<PAGE>
FILED PURSUANT TO RULE 424(B)(4)
REGISTRATION STATEMENT NO. 333-85997
PROSPECTUS
4,000,000 Shares
[LOGO OF SONICWALL, INC.]
$14.00 per share
----------------
This is the initial public offering of SonicWALL, Inc. We are selling
4,000,000 shares of our common stock. In addition, the shareholders listed on
page 54 have granted the underwriters a 30-day option to purchase up to an
additional 600,000 shares of common stock to cover any over-allotments. We
will not receive any of the proceeds from the sale of shares by the selling
shareholders.
Our common stock has been approved for quotation on the Nasdaq National Market
under the symbol "SNWL."
Investing in our common stock involves a high degree of risk. See "Risk
Factors" beginning on page 6 to read about the risks you should consider
before buying shares of our common stock.
Neither the Securities and Exchange Commission nor any other regulatory body
has approved or disapproved of these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
----------------
<TABLE>
<CAPTION>
Per Share Total
--------- -----------
<S> <C> <C>
Public offering price.................................... $14.00 $56,000,000
Underwriting discounts and commissions................... $ 0.98 $ 3,920,000
Proceeds, before expenses to us.......................... $13.02 $52,080,000
Proceeds to the selling shareholders (1)................. $13.02 $ 7,812,000
</TABLE>
----------------
(1) The underwriters may purchase up to an additional 600,000 shares from
Sreekanth Ravi and Sudhakar Ravi, two of our executive officers and principal
shareholders, at the initial public offering price less the underwriting
discount, solely to cover over-allotments.
The underwriters expect to deliver the shares in New York, New York on or
about November 16, 1999.
----------------
Bear, Stearns & Co. Inc.
Hambrecht & Quist
Thomas Weisel Partners LLC
The date of this prospectus is November 10, 1999
<PAGE>
Title: SonicWALL (logo)
[PICTURE OF SONICWALL PRODUCTS]
Firewall Security
Blocks access to the network by unauthorized persons.
Virtual Private Networking
Enables secure communications between branch offices and their corporate
networks.
Content Filtering
Blocks objectionable websites.
[SonicWALL, Inc. LOGO]
GATEFOLD ARTWORK TEXT:
Title: SonicWALL (logo) Internet Security Appliances
Corporate Firewall
Our products are compatible with Internet security products for large corporate
networks such as Check Point Software's Firewall-1. We have no affiliation with
these companies.
Virtual Private Networking
With SonicWALL, mobile workers can use VPN to connect securely to the office.
Mobile Worker
Cable Modem or DSL Connection
Virtual Private Networking (branch office)
A SonicWALL may be deployed at each branch office for complete Internet
security: firewalling, VPN and content filtering.
Firewall Security
With SonicWALL, small to medium size businesses can deploy Internet security.
SonicWALL DMZ protects Web and e-commerce servers deployed by these businesses.
Content Filtering
With SonicWALL with content filtering schools and libraries can protect
children from objectionable Web sites as well as secure the network from
Internet hackers.
Firewall Security: Blocks access to the network by unauthorized
persons..Virtual Private Networking (VPN): Enables secure communications
between branch offices and their corporate networks..Content Filtering: Block
objectionable websites.
GATEFOLD ARTWORK DESCRIPTION OF GRAPHICS:
Diagram showing the Internet as an oval symbol and lines connecting from the
Internet through depiction of SonicWALL products as they relate to various user
groups, such as Branch Offices, Small to Medium Size Businesses, Schools, and
Mobile Workers.
<PAGE>
PROSPECTUS SUMMARY
You should read this summary together with the more detailed information
regarding our company and the common stock being sold in this offering and our
consolidated financial statements and related notes to financial statements
appearing elsewhere in this prospectus. Because this is only a summary, you
should read the rest of the prospectus before you invest in our common stock.
SonicWALL, Inc.
SonicWALL, Inc. designs, develops, manufactures and sells Internet security
infrastructure products designed to provide secure Internet access to our
broadband customers. Broadband access, such as digital subscriber line, or DSL,
and cable modems, allows users to connect to the Internet at speeds
significantly greater than analog modems. We believe our security appliances
provide high performance, robust, reliable, easy-to-use and affordable Internet
security. We also sell content filtering services on an annual subscription
basis. We sell our products to customers in the small to medium enterprise,
branch office, telecommuter and education markets. Small to medium enterprises
are generally considered to have less than 1,000 people. As of September 30,
1999, we had sold more than 18,000 of our Internet security appliances
worldwide. An investment in our shares involves a high degree of risk. The
risks associated with investing in our stock include the following. We may not
achieve profitability in the future. We compete in a highly competitive market
and competition may intensify. After the offering, our officers and directors
and their affiliates will own approximately 66.4% of our outstanding stock and,
if acting together, would be able to significantly influence all matters
requiring shareholder approval. We depend on three distributors for
approximately 57% of our revenue. Due to any of these risks, the trading price
of our common stock could decline and you could lose all or part of your
investment. Read this entire prospectus carefully, especially the risks
described under "Risk Factors."
From inception in 1991 through 1996, we derived substantially all of our
revenue from the sale of networking products for Apple Computer Inc. Macintosh
computers. These products enable Apple Macintosh computers to connect to
computer networks using Ethernet communications standards. The Ethernet
standard was developed in the 1970s by Xerox Corporation and is the most widely
used technology to facilitate communication between computers on local area
networks. The Ethernet standard is defined by the Institute of Electrical and
Electronics Engineers and specifies the speed and other characteristics of a
computer network. In 1998, we made a strategic business decision to concentrate
our resources in the Internet security market due to our belief that this
market had better long-term growth prospects. As a result, we intend to stop
shipments of our Ethernet product line by December 1999. In October 1997, we
began shipments of our Internet security appliance products, and we now focus
all of our development, sales and marketing efforts on the Internet security
appliance market. In 1998, our Internet security products represented
approximately 31% of our total revenue and in the nine months ended
September 30, 1999, they represented 88% of our total revenue. In 1998, our
Ethernet products represented approximately 69% of our total revenue and in the
nine months ended September 30, 1999, Ethernet products represented
approximately 12% of our total revenue. In the years ended December 31, 1996,
1997 and 1998 we incurred losses of $32,000, $467,000 and $1,461,000,
respectively. As of September 30, 1999 we had an accumulated deficit of
$997,000.
Although the need for Internet security solutions is widespread, security
vendors generally have focused on providing solutions for large enterprises
with highly complex needs and extensive information technology, or IT, support
organizations. These solutions have typically involved expensive enterprise
firewall software that runs on a dedicated server or personal computer, or PC,
and requires extensive support, constant monitoring, and regular updates to
maintain effectiveness. In addition, these solutions often require additional
products to incorporate enhanced functionalities such as virtual private
networking and content filtering. We believe the expense and complexity of
these solutions make them impractical for the majority of small to medium
enterprises, branch offices, telecommuters and education users. These users are
increasingly demanding robust, reliable, easy-to-use and affordable Internet
security products.
3
<PAGE>
Our SonicWALL product line provides our customers with a comprehensive
integrated security solution that includes a firewall, content filtering and
virtual private networking. A firewall blocks access to the network by
unauthorized persons. Content filtering blocks access to objectionable web
sites. Virtual private networking enables secure communications between branch
offices or telecommuters and their corporate networks. We believe the SonicWALL
product line is easy to install and use and minimizes the purchase,
installation and maintenance costs of Internet security. With suggested retail
prices ranging from $495 to $2,995, versus competitive products which range in
price from approximately $5,000 to more than $15,000, our products are designed
to enable customers to reduce purchase costs and avoid hiring costly IT
personnel. Our SonicWALL products are designed to maximize reliability and
uptime, can be used in networks ranging in size from 1 to 1,000 users, and are
fully compatible with more expensive enterprise security products offered by,
among others, Check Point Software Technologies, Ltd. and Cisco Systems, Inc.
We initially incorporated in California in 1991 as Sonic Systems. In August
1999 we changed our name to SonicWALL, Inc. References to "we," "our" and "us"
in this prospectus refer to SonicWALL, Inc. Our executive offices are located
at 1160 Bordeaux Drive, Sunnyvale, California 94089, and our telephone number
is (408) 745-9600. Our Web site is located at http://www.sonicwall.com. Any
information that is included on or linked to our Web site is not a part of this
prospectus.
We own or have rights to various trademarks and trade names used in our
business. These include the SonicWALL name and our logo. This prospectus also
includes trademarks, service marks and trade names of other companies, which
remain the property of their owners.
THE OFFERING
<TABLE>
<C> <S>
Common stock offered by SonicWALL, Inc.............. 4,000,000 shares
Common stock to be outstanding after this offering.. 23,675,385 shares
Use of proceeds..................................... Growth, capital
expenditures to expand
our internal computer
systems, including
financial reporting,
human resources and other
related internal systems,
and general corporate
purposes which includes
working capital. See "Use
of Proceeds."
Nasdaq National Market Symbol....................... SNWL
</TABLE>
The number of shares of common stock to be outstanding after this offering
is based upon shares outstanding as of November 9, 1999. This number excludes
802,760 shares of common stock reserved for issuance under our stock plans and
3,840,709 shares of common stock issuable upon exercise of outstanding stock
options.
----------
Except where stated otherwise, the information we present in this prospectus
(1) gives effect to a 2 for 1 split of our common stock effected on August 25,
1999, (2) assumes the conversion of all outstanding shares of our redeemable
Series A convertible preferred stock into 2,876,754 shares of common stock at
the closing of this offering, and (3) assumes no exercise by the underwriters
of their over-allotment option.
4
<PAGE>
SUMMARY FINANCIAL DATA
(In thousands, except per share data)
<TABLE>
<CAPTION>
Year Ended December Nine Months Ended
31, September 30,
----------------------- ------------------
1996 1997 1998 1998 1999
------ ------ ------- -------- --------
Statement of Operations Data: (unaudited)
<S> <C> <C> <C> <C> <C>
Revenue
Internet security............... $ -- $ 250 $ 2,349 $ 924 $ 10,677
Ethernet........................ 9,356 9,092 5,166 4,456 1,474
------ ------ ------- -------- --------
Total revenue.................. 9,356 9,342 7,515 5,380 12,151
Cost of revenue.................. 5,915 4,842 3,308 2,485 3,462
------ ------ ------- -------- --------
Gross margin..................... 3,441 4,500 4,207 2,895 8,689
Operating expenses
Research and development........ 1,048 1,983 2,051 1,417 2,198
Sales and marketing............. 1,665 2,468 2,870 2,082 3,408
General and administrative...... 432 644 753 541 1,189
Deferred stock compensation..... -- -- 42 -- 1,301
------ ------ ------- -------- --------
Total operating expenses....... 3,145 5,095 5,716 4,040 8,096
Income (loss) from operations.... 296 (595) (1,509) (1,145) 593
Other income (expense), net...... 22 29 54 36 205
------ ------ ------- -------- --------
Income (loss) before income
taxes........................... 318 (566) (1,455) (1,109) 798
Benefit from (provision for)
income taxes.................... (350) 99 (6) -- (787)
------ ------ ------- -------- --------
Net income (loss) ............... $ (32) $ (467) $(1,461) $ (1,109) $ 11
====== ====== ======= ======== ========
Basic net income (loss) per
share........................... $ -- $(0.06) $ (0.13) $ (0.11) $ --
====== ====== ======= ======== ========
Diluted net income (loss) per
share........................... $ -- $(0.06) $ (0.13) $ (0.11) $ --
====== ====== ======= ======== ========
Shares used in computing basic
net income (loss) per share..... 8,460 8,461 11,251 10,290 16,367
====== ====== ======= ======== ========
Shares used in computing diluted
net income (loss) per share..... 8,460 8,461 11,251 10,290 19,421
====== ====== ======= ======== ========
Pro forma basic net income per
share........................... $ --
========
Pro forma diluted net income per
share........................... $ --
========
Shares used in computing pro
forma basic net income per
share........................... 18,727
========
Shares used in computing pro
forma diluted net income per
share........................... 19,421
========
</TABLE>
<TABLE>
<CAPTION>
September 30, 1999
-----------------------------
(unaudited)
Pro Forma
Consolidated Balance Actual Pro Forma as Adjusted
Sheet Data: ------- --------- -----------
<S> <C> <C> <C>
Cash and cash
equivalents............ $ 8,766 $ 8,766 $59,622
Total assets............ 15,107 15,107 65,963
Redeemable Series A
convertible preferred
stock.................. 4,971 -- --
Total shareholders'
equity................. 3,168 8,139 58,995
</TABLE>
The preceding table summarizes
. actual balance sheet data;
. pro forma balance sheet data assuming the conversion of all outstanding
redeemable Series A convertible preferred stock into shares of common
stock; and
. pro forma as adjusted balance sheet data to give effect to (1) the sale
by SonicWALL, Inc. of 4,000,000 shares of common stock in this offering,
after deducting underwriting discounts and commissions and estimated
offering expenses and (2) the conversion of all outstanding redeemable
Series A convertible preferred stock into 2,876,754 shares of common
stock.
See Note 1 of Notes to Financial Statements for information concerning the
calculation of pro forma basic and diluted net income per share.
5
<PAGE>
RISK FACTORS
An investment in our shares involves a high degree of risk. In addition to
the other information contained in this prospectus, you should consider
carefully the following risks before purchasing our common stock. If any of
these risks occurs, our business, financial condition or operating results
could be adversely affected. In that case, the trading price of our common
stock could decline and you could lose all or part of your investment.
Company Risks
We have just recently entered the emerging market for broadband Internet
security appliances, and we do not know if we will be successful in marketing
our products to our target customers.
From inception through 1996, we derived substantially all of our revenue
from the sale of Ethernet products for Apple Macintosh computers. In October
1997, we introduced our SonicWALL line of products, and in 1998 we made a
strategic decision to concentrate our resources in the Internet security
market. As a result, we expect to stop shipment of Ethernet products by
December 1999. In 1996, 1997 and 1998 our Ethernet revenue were $9,356,000,
$9,092,000, and $5,166,000 and represented approximately 100%, 97%, and 69%,
respectively, of our total revenue. For the nine-month period ended September
30, 1999, Ethernet product revenue was approximately $1,474,000 and represented
12.1% of our total revenue.
We believe that many potential customers in our target markets are not fully
aware of the need for Internet security products and services. Historically,
only enterprises having substantial resources developed or purchased Internet
security solutions. Also, there is a perception that Internet security is
costly and difficult to implement. Therefore, we will not succeed unless we can
educate our target markets about the need for Internet security and convince
potential customers of our ability to provide this security in a cost-effective
and easy-to-use manner. Although we have spent, and will continue to spend,
considerable resources educating potential customers about the need for
Internet security and the benefits of our products and services, our efforts
may be unsuccessful.
Even if we convince our target markets about the importance of and need for
Internet security, we do not know if this will result in the sale of our
products. We currently expect that almost all of our future revenue will be
generated through sales of our SonicWALL products, including related services
such as subscription and license fees. Our success depends on market acceptance
of our products and services.
We may be unable to manage our growth, and if we cannot do so, it could have a
material adverse effect on our business.
Our business has grown rapidly in the last year. At the end of 1998, we had
26 employees. As of September 30, 1999, we had 53 employees, an increase of
approximately 104%. In addition, we have experienced expansion in our
manufacturing and shipping requirements, our product lines, our customer base
and our end user installed base. This rapid expansion has placed significant
strain on our administrative, operational and financial resources and has
resulted in ever-increasing responsibilities for our management personnel.
These changes have increased the complexity of managing SonicWALL, Inc. If we
continue to experience significant growth, our current systems, management and
resources will be inadequate, and our organization will need to grow rapidly in
order to meet the demands placed on our business. If we cannot manage our
growth effectively, our business prospects will be materially adversely
affected.
We incurred losses during the last three years. We do not know if we will be
profitable in the future.
We incurred losses of $32,000 in 1996, $467,000 in 1997 and $1,461,000 in
1998, which represented 0.3%, 5.0% and 19.5%, respectively, of total revenue.
We made $11,000 in profit, or less than 1% of revenue, for the nine months
ended September 30, 1999. As of September 30, 1999 we had an accumulated
deficit of $997,000. We do not know if we will be able to achieve profitability
in the future. If we are not able to achieve profitability, your investment may
decline in value.
6
<PAGE>
Because we recently introduced our Internet security products, we cannot
predict our future operating results or our future revenues from these
products.
Because we recently changed our business focus from Ethernet products for
Macintosh computers to Internet security products, our historical financial
information is of limited value in projecting future operating results. We
believe that comparing different periods of our operating results is not
meaningful and you should not rely on the results for any period as an
indication of our future performance.
Our limited experience with sales of Internet security products is one of
many factors underlying our inability to predict our revenue for a given
period. We base our spending levels for product development, sales and
marketing, and other operating expenses largely on our expected future revenue.
A large proportion of our expenses is fixed for a particular quarter or year,
and therefore, we may be unable to decrease our spending in time to compensate
for any unexpected quarterly or annual shortfall in revenue. As a result, any
shortfall in revenue could adversely affect our operating results.
We depend on three major distributors for approximately 57% of our revenue, and
if they or others cancel or delay purchase orders, our revenue may decline and
the price of our stock may fall.
Approximately 95% of our sales are to distributors and original equipment
manufacturers. To date, sales to a limited number of distributors have
accounted for a significant portion of our revenue. Two of our distributors,
Ingram Micro, Inc. and Tech Data Corp., both of which are global computer
equipment and accessory distributors, account for approximately 46% of our
revenue. In 1998, sales to Ingram Micro accounted for 34% of our revenue. For
the nine months ended September 30, 1999, sales to Ingram Micro, Tech Data and
Sumitomo Metal Systems Development Company, a computer equipment and accessory
distributor in Japan, accounted for 35%, 11% and 11% of our revenue,
respectively. We cannot assure you that any of these existing customers will
continue to place orders with us, that orders by these existing customers will
continue at the levels of previous periods or that we will be able to obtain
large orders from new customers.
We anticipate that sales of our products to relatively few customers will
continue to account for a significant portion of our revenue. If any of our
major distributors or original equipment manufacturers stops or delays its
purchase of our products, our revenue and profitability would be adversely
affected. In addition, as of September 30, 1999, Ingram Micro, Tech Data, and
Sumitomo Metal represented $1.4 million, $0.6 million, and $0, respectively, of
our accounts receivable, constituting 56%, 23% and 0%, respectively, of total
receivables on such date. The failure of any of these distributors to pay us in
a timely manner would adversely affect our payments to suppliers and our
creditworthiness, which would make it more difficult to conduct business.
Although we have limited one year agreements with Ingram Micro, Tech Data
and Sumitomo Metal, these contracts are subject to termination at any time, and
we do not know if these customers will continue to place orders for our
products.
Our sales are usually done on a purchase order basis and we have no binding
purchase commitments from our distributors or original equipment manufacturers,
which could result in a lack of sales.
We sell our products to end users through distributors, resellers and
original equipment manufacturers. Our success depends in large part on their
performance. These customers:
. are not obligated to purchase or market our products and can stop
doing so at any time; and
. have no exclusive arrangements with us, and are not obligated to
renew their agreements with us.
7
<PAGE>
Average selling prices of our products may decrease, which may reduce our gross
margins.
The average selling prices for our products may decline as a result of
competitive pricing pressures, promotional programs and customers who negotiate
price reductions in exchange for longer term purchase commitments. The pricing
of products depends on the specific features and functions of the products,
purchase volumes and the level of sales and service support. We expect
competition to increase in the future. As we experience pricing pressure, we
anticipate that the average selling prices and gross margins for our products
will decrease over product life cycles. We cannot assure you that we will be
successful in developing and introducing on a timely basis new products with
enhanced features, or that these products, if introduced, will enable us to
maintain our average selling prices and gross margins at current levels.
We offer retroactive price protection to our major distributors and if we fail
to balance their inventory with end user demand for our products, our allowance
for price protection may be inadequate. This could adversely affect our results
of operations.
We provide our major distributors with price protection rights for
inventories of our products held by them. If we reduce the list price of our
products, our major distributors receive refunds or credits from us that reduce
the price of such products held in their inventory based upon the new list
price. As of September 30, 1999, we estimate that approximately $1.2 million of
our products were in our distributors' inventory and therefore subject to price
protection. This amount represented approximately 10% of our revenue for the
nine-month period ending at such date. We have provided less than $100,000 of
credits under our price protection policies in the past three fiscal years.
Future credits for price protection will depend on the percentage of our price
reductions for the products in inventory and our ability to manage the level of
our major distributors' inventory. New product introductions or price
reductions by us or our competitors could result in significant product price
adjustments. If future price protection adjustments are higher than expected,
our future results of operations could be materially adversely affected.
We are dependent on international sales for a substantial amount of our
revenue. We face the risks of international business and associated currency
fluctuations, which might adversely affect our operating results.
International revenue represented 32% of total revenue in 1998 and 33% of
total revenue for the nine months ended September 30, 1999. For the nine months
ended September 30, 1999, revenue from Japan represented 15% of our total
revenue, and revenue from Europe, the Middle East and Africa collectively
represented approximately 13% of our total revenue. We expect that
international revenue will continue to represent a substantial portion of our
total revenue in the foreseeable future. Our risks of doing business abroad
include our ability to maintain distribution relationships on favorable terms.
To the extent we are unable to favorably renew our distribution agreements or
make alternative arrangements, revenue may decrease from our international
operations. We also face risks associated with general economic conditions and
regulatory uncertainties associated with our international sales. Because our
sales are denominated in United States dollars, the weakness of a foreign
country's currency against the dollar could increase the price of our products
in such country and reduce our product unit sales by making our products more
expensive in the local currency.
We are subject to the risks of conducting business internationally,
including potential foreign government regulation of our technology, and
general geopolitical risks associated with political and economic instability,
changes in diplomatic and trade relationships, and foreign countries' laws
affecting the Internet generally.
Delays in deliveries from our component suppliers could cause our revenue to
decline and adversely affect our results of operations.
Our SonicWALL products incorporate components or technologies which are only
available from single or limited sources of supply. We purchase such products
under purchase orders and technology licenses. Specifically, our products rely
upon microprocessors from Motorola, Inc. and Intel Corporation and incorporate
software products from third-party vendors. We do not have long-term supply
arrangements with any vendor, and this may adversely affect our ability to
obtain necessary components or technology for our products. If we
8
<PAGE>
are unable to purchase such components or maintain licenses from these
suppliers, this may delay or prevent product shipments and result in a loss of
sales. This could cause a loss of revenue which would adversely affect our
results of operations. We may not be able to replace any of these supply
sources on economically advantageous terms.
We may have to defend lawsuits or pay damages in connection with any alleged or
actual failure of our products and services.
Because our products and services provide and monitor Internet security and
may protect valuable information, we may face claims for product liability,
tort or breach of warranty. Anyone who circumvents our security measures could
misappropriate the confidential information or other property of end-users
using our products and services or interrupt their operations. If that happens,
affected end-users or others may sue us. In addition, we may face liability for
breaches caused by faulty installation of our products by resellers or end-
users. Although we attempt to reduce the risk of losses from claims through
contractual warranty disclaimers and liability limitations, these provisions
may be unenforceable. Some courts, for example, have found contractual
limitations of liability in standard computer and software contracts to be
unenforceable in some circumstances. Defending a lawsuit, regardless of its
merit, could be costly and could divert management attention. Although we
currently maintain business liability insurance, this coverage may be
inadequate or may be unavailable in the future on acceptable terms, if at all.
Our business liability insurance has no specific provisions for potential
liability for Internet security breaches.
A security breach of our internal systems or those of our customers could harm
our business.
Because we provide Internet security, we may become a greater target for
attacks by computer hackers. We will not succeed unless the marketplace is
confident that we provide effective Internet security protection. Networks
protected by our products may be vulnerable to electronic break-ins. Because
the techniques used by computer hackers to access or sabotage networks change
frequently and generally are not recognized until launched against a target, we
may be unable to anticipate these techniques. Although we have not experienced
any act of sabotage or unauthorized access by a third party of our internal
network to date, if an actual or perceived breach of Internet security occurs
in our internal systems or those of our end-user customers, regardless of
whether we cause the breach, it could adversely affect the market perception of
our products and services. This could cause us to lose current and potential
customers, resellers, distributors or other business partners.
We rely primarily on one contract manufacturer for all of our product
manufacturing and assembly, and if we cannot obtain its services, we may not be
able to ship products.
We outsource all of our hardware manufacturing and assembly primarily to one
third-party manufacturer and assembly house--Flash Electronics, Inc. We do not
have a long-term manufacturing contract with this vendor. Flash Electronics has
produced products with acceptable quality, quantity and cost in the past, but
it may be unable or unwilling to meet our future demands. Our operations could
be disrupted if we have to switch to a replacement vendor or if our hardware
supply is interrupted for an extended period. This could result in loss of
customer orders and revenue.
We may have to reduce or cease operations if we are unable to obtain the
funding necessary to meet our working capital requirements.
We believe that the net proceeds from this offering, together with our
existing cash balances and our existing line of credit, will be sufficient to
meet our capital requirements for at least the next twelve months. However, if
our future revenue is insufficient to support the expenses of our operations
and the expansion of our business, we may need additional equity or debt
capital to finance our operations. If we are unable to generate sufficient cash
flow from operations or obtain funds through additional financing, we may have
to reduce some or all of our development and sales and marketing efforts or
cease operations. Our funding requirements depend on several factors, including
the rate of market acceptance of our products and services, our ability to
expand our customer base and the growth of our sales and marketing
capabilities. If our funding
9
<PAGE>
requirements vary from our current plans, we may require additional financing
sooner than we anticipate. To the extent that the proceeds of this offering and
our existing sources of cash and cash flow from operations, if any, are
insufficient to fund our activities, we may need to raise additional funds. If
we issue additional stock to raise capital, your percentage ownership in our
Company would be reduced. Additional financing may not be available when needed
and, if such financing is available, it may not be available on terms favorable
to us.
We may be unable to adequately protect our proprietary rights, which may limit
our ability to compete effectively.
Unauthorized parties may misappropriate or infringe our trade secrets,
copyrights, trademarks and similar proprietary rights. We have not received any
patent protection for our technology or products. Even if we obtain such
patents, that does not guarantee that our patent rights are valuable, create a
competitive barrier, or will be free from infringement. We face additional risk
when conducting business in countries that have poorly developed or
inadequately enforced intellectual property laws. In any event, competitors may
independently develop similar or superior technologies or duplicate the
technologies we have developed, which could substantially limit the value of
our intellectual property.
Potential intellectual property claims and litigation could subject us to
significant liability for damages and invalidation of our proprietary rights.
In the future, we may have to resort to litigation to protect our
intellectual property rights or trade secrets or to determine the validity and
scope of the proprietary rights of others. Any litigation, regardless of its
success, would probably be costly and require significant time and attention of
our key management and technical personnel. Litigation could also force us to:
. stop or delay selling, incorporating or using products that
incorporate the challenged intellectual property;
. pay damages;
. enter into licensing or royalty agreements, which may be unavailable
on acceptable terms; or
. redesign products or services that incorporate infringing
technology.
We may face infringement claims from third parties in the future. The
computer industry has seen frequent litigation over intellectual property
rights. We expect that infringement claims will be more frequent for Internet
participants as the number of products, services and competitors grows and
functionality of products and services overlaps.
