August 10, 2000
F5 NETWORKS INC (FFIV)
Quarterly Report (SEC form 10-Q)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Statements in this report concerning future events or future performance, financial results or achievements of F5, or other statements which are not statements of historical facts are forward-looking statements. These statements may be identified by terminology such as "may," "will," "should," "expects," "plans," "anticipates," "believes," "estimates," "predicts", "potential" or "continue" or the negative of such terms or comparable terms. These statements are subject to a number of known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to differ from those expressed or implied by those statements. Relevant risks and uncertainties include among others: our limited operating history; variability of our operating results; market acceptance of our Internet traffic and content management products; our timely development of new products and features; our ability to manage our growth; our ability to maintain and develop distribution relationships; competition in the Internet traffic and content management market; our ability to expand in the international markets; unpredictability of our sales cycle and other risk factors referenced in our public filings with the Securities and Exchange Commission, and in particular, those set forth under the heading "Risk Factors" in our Annual Report on Form 10-K filed with the SEC on December 28, 1999. These forward-looking statements speak only as of the date of this report. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained in this report to reflect any change in our expectations with regard to such statements or any change in events, conditions or circumstances on which any statement is based.
The following information should be read in conjunction with the "Management's Discussion and Analysis of Financial Condition and Results of Operations" on pages 15 through 27 of our Annual Report on Form 10-K.
OVERVIEW
F5 is a leading provider of integrated Internet traffic and content management solutions designed to improve the availability and performance of mission-critical Internet-based servers and applications. Our products monitor and manage an organization's geographically dispersed servers and intelligently direct traffic to the server best able to handle a user's request, preventing system failure and providing timely responses and optimal data flow.
We were incorporated on February 26, 1996 and began operations in April 1996. During the period from February 26, 1996 through September 30, 1996, we were a development stage enterprise and had no product revenues. Our operating activities during this period related primarily to developing our initial product, recruiting personnel, building our corporate infrastructure and raising capital.
In July 1997, we released our first version of our BIG-IP(R) Local Traffic Controller and began to expand our operations. We continue to commit a significant amount of resources to research and development, marketing programs, domestic and international sales channels, customer support and services and our general and administrative infrastructure. Some of our key milestones, as of June 30, 2000 include:
- hired more than 370 employees;
- expanded international operations into Canada, Europe and Asia
Pacific;
- established a customer base of over 2,000 businesses; and
- expanded our suite of products to include 3-DNS(R) Distributed
Traffic Controller, SEE-IT(TM) Network Manager and
GLOBAL-SITE(TM) Content Controller.
Our net revenues grew from $7.6 million for the three months ended June 30, 1999 to $29.2 million for the three months ended June 30, 2000. Currently, we derive approximately 69% of our net revenues from sales of our BIG-IP. We expect to continue to derive a significant portion of our net revenues from sales of BIG-IP in the future. One of our resellers accounted for 13% of our net revenues for the three months ended June 30, 2000, and for 17% of
the Company's net revenues for the nine months ended June 30, 2000. This reseller accounted for 6% of our accounts receivable balance at June 30, 2000.
Net revenues derived from customers located outside of the United States were $677,000 and $5.9 million for the three months ended June 30, 1999 and 2000, respectively, and $1.0 million, and $12.5 million for the nine months ended June 30, 1999 and 2000, respectively. We plan to continue expanding our international operations significantly, particularly in selected countries in the European and Asia Pacific markets, because we believe international markets represent a significant growth opportunity.
Customers who purchase our products generally receive installation services and an initial customer support contract, typically covering a 12-month period. We generally combine the software license, hardware, installation, and customer support elements of our products into a package for a single price. We allocate a portion of the sales price to each element of the bundled package based on their respective fair values when the individual elements are sold separately. Revenues from the license of software are recognized, net of allowances for estimated returns, when the product has been shipped and the customer is obligated to pay for the product. Installation revenue is recognized when the product has been installed at the customer's site. Revenues for customer support are recognized on a straight-line basis over the service contract term. Our ordinary payment terms to our customers are net 30 days, but we have extended payment terms beyond net 30 days to some customers. For extended payment term arrangements, revenue is recognized ratably over the term of the arrangement. Estimated sales returns are based on historical experience by product and are recorded at the time revenues are recognized. Customers may also purchase consulting services and renew their initial customer support contract. Consulting services are customarily billed at fixed rates, plus out-of-pocket expenses. Based on our limited operating history, it is difficult to predict what our rate of renewals will be in the future.
