ITEM 1. BUSINESS
The discussion in this report on Form 10-K contains forward-looking statements that involve risks and uncertainties. The statements contained in this Report that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements on our expectations, beliefs, intentions or strategies regarding the future. All forward-looking statements included in this document are based on information available to us on the date hereof. We assume no obligation to update any such forward-looking statements. Our actual results could differ materially from those indicated in such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, fluctuations in quarterly operating results, uncertainty in future operating results, litigation, product concentration, competition, technological changes, management of our growth and expansion, integration of acquisitions and other risks discussed in this item under the heading "Factors Affecting Future Operating Results" and the risks discussed in our other Securities and Exchange Commission filings.
Overview
CacheFlow Inc., a Delaware corporation also referred to in this report as "we" or the "Company", was formed on March 13, 1996. We design, develop and market Internet caching appliances that are purpose-built to accelerate and optimize the flow of information over the Internet. Our products are deployed by our customers throughout their network infrastructures to improve the performance of their networks and reduce network costs, while enhancing network security. Customers for our products include large and small Internet service providers, or ISPs, and corporate enterprises. These companies purchase our products in order to improve the performance of their networks and to accelerate and optimize the delivery of content to the end-user over the Internet.
Industry Background
The Internet is dramatically changing the way businesses and individuals communicate and conduct commerce. As a result, the increasing volume of Internet traffic is much more than just web surfing; it's big business. The Gartner Group projects that business-to-business e-commerce revenues will reach $3.9 trillion by 2003. With this rising volume of traffic, Internet and Intranet infrastructures are quickly reaching capacity. Slow response times and site outages due to heavy demand are common outcomes of these overburdened network infrastructures. For organizations that rely on the web for commerce and/or operational purposes, these problems can be expected to have a direct, adverse impact on both the top and bottom lines. For example, Zona Research has published a study that demonstrates how online customers abandon a site after more than an 8-second delay. Many of these customers may simply visit a competitor's site to complete their purchase, potentially never returning to the "troubled" site. In the past, sites that wanted to avoid these issues had little choice but to invest in more infrastructure--more servers, more network equipment, more staff and more data center space.
Now, through the emergence of caching technology, these sites can effectively address the problems of performance, scaling and management. Caching optimizes how content is delivered, either moving it closer to the requesting users or accelerating it outward from the web site. There are two primary types of caching solutions: software-based and appliance. Software- based approaches consist of a caching software application running on a general-purpose operating system like Solaris, Linux or Windows 2000. While these systems offer flexibility, they suffer from complex administration and potential security breaches of the well-known operating
system. Appliances are self-contained solutions which are expressly built for caching. Due to this singular design, they are fast, simple, reliable and secure.
Much as network routing has evolved from a general-purpose to a purpose- built solution, so is caching. The advantages of a specialized appliance are clear. When a device is designed to perform a dedicated task, it will perform that task more effectively than a multi-function alternative. The results of an appliance approach to caching are significant: reduced web response times, simpler administration and management, lower network and data center costs, higher reliability, robust data security and always-accurate content. Driven by these benefits, the caching appliance market is projected to expand from $440 million in 2000 to $2.1 billion by 2003 (source: GartnerGroup/Dataquest).
The CacheFlow Solution
CacheFlow designs, develops, markets, and sells Internet acceleration and content management solutions which include specialized devices that are purpose-built to accelerate and optimize the flow of information over the Internet. Our products improve response time for Internet users and provide network administrators and managers a high degree of control over the access, flow and delivery of Internet content. Our products also reduce the number of redundant requests for information that must be processed and delivered, thus reducing the load on the Internet and corporate networks. The principal benefits of our Internet caching appliances include:
High Performance. Our purpose-built appliances were designed from inception for high-performance Internet caching. Our appliances provide high data throughput and reduce latency, or the time between initiating a request for data and the completion of the actual data transfer. Even content that is not stored in our caching appliances is accelerated when the request for that content goes through a CacheFlow appliance, since our appliances simultaneously retrieve numerous objects from the origin server. In many cases, our appliances double the speed of content delivery.
Ease of Installation and Management. Our products are designed for easy installation and maintenance, reducing the cost and time required for implementation and use. Network managers at ISPs and enterprises generally install our appliances in the same racks that hold their servers and other network equipment. In many cases, our Internet caching appliances can be installed in under thirty minutes. All of or products provide customers with a range of management features, functions, user interfaces and modes of operation. In addition, the software and operating systems of our appliances are designed to efficiently interact with our customers' existing networking equipment.
Attractive Return on Investment. By allowing content to be served from a cache located closer to the user, instead of the origin server on the Internet, enterprises and ISPs employing our Internet caching appliances require less network capacity and can reduce data transmission costs. Our customers better utilize the capacity of their existing network since redundant traffic is removed from the network and served from the cache. The need for enterprises engaged in e-commerce to purchase additional servers can be reduced since our Internet caching appliances eliminate a significant amount of traffic that could otherwise overload their existing servers, requiring incremental server capacity. Our products also help to improve the productivity of Internet users by reducing web response time. Faster downloading of web content increases productivity and end-user satisfaction.
Security. Our appliances run on a proprietary and purpose-built operating system. CacheOS is designed to be less vulnerable to unauthorized entry than caches based on more commonly understood, general-purpose operating systems, such as Windows NT, UNIX or NetWare. Because it was designed specifically for caching, CacheOS consists of far fewer lines of code than general-purpose operating systems, creating fewer potential bugs and fewer potential ways to break into the operating system. In addition, CacheOS employs authentication and filtering capabilities that prohibit unauthorized users from accessing or penetrating through the cache.
Broad Product Suite. Enterprises and ISPs have varying capacity, reliability and data throughput needs, depending on the size and nature of their operations. We offer a wide range of products to meet different price, performance and reliability requirements, and provide an upgrade path to our customers as they expand their networks. Our products can be deployed in a variety of environments, ranging from small or remote network locations to large ISPs or enterprise headquarters.
Delivery of Fresh Web Content. Moving content closer to the user increases network efficiency, but creates the risk that the content delivered is not up-to-date, or fresh. Internet caching appliances store content, but do not originate or own that content, so in order to provide fresh content, caches must monitor the source of content for changes. Unlike traditional caches that have no mechanisms to monitor and ensure freshness, our Internet caching appliances actively check the origin servers and update content through efficient and sophisticated algorithms that monitor user activity and the frequency with which source content is changed without requiring additional capacity or adversely affecting response time. These algorithms are managed through a control mechanism that allows the network administrator to easily set the level of freshness delivered by the cache. The algorithms are self-adapting based on the administrative settings.
Ability to Manage the Flow of Content. Our Internet caching appliances are installed at points in the Internet infrastructure where all of the content being requested by a user can flow through our appliances. Our appliances are able to take advantage of their placement at this network juncture to provide a range of additional value-added services, including user authentication, content filtering, user tracking and control of cached content.
Customers and Applications
Customers have purchased and used our products for a variety of different applications. ISPs typically use our products to help generate new sources of revenue from content providers and/or content consumers (e.g. broadband services, web hosting, content distribution, etc.), or to reduce their operating costs by improving their use of network capacity or facilities. Enterprises typically use our products for handling e-commerce related traffic and as a replacement for proxy servers. Backlog for products ordered but not yet shipped was $14.1 million, none and none for the three years ended April 30, 2000, 1999 and 1998.
The following are our principal target markets:
Service Providers
Competition in the service provider market is intense. As a result service providers are consistently looking for competitive advantage. Competitive advantage typically comes in one of two forms, additional value added services which become incremental sources of revenue, or reduced operating costs which contribute to improved profitability. Our products can help service providers at both.
Bandwidth gain reduces service provider operating costs. Our caching appliances store and serve the most frequently requested Internet content closer to the users requesting that content. By deploying our products throughout their network, service providers can increase the quantity of customers they can service without adding to the traffic levels on their backbone, or adding to the network capacity that they purchase from other service providers. This "bandwidth gain," allows them to improve quality of service for existing customers and provide the infrastructure to scale for new customer additions, all while preserving valuable network capacity and in turn controlling operating costs.
Improved performance attracts more revenues from end user customers. This is most apparent amongst the new broadband service providers. Broadband ISPs, using DSL or cable infrastructure to offer high- speed Internet access, enable the delivery of a wide range of new content and the ability to make the Internet a truly interactive medium. However, while these solutions offer faster access speeds from the user to their ISP, they do not shorten the physical distance between user and web content or reduce network traffic congestion on the Internet itself. For example, it does not help to build a twelve-lane on-
ramp to a highway if the highway itself has only two lanes and it is congested. Despite the ability to move content more quickly, broadband networks still frequently suffer diminished performance when content must be transmitted many times over the same network path or when many users request the same content from the origin server simultaneously. These problems are particularly acute when the content being transmitted includes large files, which is the nature of broadband content such as video. Therefore, faster access speeds do not necessarily result in significantly faster response times when a user is accessing web content that originated across the Internet. Consumers, therefore, may not enjoy the full benefit that they expect from broadband. Our appliances can enhance the capabilities of a broadband network, helping broadband ISPs compete to attract and retain customers. Our products help broadband providers deliver better performance to their customers. This gives broadband providers that use our products a competitive advantage over their competitors that do not use our products.
Value added services attracts more revenues from content provider customers. Content hosting service providers are seeking to capitalize on the growth of e-commerce. These companies manage the e-commerce infrastructure and networks for third party content providers, allowing them to focus on content and customers rather than network management. Content hosting providers are using caching to accelerate the performance of their hosted customers' e-commerce sites. To generate performance improvements, service providers deploy caches in various geographically dispersed data center locations and distribute site content to these caches. When an online user accesses a Web site, they are actually directed to the cache in close proximity to their location. Since content does not have to travel through as many network points to reach its destination, users see faster response times, resulting in a more productive web experience.
Enterprise Proxy Server Replacement
The amount of data traffic over many enterprise networks has increased significantly. For many enterprises, exchanging and accessing information over their intranets and from the Internet is a strategically important tool in increasing productivity. With this dependence on remote sources of information, enterprises face a number of risks, including end user access of inappropriate content, unauthorized outside entities gaining access to their networks, unpredictable network traffic volumes, and new traffic types that, if not controlled, could have adverse effects on network capacity and performance. Proxy servers are devices that allow the network administrator to implement corporate policies to control the flow of information in and out of the network. However, the growth in data traffic in large enterprises has outpaced the growth in proxy server capacity, forcing many network administrators to choose between accommodating growth and maintaining control. The growth in Internet usage has created a number of difficulties with the performance, management and reliability of existing proxy server solutions. Our appliances are designed to replace proxy servers in enterprise networks, enabling Web-dependent organizations to improve the performance of their networks.
E-commerce
Many organizations have come to rely on their web sites as a means of attracting new customers and generating additional revenue. Increased business use of the Internet, coupled with the widespread adoption of e- commerce by consumers, has resulted in large amounts of traffic flowing to e-commerce sites. Many organizations' current network infrastructures are incapable of handling this increase in traffic, resulting in overburdened firewalls, which are network security systems, and e-commerce servers, which are used to process commercial transactions over the Internet, resulting in fewer transactions per day for the e-commerce site. Furthermore, slower response times and poor quality of service can lead consumers to become dissatisfied with the e-commerce experience and either stop making web purchases or go to a competitor's web site where performance is better, which can result in a loss of potential revenues. Deploying caches as part of an e-commerce infrastructure solution can improve capacity, throughput and response times, while helping to reduce costs. By storing and delivering frequently requested content from
caches deployed at the network boundary, congested e-commerce sites can decrease the traffic load from Web servers and firewalls. This can result in a network that can serve more Web pages faster, improving the end-user experience and enabling the infrastructure to support more transactions.
Products
All of our products are designed as integrated appliances, which are specialized hardware platforms coupled tightly with our CacheOS operating system. We have specialized our products around several attributes including type of content (traditional web or streaming), type of customer (service provider, enterprise, or ecommerce), and type of deployment (content provider or content consumer). These specializations allow us to meet the different price, performance, capacity, feature set, and reliability requirements of both our customers and our potential customers in each of our target market segments.
Current Products include:
100 Series--The CacheFlow 110 Internet caching appliance, the sole model within the 100 Series, is designed for use by small ISPs and corporate branch or remote offices. The CacheFlow 110 is designed to support Internet traffic loads of up to 1.5 million bits per second or the equivalent speed of a T-1 connection.
500 Series--The CacheFlow 500 Series includes our 515, 525 and 545 Internet caching appliances, which are specifically designed to support ISPs and enterprises with Internet connections up to 15 million bits per second. The CacheFlow 500 Series is typically deployed in front of web servers, which are used to publish information on the Internet, and firewalls, which are network security systems, and is used for accelerating the delivery of content to ISP and enterprise users.