Undetected product errors or defects could result in loss of revenue, delayed
market acceptance and claims against us.
We offer a one-year warranty on all of our products, allowing the end user
to receive a repaired or replacement product for any defective unit.
Historically, refunds based on product warranty claims have been insignificant.
Although we have discovered few errors or defects in our products, our products
may contain undetected errors or defects. If there is a product failure, we may
have to replace all affected products without being able to book revenue for
such replacement units, or we may have to refund the purchase price for such
units. Because of our recent introduction of Internet security products, we
have little experience in gauging the risk of unexpected product failures or
defects. Despite extensive testing, some errors are discovered only after a
product has been installed and used by customers. Any errors discovered after
commercial release could result in loss of revenue and claims against us. In
the nine months ended September 30, 1999, refunds attributable to errors or
defects in products amounted to less than 1% of total revenue for the period.
10
<PAGE>
If we do not retain our key employees and attract new employees, our ability to
execute our business strategy will be impaired.
We compete for employees in California's Silicon Valley, one of the most
difficult employer environments in the United States. Our future success will
depend largely on the efforts and abilities of our current senior management
and our ability to attract and retain additional key development, technical,
operations, information systems, customer support and sales and marketing
personnel. We do not have employment contracts with any of our key employees,
who may leave us at any time. Specifically, the services of Sreekanth Ravi,
President and Chief Executive Officer, and Sudhakar Ravi, Vice President of
Engineering, would be difficult to replace. We do not maintain life insurance
for any of our key personnel. See "Management" for detailed information on our
key personnel.
Industry Risks
Our revenue growth is dependent on the continued growth of broadband access
services, which are currently in early stages of development, and if such
services are not widely adopted or we are unable to address the issues
associated with the development of such services, our sales will be adversely
affected.
Sales of our products depend on the increased use and widespread adoption of
broadband access services, such as cable, DSL, Integrated Services Digital
Network, or ISDN, Frame Relay and T-1. These broadband access services
typically are more expensive in terms of required equipment and ongoing access
charges than is the case with Internet dial-up access providers. Our business,
prospects, results of operations and financial condition would be materially
adversely affected if the use of broadband access services does not increase as
anticipated or if our customers' access to broadband services is limited.
Critical issues concerning use of broadband access services are unresolved and
will likely affect the use of broadband access services. These issues include:
. security;
. reliability;
. bandwidth;
. congestion;
. cost;
. ease of access; and
. quality of service.
Even if these issues are resolved, if the market for products that provide
broadband access to the Internet fails to develop, or develops at a slower pace
than we anticipate, our business, prospects, results of operations and
financial condition would be materially adversely affected.
The broadband access services market is new and is characterized by rapid
technological change, frequent enhancements to existing products and new
product introductions, changes in customer requirements and evolving industry
standards. We may be unable to respond quickly or effectively to these
developments. The introduction of new products by competitors, market
acceptance of products based on new or alternative technologies, or the
emergence of new industry standards, could render our existing or future
products obsolete, which would materially adversely affect our business,
prospects, results of operations and financial condition.
The emergence of new industry standards might require us to redesign our
products. If our products fail to comply with widely adopted industry
standards, our customers and potential customers may not purchase our products.
This would have a material adverse effect on our business, prospects, results
of operations and financial condition.
11
<PAGE>
If we are unable to compete successfully in the highly competitive market for
Internet security products and services, our business will fail.
The market for Internet security products is world-wide and highly
competitive, and we expect competition to intensify in the future. There are
few substantial barriers to entry, and additional competition from existing
competitors and new market entrants will likely occur in the future. Current
and potential competitors in our markets include, but are not limited to the
following, all of whom sell world-wide or have a presence in most of the major
markets for such products:
. enterprise firewall software vendors such as Check Point Software
and Axent Technologies, Inc.;
. network equipment manufacturers such as Cisco Systems, Lucent
Technologies, Inc., Nortel Networks Corp., 3COM Corporation and
Nokia Corp.;
. computer or network component manufacturers such as Intel
Corporation;
. operating system software vendors such as Microsoft Corporation,
Novell, Inc. and Sun Microsystems, Inc.;
. security appliance suppliers such as Watchguard Technologies, Inc.;
and
. low cost Internet router suppliers which may include limited
Internet security functionality.
Most of our competitors to date have generally targeted large enterprises'
security needs with firewall products that range in price from approximately
$5,000 to more than $15,000. At any time, any of these competitors may adapt
existing products to compete in our target markets. Many of our current or
potential competitors have longer operating histories, greater name
recognition, larger customer bases and significantly greater financial,
technical, marketing and other resources than we do. Nothing prevents or
hinders these actual or potential competitors from entering our target markets
at any time. In addition, our competitors may bundle products competitive to
ours with other products that they may sell to our current or potential
customers. These customers may accept these bundled products rather than
separately purchasing our products. If these companies were to use their
greater financial, technical and marketing resources in our target markets, it
could adversely affect our business.
Rapid changes in technology and industry standards could render our products
and services unmarketable or obsolete, and we may be unable to successfully
introduce new products and services.
To succeed, we must continually change and improve our products in response
to rapid technological developments and changes in operating systems, broadband
Internet access, application and networking software, computer and
communications hardware, programming tools, computer language technology and
other security threats. We may be unable to develop new products and services
or achieve and maintain market acceptance of them once they have come to
market. Product development for Internet security appliances requires
substantial engineering time and testing. Releasing new products and services
prematurely may result in quality problems, and delays may result in loss of
customer confidence and market share. In the past, we have on occasion
experienced delays in the scheduled introduction of new and enhanced products
and services, and we may experience delays in the future. When we do introduce
new or enhanced products and services, we may be unable to manage the
transition from the older products and services to minimize disruption in
customer ordering patterns, avoid excessive inventories of older products and
deliver enough new products and services to meet customer demand.
Governmental regulations affecting Internet security could affect our revenue.
Any additional governmental regulation of imports or exports or failure to
obtain required export approval of our encryption technologies could adversely
affect our international and domestic sales. The United States and various
foreign governments have imposed controls, export license requirements and
restrictions on the import or export of some technologies, especially
encryption technology. In addition, from time to time governmental agencies
have proposed additional regulation of encryption technology, such as requiring
the escrow and governmental recovery of private encryption keys. Additional
regulation of encryption technology could delay or prevent the acceptance and
use of encryption products and public networks for secure communications. This,
in turn, could decrease demand for our products and services.
12
<PAGE>
In addition, some foreign competitors are subject to less stringent controls
on exporting their encryption technologies. As a result, they may be able to
compete more effectively than we can in the United States and international
Internet security market.
Recently, political attention has resulted in legislative efforts to make
the Internet safe for children at schools and other educational institutions
receiving federal assistance by linking the receipt of federal funds to the
existence of content filtering and security software for such institutions'
Internet connections. Some have questioned the constitutionality or other
legality of such efforts, but we believe that any government controls or
attempts to regulate the Internet could have a material effect on our business.
A government requirement of Internet security for schools receiving federal
funds would encourage purchases of our SonicWALL products; a court ruling that
prohibited such a requirement after the requirement was in place might reduce
sales to these market segments.
Our failure or the failure of our key suppliers and customers to be Year 2000
compliant could negatively impact our business.
The Year 2000 computer issue creates a variety of risks for us. If systems
do not correctly recognize date information when the year changes to 2000, our
business, results of operations and financial condition could be materially
adversely affected. The risks involve:
. potential warranty or other claims by our customers;
. errors in systems we use to run our business;
. errors in systems used by our suppliers; and
. errors in systems used by our customers.
We may experience material unanticipated problems and costs caused by
undetected errors or defects in the technology used in our internal information
technology and non-information technology systems. These unanticipated problems
and costs could have a material adverse effect on our business, results of
operations and financial condition.
We are in the process of contacting our critical suppliers to determine if
the suppliers' operations and the products and services provided to us are Year
2000 compliant. However, our failure to mitigate our Year 2000 risks remains a
possibility and could have a material adverse impact on our business, results
of operations and financial condition.
We believe that our SonicWALL product line is Year 2000 compliant. However,
despite testing by us and by current and potential customers, and despite
assurances from developers of products incorporated into SonicWALL, our
products may contain undetected errors or defects associated with Year 2000
date functions. We have assured our customers that SonicWALL is Year 2000
compliant. If our products are not Year 2000 compliant, this would result in
numerous customer claims, which could have a material adverse impact on our
business, results of operations and financial condition.
We do not have information concerning the Year 2000 compliance status for
all of our customers. Our current or potential customers may incur significant
expenses to achieve Year 2000 compliance. If our customers are not Year 2000
compliant, they may experience material costs to remedy problems, or they may
face litigation costs. In either case, spending on Year 2000 issues could
reduce or eliminate the budgets that our current or potential customers could
have for purchases of our products. As a result, our business, results of
operations and financial condition could be materially adversely affected.
If our internal systems, our products or the internal systems at our
manufacturers are not Year 2000 compliant, our business, results of operations
and financial condition would be materially adversely affected.
13
<PAGE>
We do not currently have any contingency plans with respect to Year 2000
worst case scenarios. In the worst case scenario, any Year 2000 related failure
of any of our critical suppliers or customers could cause a significant
disruption of our assembly operations or sales channels and could result in our
inability to conduct business without interruption. If, in the worst case
scenario, our products are affected by date-related issues, our customers may
file claims against us or require us to repair any damage to their systems
caused by our products. In such instance, our revenues may be adversely
affected, our maintenance, technical support and management costs could
increase and our reputation could be damaged. However, we have recently begun
planning preparations to handle the most reasonably likely worst case scenarios
described above. We intend to complete the contingency plans for these
scenarios during the fourth quarter of 1999.
Investment Risk
Our management has broad discretion as to how to use the proceeds from this
offering and the proceeds may not be used appropriately.
We expect to use the net proceeds of this offering primarily for working
capital and other general corporate purposes. In particular, we intend to
increase our spending on sales and marketing, research and development and
administrative infrastructure. We may also use some of the proceeds to acquire
other businesses, products or technology which would complement our existing
products, expand our market coverage or enhance our technological capabilities.
We have no specific plan as to how we will spend the majority of the proceeds
of this offering. If our management uses poor judgment in spending the
proceeds, our business will be adversely affected. We cannot assure you that
investment of the proceeds will yield a favorable return or any return. See
"Use of Proceeds."
Because they will own approximately 66.4% of our stock ownership after the
offering, our officers, directors and their affiliates will be able to elect
the board of directors and control all matters requiring shareholder approval.
Executive officers, directors, and entities affiliated with them, will, in
the aggregate, beneficially own approximately 66.4% of our outstanding common
stock following the completion of this offering. These shareholders, if acting
together, would be able to significantly influence all matters requiring
shareholder approval, including the election of directors, mergers or other
forms of business combinations. See "Principal and Selling Shareholders."
The price of our common stock may be volatile.
The trading price of the shares being sold in this offering may fluctuate
widely as a result of a number of factors, most of which are outside our
control. Some of these factors include:
. quarter-to-quarter variations in our operating results;
. our announcements about the performance of our products and our
competitors' announcements about performance of their products; and
. changes in earnings estimates by, or failure to meet the
expectations of, analysts.
In addition, the stock market has experienced extreme price and volume
fluctuations, which have particularly affected the market prices of many
technology and computer software companies and which have often been unrelated
to the operating performance of these companies.
We have negotiated the initial offering price of the common stock with our
underwriters. However, the initial offering price may not be indicative of the
prices that will prevail in the public market after the offering, and the
market price of the common stock could fall below the initial offering price.
See "Underwriting."
14
<PAGE>
Charter and bylaw provisions limit the authority of our shareholders, and
therefore minority shareholders may not be able to significantly influence
SonicWALL, Inc.'s governance or affairs.
Upon completion of this offering, our board of directors will have the
authority to issue shares of preferred stock and to determine the price,
rights, preferences, privileges and restrictions, including voting rights, of
those shares without any further vote or action by shareholders. The rights of
the holders of common stock will be subject to, and may be adversely affected
by, the rights of the holders of any preferred stock that may be issued in the
future. The issuance of preferred stock, while providing flexibility in
connection with possible acquisitions and other corporate purposes, could have
the effect of making it more difficult for a third party to acquire a majority
of our outstanding voting stock.
Our charter documents also provide for limitations on the ability of
shareholders to call special meetings and act by written consent and prohibit
cumulative voting for directors. As a result, minority shareholder
representation on the board of directors may be difficult to establish. The
charter documents also limit the persons who may call special meetings of the
shareholders, prohibit shareholder actions by written consent and establish
advance notice requirements for nominations for election to the board of
directors or for proposing matters that can be acted on by shareholders at
shareholder meetings.
Substantial future sales of our common stock in the public market could cause
our stock price to fall.
If our shareholders sell substantial amounts of our common stock in the
public market following this offering, including shares issued upon the
exercise of outstanding options, the trading price of our common stock could
fall. Such sales also might make it more difficult for us to raise capital in
the future at a time and price that we deem appropriate. Upon completion of
this offering, we will have outstanding 23,675,385 shares of common stock based
upon shares outstanding as of November 9, 1999, assuming no exercise of
outstanding options after November 9, 1999. Of these shares, the 4,000,000
shares sold in this offering will be freely tradable, and 19,675,385 are
subject to lock up agreements until the times described below, when they are
available for sale.
<TABLE>
<CAPTION>
Number of
Date of Availability for Sale Shares
----------------------------- ----------
<S> <C>
180 days after the date of this prospectus...................... 16,963,985
At various times after 180 days (as Rule 144 holding periods
expire)........................................................ 2,711,400
</TABLE>
After this offering, the holders of approximately 2,876,754 shares of common
stock will be entitled to require us to register their shares under the
Securities Act of 1933, as amended, the "Act", if more than 50% of the holders
of registration rights demand registration of at least half of their shares
having an expected aggregate offering price of $2,000,000 or more. These
holders and holders of approximately 2,301,400 shares of common stock have the
right to participate in any registration of shares we undertake on our own,
except a registration of shares in connection with an employee benefit plan or
merger. If these shareholders exercise their registration rights, a large
number of our shares may be registered and sold in the public market. This
could adversely affect the trading price for our shares. If we attempted to
raise money through a registration and sale of our stock and these shareholders
forced us to allow them to participate in the registration, our ability to
raise the amount of money we need to execute our business plan could be
adversely affected. See "Description of Capital Stock--Registration Rights."
Bear, Stearns & Co. Inc. may, in its sole discretion and at any time without
notice, release all or any portion of the securities subject to lock-up
agreements. See "Shares Eligible for Future Sale."
You will experience substantial dilution in the value of your shares
immediately following this offering.
The price of the shares is substantially higher than the net tangible book
value per share. If you buy any shares in the offering, you will incur
immediate and substantial dilution in the pro forma net tangible book value of
each share. If others exercise options to purchase our common stock, you will
suffer further dilution. See "Dilution."
15
<PAGE>
CAUTIONARY NOTE ON FORWARD-LOOKING STATEMENTS
Some of the matters discussed under the captions "Prospectus Summary," "Risk
Factors," "Management's Discussion and Analysis of Financial Condition and
Results of Operations," "Business" and elsewhere in this prospectus include
forward-looking statements. We have based these forward-looking statements on
our current expectations and projections about future events, including, among
other things:
. implementing our business strategy;
. developing and introducing new products;
. obtaining and expanding market acceptance of the products we offer;
. meeting our requirements with our customers; and
. competition in the Internet security market.
In some cases, you can identify forward-looking statements by terminology
such as "may," "will," "should," "potential," "continue," "expects,"
"anticipates," "intends," "plans," "believes," "estimates" and similar
expressions. These statements are based on our current beliefs, expectations
and assumptions and are subject to a number of risks and uncertainties. A
description of some risks that could cause our results to vary appears under
the caption "Risk Factors" and elsewhere in this prospectus. In light of these
assumptions, risks and uncertainties, the forward-looking events discussed in
this prospectus might not occur.
USE OF PROCEEDS
Our net proceeds from the sale and issuance of 4,000,000 shares of common
stock will be approximately $50.9 million, after deducting underwriting
discounts and commissions and the estimated offering expenses payable by the
Company.
We are conducting this offering primarily to increase our equity capital,
create a public market for our common stock and to facilitate future access by
us to public equity markets. We do not have specific uses planned for much of
the offering proceeds. Of the net proceeds, we currently expect to use:
. approximately $3.0 million for growth and capital expenditures to
expand our internal computer systems, including financial reporting,
human resources and other related internal systems; and
. the remaining net proceeds of this offering for general corporate
purposes, including working capital.
We may use a portion of the net proceeds to acquire complementary
businesses, products or technologies. From time to time, we evaluate these
potential acquisitions and we anticipate continuing to make such evaluations.
We have no current plans, agreements or commitments with respect to any such
acquisitions. Pending any of these uses, we intend to invest the net proceeds
of this offering in short-term, interest-bearing, investment grade securities.
DIVIDEND POLICY
We have never declared or paid any cash dividends on our capital stock and
we do not anticipate paying any cash dividends on our capital stock in the
foreseeable future. We currently intend to retain any future earnings for use
in our business. Our line of credit arrangement prohibits us from paying
dividends without the lender's prior consent.
16
<PAGE>
CAPITALIZATION
The following table shows as of September 30, 1999:
. our actual capitalization;
. our pro forma capitalization assuming the conversion of all
outstanding redeemable Series A convertible preferred stock into
shares of common stock; and
. our pro forma capitalization as adjusted to reflect the sale by us
of 4,000,000 shares of common stock in this offering, after
deducting underwriting discounts and commissions and estimated
expenses.
This table should be read in conjunction with the consolidated financial
statements and notes appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
September 30, 1999
----------------------------------------
(unaudited)
Pro Forma
Actual Pro Forma As Adjusted
----------- ----------- -------------
(In thousands, except share data)
<S> <C> <C> <C>
Preferred stock: 10,000,000 preferred
shares authorized,
1,438,377 shares of redeemable Series A
convertible preferred stock issued and
outstanding, actual; no shares issued
and outstanding, pro forma and pro forma
as adjusted............................. $ 4,971 $ -- $ --
Shareholders' equity:
Common stock: 200,000,000 shares
authorized; 16,723,840 shares issued
and outstanding, actual; 19,600,594
shares issued and outstanding, pro
forma; 23,600,594 shares issued and
outstanding, pro forma as adjusted.... 7,494 12,465 63,321
Deferred stock compensation............ (3,029) (3,029) (3,029)
Notes receivable from shareholders..... (300) (300) (300)
Accumulated deficit.................... (997) (997) (997)
----------- ----------- -----------
Total shareholders' equity........... 3,168 8,139 58,995
----------- ----------- -----------
Total capitalization................. $ 8,139 $ 8,139 $ 58,995
=========== =========== ===========
</TABLE>
The number of shares of common stock issued and outstanding as of September
30, 1999 excludes:
. 1,131,760 shares available for grant under our stock option plans;
. 3,586,500 shares of common stock issuable upon exercise of options
outstanding under our stock option plans, at a weighted average
exercise price of $3.82 per share, of which options to purchase
576,790 shares are currently exercisable; and
. 250,000 shares of common stock available for issuance under our
employee stock purchase plan.
17
<PAGE>
DILUTION
If you invest in our common stock, your interest will be diluted to the
extent of the difference between the initial public offering price per share
and the net tangible book value per share after this offering. We calculate net
tangible book value per share by dividing the net tangible book value, which is
total assets less intangible assets and total liabilities, by the number of
then outstanding shares of common stock.
Our pro forma net tangible book value at September 30, 1999, after giving
effect to the conversion of all outstanding redeemable Series A convertible
preferred stock into common stock, was $6,601,000, or $0.34 per share of common
stock. After giving effect to the sale of 4,000,000 shares of common stock by
us in this offering, less underwriting discounts and commissions and estimated
expenses we expect to pay, our net tangible book value at September 30, 1999
would have been $57.5 million, or $2.43 per share. This represents an immediate
increase in the net tangible book value of $2.09 per share to existing
shareholders and an immediate dilution of $11.57 per share to new investors, or
approximately 83% of the initial offering price. The following table
illustrates this per-share dilution:
<TABLE>
<S> <C> <C>
Initial public offering price per share........................ $14.00
Pro forma net tangible book value per share at September 30,
1999........................................................ 0.34
Increase per share attributable to the offering ............. 2.09
----
Net tangible book value per share after this offering.......... 2.43
------
Dilution per share to new investors............................ $11.57
======
</TABLE>
The following table shows, at September 30, 1999, the number of shares of
common stock purchased from us, after giving effect to the conversion of all
outstanding redeemable Series A convertible preferred stock into common stock,
the total consideration paid and the average price paid per share by existing
shareholders and by new investors purchasing common stock in this offering.
<TABLE>
<CAPTION>
Shares Purchased Total Consideration
------------------ ------------------- Average Price
Number Percent Amount Percent Per-Share
---------- ------- ----------- ------- -------------
<S> <C> <C> <C> <C> <C>
Existing shareholders.. 19,600,594 83.1 $12,465,000 18.2 $ 0.64
New Investors.......... 4,000,000 16.9 56,000,000 81.8 14.00
---------- ----- ----------- -----
Total................ 23,600,594 100.0% $68,465,000 100.0%
========== ===== =========== =====
</TABLE>
The number of shares of common stock issued and outstanding as of September
30, 1999 excludes:
. 1,131,760 shares available for grant under our stock option plans;
. 3,586,500 shares of common stock issuable upon exercise of options
outstanding under our stock option plans, at a weighted average
exercise price of $3.82 per share, of which options to purchase
576,790 shares are currently exercisable; and
. 250,000 shares of common stock available for issuance under our
employee stock purchase plan.
18
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
(In thousands, except per share data)
The following selected consolidated financial data should be read in
conjunction with our consolidated financial statements and related notes
thereto and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" included in this prospectus. The consolidated statements
of operations data for each of the years in the three year period ended
December 31, 1998 and the balance sheet data at December 31, 1997 and 1998 are
derived from the audited consolidated financial statements included elsewhere
in this prospectus. The consolidated statement of operations data for the years
ended December 31, 1994 and 1995 and the balance sheet data at December 31,
1994, 1995 and 1996 are derived from audited financial statements which are not
included in this prospectus. The consolidated statement of operations data for
the nine months ended September 30, 1998 and 1999, and the consolidated balance
sheet data at September 30, 1999 are derived from unaudited financial
statements included elsewhere in this prospectus which, in the opinion of
management, include all adjustments, consisting only of normal recurring
adjustments, that we consider necessary for fair presentation of our financial
position and results of operations for that period. The historical results are
not necessarily indicative of the operating results to be expected in the
future.
<TABLE>
<CAPTION>
Nine Months
Ended
Year Ended December 31, September 30,
---------------------------------------- ----------------
Statement of Operations 1994 1995 1996 1997 1998 1998 1999
Data: ------ ------- ------ ------ ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenue
Internet security...... $ -- $ -- $ -- $ 250 $ 2,349 $ 924 $10,677
Ethernet............... 8,996 10,482 9,356 9,092 5,166 4,456 1,474
------ ------- ------ ------ ------- ------- -------
Total revenue........ 8,996 10,482 9,356 9,342 7,515 5,380 12,151
Cost of revenue......... 5,971 6,411 5,915 4,842 3,308 2,485 3,462
------ ------- ------ ------ ------- ------- -------
Gross margin............ 3,025 4,071 3,441 4,500 4,207 2,895 8,689
Operating expenses
Research and
development........... 1,077 1,241 1,048 1,983 2,051 1,417 2,198
Sales and marketing.... 1,322 1,856 1,665 2,468 2,870 2,082 3,408
General and
administrative........ 221 529 432 644 753 541 1,189
Deferred stock
compensation.......... -- -- -- -- 42 -- 1,301
------ ------- ------ ------ ------- ------- -------
Total operating
expenses............ 2,620 3,626 3,145 5,095 5,716 4,040 8,096
------ ------- ------ ------ ------- ------- -------
Income (loss) from
operations............. 405 445 296 (595) (1,509) (1,145) 593
Other income (expense),
net.................... (8) (30) 22 29 54 36 205
------ ------- ------ ------ ------- ------- -------
Income (loss) before
income taxes........... 397 415 318 (566) (1,455) (1,109) 798
Benefit from (provision
for) income taxes...... (99) (164) (350) 99 (6) -- (787)
------ ------- ------ ------ ------- ------- -------
Net income (loss)....... $ 298 $ 251 $ (32) $ (467) $(1,461) $(1,109) $ 11
====== ======= ====== ====== ======= ======= =======
Basic net income (loss)
per share.............. $ 0.03 $ 0.03 $ -- $(0.06) $ (0.13) $ (0.11) $ --
====== ======= ====== ====== ======= ======= =======
Diluted net income
(loss) per share....... $ 0.03 $ 0.02 $ -- $(0.06) $ (0.13) $ (0.11) $ --
====== ======= ====== ====== ======= ======= =======
Shares used in
calculation of basic
net income (loss) per
share.................. 9,294 9,626 8,460 8,461 11,251 10,290 16,367
====== ======= ====== ====== ======= ======= =======
Shares used in
calculation of diluted
net income (loss) per
share.................. 9,748 11,224 8,460 8,461 11,251 10,290 19,421
====== ======= ====== ====== ======= ======= =======
Pro forma basic net
income per share....... $ --
=======
Pro forma diluted net
income per share....... $ --
=======
Shares used in the
calculation of pro
forma basic net income
per share.............. 18,727
=======
Shares used in the
calculation of pro
forma diluted net
income per share....... 19,421
=======
</TABLE>
<TABLE>
<CAPTION>
December 31,
---------------------------------- September 30,
1994 1995 1996 1997 1998 1999
------ ------ ------ ------ ------ -------------
<S> <C> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents.... $ 241 $ 145 $1,036 $ 787 $1,051 $ 8,766
Total assets................. 3,320 2,810 3,448 2,374 4,751 15,107
Redeemable Series A
convertible preferred
stock....................... -- -- -- -- -- 4,971
Total shareholders' equity... $ 702 $ 963 $ 932 $ 465 $1,488 $ 3,168
</TABLE>
See Note 1 of Notes to Consolidated Financial Statements for information
concerning the calculation of basic and diluted net loss per share and pro
forma basic and diluted net loss per share.
19
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following commentary should be read in conjunction with the financial
statements and related notes contained elsewhere in this prospectus. The
discussion contains forward-looking statements that involve risks and
uncertainties. These statements relate to future events or our future financial
performance. In many cases, you can identify forward-looking statements by
terminology such as "may," "will," "should," "expects," "plans," "anticipates,"
"believes," "estimates," "predicts," "potential," "intend" or "continue," or
the negative of such terms and other comparable terminology. These statements
are only predictions. Our actual results may differ materially from those
anticipated in these forward-looking statements as a result of a variety of
factors, including, but not limited to, those set forth under "Risk Factors"
and elsewhere in this prospectus.