Our success in growing net revenues depends on increasing our customer base and expanding our product line as well as continued growth of the emerging Internet traffic and content management market. Accordingly, we plan to continue investing heavily in sales and marketing, promotion of the F5 brand, customer service and support, research and development, operating infrastructure and general and administrative staff to support our growth. As a result of these investments, we expect that our operating expenses will continue to increase significantly. As a result of growing revenues, we have begun to generate profits during our four most recent quarters ended September 30, 1999 to June 30, 2000.
We have recorded a total of $6.2 million of unearned compensation costs since our inception through June 30, 2000. These charges represent the difference between the exercise price and the estimated fair value of certain stock options granted to our employees and outside directors. These options generally vest ratably over a four-year period. We are amortizing these costs over the vesting period of the options. We have recorded unearned compensation charges of $759,000 and $434,000 for the three months ended June 30, 1999 and 2000, respectively and $1.8 million and $1.4 million for the nine months ended June 30, 1999 and 2000, respectively.
We expect to recognize amortization expense related to unearned compensation of approximately $1.8 million, $965,000, $411,000 and $60,000 during the years ended September 30, 2000, 2001, 2002 and 2003, respectively. We cannot guarantee, however, that we will not accrue additional unearned compensation costs in the future.
In view of the rapidly changing nature of our business and our limited operating history, we believe that period-to-period comparisons of net revenues and operating results are not necessarily meaningful and should not be relied upon as indications of future performance. To maintain profitability we will need to increase our net revenues significantly. Although we have experienced rapid growth in net revenues in recent periods, we may not be able to sustain these growth rates to maintain profitability.
RESULTS OF OPERATIONS
The following table sets forth financial data as a percentage of total net revenues for the periods indicated.
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- --------------------
2000 1999 2000 1999
STATEMENT OF OPERATIONS DATA:
Net revenues:
Products 81.6% 84.7% 81.5% 84.4%
Services 18.4 15.3 18.5 15.6
----- ----- ----- -----
Total net revenues 100.0 100.0 100.0 100.0
----- ----- ----- -----
Cost of net revenues:
Products 20.6 21.5 21.8 21.9
Services 7.7 5.2 7.1 7.0
----- ----- ----- -----
Total cost of net revenues 28.3 26.7 28.9 28.9
----- ----- ----- -----
Gross margin 71.7 73.3 71.1 71.1
----- ----- ----- -----
Operating expenses:
Sales and marketing 36.2 52.7 34.4 64.8
Research and development 11.7 19.3 11.7 27.1
General and administrative 7.6 12.5 7.6 15.3
Amortization of unearned compensation 1.5 10.0 2.0 12.8
----- ----- ----- -----
Total operating expenses 57.0 94.5 55.7 120.0
----- ----- ----- -----
Income (loss) from operations 14.7 (21.2) 15.4 (48.9)
Interest income, net 2.9 1.3 3.3 1.3
----- ----- ----- -----
Income (loss) before income taxes 17.6 (20.0) 18.7 (47.6)
Provision for income taxes 4.4 -- 1.8 --
----- ----- ----- -----
Net income (loss) 13.2% (19.9)% 16.9% (47.6)%
===== ===== ===== =====
NET REVENUES:
Net revenues consist of sales of our products and services, which primarily include software licenses and services. Product revenues include revenue from software licenses and hardware sales. Service revenues include revenue from service and support agreements provided as part of the initial product sale, sales of extended service and support contracts and consulting services.
Product revenues. Product revenues increased by 270% from $6.4 million for the three months ended June 30, 1999 to $23.8 million for the three months ended June 30, 2000. Product revenues increased 394% from $11.9 million for the nine months ended June 30, 1999 to $58.6 million for the nine months ended June 30, 2000. The increases in product revenues were due primarily to an increase in the quantity of our products sold which was the result of expansion into new and existing international markets and an increase in the number of our customers.
Service revenues. Service revenues increased by 364% from $1.2 million for the three months ended June 30, 1999 to $5.4 million for the three months ended June 30, 2000. Service revenues increased 510% from $2.2 million for the nine months ended June 30, 1999 to $13.4 million for the nine months ended June 30, 2000. The increases in service revenues were due primarily to an increase in the installed base of our products and the renewal of service contracts.
International revenues represented 9% of net revenues for the three months ended June 30, 1999 and 20% of net revenues for the three months ended June 30, 2000. International revenues represented 7% of net revenues for the nine months ended June 30, 1999 and 17% of net revenues for the nine months ended June 30, 2000.