3000 Series--The CacheFlow 3000 Series is comprised of high-performance Internet caching appliances designed specifically to support ISPs and enterprises with Internet connections from 10 to 45 million bits per second or the equivalent speed of a T-3 connection. Our 3000 Series is expandable, providing our customers with the ability to add capacity to the appliance as their needs grow.
5000 Series--The CacheFlow 5000 Series is comprised of high-performance Internet caching appliances designed for high scalability and reliability. The CacheFlow 5000 is highly scalable, designed to support traffic loads ranging from 45 million bits per second or the equivalent speed of a T-3 connection, to more than 155 million bits per second, the equivalent speed of an OC-3 connection. Our 5000 Series can contain up to three separate AC or DC power supplies to allow uninterrupted operation and is expandable, providing our customers with the ability to add capacity to the appliances as their needs grow.
The CacheFlow Strategy
Our objective is to be a leading provider of Internet acceleration and content management solutions by delivering high-performance, innovative Internet caching appliances. Key elements of our strategy include the following:
Apply our Content Management Focus to Targeted Market Segments. Since our inception, we have focused exclusively on developing Internet caching appliances. We believe this exclusive focus helps us to rapidly identify and target attractive market opportunities. We are directing our product development, marketing and sales activities at specific market segments that we believe represent attractive opportunities based on a demonstrated need for caching, the opportunity to sell to numerous customers and the level of existing competition. We are focused on three market segments: service providers, enterprise proxy server replacement, and e- commerce/distributed content services. We intend to use our customer relationships in these market segments to further penetrate these segments as well as other related markets.
Enhance Capabilities of our Appliances. We intend to use our technological expertise to meet the needs of the evolving Internet acceleration and content management market. We plan to continue to
develop both the software and hardware elements of our solution to gain and maintain a competitive advantage and expand the market for our products. Our additional efforts to enhance the capabilities of our appliances include adding more functionality to control the flow of content, customizing hardware and software to enhance performance and developing enhancements to improve ease of deployment.
Broaden Distribution Channels. We intend to extend our distribution channels to meet the anticipated growth in demand for Internet caching appliances. We plan to continue to expand both our direct and indirect sales channels in order to continue to extend our marketing reach and increase our volume distribution. In particular, we plan to enter into relationships with additional resellers, systems integrators and original equipment manufacturers to increase penetration of the enterprise and ISP markets.
Build the CacheFlow Brand. We intend to establish CacheFlow as the premier brand in the Internet acceleration and content management market. We believe that brand awareness is important to increase market acceptance of Internet caching appliances generally and to identify us as a leading provider of Internet caching appliance solutions. We intend to continue to educate customers, resellers, systems integrators and original equipment manufacturers about the value of implementing caching appliances. We believe a thorough process of explanation and education of our products will help to promote brand recognition and to further an overall acceptance and understanding of caching appliances. To this end, we intend to increase our investments in a broad range of marketing and educational programs.
Strategic Relationships
We believe that our business benefits greatly from working closely with other leading communications infrastructure suppliers. By collaborating with others, we are able to design products that interoperate more effectively with other network devices, add features and functionality to our products and expand our distribution channels, enabling us to access additional customers and markets. We have recently established strategic relationships with several companies, including:
Alcatel
Alcatel is a leading global manufacturer of communications infrastructure for telecommunications and data networks. We entered into an OEM agreement with Alcatel that enables Alcatel to resell our Internet caching appliances. Alcatel has a strong international presence and large customer base, including international providers of broadband communications services and regional bell operating companies (RBOCs) in the United States.
Akamai
Akamai provides a content delivery service that improves Web site speed and reliability. We entered into a strategic alliance with Akamai. The alliance includes an initiative to integrate caching and content delivery technologies to accelerate and optimize Web performance. The product is designed to automate the process of distributing information to caching servers, significantly decreasing the time required for customers to implement Akamai's services. The combined solution will help E-commerce and content sites better service online customers through enhanced performance, scalability and reliability. In addition to the technology integration, we obtained the right to resell Akamai's Freeflow caching services and Akamai obtained the right to sell our caching appliances.
Computer Sciences Corporation
Computer Sciences Corporation , or CSC, is one of the world's leading consulting and IT services firms. We entered into a global reseller agreement with CSC that enables CSC to integrate CacheFlow appliances into solutions offered by its Global Infrastructure Services Group.
Electronic Data Systems
EDS is a global leader in providing e-business and information technology services. We entered into a global reseller agreement with EDS. The agreement enables EDS to integrate CacheFlow Internet caching
appliances with other technologies to deliver complete solutions to enterprise, e-commerce and government customers.
Hewlett-Packard
Hewlett-Packard is a global provider of computing and imaging solutions and services. We entered into a joint product development and reseller partnership with Hewlett-Packard. The alliance also includes a global reseller agreement.
WestCon
WestCon is a global channel provider of networking technology products. We entered into a distribution agreement with WestCon. They will serve as CacheFlow's primary distribution arm within North America.
Sales and Marketing
We utilize a combination of our direct sales force, resellers, systems integrators and original equipment manufacturers as appropriate for each of our target markets. We support our distribution channels with systems engineers and customer support personnel that provide technical service and support to our customers. We have entered into agreements with resellers and network equipment providers such as Akamai, Alcatel, CSC, EDS, Hewlett Packard, Lucent Technologies, Nissho Electronics, Sumitronics and WestCon. We intend to pursue relationships with additional resellers and original equipment manufacturers to implement our distribution strategy and to expand our customer base. We have also been expanding our sales force rapidly, and plan to continue to do so in the future.
Our marketing efforts focus on increasing the market awareness of our products and technology and promoting the CacheFlow brand. Our strategy is to create this awareness by distinguishing our products based on their high level of performance. We have a number of marketing programs to support the sale and distribution of our products and to inform existing and potential customers within our target market segments about the capabilities and benefits of our products. Our marketing efforts include participation in industry tradeshows, preparation of competitive analyses, sales training, maintenance of our web site, advertising and public relations.
Research and Development
Following our inception in March 1996, we developed the first version of CacheOS, which was specifically designed as the operating platform for our Internet caching appliances. Our research and development efforts are focused on developing technological improvements to and new versions of our Internet caching appliances. Research and development expenses were $9.6 million, $4.0 million, and $2.4 million for the fiscal years ended April 30, 2000, 1999, and 1998, respectively.
Our research and development team consists of engineers with extensive backgrounds in operating systems, algorithms, computer science and network engineering. We believe that the experience and capabilities of our research and development professionals represents a competitive advantage for CacheFlow. In June 2000, the Company acquired SpringBank Networks, adding additional engineers to our staff as well as complimentary technology. We have worked closely with several of our customers in developing and enhancing our products. Our current research and development efforts are primarily focused on three strategic initiatives:
developing Internet caching appliances to address price/performance points for which we do not currently offer products;
improving the performance of our Internet caching appliances, including data throughput and response time; and
adding new features and strengthening the existing features of our Internet caching appliances to give them enhanced capabilities.
We expect that most of the enhancements to our existing and future products will be accomplished by a combination of internal development and acquisition. However, we currently license some technologies and will continue to evaluate externally developed solutions for integration into our products.
Manufacturing
We currently outsource the manufacturing of all of the subassemblies and components of our Internet caching appliances, including printed circuit boards, custom power supplies, chassis, cables and subassemblies, to third parties, and we perform final assembly and testing in-house. This approach allows us to reduce investment in manufacturing capital and to take advantage of the expertise of our vendors. Our internal manufacturing operations consist primarily of prototype development, materials planning and procurement, final assembly, testing and quality control. We plan to subcontract final assembly to third parties in the future. Our standard parts and components are generally available from more than one vendor. We typically obtain these components through purchase orders and currently do not have contractual relationships or guaranteed supply arrangements with these suppliers. If one of these vendors ceased to provide us with necessary parts and components, we would likely encounter delays in product production as we make the transition to another vendor. We recently hired a Senior Vice President of Manufacturing to implement new manufacturing strategies and optimize product quality and cost.
Competition
The market for Internet caching solutions is intensely competitive, evolving and subject to rapid technological change. The intensity of competition is expected to increase in the future. Increased competition is likely to result in price reductions, reduced gross margins and loss of market share, any one of which could seriously harm our business. We may not be able to compete successfully against current or future competitors and we cannot be certain that competitive pressures we face will not seriously harm our business. Our competitors vary in size and in the scope and breadth of the products and services they offer. We primarily encounter competition from a variety of companies, including Cisco Systems, Inktomi, Network Appliance, Novell, and various others using publicly available, free software. In addition, because there are relatively low barriers to entry in the Internet caching market, we expect additional competition from other established and emerging companies as the market for Internet caching continues to develop and expand.
Many of our current and potential competitors have longer operating histories, significantly greater financial, technical, marketing and other resources, significantly greater name recognition and a larger installed base of customers than we do. In addition, many of our competitors have well- established relationships with our current and potential customers and have extensive knowledge of our industry. As a result, our competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements, or to devote greater resources to the development, marketing, promotion and sale of their products than we can. Current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the market acceptance of their products. In addition, our competitors may be able to replicate our products, make more attractive offers to existing and potential employees and strategic partners, more quickly develop new products or enhance existing products and services, or bundle Internet caching appliances in a manner that we cannot provide. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. We also expect that competition will increase as a result of industry consolidation.
Intellectual Property and Other Proprietary Rights
We depend significantly on our ability to develop and maintain the proprietary aspects of our technology. To protect our proprietary technology, we rely primarily on a combination of contractual provisions,
confidentiality procedures, trade secrets, copyright and trademark laws and patents. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or obtain and use information that we regard as proprietary. Policing unauthorized use of our products is difficult. In addition, the laws of some foreign countries do not protect our proprietary rights to as great an extent as do the laws of the United States. Our means of protecting our proprietary rights may not be adequate and our competitors may independently develop similar technology, duplicate our products or design around patents that may be issued to us or our other intellectual property.
We presently have several pending United States patent applications and several pending patent applications in foreign patent offices. Although we have not been issued any patents to date, one patent application pending before the United States Patent Office has been allowed and is expected to issue as a United States patent.
We cannot assure you that any U.S. or international patent will be issued from these applications. Even if patents are issued, we cannot assure you that we will be able to detect any infringement or, if infringement is detected, that patents issued will be enforceable or that any damages awarded to us will be sufficient to adequately compensate us.
There can be no assurance or guarantee that any products, services or technologies that we are presently developing, or will develop in the future, will result in intellectual property that is protectable under law, whether in the United States or a foreign jurisdiction, that this intellectual property will produce competitive advantage for us or that the intellectual property of competitors will not restrict our freedom to operate, or put us at a competitive disadvantage.
We rely on technology that we license from third parties, including software that is integrated with internally developed software and used in CacheOS to perform key functions. For example, we license subscription filtering technology from Secure Computing. If we are unable to continue to license any of this software on commercially reasonable terms, we will face delays in releases of our software or will be required to drop this functionality from our software until equivalent technology can be identified, licensed or developed, and integrated into our current product. Any of these delays could seriously harm our business.
There has been a substantial amount of litigation in the technology industry regarding intellectual property rights. It is possible that in the future third parties may claim that we or our current or potential future products infringe their intellectual property. We expect that companies in the Internet and networking industries will increasingly be subject to infringement claims as the number of products and competitors in our industry segment grows and the functionality of products in different industry segments overlaps. Any claims, with or without merit, could be time-consuming, result in costly litigation, cause product shipment delays or require us to enter into royalty or licensing agreements. Royalty or licensing agreements, if required, may not be available on terms acceptable to us or at all, which could seriously harm our business.
Employees
As of April 30, 2000, we had a total of 306 employees, including 68 in research and development, 173 in sales, marketing and customer support, 26 in manufacturing and 39 in general and administrative. Of these employees, 246 were located in North America with 60 located internationally. None of our employees is represented by collective bargaining agreements, nor have we experienced any work stoppages. We consider our relations with our employees to be good.
Our future operating results depend significantly upon the continued service of our key technical, sales and senior management personnel, many of whom are not bound by an employment agreement. Competition for these personnel is intense, and we may not be able to retain them in the future. Our future success also depends upon our continuing ability to attract and retain highly qualified individuals. We may experience difficulties managing our expected growth and performance if we are unable to attract and retain qualified personnel.
FACTORS AFFECTING FUTURE OPERATING RESULTS
The discussion in this report on Form 10-K contains forward-looking statements that involve risks and uncertainties. The statements contained in this Report that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements on our expectations, beliefs, intentions or strategies regarding the future. All forward-looking statements included in this document are based on information available to us on the date hereof. We assume no obligation to update any such forward-looking statements. Our actual results could differ materially from those indicated in such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, fluctuations in quarterly operating results, uncertainty in future operating results, litigation, product concentration, competition, technological changes, management of our growth and expansion, integration of acquisitions and other risks discussed in this item under the heading "Factors Affecting Future Operating Results" and the risks discussed in our other Securities and Exchange Commission filings.
