<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 JANUARY 31, 2000
OR
[_] 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 [X] No [ ]
Indicate the number of shares outstanding of the issuer's class of common
stock, as of the latest practicable date.
CLASS OUTSTANDING AT
FEBRUARY 29, 2000
-----------------
Common Stock, par value $0.0001 35,745,688
<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 January 31, 2000 and April
30, 1999 1
Condensed Consolidated Statements of Operations for the three and nine
months ended January 31, 2000 and January 31, 1999 2
Condensed Consolidated Statements of Cash Flows for the nine months
ended January 31, 2000 and January 31, 1999 3
Notes to Condensed Consolidated Financial Statements 4 - 8
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations 9 - 22
Item 3. Quantitative and Qualitative Disclosures About Market Risk 22-23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 23
Item 2. Changes in Securities and Use of Proceeds 23 - 24
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 6. Exhibits and Reports on Form 8-K 25
SIGNATURES 25
</TABLE>
<PAGE>
CACHEFLOW INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
January 31, April 30,
2000 1999
------------- -----------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $109,089 $ 2,291
Short-term investments 18,651 -
Accounts receivable, net 2,766 1,353
Inventories 4,248 932
Prepaid expenses and other current assets 457 60
------------ -----------
Total current assets 135,211 4,636
Property and equipment, net 3,695 1,351
Long-term investments 4,896 -
Other assets 1,325 729
------------ -----------
Total assets $145,127 $ 6,716
============ ===========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable $ 2,619 $ 1,464
Borrowings under line of credit - 643
Accrued payroll and related benefits 1,595 420
Deferred revenue 1,060 367
Other accrued liabilities 813 166
Current portion of long-term obligations - 789
------------ -----------
Total current liabilities 6,087 3,849
Long-term obligations, less current portion - 3,211
------------ -----------
Total liabilities 6,087 7,060
Commitments
Stockholders' equity (deficit):
Preferred stock - 1
Common stock 3 1
Additional paid-in capital 263,349 30,877
Treasury stock (509) -
Notes receivable from stockholders (3,596) (1,004)
Deferred stock compensation (55,062) (10,067)
Accumulated deficit (65,072) (20,152)
Accumulated other comprehensive loss (73) -
------------ -----------
Total stockholders' equity (deficit) 139,040 (344)
------------ -----------
Total liabilities and stockholders' equity (deficit) $145,127 $ 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 Nine Months Ended
January 31, January 31,
------------------------ -----------------------
2000 1999 2000 1999
---------- --------- ---------- ---------
<S> <C> <C> <C> <C>
Net sales $ 8,033 $ 2,201 $ 16,483 $ 4,092
Cost of goods sold 3,082 890 6,348 2,140
---------- --------- ---------- ---------
Gross profit 4,951 1,311 10,135 1,952
Operating expenses:
Research and development 2,744 978 6,655 2,691
Sales and marketing 9,255 1,654 17,829 4,708
General and administrative 1,302 510 2,798 1,470
Stock compensation 8,634 871 26,869 1,677
---------- --------- ---------- ---------
Total operating expenses 21,935 4,013 54,151 10,546
---------- --------- ---------- ---------
Operating loss (16,984) (2,702) (44,016) (8,594)
Interest income (expense), net 1,179 (115) 1,063 (11)
---------- --------- ---------- ---------
Net loss (15,805) (2,817) (42,953) (8,605)
Accretion of preferred stock (1,967) - (1,967) -
---------- --------- ---------- ---------
Net loss available to common stockholders $(17,772) $ (2,817) $(44,920) $(8,605)
========== ========= ========== =========
Basic and diluted net loss per common share $ (0.64) $ (0.45) $ (3.02) $ (1.53)
========== ========= ========== =========
Shares used in computing basic and diluted
net loss per common share 27,603 6,275 14,871 5,606
========== ========= ========== =========
Pro forma basic and diluted net loss per
common share $ (0.59) $ (0.17) $ (1.73) $ (0.53)
========== ========= ========== =========
Shares used in computing pro forma basic and
diluted net loss per common share 30,151 16,808 25,914 16,139
========== ========= ========== =========
</TABLE>
See notes to condensed consolidated financial statements.
