CACHEFLOW INC, 10-Q, 1999-12-30

CACHEFLOW INC
10-Q, 1999-12-30
COMPUTER INTEGRATED SYSTEMS DESIGN

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<PAGE>

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

------------------------

FORM 10-Q
------------------------

(MARK ONE)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED OCTOBER 31, 1999

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM ____________ TO ____________ .

COMMISSION FILE NUMBER __________

------------------------

CACHEFLOW INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

DELAWARE 91-1715963
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION)
INCORPORATION OR ORGANIZATION)

650 ALMANOR AVENUE 94086
SUNNYVALE, CALIFORNIA (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE
OFFICES)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 220-2200

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [ ] No [X]

Although the registrant has filed all reports required to be filed by Section 13
or 15(d) of the Securities Exchange Act of 1934 during the period that the
registrant was required to file such reports, the registrant did not become
subject to such filing requirements until the registration of certain shares of
its common stock pursuant to a registration statement on Form S-1 (the
"Registration Statement") was declared effective by the Securities and Exchange
Commission on November 18, 1999.

Indicate the number of shares outstanding of the issuer's class of common
stock, as of the latest practicable date.

OUTSTANDING AT
CLASS NOVEMBER 30, 1999
-----------------
Common Stock, par value $0.0001 35,882,460
<PAGE>

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I. FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements (unaudited)

Condensed Consolidated Balance Sheets as of October 31, 1999 and April
30, 1999 1

Condensed Consolidated Statements of Operations for the three and six
months ended October 31, 1999 and October 31, 1998 2

Condensed Consolidated Statements of Cash Flows for the six months
ended October 31, 1999 and October 31, 1998 3

Notes to the Condensed Consolidated Financial Statements 4 - 9

Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations 9 - 24

Item 3. Quantitative and Qualitative Disclosures About Market Risk 24

PART II. OTHER INFORMATION

Item 1. Legal Proceedings 24

Item 2. Changes in Securities and Use of Proceeds 25 - 26

Item 4. Submission of Matters to a Vote of Security Holders 26 - 27

Item 6. Exhibits and Reports on Form 8-K 27

SIGNATURES 27

</TABLE>

<PAGE>

CACHEFLOW INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)

<TABLE>
<CAPTION>
October 31, April 30,
1999 1999
----------- ---------
<S> <C> <C>
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 18,866 $ 2,291
Accounts receivable, net 2,084 1,353
Inventories 3,391 932
Prepaid expenses and other current assets 352 60
-------- --------
Total current assets 24,693 4,636
Property and equipment, net 2,578 1,351
Other assets 1,284 729
-------- --------
Total assets $ 28,555 $ 6,716
======== ========

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable $ 4,058 $ 1,464
Borrowings under line of credit 639 643
Accrued payroll and related benefits 862 420
Deferred revenue 687 367
Other accrued liabilities 518 166
Current portion of long-term obligations 1,513 789
-------- --------
Total current liabilities 8,277 3,849
Long-term obligations, less current portion 2,371 3,211
-------- --------
Total liabilities 10,648 7,060

Commitments
Stockholders' equity (deficit):
Preferred stock 1 1
Common stock 1 1
Additional paid-in capital 105,298 30,877
Advance for preferred stock issuance 3,090 -
Notes receivable from stockholders (3,549) (1,004)
Deferred stock compensation (39,634) (10,067)
Accumulated deficit (47,300) (20,152)
-------- --------
Total stockholders' equity (deficit) 17,907 (344)
-------- --------
Total liabilities and stockholders' equity (deficit) $ 28,555 $ 6,716
======== ========
</TABLE>

See notes to condensed consolidated financial statements.

1
<PAGE>

CACHEFLOW INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited, in thousands, except per share amounts)

<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
October 31, October 31,
------------------ ------------------
1999 1998 1999 1998
-------- ------- -------- -------
<S> <C> <C> <C> <C>
Net sales $ 4,838 $ 1,082 $ 8,450 $ 1,891
Cost of goods sold 1,886 652 3,266 1,250
-------- ------- -------- -------
Gross profit 2,952 430 5,184 641
Operating expenses:
Research and development 2,298 958 3,911 1,713
Sales and marketing 5,093 1,719 8,574 3,054
General and administrative 829 685 1,496 960
Stock compensation 15,243 587 18,235 806
-------- ------- -------- -------
Total operating expenses 23,463 3,949 32,216 6,533
-------- ------- -------- -------
Operating loss (20,511) (3,519) (27,032) (5,892)
Interest (expense) income, net (80) 33 (116) 104
-------- ------- -------- -------
Net loss $(20,591) $(3,486) $(27,148) $(5,788)
======== ======= ======== =======
Basic and diluted net loss per common share $ (2.35) $ (0.62) $ (3.19) $ (1.10)
======== ======= ======== =======
Shares used in computing basic and diluted
net loss per common share 8,775 5,621 8,505 5,279
======== ======= ======== =======
Pro forma basic and diluted net loss per
common share $ (0.87) $ (0.22) $ (1.19) $ (0.37)
======== ======= ======== =======
Shares used in computing pro forma basic and
diluted net loss per common share 23,790 16,154 22,878 15,814
======== ======= ======== =======
</TABLE>

See notes to condensed consolidated financial statements.

2
<PAGE>

CACHEFLOW INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)

<TABLE>
<CAPTION>
Six Months Ended
October 31,
--------------------------
1999 1998
---------- ----------
<S> <C> <C>
Operating Activities
Net loss $ (27,148) $ (5,788)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization 260 104
Stock compensation 18,235 806
Interest on notes receivable from stockholders (13) -
Changes in operating assets and liabilities:
Accounts receivable (731) (584)
Inventories (2,459) (219)
Prepaid expenses and other current assets (292) (142)
Other assets (555) (105)
Accounts payable 2,594 (171)
Accrued liabilities 1,098 323
--------- ---------
Net cash used in operating activities (9,011) (5,776)

Investing Activities
Purchases of property and equipment (1,377) (414)
--------- ---------
Net cash used in investing activities (1,377) (414)

Financing Activities
Proceeds from issuance of preferred stock 19,976 -
Proceeds from issuance of common stock 4,155 247
Proceeds from advance for preferred stock issuances 3,090 -
Repurchase of employee stock (28) -
Payments on debt obligations (230) (37)
--------- ---------
Net cash provided by financing activities 26,963 210

--------- ---------
Net increase (decrease) in cash and cash equivalents 16,575 (5,980)
Cash and cash equivalents at beginning of period 2,291 7,349
--------- ---------

Cash and cash equivalents at end of period $ 18,866 $ 1,369
========= =========

Supplemental disclosure of cash flow information
Cash paid for interest $ 275 $ 6
========= =========

Noncash investing and financing activities
Purchase of equipment under capital lease $ (110) $ -
========= =========

Issuance of note receivable to stockholder for the
exercise of stock options and related interest $ 2,532 $ -
========= =========
</TABLE>

See notes to condensed consolidated financial statements.

3
<PAGE>

CACHEFLOW INC.

Note 1. Basis of Presentation

The condensed consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All intercompany balances and
transactions have been eliminated.

The accompanying condensed consolidated financial statements and related notes
as of October 31, 1999, and for the three- and six-month periods then ended, are
unaudited, but include all adjustments, consisting only of normal recurring
adjustments, that the Company considers necessary for a fair presentation of its
consolidated financial position, operating results, and cash flows for the
interim date and periods presented. Results for the quarter ended October 31,
1999 are not necessarily indicative of results for the entire fiscal year or
future periods.

Note 2. 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 amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.

Note 3. Revenue Recognition

The Company generally recognizes product revenue at the time of shipment, net of
allowances for estimated sales returns and uncollectable customer accounts.
Maintenance contract revenue is initially deferred when the customer purchases a
maintenance contract and recorded evenly over the life of the contract. To
date, maintenance contract revenue has not been a significant portion of the
Company's net sales.

Note 4. Note Receivable from Officer

In August 1999, the Company entered into a five-year non-recourse, non-interest
bearing note for $800,000 with an officer of the Company for the purchase of a
primary residence. The note, which is included in other assets, is secured by
the officer's primary residence.

Note 5. Inventories

Inventories consist of raw materials, work-in-process and finished goods.
Inventories are recorded at the lower of cost or market using the first-in,
first-out method. Inventories consisted of the following (in thousands):

<TABLE>
<CAPTION>
October 31, April 30,
1999 1999
----------- ---------
<S> <C> <C>
Raw materials $2,633 $ 610
Work-in-process 93 45
Finished goods 665 277
-------- --------
$3,391 $ 932
======== ========
</TABLE>

4
<PAGE>

CACHEFLOW INC.