Risks Related to Our Business
We only began selling our products in May 1998 and, as a result, you may have difficulty evaluating our business and operating results.
We were founded in March 1996 and did not sell any products or services until May 1998. The market for our products is unproven. Our limited operating history makes an evaluation of our future prospects very difficult. We expect to encounter risks and difficulties frequently encountered by early stage companies in new and rapidly evolving markets. Many of these risks are described in more detail in this "Factors Affecting Future Operating Results" section. Our business will be seriously harmed if we do not successfully execute our business strategy or if we do not successfully address the risks we face.
We have a history of losses, expect to incur future losses and may never achieve profitability, which could result in the decline of the market price of our common stock.
We incurred net losses available to common stockholders of $62.7 million and $13.2 million for the years ended April 30, 2000 and 1999. As of April 30, 2000, we had an accumulated deficit of $82.8 million. We have not had a profitable quarter since our inception and we expect to continue to incur net losses in the future. To date, we have funded our operations from the sale of equity securities and through bank loans and equipment leases.
We expect to continue to incur significant operating expenses and, as a result, we will need to generate significant revenues if we are to achieve profitability. We may never achieve profitability. We expect to incur substantial non-cash costs relating to the amortization of deferred compensation, which will contribute to our net losses. As of April 30, 2000, we had an aggregate of $43.5 million of deferred compensation to be amortized. The Company may record additional compensation expense in the future if management decides to grant below-market stock options in order to attract and retain employees in a highly competitive labor market.
Because we expect our sales to fluctuate and our costs are relatively fixed in the short term, our ability to forecast our quarterly operating results is limited, and if our quarterly operating results are below the expectations of analysts or investors, the market price of our common stock may decline.
Our net sales and operating results are likely to vary significantly from quarter to quarter. We believe that quarter-to-quarter comparisons of our operating results should not be relied upon as indicators of future performance. It is likely that in some future quarter or quarters, our operating results will be below the expectations of public market analysts or investors. When this occurs, the price of our common stock could decrease significantly. A number of factors are likely to cause variations in our net sales and operating results, including factors described in this "Factors Affecting Future Operating Results" section.
We cannot reliably forecast our future quarterly sales for several reasons, including:
we have a limited operating history, and the market in which we compete is relatively new and rapidly evolving;
delays or cancellations of orders by a few customers can significantly impact net sales within a quarter; and
our sales cycle varies substantially from customer to customer.
A high percentage of our expenses, including those related to research and development, sales and marketing, general and administrative functions and amortization of deferred compensation, are essentially fixed in the short term. As a result, if our net sales are less than forecasted, our quarterly operating results are likely to be seriously harmed.
We expect increased competition and, if we do not compete effectively, we could experience a loss in our market share and sales.
The market for Internet caching solutions is intensely competitive, evolving and subject to rapid technological change. The intensity of competition is expected to increase in the future. Increased competition is likely to result in price reductions, reduced gross margins and loss of market share, any one of which could seriously harm our business. We may not be able to compete successfully against current or future competitors and we cannot be certain that competitive pressures we face will not seriously harm our business. Our competitors vary in size and in the scope and breadth of the products and services they offer. We primarily encounter competition from a variety of companies, including Cisco Systems, Inktomi, Network Appliance, Novell, and various others using publicly available, free software. In addition, because there are relatively low barriers to entry in the Internet caching market, we expect additional competition from other established and emerging companies as the market for Internet caching continues to develop and expand.
Many of our current and potential competitors have longer operating histories, significantly greater financial, technical, marketing and other resources, significantly greater name recognition and a larger installed base of customers than we do. In addition, many of our competitors have well- established relationships with our current and potential customers and have extensive knowledge of our industry. As a result, our competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements, or to devote greater resources to the development, marketing, promotion and sale of their products than we can. Current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the market acceptance of their products. In addition, our competitors may be able to replicate our products, make more attractive offers to existing and potential employees and strategic partners, more quickly develop new products or enhance existing products and services, or bundle Internet caching appliances in a manner that we cannot provide. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. We also expect that competition will increase as a result of industry consolidation.
Our variable sales cycle makes it difficult to predict the timing of a sale or whether a sale will be made, which makes our quarterly operating results less predictable.
Because customers have differing views on the strategic importance of implementing Internet caching appliances, the time required to educate customers and sell our products can vary widely. As a result, the evaluation, testing, implementation and acceptance procedures undertaken by customers can vary, resulting in a variable sales cycle, which can take as long as 9 months. While our customers are evaluating our products and before they place an order with us, we may incur substantial sales and marketing expenses and expend significant management efforts. Sales cycles for our products that are sold to enterprises have traditionally been longer than sales cycles for our products that are sold to Internet service providers, or ISPs. We expect that sales to enterprises will increase as a percentage of our total sales over time, and, accordingly, we expect that the average sales cycle for our products will increase. In addition, purchases of our products are frequently
subject to unplanned processing and other delays, particularly with respect to larger customers for whom our products represent a very small percentage of their overall purchase activity. Large customers typically require approvals at a number of management levels within their organizations, and, therefore, frequently have longer sales cycles.
We are entirely dependent on market acceptance of our Internet caching appliance product family and, as a result, a decline in sales or lack of market acceptance of these products could cause our sales to fall.
To date, our Internet caching appliance product family and related services have accounted for all of our net sales. We anticipate that revenues from our current product family and services will continue to constitute substantially all of our net sales for the foreseeable future. As a result, a decline in the prices of, or demand for, our current product family and services, or their failure to achieve broad market acceptance, would seriously harm our business. The CacheFlow 100 Series, 500 Series, 3000 Series and 5000 Series products are the only products that we currently sell. Our CacheFlow 1000 Series and 2000 Series products, which have historically accounted for a substantial portion of our net sales, have been discontinued and replaced by our recently introduced CacheFlow 3000 Series products. We introduced our 3000 Series product in September 1999 and our 5000 Series product in June 1999. We cannot be certain that our CacheFlow 3000 Series or 5000 Series products will continue to achieve any significant degree of market acceptance.
If we are unable to introduce new products and services that achieve market acceptance quickly, we could lose existing and potential customers and our sales would decrease.
We need to develop and introduce new products and enhancements to existing products on a timely basis that keep pace with technological developments and emerging industry standards and address the increasingly sophisticated needs of our customers. We intend to extend the offerings under our product family in the future, both by introducing new products and by introducing enhancements to our existing products. However, we may experience difficulties in doing so, and our inability to timely and cost-effectively introduce new products and product enhancements, or the failure of these new products or enhancements to achieve market acceptance, could seriously harm our business. Life cycles of our products are difficult to predict, because the market for our products is new and evolving and characterized by rapid technological change, frequent enhancements to existing products and new product introductions, changing customer needs and evolving industry standards. The introduction of competing products that employ new technologies and emerging industry standards could render our products and services obsolete and unmarketable or shorten the life cycles of our products and services. The emergence of new industry standards might require us to redesign our products. If our products are not in compliance with industry standards that become widespread, our customers and potential customers may not purchase our products.
Because we depend on several third-party manufacturers to build portions of our products, we are susceptible to manufacturing delays and sudden price increases, which could prevent us from shipping customer orders on time, if at all, and may result in the loss of sales and customers.
We rely on several third-party manufacturers to build portions of our products. If we are unable to manage our relationships with these manufacturers effectively or if these manufacturers fail to meet our future requirements for timely delivery, our business would be seriously harmed. We have no written agreement with any of these manufacturers and they fulfill our supply requirements on the basis of individual purchase orders from us. Accordingly, these manufacturers are not obligated to continue to fulfill our supply requirements, and the prices we are charged for these components could be increased on short notice. Any interruption in the operations of any one of these manufacturers would adversely affect our ability to meet our scheduled product deliveries to our customers, which could cause the loss of existing or potential customers and would seriously harm our business. In addition, the products that these manufacturers build for us may not be sufficient in quality or in quantity to meet our needs. Our delivery requirements could exceed the capacity of these manufacturers, which would likely result in manufacturing delays, which could result in lost sales and the loss
of existing and potential customers. We cannot be certain that these manufacturers or any other manufacturer will be able to meet the technological or delivery requirements of our current products or any future products that we may develop and introduce. The inability of these manufacturers or any other of our contract manufacturers in the future to provide us with adequate supplies of high-quality products, or the loss of any of our contract manufacturers in the future, would cause a delay in our ability to fulfill customer orders while we attempt to obtain a replacement manufacturer. Delays associated with our attempting to replace or our inability to replace one of our manufacturers would seriously harm our business.
We may experience production delays, quality control problems and assembly capacity constraints in assembling our products, which could result in a decline of sales.
We currently conduct most of the final assembly and all of the testing of our products at our headquarters in Sunnyvale, California. We have transitioned final assembly for some of our products to third parties and we may transition additional final assembly in the future. If we were unable to identify a third- party final assembler, we would be required to make additional capital investments in new or existing assembly facilities. To the extent any capital investments are required, our gross margins and, as a result, our business could be seriously harmed. We may experience production interruptions or quality control problems in connection with any transition of final assembly, either of which would seriously harm our business. Either any third-party assembler or we may experience substantial assembly capacity constraints. In the event of any capacity constraints we may be unable to accept certain orders from, and deliver products in a timely manner to, our customers. This could result in the loss of existing or potential customers and would seriously harm our business.
Because some of the key components in our products come from limited sources of supply, we are susceptible to supply shortages or supply changes, which could disrupt or delay our scheduled product deliveries to our customers and may result in the loss of sales and customers.
We currently purchase several key parts and components used in the manufacture of our Internet caching appliances from limited sources of supply. For example, we purchase custom power supplies and Intel hardware for use in all of our Internet caching appliances. The introduction by Intel or others of new versions of their hardware, particularly if not anticipated by us, could require us to expend significant resources to incorporate this new hardware into our products. In addition, if Intel or others were to discontinue production of a necessary part or component, we would be required to expend significant resources in locating and integrating replacement parts or components from another vendor. Qualifying additional suppliers for limited source components can be time-consuming and expensive. Any of these events would be disruptive to us and could seriously harm our business. Further, financial or other difficulties faced by these suppliers or unanticipated demand for these parts or components could limit the availability of these parts or components. Any interruption or delay in the supply of any of these parts or components, or the inability to obtain these parts or components from alternate sources at acceptable prices and within a reasonable amount of time, would seriously harm our ability to meet our scheduled product deliveries to our customers.
Our use of rolling forecasts could lead to excess or inadequate inventory, which could seriously harm our business.
We use rolling forecasts based on anticipated product orders, product order history and backlog to determine our materials requirements. Lead times for the parts and components that we order vary significantly and depend on factors such as the specific supplier, contract terms and demand for a component at a given time. If actual orders do not match our forecasts, we may have excess or inadequate inventory of some materials and components, which would increase our costs or prevent or delay product shipments and could seriously harm our business.
We are dependent upon key personnel and we must attract, assimilate and retain other highly qualified personnel in the future or our ability to execute our business strategy or generate sales could be harmed.
Our business could be seriously disrupted if we do not maintain the continued service of our senior management, research and development and sales personnel. All of our employees are employed on an "at-will" basis. Our ability to conduct our business also depends on our continuing ability to attract, hire, train and retain a substantial number of highly skilled managerial, technical, sales, marketing and customer support personnel. New hires frequently require extensive training before they achieve desired levels of productivity, so a high employee turnover rate could seriously impair our ability to operate and manage our business. We are particularly dependent on hiring additional personnel to increase our direct sales and research and development organizations. Competition for personnel is intense, especially in the San Francisco Bay Area, and we may fail to retain our key employees, or attract, assimilate or retain other highly qualified personnel in the future. If so, our business would be seriously harmed.
Our management team is new, and our business could be seriously harmed if integration of our management team into our company is not successful.
We have recently experienced significant transition in our management team. Brian NeSmith, our President and Chief Executive Officer, joined us in March 1999. Additionally, many members of our senior management team have joined the company within the past 12 months. Our business could be seriously harmed if integration of our management team into our company is not successful. We expect that it will take time for our new management team to integrate into our company and it is too early to predict whether these changes will be successful.
In order to manage our growth and expansion, we will need to improve and implement new systems, procedures and controls, which could be time-consuming and costly.
We have expanded our operations rapidly since the inception of our company and we currently intend to continue this expansion. This expansion of our operations has placed and is expected to continue to place a significant strain upon our management systems and financial and operational resources. If we are unable to effectively manage future growth and expansion, our business will be seriously harmed. We currently have research and development facilities in Sunnyvale, California, Redmond, Washington and Waterloo, Ontario, Canada. The coordination and management of these product development organizations that are located at different sites requires significant management attention and coordination, particularly from our managerial and engineering organizations. If we are unable to coordinate and manage these separate development organizations, our business will be seriously harmed.