Overview
From inception through 1996, we derived substantially all of our revenue
from the development and marketing of networking products for Apple Macintosh
computers. These products enable Apple Macintosh computers to connect to
computer networks using Ethernet communications standards. The Ethernet
standard was developed in the 1970s by Xerox Corporation and is the most widely
used technology to facilitate communication between computers on local area
networks. The Ethernet standard is defined by the Institute of Electrical and
Electronics Engineers and specifies the speed and other characteristics of a
computer network. In 1998, we made a strategic business decision to concentrate
our resources in the Internet security market due to our belief that this
market had better long-term growth prospects. As a result, we intend to stop
shipments of our Ethernet product line by December 1999. In October 1997, we
introduced our first Internet security appliance, the SonicWALL DMZ, and began
volume shipments in 1998. In 1998 we began offering content filtering
subscriptions to our SonicWALL customers. Customers can purchase subscriptions
for one to four years, and they receive weekly updated lists of objectionable
web site addresses to which they can block access. We now focus all our
development, marketing and sales efforts on the Internet security appliance
market. Our shift to selling Internet security products has not required any
significant restructuring of our personnel, facilities, manufacturing or
operations. We do not expect any significant charges related to our Ethernet
product inventories or warranty obligations. In 1998, our Internet security
products represented approximately 31% of our total revenue and in the nine
months ended September 30, 1999, they represented 88% of our total revenue. In
1998, our Ethernet products represented 69% of our total revenue and in the
nine months ended September 30, 1999, Ethernet products represented
approximately 12% of our total revenue.
Our SonicWALL products are sold primarily through distributors who then
resell our products to resellers and selected retail outlets. These resellers
then sell our products to end-users. In 1998 and the nine months ended
September 30, 1999, sales to Ingram Micro accounted for 34% and 35% of our
total revenue, respectively. In the nine months ended September 30, 1999, sales
to Tech Data and Sumitomo Metal accounted for 11% and 11%, respectively, of our
total revenue.
Our revenue consists primarily of product sales and, to a lesser extent,
subscription fees from content filtering services and extended warranty
contract fees. Product sales comprise approximately 96% of total revenue for
the nine months ended September 30, 1999. We generally recognize revenue when
we ship products to our customers. Agreements with many of our distributors
provide for stock rotation, price protection and co-op advertising rights.
Stock rotation rights provide a distributor the right to exchange unsold
inventory for alternative products. Ingram Micro's right to return or rotate
its stock on-hand is unlimited, and therefore we recognize revenue for product
sales to Ingram Micro when it has sold the product to its customers. Ingram
Micro does not have the right to return non-defective products to us if a
customer of Ingram Micro returns such a product to Ingram Micro. For all other
distributors, the value of stock that can be rotated is generally limited to
15% of the prior quarter's purchases. Co-op advertising rights provide a
distributor the right to be reimbursed up to 3% of the prior quarter's sales
for costs it has incurred associated with advertising our products. For all of
our distributors, we provide an allowance for sales returns, price protection
rights and
20
<PAGE>
reserves for warranty and co-op advertising costs at the time of revenue
recognition. Price reductions which may result in price protection require the
approval of our president, chief financial officer, and vice president of
sales. Subscription fees and extended warranty fees are deferred and amortized
over the period of the related contracts. Subscription and extended warranty
fees to date have not been material.
To date, a significant portion of our revenue has been dependent on large
purchase orders from a limited number of distributors. These purchase orders
typically have short lead times and are subject to delay or cancellation
without penalty. We anticipate that our operating results for a given period
will continue to depend on a small number of customers. If we experience a
decline in revenue from any of our significant distributors in a given quarter,
our revenue for that quarter, or following quarters, will be adversely
affected. This could adversely affect our business, prospects, results of
operations and financial condition. Furthermore, if any of our significant
customers experiences financial difficulties, our sales to these customers may
be reduced, and we may have difficulty collecting accounts receivable from
these customers. Any delay in large customer orders or customer financial
difficulties could have a material adverse effect on our business, prospects,
results of operations and financial condition.
We primarily use one contract manufacturer to manufacture our products. We
also rely on single or limited source suppliers to provide key components of
our products. A significant portion of our cost of revenue is related to these
suppliers. These relationships are subject to a variety of risks.
In August 1998, we acquired all the partnership interest of AckFin Networks,
a California general partnership, in exchange for an aggregate of 5,426,184
shares of all common stock with an estimated value of $0.90 per share, or
$4,883,000, and the assumption of $150,000 in liabilities. The controlling
partners of AckFin, Sreekanth Ravi and Sudhakar Ravi, two of our executive
officers and principal shareholders, were also the majority shareholders of
SonicWALL, Inc. and, therefore, were deemed to be a control group for purposes
of determining the amount of purchase price to be "stepped-up." The value of
the exchanged shares for AckFin was accounted for as a reorganization of
entities under common control. Accordingly, net assets acquired were valued by
applying carryover basis to the control group interest and a stepped-up basis
to the minority interest. The step-up of the minority interest resulted in an
intangible asset of $2,517,000. This intangible asset was attributed to
acquired completed technology and will be amortized over a period of three
years. The intangible assets acquired by the Company were rights to the
completed core technology developed by AckFin that provides the foundation for
our Internet products. Since this transaction occurred between entities that
were under common control, the financial results of AckFin have been combined
with our results for the period since the inception of AckFin, April 1997,
through the date of exchange, August 1998. Expenses totalling $150,000 and
$775,000 for the years ended December 31, 1997 and 1998, respectively, were
included in the accompanying statements of operations. AckFin did not have any
revenue transactions with unrelated third parties. Except for the expenses
noted above, all other financial transactions for AckFin were eliminated upon
combination with SonicWALL, Inc.
In 1998, we recorded total deferred stock compensation of approximately
$48,000 in connection with stock and stock options granted during 1998 at
prices subsequently deemed to be below fair market value on the date of grant.
Options granted are typically subject to a four-year vesting period. Restricted
stock acquired through the exercise of unvested stock options is subject to our
right to repurchase the unvested stock at the price paid, which right lapses
over a four-year period. We are amortizing the deferred stock compensation over
the vesting periods of the applicable options and the repurchase periods for
the restricted stock. In 1999, we have recorded approximately $4.3 million in
additional deferred stock compensation for stock options granted in the nine
months ended September 30, 1999, at prices subsequently deemed to be below fair
market value on the date of grant. We amortized approximately $1.3 million of
deferred stock compensation for the nine months ended September 30, 1999.
21
<PAGE>
Results of Operations
The following table sets forth financial data for the periods indicated as a
percentage of total revenue:
<TABLE>
<CAPTION>
Year Ended Nine Months
December 31, Ended September 30,
--------------------- ---------------------
1996 1997 1998 1998 1999
----- ----- ----- --------- ---------
<S> <C> <C> <C> <C> <C>
Revenue
Internet Security............. -- % 2.7% 31.3% 17.2% 87.9%
Ethernet...................... 100.0 97.3 68.7 82.8 12.1
----- ----- ----- --------- ---------
Total revenue................ 100.0 100.0 100.0 100.0 100.0
Cost of revenue................ 63.2 51.8 44.0 46.2 28.5
----- ----- ----- --------- ---------
Gross margin................... 36.8 48.2 56.0 53.8 71.5
Operating expenses
Research and development...... 11.2 21.3 27.3 26.3 18.1
Sales and marketing........... 17.8 26.4 38.2 38.7 28.0
General and administrative.... 4.6 6.9 10.0 10.1 9.8
Deferred stock compensation... -- -- 0.6 -- 10.7
----- ----- ----- --------- ---------
Total operating expenses..... 33.6 54.6 76.1 75.1 66.6
----- ----- ----- --------- ---------
Income (loss) from operations 3.2 (6.4) (20.1) (21.3) 4.9
Other income (expense), net.... 0.2 0.3 0.7 0.7 1.7
----- ----- ----- --------- ---------
Income (loss) before income
taxes......................... 3.4 (6.1) (19.4) (20.6) 6.6
Benefit from (provision for)
income taxes.................. (3.7) 1.1 (0.1) -- (6.5)
----- ----- ----- --------- ---------
Net income (loss).............. (0.3)% (5.0)% (19.5)% (20.6)% 0.1%
===== ===== ===== ========= =========
</TABLE>
Nine Months Ended September 30, 1999 and 1998
Internet security revenue. We shipped our first Internet security appliance
product, the SonicWALL DMZ, near the end of 1997, and in the first nine months
of 1998 we were in the early stages of our sales and marketing efforts for this
product. Accordingly, Internet security revenue in the nine months ended
September 30, 1998 was minimal. Revenue from sales of our security appliance
products increased to $10.7 million in the nine months ended September 30, 1999
from $0.9 million in the nine months ended September 30, 1998. This revenue
growth was due primarily to the introduction of our second security appliance
product, the SonicWALL, in August 1998, and the introduction of our SonicWALL
Pro product in May 1999.
Ethernet revenue. Revenue from our Ethernet products declined to $1.5
million in the nine months ended September 30, 1999 from $4.5 million in the
nine months ended September 30, 1998. This decrease was directly related to our
1997 decision to focus our development, sales and marketing efforts on our
Internet security appliance products. We expect revenue from our Ethernet
products to continue to decline through the remainder of 1999. We expect to
stop shipment of Ethernet products by December 1999.
Cost of revenue; gross margin. Cost of revenue includes all costs associated
with the production of our products, including cost of materials, manufacturing
and assembly costs paid to contract manufacturers and related overhead costs
associated with our manufacturing operations personnel. Additionally, all
warranty costs and any inventory provisions or write-downs are expensed as cost
of revenue. Cost of revenue increased to $3.5 million in the nine months ended
September 30, 1999 from $2.5 million in the nine months ended
22
<PAGE>
September 30, 1998, primarily as a result of increased product sales. Gross
margin increased to $8.7 million, or 72% of total revenue, in the nine months
ended September 30, 1999 from $2.9 million, or 54% of total revenue, in the
nine months ended September 30, 1998. The increase in gross margin relates
primarily to the increase in sales of higher gross margin security appliance
products, and a decrease in sales of lower gross margin Ethernet products. In
addition, as the volume of units shipped has increased, our cost of revenue has
declined as a percentage of revenue as a result of lower component costs due to
higher purchase volumes, and lower manufacturing and overhead costs per unit
related to economies of scale. Our gross margins are affected by fluctuations
in manufacturing volumes, component costs and the mix of products sold. In
addition, an increase in total sales to original equipment manufacturers
compared to total sales to our distribution partners will result in a decrease
in gross margins. We must manage each of these factors effectively for our
gross margins to remain at current levels.
Research and development. Research and development expenses primarily
consist of personnel costs related to engineering and technical support,
contract consultants, outside testing services, amortization of acquired
technology from AckFin, and equipment and supplies associated with enhancing
existing products and developing new products. Research and development
expenses increased to $2.2 million in the nine months ended September 30, 1999
from $1.4 million in the nine months ended September 30, 1998. Research and
development spending increased in the nine months ended September 30, 1999 by
approximately $1.1 million related to the hiring of additional personnel,
amortization of acquired technology of approximately $0.6 million and increased
overhead and consulting costs. This increase was offset by a decrease of
approximately $0.3 million in compensation paid to a founder in the nine months
ended September 30, 1999.
Sales and marketing. Sales and marketing expenses primarily consist of
personnel costs, including commissions, costs associated with the development
of our business and corporate identification, and costs related to customer
support, travel, trade shows, promotional and advertising costs. Sales and
marketing expenses increased to $3.4 million in the nine months ended September
30, 1999 from $2.1 million in the nine months ended September 30, 1998. This
increase in absolute dollars primarily relates to increased hiring of sales and
marketing personnel, increased travel and attendance at trade shows, increases
in customer support personnel and expanded sales and marketing efforts in
international markets. These increases were partially offset by a decrease in
compensation paid to a founder of $0.3 million in the nine months ended
September 30, 1999. We intend to increase sales and marketing expenses as we
add personnel to support our domestic and international sales and marketing
efforts.
General and administrative. General and administrative expenses primarily
consist of personnel costs for administrative officers and support personnel,
legal, accounting and consulting fees, and facility expenses. Our general and
administrative expenses increased to $1.2 million for the nine months ended
September 30, 1999 from $0.5 million in the nine months ended September 30,
1998. This increase was primarily due to increases in staffing and related
personnel costs to support our growth, as well as increased professional
services costs.
Deferred stock compensation. Amortization of deferred stock compensation was
$1,301,000 in the nine months ended September 30, 1999. This amortization
relates to deferred compensation of $4.3 million, related to stock options
granted in the nine months ended September 30, 1999. We are amortizing this
amount over the vesting periods of the applicable options. There was no
amortization of deferred stock compensation in the nine months ended September
30, 1998.
Other income (expense), net. Other income (expense), net consists primarily
of interest income on the Company's cash and cash equivalents, and increased to
$0.2 million for the nine months ended September 30, 1999 from $36,000 in the
nine months ended September 30, 1998. This increase was related primarily to
higher interest earnings on cash that increased in amount from $1.5 million to
$8.8 million in the comparable period.
Provision for income taxes. The provision for income taxes in the nine
months ended September 30, 1999 was $0.8 million. There was no provision for
income taxes in the comparable 1998 period. In both periods, the provision for
income taxes is based on an estimated effective rate for each of the respective
calendar years. The effective tax rate in the nine months ended September 30,
1999 was 37.5% before the
23
<PAGE>
effect of amortization of deferred compensation, a permanent, non-deductible
book/tax difference. This effective rate reflects statutory federal and state
tax rates net of the estimated realization of deferred tax assets. In determing
this effective rate, we concluded that it was more likely than not that we
would realize the full value of this deferred tax asset based upon our estimate
of profitability and our assessment of tax refunds available from net loss
carrybacks in the event future profitability was less than our estimates. We
incurred a loss in 1998 so there was no provision for income taxes in the nine
months ended September 30, 1998.
Years Ended December 31, 1998, 1997 and 1996
Internet security revenue. Internet security revenue increased to $2.3
million in 1998 from $0.3 million in 1997 and related primarily to a full year
of shipments of our expanded SonicWALL product offerings in 1998. There was no
Internet security revenue in 1996.
Ethernet revenue. Ethernet revenue declined to $5.2 million in 1998 from
$9.1 million in 1997, which declined from $9.4 million in 1996. These declines
in Ethernet revenue related to our 1997 decision to focus development, sales
and marketing efforts on our Internet security appliance products. Our
development, marketing and sales efforts are now entirely focused on the
Internet security appliance market, and while we continue to ship our Ethernet
products, we plan to terminate shipment of these products by December 1999.
Gross margin. In 1998, gross margin was $4.2 million, or 56% of revenue,
compared to $4.5 million, or 48% of revenue, in 1997. The percentage increase
in gross margin from 1997 to 1998 relates primarily to the increase in sales of
higher margin Internet security appliance products. In 1996, gross margin was
$3.4 million, or 37% of revenue. The increase in gross margin percentage from
1996 to 1997 is primarily attributable to the cost reduction associated with
the commencement of turnkey, offshore manufacturing of our Ethernet products in
January 1997.
Research and development. Research and development expenses increased to
$2.1 million in 1998 from $2.0 million in 1997, and increased from $1.0 million
in 1996. This increase from 1997 to 1998 relates primarily to amortization of
acquired technology offset in part by a reduction in compensation paid to a
founder. The research and development expense increase in 1997 over 1996 of
$0.9 million was primarily related to increased personnel and consulting costs
associated partly with the development of the security appliance products which
commenced in 1997.
Sales and marketing. Sales and marketing expenses increased to $2.9 million
in 1998 from $2.5 million in 1997 and from $1.7 million in 1996. These
increases were primarily due to the hiring of additional sales and marketing
personnel, as well as increases in travel, trade shows, promotional and
advertising costs.
General and administrative. General and administrative expenses increased to
$0.8 million in 1998 from $0.6 million in 1997, and increased from $0.4 million
in 1996. These increases were due mainly to the addition of administrative
personnel, professional services fees and facility expenses to support the
growth of our operations.
Deferred stock compensation. During 1998, we recorded deferred compensation
of $48,000 in connection with stock option grants of which $42,000 was
amortized in the year ended December 31, 1998. We are amortizing this amount
over the vesting periods of the applicable options.
Quarterly Results of Operations
The following tables set forth our unaudited quarterly results of
operations, in dollars and as a percentage of total revenue, for the seven
quarters ended September 30, 1999. You should read the following tables in
conjunction with the financial statements and related notes contained elsewhere
in this prospectus. We have prepared this unaudited information on the same
basis as our audited financial statements. These tables include all
adjustments, consisting only of normal recurring adjustments, that we consider
necessary for a fair
24
<PAGE>
presentation of our financial position and operating results for the quarters
presented. You should not draw any conclusions about our future results from
the results of operations for any quarter.
<TABLE>
<CAPTION>
Three Months Ended
---------------------------------------------------------------------------------
March 31, June 30, September 30, December 31, March 31, June 30, September 30,
1998 1998 1998 1998 1999 1999 1999
--------- -------- ------------- ------------ --------- -------- -------------
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Revenue
Internet Security...... $ 157 $ 248 $ 519 $1,425 $2,251 $3,223 $5,203
Ethernet............... 1,546 1,355 1,555 710 813 403 258
------ ------ ------ ------ ------ ------ ------
Total revenue........ 1,703 1,603 2,074 2,135 3,064 3,626 5,461
------ ------ ------ ------ ------ ------ ------
Cost of revenue......... 833 819 833 823 943 1,055 1,464
------ ------ ------ ------ ------ ------ ------
Gross margin............ 870 784 1,241 1,312 2,121 2,571 3,997
Operating expenses
Research and
development........... 385 437 595 634 658 723 817
Sales and marketing.... 661 739 682 788 811 1,043 1,554
General and
administrative........ 184 125 232 212 332 362 495
Deferred stock
compensation.......... -- -- -- 42 15 768 518
------ ------ ------ ------ ------ ------ ------
Total operating
expenses............ 1,230 1,301 1,509 1,676 1,816 2,896 3,384
------ ------ ------ ------ ------ ------ ------
Income (loss) from
operations............. (360) (517) (268) (364) 305 (325) 613
Other income (expense),
net.................... 9 13 14 18 41 91 73
------ ------ ------ ------ ------ ------ ------
Income (loss) before
income taxes........... (351) (504) (254) (346) 346 (234) 686
Provision for income
taxes.................. -- -- -- 6 135 200 452
------ ------ ------ ------ ------ ------ ------
Net income (loss)....... $ (351) $ (504) $ (254) $ (352) $ 211 $ (434) $ 234
====== ====== ====== ====== ====== ====== ======
<CAPTION>
As a Percentage of Revenue
---------------------------------------------------------------------------------
March 31, June 30, September 30, December 31, March 31, June 30, September 30,
1998 1998 1998 1998 1999 1999 1999
--------- -------- ------------- ------------ --------- -------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenue
Internet Security...... 9.2 % 15.5 % 25.0 % 66.7 % 73.5% 88.9 % 95.3%
Ethernet............... 90.8 84.5 75.0 33.3 26.5 11.1 4.7
------ ------ ------ ------ ------ ------ ------
Total revenue........ 100.0 100.0 100.0 100.0 100.0 100.0 100.0
------ ------ ------ ------ ------ ------ ------
Cost of revenue......... 48.9 51.1 40.2 38.5 30.8 29.1 26.8
------ ------ ------ ------ ------ ------ ------
Gross margin............ 51.1 48.9 59.8 61.5 69.2 70.9 73.2
Operating expenses
Research and
development........... 22.6 27.3 28.7 29.7 21.5 19.9 15.0
Sales and marketing.... 38.8 46.1 32.9 36.9 26.4 28.8 28.5
General and
administrative........ 10.8 7.8 11.2 9.9 10.8 10.0 9.0
Deferred stock
compensation.......... -- -- -- 2.0 0.5 21.2 9.5
------ ------ ------ ------ ------ ------ ------
Total operating
expenses............ 72.2 81.2 72.8 78.5 59.2 79.9 62.0
Income (loss) from
operations............. (21.1) (32.3) (13.0) (17.0) 10.0 (9.0) 11.2
Other income (expense),
net.................... 0.5 0.8 0.7 0.8 1.3 2.5 1.3
------ ------ ------ ------ ------ ------ ------
Income (loss) before
income taxes........... (20.6) (31.5) (12.3) (16.2) 11.3 (6.5) 12.5
Provision for income
taxes.................. -- -- -- 0.3 4.4 5.5 8.3
------ ------ ------ ------ ------ ------ ------
Net income (loss)....... (20.6)% (31.5)% (12.3)% (16.5)% 6.9% (12.0)% 4.2%
====== ====== ====== ====== ====== ====== ======
</TABLE>
Internet security revenue. Internet security revenue has increased in each
of the seven quarters ended September 30, 1999, due to increasing market
acceptance of our security appliance solution and the expansion of our product
line to include the SonicWALL in August 1998 and SonicWALL Pro in May 1999.
Ethernet revenue. Ethernet revenue remained relatively flat through the
first three quarters of 1998, and decreased significantly in the fourth quarter
of 1998 and the first three quarters of 1999. The overall decline in Ethernet
revenue relates primarily to our decision to focus our development, sales and
marketing resources exclusively on the security appliance product family. We
expect to stop shipment of Ethernet products by December 1999.
25
<PAGE>
Gross margin. Our gross margin has generally increased each quarter since
the quarter ended March 31, 1998. These increases have been due to the
introduction of our new security appliance products, which have higher average
selling prices and higher gross margins, the reduction of production costs on a
per unit basis as manufacturing volumes have increased, the reduction in
materials costs due to increased purchase volumes, and improved absorption of
manufacturing infrastructure costs.
Operating expenses. Our operating expenses have increased in each of the
seven quarters ended September 30, 1999 to $3.4 million in the quarter ended
September 30, 1999 from $1.2 million in the quarter ended March 31, 1998. These
increases related primarily to development of new products, increased marketing
of new products, and increased investments in our internal infrastructure to
support our growth.
Liquidity and Capital Resources
Since our inception, we have financed our operations through cash flows from
operations, private sales of securities and, to a lesser extent, bank
borrowings. During the nine months ended September 30, 1999, we generated $2.6
million in cash from operating activities. This increase resulted from a
significant increase in Internet security revenue, offset in part by a $1.6
million increase in accounts receivable and a $0.2 million increase in
inventories. We expect that accounts receivable and inventory will continue to
increase if our revenue continues to rise and that we will continue to increase
our investment in capital assets to expand our operations. During 1998, we
generated $0.4 million in cash from operating activities, compared to a
$0.4 million decrease from operating activities in 1997. Investing activities
related to purchases of property and equipment used cash of $0.1 million in
1998 and $0.2 million in the nine months ended September 30, 1999. In 1996 and
1997 purchases of property and equipment were immaterial.
In February 1999, SonicWALL, Inc. completed a private placement of
approximately $5.0 million of redeemable Series A convertible preferred stock.
SonicWALL, Inc. conducted no significant financing activities in 1997 or 1998.
Our principal source of liquidity as of September 30, 1999 consisted of $8.8
million in cash and cash equivalents. As of September 30, 1999 we have a credit
facility with Comerica Bank of California that provides for borrowings up to
the lesser of $1.0 million or 80% of eligible accounts receivable, as defined
in the credit facility. Our line of credit bears interest at the bank's
reference rate plus 1.75%, which equaled 10.0% at September 30, 1999 and
borrowings are secured by accounts receivable, inventories, property and
equipment. The credit facility may be terminated by the lender or us on thirty
days prior notice. As of September 30, 1999, there were no borrowings
outstanding under this credit facility.
We believe that the market risk arising from our holdings of financial
instruments is not material.
We believe our existing cash balances and available line of credit will be
sufficient to meet our cash requirements at least through the next twelve
months. However, we may be required, or could elect, to seek additional funding
prior to that time. Our future capital requirements will depend on many
factors, including our rate of revenue growth, the timing and extent of
spending to support product development efforts and expansion of sales and
marketing, the timing of introductions of new products and enhancements to
existing products, and market acceptance of our products. We cannot assure you
that additional equity or debt financing will be available on acceptable terms
or at all. As of the date of this offering, our sources of liquidity beyond
twelve months, in management's opinion, will be our then current cash balances,
funds from operations and whatever long-term credit facilities we can arrange.
We have no other agreements or arrangements with third parties to provide us
with sources of liquidity and capital resources beyond twelve months.
Any time after February 17, 2004, all currently outstanding shares of
preferred stock are eligible to be redeemed in full upon a written notice by at
least 67% of the holders of the outstanding preferred stock. In the event of
redemption, we would be required to pay the preferred shareholders
approximately $5.0 million. However, upon completion of this offering, all such
shares of preferred stock are automatically converted to common stock and this
contingency would not apply. We do not have any other debt, long-term
obligations or long-term capital commitments.
26
<PAGE>
Year 2000 Readiness Disclosure
Year 2000 Program
Historically, computer programs used two digits rather than four to
designate specific years. Computer programs that use two digits to designate a
specific year may recognize a date using "00" as the year 1900 rather than the
year 2000. This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary
inability to process transactions, send invoices or engage in normal business
activities. This is known as the Year 2000 problem.
We have addressed and are continuing to address the Year 2000 problem
through the following means:
. Awareness--making our customers, suppliers and employees aware of the
problem.
. Identification--identifying date sensitive information technology
systems and non-information technology systems.
. Development--assessment of date sensitivity and modification or
replacement of date sensitive products.
. Testing--verification of our development efforts.
. Contingency planning--evaluating the needs for contingency plans to
address potential worst-case scenarios
Our state of readiness and business risks
We have completed an assessment of both our information technology systems
and our non-information technology systems. Based upon our examination, we
believe that our non-information technology systems do not contain any
elements that are susceptible to Year 2000 problems. However, we will modify
or replace some portions of our internal information technology systems as
Year 2000 compliant versions of these systems are released by outside vendors
(e.g. Microsoft releases of Windows NT). If, in the worst case scenario, such
replacement is not made, or is not completed on a timely basis, our operations
could be materially affected.
As part of our Year 2000 program, we have tested and continue to test all
of the products we currently market. While we do not know of any Year 2000
compliance problems with any of our products, there can be no assurances that
products we developed will not contain undetected errors or defects associated
with Year 2000 date functions. If, in the worse case scenario, our products
are affected by date-related issues, our customers may file claims against us
or require us to repair any damage to their systems caused by our products. In
addition, our revenues may be adversely affected, our maintenance, technical
support and management costs could increase and our reputation could be
damaged.
Our products are ultimately used with a number of different hardware and
software products, and to the extent any third party products are not Year
2000 compliant, the interoperability of our products could be materially
adversely affected. Given the large number of third party components used in
conjunction with our products and our limited resources, we do not expect to
review third party products for Year 2000 compliance.
Our operations also rely on third party suppliers for Internet, cellular
telephone, telecommunications, utilities and building services. We have begun
the process of contacting our critical suppliers about the nature and progress
of their Year 2000 compliance to determine the extent to which their failure
to remedy their own Year 2000 problems could materially affect us. To date we
have not received written compliance statements from any of these entities. We
expect it will be difficult to obtain assurances of Year 2000 compliance from
telecommunications infrastructure and utility suppliers which generally do not
provide such assurances. We intend to consider use of alternative
telecommunications and utility suppliers if reasonable assurances are not
provided. In a worst case scenario, any Year 2000-related failure of any of
our critical suppliers could cause a significant disruption of our business.