Note 6. Litigation

On September 16, 1999, Nokia IP filed a lawsuit in Santa Clara County Superior
Court naming CacheFlow Inc., and certain officers of the company, as defendants.
These officers were formerly employed by Ipsilon Networks, Inc., which was
acquired by Nokia in December 1997. Following the acquisition, these officers
became employees of Nokia upon completion of the acquisition. In essence, Nokia
claims that the Company and these officers acted improperly in hiring Nokia's
employees. Nokia also claims that a certain officer of the Company violated a
non-competition provision contained in his employment agreement with Nokia.
Nokia is seeking compensatory and punitive damages and orders prohibiting the
defendants from disclosing or using Nokia's trade secrets or confidential
information and acting in a manner that violates these officers' contractual and
fiduciary duties to Nokia. The Company and other defendants have filed an answer
to this Complaint denying the allegations and believe that there are meritorious
defenses to the asserted claims. On November 14, 1999, the Company entered into
a term sheet with Nokia to settle the litigation. The term sheet does not
require the Company to make any monetary payments to Nokia. The Company is
currently negotiating a definitive settlement agreement with Nokia. As of
December 22, 1999, a final draft of the definitive settlement agreement is being
circulated for approval by the parties. If the Company is unable to negotiate
the definitive settlement agreement or to enforce the term sheet, the Company
intends to defend the litigation vigorously. The outcome of litigation is
inherently unpredictable and the results of the litigation may not be favorable
to the Company or the other defendants and could include monetary damages and a
court order restricting our ability to hire Nokia's employees. Although the
Company believes that the ultimate outcome of the dispute with Nokia will not
have a material adverse effect on the Company's consolidated financial position,
results of operations and cash flows, there can be no assurance that Nokia IP
will not prevail in this dispute. If Nokia IP were to prevail in this dispute on
all of its claims, it could have a material adverse effect on the Company's
consolidated financial position, results of operations, and cash flows.

Note 7. Comprehensive Income (Loss)

The Company reports comprehensive income (loss) in accordance with the Financial
Accounting Standards Board's (FASB) Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income." The comprehensive net losses for the
three- and six-month periods ended October 31, 1999 and 1998 do not differ from
the reported net losses.

Note 8. Net Loss Per Share

Basic net loss per common share and diluted net loss per common share are
presented in conformity with the FASB's Statement of Financial Accounting
Standards No. 128, "Earnings Per Share" (FAS 128), for all periods presented.

In accordance with FAS 128, basic and diluted net loss per common share has been
computed using the weighted-average number of shares of common stock outstanding
during the period, less the weighted average number of shares of common stock
issued to founders, investors and employees that are subject to repurchase. Pro
forma basic and diluted net loss per common share, as presented in the condensed
consolidated statements of operations, have been computed as described above and
also give effect, under Securities and Exchange Commission guidance, to the
conversion of the convertible preferred stock (using the if-converted method)
from the original date of issuance. The shares used in calculating the pro forma
basic and diluted net loss per common share amounts also include warrants to
purchase series A and C preferred stock as such warrants expire upon the
completion of the Company's initial public offering of its common stock. The
Company assumes the warrants will be exercised prior to or in connection with
the completion of the initial public offering because these warrants expire upon
completion of the offering and the exercise prices are significantly lower than
the estimated offering price. The weighted average share amounts exclude
warrants to purchase series B preferred stock as such warrants will remain
outstanding after the initial public offering is complete.

5
<PAGE>

CACHEFLOW INC.

The following table presents the calculation of basic and diluted net loss per
common share and pro forma basic and diluted net loss per common share (in
thousands, except per share amounts):

<TABLE>
<CAPTION>
Three months ended Six months ended
October 31, October 31,
--------------------------- ---------------------------
1999 1998 1999 1998
--------------------------- ---------------------------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Historical:
Net loss $(20,591) $(3,486) $(27,148) $(5,788)
============ =========== ============ ===========

Weighted-average shares of common stock
outstanding 13,037 9,205 12,864 8,791

Less: Weighted-average shares subject to
repurchase (4,262) (3,584) (4,359) (3,512)
------------ ----------- ------------ -----------
Weighted-average shares used in computing basic
and diluted net loss per common share 8,775 5,621 8,505 5,279
============ =========== ============ ===========
Basic and diluted net loss per common share $ (2.35) $ (0.62) $ (3.19) $ (1.10)
============ =========== ============ ===========

Pro forma:
Shares used above 8,775 5,621 8,505 5,279

Pro forma adjustment to reflect the weighted
effect of the assumed conversion of preferred
stock 14,342 9,970 13,700 9,970

Pro forma adjustment to reflect the weighted
effect of assumed exercise and conversion of
preferred stock warrants 673 563 673 563
------------ ----------- ------------ -----------
Shares used in computing pro forma basic and
diluted net loss per common share 23,790 16,154 22,878 15,812
============ =========== ============ ===========
Pro forma basic and diluted net loss per common
share $ (0.87) $ (0.22) $ (1.19) $ (0.37)
============ =========== ============ ===========
</TABLE>

The Company has excluded all preferred stock, warrants for preferred stock,
outstanding stock options and shares subject to repurchase from the calculation
of diluted net loss per common share because all such securities are
antidilutive for all periods presented.

Note 9. Stockholders' Equity (Deficit)

In June 1999, the Company's Board of Directors and stockholders approved a
2-for-1 stock split of the Company's authorized, issued and outstanding common
and preferred stock. All common and preferred share and per share amounts in the
accompanying consolidated financial statements have been retroactively adjusted
to reflect the 2-for-1 stock split.

6
<PAGE>

CACHEFLOW INC.

Preferred Shares

In September 1999, the Company's Board of Directors approved a decrease in
authorized shares of preferred stock from 30,000,000 to 10,000,000 upon the
completion of the Company's initial public offering of its common stock.

Common Stock

The Company has entered into Stock Purchase Agreements in connection with the
sale of common stock to employees, consultants and directors. The Company
typically has the right to repurchase, at the original issue price, a declining
percentage of certain of the shares of common stock issued based on the
employees, consultants, and directors service periods. The repurchase right
generally declines on a percentage basis over four years based on the length of
the founder's and each respective employee's continued employment with the
Company, and the director's membership on the Board of Directors under this
agreement. As of October 31, 1999 and 1998, 4,781,814 and 3,245,981 shares,
respectively, of common stock issued under these agreements were subject to
repurchase.

In September 1999, the Company's Board of Directors approved an increase in
authorized shares of common stock from 60,000,000 to 200,000,000 upon the
completion of the Company's initial public offering of its common stock.

Employee Stock Purchase Plan

In September 1999, the Company's Board of Directors adopted the Employee Stock
Purchase Plan. The plan became effective upon the effective date of the
Company's initial public offering of its common stock. A total of 2,500,000
shares of common stock have been reserved for issuance under the plan. Under the
plan, eligible employees may purchase common stock through payroll deductions,
which in any event may not exceed 15% of an employee's compensation, at a price
equal to the lower of 85% of the fair market value of the common stock at the
beginning of each offering period or at the end of each purchase period. The
number of shares reserved under the Employee Stock Purchase Plan will
automatically increase by 500,000 shares annually beginning January 31, 2000.
The Company's Board of Directors, at its discretion, may reduce the automatic
annual increase in reserved shares.

1999 Stock Incentive Plan

In September 1999, the Company's Board of Directors adopted the 1999 Stock
Incentive Plan (the "Incentive Plan") under which 5,000,000 shares have been
reserved for issuance. The plan became effective upon the effective date of the
Company's initial public offering of its common stock. The number of shares
reserved under the Incentive Plan will automatically increase annually beginning
January 1, 2000 by the lesser of 5% of the total amount of common stock shares
outstanding or 2,000,000 shares. The exercise price for incentive stock options
and non-qualified stock options may not be less than 100% and 85%, respectively,
of the fair market value of common stock on the option grant date.

7
<PAGE>

CACHEFLOW INC.

1999 Director Option Plan

In September 1999, the Company's Board of Directors adopted the 1999 Director
Option Plan (the "Directors' Plan") under which 500,000 shares have been
reserved for issuance. The 1999 Director Option Plan became effective on the
date of its adoption. Each non-employee joining the Board of Directors following
the effective date of the initial public offering will automatically receive
options to purchase 25,000 shares of common stock. In addition, each non-
employee director will automatically receive options to purchase 5,000 shares of
common stock at each annual meeting of the Board of Directors held in the year
2000 and thereafter. Each option will have an exercise price equal to the fair
market value of the common stock on the option grant date. The number of shares
reserved under the Directors' Plan will automatically increase by 100,000 shares
annually beginning January 1, 2000. The Company's Board of Directors, at its
discretion, may reduce the automatic annual increase in reserved shares.

Stock Option Grants

During the three months ended October 31, 1999, the Company granted options to
purchase 4,383,230 shares of common stock. This includes a grant of 677,380
options to a consultant of the Company on October 13, 1999 to purchase common
stock at an exercise price of $4.00 per share. The 677,380 options were
immediately vested, nonforfeitable and exercisable and were subsequently
exercised. The fair value of the options was estimated using the Black-Scholes
option pricing model with the following weighted average assumptions: risk free
rate of 6.0%, expected life of the options of 0.05 years, 60% volatility and no
dividend yield. The Company calculated a value of approximately $8,129,000 for
the consultant's options and recorded this amount as both deferred stock
compensation and stock compensation expense in the three months ended October
31, 1999. The Company also recorded additional deferred stock compensation of
approximately $25,434,000 with respect to other stock option grants made during
this period.

Stock Compensation

For the three months ended October 31, 1999 and 1998, the Company recorded
deferred stock compensation of $33,563,000 and $2,149,000, respectively. For the
six months ended October 31, 1999 and 1998, the Company recorded deferred stock
compensation of $47,786,000 and $3,319,000, respectively. These amounts
represent the difference between the exercise price and the deemed fair value of
the Company's common stock on the date such stock options were granted. For the
three months ended October 31, 1999 and 1998, the Company recorded amortization
of stock compensation of $15,243,000 and $587,000, respectively. For the six
months ended October 31, 1999 and 1998, the Company recorded amortization of
stock compensation of $18,235,000 and $806,000, respectively. At October 31,
1999 and April 30, 1999, the Company had $39,634,000 and $10,067,000,
respectively, of remaining unamortized deferred compensation. Such amounts are
included as a reduction of stockholders' equity (deficit) and are being
amortized using a graded method over the vesting period of each respective
option.