Our ability to compete effectively and to manage future expansion of our operations will require us to continue to improve our financial and management controls, reporting systems and procedures on a timely basis, and expand, train and manage our employee work force. The number of our employees increased from 40 at April 30, 1998 to 306 at April 30, 2000, and we plan to further increase our headcount. We recently implemented a new enterprise resource planning software system that replaced substantially all of our business and manufacturing systems. While we have not had significant problems to date, we may encounter difficulties in transitioning to the new enterprise resource planning software system. Even after we implement this system, our personnel, systems, procedures and controls may be inadequate to support our future operations.
If we fail to expand our direct and indirect sales channels, our sales will not grow.
We need to substantially expand our direct sales operations, both domestically and internationally, in order to increase market awareness and sales of our products and services. Our products and services require a sophisticated sales effort targeted at senior management of our customers. We have recently expanded our direct sales force and plan to hire additional sales personnel. New hires will require extensive training and
typically take several months to achieve productivity. Competition for qualified sales personnel is intense, and we might not be able to hire the kind and number of sales personnel we are targeting. If we fail to increase our direct sales capabilities as we have planned, our business will be seriously harmed.
We also need to expand our indirect sales channels, and if we fail to do so our ability to market and sell our products could be seriously harmed. We depend on our indirect sales channels, which include resellers, systems integrators and original equipment manufacturers, for a significant percentage of our net sales. For example, for the year ended April 30, 2000, approximately 55% of our net sales resulted from sales through indirect channels. Our agreements with our indirect channel partners are generally not exclusive and in many cases may be terminated by either party without cause. Many of these indirect channel partners do not have minimum purchase or resale requirements and carry products that are competitive with our products. These resellers may not give a high priority to the marketing of our products or may not continue to carry our products. They may give a higher priority to other products, including the products of competitors. We may not retain any of our current indirect channel partners or successfully recruit new indirect channel partners. Events or occurrences of this nature could seriously harm our business.
If we are unable to expand our customer service and support organization, we may not be able to retain our existing customers or attract new customers, and our sales may decline.
We currently have a small customer service and support organization and will need to increase our capabilities to support new customers and the expanding needs of our existing customers. If we are unable to expand our customer service and support organization, we may not be able to retain our existing customers or attract new customers.
We may not be able to enter into new international markets or generate a significant level of sales from the international markets in which we currently operate.
For the fiscal year ended April 30, 2000, sales to customers outside of the United States and Canada accounted for approximately 48% of our net sales. We expect international customers to continue to account for a significant percentage of net sales in the future, but we may fail to maintain or increase international market demand for our products. Also, because our international sales are currently denominated in United States dollars, an increase in the value of the United States dollar relative to foreign currencies could make our products more expensive and, therefore, potentially less competitive in international markets, and this would decrease our international sales. Our ability to expand international sales depends on our ability to expand our international operations, including establishing manufacturing assembly capabilities overseas, hire international personnel and recruit additional international resellers. To the extent we are unable to do so in a timely manner, our growth, if any, in international sales will be limited and our business could be seriously harmed. In addition, if we fail to expand and improve our worldwide operating systems, our ability to accurately forecast sales demand, manage our supply chain and record and report financial and management information will be adversely affected, seriously harming our business.
Undetected software or hardware errors could cause us to incur significant warranty and repair costs and negatively impact the market acceptance of our products.
Our products may contain undetected software or hardware errors. These errors may cause us to incur significant warranty and repair costs, divert the attention of our engineering personnel from our product development efforts and cause significant customer relations problems. The occurrence of these problems could result in the delay or loss of market acceptance of our products and would likely seriously harm our business. All of our products operate on our internally developed CacheOS operating system. As a result, any error in CacheOS will affect all of our products. We have experienced minor errors in the past in connection with new products. We expect that errors will be found from time to time in new or enhanced products after commencement of commercial shipments.
We could be subject to product liability claims, which are time-consuming and costly to defend.
Our customers install our Internet caching appliances directly into their network infrastructures. Any errors, defects or other performance problems with our Internet caching appliance products could negatively impact our customers' internal networks, resulting in financial or other damages to our customers. Our customers may then seek damages from us for their losses. If a claim were brought against us, we may not have sufficient protection from statutory limitations, or license or contract terms with our customers and any unfavorable judicial decisions could seriously harm our business. We have not experienced any product liability claims to date. However, a product liability claim brought against us, even if not successful, would likely be time- consuming and costly. A product liability claim could seriously harm our business reputation.
Risks Associated with Potential Acquisitions
We consummated a merger with SpringBank Networks in June 2000. If we fail to develop and integrate SpringBank Networks' technology into our products and services, our quarterly and annual operating results may be adversely affected. Other risks we may face with respect to our merger with SpringBank Networks include the potential disruption of our ongoing business and distraction of management; the difficulty of assimilating SpringBank Networks' personnel; and the maintenance of uniform standards, corporate cultures, controls, procedures and policies. Our inability to address any of these risks successfully could harm our business.
We may make acquisitions in the future. Acquisitions of companies, products or technologies entail numerous risks, including an inability to successfully assimilate acquired operations and products, diversion of management's attention, loss of key employees of acquired companies and substantial transaction costs. Some of the products acquired may require significant additional development before they can be marketed and may not generate revenue at levels anticipated by us. Moreover, future acquisitions by us may result in dilutive issuances of equity securities, the incurrence of additional debt, large one-time write-offs and the creation of goodwill or other intangible assets that could result in significant amortization expense. Any of these problems or factors could seriously harm our business.
If the protection of our proprietary technology is inadequate, our competitors may gain access to our technology, and our market share could decline.
We depend significantly on our ability to develop and maintain the proprietary aspects of our technology. If we were unable to do so, our business would be seriously harmed. For a discussion of our efforts to protect our proprietary technology, see "Business--Intellectual Property and Other Proprietary Rights."
If we are unable to raise additional capital, our ability to effectively manage our growth or enhance our products could be harmed.
At April 30, 2000, we had approximately $91.5 million in cash and cash equivalents and $33.8 million in short-term investments. We believe that these amounts will enable us to meet our capital requirements for at least the next twelve months. However, if cash is used for acquisitions or other unanticipated uses, we may need additional capital. The development and marketing of new products and the expansion of indirect channels and associated support personnel will require a significant commitment of resources. In addition, if the market for Internet caching appliances develops at a slower pace than anticipated or if we fail to establish significant market share and achieve a meaningful level of sales, we could be required to raise substantial additional capital. We cannot be certain that additional capital will be available to us on favorable terms, or at all. If we were unable to raise additional capital when we require it, our business would be seriously harmed.
Risks Related to the Internet Caching Appliance Industry
The market for Internet caching appliances is new and unpredictable, and if this market does not develop as we anticipate, our sales may not grow.
Sales of our products depend on increased demand for Internet caching appliances. The market for Internet caching appliances is a new and rapidly evolving market. If the market for Internet caching appliances fails to grow as we anticipate, or grows more slowly than we anticipate, our business will be seriously harmed. Because this market is new, we cannot predict its potential size or future growth rate. Our ability to generate net sales in this emerging market will depend on, among other things, our ability to:
educate potential end users and indirect channel partners about the benefits of Internet caching appliances;
continue to develop our direct sales channel; and
establish and maintain relationships with leading indirect channel partners.
The legal environment in which we operate is uncertain and claims against us could cause our business to suffer.
Our Internet caching appliances operate in part by storing material available on the Internet and making this material available to end users from our appliance. This creates the potential for claims to be made against us, either directly or through contractual indemnification provisions with customers, for defamation, negligence, copyright or trademark infringement, personal injury, invasion of privacy or other legal theories based on the nature, content or copying of these materials. It is also possible that if any information provided through any of our products contains errors, third parties could make claims against us for losses incurred in reliance on this information. Our insurance may not cover potential claims of this type or be adequate to protect us from all liability that may be imposed.
The adoption of laws that impose taxes on Internet commerce could adversely affect our business.
Tax authorities at the international, federal, state and local levels are currently reviewing the appropriate tax treatment of companies engaged in Internet commerce. Many of our customers are engaged in Internet commerce, and any taxes imposed on them may adversely impact their businesses and may result in order cancellations or postponements of product purchases by them, which would seriously harm our business. Laws regarding the Internet remain largely unsettled and the adoption or modification of laws or regulations relating to the Internet, or interpretations of existing law, could seriously harm our business.
Because the sales of our products are dependent on the increased use and widespread adoption of the Internet, if use of the Internet does not develop as we anticipate, our sales may not grow.
Sales of our products depend on the increased use and widespread adoption of the Internet. Our business would be seriously harmed if the use of the Internet does not increase as anticipated or if our ISP customers' Internet-related services are not well received by the marketplace. The acceptance and use of the Internet in international markets, where we derive a large portion of our net sales, are in earlier stages of development than in the United States. If the Internet fails to gain sufficient acceptance in international markets, our business could be seriously harmed. The resolution of various issues concerning the Internet will likely affect the use and adoption of the Internet. These issues include security, reliability, capacity, congestion, cost, ease of access and quality of service. For example, recently certain popular websites experienced denial-of-service attacks, which called into question the ability of these and other websites to ensure the security and reliability of their on- line businesses. Even if these issues are resolved, if the market for Internet- related products and services fails to develop, or develops at a slower pace than anticipated, our business would be seriously harmed.
Governmental regulation of the communications industry may negatively affect our customers and result in decreased demand for our products, which would cause a decline in our sales.
The jurisdiction of the Federal Communications Commission, or FCC, extends to the communications industry, to our customers and to the products that our customers sell. Future regulations set forth by the FCC or other regulatory bodies may adversely affect Internet-related industries. Regulation of our customers may seriously harm our business. For example, FCC regulatory policies that affect the availability of data and Internet services may impede our customers' penetration into some markets. In addition, international regulatory bodies are beginning to adopt standards for the communications industry. The delays that these governmental processes entail may cause order cancellations or postponements of product purchases by our customers, which would seriously harm our business.
Risks Related to Securities Markets
Our stock price is volatile and, as a result, you may have difficulty evaluating the value of our stock, and the market price of our stock may decline.
Since our initial public offering in November 1999, the market price of our common stock has fluctuated significantly. The market price of our common stock may continue to fluctuate significantly in response to the following factors:
variations in our quarterly operating results;
changes in financial estimates or investment recommendations by securities analysts;
changes in market valuations of Internet-related and networking companies;
announcements by us or our competitors of significant contracts, acquisitions, strategic partnerships, joint ventures or capital commitments;
loss of a major customer;
additions or departures of key personnel; and
fluctuations in stock market prices and volumes.
Our stock price volatility may make us susceptible to class action litigation, which is time-consuming and costly to defend.
In the past, securities class action litigation has often been brought against a company following periods of volatility in the market price of the company's securities. We may in the future be the target of similar litigation. If we become engaged in securities class action litigation, our management's attention and resources may be diverted and we may incur substantial costs, resulting in serious harm to our business.
ITEM 2.
ITEM 2. PROPERTIES
We lease approximately 53,000 square feet for our headquarters facility in Sunnyvale, California, under a lease that expires on August 31, 2005. We also lease space for research and development in Redmond, Washington and Waterloo, Ontario, Canada. In addition, we lease space for sales and support in ten metropolitan areas in North America. We also lease space for sales and support in the following countries: Australia, France, Germany, Hong Kong, Japan, People's Republic of China, Singapore, South Korea, Sweden, Taiwan, the Netherlands, United Arab Emirates, and the United Kingdom. These properties are suitable for our current operations; however, the majority of our space is being fully utilized. Therefore, we expect to continue to acquire or lease additional space as we proceed with the planned expansion of our domestic and international operations.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
See the information set forth in the note entitled "Litigation" in Item 8, Note 9 of this Form 10-K.
ITEM 4.
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 the fiscal year ended April 30, 2000.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below are biographical summaries of our executive officers as of July 15, 2000:
Brian NeSmith, 38, has served as President and Chief Executive Officer and a director of CacheFlow since March 1999. From December 1997 to March 1999, Mr. NeSmith served as Vice President of Nokia IP, Inc., a security router company, which acquired Ipsilon Networks, Inc., an IP switching company, where Mr. NeSmith served as Chief Executive Officer from May 1995 to December 1997. From October 1987 to April 1995, Mr. NeSmith held several positions at Newbridge Networks Corporation, a networking equipment manufacturer, including vice president and general manager of the VIVID group. Mr. NeSmith holds a B.S. in electrical engineering from the Massachusetts Institute of Technology.