As our net revenue base increases, we may not be able to sustain the percentage growth rates of net revenues that we have experienced historically.
COST OF NET REVENUES:
Cost of net revenues consists primarily of outsourced hardware components and manufacturing, fees for third-party software products integrated into our products, manufacturing and service and support personnel and an allocation of our facilities and depreciation expenses.
Cost of product revenues. Cost of product revenues increased 269%, from $1.6 million for the three months ended June 30, 1999 to $6.0 million for the three months ended June 30, 2000 and remained consistent as a percentage of product revenues at 25%, compared to the same period last year. Cost of product revenues increased 409% from $3.1 million for the nine months ended June 30, 1999 to $15.7 million for the nine months ended June 30, 2000 and increased as a percentage of product revenues to 27% from 26%. The increases in absolute dollars were due primarily to higher sales volume during these periods.
Cost of service revenues. Cost of service revenues increased 465%, from $396,000 for the three months ended June 30, 1999 to $2.2 million for the three months ended June 30, 2000 and increased as a percentage of service revenues to 42% from 34%. Cost of service revenues increased 421% from $976,000 for the nine months ended June 30, 1999 to $5.1 million for the nine months ended June 30, 2000 and decreased as a percentage of service revenues to 38% from 45%. The increases in cost of service revenues in absolute dollars were due primarily to increased personnel costs, related to hiring.
Sales and marketing. Our sales and marketing expenses consist primarily of salaries, commissions and related benefits to our sales and marketing staff, costs of our marketing programs, including public relations, advertising and trade shows and an allocation of our facilities and depreciation expenses. Sales and marketing expenses increased 164%, from $4.0 million for the three months ended June 30, 1999 to $10.6 million for the three months ended June 30, 2000, but decreased as a percentage of net revenues to 36% from 53%. Sales and marketing expenses increased 172% from $9.1 million for the nine months ended June 30, 1999 to $24.8 million for the nine months ended June 30, 2000, but decreased as a percentage of net revenues to 34% from 65%. The increases in absolute dollars were due to the expansion of sales and marketing personnel from 67 to 222, between June 30, 1999 and June 30, 2000, as well as increased commissions, and increased advertising and promotional activities over the three and nine month periods ending June 30, 2000. We expect to continue increasing sales and marketing expenses in order to grow net revenues and expand our brand awareness.
Research and development. Our research and development expenses consist primarily of salaries and related benefits for our product development personnel and an allocation of our facilities and depreciation expenses. Research and development expenses increased 133% from $1.5 million for the three months ended June 30, 1999 to $3.4 million for the three months ended June 30, 2000, but decreased as a percentage of net revenues to 12% from 19%. Research and development expenses increased 121% from $3.8 million for the nine months ended June 30, 1999 to $8.4 million for the nine months ended June 30, 2000, but decreased as a percentage of net revenues to 12% from 27%. These increases in absolute dollars were due to an increase in product development personnel from 54 to 101, between June 30, 1999 to June 30, 2000.
Our future success is dependent in large part on the continued enhancement of our current products and our ability to develop new, technologically advanced products that meet the sophisticated needs of our customers. We expect research and development expenses to increase in absolute dollars in future periods.
General and administrative. Our general and administrative expenses consist primarily of salaries, benefits and related costs of our executive, finance, information technology, human resource and legal personnel, third-party professional service fees, and an allocation of our facilities and depreciation expenses. General and administrative expenses increased 133% from $954,000 for the three months ended June 30, 1999 to $2.2 million for the three months ended June 30, 2000, but expenses decreased as a percentage of net revenues to 8% from 13%. General and administrative expenses increased 154% from $2.1 million for the nine months ended June 30, 1999 to $5.4 million
for the nine months ended June 30, 2000, but decreased as a percentage of net revenues from 15% to 8%. These increases in absolute dollars were due primarily to an increase in general and administrative personnel from 30 to 54, between June 30, 1999 to June 30, 2000. We expect general and administrative expenses to increase in absolute dollars as we expand our staff in order to manage our growth.
Amortization of unearned compensation. We recorded amortization expense of unearned compensation of $759,000 and $434,000 for the three months ended June 30, 1999 and 2000, respectively. For the nine months ended June 30, 1999 and 2000, we recorded amortization of unearned compensation charges of $1.8 million and $1.4 million, respectively. Unearned compensation charges represent the difference between the exercise price and the estimated fair value of certain stock options granted to our employees and the outside directors and are amortized over the vesting period of the option.