Note 10. Subsequent Events

Preferred Stock

On November 1, 1999, the Company authorized and issued 280,953 shares of series
D preferred stock at $11.00 per share. The series D preferred stock has similar
rights, preferences and privileges as series A, B, and C preferred stock. In
connection with the issuance of the series D preferred stock the Company expects
to record a non-cash charge of approximately $1,967,000 in the three months
ending January 31, 2000 to accrete the value of the preferred stock to its fair
value. This non-cash charge will be recorded as an increase in accumulated
deficit with a corresponding credit to additional paid in capital.

Initial Public Offering

8
<PAGE>

CACHEFLOW INC.

On November 19, 1999, the Company completed its initial public offering in which
it sold 5,750,000 shares of common stock (including an over-allotment option of
750,000 shares) at $24 per share. Upon the closing of the offering, all of the
Company's preferred stock converted to common stock. Proceeds from the offering
were $128,340,000, net of underwriter's discounts and commissions. As of
November 30, 1999, 35,882,460 shares of common stock were outstanding.

Stock Option Grants

Between November 1 and November 30, 1999, the Company granted options to
purchase 1,975,250 shares of common stock. The Company expects to record
additional deferred stock compensation of approximately $6,003,000 with respect
to stock option grants made during this period.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The statements contained in this report that are not purely historical are
forward-looking statements, including statements regarding our expectations,
beliefs, intentions, or strategies regarding the future. All forward-looking
statements included in this document are based upon information available to us
as of the date hereof, and we assume no obligation to update any such forward-
looking statements. Forward-looking statements involve risks and uncertainties,
which could cause actual results to differ materially from those projected.
These and other risks relating to our business are set forth under "Factors
Affecting Future Operating Results" and elsewhere in this report as well as in
our Registration Statement on Form S-1 filed with the Securities and Exchange
Commission on November 18, 1999.

Overview

The Company designs, develops, markets and supports high-performance Internet
caching appliances. From our inception in March 1996 through April 30, 1998, we
were considered to be in the development stage. Our activities were related
primarily to conducting research and development, developing our initial
product, recruiting personnel, building sales channels, establishing the market
for our initial product, raising capital and purchasing operating assets.

We began commercial shipment of our first products in May 1998. Since that time,
we have introduced other Internet caching appliances, which have a variety of
hardware configurations designed for the different price, performance, capacity
and reliability requirements of our customers. The list prices of our caching
appliances increase as they become more highly configured. Substantially all of
our net sales through October 31, 1999 were attributable to sales of our
Internet caching appliance products. We anticipate that these products will
continue to account for a substantial portion of our future net sales for the
foreseeable future.

The Company recorded deferred stock compensation of approximately $33.6 million
and $2.1 million for the three months ended October 31, 1999 and 1998,
respectively, and $47.8 million and $3.3 million for the six months ended
October 31, 1999 and 1998, respectively. These amounts represent the difference
between the exercise price and the deemed fair value of stock option and warrant
grants to employees, consultants, directors and third parties on the date such
stock awards were granted. The Company recorded stock compensation expense of
approximately $15.2 million and $587,000 for the three months ended October 31,
1999 and 1998, respectively, and $18.2 million and $806,000 for the six months
ended October 31, 1999 and 1998, respectively. Based on grants from November 1
to November 30, 1999, we expect to record additional deferred stock compensation
of approximately $6.0 million. We expect compensation expense, which is
primarily attributable to amortization of deferred compensation charges, to
impact our reported results through April 30, 2004. Based on option grants
through November 30, 1999,

9
<PAGE>

CACHEFLOW INC.

we expect stock compensation expense to be approximately $34.6 million for the
fiscal year ending April 30, 2000. Given the balance of deferred stock
compensation on the balance sheet and recent grant history, we expect stock
compensation expense to be a significant operating expense as this deferral is
recognized. Additionally, we expect to record a charge of approximately $2.0
million related to the beneficial conversion feature of the series d preferred
stock issued on November 1, 1999.

We have incurred net losses in each quarter since inception. As of October 31,
1999, we had an accumulated deficit of $47.3 million. Our net loss for the three
months ended October 31, 1999 was $20.6 million and our net loss for the six
months ended October 31, 1999 was $27.1 million. These losses resulted from
significant costs incurred in the development and sale of our products and
services. We expect to experience significant growth in our operating expenses,
particularly research and development and sales and marketing expenses. As a
result, we expect to incur additional losses and continued negative cash flow
from operations for the foreseeable future.

Our limited operating history makes the prediction of future operating results
difficult. We believe that period-to-period comparisons of our operating results
should not be relied upon as predictive of future performance. Our prospects
must be considered in light of the risks, expenses and difficulties encountered
by companies at an early stage of development, particularly companies in new and
rapidly evolving markets. We may not be successful in addressing these risks and
difficulties.

Results of Operations

The following table sets forth, as a percentage of net sales, consolidated
statements of operations data for the periods indicated:

<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
October 31, October 31,
--------------------------------------- --------------------------------
1999 1998 1999 1998
----------------- ---------------- ------------ --------------

<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 39.0 60.3 38.7 66.1
----------------- ---------------- ------------ --------------
Gross margin 61.0 39.7 61.3 33.9

Operating expenses:
Research and development 47.5 88.5 46.3 90.6
Sales and marketing 105.3 158.9 101.5 161.5
General and administrative 17.1 63.3 17.7 50.8
Stock compensation 315.0 54.3 215.8 42.6
----------------- ---------------- ------------ --------------
Total operating expenses 484.9 365.0 381.3 345.5

Operating loss (423.9) (325.3) (320.0) (311.6)

Interest (expense) income, net (1.7) 3.0 (1.4) 5.5
----------------- ---------------- ------------ --------------

Net loss (425.6) % (322.3) % (321.4) % (306.1)%
================= ================ ============ ==============
</TABLE>

Net Sales. Net sales increased to $4.8 million for the quarter ended October 31,
1999 from $1.1 million for the quarter ended October 31, 1998. This increase was
attributable to higher sales volumes resulting from the introduction of new
products and growth in our customer base as we expanded our sales force. In
particular, the higher unit sales volumes reflect the introduction of the 500,
2000, 3000 and 5000 Series products, offset by decreased unit sales of 1000
Series products. During the quarter ended October 31,

10
<PAGE>

CACHEFLOW INC.

1999, one customer accounted for 17% of our net sales, and during the quarter
ended October 31, 1998, each of two customers accounted for 20% of our net
sales. Direct and indirect channel sales accounted for 73% and 27% of our net
sales for the quarter ended October 31, 1999 and 59% and 41% of our net sales
for the quarter ended October 31, 1998. Net sales from international operations
were $1.9 million, or 40% of net sales, for the quarter ended October 31, 1999,
and $109,000, or 10% of net sales, for the quarter ended October 31, 1998.

Net sales increased to $8.5 million for the six months ended October 31, 1999
from $1.9 million for the six months ended October 31, 1998. As noted above,
this increase was attributable to higher sales volumes resulting from the
introduction of new products and growth in our customer base as we expanded our
sales force. During the six months ended October 31, 1999, one customer
accounted for approximately 14% of our net sales, and during the six-months
ended October 31, 1998, three customers accounted for 10%, 11%, and 15% of our
net sales. Direct and indirect channel sales accounted for 68% and 32% of our
net sales for the six months ended October 31, 1999 and 46% and 54% of our net
sales for the six months ended October 31, 1998. Net sales from international
operations were $3.6 million, or 43% of net sales, for the six months ended
October 31, 1999, and $316,000, or 17% of net sales, for the six months ended
October 31, 1998. We expect our net sales to increase as a result of continued
growth in our sales force, broader acceptance of our products in the
marketplace, and the introduction of new products, although the growth rate in
our net sales of 347% will likely not continue in the future.

Gross Profit. Gross profit increased to $3.0 million for the quarter ended
October 31, 1999 from $430,000 for the quarter ended October 31, 1998. Gross
profit increased to $5.2 million for the six months ended October 31, 1999 from
$641,000 for the six months ended October 31, 1998. These increases in gross
profit were primarily attributable to the introduction of new products and their
growing acceptance in the marketplace and higher sales volumes. Gross margin
increased to 61.0% for the quarter ended October 31, 1999 from 39.7% for the
quarter ended October 31, 1998. Gross margin increased to 61.3% for the six
months ended October 31, 1999 from 33.9% for the six months ended October 31,
1998. These increases in gross margin were principally due to the resulting
economies of scale from higher unit production and cost savings achieved by
outsourcing component manufacturing. Our gross margin has been and will continue
to be affected by a variety of factors, including competition, fluctuations in
demand for our products, the timing and size of customer orders and product
implementations, the mix of direct and indirect sales, the mix and average
selling prices of products, new product introductions and enhancements,
component costs, manufacturing costs and product configuration.