Nai-Ting Hsu, 51, has served as Senior Vice President of CacheFlow Ventures since July 2000 and prior to that as Senior Vice President of Research and Development at CacheFlow since October 1999. From May 1997 to October 1999, Dr. Hsu served as Vice President and General Manager of the Consumer Network Division, Senior Vice President of Asia Pacific, and Senior Vice President and General Manager of the Consumer Products Division of C-Cube Microsystems Inc., a digital video compression company, which acquired DiviCom Inc., a digital television company, where Dr. Hsu served as Vice President of Engineering from April 1995 until its acquisition by C-Cube. From May 1991 until April 1995, Dr. Hsu served as Vice President of Engineering at MasPar Inc., a massive parallel computing company. Dr. Hsu holds a B.S. in Electrical Engineering from National Chiao Tung University, Taiwan, and M.S. and Ph.D. degrees in Computer Sciences from the University of Wisconsin, Madison.
Michael Johnson, 47, has served as Vice President and Chief Financial Officer of CacheFlow since July 1999. From May 1998 to July 1999, Mr. Johnson served as Vice President of Finance and Chief Financial Officer of AdiCom Wireless, Inc., a developer of CDMA based wireless access systems. From May 1994 to April 1998, Mr. Johnson served as Controller and Chief Accounting Officer of Ascend Communications Inc., a provider of wide area networking systems. Mr. Johnson holds a B.S. in business administration from California State University Hayward and is also a Certified Public Accountant.
Alan Robin, 44, has served as Senior Vice President of Sales at CacheFlow since July 1999. From January 1997 to July 1999, Mr. Robin served as Vice President of Sales of Ipsilon Networks, Inc., an IP switching company, and then of Nokia IP, Inc., a security router company, which acquired Ipsilon Networks, Inc. in December 1997. From January 1991 to January 1997, Mr. Robin held a number of sales and sales management positions at Wellfleet/Bay Networks, a networking company. Mr. Robin holds an A.B. in chemistry from Kenyon College and a M.B.A. in finance from Fairleigh Dickenson University.
PART II.
ITEM 5.
ITEM 5. MARKET FOR REGISTRANTS COMMON STOCK AND RELATED STOCKHOLDER MATTERS
Our common stock has been quoted on the Nasdaq National Market under the symbol "CFLO" since November 19, 1999. Prior to that time, there was no public market for the common stock. The following table sets forth, for the periods indicated, the high and low closing prices per share of the common stock as reported on the Nasdaq National Market.
Our present policy is to retain earnings, if any, to finance future growth. We have never paid cash dividends and have no present intention to pay cash dividends. At June 30, 2000, there were approximately 238 stockholders of record and the price per share of our common stock was $61.56. We believe that a significant number of beneficial owners of our common stock hold shares in street name.
On November 18, 1999, CacheFlow Inc. commenced its initial public offering, or IPO, pursuant to a Registration Statement on Form S-1 (File No. 333-87997). In the IPO, CacheFlow Inc. sold an aggregate of 5,750,000 shares of common stock (including an over-allotment option of 750,000 shares) at $24.00 per share. The IPO generated aggregate gross proceeds of approximately $138,000,000 for the Company. The aggregate net proceeds to the Company were approximately $126,502,000, after deducting underwriting discounts and commissions of approximately $9,660,000 and expenses of the offering of approximately $1,838,000. The Company intends to continue to use the net proceeds of the IPO for general corporate purposes, including to fund our operating losses, working capital needs, expenditures for research and development and sales and marketing efforts. In addition, we may use a portion of the net proceeds to fund acquisitions or investments in complementary businesses, technologies, or products. Pending any of these uses, we will continue to invest the net proceeds in investment grade, interest-bearing securities.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial data from March 13, 1996, our inception date, through the fiscal year ended April 30, 2000.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The discussion in this report on Form 10-K contains forward-looking statements that involve risks and uncertainties. The statements contained in this Report that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements on our expectations, beliefs, intentions or strategies regarding the future. All forward-looking statements included in this document are based on information available to us on the date hereof. We assume no obligation to update any such forward-looking statements. Our actual results could differ materially from those indicated in such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, fluctuations in quarterly operating results, uncertainty in future operating results, litigation, product concentration, competition, technological changes, management of our growth and expansion, integration of acquisitions and other risks discussed in this item under the heading "Factors Affecting Future Operating Results" and the risks discussed in our other Securities and Exchange Commission filings.
Overview
The Company designs, develops, markets and supports Internet acceleration and content management solutions, which include high-performance Internet caching appliances. From our inception in March 1996 through April 30, 1998, we were considered to be in the development stage. Our activities were related primarily to conducting research and development, developing our initial product, recruiting personnel, building sales channels, establishing the market for our initial product, raising capital and purchasing operating assets.
We began commercial shipment of our first products in May 1998. Since that time, we have introduced other Internet caching appliances, which have a variety of hardware configurations designed for the different price, performance, capacity and reliability requirements of our customers. The list prices of our caching appliances increase as they become more highly configured. Substantially all of our net sales through April 30, 2000 were attributable to sales of our Internet caching appliance products. We anticipate that these products will continue to account for a substantial portion of our net sales for the foreseeable future.
The Company recorded deferred stock compensation of approximately $71.8 million, $13.6 million and $150,000 for the years ended April 30, 2000, 1999 and 1998. These amounts represent the difference between the exercise price and the deemed fair value of stock option and warrant grants to employees, consultants, directors and third parties on the date such stock awards were granted. Related stock compensation expense is recorded over the option vesting period, generally two to four years, or immediately if there is no vesting period. The Company recorded stock compensation expense of approximately $38.4 million, $3.8 million and $59,000 for the years ended April 30, 2000, 1999, and 1998. Between May 1, 2000 and June 15, 2000, we recorded additional deferred stock compensation totaling $494,000, and the Company may record additional compensation in the future if management decides to grant below-market stock options in order to attract and retain employees in a highly competitive labor market. We expect compensation expense, which is primarily attributable to amortization of deferred compensation charges, to impact our reported results through April 30, 2004. Given the balance of deferred stock compensation on the balance sheet and recent grant history, we expect stock compensation expense to be a significant operating expense as this deferral is recognized.
We have incurred net losses in each quarter since inception. As of April 30, 2000, we had an accumulated deficit of $82.8 million. Our net loss available to common shareholders for the years ended April 30, 2000, 1999 and 1998 was $62.7 million, $13.2 million and $5.5 million. These losses resulted from significant costs incurred in the development and sale of our products and services, and from amortization of deferred stock compensation. We expect our operating expenses to increase significantly, particularly sales and marketing and research and development expenses. As a result, we expect to incur additional operating losses and continued negative cash flow from operations through the third quarter of fiscal year 2001.
Our limited operating history makes the prediction of future operating results difficult. We believe that period-to-period comparisons of our operating results should not be relied upon as predictive of future performance. Our prospects must be considered in light of the risks, expenses and difficulties encountered by companies at an early stage of development, particularly companies in new and rapidly evolving markets. We may not be successful in addressing these risks and difficulties.
Results of Operations
For the year ended April 30, 1998, we did not record any net sales. The following table sets forth, as a percentage of net sales, consolidated statements of operations data for the periods indicated:
Net Sales. We did not generate any sales for the period from inception to April 30, 1998. Net sales increased to $29.3 million in fiscal 2000 from $7.0 million in fiscal 1999. This increase was attributable to higher sales volumes resulting from the introduction of new products and growth in our customer base as we expanded our sales force. During fiscal 2000, no customer accounted for more than 10% of our net sales, and during fiscal 1999, three customers accounted for an aggregate of approximately 33% of our net sales. Direct and indirect channel sales accounted for 45% and 55% of our net sales in fiscal 2000 and 59% and 41% of our net sales in fiscal 1999. Net sales from international operations were $14.1 million, or 48% of net sales, in fiscal 2000, and $3.1 million, or 44% of net sales, in fiscal 1999. In the quarter ended April 30, 2000, approximately 55% of our net sales were from international customers. We expect this trend of more revenue being generated from international customers to continue in the future. Overall, we expect our net sales to increase as a result of continued growth in our sales force, broader acceptance of our products in the marketplace, and the introduction of new products, although the current year-over-year growth rate in our net sales will not continue in the future.
Gross Profit. Gross profit increased to $18.1 million in fiscal 2000 from $3.7 million in fiscal 1999. This increase in gross profit was primarily attributable to the introduction of new products and their growing acceptance in the marketplace and higher sales volumes. Gross margin increased to 61.7% in fiscal 2000 from 53.1% in fiscal 1999. This increase in gross margin was principally due to the resulting economies of scale from higher unit production and cost savings achieved by outsourcing component manufacturing. Our gross
margin has been and will continue to be affected by a variety of factors, including competition, fluctuations in demand for our products, the timing and size of customer orders and product implementations, the mix of direct and indirect sales, the mix and average selling prices of products, new product introductions and enhancements, component costs, manufacturing costs and product configuration.
Research and Development. Research and development expenses consist primarily of salaries and benefits, and prototype and test equipment costs. Research and development expenses increased to $9.6 million in fiscal 2000 from $4.0 million in fiscal 1999 and $2.4 million in fiscal 1998. These increases in research and development expenses in absolute dollars were primarily attributable to increased staffing and associated support for engineers required to expand and enhance our product line, and, to a lesser extent, expenses related to prototype and test equipment units. Research and development headcount increased to 68 at April 30, 2000 from 21 in fiscal 1999 and 18 in fiscal 1998. As a percentage of net sales, research and development expenses decreased to 32.9% in fiscal 2000 from 57.3% in fiscal 1999. This decrease in research and development expenses as a percentage of net sales reflects the fact that our net sales during these periods increased more rapidly than our research and development expenses. We believe that significant investments in research and development will be required to remain competitive and expect that research and development expenses will continue to increase in absolute dollars in future periods. Through April 30, 2000, all research and development costs have been expensed as incurred.
Sales and Marketing. Sales and marketing expenses consist primarily of salaries and benefits, commissions, advertising and promotional expenses, and customer service and support costs. Sales and marketing expenses increased to $28.9 million in fiscal 2000 from $6.9 million in fiscal 1999 and $1.7 million in fiscal 1998. These increases in sales and marketing expenses in absolute dollars were related to the expansion of our sales and marketing organization as we increased headcount and added sales and support facilities worldwide. Sales and marketing headcount increased to 173 at April 30, 2000 from 30 in fiscal 1999 and 19 in fiscal 1998. As a percentage of net sales, sales and marketing expenses increased to 98.7% for the year ended April 30, 2000 from 97.6% in fiscal 1999. We expect to continue to increase our sales and marketing expenses significantly in absolute dollars in an effort to expand domestic and international markets, introduce new products, and establish and expand new distribution channels.
General and Administrative. General and administrative expenses increased to $4.8 million in fiscal 2000 from $2.1 million in fiscal 1999 and $1.6 million in fiscal 1998. These increases in general and administrative expenses in absolute dollars were primarily attributable to increased staffing and associated expenses necessary to manage and support our growth. General and administrative headcount increased to 39 at April 30, 2000 from 10 in fiscal 1999 and 6 in fiscal 1998. As a percentage of net sales, general and administrative expenses decreased to 16.2% for the year ended April 30, 2000 from 29.4% in fiscal 1999. These decreases in general and administrative expenses as a percentage of net sales reflect the fact that our net sales during these periods increased more rapidly than our general and administrative expenses. We expect general and administrative expenses to increase in absolute dollars as we continue to increase headcount to manage expanding operations and facilities and incur the additional expenses associated with operating as a public company.
Stock Compensation. Stock compensation expense increased to $38.4 million in fiscal 2000 from $3.8 million in fiscal 1999 and $59,000 in fiscal 1998. This non-cash charge reflects the amortization of deferred stock compensation. Stock compensation has increased significantly in fiscal 2000 as a result of the amortization of significant stock compensation, which was recorded concurrent with the Company's November 1999 initial public offering. Based on the options granted through April 30, 2000, we expect stock compensation to remain a significant component of our operating expenses through fiscal 2004.
Other Income (Expense), Net. Other income (expense), net increased to net other income of $3.0 million in fiscal 2000, from net other expense of $197,000 in fiscal 1999 and net other income of $233,000 in fiscal 1998. This increase is primarily attributable to increased interest income earned on the Company's cash equivalents and short-term investments, which grew significantly following the completion of the Company's initial public offering in November 1999.
Provision for Income Taxes. The provision for income taxes of $73,000 in fiscal 2000 is composed entirely of foreign corporate income taxes. The foreign corporate income taxes are a function of the Company's international expansion and the establishment of branches and subsidiaries in various jurisdictions. The provision for income taxes is based on income taxes on minimum profits the foreign operations generated for services provided to the Company. The Company's tax expense for fiscal 2001 will continue to be significantly dependent on the amount and mix of income derived from sources subject to corporate income taxes of foreign taxing jurisdictions.