Interest income, net. Interest income consists of earnings on our cash and cash equivalent balances. Interest income, net was $97,000 for the three months ended June 30, 1999 and $855,000 for the three months ended June 30, 2000. For the nine months ended June 30, 1999 and 2000, interest income, net was $186,000 and $2.4 million, respectively. These increases were due primarily to the investment of proceeds received from our initial and secondary public offerings in June and October 1999.
Income taxes. FASB Statement No. 109 provides for the recognition of deferred tax assets if realization is more likely than not. Based on available evidence, which includes our historical operating performance and the reported cumulative net losses in all prior years, we historically provided for a full valuation allowance against our net deferred tax assets. Based on our operating performance, we have recently determined that certain of these assets are more likely than not realizable. As a result the valuation allowance has been partially reversed against our net deferred assets. We have maintained a valuation allowance on our remaining net operating loss carryforwards as of June 30, 2000 (approximately $4.7 million). These remaining net operating loss carryforwards primarily relate to the tax benefits associated with our stock option plans. The recognition of net operating loss carryforwards related to stock option plan benefits will be offset against shareholders' equity.
We have recorded a provision for income taxes of $1.3 million for the three months ended June 30, 2000. The effective tax rate for the three months ended June 30, 2000 was 25%, which is lower than the federal statutory rate due to the tax benefit received from the reversal of the valuation allowance. The effective tax rate for the remainder of the fiscal year 2000 is estimated to be 36%.
As of September 30, 1999, we had approximately $7.8 million of net operating loss carryforwards for federal income tax purposes. Accordingly, there was no provision for federal or state income taxes for any prior period. Utilization of the net operating loss carryforwards may be subject to annual limitations due to the ownership change limitations contained in the Internal Revenue Code of 1986 and similar state provisions. Annual limitations may result in the expiration of the net operating losses before we can utilize them. The federal net operating loss carryforwards will expire at various dates beginning in 2011 through 2019 if we do not use them.
LIQUIDITY AND CAPITAL RESOURCES
From our inception through May 1999, we financed our operations and capital expenditures primarily through the sale of approximately $12.4 million in equity securities. In June 1999, we completed an initial public offering of 2,860,000 shares of common stock and raised approximately $25.5 million, net of offering costs. In October 1999, we completed a secondary public offering of 500,000 shares of common stock and raised approximately $31.5 million, net of offering costs.
Cash provided by (used in) our operating activities was $(3.9) million for the nine months ended June 30, 1999 and $7.5 million for the nine months ended June 30, 2000. As of June 30, 2000, we had $56.2 million in cash and cash equivalents and $6.1 million in restricted cash. We expect that accounts receivable and inventories will continue to increase to the extent our revenues continue to increase. Any such increases can be expected to reduce cash and cash equivalents. We have provided extended payment terms to one of our resellers and expect to offer financing programs to other resellers in the future.
Cash used in investing activities was $1.5 million for the nine months ended June 30, 1999 and $10.9 million for the nine months ended June 30, 2000, substantially all of which was used for the purchase of property and equipment. We expect capital expenditures to continue to increase through the end of 2000, due to the costs of expansion and expenditures for information systems and test equipment.
In April 2000, we entered into a lease agreement on two buildings for a new corporate headquarters. The lease commenced in July 2000 on the first building; and the lease on the second building will commence in October 2000. The lease for both buildings expires in 2012 with an option for renewal. We will begin taking occupancy of the new facilities in the quarter ending September 30, 2000.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Interest Rate Risk. We do not hold derivative financial instruments or equity securities in our investment portfolio. Our cash equivalents consist of high-quality securities, as specified in our investment policy guidelines. The policy limits the amount of credit exposure to any one issue or issuer to a maximum of 20% of the total portfolio with the exception of treasury securities, commercial paper and money market funds, which are exempt from size limitation. The policy limits all short-term investments to those that mature in two years or less, with the average maturity being one year or less. These securities are subject to interest rate risk and will decrease in value if interest rates increase.
Foreign Currency Risk. Currently the majority of our sales and expenses are denominated in U.S. dollars and as a result, we have not experienced significant foreign exchange gains and losses to date. While we have conducted some transactions in foreign currencies during the fiscal year ended September 30, 1999 and the three and nine months ended June 30, 2000 and expect to continue to do so, we do not anticipate that foreign exchange gains and losses will be significant. We have not engaged in foreign currency hedging to date, however we may do so in the future.