2
<PAGE>
CACHEFLOW INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
<TABLE>
<CAPTION>
Nine Months Ended
January 31,
----------------------------
2000 1999
---------- ---------
<S> <C> <C>
Operating Activities
Net loss $(42,953) $(8,605)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization 479 174
Stock compensation 26,869 1,830
Unrealized loss on investments (73) -
Interest on notes receivable from stockholders (73) -
Changes in operating assets and liabilities:
Accounts receivable (1,413) (2,000)
Inventories (3,316) (777)
Prepaid expenses and other current assets (397) (733)
Other assets (596) (82)
Accounts payable 1,155 431
Accrued liabilities 2,515 506
---------- ---------
Net cash used in operating activities (17,803) (9,256)
Investing Activities
Purchases of property and equipment (2,713) (592)
Purchases of investments, net (23,547) -
---------- ---------
Net cash used in investing activities (26,260) (592)
Financing Activities
Net proceeds from issuance of preferred stock 23,526 -
Net proceeds from issuance of common stock 132,245 730
Repurchase of employee stock (157) -
Borrowings from line of credit - 645
Proceeds from issuance of debt obligations - 3,907
Payments on debt obligations and line of credit (4,753) (52)
---------- ---------
Net cash provided by financing activities 150,861 5,230
---------- ---------
Net increase (decrease) in cash and cash equivalents 106,798 (4,618)
Cash and cash equivalents at beginning of period 2,291 7,349
---------- ---------
Cash and cash equivalents at end of period $109,089 $ 2,731
========== =========
Supplemental disclosure of cash flow information
Cash paid for interest $ 309 $ 145
========== =========
Non-cash investing and financing activities
Purchase of equipment under capital lease $ 110 $ -
========== =========
Net exercise of preferred stock warrants $ 509 $ -
========== =========
Accretion of preferred stock $ 1,967 $ -
========== =========
Issuance of note receivable to stockholder $ 2,519 $ -
========== =========
</TABLE>
See notes to condensed consolidated financial statements.
3
<PAGE>
CACHEFLOW INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
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 January 31, 2000, and for the
three- and nine-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 January 31, 2000 are not necessarily
indicative of results for the entire fiscal year or future periods.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted under the Securities and Exchange Commission's
rules and regulations. These condensed consolidated financial statements and
notes included herein should be read in conjunction with the Company's audited
consolidated financial statements and notes for the year ended April 30, 1999,
included in the Company's Form S-1 declared effective November 18, 1999 by the
Securities and Exchange Commission.
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 upon 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. 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>
<S> <C> <C>
January 31, April 30,
2000 1999
------------ ------------
Raw materials $3,240 $ 610
Work-in-process 720 45
Finished goods 288 277
------------ ------------
$4,248 $ 932
============ ============
</TABLE>
Note 5. Litigation
On September 16, 1999, Nokia IP, Inc. filed a lawsuit in Santa Clara County
Superior Court naming CacheFlow Inc., and certain officers of the company, as
defendants. These officers were formerly employed by Ipsilon Networks, Inc.,
which was acquired by Nokia in December 1997. Following the acquisition, these
officers became employees of Nokia upon completion of the acquisition. Nokia's
Complaint alleges that the Company and these officers formerly employed by Nokia
acted improperly in hiring other former Nokia employees. The lawsuit also claims
that a certain officer of the Company
4
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CACHEFLOW INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
violated a non-competition provision contained in his employment agreement with
Nokia. The Complaint demanded compensatory and punitive damages as well as a
court order prohibiting the defendants from disclosing or using Nokia's trade
secrets or confidential information, or acting in a manner that violates these
officers' contractual duties to Nokia. The Company and the individual defendants
filed an answer to the Complaint denying Nokia's allegations. On November 14,
1999, the Company and Nokia executed a term sheet settling the litigation. On
February 8, 2000, the Company completed a definitive settlement agreement with
Nokia and thereafter Nokia filed with the court a notice of dismissal
terminating the lawsuit. The confidential settlement agreement does not require
the Company to make any monetary payments to Nokia.