Accretion of Preferred Stock. Accretion of preferred stock increased to $2.0 million in fiscal 2000, from none in fiscal 1999 and 1998. This charge was recorded in connection with the November 1999 issuance of 280,953 shares of Series D preferred stock at $11.00 per share to accrete the stock to its fair value. During November 1999, all of the shares of Series D preferred stock converted to common stock upon completion of the Company's initial public offering.
Post year-end Acquisition. On June 5, 2000, the Company and SpringBank Networks, Inc., a Delaware corporation ("SpringBank"), consummated a merger pursuant to a merger agreement dated as of June 3, 2000. SpringBank has survived the merger as a wholly-owned subsidiary of CacheFlow. Pursuant to the agreement, each issued and outstanding share of common stock of SpringBank was converted into the right to receive 0.2 shares of common stock of CacheFlow. In addition, each outstanding option to purchase SpringBank Common Stock was assumed by CacheFlow and converted into an option to purchase 0.2 shares of CacheFlow Common Stock pursuant to the exchange ratio in the merger agreement. The exercise price of the options to purchase CacheFlow Common Stock was also determined pursuant to the exchange ratio in the merger agreement. Purchase consideration totaled approximately $177 million and included approximately 2.8 million shares of CacheFlow Common Stock and approximately $8 million of assumed liabilities. This transaction was accounted for as a purchase, and the purchase price was allocated to tangible and intangible assets in proportion to the fair value of those assets.
Liquidity and Capital Resources
From inception through November 1999, we financed our operations and the purchase of property and equipment through private sales of preferred stock, with net proceeds of $37.9 million, as well as through bank loans and equipment leases. In November 1999, we financed our operations through an initial public offering of our common stock, with net proceeds of $126.5 million, net of underwriting discounts, commissions and offering costs. At April 30, 2000, we had $91.5 million in cash and cash equivalents, $33.8 million in short-term investments, and $126.4 million in working capital.
Net cash used in operating activities was $23.6 million in fiscal 2000, $9.7 million in fiscal 1999, and $5.1 million in fiscal 1998. We used cash primarily to fund our net losses from operations.
Net cash used in investing activities was $37.9 million in fiscal 2000 and $971,000 in fiscal 1999. Net cash used in investing activities was primarily attributable to purchases of short-term securities, and to a lesser extent, to purchases of property, plant and equipment. Net cash provided by investing activities was $2.8 million in fiscal 1998 and was primarily attributable to the sale of short-term investments. We expect that, in the future, any cash in excess of current requirements will continue to be invested in short-term investment grade, interest-bearing securities.
Capital expenditures were $4.0 million in fiscal 2000, $971,000 in fiscal 1999, and $623,000 in fiscal 1998. Our capital expenditures consisted primarily of purchases of plant, equipment and software. Current capital commitments are approximately $500,000, principally for office furniture and equipment. We expect that our capital expenditures will continue to increase in the future.
Net cash provided by financing activities was $150.7 million in fiscal 2000, $5.6 million in fiscal 1999, and $9.4 million in fiscal 1998. During May 1999, we raised approximately $20.0 million in gross proceeds from the sale of Series C Preferred Stock at $4.575 per share. During October 1999, we raised approximately $2.8 million through the cash exercise of options granted to a board member and consultant to purchase
702,380 shares of common stock at $4.00 per share. During November 1999, we raised approximately $3.1 million through the sale of 280,953 shares of Series D Preferred Stock at $11.00 per share. We also raised approximately $126.5 million, net of underwriting discounts, commissions and offering costs through the sale of 5,750,000 shares of our common stock in an initial public offering at $24.00 per share. During December 1999, $4.5 million of these proceeds were used to repay all of the Company's outstanding debt. In fiscal 1999, cash provided by financing activities was primarily attributable to the issuance of $4.0 million in debt obligations. In fiscal 1998, cash provided by financing activities was primarily attributable to $9.3 million in net proceeds from private sales of preferred stock.
We believe that working capital will be sufficient to meet our working capital and capital expenditure requirements for at least the next twelve months. Thereafter, we may find it necessary to obtain additional equity or debt financing. Furthermore, if cash is used for acquisitions or other unanticipated uses, we may need additional capital sooner than expected. In the event additional financing is required, we may not be able to raise it on acceptable terms or at all.
Year 2000 Readiness
In the past, the Company discussed the nature and progress of its plans to become Year 2000 ready. In late 1999, the Company completed its assessment and testing of systems. The Company experienced no significant disruptions in mission critical information technology and non-information technology systems and believes those systems successfully responded to the year 2000 date change. To date, Year 2000 compliance costs have not been material. The Company is not aware of any material problems resulting from Year 2000 issues, either with its products, its internal systems, or the products and services of third parties. The Company will continue to monitor its mission critical computer applications and those of its suppliers and vendors throughout the year 2000 to ensure that any latent Year 2000 matters that may arise are addressed promptly.
If it comes to our attention that there are any Year 2000 problems with our products or that any third-party hardware and software used in our internal systems is not Year 2000 compliant, then we will endeavor to make modifications to our products and internal systems, or purchase new internal systems, to quickly respond to the problem. At the present time, however, we do not anticipate incurring additional material costs related to Year 2000 compliance.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We develop products in the United States and sell them throughout the world. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. Since all of our sales are currently made in United States dollars, a strengthening of the dollar could make our products less competitive in foreign markets. If any of the events described above were to occur, our net sales could be seriously impacted, since a significant portion of our net sales are derived from international operations. Net sales from international operations represented 48% of total net sales for the year ended April 30, 2000.
Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. As of April 30, 2000, we had approximately $124.4 million invested primarily in fixed-rate, short-term corporate and U.S. government debt securities which are subject to interest rate risk and will decrease in value if market U.S. interest rates increase. We maintain a strict investment policy, which is intended to ensure the safety and preservation of our invested funds by limiting default risk, market risk, and reinvestment risk. The table below presents notional amounts and related weighted-average interest rates by year of maturity for our investment portfolio as of April 30, 2000 (none as of April 30, 1999).
We do not hold any equity securities or derivative investments.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Consolidated Financial Statements
CACHEFLOW INC.
CONSOLIDATED BALANCE SHEETS (in thousands, except per share amounts)
See accompanying notes to the consolidated financial statements.
CACHEFLOW INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share amounts)
See accompanying notes to the consoldiated financial statements.
CACHEFLOW INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) (in thousands)
See accompanying notes to the consolidated financial statements.
CACHEFLOW INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
See accompanying notes to the consolidated financial statements.
CACHEFLOW, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Organization and Summary of Significant Accounting Policies
Organization
CacheFlow Inc., hereafter also referred to as the "Company," was organized and incorporated in the state of Delaware on March 13, 1996. The Company operates in one segment to design, develop, market and support high-performance Internet caching appliances.
Basis of Presentation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated. From inception in March 1996 through April 30, 1998, the Company was considered to be in the development stage. The Company's sales activities were initiated in the first quarter of fiscal 1999.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
Cash, Cash Equivalents and Short-Term Investments
The Company considers all highly liquid investments with an original maturity of three months or less when purchased to be cash equivalents. Cash equivalents consisted primarily of commercial paper investments at April 30, 2000, and money market investments at April 30, 1999. Short-term investments consisted of debt securities with original maturities between three months and two years.
Management determines the appropriate classification of debt and equity securities at the time of purchase and evaluates such designation as of each balance sheet date. To date, all marketable debt securities have been classified as available-for-sale and are carried at fair value with unrealized gains and losses, if any, included in accumulated other comprehensive income (loss) in stockholders' equity (deficit). Realized gains and losses and declines in value of securities judged to be other than temporary are included in interest income and have not been significant to date. Interest and dividends on all securities are included in interest income.
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to credit risk consist of demand deposit accounts, money market accounts, commercial paper, corporate debt securities, and trade receivables. The Company maintains its demand deposit accounts and its money market accounts primarily with one financial institution. The Company's investment advisors are instructed to only invest in high-quality, investment grade securities and to limit investment exposure in any one issue. The Company has partially financed its operations through long-term debt with a lending institution. Management believes the financial risks associated with these financial instruments are minimal.
The Company generally does not require collateral for sales to customers. For the year ended April 30, 2000, no customers individually accounted for over 10% of our net sales. For the year ended April 30, 1999, three customers individually accounted for over 10% of our net sales, for an aggregate of approximately 33% of our net sales.
CACHEFLOW, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Concentrations of Supply
The Company currently purchases several key parts and components used in the manufacture of its Internet caching appliance products from limited sources of supply.
Concentrations of Sales
The Company's Internet caching appliance product family and related services have accounted for all of the Company's net sales for the two years ended April 30, 2000.
Inventories
Inventories consist of raw materials, work-in-process and finished goods. Inventories are recorded at the lower of cost or market using the first-in, first-out method.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are provided on a straight-line basis over the lesser of the estimated useful life, generally three to five years, or the lease term of the respective assets.
Revenue Recognition
The Company generally recognizes product revenue upon shipment assuming that collectibility is probable, unless the Company has future obligations for installation or must obtain customer acceptance, in which case revenue is deferred until these obligations are met. Maintenance contract revenue is initially deferred when the customer purchases a maintenance contract and recorded evenly over the life of the contract. Maintenance contract revenue for the year ended April 30, 2000 and 1999 was $360,000 and $25,000, respectively.
Warranty Reserves
The Company's products generally carry a one-year warranty that includes factory repair services. Estimated expenses for warranty obligations, including the cost of replacement parts, are generally accrued at the same time as related product revenue is recognized.
Income Taxes
The Company uses the liability method to account for income taxes as required by the Financial Accounting Standards Board's (FASB) Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates and laws that will be in effect when the differences are expected to reverse.
Research and Development
Costs to develop the Company's products are expensed as incurred in accordance with the FASB's Statement of Financial Accounting Standards No. 2, "Accounting for Research and Development Costs," which establishes accounting and reporting standards for research and development.
CACHEFLOW, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Comprehensive Income (Loss)
The Company reports comprehensive income (loss) in accordance with the Financial Accounting Standards Board's (FASB) Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income." Included in other comprehensive income (loss) for the Company are adjustments to record unrealized gains and losses on available-for-sale securities. These adjustments are accumulated in "Accumulated other comprehensive loss" in the stockholder's equity section of the balance sheet. The following table presents the Company's comprehensive net loss (in thousands):
Stock-Based Compensation
The Company accounts for its stock options and equity awards in accordance with the provisions of the Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and has elected to follow the "disclosure only" alternative prescribed by the FASB's Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (FAS 123).
Fair Value of Financial Instruments
The fair value of the Company's short-term investments is based on quoted market prices. The fair value of long-term debt obligations are estimated based on current interest rates available to the Company for debt instruments with similar terms, degrees of risk, and remaining maturities. The carrying values of these obligations approximate their fair values.
Net Loss Per Common Share
Basic net loss per common share and diluted net loss per common share are presented in conformity with the FASB's Statement of Financial Accounting Standards No. 128, "Earnings Per Share" (FAS 128), for all periods presented.
In accordance with FAS 128, basic and diluted net loss per common share has been computed using the weighted-average number of shares of common stock outstanding during the period, less the weighted average number of shares of common stock issued to founders, investors and employees that are subject to repurchase. Pro forma basic and diluted net loss per common share, as presented in the condensed consolidated statements of operations, have been computed as described above and also give effect, under Securities and Exchange Commission guidance, to the conversion of the convertible preferred stock (using the if- converted method) from the original date of issuance. The shares used in calculating the pro forma basic and diluted net loss per common share amounts also include warrants to purchase series A and C preferred stock as such warrants expired upon the completion of the Company's initial public offering of its common stock. The weighted average share amounts exclude warrants to purchase series B preferred stock as such warrants remained outstanding after the initial public offering was complete.
CACHEFLOW, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table presents the calculation of basic and diluted net loss per common share and pro forma basic and diluted net loss per common share (in thousands, except per share amounts):
The Company has excluded all preferred stock, warrants for preferred stock, outstanding stock options and shares subject to repurchase from the calculation of diluted net loss per common share because all such securities are antidilutive for all periods presented. The total number of shares excluded from the calculations of diluted net loss per common share was (in thousands) 14,784, 16,980, and 14,548 for the three years ended April 30, 2000, 1999 and 1998.
Foreign Currency Adjustments
Management has determined that the functional currency of the Company's domestic and foreign operations is the U.S. dollar. Accordingly, the effects of foreign currency transactions, and of remeasuring the financial position and results of operations from local currencies into the functional currency, are included in "interest expense." These amounts have not been material for each of the three years in the period ended April 30, 2000.
Advertising Costs
The Company expenses advertising costs as incurred. Advertising expenses for the years ended April 30, 2000, 1999 and 1998 were $450,000, $270,000, and $84,000, respectively, and are included in sales and marketing expenses.