Al grüßt optimistisch
F5 NETWORKS INC (FFIV)
Quarterly Report (SEC form 10-Q)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Statements in this report concerning future events or future performance, financial results or achievements of F5, or other statements which are not statements of historical facts are forward-looking statements. These statements may be identified by terminology such as "may," "will," "should," "expects," "plans," "anticipates," "believes," "estimates," "predicts", "potential" or "continue" or the negative of such terms or comparable terms. These statements are subject to a number of known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to differ from those expressed or implied by those statements. Relevant risks and uncertainties include among others: our limited operating history; variability of our operating results; market acceptance of our Internet traffic and content management products; our timely development of new products and features; our ability to manage our growth; our ability to maintain and develop distribution relationships; competition in the Internet traffic and content management market; our ability to expand in the international markets; unpredictability of our sales cycle and other risk factors referenced in our public filings with the Securities and Exchange Commission, and in particular, those set forth under the heading "Risk Factors" in our Annual Report on Form 10-K filed with the SEC on December 28, 1999. These forward-looking statements speak only as of the date of this report. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained in this report to reflect any change in our expectations with regard to such statements or any change in events, conditions or circumstances on which any statement is based.
The following information should be read in conjunction with the "Management's Discussion and Analysis of Financial Condition and Results of Operations" on pages 15 through 27 of our Annual Report on Form 10-K.
OVERVIEW
F5 is a leading provider of integrated Internet traffic and content management solutions designed to improve the availability and performance of mission-critical Internet-based servers and applications. Our products monitor and manage an organization's geographically dispersed servers and intelligently direct traffic to the server best able to handle a user's request, preventing system failure and providing timely responses and optimal data flow.
We were incorporated on February 26, 1996 and began operations in April 1996. During the period from February 26, 1996 through September 30, 1996, we were a development stage enterprise and had no product revenues. Our operating activities during this period related primarily to developing our initial product, recruiting personnel, building our corporate infrastructure and raising capital.
In July 1997, we released our first version of our BIG-IP(R) Local Traffic Controller and began to expand our operations. We continue to commit a significant amount of resources to research and development, marketing programs, domestic and international sales channels, customer support and services and our general and administrative infrastructure. Some of our key milestones, as of June 30, 2000 include:
- hired more than 370 employees;
- expanded international operations into Canada, Europe and Asia
Pacific;
- established a customer base of over 2,000 businesses; and
- expanded our suite of products to include 3-DNS(R) Distributed
Traffic Controller, SEE-IT(TM) Network Manager and
GLOBAL-SITE(TM) Content Controller.
Our net revenues grew from $7.6 million for the three months ended June 30, 1999 to $29.2 million for the three months ended June 30, 2000. Currently, we derive approximately 69% of our net revenues from sales of our BIG-IP. We expect to continue to derive a significant portion of our net revenues from sales of BIG-IP in the future. One of our resellers accounted for 13% of our net revenues for the three months ended June 30, 2000, and for 17% of
the Company's net revenues for the nine months ended June 30, 2000. This reseller accounted for 6% of our accounts receivable balance at June 30, 2000.
Net revenues derived from customers located outside of the United States were $677,000 and $5.9 million for the three months ended June 30, 1999 and 2000, respectively, and $1.0 million, and $12.5 million for the nine months ended June 30, 1999 and 2000, respectively. We plan to continue expanding our international operations significantly, particularly in selected countries in the European and Asia Pacific markets, because we believe international markets represent a significant growth opportunity.
Customers who purchase our products generally receive installation services and an initial customer support contract, typically covering a 12-month period. We generally combine the software license, hardware, installation, and customer support elements of our products into a package for a single price. We allocate a portion of the sales price to each element of the bundled package based on their respective fair values when the individual elements are sold separately. Revenues from the license of software are recognized, net of allowances for estimated returns, when the product has been shipped and the customer is obligated to pay for the product. Installation revenue is recognized when the product has been installed at the customer's site. Revenues for customer support are recognized on a straight-line basis over the service contract term. Our ordinary payment terms to our customers are net 30 days, but we have extended payment terms beyond net 30 days to some customers. For extended payment term arrangements, revenue is recognized ratably over the term of the arrangement. Estimated sales returns are based on historical experience by product and are recorded at the time revenues are recognized. Customers may also purchase consulting services and renew their initial customer support contract. Consulting services are customarily billed at fixed rates, plus out-of-pocket expenses. Based on our limited operating history, it is difficult to predict what our rate of renewals will be in the future.