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<PAGE>
We do not have information concerning the Year 2000 compliance status for
all of our customers. We are in the process of evaluating written compliance
statements from our three largest distributors, Ingram Micro, Tech Data and
Sumitomo Metal. In a worst case scenario, if any of our key customers encounter
significant Year 2000 problems that cause them to delay or cancel substantial
purchase orders or product deliveries, our business, results of operations and
financial condition could be materially adversely affected.
We have obtained a Year 2000 compliance letter from our contract
manufacturer, Flash Electronics, which indicates that it is in the process of
evaluating its Year 2000 readiness. It further states that Flash Electronics
believes it will have addressed any Year 2000 problems prior to December 31,
1999. However, in a worst case scenario, Flash Electronics may experience
material unanticipated problems and costs caused by undetected errors or
defects in the technology used in its internal information technology and non-
information technology systems. These unanticipated problems and costs could
have a material adverse effect on its business, results of operations and could
adversely affect either firm's operations, which in turn could materially
adversely affect our business, results of operations and financial condition.
Status and Costs
We have completed an initial audit of our critical internal financial,
informational and operational systems to identify and evaluate those areas that
may be affected as a result of the Year 2000 problem. To date, we have not
incurred material expense associated with our efforts to become Year 2000
compliant and do not anticipate that any future costs associated with our Year
2000 remediation efforts will exceed $100,000. In addition, we have not
deferred any material information technology projects as a result of our Year
2000 problem activities.
Although we plan to complete modifications or upgrades of our systems prior
to the year 2000, we may not be able to implement a plan that adequately
addresses the Year 2000 problem in a timely manner. If, in the worst case
scenario, our products are affected by date-related issues, our customers may
file claims against us or require us to repair any damage to their systems
caused by our products. In such instance our revenue may be adversely affected,
our maintenance, technical support and management costs could increase and our
reputation could be damaged.
Contingency Plan
We currently do not have a Year 2000 contingency plan with respect to Year
2000 worst case scenario. However, we have recently begun planning preparations
to handle the most reasonably likely worst case scenarios described above. We
intend to complete the contingency plans for these scenarios during the fourth
quarter of 1999.
Disclosures About Market Risk
Our exposure to market risk for changes in interest rates relates primarily
to our cash and cash equivalents. We do not use derivative financial
instruments in our investment portfolio. As stated in our investment policy, we
are averse to principal loss and ensure the safety and preservation of our
invested funds by limiting default and market risk. We mitigate default risk by
investing in only investment-grade instruments.
We invoice all of our foreign customers from the United States in U.S.
dollars and all revenue is collected in U.S. dollars. In addition, we do not
have any cash balances denominated in foreign currencies. As a result, we do
not have significant market risks associated with foreign currencies or related
to sales and collections.
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BUSINESS
Overview
SonicWALL, Inc. designs, develops, manufactures and sells Internet security
infrastructure products designed to provide secure Internet access to our
broadband customers. Broadband access, such as digital subscriber line, or DSL,
and cable modems, allows users to connect to the Internet at speeds
significantly greater than analog modems. We believe our security appliances
provide high performance, robust, reliable, easy-to-use and affordable Internet
security. We also sell content filtering services on an annual subscription
basis. We sell our products to customers in the small to medium enterprise,
branch office, telecommuter and education markets. As of September 30, 1999, we
had sold more than 18,000 of our Internet security appliances worldwide.
Our SonicWALL product line provides our customers with a comprehensive
integrated security solution that includes firewall, content filtering, and
virtual private network functionality so users can enjoy affordable, secure
Internet communications. SonicWALL products deliver a plug and play appliance
solution that we believe is easy to install and use and minimizes the purchase,
installation and maintenance costs of Internet security. With suggested retail
prices ranging from $495 to $2,995, versus competitive products which range in
price from approximately $5,000 to more than $15,000, our products are designed
to enable customers to reduce purchase costs and avoid hiring costly IT
personnel for Internet security. By using an embedded single purpose operating
system and a hardware design without moving parts, our SonicWALL products are
designed to maximize reliability and uptime. The SonicWALL product line can be
used in networks ranging in size from 1 to 1,000 users and is fully compatible
with more expensive enterprise security solutions offered by, among others,
Check Point Software and Cisco Systems.
Industry Background
Growth of Internet Usage By Small to Medium Enterprise, Branch Office,
Telecommuter, and Education Markets
Businesses and consumers are increasingly accessing the Internet for a wide
variety of uses including communications, information gathering and commerce.
Because it is an affordable means of achieving global reach and brand
awareness, the Internet is a particularly attractive vehicle for small and
medium size businesses as they endeavor to access and share information with a
large number of geographically dispersed customers, employees and business
partners. For example, of the 87.4 million devices estimated by International
Data Corporation, or IDC, a market research organization, to have Internet
access in 1998, approximately 60% were used by small businesses and home
offices. IDC estimates that the proportion of small businesses, those with less
than 100 people, accessing the Internet in the United States will increase from
approximately 50% in 1998 to approximately 65% by 2001, to a total of 4.7
million businesses.
Today's large business enterprise is characterized by many branch offices,
mobile workers, and telecommuters, all of whom connect electronically to the
corporate office and each other. Because of the confidential nature of business
data, these connections must be secure. Virtual private networks provide secure
Internet connections between the business enterprise and dispersed employees
and business partners. Communicating using virtual private networks offers
significant cost savings over alternative solutions such as private leased line
or frame relay networks. TeleChoice, a market researcher, estimates that
virtual private networks can cut telecommunication costs by as much as 90% over
private leased line networks, and for this reason, their use is expected to
grow rapidly. Infonetics Research projects worldwide expenditures on virtual
private networks will grow by 100% per year through 2001, when they are
expected to reach $11.9 billion.
The Internet also has become a vital tool of information access and
communication for schools and libraries. According to the National Center for
Education Statistics, there were over 96,000 K-12 public schools and libraries
in the United States in 1998, of which 89% of schools and 35% of libraries were
connected to the Internet. The growth in Internet connectivity in this market,
combined with the proliferation of objectionable Web sites, has created a need
for Internet security products that include content filtering capabilities.
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Increasing Demand for Broadband Access Technologies
Many small to medium enterprises and branch offices have addressed the need
for Internet access by installing a single computer with a dial-up connection
that is shared throughout the office, or by installing a dedicated network data
connection at a significantly greater expense, such as a T-1 line. Recently,
new high-speed technologies have emerged that can better satisfy the bandwidth
requirements of small to medium enterprises at a fraction of the cost of
traditional solutions. These technologies include DSL and cable modems, which
provide access speeds of up to 100 times faster than traditional 28.8 kbps
analog modems. In addition, new generations of Internet-based applications,
such as business to business e-commerce, sales force automation and enterprise
resource planning, or ERP, continue to emerge that require higher bandwidth
than is available through dial-up solutions. As DSL and cable services have
become more affordable and widely available, small to medium enterprises,
branch offices, and telecommuters are increasingly deploying these technologies
as their Internet access solution. The Yankee Group estimates that in the
United States DSL subscribers will increase from 0 to 1.5 million from 1997 to
2001, and cable modem subscribers will increase from 100,000 to 3.0 million
over the same period.
Importance of Internet Security
Secure access to the Internet is a growing concern for most Internet users.
Because broadband technologies, including DSL and cable, are always connected
to the Internet, they present greater security issues than dial up connections
and increase the risk that proprietary data or other sensitive information
might be compromised. These types of Internet connections present ongoing
security issues for small to medium enterprises, branch offices, and
telecommuters and increase the risk that computer hackers, disgruntled
employees, contractors or competitors might successfully access proprietary
data or other sensitive information. In addition, as more Web-enabled, mission
critical business applications are developed and offered by vendors such as
Oracle Corp., PeopleSoft Inc., Siebel Systems Inc., and SAP AG, the amount of
sensitive data transmitted over the Internet has increased and led
organizations to look for high performance, robust solutions to address these
security needs.
Many Internet users also seek solutions that enable control over access to
undesirable content, either to avoid potential legal liability or to eliminate
distracting activity by employees or other users. In addition, public attention
has recently focused on the advantages of using filtering software to screen
offensive material for children accessing the Internet at libraries, schools,
and other public institutions.
The market for Internet security products includes a variety of applications
to address these issues, such as firewall, content filtering, Internet
Protocol, address management and VPN. According to IDC, the market for Internet
security products increased over 45% in 1998 to $3.2 billion and is expected to
grow at a compounded annual growth rate of 21% to $8.3 billion by 2003.
Firewall products represent the fastest growing segment, with an expected
compounded annual growth rate of 27% over the same period.
Lack of a Cost Effective, High Performance Security Solution for the Broadband
Access Market
Although the need for Internet security products is widespread, security
vendors generally have focused on providing solutions for large enterprises
with highly complex needs and extensive information technology support
organizations. These solutions have typically involved expensive enterprise
firewall software that runs on a dedicated server or personal computer and
requires extensive support, constant monitoring and regular updates by IT
personnel to maintain its effectiveness. The expense and complexity of these
solutions, which often require additional products to incorporate VPN
capabilities, IP address management or content filtering, are impractical for
the majority of small to medium enterprises due to their more limited
resources. While there are suppliers of low cost Internet routers which may
provide limited Internet security functionality, we believe these products are
difficult to install and configure and provide relatively low performance.
30
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The SonicWALL Solution
SonicWALL, Inc. provides Internet security products designed for broadband
access customers in the small to medium enterprise, branch office, telecommuter
and education markets. We believe our security appliances provide high
performance, robust, reliable, easy-to-use and affordable Internet security.
SonicWALL products enable our customers to securely utilize Internet
applications and services as an integral part of their business. As of
September 30, 1999, we had sold more than 18,000 of our Internet security
appliances worldwide. The SonicWALL product line provides our customers with
the following key benefits:
. High Performance, Robust Security. The SonicWALL product family
provides a comprehensive integrated security solution that includes
firewall, content filtering and VPN functionality. Our firewall
security protects private networks against Internet-based theft,
destruction, or modification of data, and automatically notifies
customers if their network is under attack. SonicWALL has been
awarded the internationally recognized International Computer
Security Association, or ICSA, Firewall Certification, the same
certification awarded to significantly more expensive products sold
by Check Point Software and Cisco Systems. Our VPN capabilities
enable affordable, secure communications among remote offices,
mobile employees and business partners over the Internet. Our
content filtering enables businesses, schools and libraries to
restrict access to objectionable or inappropriate Web sites.
. Ease of Installation and Use. The SonicWALL product family delivers
a plug-and-play appliance designed for easy installation and use.
Installation involves simply connecting SonicWALL between the
private network and the broadband Internet access device. SonicWALL
is easily configured and managed through a Web browser-based
interface. No reconfiguration of any PC application is required. Our
products are pre-configured to interface with all major Internet
access technologies, including cable, DSL, ISDN, Frame Relay, and T-
1. In addition, SonicWALL's AutoUpdate capability automatically
notifies all registered customers via e-mail when bug fixes or new
features and products that have been purchased are available for
download from our Web site.
. Low Total Cost of Ownership. The SonicWALL product design minimizes
the purchase, installation and maintenance costs of Internet
security. The suggested retail prices of our products range from
$495 to $2,995, versus competitive products which range in price
from approximately $5,000 to more than $15,000. Our affordable,
easy-to-manage Internet security appliances also enable customers to
avoid the expense of hiring costly information technology personnel
who may otherwise be required to implement and maintain an effective
Internet security solution.
. Reliability. The SonicWALL product design maximizes reliability and
uptime. Our product uses an embedded single purpose operating system
and a hardware design which contains no moving parts. Most
competitors' products consist of software installed on general
purpose host computers which use the Windows NT or UNIX operating
systems. General purpose operating systems such as these are
designed to run multiple applications, creating an environment in
which random system crashes are commonplace. Moreover, since general
purpose computers contain many moving parts, such as hard disk
drives, floppy drives, fans and switching power supplies, they are
more prone to hardware failures over time. These software and
hardware failures can compromise Internet security.
. Scalability and Compatibility. SonicWALL products are designed to
provide comprehensive Internet security for networks ranging in size
from 1 to 1,000 users. Our products consist of three separate models
designed to serve the specific security needs of our target markets.
Our products vary with respect to the number of supported users, the
number of ports and feature options such as VPN or content
filtering. In addition to serving the security needs of the small to
medium enterprise market, SonicWALL products are a fully compatible,
perimeter security solution for large, distributed enterprises and
their branch offices and telecommuters. Our products are designed to
interoperate with enterprise security products offered by, among
others, Check Point Software and Cisco Systems.
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<PAGE>
Strategy
Our goal is to extend our leadership position and become the industry
standard Internet security solution for broadband access users in our target
markets--the small to medium enterprise, branch office, telecommuter, and
education markets. Key elements of our strategy include:
. Extend Our Leadership Position in Target Markets. We believe that we
have established a market leadership position as a provider of
Internet security products designed for our target markets by
offering robust, reliable, easy-to-use products at attractive prices.
We intend to continue to focus our product development efforts,
distribution strategies, and marketing programs to satisfy the
growing needs of these markets. We believe that the current Internet
security offerings of most vendors are relatively expensive,
technically complex, and generally unable to satisfy these target
markets.
. Strengthen the SonicWALL Brand. We believe that strong brand
recognition in our target markets is important to our long term
success. We intend to continue to strengthen our SonicWALL brand name
through industry trade shows, our Web site, advertising, direct
mailings to both our resellers and our end users, and public
relations. Our reputation as a reliable, high performance, easy-to-
use and affordable Internet security vendor contributes to our
resellers' sales efforts.
. Expand Our Indirect Channel. Our target markets are generally served
by a two-tier distribution channel. We have successfully penetrated
these markets with over 800 value added resellers, systems
integrators, and distributors, who sell our products in over thirty
countries, including large distributors such as Ingram Micro and Tech
Data. We intend to build and expand our base of indirect channel
relationships through additional marketing programs, hiring
additional marketing staff, and increased advertising.
. Develop Strategic Original Equipment Manufacturer Relationships. By
entering into original equipment manufacturer arrangements to sell
our products, we intend to build upon the brand awareness and
worldwide channels of major networking and telecommunications
equipment suppliers to further penetrate our target markets. We
presently have original equipment manufacturer agreements with the
following three companies: Ramp Networks, a manufacturer of shared
Internet access devices for small offices, Com21, a supplier of cable
modems, and 3COM Corporation, a provider of diversified networking
products. The terms of our agreements with these customers are
variable but none of such purchasers is currently required to
purchase a specified amount of our products or technology. Our 3COM
agreement expires July 2002, with automatic renewal for successive
one year periods, subject to either party's election to terminate on
six months prior notice. Our Com21 agreement terminates in January
2001, with automatic renewal for successive one year periods, subject
to either party's cancellation upon not less than thirty days prior
notice. Our agreement with Ramp Networks expires in January 2000, but
is automatically renewable for successive one year terms unless
either party elects to terminate upon thirty days prior notice. Com21
is licensed to incorporate our technology in its products. Ramp
Networks sells our products under its own name, as does 3COM
Corporation. We manufacture the products which Ramp Networks and 3COM
Corporation purchase from us for resale through their own
distribution channels. In the nine months ended September 30, 1999,
revenue from Com21 and Ramp Networks constituted approximately 6% of
total revenue. As of September 30, 1999, we had not recognized any
revenue from the 3COM agreement. We are pursuing relationships with
other broadband access equipment providers with the intent of further
penetrating our target markets.
. Building Upon Our Installed Base. We intend to develop new
subscription services and add on products to generate additional
revenue from our installed base. We have dedicated marketing
personnel and programs that focus on selling products and services to
this existing base of customers. We have actively sought registration
of our customers and we have experienced a registration rate of
nearly 50% to date. This has enabled us to pursue cost effective,
targeted marketing campaigns to our installed base of registered
users. Our AutoUpdate feature encourages our customers to register
their product by offering periodic notifications via email of new
security threats, bug fixes and marketing information on new features
and products. Each SonicWALL model is configured to allow end-users
to easily and conveniently download new features and products that
have been purchased, either through our resellers
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<PAGE>
or our Web site. Such sales could include additional functionality
such as virtual private networking or additional recurring revenue
opportunities such as content filtering services.
. Continue to Develop New Products and Reduce Manufacturing Costs. We
intend to use our product design and development expertise to expand
our product offerings and reduce our manufacturing costs. New
products and services may include offerings such as bandwidth
management, e-mail spam filtering and virus scanning. We are working
to achieve a higher level of Application Specific Integrated
Circuit, or ASIC, design and integration to reduce product costs and
increase product performance. We believe that these new product
offerings and associated cost reductions will strengthen our market
position and assist us in penetrating new markets.
Products and Services
We believe the SonicWALL product line provides cost effective and high
performance Internet security solutions for the small and medium size
enterprise, branch office, telecommuter, and education markets. We design our
products to address the specific needs of customers within each of these market
segments. Our products vary with respect to the number of supported users, the
number of ports, product features, processor speed and scalability. All of our
products provide firewall security and are capable of delivering features such
as content filtering and virtual private networking in a single, integrated
security appliance that is managed through an intuitive and easy-to-use Web
browser-based interface.
[DESCRIPTION OF GRAPHICS:
Diagram showing WebServer, E-Commerce Server and three PC's connected to a
SonicWALL DMZ or PRO security appliance on the left side, which is
connected to a modem router in the middle of the graphic which is connected
to an oval on the right side of the graphic with the words "THE INTERNET"
in the center of the oval.]
SonicWALL. SonicWALL has two 10Base-T Ethernet ports and is designed to
provide security for smaller networks using broadband connections to the
Internet such as cable and DSL. SonicWALL provides protection against
unauthorized access to the private network, filters out objectionable Web
sites, and manages the complexity of IP addressing. It also has a virtual
private networking option to give telecommuters and small remote offices
affordable and secure connectivity to the main office. SonicWALL supports 10,
50 or unlimited user connections depending on the model purchased.
SonicWALL DMZ. SonicWALL DMZ has three 10Base-T Ethernet ports and is
designed to meet the Internet security needs of small and medium size networks
in business and education. SonicWALL security code operates between each port's
connections to prevent unauthorized communication, regardless of its source. In
addition to the features provided by SonicWALL, SonicWALL DMZ provides a third
port, a DMZ, or De-Militarized Zone. With the additional DMZ port, public Web
and e-commerce servers can both be accessed from the Internet without exposing
the private network to Internet based attacks. SonicWALL DMZ protects the
computers on the LAN port and the public servers on the DMZ port from Internet-
based attacks. SonicWALL DMZ supports unlimited users.
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<PAGE>
SonicWALL PRO. SonicWALL PRO has three 10/100Base-T Fast Ethernet ports and
is designed to meet the Internet security needs of medium and large size
businesses and branch offices. SonicWALL PRO supports all of the features found
in other SonicWALL models, and offers a more powerful and scalable platform for
larger networks requiring faster connections, high performance virtual private
networking and future expansion options. SonicWALL PRO supports unlimited
users.
The following table provides a summary of SonicWALL models:
<TABLE>
<CAPTION>
SonicWALL Model SonicWALL SonicWALL DMZ SonicWALL PRO
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Target Markets . Telecommuter . Small to medium . Medium to large
size business size business
. Small to medium . Education . Branch offices
size business
- ----------------------------------------------------------------------------------------
Virtual Private Networking Optional Optional Standard
- ----------------------------------------------------------------------------------------
Number of Users 10, 50, Unlimited Unlimited Unlimited
- ----------------------------------------------------------------------------------------
LAN and WAN Ports X X X
- ----------------------------------------------------------------------------------------
DMZ Port for Public Servers X X
- ----------------------------------------------------------------------------------------
Expandable Memory and PCI X
Expansion Slot
- ----------------------------------------------------------------------------------------
Type of Ports 10Base-T 10Base-T 10/100Base-T
(Ethernet) (Ethernet) (Fast Ethernet)
- ----------------------------------------------------------------------------------------
Microprocessor Motorola Motorola Intel
33MHz MC 68360 33MHz MC 68360 233MHz StrongARM
- ----------------------------------------------------------------------------------------
List Price $495 - $1,495 $1,795 $2,995
</TABLE>
End users may also purchase various product upgrades and subscriptions, such
as updated content filter lists, virtual private networking, number of user
upgrades, and extended warranties and premium support contracts.
<TABLE>
<CAPTION>
Upgrade or Subscription Description List Price
- ----------------------------------------------------------------------------------------
<S> <C> <C>
Virtual Private Networking Activates optional virtual private
Upgrade networking feature for SonicWALL and
SonicWALL DMZ models $495 - $695
- ----------------------------------------------------------------------------------------
Number of Users Upgrade Adds support for additional users for
user-limited models (SonicWALL/10 and
SonicWALL/50) $650 - $1,300
- ----------------------------------------------------------------------------------------
Content Filter Subscription Annual subscription to a continuously
updated list of Internet sites $175 - $695 /
containing objectionable content year
- ----------------------------------------------------------------------------------------
Extended Warranty and Annual extended warranty on SonicWALL
Premium Support hardware and premium technical support $80 - $675 /
contract year
</TABLE>
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<PAGE>
[DESCRIPTION OF GRAPHICS:
Diagram showing the Internet as an oval symbol and lines connecting from
the Internet through depiction of SonicWALL products to graphic for SME
(office building), telecommuter (house), school or library (school), branch
office (office building), corporate headquarters (office building), and
mobile worker (laptop computer).]
The SonicWALL product line shares a common set of Internet security features
that have been tailored to meet the needs of our target markets:
Firewall Security. Our firewall security protects private networks against
Internet-based theft, destruction, or modification of data, and automatically
notifies customers if their networks are under attack. SonicWALL has been
awarded the internationally recognized ICSA Firewall Certification, the same
certification awarded to significantly more expensive products sold by Check
Point Software and Cisco Systems. In addition, SonicWALL is pre-configured to
automatically detect and thwart Denial of Service attacks such as Ping of
Death, SYN Flood, LAND Attack, and IP Spoofing.
Virtual Private Networking. Our virtual private networking capabilities
enable affordable and secure communications over the Internet between branch
offices, telecommuters, mobile workers and business partners. SonicWALL virtual
private networking uses industry-standard data encryption algorithms and
interoperates with other virtual private networking products such as Check
Point Software's Firewall-1.
Content Filtering. Our content filtering feature enables businesses,
families, schools and libraries to control access to objectionable or
inappropriate Web sites. SonicWALL can filter Internet content by URL or
keyword. We offer a content filter subscription service that provides a list of
objectionable Web sites that is automatically updated on a weekly basis.
IP Address Management. SonicWALL includes Network Address Translation, or
NAT, which allows a customer to connect multiple users on their private network
to the Internet using a single public IP address. SonicWALL also includes
Dynamic Host Configuration Protocol, or DHCP, Client and Server capabilities.
DHCP Client allows SonicWALL to automatically acquire its IP address settings
from the Internet Service Provider, or ISP. DHCP Server allows computers on the
private network to automatically acquire IP address settings from SonicWALL,
simplifying client PC configuration.
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<PAGE>
AutoUpdate. Our AutoUpdate feature automatically notifies all registered
customers via e-mail when bug fixes or new products that have been purchased
are available for download from our Web site. With AutoUpdate, we give our
customers an easy-to-use method to address rapidly evolving Internet security
issues.
Logging and Reporting. SonicWALL maintains an event log of potential
security concerns which can be viewed with a Web browser or automatically sent
to any e-mail address on a periodic basis. SonicWALL notifies the administrator
of high-priority security issues, such as an attack on a server, by immediately
sending an alert message to a priority e-mail account such as an e-mail pager.
SonicWALL also provides pre-defined reports that show different views of
Internet usage, such as the most commonly accessed Web sites.
Web Browser-Based Management. SonicWALL is easily and securely configured
and managed through a Web browser-based interface. The SonicWALL interface
effectively insulates the user from the underlying complexity of Internet
security, while providing enough flexibility to meet the diverse needs of our
customers.
Case Studies
SonicWALL customers range from home users with Internet cable or DSL access
to global companies with numerous branch offices and telecommuters. The
following case studies illustrate how our customers are using our products and
services.
Small to Medium Size Enterprise
The Charlotte Hornets professional basketball franchise depends on the
Internet for league communications, marketing and public relations. The
Hornets' office uses an always-on broadband Internet connection that requires
Internet security to protect confidential franchise and league information. A
SonicWALL DMZ is used to provide firewall protection for all computers on the
private network. Four Web sites and other servers are hosted on the DMZ port,
where they are accessible from the Internet, but protected from Internet
attacks.
Branch Office
Pixar, an Academy Award-winning computer animation studio with technical,
creative and production capabilities, develops well-known computer-animated
feature films. In addition to its headquarters in Richmond, California, Pixar
has six branch offices with always-on broadband Internet connections that
require firewall security to protect the computers on their private networks
and virtual private networking connectivity to allow secure communications with
headquarters. A SonicWALL at each branch office provides Pixar with firewall
security. With the SonicWALL virtual private networking upgrade at each branch
office and Check Point Software's Firewall-1 at headquarters, Pixar has created
a secure distributed network that allows employees in different offices to
collaborate on projects and to disseminate confidential information securely
over the Internet throughout the enterprise.
Telecommuter
Mr. Marshall subscribes to Excite@Home's high speed Internet cable access
service in Fremont, California. Recently, Mr. Marshall's employer installed a
SonicWALL PRO at the office to allow telecommuters to use virtual private
networking for secure access to sensitive resources on the company's private
network, such as file servers and databases. Mr. Marshall installed a
SonicWALL/10 with the virtual private networking upgrade at home to create a
virtual private networking connection to his company's private network,
allowing him to securely collaborate on projects and distribute private
information with other employees over the Internet.
Education
The Santa Clara County California Library system offers free Internet access
to all members of the community from any of its computer terminals located
throughout nine community libraries. Responding to
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<PAGE>
community concerns, the Library's governing body mandated the use of content
filtering to restrict access to sexually explicit Internet sites in the
children's rooms of all Library branches. Following a six-week study during
which multiple security and filtering products were analyzed, the Library
installed a SonicWALL DMZ with our content filtering subscription service to
restrict access to objectionable Web sites. SonicWALL DMZ is configured to
allow adult patrons to decide between filtered or unfiltered access while the
computers in the children's rooms are always filtered. In addition to content
filtering, SonicWALL DMZ provides firewall security for all of the Library's
computers.
Sales and Marketing
Our sales and marketing efforts focus on successfully penetrating the small
to medium enterprise, branch office, telecommuter, and education markets. Our
marketing programs promote SonicWALL brand awareness and reputation as a
reliable, high performance, easy-to-use, and affordable Internet security
appliance. We try to strengthen our brand through a variety of marketing
programs which include on-going public relations, our Web site, advertising,
direct mail, industry and regional trade shows and seminars. We intend to
rapidly expand our indirect channel relationships through additional marketing
programs, additional marketing staff and increased advertising.
We believe that SonicWALL products are ideally suited for the indirect
channel where it is not economically efficient for us to sell directly to the
end users of our products. We primarily market and sell our products in this
indirect channel through a two-tiered distribution structure consisting of
distributors and resellers, both in the United States and over 30 countries.
Distributors accounted for approximately 89% of our total revenue for the nine
months ended September 30, 1999. Resellers, which include systems integrators,
ISPs, dealers, mail order catalogs and online catalogs, generally purchase our
products from our distributors and then sell our products to end-users in our
target markets. Except for our Sonic Platinum level resellers described below,
we do not have purchase agreements with or sell directly to our resellers. Our
distributor and reseller agreements are non-exclusive.