Research and Development. Research and development expenses consist primarily of
salaries and benefits, and prototype and test equipment costs. Research and
development expenses increased to $2.3 million for the quarter ended October 31,
1999 from $958,000 for the quarter ended October 31, 1998. Research and
development expenses increased to $3.9 million for the six months ended October
31, 1999 from $1.7 million for the six months ended October 31, 1998. These
increases in research and development expenses in absolute dollars were
primarily attributable to increased staffing and associated support for
engineers required to expand and enhance our product line, and, to a lesser
extent, expenses related to prototype and test equipment units. Research and
development headcount increased to 43 at October 31, 1999 from 20 at October 31,
1998. As a percentage of net sales, research and development expenses decreased
to 47.5% for the quarter ended October 31, 1999 from 88.5% for the quarter ended
October 31, 1998. As a percentage of net sales, research and development
expenses decreased to 46.3% for the six months ended October 31, 1999 from 90.6%
for the six months ended October 31, 1998. These decreases in research and
development expenses as a percentage of net sales reflect the fact that our net
sales during these periods increased more rapidly than our research and
development expenses. We believe that significant investments in research and
development will be required to remain competitive and expect that research and
development expenses will continue to increase in absolute dollars. Through
October 31, 1999, all research and development costs have been expensed as
incurred.

Sales and Marketing. Sales and marketing expenses consist primarily of salaries
and benefits, commissions, advertising and promotional expenses, and customer
service and support costs. Sales and marketing expenses increased to $5.1
million for the quarter ended October 31, 1999 from $1.7 million for the quarter

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CACHEFLOW INC.

ended October 31, 1998. Sales and marketing expenses increased to $8.6 million
for the six months ended October 31, 1999 from $3.1 million for the six months
ended October 31, 1998. These increases in sales and marketing expenses in
absolute dollars were related to the expansion of our sales and marketing
organization as we hired people and added sales and support facilities
worldwide. Sales and marketing headcount increased to 101 at October 31, 1999
from 28 at October 31, 1998. As a percentage of net sales, sales and marketing
expenses decreased to 105.3% for the quarter ended October 31, 1999 from 158.9%
for the quarter ended October 31, 1998. As a percentage of net sales, sales and
marketing expenses decreased to 101.5% for the six months ended October 31, 1999
from 161.5% for the six months ended October 31, 1998. These decreases in sales
and marketing expenses as a percentage of net sales reflect the fact that our
net sales during these periods increased more rapidly than our sales and
marketing expenses. We expect to continue to increase our sales and marketing
expenses significantly in absolute dollars in an effort to expand domestic and
international markets, introduce new products, and establish and expand new
distribution channels.

General and Administrative. General and administrative expenses increased to
$829,000 for the quarter ended October 31, 1999 from $685,000 for the quarter
ended October 31, 1998. General and administrative expenses increased to $1.5
million for the six months ended October 31, 1999 from $960,000 for the six
months ended October 31, 1998. These increases in general and administrative
expenses in absolute dollars were primarily attributable to increased staffing
and associated expenses necessary to manage and support our growth. General and
administrative headcount increased to 20 at October 31, 1999 from 8 at October
31, 1998. As a percentage of net sales, general and administrative expenses
decreased to 17.1% for the quarter ended October 31, 1999 from 63.3% for the
quarter ended October 31, 1998. As a percentage of net sales, general and
administrative expenses decreased to 17.7% for the six months ended October 31,
1999 from 50.8% for the six months ended October 31, 1998. These decreases in
general and administrative expenses as a percentage of net sales reflect the
fact that our net sales during these periods increased more rapidly than our
general and administrative expenses. We expect general and administrative
expenses to increase in absolute dollars as we continue to increase staffing to
manage expanding operations and facilities and incur the additional expenses
associated with operating as a public company.

Stock Compensation. Stock compensation expense increased to $15.2 million for
the quarter ended October 31, 1999 from $587,000 for the quarter ended October
31, 1998. Stock compensation expense increased to $18.2 million for the six
months ended October 31, 1999 from $806,000 for the six months ended October 31,
1998.

Other (Expense) Income, Net. Other (expense) income, net decreased to net other
expense of $80,000 for the quarter ended October 31, 1999, from net other income
of $33,000 for the quarter ended October 31, 1998. Other (expense) income, net
decreased to net other expense of $116,000 for the six months ended October 31,
1999, from net other income of $104,000 for the six months ended October 31,
1998. These decreases were primarily attributable to increased interest costs as
a result of incurring additional borrowings.

Liquidity and Capital Resources

From inception through October 31, 1999, we financed our operations and the
purchase of property and equipment through private sales of preferred stock,
with net proceeds of $34.8 million, as well as through bank loans and equipment
leases. At October 31, 1999, we had $18.9 million in cash and cash equivalents
and $16.4 million in working capital. Subsequent to October 31, 1999, we
financed our operations through the private sale of series D preferred stock,
with net proceeds of $3.1 million, and through an initial public offering of our
common stock, with proceeds of $128.3 million, net of underwriting discounts and
commissions.

Net cash used in operating activities was $9.0 million for the six months ended
October 31, 1999 and $5.8 million for the six months ended October 31, 1999. We
used cash primarily to fund our net losses from operations.

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CACHEFLOW INC.

Net cash used in investing activities was $1.4 million for the six months ended
October 31, 1999 and $414,000 for the six months ended October 31, 1998. Net
cash used in investing activities was primarily attributable to purchases of
property, plant and equipment. We expect that, in the future, any cash in excess
of current requirements will be invested in investment grade, interest-bearing
securities.

Net cash provided by financing activities was $27.0 million for the six months
ended October 31, 1999 and $210,000 for the six months ended October 31, 1998.
During May 1999, we raised approximately $20.0 million in gross proceeds from
the sale of series C preferred stock at $4.575 per share. During October 1999,
we raised approximately $2.8 million through the cash exercise of options
granted to a board member and consultant to purchase 702,380 shares of common
stock at $4.00 per share. Subsequent to October 31, 1999, we raised
approximately $3.1 million of capital through the sale of 280,953 shares of
series D preferred stock at $11.00 per share, and approximately $128.3 million,
net of underwriting discounts and commissions, through the sale of 5,750,000
shares of our common stock in an initial public offering.

Capital expenditures were $1.4 million for the six months ended October 31, 1999
and $414,000 for the six months ended October 31, 1998. Our capital expenditures
consisted of purchases of plant, equipment and software. Current capital
commitments are approximately $700,000, principally for a new enterprise
resource planning system. We expect that our capital expenditures will continue
to increase in the future.

We currently have two credit facilities. Our $3.0 million credit facility, which
expired in November 1999 and was extended to April 2000, bears interest at the
prime interest rate plus .50%. In December 1999, the outstanding balance on this
line of credit was repaid, and $2.5 million is currently available for
borrowing. Our second credit facility includes a $3.5 million three-year term
loan and a $350,000 equipment line of credit. The term loan and equipment line
of credit are secured by all of our assets and bear interest at 13.0% and 11.4%
and mature in November 2002 and May 2000. As of October 31, 1999, $3.3 million
under the term loan had been borrowed, and $110,000 under the equipment line of
credit had been borrowed. In December 1999, all amounts outstanding under the
term loan and equipment line of credit were repaid and the credit facility was
terminated. Both of our credit facilities require us to maintain compliance with
financial covenants that, among other things, specify minimum financial ratios
and prohibit us from paying dividends on our capital stock.

We believe that working capital, including the net proceeds from the sale of our
common stock in the initial public offering, will be sufficient to meet our
working capital and capital expenditure requirements for at least the next
twelve months. Thereafter, we may find it necessary to obtain additional equity
or debt financing. In the event additional financing is required, we may not be
able to raise it on acceptable terms or at all.

Year 2000 Readiness

We believe that our current products are Year 2000 compliant when configured and
used as described in the product documentation. Our product is installed as a
part of a network and its performance may be harmed by other network connected
devices that may not be Year 2000 compliant. We continue to respond to customer
questions about prior versions of our products on a case-by-case basis.

We have defined Year 2000 compliant as the ability to:

. correctly handle date information needed for the December 31, 1999 to
January 1, 2000 date change;

. function according to the product documentation provided for this date
change, without changes in operation resulting from the advent of a
new century, assuming correct configuration;

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CACHEFLOW INC.

. respond to two-digit date input in a way that resolves the ambiguity
as to century in a disclosed, defined and predetermined manner;

. store and provide output of date information in ways that are
unambiguous as to century if the date elements in interfaces and data
storage specify the century; and

. recognize Year 2000 as a leap year.

We have tested software obtained from third parties, including licensed
software, shareware and freeware, that is incorporated into our products, and we
have received assurances from our vendors that licensed software is Year 2000
compliant. Despite testing by us and current and potential customers, and
assurances from developers of products incorporated into our products, our
products may contain undetected errors or defects associated with Year 2000 date
functions. Known or unknown errors or defects in our products could result in
delay or loss of net sales, diversion of development resources, damage to our
reputation, or increased service and warranty costs, any of which could
seriously harm our business. Some commentators have predicted significant
litigation regarding Year 2000 compliance issues, and we are aware of these
lawsuits against software vendors. Because of the unprecedented nature of this
litigation, it is uncertain whether or to what extent we may be affected by it.

We have completed an assessment of our material internal information and other
technology systems, including both our own software products and third-party
software and hardware technologies. We have received assurances from our third-
party software vendors that their systems are Year 2000 compliant. In addition,
we intend to seek assurances from the vendors of any future software we
purchase, including our planned purchase of a new enterprise resource planning
system. We are not currently aware of any material operational issues or costs
associated with preparing our internal information technology and non-
information technology systems for the Year 2000. However, 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.

We do not intend to seek any information concerning the Year 2000 compliance
status of our customers. Our current or future 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, Year 2000 issues could reduce or
eliminate the budgets that current or potential customers could have for
purchases of our products and services. As a result, our business could be
seriously harmed.