Our success in growing net revenues depends on increasing our customer base and expanding our product line as well as continued growth of the emerging Internet traffic and content management market. Accordingly, we plan to continue investing heavily in sales and marketing, promotion of the F5 brand, customer service and support, research and development, operating infrastructure and general and administrative staff to support our growth. As a result of these investments, we expect that our operating expenses will continue to increase significantly. As a result of growing revenues, we have begun to generate profits during our four most recent quarters ended September 30, 1999 to June 30, 2000.
We have recorded a total of $6.2 million of unearned compensation costs since our inception through June 30, 2000. These charges represent the difference between the exercise price and the estimated fair value of certain stock options granted to our employees and outside directors. These options generally vest ratably over a four-year period. We are amortizing these costs over the vesting period of the options. We have recorded unearned compensation charges of $759,000 and $434,000 for the three months ended June 30, 1999 and 2000, respectively and $1.8 million and $1.4 million for the nine months ended June 30, 1999 and 2000, respectively.
We expect to recognize amortization expense related to unearned compensation of approximately $1.8 million, $965,000, $411,000 and $60,000 during the years ended September 30, 2000, 2001, 2002 and 2003, respectively. We cannot guarantee, however, that we will not accrue additional unearned compensation costs in the future.
In view of the rapidly changing nature of our business and our limited operating history, we believe that period-to-period comparisons of net revenues and operating results are not necessarily meaningful and should not be relied upon as indications of future performance. To maintain profitability we will need to increase our net revenues significantly. Although we have experienced rapid growth in net revenues in recent periods, we may not be able to sustain these growth rates to maintain profitability.
RESULTS OF OPERATIONS
The following table sets forth financial data as a percentage of total net revenues for the periods indicated.
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- --------------------
2000 1999 2000 1999
STATEMENT OF OPERATIONS DATA:
Net revenues:
Products 81.6% 84.7% 81.5% 84.4%
Services 18.4 15.3 18.5 15.6
----- ----- ----- -----
Total net revenues 100.0 100.0 100.0 100.0
----- ----- ----- -----
Cost of net revenues:
Products 20.6 21.5 21.8 21.9
Services 7.7 5.2 7.1 7.0
----- ----- ----- -----
Total cost of net revenues 28.3 26.7 28.9 28.9
----- ----- ----- -----
Gross margin 71.7 73.3 71.1 71.1
----- ----- ----- -----
Operating expenses:
Sales and marketing 36.2 52.7 34.4 64.8
Research and development 11.7 19.3 11.7 27.1
General and administrative 7.6 12.5 7.6 15.3
Amortization of unearned compensation 1.5 10.0 2.0 12.8
----- ----- ----- -----
Total operating expenses 57.0 94.5 55.7 120.0
----- ----- ----- -----
Income (loss) from operations 14.7 (21.2) 15.4 (48.9)
Interest income, net 2.9 1.3 3.3 1.3
----- ----- ----- -----
Income (loss) before income taxes 17.6 (20.0) 18.7 (47.6)
Provision for income taxes 4.4 -- 1.8 --
----- ----- ----- -----
Net income (loss) 13.2% (19.9)% 16.9% (47.6)%
===== ===== ===== =====
NET REVENUES:
Net revenues consist of sales of our products and services, which primarily include software licenses and services. Product revenues include revenue from software licenses and hardware sales. Service revenues include revenue from service and support agreements provided as part of the initial product sale, sales of extended service and support contracts and consulting services.
Product revenues. Product revenues increased by 270% from $6.4 million for the three months ended June 30, 1999 to $23.8 million for the three months ended June 30, 2000. Product revenues increased 394% from $11.9 million for the nine months ended June 30, 1999 to $58.6 million for the nine months ended June 30, 2000. The increases in product revenues were due primarily to an increase in the quantity of our products sold which was the result of expansion into new and existing international markets and an increase in the number of our customers.
Service revenues. Service revenues increased by 364% from $1.2 million for the three months ended June 30, 1999 to $5.4 million for the three months ended June 30, 2000. Service revenues increased 510% from $2.2 million for the nine months ended June 30, 1999 to $13.4 million for the nine months ended June 30, 2000. The increases in service revenues were due primarily to an increase in the installed base of our products and the renewal of service contracts.
International revenues represented 9% of net revenues for the three months ended June 30, 1999 and 20% of net revenues for the three months ended June 30, 2000. International revenues represented 7% of net revenues for the nine months ended June 30, 1999 and 17% of net revenues for the nine months ended June 30, 2000.