Segment Information
The Company has adopted the FASB's Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and Related Information." The Company operates in one
CACHEFLOW, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
segment to design, develop and market Internet caching appliances that are specifically designed, or purpose-built, to accelerate and manage the flow of information over the Internet.
Recent Accounting Pronouncements
In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" (FAS 133), which will be effective for the Company's fiscal year ending April 30, 2002. This statement establishes accounting and reporting standards requiring that every derivative instrument, including certain derivative instruments embedded in other contracts, be recorded in the consolidated balance sheet as either an asset or liability measured at its fair value. The statement also requires that changes in the derivative's fair value be recognized in earnings unless specific hedge accounting criteria are met. The Company has not evaluated the impact of FAS 133; however, it believes the adoption of FAS 133 will not have a material effect on the consolidated financial position, results of operations, or cash flows as the Company has not entered into any derivative contracts.
In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" (SAB 101), which provides guidance on the recognition, presentation and disclosure of revenue in financial statements of public registrants. The provisions of SAB 101 are effective for the Company in the fourth quarter of fiscal 2001. SAB 101 had no effect on our operating results for the year ended April 30, 2000 and is not expected to materially impact our future results of operations.
Note 2. Balance Sheet Data
Cash equivalents and short-term investments consisted of the following (in thousands):
As of April 30, 1999, the Company had $2,263,000 of money market funds in cash and cash equivalents.
CACHEFLOW, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Inventories consisted of the following (in thousands):
Certain computer and office equipment are recorded under capital lease arrangements that aggregated $29,000 as of April 30, 1999 (none were outstanding as of April 30, 2000). Accumulated amortization on the assets recorded under capital leases aggregated $8,000 as of April 30, 1999.
Note Receivable from Officer
In August 1999, the Company entered into a five-year non-recourse, non- interest bearing note for $800,000 with an officer of the Company for the purchase of a primary residence. The note is secured by the officer's primary residence, and is presented in "Other assets" in the Company's balance sheet at April 30, 2000.
Note 3. Stockholders' Equity (Deficit)
Stock Split
In June 1999, the Company's Board of Directors and stockholders approved a 2-for-1 stock split of the Company's authorized, issued and outstanding common and preferred stock. All common and preferred share and per share amounts in the accompanying consolidated financial statements have been retroactively adjusted to reflect the 2-for-1 stock split.
CACHEFLOW, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Preferred Stock
Preferred stock consisted of the following series (in thousands, except per share amounts):
The holders of Series A, B, C and D preferred stock are entitled to annual noncumulative dividends per share as shown above when and if declared by the board of directors. In the event of any voluntary or involuntary liquidation of the Company, Series A, B, C and D preferred stockholders are entitled to a liquidation preference per share as shown above plus any declared but unpaid dividends, all in preference to the holders of the common stock. If upon occurrence of such event, the asset and funds thus distributed among the holders of the preferred stock shall be insufficient to permit the payment to such holders, then the entire assets and funds of the corporation legally available for distribution shall distribute ratably among the holders of Series A, B, C and D preferred stock in proportion to the aggregate preferential amounts each such holder is otherwise entitled to receive. Upon the completion of a distribution, the holders of the common stock will ratably receive any and all remaining assets of the Company. No dividends on the Company's preferred stock have been declared.
The holders of Series A, B and C preferred stock have the right, at any time after the date of issuance, to convert each of their shares into common shares. The initial conversion ratio is one-to-one for shares of Series A, B, and C preferred shares but is subject to adjustments for dilution. The holders of each share of preferred stock have the right to one vote for each share of common stock into which the preferred stock can be converted.
In September 1999, the Company's Board of Directors approved a decrease in authorized shares of preferred stock from 30,000,000 to 10,000,000 upon the completion of the Company's initial public offering of its common stock.
In November 1999, the Company authorized and issued 280,953 shares of series D preferred stock at $11.00 per share. The series D preferred stock has similar rights, preferences and privileges as series A, B, and C preferred stock. In connection with the issuance of the series D preferred stock, the Company recorded a non-cash charge of approximately $1,967,000 to accrete the stock to its fair value.
In November 1999, the Company closed its initial public offering of its common stock and all preferred shares outstanding on the close date were converted one-for-one into shares of common stock.
Stock Option Grants
The Company granted 677,380 options to a consultant of the Company who is also the holder of Series D preferred shares on October 13, 1999 to purchase common stock at an exercise price of $4.00 per share. The
CACHEFLOW, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
options were immediately vested, nonforfeitable and exerciseable and were subsequently exercised. The fair value of the options was estimated using the Black-Scholes option pricing model with the following weighted average assumptions: risk free rate of 6.0%, expected life of the options of 0.05 years, 60% volatility and no dividend yield. The Company calculated a value of approximately $8,129,000 for the consultant's options and recorded this amount in October 1999.
Warrants
In October and November of 1996, the Company issued a total of 562,850 warrants to purchase Series A preferred stock at an exercise price of $0.875 per share. The warrants were immediately exercisable and expired at the earlier of April 30, 2000 or at the completion of the Company's initial public offering of its common stock. In November 1999, all of these warrants were exercised prior to the completion of the Company's initial public offering.
In connection with the long-term debt agreements entered into in November 1998, the Company issued warrants to purchase 141,842 shares of Series B preferred stock at an exercise price of $3.42 per share. The value of the Series B warrants was estimated using the Black-Scholes option pricing model with the following assumptions: weighted-average risk free interest rate of 6.0%, weighted-average contractual life of 0.22 years, 60% volatility and no dividend yield. The Company calculated a value of $507,000 and this amount was recorded as deferred issuance costs in other assets. This amount was amortized over the term of the agreement to interest expense. In December 1999, this long-term debt arrangement was repaid and terminated, at which time the unamortized deferred issuance costs, which were immaterial, were written off as interest expense.
In April 1999, the Company entered into a strategic relationship with a customer. As part of the arrangement the Company issued warrants to purchase 110,000 shares of Series C preferred stock at an exercise price of $4.575 per share. A portion of the warrants was immediately exercisable and the remaining warrants became exercisable in September 1999. The warrants expired at the earlier of April 30, 2002 or at the completion of the Company's initial public offering of its common stock. In April 1999, the Company recorded a charge of $17,000 based on the fair value of the warrants. The Company recorded an additional charge of approximately $604,000 in the year ended April 30, 2000, which represents the fair value of the warrants. The fair value of the warrants was determined using the Black-Scholes model. In November 1999, all of these warrants were exercised prior to completion of the Company's initial public offering.
Common Stock
On November 19, 1999, the Company completed its initial public offering, in which it sold 5,750,000 shares of common stock (including an over-allotment option of 750,000 shares) at $24 per share. Upon the closing of the offering, all of the Company's preferred stock converted to common stock. Proceeds from the offering were approximately $126,502,000, net of underwriter's discounts, commissions and offering costs.
The Company has entered into Stock Purchase Agreements in connection with the sale of common stock to employees, consultants and directors. The Company typically has the right to repurchase, at the original issue price, a declining percentage of certain of the shares of common stock issued based on the employees, consultants, and directors service periods. The repurchase right generally declines on a percentage basis over four years based on the length of the each respective employee's continued employment with the Company, and the director's membership on the Board of Directors under this agreement. As of April 30, 2000, 1999 and 1998, 3,987,916, 4,963,456 and 1,467,082 shares, respectively, of common stock issued under these agreements were subject to repurchase.
CACHEFLOW, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In September 1999, the Company's Board of Directors approved an increase in authorized shares of common stock from 60,000,000 to 200,000,000 upon the completion of the Company's initial public offering of its common stock.
Shares of Common Stock Reserved for Future Issuance
Common stock reserved for future issuance consisted of the following (in thousands):
Notes Receivable from Stockholders
In April 1999, the Company entered into a note for $999,900 with an officer of the Company for the purchase of common stock. The note bears interest at 4.99% and the note and related interest are payable in full on April 12, 2004. The note is secured by 2 million shares of common stock of the Company owned by the officer. The note was issued with full recourse.
In September 1999, the Company entered into two five-year notes for $495,000 each with two employees of the Company for the purchase of common stock. The notes bear interest at 5.98% and the notes and related interest are payable in full in September 2004. Each note is secured by 90,000 shares of common stock of the Company owned by each employee. The notes are full recourse.
In October 1999, the Company entered into a five-year note for $2,519,900 with an officer of the Company for the purchase of common stock. The note bears interest at 5.54% and the note and related interest are payable in full in October 2004. The note is secured by 420,000 shares of common stock of the Company owned by the officer. The note is full recourse.
Note 4. Employee and Director Stock Plans
In 1996, the Company established the 1996 Stock Option Plan (the 1996 Plan) under which stock options may be granted to employees, directors and consultants of the Company and authorized 1,000,000 shares of common stock thereunder. Through various amendments, the Board of Directors and stockholders approved the increase in the number of shares authorized for issuance under the 1996 Plan to 15,643,000. Under the 1996 Plan, nonstatutory stock options may be granted to employees and consultants, and incentive stock options (ISO) may be granted only to employees. In the case of an ISO that is granted to an employee who, at the time of the grant of such option, owns stock representing more than 10% of the total combined voting power of all classes of stock of the Company, the per share exercise price shall not be less than 110% of the fair market value per share on the date of grant or, granted to any other employee, the per share exercise price shall not be
CACHEFLOW, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
less than 100% of the fair value per share on the date of grant. The exercise price for non-qualified options may not be less than 85% of the fair value of common stock at the option grant date.
Options issued under the 1996 Plan are immediately exercisable, and shares issued upon exercise of an option are subject to a right of repurchase by the Company at the original issuance price. The repurchase right lapses as determined by the Company's Board of Directors, generally 25% after one year and 2.08% per month thereafter. At April 30, 2000, 1999, and 1998 the Company had 3,988,000, 4,327,000, and 269,000 shares, respectively, which were subject to repurchase rights under the 1996 Plan. No shares were repurchased under the 1996 plan during fiscal 1999 and 1998. For the year ended April 30, 2000, 429,000 shares were repurchased under the 1996 Plan at the original issuance price.
The 1996 Plan will continue in effect for a term of ten years unless terminated by the Company's Board of Directors at an earlier date. Any option granted under the 1996 plan shall be exercisable at such times and under such conditions as determined by the Company's Board of Directors.
Employee Stock Purchase Plan
In September 1999, the Company's Board of Directors adopted the Employee Stock Purchase Plan, or ESPP. The plan became effective upon the effective date of the Company's initial public offering of its common stock. As of April 30, 2000, a total of 3,000,000 shares of common stock have been reserved for issuance under the plan. Under the plan, eligible employees may purchase common stock through payroll deductions, which in any event may not exceed 15% of an employee's compensation, at a price equal to the lower of 85% of the fair market value of the common stock at the beginning of each offering period or at the end of each purchase period. The number of shares reserved under the Employee Stock Purchase Plan automatically increased by 500,000 shares beginning January 31, 2000, and will continue to do so annually. The Company's Board of Directors, at its discretion, may reduce the automatic annual increase in reserved shares.
1999 Stock Incentive Plan
In September 1999, the Company's Board of Directors adopted the 1999 Stock Incentive Plan (the "Incentive Plan") under which 5,000,000 shares of common stock have been reserved for issuance. The plan became effective upon the effective date of the Company's initial public offering of its common stock. The number of shares reserved under the Incentive Plan automatically increased on January 1, 2000 by 1,794,013 shares and will increase on an annual basis by the lesser of 5% of the total amount of common stock outstanding or 2,000,000 shares. The exercise price for incentive stock options and non-qualified stock options may not be less than 100% and 85%, respectively, of the fair market value of common stock on the option grant date.
1999 Director Option Plan
In September 1999, the Company's Board of Directors adopted the 1999 Director Option Plan (the "Directors' Plan") under which 500,000 shares of common stock have been reserved for issuance. The Director's Plan became effective on the date of its adoption. Each non-employee director joining the Board of Directors following the effective date of the initial public offering will automatically receive options to purchase 25,000 shares of common stock. In addition, each non-employee director will automatically receive options to purchase 5,000 shares of common stock at each annual meeting of the Board of Directors held in the year 2000 and thereafter. Each option will have an exercise price equal to the fair market value of the common stock on the option grant date. The number of shares reserved under the Directors' Plan automatically increased by 100,000 shares beginning January 31, 2000 and will continue to do so annually. The Company's Board of Directors, at its discretion, may reduce the automatic annual increase in reserved shares.
CACHEFLOW, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
2000 Supplemental Stock Option Plan
In February 2000, the Company's board of directors adopted the 2000 Supplemental Stock Option Plan (the "2000 Plan") under which 3,000,000 shares of common stock have been reserved for issuance. Employees and consultants are eligible to participate in the 2000 Plan, and outside directors and executive officers are not eligible to participate. The 2000 Plan provides for the grant of nonstatutory stock options to purchase shares of our common stock and restricted shares of our common stock. The exercise price for stock options issued under the 2000 Plan may not be less than 25% of the fair market value of common stock on the option grant date.