We do not intend to seek any information concerning the Year 2000 compliance
status of our component suppliers. Our component suppliers may experience
significant interruptions in their manufacturing operations, which could result
in significant delays in their ability to supply us with the components
necessary for our Internet caching appliances. As a result, our business could
be seriously harmed.

We have not separately accounted for Year 2000 costs in the past. To date, these
costs have not been material. We will incur additional costs related to the Year
2000 efforts for administrative personnel to manage the project, outside
contractor assistance, technical support for our products, product engineering
and customer satisfaction. In addition, we may experience significant problems
and costs with Year 2000 compliance that could seriously harm our business.

Based upon our examination of our internal technology systems, we do not believe
it will be necessary to develop a contingency plan to address situations that
may result if we are unable to achieve Year 2000 readiness of our critical
operations. If we find it necessary to develop a contingency plan the cost of
developing and implementing a contingency plan may be significant. Finally, we
are subject to external forces that might generally affect industry and
commerce, such as utility or transportation company Year 2000 compliance failure
interruptions.

FACTORS AFFECTING FUTURE OPERATING RESULTS

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CACHEFLOW INC.

Our business, financial condition and results of operations could be seriously
harmed by any of the following risks. The trading price of our common stock
could decline due to any of these risks.

Risks Related to Our Business

We only began selling our products in May 1998 and, as a result, you may have
difficulty evaluating our business and operating results.

We were founded in March 1996 and did not sell any products or services until
May 1998. The market for our products is unproven. Our limited operating history
makes an evaluation of our future prospects very difficult. We expect to
encounter risks and difficulties frequently encountered by early stage companies
in new and rapidly evolving markets. Many of these riss are described in more
detail in this "Factors Affecting Future Operating Results" section. Our
business will be seriously harmed if we do not successfully execute our business
strategy or if we do not successfully address the risks we face.

We have a history of losses, expect to incur future losses and may never achieve
profitability, which could result in the decline of the market price of our
common stock.

We incurred net losses of $20.6 million and $3.5 million for the three months
ended October 31, 1999 and 1998, respectively. We incurred net losses of $27.1
million and $5.8 million for the six months ended October 31, 1999 and 1998,
respectively. As of October 31, 1999, we had an accumulated deficit of $47.3
million. We have not had a profitable quarter since our inception and we expect
to continue to incur net losses in the future. To date, we have funded our
operations from the sale of equity securities and through bank loans and
equipment leases.

We expect to continue to incur significant operating expenses and, as a result,
we will need to generate significant revenues if we are to achieve
profitability. We may never achieve profitability. We expect to incur
substantial non-cash costs relating to the amortization of deferred
compensation, which will contribute to our net losses. As of October 31, 1999,
we had an aggregate of $39.6 million of deferred compensation to be amortized.
Between November 1, 1999 and November 30, 1999, we recorded additional deferred
compensation of $6.0 million with respect to stock options granted during this
period.

Because we expect our sales to fluctuate and our costs are relatively fixed in
the short term, our ability to forecast our quarterly operating results is
limited, and if our quarterly operating results are below the expectations of
analysts or investors, the market price of our common stock may decline.

Our net sales and operating results are likely to vary significantly from
quarter to quarter. We believe that quarter-to-quarter comparisons of our
operating results should not be relied upon as indicators of future performance.
It is likely that in some future quarter or quarters, our operating results will
be below the expectations of public market analysts or investors. When this
occurs, the price of our common stock could decrease significantly. A number of
factors are likely to cause variations in our net sales and operating results,
including factors described in this "Factors Affecting Future Operating
Results" section.

We cannot reliably forecast our future quarterly sales for several reasons,
including:

. sales in any quarter are dependent on orders booked and shipped in
that quarter, and we often operate with very little order backlog;

. we have a limited operating history, and the market in which we
compete is relatively new and rapidly evolving;

. we expect that, for the foreseeable future, most of our sales will
come from a small number of customers, so delays or cancellations of
orders by a few customers can significantly impact net sales within a
quarter; and

. our sales cycle varies substantially from customer to customer.

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CACHEFLOW INC.

A high percentage of our expenses, including those related to research and
development, sales and marketing, general and administrative functions and
amortization of deferred compensation, are essentially fixed in the short term.
As a result, if our net sales are less than forecasted, our quarterly operating
results are likely to be seriously harmed.

We expect increased competition and, if we do not compete effectively, we
could experience a loss in our market share and sales.

The market for Internet caching solutions is intensely competitive, evolving
and subject to rapid technological change. The intensity of competition is
expected to increase in the future. Increased competition is likely to result in
price reductions, reduced gross margins and loss of market share, any one of
which could seriously harm our business. We may not be able to compete
successfully against current or future competitors and we cannot be certain that
competitive pressures we face will not seriously harm our business. Our
competitors vary in size and in the scope and breadth of the products and
services they offer. We primarily encounter competition from a variety of
companies, including Cisco Systems, Inktomi, Network Appliance, Novell and
various others using publicly available, free software. In addition, because
there are relatively low barriers to entry in the Internet caching market, we
expect additional competition from other established and emerging companies as
the market for Internet caching continues to develop and expand.

Many of our current and potential competitors have longer operating histories,
significantly greater financial, technical, marketing and other resources,
significantly greater name recognition and a larger installed base of customers
than we do. In addition, many of our competitors have well-established
relationships with our current and potential customers and have extensive
knowledge of our industry. As a result, our competitors may be able to respond
more quickly to new or emerging technologies and changes in customer
requirements, or to devote greater resources to the development, marketing,
promotion and sale of their products than we can. Current and potential
competitors have established or may establish cooperative relationships among
themselves or with third parties to increase the market acceptance of their
products. In addition, our competitors may be able to replicate our products,
make more attractive offers to existing and potential employees and strategic
partners, more quickly develop new products or enhance existing products and
services, or bundle Internet caching appliances in a manner that we cannot
provide. Accordingly, it is possible that new competitors or alliances among
competitors may emerge and rapidly acquire significant market share. We also
expect that competition will increase as a result of industry consolidation.

Our variable sales cycle makes it difficult to predict the timing of a sale or
whether a sale will be made, which makes our quarterly operating results less
predictable.

Because customers have differing views on the strategic importance of
implementing Internet caching appliances, the time required to educate customers
and sell our products can vary widely. As a result, the evaluation, testing,
implementation and acceptance procedures undertaken by customers can vary,
resulting in a variable sales cycle, which typically ranges from two to six
months. While our customers are evaluating our products and before they place an
order with us, we may incur substantial sales and marketing expenses and expend
significant management efforts. Sales cycles for our products that are sold to
enterprises have traditionally been longer than sales cycles for our products
that are sold to Internet service providers, or ISPs. We expect that sales to
enterprises will increase as a percentage of our total sales over time, and,
accordingly, we expect that the average sales cycle for our products will
increase. In addition, purchases of our products are frequently subject to
unplanned processing and other delays, particularly with respect to larger
customers for whom our products represent a very small percentage of their
overall purchase activity. Large customers typically require approvals at a
number of management levels within their organizations, and, therefore,
frequently have longer sales cycles.

We are entirely dependent on market acceptance of our Internet caching appliance
product family and, as a result, a decline in sales or lack of market acceptance
of these products could cause our sales to fall.

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CACHEFLOW INC.

To date, our Internet caching appliance product family and related services have
accounted for all of our net sales. We anticipate that revenues from our current
product family and services will continue to constitute substantially all of our
net sales for the foreseeable future. As a result, a decline in the prices of,
or demand for, our current product family and services, or their failure to
achieve broad market acceptance, would seriously harm our business. The
CacheFlow 100 Series, 500 Series, 3000 Series and 5000 Series products are the
only products that we currently sell. Our CacheFlow 1000 Series and 2000 Series
products, which have historically accounted for a substantial portion of our net
sales, have been discontinued and replaced by our recently introduced CacheFlow
3000 Series products. We introduced our 3000 Series product in September 1999
and our 5000 Series product in June 1999. We cannot be certain that our
CacheFlow 3000 Series or 5000 Series products will achieve any significant
degree of market acceptance.

If we are unable to introduce new products and services that achieve market
acceptance quickly, we could lose existing and potential customers and our sales
would decrease.

We need to develop and introduce new products and enhancements to existing
products on a timely basis that keep pace with technological developments and
emerging industry standards and address the increasingly sophisticated needs of
our customers. We intend to extend the offerings under our product family in the
future, both by introducing new products and by introducing enhancements to our
existing products. However, we may experience difficulties in doing so, and our
inability to timely and cost-effectively introduce new products and product
enhancements, or the failure of these new products or enhancements to achieve
market acceptance, could seriously harm our business. Life cycles of our
products are difficult to predict, because the market for our products is new
and evolving and characterized by rapid technological change, frequent
enhancements to existing products and new product introductions, changing
customer needs and evolving industry standards. The introduction of competing
products that employ new technologies and emerging industry standards could
render our products and services obsolete and unmarketable or shorten the life
cycles of our products and services. The emergence of new industry standards
might require us to redesign our products. If our products are not in
compliance with industry standards that become widespread, our customers and
potential customers may not purchase our products.

Because we depend on several third-party manufacturers to build portions of our
products, we are susceptible to manufacturing delays and sudden price increases,
which could prevent us from shipping customer orders on time, if at all, and may
result in the loss of sales and customers.

