its existing deferred tax assets. Therefore, no valuation
allowance was required as of December 31, 2000, and 2001.
The Company's income taxes payable for federal and state purposes have been
reduced, and the deferred tax assets increased, by the tax benefits associated
with taxable dispositions of employee stock options. When an employee exercises
a stock option issued under a nonqualified plan or has a disqualifying
disposition related to a qualified plan, the Company receives an income tax
benefit calculated as the difference between the fair market value of the stock
issued at the time of the exercise and the option price, tax effected. These
benefits were credited directly to stockholders' equity and amounted to $0.9
million, $57.9 million and $10.5 million for the years ended December 31, 1999,
2000, and 2001, respectively. Benefits reducing taxes payable amounted to
approximately $55.2 million and $8.1 million for the years ended December 31,
2000 and 2001, respectively. Benefits increasing gross deferred tax assets
amounted to $2.7 million and $2.4 million for the years ended December 31, 2000
and 2001, respectively.
Liquidity and Capital Resources
At December 31, 2001, Foundry had cash and cash equivalents and short-term
investments totaling $274.7 million as compared to $252.2 million at December
31, 2000, an increase of $22.5 million.
Cash provided by operating activities was $19.6 million, $86.0 million and
$32.6 million for the years ended December 31, 1999, 2000 and 2001,
respectively. The increase from 1999 to 2000 was due primarily to the
significant increase in net income combined with an income tax benefit realized
from stock option exercises totaling $57.9 million, offset by purchases of
inventories and increase in accounts receivables. Cash provided by operating
activities decreased to $32.6 million for 2001 as a result of significantly
lower net income in 2001, lower tax benefit from stock option exercises, a
significant increase in deferred tax assets offset by increases in the
provisions for doubtful accounts and excess and obsolete inventories.
Cash utilized in investing activities was $40.8 million, $49.2 million, and
$100.5 million for the years ended December 31, 1999, 2000, and 2001,
respectively. The increases were primarily due to purchases of short-term
investments offset by proceeds received from the maturities of held-to-maturity
investments.
Financing activities in 1999 provided $137.1 million, arising primarily from
proceeds from our initial public offering on October 1, 1999. Financing
activities in 2000 provided $11.2 million primarily from stock option
25
exercises and, to a lesser extent, the collection of stockholder promissory
notes. During 2001, we utilized $2.6 million for financing activities, which
comprised primarily of $15.0 million used for the repurchase of Foundry common
stock in the open market offset by $12.4 million of proceeds from stock option
exercises and sale of common stock under the Employee Stock Purchase Plan.
As of December 31, 2001, we had inventory purchase commitments to our
contract manufacturers totaling $35.4 million and operating lease commitments
totaling $25.6 million. We may incur higher capital expenditures in the near
future, when market conditions improve and if we expand our operations.
Although we do not have any current plans or commitments to do so, from time to
time, we may also consider the acquisition of products and businesses
complementary to our business. Any acquisition or investments may require
additional capital. Although it is difficult for us to predict future liquidity
requirements with certainty, we believe that our existing cash balances and
anticipated funds from operations, will satisfy our cash requirements for at
least the next 12 months. Key factors impacting our cash flows include our
ability to effectively manage our working capital, in particular inventory and
accounts receivable, as well as future demand for our products and related
pricing.
Recently Issued Accounting Standards
See Note 2 of Notes to Consolidated Financial Statements for recently
adopted and issued accounting standards.
26
Risk Factors That May Affect Future Results and Market Price of Stock
We may not be able to maintain profitability in the future.
We generated net income of $88.1 million and $2.9 million for the year ended
December 31, 2000 and 2001 on revenues of $377.2 million and $311.2 million,
respectively. As of December 31, 2001, we had retained earnings of $93.5
million. Although we have been profitable on an annual basis for the last three
consecutive years, we incurred a net loss of $10.7 million for the fourth
quarter ended December 31, 2001. This is our first quarterly operating loss
since the quarter ended December 31, 1998. When economic conditions improve, we
may incur increased costs and expenses related to sales and marketing,
including expansion of our direct sales operation and distribution channels,
product development, customer support, expansion of our corporate
infrastructure, and facilities expansion. We base our operating expenses on
anticipated revenue trends and a high percentage of our expenses are fixed in
the short term. As a result, any significant shortfall in revenue relative to
our expectations could cause a significant decline in our quarterly operating
results. In order to be profitable, we must generate and sustain substantially
higher revenue while maintaining reasonable cost and expense levels. We may not
be able to sustain or increase profitability on a quarterly or annual basis in
the future.