Stock option activity under all plans and options issued outside all plans were as follows (in thousands except per share amounts):
The following table summarizes information about stock options outstanding at April 30, 2000 (in thousands except per share amounts and life).
At April 30, 2000, 7,266,827 shares were available for future option grants under all plans.
CACHEFLOW, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Stock Compensation
For the three years ended April 30, 2000, 1999, and 1998 the Company recorded deferred stock compensation of $71,848,000, $13,569,000 and $150,000, respectively. These amounts represent the difference between the exercise price and the deemed fair value of the Company's common stock on the date such stock options were granted. For the three years ended April 30, 2000, 1999, and 1998 the Company recorded amortization of stock compensation of $38,426,000, $3,600,000 and $52,000, respectively. At April 30, 2000 and 1999, the Company had $43,489,000 and $10,067,000, respectively, of remaining unamortized deferred compensation. Such amounts are included as a reduction of stockholders' equity (deficit) and are being amortized using a graded method over the vesting period of each respective option.
Pro Forma Disclosures of the Effect of Stock-Based Compensation
Pro forma information regarding results of operations and net loss per share is required by FAS 123, which also requires that the information be determined as if the Company had accounted for its stock-based awards to employees under the fair value method of FAS 123. The fair value for each stock-based award was estimated at the date of grant using the Black-Scholes option pricing model for the year ended April 30, 2000 and the minimum value option pricing model for the years ended April 30, 1999 and 1998 with the following weighted-average assumptions:
The option valuation models were developed for use in the estimation of the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected life of the option. Because the Company's employee stock-based awards have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock-based awards.
For purposes of pro forma disclosures, the estimated fair value of the Company's stock-based awards to employees is amortized to pro forma expense over the vesting period for stock options and over the six-month purchase period for stock purchases under the ESPP. Pro forma information follows (in thousands, except per share amounts):
The per share weighted average grant date fair value of options granted, which is the value assigned to the options under FAS 123, was $19.79, $0.14 and $0.02, for options granted for the years ended April 30, 2000, 1999 and 1998, respectively. The weighted average fair value of employee stock purchase rights issued under the Company's ESPP was $17.36 per share for the year ended April 30, 2000 (the year the ESPP was adopted).
CACHEFLOW, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The pro forma impact of stock-based awards on the net loss for the year ended April 30, 1998 reflects compensation expense for two years' vesting while the year ended April 30, 1999 reflects compensation expense for three years' vesting of outstanding stock-based awards.
Note 5. Income Taxes
The provision for income taxes of $73,000 for the year ended April 30, 2000 is composed entirely of foreign corporate income taxes. There is no provision for income taxes for the years ended April 30, 1999 and 1998.
A reconciliation of the income tax provision to the amount computed by applying the statutory federal income tax rate to income (loss) before income tax provision is summarized as follows (in thousands):
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets are as follows (in thousands):
The Company has incurred losses from inception through fiscal 2000. Management believes that, based on the history of such losses and other factors, the weight of available evidence indicates that it is more likely than not that the Company will not be able to realize its deferred tax assets and thus a full valuation allowance has been recorded at April 30, 2000 and 1999. The valuation allowance increased $15,067,000 and $3,621,000 during 2000 and 1999, respectively.
As of April 30, 2000, the Company had net operating loss carryforwards for federal income tax purposes of approximately $33,476,000, which expire in fiscal years 2011 through 2020.
The Company also had net operating loss carryforwards for state income tax purposes of approximately $16,400,000, which expire in fiscal years 2004 through 2005.
Utilization of the Company's net operating loss may be subject to substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. Such an annual limitation could result in the expiration of the net operating loss before utilization.
CACHEFLOW, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Note 6. Lines of Credit and Long-Term Debt Obligations
In November 1996, the Company entered into a borrowing arrangement with a financial institution for a line of credit of $400,000. The borrowings under the line of credit bore interest at the prime rate plus 2% (10.5% at April 30, 1998) and were scheduled to expire in May 1999. In November 1998, the Company amended the line of credit agreement with the same financial institution such that the total available credit was increased from $400,000 to $3,000,000. The amended $3,000,000 credit line was comprised of two components: a $2,500,000 credit line and a $500,000 term loan. Each component is discussed further below.
The $2,500,000 credit line was limited such that the Company may not borrow in excess of $2,500,000 or 80% of eligible domestic accounts receivable balances plus 65% of foreign accounts receivable balances. The amended $2,500,000 amended credit line bore interest at the financial institution's prime rate plus 0.75% (8.5% at April 30, 1999, respectively) and was scheduled to expire in November 1999. As of April 30, 1999, the outstanding balance under the amended line of credit was $643,000. In November 1999, the Company again amended the line of credit agreement with the same financial institution such that the $2,500,000 credit line bore interest at the financial institution's prime rate plus 0.50% and was scheduled to expire in April 2000. In December 1999, the outstanding balance was repaid in full and the credit line was terminated.
The $500,000 term loan, which was scheduled to expire in November 2002, bore interest at the financial institution's prime rate plus 1.75% (9.5% at April 30, 1999). As of April 30, 1999, the full $500,000 was outstanding under the term loan. In December 1999, the outstanding balance was repaid in full and the term loan was terminated.
In November 1998, the Company entered into an additional credit agreement with another financial institution, which provided a total credit facility of $3,850,000. A portion of the credit facility represented a $3,500,000 three- year term loan, all of which was outstanding as of April 30, 1999. The remaining $350,000 of available credit is related to an equipment line of credit, of which no amount was outstanding as of April 30, 1999. The term loan and equipment line of credit were secured by substantially all of the Company's assets, bore interest at 13% and 11.4% and were scheduled to mature in November 2002 and May 2000, respectively. This credit facility was repaid in full during December 1999 and was terminated.
The above agreements required the Company to maintain compliance with certain financial covenants and prohibit the Company from paying dividends on its common stock. As of April 30, 1999 the Company was in compliance with such financial covenants. The compliance covenants were not in effect as of April 30, 2000 since all of the Company's credit facilities had been terminated by that date. As of April 30, 2000 and 1999, the total amount available under the Company's financial arrangements was none and $568,000, respectively.
Note 7. Defined Contribution Benefit Plan
The Company has a defined contribution benefit plan under Section 401(k) of the Internal Revenue Code, which covers substantially all United States-based employees. Eligible employees may contribute pre-tax amounts to the plan via payroll withholdings, subject to certain limitations. The Company does not match contributions by plan participants.
CACHEFLOW, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Note 8. Lease Commitments
The Company leases certain facilities and equipment under noncancelable operating leases. Certain of the Company's facility leases provide for periodic rent increases based on the general rate of inflation. Future minimum lease payments under operating leases are as follows (in thousands):
Rent expense for the three years ended April 30, 2000, 1999 and 1998 was $2,342,000, $1,300,000 and $329,000 respectively.
Note 9. Litigation
On September 16, 1999, Nokia IP, Inc. filed a lawsuit in Santa Clara County Superior Court naming CacheFlow Inc., and certain officers of the company, as defendants. These officers were formerly employed by Ipsilon Networks, Inc., which was acquired by Nokia in December 1997. Following the acquisition, these officers became employees of Nokia upon completion of the acquisition. Nokia's complaint alleged that the Company and these officers formerly employed by Nokia acted improperly in hiring other former Nokia employees. The lawsuit also claimed that a certain officer of the Company violated a non-competition provision contained in his employment agreement with Nokia. The complaint demanded compensatory and punitive damages as well as a court order prohibiting the defendants from disclosing or using Nokia's trade secrets or confidential information, or acting in a manner that violates these officers' contractual duties to Nokia. The Company and the individual defendants filed an answer to the complaint denying Nokia's allegations. On November 14, 1999, the Company and Nokia executed a term sheet settling the litigation. On February 8, 2000, the Company completed a definitive settlement agreement with Nokia and thereafter Nokia filed with the court a notice of dismissal terminating the lawsuit. The confidential settlement agreement does not require the Company to make any monetary payments to Nokia.
From time to time and in the ordinary course of business, the Company may be subject to various claims, charges, and litigation. In the opinion of management, final judgments from such pending claims, charges, and litigation, if any, against the Company would not have a material adverse effect on its consolidated financial position, results of operations, or cash flows.
Note 10. Geographic Information Reporting
The Company operates in one segment to design, develop, market and support high-performance Internet caching appliances. Total export revenue consisted of sales from the Company's U.S. operations to non-affiliated customers in other geographic regions. Sales between geographic areas are accounted for at prices that provide a profit, and are in accordance with the rules and regulations of the respective governing authorities. During fiscal 2000 and 1999, there were no intra-enterprise sales, and no material long-lived assets were located in the Company's foreign operations. No geographical information was provided for 1998, as there were no net sales.
CACHEFLOW, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following is a summary of net sales by geographic area (in thousands):
Note 11. Selected Quarterly Financial Data (unaudited, in thousands, except per share data)
Note 12. Subsequent Event
Business Acquisition
On June 5, 2000, the Company acquired all of the outstanding capital stock of SpringBank Networks, Inc. ("SpringBank"), through a stock-for-stock merger, pursuant to which each issued and outstanding share of common stock of SpringBank was converted into the right to receive 0.2 shares of common stock of CacheFlow. In addition, each outstanding option to purchase SpringBank Common Stock was assumed by CacheFlow and converted into an option to purchase 0.2 shares of CacheFlow Common Stock determined pursuant to the exchange ratio in the Merger Agreement. The exercise price of the options to purchase CacheFlow Common Stock was also determined pursuant to the exchange ratio in the Merger Agreement. Purchase consideration totaled approximately $177 million and included approximately 2.8 million shares of CacheFlow Common Stock and approximately $8 million of assumed liabilities. This transaction was accounted for as a purchase, and the purchase price was allocated to tangible and intangible assets in proportion to the fair value of those assets.
Repayment of Notes Receivable
As of July 10, 2000, an officer of the Company repaid the Company all principal and accrued interest owed under an $800,000 promissory note to purchase a primary residence and a $999,900 promissory note to purchase shares of common stock.
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders CacheFlow Inc.
We have audited the accompanying consolidated balance sheets of CacheFlow Inc. as of April 30, 2000 and 1999, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended April 30, 2000. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of CacheFlow Inc. at April 30, 2000 and 1999, and the consolidated results of their operations and their cash flows for each of the three years in the period ended April 30, 2000, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects, the information set forth therein.
/s/ Ernst & Young LLP
Walnut Creek, California May 16, 2000 except Note 12, which is as of July 10, 2000.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III.
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Executives of the Registrant
See the information set forth in the section entitled "Proposal No. 1-- Election of Directors" in our Proxy Statement for the 2000 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission with 120 days after the end of our fiscal year ended April 30, 2000 (the "2000 Proxy Statement"), which is incorporated herein by reference, and the information set forth in the section entitled "Executive Officers of the Registrant." See also the information set forth in the section entitled "Compliance with Section 16(a) of the Exchange Act" in the 2000 Proxy Statement, which is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
See the information set forth in the section entitled "Executive Compensation and Related Information" in the 2000 Proxy Statement, which is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
See the information set forth in the section entitled "Security Ownership of Certain Beneficial Owners and Management" in the 2000 Proxy Statement, which is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
See the information set forth in the section entitled "Certain Relationships and Related Transactions" in the 2000 Proxy Statement, which is incorporated herein by reference.
PART IV.
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Financial Statements and Financial Statement Schedules
1. Financial Statements
See Item 8 of this Form 10-K
2. Financial Statement Schedules
The following financial statement schedule of CacheFlow Inc. is filed as part of this Report and should be read in conjunction with the Financial Statements of CacheFlow Inc.
Schedule II Valuation and Qualifying Accounts and Reserves
Schedules not listed above have been omitted because the information required to be set forth therein is not applicable or is shown in the financial statements or notes thereto.
3. Exhibits
(b) No reports on Form 8-K were filed during the quarter ended April 30, 2000.
SIGNATURES
Pursuant to the requirements of Section 13 of 15(d) of the Securities Exchange Act of 1934, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Cacheflow Inc. (Registrant)
/s/ Brian M. NeSmith July 28, 2000 By: _________________________________ Brian M. NeSmith President, Chief Executive Officer and Director
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Brian M. NeSmith and Michael J. Johnson, or either of them, each with the power of substitution, his attorney-in-fact, to sign any amendments to this Form 10-K (including post-effective amendments), and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of Sections 13 or 15(d) the Securities Exchange Act of 1934, the Registrant has caused this report to be signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:
EXHIBIT INDEX
SCHEDULE II
CACHEFLOW, INC.
VALUATION AND QUALIFYING ACCOUNTS
Allowance for Doubtful Accounts and Sales Returns