We rely on several third-party manufacturers to build portions of our products.
If we are unable to manage our relationships with these manufacturers
effectively or if these manufacturers fail to meet our future requirements for
timely delivery, our business would be seriously harmed. We have no written
agreement with any of these manufacturers and they fulfill our supply
requirements on the basis of individual purchase orders from us. Accordingly,
these manufacturers are not obligated to continue to fulfill our supply
requirements, and the prices we are charged for these components could be
increased on short notice. Any interruption in the operations of any one of
these manufacturers would adversely affect our ability to meet our scheduled
product deliveries to our customers, which could cause the loss of existing or
potential customers and would seriously harm our business. In addition, the
products that these manufacturers build for us may not be sufficient in quality
or in quantity to meet our needs. Our delivery requirements could exceed the
capacity of these manufacturers, which would likely result in manufacturing
delays, which could result in lost sales and the loss of existing and potential
customers. We cannot be certain that these manufacturers or any other
manufacturer will be able to meet the technological or delivery requirements of
our current products or any future products that we may develop and introduce.
The inability of these manufacturers or any other of our contract manufacturers
in the future to provide us with adequate supplies of high-quality products, or
the loss of any of our contract manufacturers in the future, would cause a delay
in our ability to fulfill customer orders while we attempt to obtain a
replacement manufacturer. Delays associated with our attempting to replace or
our inability to replace one of our manufacturers would seriously harm our
business.

We may experience production delays, quality control problems and assembly
capacity constraints in assembling our products, which could result in a decline
of sales.

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CACHEFLOW INC.

We currently conduct all final assembly and testing of our products at our
headquarters in Sunnyvale, California. We plan to transition final assembly to
third parties in the future. If we are unable to identify a third-party final
assembler, we would be required to make additional capital investments in new or
existing assembly facilities. To the extent any capital investments are
required, our gross margins and, as a result, our business could be seriously
harmed. We may experience production interruptions or quality control problems
in connection with any transition of final assembly, either of which would
seriously harm our business. Either any third-party assembler or we may
experience substantial assembly capacity constraints. In the event of any
capacity constraints we may be unable to accept certain orders from, and deliver
products in a timely manner to, our customers. This could result in the loss of
existing or potential customers and would seriously harm our business.

Because some of the key components in our products come from limited sources of
supply, we are susceptible to supply shortages or supply changes, which could
disrupt or delay our scheduled product deliveries to our customers and may
result in the loss of sales and customers.

We currently purchase several key parts and components used in the manufacture
of our Internet caching appliances from limited sources of supply. For example,
we purchase custom power supplies and Intel hardware for use in all of our
Internet caching appliances. The introduction by Intel or others of new versions
of their hardware, particularly if not anticipated by us, could require us to
expend significant resources to incorporate this new hardware into our products.
In addition, if Intel or others were to discontinue production of a necessary
part or component, we would be required to expend significant resources in
locating and integrating replacement parts or components from another vendor.
Qualifying additional suppliers for limited source components can be time-
consuming and expensive. Any of these events would be disruptive to us and could
seriously harm our business. Further, financial or other difficulties faced by
these suppliers or unanticipated demand for these parts or components could
limit the availability of these parts or components. Any interruption or delay
in the supply of any of these parts or components, or the inability to obtain
these parts or components from alternate sources at acceptable prices and within
a reasonable amount of time, would seriously harm our ability to meet our
scheduled product deliveries to our customers.

Our use of rolling forecasts could lead to excess or inadequate inventory, which
could seriously harm our business.

We use rolling forecasts based on anticipated product orders, product order
history and backlog to determine our materials requirements. Lead times for the
parts and components that we order vary significantly and depend on factors such
as the specific supplier, contract terms and demand for a component at a given
time. If actual orders do not match our forecasts, we may have excess or
inadequate inventory of some materials and components, which would increase our
costs or prevent or delay product shipments and could seriously harm our
business.

We are dependent upon key personnel and we must attract, assimilate and retain
other highly qualified personnel in the future or our ability to execute our
business strategy or generate sales could be harmed.

Our business could be seriously disrupted if we do not maintain the continued
service of our senior management, research and development and sales personnel.
All of our employees are employed on an "at-will" basis. Our ability to conduct
our business also depends on our continuing ability to attract, hire, train and
retain a substantial number of highly skilled managerial, technical, sales,
marketing and customer support personnel. New hires frequently require extensive
training before they achieve desired levels of productivity, so a high employee
turnover rate could seriously impair our ability to operate and manage our
business. We are particularly dependent on hiring additional personnel to
increase our direct sales and research and development organizations.
Competition for personnel is intense, especially in the San Francisco Bay Area,
and we may fail to retain our key employees, or attract, assimilate or retain
other highly qualified personnel in the future. If so, our business would be
seriously harmed.

Our management team is new, and our business could be seriously harmed if
integration of our management team into our company is not successful.

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CACHEFLOW INC.

We have recently experienced significant transition in our management team.
Brian NeSmith, our President and Chief Executive Officer, joined us in March
1999. Stuart Aaron, our Vice President of Marketing and Product Management,
joined us in April 1999. Terry Printy, our Vice President of Customer Support,
joined us in June 1999. Alan Robin, our Senior Vice President of Sales, and
Michael Johnson, our Vice President and Chief Financial Officer, joined us in
July 1999. Bret Lawson, our Controller and Chief Accounting Officer, joined us
in September 1999. Nai-Ting Hsu, our Senior Vice President of Research and
Development, joined us in October 1999. Our business could be seriously harmed
if integration of our management team into our company is not successful. We
expect that it will take time for our new management team to integrate into our
company and it is too early to predict whether these changes will be successful.

The Nokia IP litigation could divert our management's focus and could be costly
and time-consuming to defend, and a judgment against us could harm our business.

In order to manage our growth and expansion, we will need to improve and
implement new systems, procedures and controls, which could be time-consuming
and costly.

We have expanded our operations rapidly since the inception of our company and
we currently intend to continue this expansion. This expansion of our operations
has placed and is expected to continue to place a significant strain upon our
management systems and financial and operational resources. If we are unable to
effectively manage future growth and expansion, our business will be seriously
harmed. We currently have research and development facilities in Sunnyvale,
California; Redmond, Washington and Waterloo, Ontario, Canada. The coordination
and management of these product development organizations that are located at
different sites requires significant management attention and coordination,
particularly from our managerial and engineering organizations. If we are unable
to coordinate and manage these separate development organizations, our business
will be seriously harmed.

Our ability to compete effectively and to manage future expansion of our
operations will require us to continue to improve our financial and management
controls, reporting systems and procedures on a timely basis, and expand, train
and manage our employee work force. The number of our employees increased from
40 at April 30, 1998 to 175 at October 31, 1999, and we plan to further increase
our headcount. We

19
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CACHEFLOW INC.

believe that our existing managerial and other systems will not be adequate to
support our anticipated growth, and we are currently planning to implement a new
enterprise resource planning software system that will replace substantially all
of our business and manufacturing systems. We may encounter difficulties in
transitioning to the new enterprise resource planning software system. Even
after we implement this system, our personnel, systems, procedures and controls
may be inadequate to support our future operations.

Because we depend on a limited number of customers, our quarterly operating
results may decline substantially if we are unable to complete one or more large
sales.

To date, a significant portion of our net sales has resulted from a small number
of customers placing relatively large orders. For the quarter ended October 31,
1999, one customer accounted for approximately 17% of our net sales. We
anticipate that our operating results for any given period will continue to
depend to a significant extent on large orders from a small number of customers.
As a result, our quarterly operating results may fluctuate significantly if we
are unable to complete one or more substantial sales in a quarter.

If we fail to expand our direct and indirect sales channels, our sales will not
grow.

We need to substantially expand our direct sales operations, both domestically
and internationally, in order to increase market awareness and sales of our
products and services. Our products and services require a sophisticated sales
effort targeted at senior management of our customers. We have recently expanded
our direct sales force and plan to hire additional sales personnel. New hires
will require extensive training and typically take several months to achieve
productivity. Competition for qualified sales personnel is intense, and we might
not be able to hire the kind and number of sales personnel we are targeting. If
we fail to increase our direct sales capabilities as we have planned, our
business will be seriously harmed.

We also need to expand our indirect sales channels, and if we fail to do so our
ability to market and sell our products could be seriously harmed. We depend on
our indirect sales channels, which include resellers, systems integrators and
original equipment manufacturers, for a significant percentage of our net sales.
For example, for the quarter ended October 31, 1999, approximately 27% of our
net sales resulted from sales through indirect channels. Our agreements with our
indirect channel partners are generally not exclusive and in many cases may be
terminated by either party without cause. Many of these indirect channel
partners do not have minimum purchase or resale requirements and carry products
that are competitive with our products. These resellers may not give a high
priority to the marketing of our products or may not continue to carry our
products. They may give a higher priority to other products, including the
products of competitors. We may not retain any of our current indirect channel
partners or successfully recruit new indirect channel partners. Events or
occurrences of this nature could seriously harm our business.

If we are unable to expand our customer service and support organization, we may
not be able to retain our existing customers or attract new customers, and our
sales may decline.

We currently have a small customer service and support organization and will
need to increase our capabilities to support new customers and the expanding
needs of our existing customers. If we are unable to expand our customer service
and support organization, we may not be able to retain our existing customers or
attract new customers.

We may not be able to enter into new international markets or generate a
significant level of sales from the international markets in which we currently
operate.