As our net revenue base increases, we may not be able to sustain the percentage growth rates of net revenues that we have experienced historically.
COST OF NET REVENUES:
Cost of net revenues consists primarily of outsourced hardware components and manufacturing, fees for third-party software products integrated into our products, manufacturing and service and support personnel and an allocation of our facilities and depreciation expenses.
Cost of product revenues. Cost of product revenues increased 269%, from $1.6 million for the three months ended June 30, 1999 to $6.0 million for the three months ended June 30, 2000 and remained consistent as a percentage of product revenues at 25%, compared to the same period last year. Cost of product revenues increased 409% from $3.1 million for the nine months ended June 30, 1999 to $15.7 million for the nine months ended June 30, 2000 and increased as a percentage of product revenues to 27% from 26%. The increases in absolute dollars were due primarily to higher sales volume during these periods.
Cost of service revenues. Cost of service revenues increased 465%, from $396,000 for the three months ended June 30, 1999 to $2.2 million for the three months ended June 30, 2000 and increased as a percentage of service revenues to 42% from 34%. Cost of service revenues increased 421% from $976,000 for the nine months ended June 30, 1999 to $5.1 million for the nine months ended June 30, 2000 and decreased as a percentage of service revenues to 38% from 45%. The increases in cost of service revenues in absolute dollars were due primarily to increased personnel costs, related to hiring.
Sales and marketing. Our sales and marketing expenses consist primarily of salaries, commissions and related benefits to our sales and marketing staff, costs of our marketing programs, including public relations, advertising and trade shows and an allocation of our facilities and depreciation expenses. Sales and marketing expenses increased 164%, from $4.0 million for the three months ended June 30, 1999 to $10.6 million for the three months ended June 30, 2000, but decreased as a percentage of net revenues to 36% from 53%. Sales and marketing expenses increased 172% from $9.1 million for the nine months ended June 30, 1999 to $24.8 million for the nine months ended June 30, 2000, but decreased as a percentage of net revenues to 34% from 65%. The increases in absolute dollars were due to the expansion of sales and marketing personnel from 67 to 222, between June 30, 1999 and June 30, 2000, as well as increased commissions, and increased advertising and promotional activities over the three and nine month periods ending June 30, 2000. We expect to continue increasing sales and marketing expenses in order to grow net revenues and expand our brand awareness.
Research and development. Our research and development expenses consist primarily of salaries and related benefits for our product development personnel and an allocation of our facilities and depreciation expenses. Research and development expenses increased 133% from $1.5 million for the three months ended June 30, 1999 to $3.4 million for the three months ended June 30, 2000, but decreased as a percentage of net revenues to 12% from 19%. Research and development expenses increased 121% from $3.8 million for the nine months ended June 30, 1999 to $8.4 million for the nine months ended June 30, 2000, but decreased as a percentage of net revenues to 12% from 27%. These increases in absolute dollars were due to an increase in product development personnel from 54 to 101, between June 30, 1999 to June 30, 2000.
Our future success is dependent in large part on the continued enhancement of our current products and our ability to develop new, technologically advanced products that meet the sophisticated needs of our customers. We expect research and development expenses to increase in absolute dollars in future periods.
General and administrative. Our general and administrative expenses consist primarily of salaries, benefits and related costs of our executive, finance, information technology, human resource and legal personnel, third-party professional service fees, and an allocation of our facilities and depreciation expenses. General and administrative expenses increased 133% from $954,000 for the three months ended June 30, 1999 to $2.2 million for the three months ended June 30, 2000, but expenses decreased as a percentage of net revenues to 8% from 13%. General and administrative expenses increased 154% from $2.1 million for the nine months ended June 30, 1999 to $5.4 million
for the nine months ended June 30, 2000, but decreased as a percentage of net revenues from 15% to 8%. These increases in absolute dollars were due primarily to an increase in general and administrative personnel from 30 to 54, between June 30, 1999 to June 30, 2000. We expect general and administrative expenses to increase in absolute dollars as we expand our staff in order to manage our growth.
Amortization of unearned compensation. We recorded amortization expense of unearned compensation of $759,000 and $434,000 for the three months ended June 30, 1999 and 2000, respectively. For the nine months ended June 30, 1999 and 2000, we recorded amortization of unearned compensation charges of $1.8 million and $1.4 million, respectively. Unearned compensation charges represent the difference between the exercise price and the estimated fair value of certain stock options granted to our employees and the outside directors and are amortized over the vesting period of the option.