We divide our sales organization regionally into three areas: the United
States and Canada; the Pacific Rim and Latin America; and Europe, the Middle
East and Africa. Regional sales representatives manage our relationships with
our network of distributors, value added resellers and customers, help our
value added reseller network sell and support key customer accounts, and act as
a liaison between our value added reseller network and our marketing
organization. The regional sales representative's primary responsibility is to
help the indirect channel succeed and grow within the territory. We also have
an internal sales staff that supports the indirect channel, and a dedicated
business development organization whose primary responsibilities are
identifying, promoting, and managing strategic relationships to sell our
products with ISPs, industry leaders, and original equipment manufacturers as
well as to obtain technology for incorporation in our product line.
Domestic Channel. In the United States, the primary distributors of our
products to resellers are Ingram Micro and Tech Data. Ingram Micro accounted
for 34% of our revenue in 1998 and 35% in the nine months ended September 30,
1999. Tech Data began distributing our Internet security products in February
1999, and in the nine months ended September 30, 1999, accounted for
approximately 11% of total revenue.
Domestic resellers receive various benefits and product discounts depending
on the level of purchases that the reseller commits to or achieves. The basic
program is the Sonic Reseller level which offers access to privileged
information and sales and marketing materials. Next we offer a Sonic Silver
level, which extends those benefits by adding access to an expanded set of
sales and marketing tools, as well as priority technical support. The top level
is Sonic Gold, where additional benefits such as sales leads and market
development funds are available. Sonic Reseller, Silver, and Gold resellers all
source our products through a distributor. We also have a Sonic Platinum level
program for selected resellers which includes sales leads, access to additional
discounted demonstration units and market development funds. We sell directly
to these Platinum level resellers.
International Channel. We believe there is a strong international market for
our products. International sales represented 32% of our revenue in 1998 and
approximately 33% of revenue in the nine months ended
37
<PAGE>
September 30, 1999. Sales to Japan accounted for 15% of total revenue in the
nine months ended September 30, 1999. Sumitomo Metal Systems Development
Company, a distributor in Japan, accounted for 11% of total revenue in the nine
months ended September 30, 1999 and is our largest international distributor.
We direct all of our international resellers to the appropriate distributor
in each territory. We support our international distributors by offering
customizable marketing materials, sales tools, leads, co-operative marketing
funds, joint advertising, discounted demonstration units, and training. We also
participate in regional press tours, trade shows, and seminars. Additional key
international distributors include ME Networks in Switzerland, Tekdata
Distribution in England, DataWorld in Hong Kong and Allasso in England.
Original Equipment Manufacturer Channel. We enter into select original
equipment manufacturer relationships in order to take advantage of the channels
of well established companies that sell into our target markets. We believe
these channels expand our overall market while having a minor impact on our own
indirect channel sales. We currently have agreements to sell our products or
services through the following original equipment manufacturers: Com21, a
supplier of cable modems, Ramp Networks, a provider of networking equipment to
small businesses, and 3COM Corporation. The terms of our agreements with these
customers are variable. Com21 is licensed to incorporate our technology in its
cable modem products. Ramp Networks sells our products under its own name, as
does 3COM Corporation. We manufacture the products which Ramp Networks and 3COM
Corporation purchase from us for resale through their own distribution
channels. In the nine months ended September 30, 1999, our original equipment
manufacturer revenue accounted for approximately 6% of total revenue.
Customer Service and Technical Support
We offer our customers a comprehensive range of support programs through a
customer service and technical support organization which provides product
maintenance and technical support services on a worldwide basis. Our technical
support staff is located in Santa Clara, California. In addition to standard
support, we offer premium support services which an end user customer located
in the United States can purchase from us or our channel partners.
Standard Support. Included during the warranty period, standard support is a
unique Web-based technical support mechanism whereby distributors, channel
partners, and end users can use our extensive on-line technical support
resource database. If the resource database does not answer a question, the
user can immediately enter a query or "trouble ticket" on-line and our customer
service organization will then generate a response via phone, fax, or e-mail.
Premium Support. Available for purchase only in the continental United
States, our annual subscription-based Premium Support program offers extended
benefits to the Standard Support offering. Premium Support benefits include:
. expedited response time;
. access to a dedicated toll-free support telephone number;
. overnight replacement of defective units; and
. free shipping for units which we authorize for return.
Our products include a standard one-year warranty, which can be extended at
additional cost. The warranty provides access to our standard technical support
services along with repair or replacement guarantees for units with product
defects.
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<PAGE>
Customers
We sell over 95% of our products through distributors and original equipment
manufacturers. As of September 30, 1999, we had sold more than 18,000 Internet
security appliances. The following lists our top five international and
domestic distributors based on revenues in the nine months ended September 30,
1999, and all of our current original equipment manufacturers. The top five
domestic distributors each represent between 1% and 35% of our total revenue.
The top five international distributors each represent between 1% and 11% of
our total revenue.
<TABLE>
<S> <C> <C>
Top 5
Domestic
Distributors Top 5 International Distributors Original Equipment Manufacturers
. Ingram .Sumitomo Metal Systems (Japan) .3COM Corp.
Micro
. Tech Data .ME Networks (Switzerland) .Com21
. StarCom .Tekdata (England) .Ramp Networks
. Sound .DataWorld (Hong Kong)
Business
Systems
. VITTS .Allasso (England)
</TABLE>
End Users
Although we do not sell directly to end users, more than 50% of the products
we have sold to date have been registered for use with us by our end users in
our target markets. The following is a representative list of end users in each
of our target markets who have deployed one or more SonicWALL products. These
include the small to medium enterprise, the branch offices of large
corporations, telecommuter, and the education and public institution markets.
<TABLE>
<S> <C> <C> <C>
Small to Medium
Enterprises Branch Offices Telecommuter Education and Public Institutions
. Charlotte Hornets .American Express .Compaq Computer Corporation .Albany County School District
. General Magic .Bank of Nova Scotia .Lucent Technologies .City of Santa Cruz
. Los Angeles Lakers .Centurion/Bank of Ireland .Microsoft Corporation .Comision Federal de Electricidad
. Pixar . Commercial Bank of .NEC .Duke University
San Francisco .PricewaterhouseCoopers LLP .Johns Hopkins University
.Wells Fargo .Sun Microsystems . Santa Clara County California
Library
</TABLE>
Technology
We have designed our SonicWALL products using a unique combination of
proprietary hardware and software that delivers comprehensive Internet security
with what we believe are exceptional ease-of-use and industry-leading
price/performance.
The SonicWALL product line currently has two base hardware configurations:
. SonicWALL and SonicWALL DMZ. These SonicWALL products use the 33MHz
Motorola 68360 microprocessor. Both products have two 10 megabit per
second (Mbps) Ethernet ports. A LAN port connects the SonicWALL to
the user's internal, private network. A Wide Area Network, or WAN,
port connects to the external, public network. The SonicWALL DMZ has
a third 10 Mbps Ethernet port (DMZ) which connects to public servers
that are separated from both the public and private networks but
still protected from security breaches.
. SonicWALL PRO. The SonicWALL PRO product uses Intel's 233MHz
StrongARM 110 microprocessor, and has three 10/100 Mbps Fast Ethernet
ports. These three ports function just like the SonicWALL DMZ. For
feature expansion, the SonicWALL PRO has an internal Peripheral
Component Interconnect, or PCI, interface, upgradeable RAM, and flash
memory.
The SonicWALL product line consists of the following core modules:
. Firewall. The core technology is the stateful packet inspection
firewall software. Stateful packet inspection is generally accepted
as the most advanced and secure method of implementing an Internet
firewall. It examines all layers of the packet (from the physical
layer up to application layer) and
39
<PAGE>
determines whether to accept or reject the requested communication
based on state information derived from previous communications and
the applications in use. Stateful packet inspection dynamically
adjusts based on the changing state of the communication running
across the firewall and is invisible to users on the protected
network. It therefore requires no client PC configuration. Our
SonicWALL firewall protects against a known set of security threats.
. Content Filter. The SonicWALL Internet content filter blocks
objectionable content using a list of forbidden URLs and keywords. We
license Microsystems Software's CyberNOT list of URLs and adapt it
for our products. Each SonicWALL can automatically download an
updated URL list weekly to keep pace with the dynamic nature of
Internet content.
. IP Address Management. We have developed tools to hide the complexity
of IP addressing. NAT allows networks to share a small number of
valid public IP addresses with an equal or larger number of client
computers on the LAN. This is a common challenge in new broadband-
connected networks. Our DHCP Server and Client tools allow both the
firewall and the client computers behind it to obtain their
respective IP addresses dynamically from a server and thereby
eliminate the need for manual configuration.
. Virtual Private Networking. We developed virtual private networking
support for the SonicWALL products to provide a means for our
customers to use the Internet for secure communication between LANs,
and from remote clients to LANs. SonicWALL virtual private networking
complies with the Internet Protocol Security (IPSec) standard and
supports three data encryption methods: 56 bit Data Encryption
Standard (DES); 168 bit Data Encryption Standard (Triple-DES); and 56
bit ARCFour (ARC4). By building our virtual private networking
technology on industry standards--IPSec, DES and Triple-DES--we have
been able to establish virtual private networking interoperability
with other leading virtual private networking solutions such as Check
Point Software's FW-1.
. Web Browser-Based Management Interface. We believe our products have
an intuitive and easy-to-use Web-based management interface for rapid
installation, configuration and maintenance, without the need for a
dedicated information technology staff to install and maintain the
solution. This interface can be easily accessed from any Web browser
on the internal, private network. This interface can also be accessed
remotely in a secure manner using the virtual private networking
feature described above.
Research and Development
We believe that our future competitive position will depend in large part
on our ability to develop new and enhanced Internet security solutions and our
ability to meet the rapidly changing needs of our target customers who have
broadband access to the Internet. We focus our research and development on
evolving Internet security needs. In addition, we have also made substantial
investments in hardware and ASIC technologies which are critical to drive
product cost reductions and higher performance solutions. Current activities
include:
. virtual private networking improvements such as public key
infrastructure support and strong authentication;
. other security and filtering improvements such as intrusion
detection, virus scanning and e-mail spam filtering; and
. new management capabilities such as bandwidth management and a new
distributed management framework.
All of our research and development activities are conducted at our
principal facility in Santa Clara, California. In 1996, 1997, and 1998, we
spent $1,048,000, $1,983,000, and $2,051,000 respectively on research and
development.
40
<PAGE>
Competition
The market for Internet security products is world-wide and highly
competitive, and we expect competition to intensify in the future. There are
few substantial barriers to entry, and additional competition from existing
competitors and new market entrants will occur in the future. Current and
potential competitors in our markets include, but are not limited to the
following, all of whom sell world-wide or have a presence in most of the major
markets for such products:
. enterprise firewall software vendors such as Check Point Software
and Axent Technologies;
. network equipment manufacturers such as Cisco Systems, Lucent
Technologies, Nortel Networks, 3COM and Nokia;
. computer or network component manufacturers such as Intel
Corporation;
. operating system software vendors such as Microsoft Corporation,
Novell and Sun Microsystems;
. security appliance suppliers such as Watchguard Technologies; and
. low cost Internet router suppliers which may include limited
Internet security functionality.
Most of our competitors to date have generally targeted large enterprises'
security needs with firewall products that are typically very complex and
expensive, ranging in price from approximately $5,000 to more than $15,000, and
requiring active management by IT personnel. While there are suppliers of low
cost Internet routers which may provide limited Internet security
functionality, we believe these products are difficult to install and configure
and provide relatively low performance. At any time, any of these competitors
may adapt existing products for our target markets. Many of our current or
potential competitors have longer operating histories, greater name
recognition, larger customer bases and significantly greater financial,
technical, marketing and other resources than we do. Nothing prevents or
hinders these actual or potential competitors from entering our target markets
at any time. In addition, our competitors may bundle products competitive to
ours with other products that they may sell to our current or potential
customers. These customers may accept these bundled products rather than
separately purchasing our products. If these companies were to use their
greater financial, technical and marketing resources in our target markets, it
could adversely affect our business.
Proprietary Rights
We currently rely on a combination of copyright and trademark laws, trade
secrets, confidentiality provisions and other contractual provisions to protect
our proprietary rights. Despite our efforts to protect our proprietary rights,
unauthorized parties may misappropriate or infringe on our trade secrets,
copyrights, trademarks, service marks and similar proprietary rights. Although
we are currently investigating patent protection for some of our proprietary
technology, we have not yet received any patent protection for our technology
or products. Even if we obtain such patents, that does not guarantee that our
patent rights are valuable, create a competitive barrier, or will be free from
infringement. We face additional risk when conducting business in countries
that have poorly developed or inadequately enforced intellectual property laws.
In any event, competitors may independently develop similar or superior
technologies or duplicate the technologies we have developed, which could
substantially limit the value of our intellectual property.
U.S. Government Export Regulation Compliance
Our products are subject to federal export restrictions on encryption
strength. Recent federal legislation, however, has increased exportable
encryption strength and allows the export of any-strength encryption to
designated business sectors overseas, including U.S. subsidiaries, banks,
financial institutions, insurance companies and health and medical end users.
In addition, we have obtained a federal export license that allows us to export
encryption technology to commercial entities in approved countries. With these
expanded export rights, we may export strong encryption to a wide range of
foreign end-users, subject to limitations and
41
<PAGE>
record-keeping requirements. To comply with these constraints, we obtain from
our distributors and resellers detailed information about each foreign end-user
customer that will obtain strong encryption.
Manufacturing
We currently outsource our manufacturing to one contract manufacturer, Flash
Electronics, under an agreement which may be cancelled upon 180 days prior
notice by either party. Outsourcing our manufacturing enables us to reduce
fixed overhead and personnel costs and to provide flexibility in meeting market
demand.
We design and develop all the key components of our products, including
printed circuit boards and software. In addition, we determine the components
that are incorporated in our products and select the appropriate suppliers of
these components. Product testing and burn-in is performed by our contract
manufacturers using tests that we specify.
Employees
As of September 30, 1999, we had 53 employees. Of these, 28 were employed in
sales and marketing, 5 in finance and administration, 10 in research and
development and 10 in operations. We are not parties to any collective
bargaining agreements with our employees and we have not experienced any work
stoppages. We believe we have good relations with our employees.
Facilities
Our principal administrative, marketing, sales, development and operations
facility is located in Sunnyvale, California. We occupy approximately 32,256
square feet in this facility, under a lease that expires in September 2004.
Legal Proceedings
We currently are not a party to any material legal proceeding.
42
<PAGE>
MANAGEMENT
Executive Officers, Directors and Key Employees
The following table lists the executive officers, directors and key
employees of SonicWALL as of September 30, 1999.
<TABLE>
<CAPTION>
Name Age Position
- ---- --- --------
<S> <C> <C>
Sreekanth Ravi(1)....... 33 Chairman of the Board, President and Chief Executive Officer
Sudhakar Ravi(1)........ 34 Vice President, Engineering and Director
Michael J. Sheridan(1).. 35 Vice President, Finance, Chief Financial Officer and Secretary
Steven R. Perricone..... 39 Vice President, Sales
Richard Pearce.......... 38 Vice President, Business Development
Fara Zarrabi............ 58 Vice President, Operations
Jerrold F.
Petruzzelli(2)......... 46 Director
David A. Shrigley(3).... 51 Director
Robert M.
Williams(2)(3)......... 44 Director
</TABLE>
- ----------
(1)Executive officer
(2)Member of audit committee
(3)Member of compensation committee
We have no employment agreements with our executive officers or key
employees. All are subject to termination at will. The board of directors is
elected annually by shareholders, and members of the board serve until the next
annual meeting of shareholders unless they resign before such meeting. The last
annual shareholders meeting was held in September, 1999.
Sreekanth Ravi has served as our Chairman of the Board, President and Chief
Executive Officer since co-founding SonicWALL, Inc. in February 1991. Prior to
SonicWALL, Inc., Mr. Ravi was the founder and chief executive officer of
Generation Systems, a manufacturer of high performance video products, which he
later sold to a publicly held computer products company in 1990. Mr. Ravi
received a bachelor of science degree in electrical engineering from the
University of Illinois, Champaign-Urbana. Sreekanth Ravi and Sudhakar Ravi are
brothers.
Sudhakar Ravi has served as our Vice President, Engineering and director
since co-founding SonicWALL, Inc. in February 1991. Prior to SonicWALL, Inc.,
Mr. Ravi was involved in semiconductor research at Stanford University. Mr.
Ravi received a bachelor of science degree from the University of Illinois,
Champaign-Urbana and a masters of science degree in computer science from
Stanford University. Sudhakar Ravi and Sreekanth Ravi are brothers.
Michael J. Sheridan has served as our Chief Financial Officer since joining
SonicWALL, Inc. in May 1999, and became Secretary in September, 1999. Mr.
Sheridan joined SonicWALL, Inc. from Genesys Telecommunications Laboratories,
Inc., an enterprise software company in the call center automation industry,
where he served as Vice President of Finance from January 1998 to May 1999, and
served as Corporate Controller from November 1996 to December 1997. From August
1995 to November 1996, Mr. Sheridan was the Corporate Controller for Network
Appliance, Inc., a network file server manufacturer. From 1986 to 1995,
Mr. Sheridan was an audit professional with Arthur Andersen LLP, where he was
involved primarily with high technology clients. Mr. Sheridan received a
bachelor's degree in commerce from Santa Clara University and is a Certified
Public Accountant.
43
<PAGE>
Steven R. Perricone has served as our Vice President, Sales since joining
SonicWALL, Inc. in April 1998. Mr. Perricone joined SonicWALL, Inc. from
Structured Internetworks, an IP bandwidth management company, where he served
as Vice President of Worldwide Sales and Support from July 1997 to April 1998.
From July 1994 to June 1997, Mr. Perricone was Vice President of Worldwide
Sales at Network TeleSystems, a provider of TCP/IP client and server technology
for Internet access. Prior to Network TeleSystems, Mr. Perricone held various
sales management positions at Emulex and Xylogics (now part of Nortel Networks
Corp.). Mr. Perricone received a bachelor's degree in business from California
State University.
Richard Pearce, Ph.D. has served as our Vice President, Business Development
since joining SonicWALL, Inc. in June 1999. Dr. Pearce joined SonicWALL, Inc.
from WinNet MCS, Inc., a high-bandwidth wireless communications company where
he served as Vice President of Marketing from November 1998 to June 1999. Prior
to joining WinNet, Dr. Pearce was Director of Business Development for Bay
Networks (a Nortel Networks Corp. company) from August 1996 to November 1998,
responsible for defining and managing programs to add IP technology to Nortel's
product lines. He was also responsible for identifying and developing market
opportunities enabled by the innovative mixing of Nortel products and
technologies. Prior to Bay Networks' acquisition by Nortel, Dr. Pearce was
responsible for developing emerging market opportunities for Bay Networks. From
July 1994 to August 1996, Dr. Pearce was Senior Manager, Technology Alliances
for Bay Networks. Dr. Pearce received a bachelor of science degree in applied
physics & electronics and a Ph.D. in data networking from Durham University in
the United Kingdom.
Fara Zarrabi has served as our Vice President, Operations since joining
SonicWALL, Inc. in July 1999. Mr. Zarrabi joined SonicWALL, Inc. from Genesys
Telecommunications Laboratories, Inc., where he was Director of Operations from
February 1997 to June 1999. Prior to Genesys Telecommunications, Mr. Zarrabi
was the Director of Operations at Network Appliance, Inc., from February 1996
to February 1997. From May 1994 to February 1996, Mr. Zarrabi was Director of
Manufacturing Operations at Radius, Inc., a manufacturer of computer graphics
and video hardware. Mr. Zarrabi received a bachelor's degree in electronic
engineering from the University of California, Berkeley.
Jerrold F. Petruzzelli has served as a director since October 1993. From
October 1993 through September 1999, Mr. Petruzzelli also was our Secretary.
Mr. Petruzzelli has been a partner of Manatt, Phelps & Phillips, LLP, legal
counsel to SonicWALL, Inc., since June 1999 and previously was a partner of
Holtzmann Wise & Shepard, legal counsel to the Company, from January 1990 to
July 1995, and a partner of Wise & Shepard LLP, legal counsel to the Company,
from July 1995 to June 1999, at which time Wise & Shepard LLP merged with
Manatt, Phelps & Phillips, LLP. Mr. Petruzzelli received a bachelor of arts
degree from Yale University and a J.D. degree from the University of Chicago.
David S. Shrigley has been a director since July 1999. Since July, 1999, Mr.
Shrigley has been a venture partner of Sevin Rosen Funds, a venture capital
firm. From November 1996 to April 1999, Mr. Shrigley was Executive Vice
President, Sales and Services of Nortel Networks Corp., a network
telecommunications company. From December 1978 to November 1996, Mr. Shrigley
was an employee of Intel Corporation, a semiconductor manufacturing company,
where he was last employed as Vice President, Corporate Marketing. Mr. Shrigley
received a bachelor of science degree in business administration from Franklin
University.
Robert M. Williams has been a director since May 1999. Bay Partners, two
shareholders of SonicWALL, Inc., and SonicWALL, Inc. are parties to a voting
agreement whereby Bay Partners is entitled to name a member of SonicWALL,
Inc.'s Board of Directors. The voting agreement terminates upon the effective
date of this offering. Since January 1998, Mr. Williams has been a general
partner of Bay Partners, a venture capital firm. From May 1993 to December
1997, Mr. Williams was Vice President, Marketing and Business Development of
NetManage, Inc., a networking software product development and sales company.
Before then, Mr. Williams held various marketing positions at several
companies, including Verity, Inc., an Internet text engine developer, and
Ingres Corp., a developer of relational database management software. Mr.
Williams received a bachelor of arts degree from Dartmouth College and a MBA
from the Stanford Graduate School of Business.
44
<PAGE>
Committees of the Board of Directors
The compensation committee of our board of directors consists of Messrs.
Shrigley and Williams. The compensation committee:
. reviews and approves the compensation and benefits for our executive
officers and grants stock options under our stock option plan; and
. makes recommendations to the board of directors regarding these
matters.
The audit committee consists of Messrs. Petruzzelli and Williams. The audit
committee:
. makes recommendations to the board of directors regarding the
selection of independent auditors;
. reviews the results and scope of the audit and other services
provided by our independent auditors; and
. reviews and evaluates our audit and control functions.
We established these committees in August 1999.
Director Compensation
We do not pay cash compensation to our directors for their services as
directors or members of committees of the board of directors, but we do
reimburse them for reasonable expenses they incur in attending meetings of the
board of directors. Directors of SonicWALL, Inc. are eligible to participate in
our stock option plans.
Director and Officer Indemnification and Liability
Our articles of incorporation limit the liability of directors to the full
extent permitted by California law. California law provides that a
corporation's articles of incorporation may eliminate or limit the personal
liability of directors for monetary damages for breach of their fiduciary
duties as directors, except liability for:
. acts or omissions that involve intentional misconduct or a knowing
and culpable violation of law;
. acts or omissions that a director believes to be contrary to the
best interest of the corporation or its shareholders or that involve
the absence of good faith on the part of the director;
. any transaction from which a director derived an improper personal
benefit;
. acts or omissions that show a reckless disregard for the director's
duty to the corporation or its shareholders in circumstances in
which the director was aware, or should have been aware, in the
ordinary course of performing a director's duties, of a risk of
serious injury to the corporation or its shareholders;
. acts or omissions that constitute an unexcused pattern of
inattention that amounts to an abdication of the director's duty to
the corporation or its shareholders;
. unlawful payments of dividends or unlawful stock repurchases or
redemptions, unlawful distribution of assets to shareholders or
unlawful loans or guarantees to directors, officers and others; or
. any transaction between a director and the Company.
Our bylaws provide that we will indemnify our directors and officers to the
fullest extent permitted by California law, including circumstances in which
indemnification is otherwise discretionary under California
45
<PAGE>
law. We have entered into indemnification agreements with our directors and
officers containing provisions that are in some respects broader than the
specific indemnification provisions contained in the California Corporations
Code. The indemnification agreements may require us:
. to indemnify our directors and officers against liabilities that may
arise by reason of their status or service as directors or officers,
other than liabilities arising from willful misconduct of a culpable
nature;
. to advance their expenses incurred as a result of any proceeding
against them as to which they could be indemnified; and
. to obtain directors' and officers' insurance if available on
reasonable terms.
At present, there is no pending litigation or proceeding involving any
director, officer, employee or agent of ours in which indemnification would be
required or permitted. We are not aware of any threatened litigation or
proceeding that might result in a claim for indemnification. We believe that
our charter provisions and indemnification agreements are necessary to attract
and retain qualified persons as directors and officers.
The Securities and Exchange Commission has advised us that, in its opinion,
any indemnification of our directors and officers for liabilities arising under
the Act is against public policy as expressed in the Act and is therefore
unenforceable.
Compensation Committee Interlocks and Insider Participation
Our board of directors' compensation committee currently consists of Messrs.
Shrigley and Williams. None of these individuals has at any time been an
employee or officer of SonicWALL, Inc. Until the compensation committee was
formed in August 1999, the full board of directors made all decisions regarding
executive compensation. No member of our board of directors or of its
compensation committee serves as a member of the board of directors or
compensation committee of any entity that has one or more executive officers
serving as members of its board of directors or its compensation committee.
Executive Compensation
The following table provides information concerning the compensation
received for services rendered to SonicWALL, Inc. in all capacities during the
year ended December 31, 1998, by our chief executive officer and each of the
other most highly compensated executive officers or key employees of SonicWALL,
Inc. whose compensation exceeded $100,000 in fiscal 1998.
Summary Compensation Table
<TABLE>
<CAPTION>
Long-Term
Compensation
Annual Compensation Awards
-------------------- ------------
Securities
Name and Principal Other Annual Underlying All Other
Position Year Salary ($) Bonus ($) Compensation ($) Options (#) Compensation ($)
- ------------------ ---- ---------- --------- ---------------- ------------ ----------------
<S> <C> <C> <C> <C> <C> <C>
Sreekanth Ravi......... 1998 $240,000 $732,345 N/A N/A $13,846(1)
President and Chief
Executive Officer
Sudhakar Ravi.......... 1998 $240,000 $816,871 N/A N/A $13,846(1)
Vice President,
Engineering
Steven R. Perricone.... 1998 $ 78,231 $ 23,389 N/A 600,000 $ 1,538(1)
Vice President, Sales
Michael J.
Sheridan(2)........... 1998 N/A N/A N/A N/A N/A
Vice President,
Finance, Chief
Financial Officer
and Secretary
</TABLE>
- ----------
(1) Cash payment in lieu of vacation days
(2) Hired in May 1999
46
<PAGE>
The following table provides information regarding stock options we granted
in fiscal 1998 to our chief executive officer and the other executive officers
or key employees whose compensation exceeded $100,000 in fiscal 1998. The table
includes the potential realizable value over the ten-year term of the options,
based on assumed rates of stock appreciation of 5% and 10%, compounded
annually. The assumed rates of appreciation are prescribed by the Securities
and Exchange Commission for illustrative purposes only and are not intended to
forecast or predict future stock prices. Any actual gains on option exercises
will depend on the future performance of our stock. The value of realized and
the value of unexercised in-the-money options is calculated on the basis of the
initial public offering price of $14.00 per share as the fair market value at
December 31, 1998.