For the quarter ended October 31, 1999, sales to customers outside of the United
States and Canada accounted for approximately 40% of our net sales. We expect
international customers to continue to account for a significant percentage of
net sales in the future, but we may fail to maintain or increase international
market demand for our products. Also, because our international sales are
currently denominated in United States dollars, an increase in the value of the
United States dollar relative to foreign currencies could make our products more
expensive and, therefore, potentially less competitive in

20
<PAGE>

CACHEFLOW INC.

international markets, and this would decrease our international sales. Our
ability to expand international sales depends on our ability to expand our
international operations, including establishing manufacturing assembly
capabilities overseas, hire international personnel and recruit additional
international resellers. To the extent we are unable to do so in a timely
manner, our growth, if any, in international sales will be limited and our
business could be seriously harmed. In addition, if we fail to expand and
improve our worldwide operating systems, our ability to accurately forecast
sales demand, manage our supply chain and record and report financial and
management information will be adversely affected, seriously harming our
business.

Undetected software or hardware errors could cause us to incur significant
warranty and repair costs and negatively impact the market acceptance of our
products.

Our products may contain undetected software or hardware errors. These errors
may cause us to incur significant warranty and repair costs, divert the
attention of our engineering personnel from our product development efforts and
cause significant customer relations problems. The occurrence of these problems
could result in the delay or loss of market acceptance of our products and would
likely seriously harm our business. All of our products operate on our
internally developed CacheOS operating system. As a result, any error in CacheOS
will affect all of our products. We have experienced minor errors in the past in
connection with new products. We expect that errors will be found from time to
time in new or enhanced products after commencement of commercial shipments.

We could be subject to product liability claims, which are time-consuming and
costly to defend.

Our customers install our Internet caching appliances directly into their
network infrastructures. Any errors, defects or other performance problems with
our Internet caching appliance products could negatively impact our customers'
internal networks, resulting in financial or other damages to our customers. Our
customers may then seek damages from us for their losses. Although our license
agreements typically contain provisions designed to limit our exposure to
claims, unfavorable judicial decisions could negate these limitation of
liability provisions. We have not experienced any product liability claims to
date. However, a product liability claim brought against us, even if not
successful, would likely be time-consuming and costly. A product liability claim
could seriously harm our business reputation.

Our business could be affected by Year 2000 issues, which could disrupt or delay
our scheduled product deliveries to customers or affect customer demand for our
products and result in the loss of sales and customers.

The "Year 2000 issue" refers generally to the problems that some software and
hardware may have in determining the correct century for the year. For example,
software with date-sensitive functions that is not Year 2000 compliant may not
be able to distinguish whether "00" means 1900 or 2000, which may result in
failures or the creation of erroneous results. Year 2000 issues may affect our
products and internal systems and those of our suppliers and customers. If they
were, our business would likely be harmed. For a discussion of our efforts
regarding Year 2000 issues, see "Year 2000 Readiness" above.

If the protection of our proprietary technology is inadequate, our competitors
may gain access to our technology, and our market share could decline.

We depend significantly on our ability to develop and maintain the proprietary
aspects of our technology. If we were unable to do so, our business would be
seriously harmed.

To protect our proprietary technology, we rely primarily on a combination of
contractual provisions, confidentiality procedures, trade secrets, copyright and
trademark laws and patents. Despite our efforts to protect our proprietary
rights, unauthorized parties may attempt to copy aspects of our products or
obtain and use information that we regard as proprietary. Policing unauthorized
use of our products is difficult. In addition, the laws of some foreign
countries do not protect our proprietary rights to as great an extent as do the
laws of the United States. Our means of protecting our proprietary rights may
not be adequate and
21
<PAGE>

CACHEFLOW INC.

our competitors may independently develop similar technology, duplicate our
products or design around patents that may be issued to us or our other
intellectual property.

We currently have four United States patent applications on file and pending
before the United States Patent and Trademark Office. We also currently have
four PCT International Applications on file to reserve rights in foreign
jurisdictions under appropriate international treaties.

We cannot assure you that any U.S. or international patent will be issued from
these applications. Even if patents are issued, we cannot assure you that we
will be able to detect any infringement or, if infringement is detected, that
issued patents will be enforceable or that any damages awarded to us will be
sufficient to adequately compensate us.

There can be no assurance or guarantee that any products, services or
technologies that we are presently developing, or will develop in the future,
will result in intellectual property that is protectable under law, whether in
the United States or a foreign jurisdiction, that this intellectual property
will produce competitive advantage for us or that the intellectual property of
competitors will not restrict our freedom to operate, or put us at a competitive
disadvantage.

We rely on technology that we license from third parties, including software
that is integrated with internally developed software and used in CacheOS to
perform key functions. For example, we license subscription filtering technology
from Secure Computing. If we are unable to continue to license any of this
software on commercially reasonable terms, we will face delays in releases of
our software or will be required to drop this functionality from our software
until equivalent technology can be identified, licensed or developed, and
integrated into our current product. Any of these delays could seriously harm
our business.

There has been a substantial amount of litigation in the technology industry
regarding intellectual property rights. It is possible that in the future third
parties may claim that we or our current or potential future products infringe
their intellectual property. We expect that companies in the Internet and
networking industries will increasingly be subject to infringement claims as the
number of products and competitors in our industry segment grows and the
functionality of products in different industry segments overlaps. Any claims,
with or without merit, could be time-consuming, result in costly litigation,
cause product shipment delays or require us to enter into royalty or licensing
agreements. Royalty or licensing agreements, if required, may not be available
on terms acceptable to us or at all, which could seriously harm our business.

If we are unable to raise additional capital, our ability to effectively manage
our growth or enhance our products could be harmed.

At October 31, 1999, we had approximately $18.9 million in cash and cash
equivalents. In November 1999, we raised $128.3 million, net of underwriting
discounts and commissions, in our initial public offering. We believe that
these amounts will enable us to meet our capital requirements for at least the
next twelve months. However, if cash is used for acquisitions or other
unanticipated uses, we may need additional capital. The development and
marketing of new products and the expansion of indirect channels and associated
support personnel will require a significant commitment of resources. In
addition, if the market for Internet caching appliances develops at a slower
pace than anticipated or if we fail to establish significant market share and
achieve a meaningful level of sales, we could be required to raise substantial
additional capital. We cannot be certain that additional capital will be
available to us on favorable terms, or at all. If we were unable to raise
additional capital when we require it, our business would be seriously harmed.

Risks Related to the Internet Caching Appliance Industry

The market for Internet caching appliances is new and unpredictable, and if this
market does not develop as we anticipate, our sales may not grow.

22
<PAGE>

CACHEFLOW INC.

Sales of our products depend on increased demand for Internet caching
appliances. The market for Internet caching appliances is a new and rapidly
evolving market. If the market for Internet caching appliances fails to grow as
we anticipate, or grows more slowly than we anticipate, our business will be
seriously harmed. Because this market is new, we cannot predict its potential
size or future growth rate. Our ability to generate net sales in this emerging
market will depend on, among other things, our ability to:

. educate potential end users and indirect channel partners about the
benefits of Internet caching appliances;

. continue to develop our direct sales channel; and

. establish and maintain relationships with leading indirect channel
partners.

The legal environment in which we operate is uncertain and claims against us
could cause our business to suffer.

Our Internet caching appliances operate in part by storing material available on
the Internet and making this material available to end users from our appliance.
This creates the potential for claims to be made against us, either directly or
through contractual indemnification provisions with customers, for defamation,
negligence, copyright or trademark infringement, personal injury, invasion of
privacy or other legal theories based on the nature, content or copying of these
materials. It is also possible that if any information provided through any of
our products contains errors, third parties could make claims against us for
losses incurred in reliance on this information. Our insurance may not cover
potential claims of this type or be adequate to protect us from all liability
that may be imposed.

The adoption of laws that impose taxes on Internet commerce could adversely
affect our business.

Tax authorities at the international, federal, state and local levels are
currently reviewing the appropriate tax treatment of companies engaged in
Internet commerce. Many of our customers are engaged in Internet commerce, and
any taxes imposed on them may adversely impact their businesses and may result
in order cancellations or postponements of product purchases by them, which
would seriously harm our business. Laws regarding the Internet remain largely
unsettled and the adoption or modification of laws or regulations relating to
the Internet, or interpretations of existing law, could seriously harm our
business.

Because the sales of our products are dependent on the increased use and
widespread adoption of the Internet, if use of the Internet does not develop as
we anticipate, our sales may not grow.

Sales of our products depend on the increased use and widespread adoption of the
Internet. Our business would be seriously harmed if the use of the Internet does
not increase as anticipated or if our ISP customers' Internet-related services
are not well received by the marketplace. The acceptance and use of the Internet
in international markets, where we derive a large portion of our net sales, are
in earlier stages of development than in the United States. If the Internet
fails to gain sufficient acceptance in international markets, our business could
be seriously harmed. The resolution of various issues concerning the Internet
will likely affect the use and adoption of the Internet. These issues include
security, reliability, capacity, congestion, cost, ease of access and quality of
service. Even if these issues are resolved, if the market for Internet-related
products and services fails to develop, or develops at a slower pace than
anticipated, our business would be seriously harmed.

Governmental regulation of the communications industry may negatively affect our
customers and result in decreased demand for our products, which would cause a
decline in our sales.