The current economic downturn may continue to adversely affect our revenues,
gross margins and expenses.
Our quarterly revenue and operating results have and may continue to
fluctuate due to the effects of general economic conditions in the United
States and globally, and, in particular, market conditions in the
communications and networking industries. In recent quarters, our operating
results have been adversely affected as a result of the current recession and
reduced capital spending, particularly in the United States. The downturn has
also contributed to declines in revenue during 2001. We have also experienced
gross margin declines, reflecting the effect of competitive pressures as well
as writedowns for inventories and other asset impairments as a result of the
downturn. Our general and administrative expenses were higher than expected due
in part to an increase in the provision for doubtful accounts and write-down of
a note receivable from a stockholder. We are uncertain about the extent,
severity, and length of the economic downturn. If the economic conditions in
the United States and globally do not improve, or if we experience a worsening
in the global economic slowdown, we may continue to experience material
negative effects on our business, operating results, and financial condition.
We may not meet quarterly financial expectations, which could cause our stock
price to decline.
Our quarterly revenue and operating results are difficult to predict,
especially in recent periods, and may fluctuate significantly from quarter to
quarter. Delays in generating or recognizing forecasted revenue could cause our
quarterly operating results to be below the expectations of public market
analysts or investors, which could cause the price of our common stock to fall.
In addition, demand for our products may fluctuate as a result of seasonality,
particularly in Europe.
We may experience a delay in generating or recognizing revenue for a number
of reasons. Orders at the beginning of each quarter typically do not equal
expected revenue for that quarter and are generally cancelable at any time.
Therefore, we depend on obtaining orders in a quarter for shipment in that
quarter to achieve our revenue objectives. In addition, the failure to ship
products by the end of a quarter may negatively affect our operating results.
Our reseller agreements typically provide that the reseller may delay scheduled
delivery dates without penalty. Further, our customer purchase orders and
reseller agreements sometimes provide that the customer or reseller may cancel
orders within specified time frames without significant penalty.
Terrorist acts and acts of war may harm our business and operating results.
The terrorist attacks in New York and Washington D.C. on September 11, 2001
have disrupted commerce throughout the world and have intensified the
uncertainty of the U.S. and global economies. The long-term effects on our
business from these attacks are unknown. The continued threat of terrorism and
heightened
27
security and military action in response to this threat may cause further
disruption to the economy. To the extent that such disruptions result in delays
or cancellations of customer orders, the manufacture or shipment of our
products, our business and results of operations could be materially and
adversely affected.
Although our customer base has increased substantially, we still depend on
large, recurring purchases from certain customers, and any loss, cancellation
or delay in purchases by these customers could negatively impact our revenue.
For the years ended December 31, 2000 and 2001, no customers accounted for
greater than 10% of our net revenue. This may not necessarily be indicative of
future customer concentrations. Although our customer base has become less
concentrated, the loss of continued orders from our more significant customers
could cause our revenue and profitability to suffer.
While our financial performance may depend on large, recurring orders from
certain customers and resellers, we do not generally have binding commitments
from them. For example:
. our reseller agreements generally do not require minimum purchases;
. our customers can stop purchasing and our resellers can stop marketing our
products at any time;
. our reseller agreements generally are not exclusive and are for one year
terms, with no obligation of the resellers to renew the agreements; and
. our reseller agreements provide for discounts based on expected or actual
volumes of products purchased or resold by the reseller in a given period.
Because our expenses are based on our revenue forecasts, a substantial
reduction or delay in sales of our products to, or unexpected returns from
customers and resellers, or the loss of any significant customer or reseller
could harm our business. Although our largest customers may vary from period to
period, we anticipate that our operating results for any given period will
continue to depend on large orders from a small number of customers.