Option Grants in Last Fiscal Year
<TABLE>
<CAPTION>
Individual Grants
------------------------
Potential Realizable
Value at Assumed Annual
Number of Percent of Rates of Stock Price
Securities Total Options Appreciation for Option
Underlying Granted to Exercise Term
Options Employees in Price Expiration -----------------------
Name Granted(#) Fiscal Year ($/Sh) Date 5%($) 10%($)
---- ---------- ------------- -------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Sreekanth Ravi.......... 0 N/A N/A N/A N/A N/A
Sudhakar Ravi........... 0 N/A N/A N/A N/A N/A
Steven R. Perricone..... 600,000 59% $0.125 7/23/08 $13,607,714 $21,712,434
Michael J. Sheridan(1).. 0 N/A N/A N/A N/A N/A
</TABLE>
- ----------
(1) Hired in May 1999
Options vest and become exercisable over four years, provided the employee
remains employed at the Company. In 1998, we granted options to purchase up to
an aggregate of 1,015,000 shares to employees, directors and consultants. We
granted all options under our stock option plans at exercise prices at the fair
market value of our common stock on the date of grant, as determined in good
faith by our board of directors.
The following table provides information regarding options exercised during
1998 and unexercised options held as of December 31, 1998 by our chief
executive officer and the other executive officers or key employees whose
compensation exceeded $100,000 in fiscal 1998. The value of realized and the
value of unexercised in-the-money options is calculated on the basis of the
initial public offering price of $14.00 per share as the fair market value at
December 31, 1998.
Aggregate Option Exercises FY-End Option Values
<TABLE>
<CAPTION>
Number of
Number of Securities Underlying Value of Unexercised
Shares Unexercised Options at In-the-Money Options at
Acquired Fiscal Year End (#) Fiscal Year-End($)
on Value ------------------------- -------------------------
Name Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
---- --------- ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Sreekanth Ravi.......... 1,067,440 $14,837,416 0 0 N/A N/A
Sudhakar Ravi........... 1,067,440 $14,837,416 0 0 N/A N/A
Steven R. Perricone..... 0 0 111,600 488,400 $1,487,400 $6,776,550
Michael J. Sheridan..... 0 0 0 0 0 0
</TABLE>
Employee Benefit Plans
1998 and 1994 Stock Option Plans
The 1998 stock option plan provides for the grant of incentive stock
options, as defined in Section 422 of the Internal Revenue Code, to employees
and the grant of nonstatutory stock options to employees, non-employee
directors and consultants. The purposes of the 1998 stock option plan are:
. to attract and retain the best available personnel;
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<PAGE>
. to provide additional incentives to our employees and consultants;
and
. to promote the success of our business.
The 1998 stock option plan was adopted by our board of directors in July
1998, approved by our stockholders in July 1998, and amended by the
shareholders to increase the number of shares available for grant thereunder in
February 1999. Unless terminated earlier by the board of directors, the 1998
stock option plan will terminate in July 2008. The 1998 stock option plan was
amended by our board of directors in August 1999 to include some of the
provisions provided below. These amendments were approved by our shareholders
in August 1999. The number of shares reserved for issuance under the 1998 stock
option plan will be subject to an automatic annual increase in the first day of
2000 through 2008 equal to the lesser of:
. 2,000,000 shares;
. 4% of our outstanding common stock on the last day of the
immediately preceding fiscal year; or
. a number of shares determined by the administrator.
The compensation committee currently administers the 1998 stock option plan.
The administrator of the 1998 stock option plan determines numbers of shares
subject to options, vesting schedules and exercise prices for options granted
under the 1998 stock option plan.
The exercise price of incentive stock options must be at least equal to 100%
of the fair market value of our common stock on the date of grant, and at least
equal to 110% of the fair market value in the case of incentive stock options
granted to an employee who holds, at the time the option is granted, more than
10% of the total voting power of all classes of our stock or any parent's or
subsidiary's stock. Nonstatutory stock options will have an exercise price of
at least 85% of the fair market value of our stock. Payment of the exercise
price may be made in cash or other form of consideration approved by the
administrator. The administrator determines the term of options, which may not
exceed ten years, or five years in the case of an incentive stock option
granted to an employee who holds, at the time the option is granted, more than
10% of the total voting power of all classes of our stock or any parent's or
subsidiary's stock. No option may be transferred by the optionee other than by
will or the laws of descent or distribution, provided, however, that the
administrator may in its discretion provide for the transferability of
nonstatutory stock options. The administrator determines when options become
exercisable. Options granted under the 1998 stock option plan become
exercisable at a rate not less than 20% per year. To the extent an optionee
would have the right in any calendar year to exercise for the first time one or
more incentive stock options for shares having an aggregate fair market value
in excess of $100,000 as of the date the options were granted, the excess
options will be treated as nonstatutory stock options.
In the event of a change of control of SonicWALL, Inc., outstanding options
may be assumed or substituted by the successor corporation. If the successor
corporation does not agree to this assumption or substitution, the options will
terminate upon the closing of the transaction.
The board of directors may amend, modify or terminate the 1998 stock option
plan if any amendments, modification or termination does not impair existing
rights of plan participants. Additionally, shareholder approval is required for
an amendment to the extent required by applicable law, regulations or rules.
Options outstanding under the 1994 stock option plan are subject to
substantially the same terms as options under the 1998 stock option plan.
As of September 30, 1999:
. a total of 7,358,324 shares have been authorized for issuance under
the 1994 and 1998 stock option plans;
. options to purchase an aggregate of 3,586,500 shares of common stock
were outstanding under the 1994 stock option plan and 1998 stock
option plan at a weighed average exercise price of $3.82;
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<PAGE>
. 2,640,064 shares had been issued upon exercise of outstanding
options, net of repurchases, under the 1994 and 1998 stock option
plans; and
. 1,131,760 shares remained available for future grant under the 1994
and 1998 stock option plans.
1999 Employee Stock Purchase Plan
Our 1999 employee stock purchase plan was adopted by the board of directors
and shareholders in August 1999. The 1999 employee stock purchase plan becomes
effective on the effective date of this offering. A total of 250,000 shares of
common stock has been reserved for issuance under the 1999 employee stock
purchase plan.
The 1999 employee stock purchase plan, which is intended to qualify under
Section 423 of the Internal Revenue Code, provides our employees with an
opportunity to purchase our common stock through accumulated payroll
deductions. The 1999 employee stock purchase plan will be administered by the
board of directors or by a committee appointed by the board of directors. The
1999 employee stock purchase plan permits an eligible employee to purchase
common stock through payroll deductions of up to 15% of that employee's
compensation. Employees, including officers and employee directors, of
SonicWALL, Inc., or of any majority-owned subsidiary designated by the board of
directors, are eligible to participate in the 1999 employee stock purchase plan
if they are employed by SonicWALL, Inc. or any designated subsidiary for at
least 20 hours per week and more than five months per year. Unless the board of
directors or its committee determines otherwise, the 1999 employee stock
purchase plan will be implemented by a series of overlapping offering periods
generally of 24 months' duration with new offering periods commencing on
February 1 and August 1 of each year. Each offering period will be divided into
four consecutive purchase periods of approximately six months' duration. The
first offering period is expected to commence on the date of this offering and
end on July 31, 2001; the initial purchase period is expected to end six months
after the offering date. The price at which common stock will be purchased
under the 1999 employee stock purchase plan is equal to 85% of the fair market
value of the common stock on the first day of the applicable offering period or
the last day of the applicable purchase period, whichever is lower. Employees
may end their participation in an offering period at any time, and
participation automatically ends on termination of employment.
Under the 1999 employee stock purchase plan, no employee may be granted an
option if immediately after the grant the employee would own stock and/or hold
outstanding options to purchase stock equaling 5% or more of the total voting
power or value of all classes of our stock or that of our subsidiaries. In
addition, no employee may be granted an option under the 1999 employee stock
purchase plan if the option would permit the employee to purchase stock under
all of our employee stock purchase plans in an amount that exceeds $25,000 of
fair market value for each calendar year in which the option is outstanding at
any time. In addition, no employee may purchase more than 2,000 shares of
common stock under the 1999 employee stock purchase plan in any one purchase
period. If the fair market value of the common stock on a purchase date other
than the final purchase date of an offering period is less than the fair market
value at the beginning of the offering period, each participant in the 1999
employee stock purchase plan will automatically be withdrawn from the offering
period as of the purchase date and re-enrolled in a new 24-month offering
period on the first business day following the purchase date.
The 1999 employee stock purchase plan provides that, in the event of a
change of control of SonicWALL, Inc. each right to purchase stock under the
1999 employee stock purchase plan will be assumed or an equivalent right
substituted by the successor corporation. However, our board of directors will
shorten any ongoing offering period so that employees' rights to purchase stock
under the 1999 employee stock purchase plan are exercised prior to the
transaction if the successor corporation refuses to assume each purchase right
or to substitute an equivalent right.
The 1999 employee stock purchase plan will terminate in August 2009 unless
terminated earlier in accordance with its provisions. The board of directors
has the power to amend or terminate the 1999 employee
49
<PAGE>
stock purchase plan if its action does not adversely affect any outstanding
rights to purchase stock thereunder. However, our board of directors may amend
or terminate the 1999 employee stock purchase plan or an offering period even
if it would adversely affect options in order to avoid our incurring adverse
accounting charges.
401(k) Plan
We maintain a 401(k) plan that covers all our employees who satisfy the
plan's eligibility requirements relating to minimum age, length of service and
hours worked. We may make an annual contribution for the benefit of eligible
employees in an amount determined by our board of directors. We have not made
any contribution to date and have no current plans to do so. Eligible employees
may make pretax elective contributions of up to 15% of their compensation,
subject to maximum limits on contributions prescribed by law.
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<PAGE>
CERTAIN TRANSACTIONS AND BUSINESS RELATIONSHIPS
Since January 1, 1996, SonicWALL, Inc. has not been a party to any
transaction or series of similar transactions in which the amount involved
exceeds $60,000 and in which any director, executive officer, or holder of more
than 5% of our common stock had or will have a direct or indirect material
interest other than
. normal compensation arrangements which are described under
"Management--Executive Compensation" above; and
. the transactions described below.
Transactions with Executive Officers, Directors and Significant Shareholders
(1) In August 1998, SonicWALL, Inc. acquired all the partnership interest of
AckFin Networks ("AckFin"), a California general partnership, in exchange
for an aggregate of 5,426,184 shares of common stock and the assumption of
$150,000 in liabilities. The controlling partners of AckFin were Sreekanth
Ravi and Sudhakar Ravi, executive officers and directors of SonicWALL, Inc.
Additional partners were Ravi Anne and Bruce Wonnacott. The deemed fair
market value of our common stock on the date of acquisition was $0.90 per
share, resulting in an aggregate value of $4.9 million of common stock
issued in this transaction. The intangible assets acquired by the Company
were rights to the completed core technology developed by AckFin that
provides the foundation for our Internet products.
(2) On December 23, 1998, we extended two loans in the aggregate amount of
$96,069.60 to Sreekanth Ravi, Chairman of the Board, Chief Executive
Officer, President and a director of SonicWALL, Inc. to pay the exercise
price of options to purchase 1,067,440 shares of our common stock. Each
loan had an interest rate of 8% per year, payable over four years and was
secured by the shares of common stock purchased upon the exercise of Mr.
Ravi's stock options. These loans were repaid in full in August 1999.
(3) On December 23, 1998, we extended two loans in the aggregate amount of
$96,069.60 to Sudhakar Ravi, Vice President Engineering and a director of
SonicWALL, Inc. to pay the exercise price of options to purchase 1,067,440
shares of our common stock. Each loan had an interest rate of 8% per year,
payable over four years and was secured by the shares of common stock
purchased upon the exercise of Mr. Ravi's stock options. These loans were
repaid in full in August 1999.
(4) On February 19, 1999, we issued an aggregate of 1,438,377 shares of our
redeemable Series A convertible preferred stock at a purchase price of
$3.48 per share to several investors, including 14,384 shares issued to
Robert Williams, a director of the Company, 1,150,700 shares to Bay
Partners SBIC II, L.P. Mr. Williams is a partner of Bay Management Company
1997, the general partner of Bay Partners SBIC II, L.P. The purchasers of
redeemable Series A convertible preferred stock are entitled to
registration rights in respect of the common stock issued or issuable upon
conversion of the redeemable Series A convertible preferred stock.
(5) On May 26, 1999, we extended a loan in the amount of $300,000 to Michael
Sheridan, Vice President Finance, Chief Financial Officer, and Secretary of
SonicWALL, Inc. to pay the exercise price of options to purchase 300,000
shares of our common stock. Mr. Sheridan has purchased the optioned shares,
and SonicWALL, Inc. has the right to repurchase the optioned shares for the
purchase price paid, which right lapses over four years. The loan has an
interest rate of 8% per year and is payable over four years. The loan is
payable in full if Mr. Sheridan is no longer an employee, officer, director
or consultant of SonicWALL, Inc. As of September 30, 1999, aggregate
principal and interest of approximately $308,000 were outstanding under the
loan.
(6) On August 6, 1999, Sreekanth Ravi, Chairman of the Board, Chief Executive
Officer and President, and Sudhakar Ravi, Vice President of Engineering and
a director, sold an aggregate of 1,832,364 shares of common stock to Bay
Sonic Investors, LLC at a purchase price of $6.52 per share. On August 11,
1999, two shareholders also sold an aggregate of 400,000 shares of common
stock to Bay Sonic Investors, LLC at a purchase price of $6.52 per share.
Robert Williams, a director of the Company, is a managing member of Bay
Sonic Investors, LLC. In addition, on August 6, 1999, Sreekanth Ravi sold
38,354 shares of
51
<PAGE>
common stock to David Shrigley, a director of the Company, at a purchase
price of $6.52 per share and 30,682 shares of common stock to John McNulty
at a purchase price of $6.52 per share. The purchasers of common stock in
these transactions are entitled to registration rights in respect of the
common stock purchased.
(7) Jerrold F. Petruzzelli, a director of SonicWALL, Inc. is a partner of
Manatt, Phelps & Phillips, LLP, legal counsel to SonicWALL, Inc. In 1998,
SonicWALL, Inc. paid Wise & Shepard LLP, a law firm of which Mr.
Petruzzelli was then a partner, $88,772 in legal fees and expenses. In
June 1999, Wise & Shepard LLP merged into Manatt, Phelps & Phillips, LLP
and Mr. Petruzzelli became a partner of Manatt, Phelps & Phillips, LLP.
For the nine months ended September 30, 1999, SonicWALL, Inc. had paid
Wise & Shepard LLP and Manatt, Phelps & Phillips LLP an aggregate of
$55,894 in legal fees and expenses.
Indemnification Agreements
We have entered into indemnification agreements with some of our officers
and directors. See "Management--Director and Officer Indemnification and
Liability."
Registration Rights Agreements
Some of our shareholders are entitled to have their shares registered by us
for resale. See "Description of Capital Stock--Registration Rights."
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<PAGE>
PRINCIPAL AND SELLING SHAREHOLDERS
Principal Shareholders
The following table provides information regarding the actual beneficial
ownership of our outstanding common stock as of September 30, 1999, assuming
the conversion of all outstanding shares of our redeemable Series A convertible
preferred stock and as adjusted to reflect the sale of common stock offered by
this prospectus, for:
. each person or group that we know beneficially owns more than 5% of
our common stock;
. each of our directors;
. our chief executive officer;
. the other executive officers whose compensation exceeded $100,000 in
fiscal 1998; and
. all of our directors and executive officers as a group.
Percentage of beneficial ownership is based on 19,600,594 shares of common
stock outstanding as of September 30, 1999, together with options that are
exercisable within 60 days of September 30, 1999 for each shareholder. Under
the rules of the Securities and Exchange Commission, beneficial ownership
includes shares over which the indicated beneficial owner exercises voting
and/or investment power. Shares of common stock subject to options that are
currently exercisable or will become exercisable within 60 days are deemed
outstanding for computing the percentage ownership of the person holding the
option, but are not deemed outstanding for purposes of computing the percentage
ownership of any other person. The percentages for beneficial ownership after
offering assume that the underwriters do not exercise their over-allotment
option. Unless otherwise indicated in the footnotes below, we believe that the
persons and entities named in the table have sole voting and investment power
with respect to all shares beneficially owned, subject to applicable community
property laws. Unless otherwise indicated, the following beneficial owners can
be reached at our principal offices.
<TABLE>
<CAPTION>
Percentage of
Number of Shares Shares of Common
of Common Stock Stock Outstanding
Beneficially Owned -----------------
as of Before After
Name and Address September 30, 1999 Offering Offering
- ---------------- ------------------ -------- --------
<S> <C> <C> <C>
Sreekanth Ravi(1)........................ 5,193,286 26.5% 22.0%
Sudhakar Ravi(2)......................... 5,193,286 26.5% 22.0%
Steven R. Perricone(3)................... 248,000 1.3% 1.1%
Michael J. Sheridan...................... 300,000 1.5% 1.3%
Bay Partners SBIC II, L.P.(4)............ 2,301,400 11.7% 9.8%
Bay Sonic Investors, LLC(5).............. 2,232,364 11.4% 9.5%
Ravi Anne................................ 1,156,546 5.9% 4.9%
Bruce Wonnacott.......................... 1,111,546 5.7% 4.7%
Jerrold F. Petruzzelli(6)................ 100,000 *% * %
David Shrigley(7)........................ 84,354 *% * %
Robert M. Williams(8).................... 28,768 *% * %
All directors and executive officers as a
group (7 persons)(9).................... 15,681,458 80% 66.4%
</TABLE>
- ----------
* Less than 1%.
(1) Includes 600,000 shares transferred to a family trust.
(2) Includes 600,000 shares transferred to a family trust.
(3) Includes 248,000 shares of common stock issuable upon exercise of
immediately exercisable options.
(4) Represents 2,301,400 shares held by Bay Partners SBIC II, L.P. Robert
Williams, a director of SonicWALL, Inc. is a partner of Bay Management
Company 1997, the general partner of Bay Partners SBIC II, L.P. He shares
voting and investing power with respect to the shares held by this entity,
and disclaims beneficial ownership of shares in which he has no pecuniary
interest. The address for Bay Partners SBIC II, L.P. is 10600 N. De Anza
Boulevard, Suite 100, Cupertino, California 95014.
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<PAGE>
(5) On August 6, 1999, Sreekanth Ravi and Sudhakar Ravi sold an aggregate of
1,832,364 shares of common stock to Bay Sonic Investors, LLC, and Ravi Anne
and Bruce Wonnacott sold an aggregate of 400,000 shares of common stock to
Bay Sonic Investors, LLC. See Note (6) in Certain Transactions and Business
Relationships above. Bay Sonic Investors, LLC is an affiliate of Robert
Williams, a director of SonicWALL, Inc. Mr. Williams is a managing member
of Bay Sonic Investors and as such may be deemed to have voting control of
the shares held by Bay Sonic Investors, LLC.
(6) Includes 5,000 shares held on behalf of a minor child in an irrevocable
trust of which Mr. Petruzzelli is the sole trustee. The address for Mr.
Petruzzelli is 3030 Hansen Way, Suite 100, Palo Alto, California 94304.
(7) Includes 4,000 shares held by children residing in the same household as
Mr. Shrigley. The address for Mr. Shrigley is 471 Santa Rosa Drive, Los
Gatos, California 95032.
(8) See note (4) above. The address for Mr. Williams is 10600 N. De Anza
Boulevard, Suite 100, Cupertino, California 95014.
(9) Includes 248,000 shares of common stock issuable upon exercise of
immediately exercisable options.
Selling Shareholders
If the underwriters exercise their over-allotment option in full, the
following directors, officers and shareholders will sell the number of shares
indicated below:
<TABLE>
<CAPTION>
Percentage of
Percentage of Shares of
Beneficial Shares of Beneficial Common Stock
Ownership Common Stock Ownership Outstanding
Prior to Before Number of After After
Over-allotment Over-allotment Shares Over-allotment Over-allotment
Name Exercise Exercise Being Offered Exercise Exercise
- ---- -------------- -------------- ------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Sreekanth Ravi 5,193,286 22.0% 300,000 4,893,286 20.7%
Sudhakar Ravi 5,193,286 22.0% 300,000 4,893,286 20.7%
</TABLE>
54
<PAGE>
DESCRIPTION OF CAPITAL STOCK
We are authorized to issue up to two hundred million shares of common stock
and ten million shares of preferred stock. You should carefully read our
articles of incorporation, which are included as an exhibit to the registration
statement of which this prospectus is a part.
Common Stock
As of November 9, 1999, assuming conversion of all outstanding shares of
redeemable Series A convertible preferred stock, there were 19,675,385 shares
of common stock outstanding, held of record by approximately 36 shareholders.
Following this offering, there will be 23,675,385 shares of common stock
outstanding, assuming no exercise of the underwriters' over-allotment option
and no exercise of outstanding options. The holders of common stock are
entitled to one vote for each share held of record on all matters submitted to
a vote of shareholders. Subject to preferences of any outstanding shares of
preferred stock, the holders of common stock are entitled to receive ratably
any dividends the board of directors declares out of funds legally available
for paying dividends. If SonicWALL, Inc. is liquidated, dissolved or wound up,
the holders of common stock are entitled to share ratably in all assets
remaining after paying liabilities and liquidation preferences of any
outstanding shares of preferred stock. Holders of common stock have no
preemptive rights or rights to convert their common stock into any other
securities. There are no redemption or sinking fund provisions applicable to
the common stock. All outstanding shares of common stock are fully paid and
nonassessable, and the shares of common stock to be issued upon completion of
this offering will be fully paid and nonassessable.
Preferred Stock
At the closing of this offering, all outstanding shares of redeemable Series
A convertible preferred stock will be converted into 2,876,754 shares of common
stock. Under our articles of incorporation, the board of directors will then
have the authority, without further action by the shareholders, to issue up to
8,561,623 shares of preferred stock in one or more series and to fix the price,
rights, privileges, preferences and restrictions of that preferred stock, any
or all of which may be greater than the rights of the common stock. The board
of directors, without shareholder approval, can issue preferred stock with
voting, conversion or other rights that could adversely affect the voting power
and other rights of the holders of common stock. Preferred stock could thus be
issued quickly with terms that could decrease the amount of earnings and assets
available for distribution to common stock holders and could delay or prevent a
change of control of SonicWALL, Inc. or make removal of management more
difficult. Additionally, the issuance of preferred stock may decrease the
market price of the common stock and may adversely affect the voting and other
rights of the holders of common stock. The board of directors does not
currently intend to seek shareholder approval prior to any issuance of
preferred stock, unless required to do so by law. We have no current plans to
issue any preferred stock.
Anti-takeover Provisions
Upon completion of this offering, some provisions of our charter documents
may have the effect of delaying, deterring or preventing changes in control or
management of SonicWALL, Inc., including changes a shareholder might consider
to be favorable. This could have an adverse affect on the market price of our
common stock. These provisions include:
. authorizing the board to issue additional preferred stock;
. prohibiting cumulative voting in the election of directors;
. limiting the persons who may call special meetings of shareholders;
. prohibiting shareholder actions by written consent; and
. establishing advance notice requirements for nominations for
election to the board of directors or for proposing matters that can
be acted on by shareholders at shareholder meetings.
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<PAGE>
Preferred Stock
Our charter documents grant the board of directors broad power to establish
the rights and preferences of the authorized but unissued preferred stock.
Preferred stock could be issued with terms that delay, deter or prevent a
change of control or management.
No Cumulative Voting for Directors
Our charter documents prohibit cumulative voting for directors. This may
limit or eliminate the power of minority shareholders to influence the
composition of our board of directors.
No Shareholder Action by Written Consent
Our charter documents provide that an action requiring or permitted to be
taken at any annual or special meeting of shareholders may only be taken at a
duly called annual or special meeting of our shareholders. This provision
prevents shareholders from initiating or effecting any such action by written
consent.
Notice Requirements
Our charter documents establish advance notice procedures with regard to all
shareholder proposals to be brought before meetings of our shareholders,
including relating to the nomination of candidates for election as directors,
the removal of directors and amendments to our articles of incorporation or
bylaws. These procedures provide that notice of these proposals must be given
in writing, no later than 60 days prior to the meeting to our Secretary and
must contain information specified in our charter documents.
Stock Option Plans
Our stock option plans and stock purchase plan generally provide for
assumption of our benefit plans or substitution of equivalent options of a
successor corporation or, alternatively, at the discretion of the board of
directors, exercise of some or all of the options, including those for non-
vested shares, or acceleration of vesting of shares issued pursuant to stock
grants, upon a change of control or similar event.
These charter provisions and stock option plans may have the effect of
delaying, deterring or preventing a change of control of SonicWALL, Inc.
Registration Rights
Under the terms of a registration rights agreement, subject to exceptions,
if we propose to register any of our shares of common stock under the Act,
either for our own account or the account of any shareholder, in any public
offering, upon the completion of this offering, investors holding an aggregate
of 5,178,154 shares of our common stock will be entitled to notice of such
registration and will be entitled to include those registrable securities in a
registration under the Act.
In addition, upon completion of this offering, investors holding an
aggregate of 2,876,754 shares of our common stock will be entitled to
additional rights under this registration rights agreement as follows: the
holder or holders of an aggregate of at least 50% of the then outstanding
registrable securities shall have the right to require us to file a
registration statement on a form, other than Form S-3 under the Act, in order
to register the registrable securities then held by such holder or holders,
provided that:
. at least six months has passed since our initial public offering of
shares of common stock under a registration statement;
. the anticipated aggregate offering price to the public is at least
$2,000,000; and
. we shall not be required to file more than two such registration
statements.
56
<PAGE>
Further, a holder or holders of at least 20% of the then outstanding
registrable securities may require us to use our best efforts to file
additional registration statements on Form S-3, provided that:
. the anticipated aggregate offering price to the public is at least
$500,000; and
. we shall not be required to file more than one such registration
statement in any twelve-month period.
The right to include any of the above described registrable securities in
any registration is subject to limitations and conditions, including the
underwriters' right to limit the number of shares being registered by all
holders. We are required to indemnify holders of registrable securities and the
underwriters, if any, for these holders under described circumstances. In
general, we are required to bear the expenses of registrations, except for the
selling shareholders' pro rata portion of the underwriting discounts and
commissions.
Transfer Agent and Registrar
The transfer agent and registrar for the common stock is BankBoston, N.A.
Nasdaq National Market Listing
Our common stock symbol on the Nasdaq National Market is SNWL.
57
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Future sales of substantial amounts of shares of our common stock in the
public market could adversely affect prevailing market prices. Furthermore,
since only a limited number of shares will be available for sale shortly after
this offering because of contractual and legal restrictions on resale, as
described below, sales of substantial amounts of common stock in the public
market after the restrictions lapse could adversely affect the prevailing
market price.