The jurisdiction of the Federal Communications Commission, or FCC, extends to
the communications industry, to our customers and to the products that our
customers sell. Future regulations set forth by the FCC or other regulatory
bodies may adversely affect Internet-related industries. Regulation of our
customers may seriously harm our business. For example, FCC regulatory policies
that affect the

23
<PAGE>

CACHEFLOW INC.

availability of data and Internet services may impede our customers' penetration
into some markets. In addition, international regulatory bodies are beginning to
adopt standards for the communications industry. The delays that these
governmental processes entail may cause order cancellations or postponements of
product purchases by our customers, which would seriously harm our business.

Risks Related to Securities Markets

Our stock price may be volatile and, as a result, you may have difficulty
evaluating the value of our stock, and the market price of our stock may
decline.

The market price of the common stock may fluctuate significantly in response to
the following factors:

. variations in our quarterly operating results;

. changes in financial estimates or investment recommendations by
securities analysts;

. changes in market valuations of Internet-related and networking
companies;

. announcements by us or our competitors of significant contracts,
acquisitions, strategic partnerships, joint ventures or capital
commitments;

. loss of a major customer;

. additions or departures of key personnel; and

. fluctuations in stock market prices and volumes.

Our stock price volatility may make us susceptible to class action litigation,
which is time-consuming and costly to defend.

In the past, securities class action litigation has often been brought against a
company following periods of volatility in the market price of the company's
securities. We may in the future be the target of similar litigation. If we
become engaged in securities class action litigation, our management's attention
and resources may be diverted and we may incur substantial costs, resulting in
serious harm to our business.

Item 3. Qualitative and Quantitative Disclosures about Market Risk

We develop products in the United States and sell them in North America, Asia
and Europe. As a result, our financial results could be affected by factors such
as changes in foreign currency exchange rates or weak economic conditions in
foreign markets. Since all of our sales are currently made in United States
dollars, a strengthening of the dollar could make our products less competitive
in foreign markets. If any of the events described above were to occur, our net
sales could be seriously impacted, since a significant portion of our net sales
are derived from international operations. Net sales from international
operations represented 40% and 43%, respectively, of total net sales for the
three- and six-month periods ended October 31, 1999. Our interest income is
sensitive to changes in the general level of United States interest rates,
particularly since the majority of our investments are cash and cash
equivalents. Due to the nature of our cash and cash equivalents, we have
concluded that they do not expose us to material risk.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

See footnote 6 in the notes to the condensed consolidated financial statements
for a discussion and update of the Company's legal proceedings.

24
<PAGE>

CACHEFLOW INC.

Item 2. Changes in Securities and Use of Proceeds

During the quarter ended October 31, 1999, the Company granted options to
purchase 4,383,230 shares of common stock to employees, consultants and other
service providers of the Company under the 1996 Stock Option Plan.

During the quarter ended October 31, 1999, employees, consultants and other
service providers of the Company exercised options to purchase 1,640,984 shares
of common stock.

On November 1, 1999, the Company authorized and issued 280,953 shares of series
D preferred stock at $11.00 per share.

Between November 1 and November 30, 1999, the Company granted options to
purchase 1,975,250 shares of common stock to employees, consultants, and other
service providers of the Company under the 1996 Stock Option Plan.

The sale of the above securities was deemed to be exempt from registration under
the Securities Act of 1933 ("the Act") in reliance upon Section 4(2) of the Act
or Rule 701 promulgated under Section 3(b) of the Act.

(d) Use of Proceeds.

On November 19, 1999, the Company completed the initial public offering of its
common stock. The managing underwriters in the offering were Morgan Stanley
Dean Witter, Credit Suisse First Boston, and Dain Rauscher Wessels, a division
of Dain Rauscher Incorporated. The shares of common stock sold in the offering
were registered under the Securities Act of 1933, as amended, on a Registration
Statement on Form S-1 (No. 333-87997). The Securities and Exchange Commission
declared the Registration Statement effective on November 18, 1999.

The offering closed on November 24, 1999 after we had sold all of the 5,000,000
shares of common stock and an additional 750,000 shares of common stock in
connection with the exercise of the underwriters' over-allotment option
registered under the Registration Statement. The initial public offering price
was $24 per share for an aggregate initial public offering of $138 million.

We paid a total of $9.7 million in underwriting discounts and commissions. In
addition, the following table sets forth the estimated cost and expenses, other
than underwriting discounts and commissions, incurred in connection with the
offering. None of the amounts shown was paid directly or indirectly to any
director, officer, or their associates, persons owning 10 percent or more of any
class of equity securities of the Company or an affiliate of the Company.

25
<PAGE>

CACHEFLOW INC.

<S> <C>
SEC registration fee $ 26,281
NASD fee 8,800
Nasdaq National Market initial listing fee 95,000
Printing and engraving 274,433
Legal fees and expenses 475,000
Accounting fees and expenses 475,000
Directors and officers liability insurance 175,989
Blue sky fees and expenses 10,000
Transfer agent fees 20,000
Miscellaneous 150,000
----------
Total $1,710,503
</TABLE>

After deducting the underwriting discounts and commissions and the offering
expenses, the estimated net proceeds to the Company from the offering were
approximately $126.6 million, which have been invested in investment grade
securities.

Item 4. Submission of Matters to a Vote of Security Holders

On August 27, 1999, the Company's stockholders approved by written consent in
lieu of a stockholders meeting an amendment to the Company's 1996 Stock Option
Plan, which amendment increased the number of shares reserved for issuance under
the plan by 3,000,000. Holders of a majority of the outstanding common stock
and a majority of the outstanding preferred stock (including holders of a
majority of each of the outstanding series of preferred stock) voted to approve
the action.

On October 13, 1999, the Company's stockholders approved by written consent in
lieu of a stockholders meeting an amendment to the Company's 1996 Stock Option
Plan, which amendment increased the number of shares reserved for issuance under
the plan by 1,500,000. Holders of a majority of the outstanding common stock
and a majority of the outstanding preferred stock (including holders of a
majority of each of the outstanding series of preferred stock) voted to approve
the action.

On October 27, 1999, the Company's stockholders approved by written consent in
lieu of a stockholders meeting (i) an amendment and restatement of the Company's
Certificate of Incorporation filed following the closing of the initial public
offering, which, among other things, increased the number of authorized shares
of common stock and eliminated the right of stockholders to take action by
written consent; (ii) an amendment and restatement of the Company's bylaws,
which, among other things, eliminated the stockholders' right to call a special
meeting of the stockholders and provided for indemnification of officers and
directors of the Company to the full extent authorized or permitted by and under
Delaware law; (iii) the adoption of the Company's 1999 Stock Incentive Plan;
(iv) the adoption of the Company's Employee Stock Purchase Plan; (v) the
adoption of the Company's 1999 Director Option Plan; and (vi) a form of
indemnification agreement to be entered into with each of the officers and
directors of the Company. Holders of a majority of the outstanding common stock
and a majority of the outstanding preferred stock (including holders of a
majority of each of the outstanding series of preferred stock) voted to approve
the action.

On October 28, 1999, the Company's stockholders approved by written consent in
lieu of a stockholders meeting an amendment and restatement of the Company's
Certificate of Incorporation, which, among other things, authorized series D
preferred stock for issuance by the Company. Holders of a majority of the
outstanding common stock and a majority of the outstanding preferred stock
(including holders of a majority of each of the outstanding series of preferred
stock) voted to approve the action.

On November 12, 1999, the Company's stockholders approved by written consent in
lieu of a stockholders meeting an amendment to the Company's 1996 Stock Option
Plan, which amendment increased the number of shares reserved for issuance under
the plan by 1,500,000. Holders of a majority of the outstanding

26
<PAGE>

CACHEFLOW INC.

common stock and a majority of the outstanding preferred stock (including
holders of a majority of each of the outstanding series of preferred stock)
voted to approve the action.

Item 6. Exhibits and Reports on Form 8-K

(a) List of Exhibits:

Number Exhibit Description
------ -------------------
27.1 Financial Data Schedule

(b) No reports on Form 8-K were filed during the quarter ended October 31,
1999.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

CACHEFLOW INC.

/s/ Michael Johnson
----------------------
Michael Johnson
Chief Financial Officer

/s/ Bret Lawson
-----------------------
Bret Lawson
Controller and Chief Accounting Officer

Dated: December 29, 1999

27
<PAGE>

CACHEFLOW INC.

EXHIBIT INDEX

Number Exhibit Description
------ -------------------

27.1 Financial Data Schedule.

<PAGE>

<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS INCLUDED IN THE COMPANY'S FORM 10-Q
FOR THE PERIOD ENDED OCTOBER 31, 1999
</LEGEND>
<MULTIPLIER> 1,000

<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> APR-30-2000
<PERIOD-START> MAY-01-1999
<PERIOD-END> OCT-31-1999
<CASH> 18,866
<SECURITIES> 0
<RECEIVABLES> 2,750
<ALLOWANCES> (666)
<INVENTORY> 3,391
<CURRENT-ASSETS> 352
<PP&E> 3,203
<DEPRECIATION> (625)
<TOTAL-ASSETS> 28,555
<CURRENT-LIABILITIES> 8,277
<BONDS> 0
0
1
<COMMON> 1
<OTHER-SE> 17,905
<TOTAL-LIABILITY-AND-EQUITY> 28,555
<SALES> 8,450
<TOTAL-REVENUES> 8,450
<CGS> 3,266
<TOTAL-COSTS> 13,981
<OTHER-EXPENSES> 18,235
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (116)
<INCOME-PRETAX> (27,148)
<INCOME-TAX> 0
<INCOME-CONTINUING> (27,148)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (27,148)
<EPS-BASIC> (3.19)
<EPS-DILUTED> (3.19)

</TABLE>