Financial results for any particular period will not predict results for future
periods.
Because of the uncertain nature of the economic environment and rapidly
changing market we serve, period-to-period comparisons of operating results may
not be meaningful. In addition, you should not rely on the results for any
period as an indication of future performance. In the future, our revenue may
remain flat, decrease or grow at a slower rate. As a consequence, operating
results for a particular quarter are extremely difficult to predict. We expect
that our operating expenses will increase if we expand our sales and marketing
operations and as we continue to develop new products. Further, we are subject
to employer payroll taxes when our employees exercise their non-qualified stock
options. The employer payroll taxes are assessed on each employee's gain, which
is the difference between the price of our common stock on the date of exercise
and the exercise price. During a particular period, these payroll taxes could
be material depending on the number of stock options exercised and the fair
market value of our common stock during such period. These employer payroll
taxes would be recorded as a charge to operations in the period such options
are exercised based on actual gains realized by employees. In addition to the
net proceeds we would receive upon the exercise of stock options, we would
receive tax deductions for gains realized by employees on the exercise of
non-qualified stock options for which the benefit is recorded as additional
paid-in capital. However, because we are unable to predict our future stock
price and the number of optionees who may exercise during any particular
period, we cannot predict what, if any, expense will be recorded in a future
period and the impact on our future financial results.
Intense competition in the market for network solutions could prevent us from
increasing revenue and sustaining profitability.
The market for network solutions is intensely competitive. In particular,
Cisco Systems Inc. maintains a dominant position in this market and several of
its products compete directly with our products.
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We also compete with other large public companies, such as Nortel Networks
and Enterasys Networks as well as other smaller public and private companies
such as Juniper Networks, Extreme Networks and Riverstone Networks. Some of our
current and potential competitors have greater market leverage, longer
operating histories, greater financial, technical, sales, marketing and other
resources, more name recognition and larger installed customer bases.
Additionally, we may face competition from unknown companies and emerging
technologies that may offer new LAN, MAN and LAN/WAN solutions to enterprises
and ISPs. Furthermore, a number of these competitors may merge or form
strategic relationships that would enable them to offer, or bring to market
earlier, products that are superior to ours in terms of features, quality,
pricing or other factors.
In order to remain competitive, we must, among other things, invest
significant resources in developing new products with superior performance at
lower prices than our competitors. We must also enhance our current products
and maintain customer satisfaction. If we fail to do so, our products may not
compete favorably with those of our competitors and our revenue and
profitability could suffer.
Our ability to increase our revenue depends on expanding our direct sales
operation and reseller distribution channels and continuing to provide
excellent customer support.
If we are unable to effectively expand, train and retain our sales and
support staff or establish and cultivate relationships with our indirect
distribution channels, our ability to grow and increase revenue could be harmed
or if our resellers are not successful in their sales efforts, sales of our
products may decrease and our operating results would suffer. Some of our
resellers also sell products that compete with our products. As a result, we
cannot assure you that our resellers will market our products effectively or
continue to devote the resources necessary to provide us with adequate sales,
marketing and technical support.
In an effort to gain market share and support our customers, we may expand
our direct sales operation and customer service staff to support new and
existing customers. The timing and extent of any such expansion is uncertain in
light of the current economic environment. Expansion of our direct sales
operation and reseller distribution channels may not be successfully
implemented and the cost of any expansion may exceed the revenue generated.
We must continue to introduce new products with superior performance in a
timely manner in order to sustain and increase our revenue.
The networking industry is characterized by rapid technological change,
frequent new product introductions, changes in customer requirements, and
evolving industry standards. Therefore, we need to introduce new products in a
timely manner that offer substantially greater performance and support a
greater number of users per device, all at lower price points to remain
competitive. The process of developing new technology is complex and uncertain,
and if we fail to develop or obtain important intellectual property and
accurately predict customers' changing needs and emerging technological trends,
our business could be harmed. We must commit significant resources to develop
new products before knowing whether our investments will eventually result in
products that the market will accept. After a product is developed, we must be
able to forecast sales volumes and quickly manufacture a sufficient mix of
products and configurations that meet customer requirements, all at low costs.
The current life cycle of our