After this offering, 23,675,385 shares of common stock will be outstanding,
assuming the conversion on a 2 for 1 basis of all outstanding shares of our
redeemable Series A convertible preferred stock and the issuance of an
aggregate of 4,000,000 shares of common stock. The number of shares outstanding
after this offering is based on the number of shares outstanding as of November
9, 1999, and assumes no exercise of outstanding options. The 4,000,000 shares
sold in this offering will be freely tradable without restriction under the
Act. The remaining 19,675,385 shares of common stock outstanding upon
completion of the offering are restricted securities in that they may be sold
in the public market only if registered or if they qualify for an exemption
from registration under the Act or Rules 144, 144(k) or 701 of the Act.
Subsequent to September 30, 1999, options to purchase an aggregate of 74,791
shares of common stock were exercised. In addition, all outstanding shares are
subject to lock-up agreements either directly with SonicWALL, Inc. or as
described below.
As of November 9, 1999, all of the officers and directors, who held an
aggregate of 15,681,458 shares of common stock, and shareholders of SonicWALL,
Inc. holding an aggregate of 3,993,927 shares of common stock have entered into
lock-up agreements providing that they will not offer, sell, contract to sell,
grant any option to purchase, pledge or otherwise dispose of, or, in any
manner, transfer all or a portion of the economic consequences associated with
the ownership of any shares of common stock or any securities convertible into
or exercisable or exchangeable for common stock beneficially owned by them
during the 180 day period following the date of this prospectus without the
prior written consent of Bear, Stearns & Co. Inc. Transfers may be made
earlier:
. as a bona fide gift or gifts, provided the donee or donees agree in
writing to be bound by this restriction;
. as a transfer to members of the undersigned's immediate family or to
trusts for the benefit of members of the undersigned's immediate
family, provided that the transferees agree in writing to be bound
by the terms of this restriction;
. as a distribution to partners, shareholders or beneficiaries of the
transferor, provided that the distributees agree in writing to be
bound by the terms of this restriction;
. with respect to dispositions of common stock acquired on the open
market;
. with respect to sales or purchases of common stock acquired on the
open market; or
. with the prior written consent of Bear, Stearns & Co. Inc.
Bear, Stearns & Co. Inc. may, in its sole discretion and at any time without
notice, release all or any portion of the securities subject to lock-up
agreements. When determining whether or not to release shares from the lock-up
agreements, Bear, Stearns & Co. Inc. will consider, among other factors, the
shareholder's reasons for requesting the release, the number of shares for
which the release is being requested and market conditions at the time.
Following the expiration of the 180 day lock-up period, additional shares of
common stock will be available for sale in the public market subject to
compliance with Rule 144 or Rule 701.
In general, under Rule 144 as currently in effect, an affiliate of
SonicWALL, Inc. or a person, or persons whose shares are aggregated, who has
beneficially owned restricted securities for at least one year, including the
holding period of any prior owner except an affiliate, would be entitled to
sell within any three-month period a number of shares that does not exceed the
greater of 1% of the then outstanding shares of SonicWALL, Inc. common stock or
the average weekly trading volume of SonicWALL, Inc. common stock on the Nasdaq
National Market during the four calendar weeks preceding such sale. Sales under
Rule 144 are also
58
<PAGE>
subject to manner of sale provisions, notice requirements and the availability
of current public information about SonicWALL, Inc. Any person, or persons
whose shares are aggregated, who is not deemed to have been an affiliate of
SonicWALL, Inc. at any time during the 90 days preceding a sale, and who has
beneficially owned shares for at least two years including any period of
ownership of preceding non-affiliated holders, would be entitled to sell such
shares under Rule 144(k) without regard to the volume limitations, manner of
sale provisions, public information requirements or notice requirements.
After the effective date of this offering, we intend to file a registration
statement on Form S-8 to register up to approximately 7,358,324 shares of
common stock reserved for issuance under our stock option plans and our
employee stock purchase plan. That registration statement will become effective
automatically upon filing. After the filing of a registration statement on Form
S-8, shares issued under our stock option plans and our employee stock purchase
plan may be sold in the open market. Some holders, however, will be subject to
the Rule 144 limitations applicable to affiliates, the lock-up agreements and
vesting restrictions imposed by us.
In addition, following this offering, the holders of an aggregate of
2,876,754 shares of outstanding common stock will have rights to require us to
register their shares for future sale. Subject to limited exceptions, these
holders and holders of approximately 2,301,400 shares of common stock have the
right to participate in any registration we undertake on our own (including an
exception for a registration of shares in connection with an employee benefit
plan or merger).
59
<PAGE>
UNDERWRITING
Subject to the terms and conditions of an underwriting agreement between us
and the underwriters named below, who are represented by Bear, Stearns & Co.
Inc., Hambrecht & Quist LLC and Thomas Weisel Partners LLC, the underwriters
have severally agreed to purchase from us the following respective number of
shares of common stock less the underwriting discounts and commissions set
forth on the cover page of this prospectus.
<TABLE>
<CAPTION>
Number of
Underwriter Shares
----------- ---------
<S> <C>
Bear, Stearns & Co. Inc. .......................................... 1,396,800
Hambrecht & Quist LLC.............................................. 853,600
Thomas Weisel Partners LLC......................................... 853,600
Banc of America Securities LLC..................................... 64,000
BancBoston Robertson Stephens Inc. ................................ 64,000
CIBC World Markets Corp. .......................................... 64,000
Credit Suisse First Boston Corporation............................. 64,000
A.G. Edwards & Sons, Inc. ......................................... 64,000
SG Cowen Securities Corporation.................................... 64,000
SoundView Technology Group, Inc. .................................. 64,000
Cantor, Weiss & Friedner, Inc. .................................... 32,000
First Albany Corporation........................................... 32,000
Gerard Klauer Mattison & Co., LLC.................................. 32,000
Jefferies & Company................................................ 32,000
Josephthal & Co. Inc. ............................................. 32,000
Leerink Swann & Company............................................ 32,000
Needham & Company, Inc. ........................................... 32,000
Northeast Securities, Inc. ........................................ 32,000
Pacific Growth Equities, Inc. ..................................... 32,000
Raymond James & Associates, Inc. .................................. 32,000
Sands Brothers & Co., Ltd. ........................................ 32,000
Suntrust Equitable Securities Corporation.......................... 32,000
Tucker Anthony Incorporated........................................ 32,000
Wit Capital Corporation............................................ 32,000
---------
Total............................................................ 4,000,000
=========
</TABLE>
The underwriting agreement provides that the underwriters are obligated to
purchase all of the shares of common stock, other than shares of common stock
covered by the over-allotment option described below, if they purchase any of
the shares. Those obligations are subject, however, to various conditions,
including the approval of legal matters by their counsel.
We and the selling shareholders have agreed to indemnify the underwriters
against various liabilities, including liabilities under the Act, and, where
such indemnification is unavailable, to contribute to payments that the
underwriters may be required to make in respect of such liabilities.
The underwriters propose to offer the shares of common stock directly to the
public initially at the public offering price set forth on the cover page of
this prospectus and to selected dealers at such price less a concession not to
exceed $0.59 per share. The underwriters may allow, and such selected dealers
may reallow, a concession not to exceed $0.10 per share and that after the
commencement of this offering, the public offering price and the concessions
may be changed.
The selling shareholders have granted to the underwriters an option to
purchase in the aggregate up to 600,000 additional shares to be sold in this
offering at the public offering price less the underwriting discount
60
<PAGE>
set forth on the cover page of this prospectus. The underwriters may exercise
this option solely to cover over-allotments, if any. The option may be
exercised in whole or in part at any time within 30 days after the date of this
prospectus. To the extent the option is exercised, the underwriters will be
severally committed, subject to several conditions, including the approval of
legal matters by their counsel, to purchase the additional shares of common
stock in proportion to their respective purchase commitments as indicated in
the preceding table.
The underwriting fee is equal to the public offering price per share of
common stock less the amount paid by the underwriters to us per share of common
stock. The following table shows the underwriters' discounts to be paid to the
underwriters by us and the selling shareholders. Such amounts are shown
assuming both no exercise and full exercise of the underwriters' option to
purchase additional shares.
<TABLE>
<CAPTION>
Per Share Total
------------------- ---------------------
Without With Without
Over- Over- Over- With Over-
Allotment Allotment Allotment Allotment
--------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Underwriting discounts and
commissions payable by us.......... $0.98 $0.98 $3,920,000 $3,920,000
Underwriting discounts and
commissions payable by the selling
shareholders....................... $ -- $0.98 $ -- $ 588,000
</TABLE>
We estimate that the total expenses of the offering, excluding underwriting
discounts and commissions, will be approximately $1,200,000. The offering of
the shares is made for delivery, when, as and if accepted by the underwriters
and subject to prior sale and to withdrawal, cancellation or modification of
the offering without notice. The underwriters reserve the right to reject an
order for the purchase of shares in whole or in part.
At our request, the underwriters have reserved for sale at the initial
public offering price up to 5% of the number of shares of common stock to be
sold in this offering to persons associated with us, such as associates of some
of our employees and selected employees of companies with which we are
developing or have commercial relationships. The number of shares available for
sale to the general public will be reduced to the extent any reserved shares
are purchased. Any reserved shares not so purchased will be offered by the
underwriters on the same basis as the other shares offered hereby and will not
be subject to resale restrictions.
We and our executive officers, directors and our current shareholders, who
own in the aggregate 19,675,385 shares of common stock, have agreed not to,
directly or indirectly, offer, sell, contract to sell, grant any option to
purchase, pledge or otherwise dispose of, or, in any manner, transfer all or a
portion of the economic consequences associated with the ownership of any
shares of common stock or any securities convertible into or exercisable or
exchangeable for common stock beneficially owned during the 180-day period
following the date of this prospectus, subject to limited exceptions, without
the prior written consent of Bear, Stearns & Co., Inc.
Prior to this offering, there has been no public market for the common
stock. Consequently, the initial public offering price has been determined
through negotiations among us and the representatives of the underwriters. The
primary factors considered in determining the public offering price were:
. our financial and operating history and condition;
. market valuations of other companies engaged in activities similar
to ours;
. our prospects and prospects for the industry in which we do
business in general;
. our management;
. prevailing equity market conditions; and
. the demand for securities considered comparable to ours.
In order to facilitate this offering, the underwriters may engage in
transactions that stabilize, maintain or otherwise affect the price of the
common stock during and after this offering. Specifically, the underwriters may
61
<PAGE>
over-allot or otherwise create a short position in the common stock for their
own account by selling more shares of common stock than have been sold to them
by us. The underwriters may elect to cover any such short position by
purchasing shares of common stock in the open market or by exercising the over-
allotment option granted to them. In addition, the underwriters may stabilize
or maintain the price of the common stock by bidding for or purchasing shares
of common stock in the open market and may impose penalty bids, under which
selling concessions allowed to syndicate members or other broker-dealers
participating in this offering are reclaimed if shares of common stock
previously distributed in this offering are repurchased in connection with
stabilization transactions or otherwise. The effect of these transactions may
be to stabilize or maintain the market price of the common stock at a level
above that which might otherwise prevail in the open market. The imposition of
a penalty bid may also affect the price of the common stock to the extent that
it discourages resales of the common stock. No representation is made as to the
magnitude or effect of any such stabilization or other transactions. Such
transactions may be effected on the Nasdaq National Market or otherwise and, if
commenced, may be discontinued at any time.
Thomas Weisel Partners LLC, one of the representatives of the underwriters,
was organized and registered as a broker-dealer in December 1998. Since
December 1998, Thomas Weisel Partners has been named as a lead or co-manager on
85 filed public offerings of equity securities, of which 58 have been
completed, and has acted as a syndicate member in an additional 41 public
offerings of equity securities. Thomas Weisel Partners does not have any
material relationship with us or any of our officers, directors or other
controlling persons, except with respect to its contractual relationship with
us pursuant to the underwriting agreement entered into in connection with this
offering.
LEGAL MATTERS
The validity of the common stock offered in this offering will be passed
upon for us by Manatt, Phelps & Phillips, LLP of Palo Alto, California. Jerrold
F. Petruzzelli, a partner of Manatt, Phelps & Phillips, LLP, is a director of
SonicWALL, Inc. and owns or has voting control over 100,000 shares of
SonicWALL, Inc. common stock. Legal matters in connection with the offering
will be passed upon for the underwriters by Latham & Watkins, San Francisco,
California.
EXPERTS
The consolidated financial statements as of December 31, 1997 and 1998 and
for each of the three years in the period ended December 31, 1998, included in
this Prospectus and the financial statement schedule included in the
Registration Statement have been so included in reliance on
PricewaterhouseCoopers LLP, independent accountants, given on the authority of
said firm as experts in auditing and accounting.
62
<PAGE>
WHERE YOU CAN FIND MORE INFORMATION
We have filed a registration statement on Form S-1 with the Securities and
Exchange Commission. This prospectus, which is part of the registration
statement, does not contain all the information included in the registration
statement. Because some information is omitted, you should refer to the
registration statement and its exhibits. For example, the descriptions in the
prospectus regarding the contents of any contract or other document are not
necessarily complete, and in each instance, reference is made to the copy of
such contract or other document filed as an exhibit to the registration
statement, each such statement being qualified in all respects by such
reference. For copies of actual contracts or documents referred to in this
prospectus, you should refer to the exhibits attached to the registration
statement. You may review a copy of the registration statement, including the
attached exhibits and schedule, at the SEC's public reference facilities in
Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and
at the regional offices of the SEC at 7 World Trade Center, Suite 1300, New
York, New York 10048, and Citicorp Center, 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661. You may also obtain copies of these materials from the
Public Reference Room of the SEC, Room 1024, Judiciary Plaza, 450 Fifth Street,
N.W., Washington, D.C. 20549, at prescribed rates. You may obtain information
on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-
0330. The SEC maintains a Web site at http://www.sec.gov that contains reports,
proxy and information statements and other information regarding registrants,
such as SonicWALL, Inc., that file electronically with the SEC.
63
<PAGE>
SONICWALL, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Accountants.......................................... F-2
Consolidated Balance Sheets................................................ F-3
Consolidated Statements of Operations...................................... F-4
Consolidated Statements of Shareholders' Equity ........................... F-5
Consolidated Statements of Cash Flows...................................... F-6
Notes to Consolidated Financial Statements................................. F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
SonicWALL, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of shareholders' equity and of cash
flows present fairly, in all material respects, the financial position of
SonicWALL, Inc. and its subsidiary at December 31, 1997 and 1998, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1998, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
San Jose, California
August 25, 1999, except for
Note 10 which is as of
October 8, 1999
F-2
<PAGE>
SONICWALL, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
<TABLE>
<CAPTION>
Pro Forma
Shareholders'
December 31, Equity
-------------- September 30, September 30,
1997 1998 1999 1999
------ ------- ------------- -------------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents........ $ 787 $ 1,051 $ 8,766
Accounts receivable, net of
allowance for doubtful accounts
of $121, $193, and $398......... 564 677 2,043
Inventories...................... 351 331 506
Deferred income taxes............ 277 366 1,556
Prepaid expenses and other
current assets.................. 301 31 381
------ ------- -------
Total current assets............ 2,280 2,456 13,252
Property and equipment, net........ 55 107 247
Intangibles and other assets....... 39 2,188 1,608
------ ------- -------
Total assets.................. $2,374 $ 4,751 $15,107
====== ======= =======
LIABILITIES, REDEEMABLE PREFERRED
STOCK AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable................. $ 663 $ 549 $ 946
Accrued payroll and related
benefits........................ 157 145 850
Other accrued liabilities ....... 310 748 1,806
Deferred revenue................. 684 1,512 2,980
Income taxes payable............. 95 309 386
------ ------- -------
Total current liabilities....... 1,909 3,263 6,968
------ ------- -------
Redeemable Series A convertible
preferred stock, no par value;
redemption and liquidation value
of $5,000, 1,438,377 shares issued
and outstanding................... -- -- 4,971 --
Commitments and contingencies (Note
9)................................
Shareholders' Equity:
Preferred stock, no par value;
10,000,000 shares authorized.... -- -- -- --
Common stock, no par value;
200,000,000 shares authorized;
8,461,100, 16,272,164 and
16,723,840 shares issued and
outstanding..................... 12 2,732 7,494 12,465
Deferred stock compensation...... -- (6) (3,029) (3,029)
Notes receivable from
shareholders.................... -- (230) (300) (300)
Retained earnings (accumulated
deficit)........................ 453 (1,008) (997) (997)
------ ------- ------- -------
Total shareholders' equity...... 465 1,488 3,168 $ 8,139
------ ------- ------- -------
Total liabilities, redeemable
preferred stock and
shareholders' equity......... $2,374 $ 4,751 $15,107
====== ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE>
SONICWALL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
<TABLE>
<CAPTION>
Nine Months
Year Ended Ended September
December 31, 30,
----------------------- ----------------
1996 1997 1998 1998 1999
------ ------ ------- ------- -------
(unaudited)
<S> <C> <C> <C> <C> <C>
Revenue
Internet security................ $ -- $ 250 $ 2,349 $ 924 $10,677
Ethernet......................... 9,356 9,092 5,166 4,456 1,474
------ ------ ------- ------- -------
Total revenue.................. 9,356 9,342 7,515 5,380 12,151
------ ------ ------- ------- -------
Cost of revenue
Internet security................ -- 225 1,035 646 2,829
Ethernet......................... 5,915 4,617 2,273 1,839 633
------ ------ ------- ------- -------
Total cost of revenue.......... 5,915 4,842 3,308 2,485 3,462
------ ------ ------- ------- -------
Gross margin....................... 3,441 4,500 4,207 2,895 8,689
Operating expenses
Research and development......... 1,048 1,983 2,051 1,417 2,198
Sales and marketing.............. 1,665 2,468 2,870 2,082 3,408
General and administrative....... 432 644 753 541 1,189
Deferred stock compensation...... -- -- 42 -- 1,301
------ ------ ------- ------- -------
Total operating expenses....... 3,145 5,095 5,716 4,040 8,096
------ ------ ------- ------- -------
Income (loss) from operations...... 296 (595) (1,509) (1,145) 593
Other income (expense), net........ 22 29 54 36 205
------ ------ ------- ------- -------
Income (loss) before income taxes.. 318 (566) (1,455) (1,109) 798
Benefit from (provision for) income
taxes............................. (350) 99 (6) -- (787)
------ ------ ------- ------- -------
Net income (loss).................. $ (32) $ (467) $(1,461) $(1,109) $ 11
====== ====== ======= ======= =======
Net income (loss) per share
Basic............................ $ -- $(0.06) $ (0.13) $ (0.11) $ --
====== ====== ======= ======= =======
Diluted.......................... $ -- $(0.06) $ (0.13) $ (0.11) $ --
====== ====== ======= ======= =======
Shares used in computing net income
(loss) per share
Basic............................ 8,460 8,461 11,251 10,290 16,367
====== ====== ======= ======= =======
Diluted.......................... 8,460 8,461 11,251 10,290 19,421
====== ====== ======= ======= =======
Pro forma net income per share
Basic............................ $ --
=======
Diluted.......................... $ --
=======
Shares used in computing pro forma
net income per share
Basic............................ 18,727
=======
Diluted.......................... 19,421
=======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE>
SONICWALL, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(In thousands, except share data)
<TABLE>
<CAPTION>
Notes Retained
Common Stock Deferred Receivable Earnings Total
------------------ Stock From (Accumulated Shareholders'
Shares Amount Compensation Shareholders Deficit) Equity
---------- ------ ------------ ------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1995................... 9,386,004 $ 81 $ -- $ (70) $ 952 $ 963
Repurchase of common
stock.................. (934,880) (70) -- 70 -- --
Issuance of common
stock.................. 9,976 1 -- -- -- 1
Net loss................ -- -- -- -- (32) (32)
---------- ------ ------- ----- ------- -------
Balance at December 31,
1996................... 8,461,100 12 -- -- 920 932
Net loss................ -- -- -- -- (467) (467)
---------- ------ ------- ----- ------- -------
Balance at December 31,
1997................... 8,461,100 12 -- -- 453 465
Issuance of common
stock.................. 2,384,880 230 -- (230) -- --
Issuance of common stock
for acquisition........ 5,426,184 2,442 -- -- -- 2,442
Deferred stock
compensation........... -- 48 (48) -- -- --
Amortization of deferred
stock compensation..... -- -- 42 -- -- 42
Net loss................ -- -- -- -- (1,461) (1,461)
---------- ------ ------- ----- ------- -------
Balance at December 31,
1998................... 16,272,164 2,732 (6) (230) (1,008) 1,488
Issuance of common
stock.................. 451,676 438 -- (300) -- 138
Payments of notes
receivable from
shareholders........... -- -- -- 230 -- 230
Deferred stock
compensation........... -- 4,324 (4,324) -- -- --
Amortization of deferred
stock compensation..... -- -- 1,301 -- -- 1,301
Net income.............. -- -- -- -- 11 11
---------- ------ ------- ----- ------- -------
Balance at September 30,
1999 (unaudited)....... 16,723,840 $7,494 $(3,029) $(300) $ (997) $ 3,168
========== ====== ======= ===== ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE>
SONICWALL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Nine Months
Year Ended Ended
December 31, September 30,
----------------------- ----------------
1996 1997 1998 1998 1999
------ ------ ------- ------- -------
(unaudited)
<S> <C> <C> <C> <C> <C>
Cash flows from operating
activities:
Net income (loss)................. $ (32) $ (467) $(1,461) $(1,109) $ 11
Adjustments to reconcile net
income (loss) to net cash
provided by (used in) operating
activities:
Depreciation and amortization.... 78 63 413 203 669
Liabilities acquired............. -- -- (75) (75) --
Provision for allowance for
doubtful accounts............... -- 52 122 53 216
Amortization of deferred stock
compensation.................... -- -- 42 -- 1,301
Changes in operating assets and
liabilities:
Accounts receivable............ 488 (252) (235) (456) (1,582)
Inventories.................... (206) 1,031 20 81 (175)
Prepaid expenses and other
current assets................ (31) (235) 270 224 (350)
Deferred income taxes.......... (73) 38 (89) 115 (1,190)
Other assets................... -- (19) 18 19 (49)
Accounts payable............... (407) (150) (114) (195) 397
Accrued payroll and related
benefits...................... -- 107 (12) 120 705
Other accrued liabilities...... 69 (43) 438 856 1,058
Deferred revenue............... 1,046 (362) 828 888 1,468
Income taxes payable........... 43 (158) 214 4 77
------ ------ ------- ------- -------
Net cash provided by (used in)
operating activities............... 975 (395) 379 728 2,556
------ ------ ------- ------- -------
Cash flows from investing
activities:
Purchase of property and
equipment........................ (10) (11) (115) (35) (180)
------ ------ ------- ------- -------
Cash flows from financing
activities:
Proceeds from exercise of stock
options.......................... 1 -- -- -- 138
Proceeds from issuance of
redeemable Series A convertible
preferred stock.................. -- -- -- -- 4,971
Payments of notes receivable from
shareholders..................... (25) 157 -- -- 230
Payments under line of credit
agreement........................ (50) -- -- -- --
------ ------ ------- ------- -------
Net cash provided by (used in)
financing activities............... (74) 157 -- -- 5,339
------ ------ ------- ------- -------
Net increase (decrease) in cash and
cash equivalents................... 891 (249) 264 693 7,715
Cash and cash equivalents at
beginning of period................ 145 1,036 787 787 1,051
------ ------ ------- ------- -------
Cash and cash equivalents at end of
period............................. $1,036 $ 787 $ 1,051 $ 1,480 $ 8,766
====== ====== ======= ======= =======
Supplemental disclosure of cash flow
information:
Cash paid for income taxes........ $ 380 $ 151 $ 1 $ -- $ 1,900
====== ====== ======= ======= =======
Supplemental disclosure of noncash
investing and financing activities:
Issuance of notes receivable upon
the exercise of stock options.... $ -- $ -- $ 230 $ -- $ 300
====== ====== ======= ======= =======
Acquisition of minority interest in
AckFin Networks.................... $ -- $ -- $ 2,517 $ 2,517 $ --
====== ====== ======= ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE>
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1--The Company and Summary of Significant Accounting Policies:
SonicWALL, Inc. (the "Company") was incorporated in California in February
1991. SonicWALL, Inc. is a leading provider of Internet security solutions
designed for broadband access customers in the small to medium enterprise, or
SME, branch office, telecommuter and education markets. The Company's SonicWALL
solution is a high-performance, solid state appliance that provides robust,
reliable, easy-to-use and affordable Internet security. The Company's products
enable its customers to securely utilize Internet applications and services as
an integral part of their business.
The following is a summary of the Company's significant accounting policies:
Consolidation
The consolidated financial statements include those of the Company and its
wholly-owned subsidiary Sonic Systems International, Inc., a Delaware
corporation. Sonic Systems International, Inc. is intended to be a sales office
but to date has not had any significant transactions. All significant
intercompany accounts and transactions are eliminated in consolidation.
In August 1998, the Company acquired all the partnership interest of AckFin
Networks ("AckFin"), a California general partnership, in exchange for an
aggregate of 5,426,184 shares of the Company's common stock (estimated value of
$0.90 per share, or $4,883,000) and the assumption of $150,000 in liabilities.
The controlling partners of AckFin, Sreekanth Ravi and Sudhakar Ravi, two of
the Company's executive officers and majority shareholders, were deemed to be a
control group for purposes of determining the amount of purchase price to be
"stepped-up." The value of the exchanged shares for AckFin was accounted for as
a reorganization of entities under common control. Accordingly, net assets
acquired were valued by applying carryover basis to the control group interest
and a stepped-up basis to the minority interest. The step-up of the minority
interest resulted in an intangible asset of $2,517,000. This intangible asset
was attributed to acquired completed technology and will be amortized over a
period of three years. The intangible assets acquired by the Company were
rights to the completed core technology developed by AckFin that provides the
foundation for our Internet products. Since this transaction occurred between
entities that were under common control, since the inception of AckFin, the
financial results of AckFin have been combined with the results of the Company
for the period since the inception of AckFin (April 1997) through the date of
exchange (August 1998). Expenses totalling $150,000 and $775,000 for the years
ended December 31, 1997 and 1998, respectively, were included in the
accompanying statements of operations. AckFin did not have any revenue
transactions with unrelated third parties. Except for the expenses noted above,
all other financial transactions for AckFin were eliminated upon combination
with the Company.
Use of estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the
reporting period. Actual results could differ from those estimates.
Unaudited interim results
The accompanying interim financial statements as of September 30, 1999 and
for the nine months ended September 30, 1998 and 1999 are unaudited. In the
opinion of management, these unaudited interim statements have been prepared on
the same basis as the audited financial statements and include all adjustments,
consisting only of normal recurring adjustments, necessary for the fair
statement of the results of these periods. The financial data and other
information disclosed in the notes to the financial statements for these
periods is unaudited.
F-7
<PAGE>
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Cash and cash equivalents
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents.
Fair value
The carrying value of the Company's financial instruments, including cash
and cash equivalents, accounts receivable, accounts payable and accrued
liabilities approximate their fair values due to their relatively short
maturities. The Company does not hold or issue financial instruments for
trading purposes.
Concentration of credit risk, foreign operations and significant customers
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of cash and cash equivalents
and accounts receivable. The Company places its temporary cash
investments in money market accounts and mutual funds with high credit quality
financial institutions. The Company's accounts receivable are derived from
revenue earned from customers located in the U.S. and certain foreign
countries and regions, including Europe, Canada, Japan and Australia. Sales to
foreign customers for the year ended December 31, 1996, 1997, 1998 and the
nine months ended September 30, 1999, all of which were denominated in U.S.
dollars, accounted for 40%, 36%, 32% and 33% of total revenue, respectively.