Interest income, net. Interest income consists of earnings on our cash and cash equivalent balances. Interest income, net was $97,000 for the three months ended June 30, 1999 and $855,000 for the three months ended June 30, 2000. For the nine months ended June 30, 1999 and 2000, interest income, net was $186,000 and $2.4 million, respectively. These increases were due primarily to the investment of proceeds received from our initial and secondary public offerings in June and October 1999.
Income taxes. FASB Statement No. 109 provides for the recognition of deferred tax assets if realization is more likely than not. Based on available evidence, which includes our historical operating performance and the reported cumulative net losses in all prior years, we historically provided for a full valuation allowance against our net deferred tax assets. Based on our operating performance, we have recently determined that certain of these assets are more likely than not realizable. As a result the valuation allowance has been partially reversed against our net deferred assets. We have maintained a valuation allowance on our remaining net operating loss carryforwards as of June 30, 2000 (approximately $4.7 million). These remaining net operating loss carryforwards primarily relate to the tax benefits associated with our stock option plans. The recognition of net operating loss carryforwards related to stock option plan benefits will be offset against shareholders' equity.
We have recorded a provision for income taxes of $1.3 million for the three months ended June 30, 2000. The effective tax rate for the three months ended June 30, 2000 was 25%, which is lower than the federal statutory rate due to the tax benefit received from the reversal of the valuation allowance. The effective tax rate for the remainder of the fiscal year 2000 is estimated to be 36%.
As of September 30, 1999, we had approximately $7.8 million of net operating loss carryforwards for federal income tax purposes. Accordingly, there was no provision for federal or state income taxes for any prior period. Utilization of the net operating loss carryforwards may be subject to annual limitations due to the ownership change limitations contained in the Internal Revenue Code of 1986 and similar state provisions. Annual limitations may result in the expiration of the net operating losses before we can utilize them. The federal net operating loss carryforwards will expire at various dates beginning in 2011 through 2019 if we do not use them.
LIQUIDITY AND CAPITAL RESOURCES
From our inception through May 1999, we financed our operations and capital expenditures primarily through the sale of approximately $12.4 million in equity securities. In June 1999, we completed an initial public offering of 2,860,000 shares of common stock and raised approximately $25.5 million, net of offering costs. In October 1999, we completed a secondary public offering of 500,000 shares of common stock and raised approximately $31.5 million, net of offering costs.
Cash provided by (used in) our operating activities was $(3.9) million for the nine months ended June 30, 1999 and $7.5 million for the nine months ended June 30, 2000. As of June 30, 2000, we had $56.2 million in cash and cash equivalents and $6.1 million in restricted cash. We expect that accounts receivable and inventories will continue to increase to the extent our revenues continue to increase. Any such increases can be expected to reduce cash and cash equivalents. We have provided extended payment terms to one of our resellers and expect to offer financing programs to other resellers in the future.
Cash used in investing activities was $1.5 million for the nine months ended June 30, 1999 and $10.9 million for the nine months ended June 30, 2000, substantially all of which was used for the purchase of property and equipment. We expect capital expenditures to continue to increase through the end of 2000, due to the costs of expansion and expenditures for information systems and test equipment.
In April 2000, we entered into a lease agreement on two buildings for a new corporate headquarters. The lease commenced in July 2000 on the first building; and the lease on the second building will commence in October 2000. The lease for both buildings expires in 2012 with an option for renewal. We will begin taking occupancy of the new facilities in the quarter ending September 30, 2000.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Interest Rate Risk. We do not hold derivative financial instruments or equity securities in our investment portfolio. Our cash equivalents consist of high-quality securities, as specified in our investment policy guidelines. The policy limits the amount of credit exposure to any one issue or issuer to a maximum of 20% of the total portfolio with the exception of treasury securities, commercial paper and money market funds, which are exempt from size limitation. The policy limits all short-term investments to those that mature in two years or less, with the average maturity being one year or less. These securities are subject to interest rate risk and will decrease in value if interest rates increase.
Foreign Currency Risk. Currently the majority of our sales and expenses are denominated in U.S. dollars and as a result, we have not experienced significant foreign exchange gains and losses to date. While we have conducted some transactions in foreign currencies during the fiscal year ended September 30, 1999 and the three and nine months ended June 30, 2000 and expect to continue to do so, we do not anticipate that foreign exchange gains and losses will be significant. We have not engaged in foreign currency hedging to date, however we may do so in the future.
Al grüßt optimistisch