The Company performs ongoing credit evaluations of its customers' financial
condition and requires no collateral from its customers. The Company maintains
an allowance for doubtful accounts receivable based upon the expected
collectibility of accounts receivable.
During the year ended December 31, 1998, one customer accounted for 34% of
the Company's revenue and at December 31, 1998, this one customer accounted
for 39% of total gross receivables. During the nine months ended September 30,
1999, three customers accounted for 57% of the Company's revenue and at
September 30, 1999, and two customers accounted for 80% of total gross
receivables.
The Company is dependent on third party contract manufacturers and some of
the key components in the Company's product come from single or limited
sources of supply.
Inventories
Inventories are stated at the lower of cost or market with cost being
determined on a first-in, first-out basis.
Property and equipment
Property and equipment are stated at cost. Depreciation is computed using
the straight-line method over their estimated useful lives, which range from
three to seven years. Depreciation expense for the years ended December 31,
1996, 1997 and 1998 was $78,000, $63,000 and $55,000, respectively.
Depreciation expense for the nine months ended September 30, 1999 was $40,000.
Intangibles and other assets
Acquired technology is amortized to expense on a straight line basis over
three years.
Long-lived assets
The Company periodically evaluates the recoverability of its long-lived
assets based on expected undiscounted cash flows and recognizes impairment
from the carrying value of long-lived assets, if any, based on the fair value
of such assets.
F-8
<PAGE>
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Stock-based compensation
The Company accounts for stock-based employee compensation arrangements in
accordance with the provisions of Accounting Principles Board Opinion ("APB")
No. 25, "Accounting for Stock Issued to Employees," and complies with the
disclosure provisions of Statement of Financial Accounting Standards ("SFAS")
No. 123, "Accounting for Stock-Based Compensation." Under APB No. 25 ,
compensation costs is determined based on the difference, if any, on the grant
date between the fair value of the Company's stock and the amount an employee
must pay to acquire the stock. Compensation expense is recognized over the
vesting period.
The Company accounts for equity instruments issued to non-employees in
accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force
96-18.
Revenue recognition
Revenue is generally recognized at the time of shipment if collectibility is
probable and no significant obligations remain. Sales to distributors are
subject to agreements allowing certain rights of return, cooperative
advertising, stock balancing rights and price protection. The largest
distributor has the right to return products that have not been sold to end
users for full credit subject to a restocking fee. Revenue from sales to this
distributor is deferred at the time of shipment and is recognized when the
distributor has sold the product to its customers. Certain other distributors
have limited rights of return which allow them to return a percentage of the
prior quarter's purchases by these distributors. Accordingly, reserves for
estimated returns and exchanges are provided at the time of shipment. These
reserves are estimated and adjusted periodically based upon historical rates of
returns and allowances, inventory levels at the distributors and other related
factors. Reserves for credits for price protection are provided at the time
list prices are reduced by the Company. In the years ended December 31, 1996,
1997 and 1998 and the nine months ended September 30, 1999, the Company
provided approximately $100,000, $300,000, $400,000 and $900,000, respectively,
of revenue reserves related to risks of product returns, stock rotation rights
and price protection rights. As of December 31, 1997 and 1998 and September 30,
1999, deferred revenues included approximately $400,000, $800,000 and $1.7
million, respectively, related to these reserves.
Revenue from extended warranty programs, premium technical assistance, and
subscriptions to content filtering services is recognized ratably over the term
of the contract or subscription.
The standard warranty provisions include technical assistance, insignificant
bug fixes and feature updates and repair or replacement guarantees for units
with product defects. The standard warranty period is one year. The estimated
costs associated with the standard warranty provisions are accrued at the time
of revenue recognition. In the years ended December 31, 1996, 1997 and 1998 and
the nine months ended September 30, 1999, the Company provided approximately
$25,000, $25,000, $100,000 and $220,000 of warranty reserves, respectively. As
of December 31, 1997 and 1998 and September 30, 1999, the accompanying balance
sheets include a warranty accrual of approximately $25,000, $130,000 and
$350,000, respectively.
The Company has co-operative advertising agreements with certain of its
distributors. These agreements allow the distributors to be reimbursed by the
Company for approved promotional activities. The amounts available for
reimbursement are related to a percentage of the distributor's eligible
purchases from the Company. The Company accrues for co-operative advertising as
the related revenue is recognized. In the years ended December 31, 1996, 1997
and 1998 and the nine months ended September 30, 1999, the Company recorded
provisions for co-op advertising costs of $538,000, $664,000, $502,000 and
$364,000, respectively. As of December 31, 1997 and 1998 and September 30,
1999, the accompanying balance sheets include an accrual for co-op advertising
costs of $79,000, $125,000 and $307,000, respectively.
F-9
<PAGE>
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Income taxes
The Company accounts for income taxes under the liability method, which
requires, among other things, that deferred income taxes be provided for
temporary differences between the tax bases of the Company's assets and
liabilities and their financial statement reported amounts. In addition,
deferred tax assets are recorded for the future benefit of utilizing net
operating losses, research and development credit carryforwards and temporary
differences. A valuation allowance is provided against deferred tax assets
unless it is more likely than not that they will be realized.
Research and development and capitalized software development costs
Software development costs incurred prior to the establishment of
technological feasibility are charged to research and development expense as
incurred. Technological feasibility is established upon completion of a working
model, which is typically demonstrated by initial beta shipment. Software
development costs incurred subsequent to the time a product's technological
feasibility has been established, through the time the product is available for
general release to customers, are capitalized if material. To date, software
development costs incurred subsequent to the establishment of technological
feasibility have been immaterial and accordingly have not been capitalized.
Advertising Costs
The Company expenses advertising costs as incurred. Advertising expense
totalled $660,000, $774,000, $515,000 and $607,000 for the years ended December
31, 1996, 1997 and 1998 and the nine months ended September 30, 1999,
respectively.
Comprehensive income
Effective January 1, 1998, the Company adopted the provisions of SFAS
No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards
for reporting comprehensive income and its components in financial statements.
Comprehensive income, as defined, includes all changes in equity during a
period from non-owner sources. To date, the Company has not had any
transactions that are required to be reported in comprehensive income.
Computation of net income (loss) per share and pro forma net income (loss) per
share
The Company computes net income (loss) per share in accordance with SFAS No.
128, "Earnings per Share" and SEC Staff Accounting Bulletin No. 98 ("SAB 98").
Under the provisions of SFAS No. 128 and SAB 98, basic net income (loss) per
share is computed by dividing the net income (loss) for the period by the
weighted average number of common shares outstanding during the period.
Weighted average shares exclude shares subject to repurchase ("restricted
shares"). Diluted net income (loss) per share is computed by dividing the net
income (loss) for the period by the weighted average number of common and
common equivalent shares outstanding during the period, if dilutive. Common
equivalent shares are composed of unvested restricted shares and incremental
common shares issuable upon the exercise of stock options and upon the
conversion of Redeemable Series A Convertible Preferred Stock.
Pro forma net loss per share is computed using the weighted average number
of common shares outstanding, including the pro forma effects of the automatic
conversion of the Company's redeemable Series A convertible preferred stock
into shares of the Company's common stock effective upon the closing of the
Company's initial public offering as if such conversion occurred on January 1,
1999, or at date of original issuance, if later.
F-10
<PAGE>
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table sets forth the computation of historical and pro forma
basic and diluted net income (loss) per share for the periods indicated (in
thousands, except per share data):
<TABLE>
<CAPTION>
Nine Months
Year Ended December Ended
31, September 30,
----------------------- ----------------
Historical 1996 1997 1998 1998 1999
- ---------- ------ ------ ------- ------- -------
(unaudited)
<S> <C> <C> <C> <C> <C>
Numerator:
Net income (loss).................. $ (32) $ (467) $(1,461) $(1,109) $ 11
------ ------ ------- ------- -------
Denominator:
Weighted average common shares
outstanding....................... 8,460 8,461 11,251 10,290 16,496
Weighted average unvested common
shares subject to repurchase...... -- -- -- -- 129
------ ------ ------- ------- -------
Denominator for basic calculation.. 8,460 8,461 11,251 10,290 16,367
Common stock equivalents........... -- -- -- -- 3,054
------ ------ ------- ------- -------
Denominator for diluted
calculation....................... 8,460 8,461 11,251 10,290 19,421
Basic net income (loss) per share.... $ -- $(0.06) $ (0.13) $ (0.11) $ --
====== ====== ======= ======= =======
Diluted net income (loss) per share.. $ -- $(0.06) $ (0.13) $ (0.11) $ --
====== ====== ======= ======= =======
<CAPTION>
Pro forma
- ---------
<S> <C> <C> <C> <C> <C>
Shares used above 16,367
Pro forma adjustment to reflect
weighted effect of assumed
conversion of redeemable
convertible preferred stock....... 2,360
-------
Shares used in computing pro forma
basic net income per share........ 18,727
=======
Pro forma basic net income per
share............................. $ --
=======
Pro forma diluted.................... 19,421
=======
Pro forma diluted net income per
share............................. $ --
=======
</TABLE>
Outstanding options to purchase 2,396,880, 2,494,880 and 1,163,676 shares of
common stock at an average exercise price of $0.09, $0.10 and $0.13 per share
have not been considered in the computation of diluted net loss per share for
the years ended December 31, 1996, 1997 and 1998, respectively, as their effect
would have been anti-dilutive.
The accompanying pro forma shareholders' equity at September 30, 1999
reflects the conversion of the redeemable Series A convertible preferred stock
at September 30, 1999. Each share of redeemable Series A convertible preferred
stock is convertible into two shares of common stock. The conversion of such
preferred stock is automatic upon the completion of an initial public offering
price of at least $5.00 per share and with proceeds of at least $15,000,000.
In May 1999, the Company issued from the 1998 Plan 300,000 shares upon the
exercise of certain stock options. At September 30, 1999, 275,000 common shares
are subject to repurchase at the option of the Company for $1.00 per share.
These shares vest ratably over a 48 month period.
F-11
<PAGE>
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Note 2--Balance Sheet Components:
<TABLE>
<CAPTION>
December 31,
------------- September 30,
1997 1998 1999
----- ------ -------------
(unaudited)
(in thousands)
<S> <C> <C> <C>
Inventories:
Raw materials................................. $ 82 $ 49 $ 211
Work-in-process............................... 2 13 64
Finished goods................................ 267 269 231
----- ------ ------
$ 351 $ 331 $ 506
===== ====== ======
Property and equipment:
Equipment..................................... $ 299 $ 161 $ 337
Leasehold improvements........................ 5 5 5
Software...................................... 49 53 57
Transportation................................ 38 94 94
----- ------ ------
391 313 493
Less: accumulated depreciation................ (336) (206) (246)
----- ------ ------
$ 55 $ 107 $ 247
===== ====== ======
Intangibles and other assets:
Acquired technology........................... $ -- $2,517 $2,517
Other Assets.................................. 39 21 70
----- ------ ------
39 2,538 2,587
Less: amortization............................ (--) (350) (979)
----- ------ ------
$ 39 $2,188 $1,608
===== ====== ======
</TABLE>
Note 3--Line of Credit:
At September 30, 1999, the Company had a line-of-credit agreement with a
bank which allows the Company to borrow up to $1,000,000. Borrowings under the
line of credit bear interest at the bank's reference rate plus 1.75% (which
equaled 10% at September 30, 1999), and are secured primarily by accounts
receivable, inventories, and property and equipment. The line of credit can be
utilized at a percentage of eligible receivables, as defined in the loan
agreement. The agreement contains certain covenants requiring the Company to
maintain certain levels of profitability, minimum tangible net worth, working
capital and other financial ratios and prohibits the payment of cash or stock
dividends on common stock over the life of the agreement. This line of credit
will be in force until terminated by either party by notice of not less than 30
days prior to the effective date of such termination. No amounts were
outstanding under the line of credit at September 30, 1999.
Note 4--Redeemable Series A Convertible Preferred Stock:
In February 1999, the Company issued 1,438,377 shares of redeemable Series A
convertible preferred stock ("Preferred Stock") at $3.48 per share for net
proceeds of $4,971,000.
Conversion--Each share of Preferred Stock is convertible at the option of
the holder into two shares of common stock based on a conversion price of
$1.74. This conversion price is subject to adjustment in certain circumstances
including certain issuances of common stock at below the conversion price.
Preferred Stock will
F-12
<PAGE>
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
automatically convert into common stock in the event of an underwritten public
offering of the Company's common stock with proceeds of at least $15,000,000,
and at a price per share of not less than $5.00.
Voting--Preferred Stock has voting rights, on an as-if converted basis,
identical to common stock.
Dividends--Holders of the Preferred Stock are entitled to receive
noncumulative dividends in preference to any dividend on the common stock at
the rate of 8 percent per share per annum, when and if declared by the Board of
Directors.
Liquidation--In the event of liquidation, the holders of Preferred Stock are
entitled to receive $3.48 per share, plus any dividends declared, but unpaid on
such shares. If assets and funds are insufficient to meet the liquidation
preference of the Preferred Stock, such assets and funds will be distributed
ratably between the holders of the Preferred Stock. Any surplus assets or funds
will then be distributed ratably between holders of the Preferred Stock on an
as-converted common stock basis and the holders of the common stock together
until the holders of the Preferred Stock have received a total of $12.17 per
share. Thereafter holders of common stock share ratably all remaining assets.
Redemption--Anytime after February 17, 2004, all outstanding shares of the
Preferred Stock are eligible to be redeemed in full upon a written notice by at
least 67% of the holder's of the outstanding Preferred Stock in two
installments the first 75 days followings the notice of redemption and the
second installment one year after the first redemption. In the event of
redemption, each holder of the Preferred Stock would be entitled to receive
$3.48 per share, plus all unpaid dividends on such shares, which have been
declared.
Note 5--Shareholders' Equity:
Stock split
Share information for all periods presented has been retroactively adjusted
to reflect a 2 for 1 stock split effected on August 25, 1999.
1999 Employee Stock Purchase Plan
The 1999 Employee Stock Purchase Plan was adopted by the board of directors
in August 1999. A total of 250,000 shares of common stock have been reserved
for issuance under the plan.
The Company's Stock Option Plans (the "Plans"), as amended, authorize the
Board of Directors to grant incentive stock options and nonstatutory stock
options to employees, directors and consultants to purchase up to a total of
7,358,324 shares of the Company's common stock. Under the Plans, incentive
stock options are granted at an exercise price that is not to be less than 100%
of the fair market value of the Company's common stock on the date of grant, as
determined by the Company's Board of Directors. Nonqualified stock options are
granted at a price that is not to be less than 85% of the fair market value of
the common stock on the date of grant, as determined by the Board of Directors.
Generally, options granted under the Plans are exercisable for a period of
ten years after the date of grant, and vest over four years.
F-13
<PAGE>
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table summarizes option activity under the stock option plans:
<TABLE>
<CAPTION>
Options Outstanding
-------------------------------
Weighted
Average
Available Exercise Exercise
for Grant Shares Price Price
---------- ---------- ---------- --------
<S> <C> <C> <C> <C>
Balance at December 31, 1996... 549,612 2,396,880 $0.08-0.09 $0.09
Granted........................ (204,000) 204,000 $ 0.25 $0.25
Exercised...................... -- -- $ -- $ --
Canceled....................... 106,000 (106,000) $ 0.08 $0.08
---------- ---------- ---------- -----
Balance at December 31, 1997... 451,612 2,494,880 $0.08-0.25 $0.10
Authorized..................... 2,000,000 -- $ -- $ --
Granted........................ (1,015,000) 1,015,000 $ 0.13 $0.13
Exercised...................... -- (2,134,880) $ 0.09 $0.09
Canceled....................... 211,324 (211,324) $0.08-0.25 $0.19
---------- ---------- ---------- -----
Balance at December 31, 1998... 1,647,936 1,163,676 $0.08-0.25 $0.13
Authorized..................... 2,358,324
Granted........................ (2,884,500) 2,884,500 $0.50-8.50 $4.86
Exercised...................... -- (451,676) $0.08-1.50 $0.97
Canceled....................... 10,000 (10,000) $0.13-0.25 $0.19
---------- ---------- ---------- -----
Balance at September 30, 1999
(unaudited)................... 1,131,760 3,586,500 $0.08-8.50 $3.82
========== ==========
</TABLE>
The following table summarizes information regarding stock options
outstanding at September 30, 1999 (unaudited):
<TABLE>
<CAPTION>
Options
Options Outstanding Exercisable
------------------------------- ----------------
Weighted
Weighted Average Weighted
Average Remaining Average
Exercise Contractual Exercise
Exercise Prices Price Shares Life (Years) Shares Price
--------------- -------- --------- ------------ ------- --------
<S> <C> <C> <C> <C> <C>
$0.08-$0.25................. $0.13 1,112,000 8.55 470,868 $0.13
$0.50-$1.50................. $1.08 648,000 9.67 101,758 $1.01
$2.50-$3.50................. $3.12 419,000 9.83 -- $ --
$7.50-$8.50................. $8.21 1,407,500 9.93 4,164 $7.50
--------- -------
$3.82 3,586,500 9.44 576,790 $ .34
========= =======
</TABLE>
For financial reporting purposes, the Company has determined that the deemed
fair value on the date of grant of certain stock options granted in 1998 and
1999 was in excess of the exercise price of the options. The deemed fair value
for options granted in the nine months ended September 30, 1999 was $18,025,700
which exceeded the aggregate exercise price of these options by $4,324,000.
This difference is considered deferred stock compensation and is amortized over
the vesting periods of the applicable options and the repurchase periods for
the restricted stock.
Based upon the above assumptions, the weighted average fair value per share
of options granted in 1998 and 1999 were $0.05 and $0.96, respectively.
Pro forma stock compensation
The Company has adopted the disclosure-only provisions of SFAS No. 123.
Accordingly, no compensation cost has been recognized for the Company's stock
option plan in the accompanying statements of operations. Had compensation cost
for the Company's stock option plan been determined based on the fair
F-14
<PAGE>
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
market value at the grant dates for stock options granted in 1998 and 1997
consistent with the provisions of SFAS No. 123, the Company's net income (loss)
would have been changed to the pro forma amounts indicated below, in thousands:
<TABLE>
<CAPTION>
Year Ended December
31, Nine Months Ended
--------------------- September 30,
1996 1997 1998 1999
----- ----- ------- -----------------
(unaudited)
<S> <C> <C> <C> <C>
Net income (loss)--as reported.... $ (32) $(467) $(1,461) $ 11
Net income (loss)--pro forma...... $(189) $(471) $(1,469) (139)
</TABLE>
The pro forma amounts reflect compensation expense related to 1996, 1997,
1998 and 1999 stock option grants only. In future years, the annual
compensation expense will increase relative to the fair value of the stock
options granted in those future years. The weighted average fair value of the
options granted in 1996, 1997, 1998 and the nine months ended September 30,
1999 of $0.05, $0.13, $0.05 and $2.24, respectively.
The fair value of each grant is estimated on the date of grant using the
minimum value method with the following assumptions:
<TABLE>
<CAPTION>
1996 1997 1998 1999
------- ------- ------------ -------------
<S> <C> <C> <C> <C>
Expected volatility........... 0% 0% 0% 0%
Risk-free interest rate....... 6.0% 6.0% 4.5% to 5.64% 4.79% to 5.83%
Expected life................. 5 years 5 years 5 years 4 years
Dividend yield................ 0% 0% 0% 0%
</TABLE>
Note 6--Notes Receivable from Shareholders:
In December 1998, the Company issued notes receivable in connection with the
exercise of 2,134,880 shares of incentive stock options held by two
shareholders. The full recourse notes totaling $192,000, accrue interest at a
rate of 8% per annum. Principal and accrued interest shall be paid one-fourth
on the first anniversary date of the note, and one-fourth every year thereafter
for a total of four years.
In May 1999, the Company issued a full recourse note for $300,000 in
connection with the exercise of 300,000 shares of incentive stock options by
one shareholder. The note accrues interest at a rate of 8% per annum. Principal
and accrued interest shall be paid one-fourth on the first anniversary date of
the note, and one-fourth every year thereafter for a total of four years.
Note 7--Income Taxes:
The (benefit from) provision for income taxes consist of the following (in
thousands):
<TABLE>
<CAPTION>
Year Ended
December 31, Nine Months Ended
----------------- September 30,
1996 1997 1998 1999
---- ----- ---- -----------------
(unaudited)
<S> <C> <C> <C> <C>
Current tax expense (benefit):
Federal............................... $336 $(138) $ 94 $ 1,558
State................................. 87 1 1 419
---- ----- ---- -------
423 (137) 95 1,977
---- ----- ---- -------
Deferred tax expense (benefit):
Federal............................... (65) 32 (89) (1,078)
State................................. (8) 6 -- (112)
---- ----- ---- -------
(73) 38 (89) (1,190)
---- ----- ---- -------
$350 $ (99) $ 6 $ 787
==== ===== ==== =======
</TABLE>
F-15
<PAGE>
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following is a reconciliation of pre-tax income (loss) per the financial
statements to taxable income (loss) (in thousands):
<TABLE>
<CAPTION>
Year Ended December
31,
---------------------
1996 1997 1998
------ ----- -------
<S> <C> <C> <C>
Pre-tax income (loss) per books ..................... $ 318 $(566) $(1,455)
Differences between book and tax:
Distributor revenue deferral (net)................. 557 166 13
Changes in non-deductible reserves and accruals ... 154 (181) 672
Non-deductible deferred stock compensation......... -- -- 42
Other.............................................. -- 59 (6)
------ ----- -------
Taxable income (loss)................................ $1,029 $(522) $ (734)
====== ===== =======
</TABLE>
The tax provision for the nine months ended September 30, 1999 was
calculated based upon the Company's estimate of pre-tax income for the calendar
year ending December 31, 1999 prior to the consideration of deferred stock
compensation, which is a permanent book/tax difference. Based upon the
Company's expected level of pre-tax income it determined the estimated
effective rate for the calendar year ending December 31, 1999 to be 37.5%.
The following is the calculation of the provision for income taxes for the
nine months ended September 30, 1999 (unaudited):
<TABLE>
<S> <C>
Pre-tax income per books............................................. $ 798
Non-deductible deferred stock compensation........................... 1,301
------
Adjusted income before taxes......................................... 2,099
Estimated effective tax rate......................................... 37.5%
------
Provision for income taxes........................................... $ 787
======
</TABLE>
Deferred tax assets comprise the following (in thousands):
<TABLE>
<CAPTION>
December 31,
------------- September 30,
1997 1998 1999
------------- -------------
(unaudited)
<S> <C> <C> <C>
Inventory reserves.............................. $ 77 $ 93 $ 121
Deferred revenue................................ 10 560 361
Other reserves & accruals....................... 190 372 1,215
----- ------- ------
277 1,025 1,697
Valuation allowance............................. -- (659) (141)
----- ------- ------
$ 277 $ 366 $1,556
===== ======= ======
</TABLE>
In assessing the realizability of deferred tax assets management has
allocated, to the extent the Company does not have carryback rights, a
valuation allowance at December 31, 1997 and 1998. The ultimate realization of
deferred tax assets at September 30, 1999 is dependent upon the generation of
future taxable income during the periods in which temporary differences
representing net future deductible amounts become deductible.
F-16
<PAGE>
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Note 8--Segment Reporting
The Company adopted SFAS No. 131, "Disclosures About Segments of an
Enterprise and Related Information." SFAS No.131 requires publicly held
companies to report financial and other information about key revenue segments
of the entity for which such information is available and is utilized by the
chief operating decision maker. The Company conducts its business within one
business segment.
Revenue by geographic region is presented as follows (in thousands):
<TABLE>
<CAPTION>
Nine Months
Year Ended December Ended
31, September 30,
-------------------- --------------
1996 1997 1998 1998 1999
------ ------ ------ ------ -------
(unaudited)
<S> <C> <C> <C> <C> <C>
United States............................ $5,623 $5,986 $5,080 $3,722 $ 8,184
Other.................................... 3,733 3,356 2,435 1,658 3,967
------ ------ ------ ------ -------
Total.................................... $9,356 $9,342 $7,515 $5,380 $12,151
====== ====== ====== ====== =======
</TABLE>
Revenue to any one foreign country did not exceed 10% of total revenue in
1996, 1997 and 1998. Revenue attributed to Japan accounted for 15% of total
revenue for the nine months ended September 30, 1999.
Note 9--Commitments and Contingencies:
The Company leases its facility under an operating lease which expires in
2001. Future minimum rental payments under the lease are $234,000 in 1999 and
$202,000 in 2000. Rent expense for the years ended December 31, 1997 and 1998
was $118,000 and $163,000, respectively. Rent expense for the nine months ended
September 30, 1999 was $172,000.
The Company is involved in various threatened legal actions arising in the
ordinary course of business. Management believes that the outcome of these
actions will not have a material adverse effect on the Company's financial
position or results of operations.
Note 10--Subsequent Events
Facility Lease
In September 1999 the Company entered into a 5 year operating lease
agreement for a new location for its facility which it began occupying in
October 1999. Future minimum rental payments related to this lease for the
period ending December 31, is $131,000 in 1999, $527,000 in 2000, $547,000 in
2001, $566,000 in 2002, $585,000 in 2003 and $450,000 thereafter.
F-17
<PAGE>
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You should rely only on the information contained in this prospectus. We have
not authorized anyone to provide you with information different from that con-
tained in this prospectus. We are offering to sell, and seeking offers to buy,
shares of common stock only in jurisdictions where offers and sales are permit-
ted. The information contained in this prospectus is accurate only as of the
date of this prospectus, regardless of the time of delivery of this prospectus
or of any sale of our common stock.
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TABLE OF CONTENTS
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<TABLE>
<CAPTION>
Page
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<S> <C>
Prospectus Summary....................................................... 3
Risk Factors............................................................. 6
Cautionary Note on Forward-Looking Statements............................ 16
Use of Proceeds.......................................................... 16
Dividend Policy.......................................................... 16
Capitalization........................................................... 17
Dilution................................................................. 18
Selected Consolidated Financial Data..................................... 19
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 20
Business................................................................. 29
Management............................................................... 43
Certain Transactions and Business Relationships.......................... 51
Principal and Selling Shareholders....................................... 53
Description of Capital Stock............................................. 55
Shares Eligible for Future Sale.......................................... 58
Underwriting............................................................. 60
Legal Matters............................................................ 62
Experts.................................................................. 62
Where You Can Find More Information...................................... 63
Index to Financial Statements............................................ F-1
</TABLE>
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Until December 5, 1999 (25 days after the date of this prospectus), all dealers
effecting transactions in the common stock offered hereby, whether or not par-
ticipating in this distribution, may be required to deliver a prospectus. This
is in addition to the obligations of dealers to deliver a prospectus when act-
ing as underwriters and with respect to their unsold allotments or
subscriptions.
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4,000,000 Shares
[LOGO OF SONICWALL, INC.]
Common Stock
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PROSPECTUS
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Bear, Stearns & Co. Inc.
Hambrecht & Quist
Thomas Weisel Partners LLC
November 10, 1999
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