From time to time and in the ordinary course of business, the Company may be
subject to various claims, charges, and litigation. In the opinion of
management, final judgments from such pending claims, charges, and litigation,
if any, against the Company would not have a material adverse effect on its
consolidated financial position, results of operations, or cash flows.
Note 6. Comprehensive Income (Loss)
The Company reports comprehensive income (loss) in accordance with the Financial
Accounting Standards Board's (FASB) Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income." Included in other comprehensive
income (loss) for the Company are adjustments to record unrealized gains and
losses on available-for-sale securities. These adjustments are accumulated in
"Accumulated other comprehensive loss" in the stockholder's equity section of
the balance sheet. The comprehensive net losses for the three- and nine-month
periods ended January 31, 2000 were $17,845,000 and $44,993,000, respectively.
The comprehensive net losses for the three- and nine-month periods ended January
31, 1999 do not differ from the reported net losses.
Note 7. Net Loss Per Common Share
Basic net loss per common share and diluted net loss per common share are
presented in conformity with the FASB's Statement of Financial Accounting
Standards No. 128, "Earnings Per Share" (FAS 128), for all periods presented.
In accordance with FAS 128, basic and diluted net loss per common share has been
computed using the weighted-average number of shares of common stock outstanding
during the period, less the weighted average number of shares of common stock
issued to founders, investors and employees that are subject to repurchase. Pro
forma basic and diluted net loss per common share, as presented in the condensed
consolidated statements of operations, have been computed as described above and
also give effect, under Securities and Exchange Commission guidance, to the
conversion of the convertible preferred stock (using the if-converted method)
from the original date of issuance. The shares used in calculating the pro forma
basic and diluted net loss per common share amounts also include warrants to
purchase series A and C preferred stock as such warrants expired upon the
completion of the Company's initial public offering of its common stock. The
weighted average share amounts exclude warrants to purchase series B preferred
stock as such warrants remained outstanding after the initial public offering
was complete.
5
<PAGE>
CACHEFLOW INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
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 Nine months ended
January 31, January 31,
------------------------- ---------------------------
<S> <C> <C> <C> <C>
2000 1999 2000 1999
---------- ---------- ---------- ----------
(unaudited) (unaudited)
Historical:
Net loss available to common stockholders $(17,772) $(2,817) $(44,920) $ (8,605)
======== ======= ======== ========
Weighted-average shares of common stock
outstanding 32,258 9,247 19,329 8,943
Less: Weighted-average shares subject to
repurchase (4,655) (2,972) (4,458) (3,337)
-------- ------- -------- ---------
Weighted-average shares used in computing basic
and diluted net loss per common share 27,603 6,275 14,871 5,606
======== ======= ======== =========
Basic and diluted net loss per common share $ (0.64) $ (0.45) $ (3.02) $ (1.53)
======== ======= ======== =========
Pro forma:
Shares used above 27,603 6,275 14,871 5,606
Pro forma adjustment to reflect the weighted
effect of the assumed conversion of preferred
stock 2,437 9,970 10,561 9,970
Pro forma adjustment to reflect the weighted
effect of assumed exercise and conversion of
preferred stock warrants 111 563 482 563
-------- ------- -------- ---------
Shares used in computing pro forma basic and
diluted net loss per common share 30,151 16,808 25,914 16,139
======== ======= ======== =========
Pro forma basic and diluted net loss per common
share $ (0.59) $ (0.17) $ (1.73) $ (0.53)
======== ======= ======== =========
</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 8. Stockholders' Equity (Deficit)
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
recorded a non-cash charge of approximately $1,967,000 in the three months ended
January 31, 2000 to accrete the value of the preferred stock to its fair value.
This non-cash charge was recorded as an increase in accumulated deficit with a
corresponding credit to additional paid-in capital.
6
<PAGE>
CACHEFLOW INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Common Stock
On November 19, 1999, the Company completed its initial public offering, in
which it sold 5,750,000 shares of common stock (including an over-allotment
option of 750,000 shares) at $24 per share. Upon the closing of the offering,
all of the Company's preferred stock converted to common stock. Proceeds from
the offering were approximately $126,490,000, net of underwriter's discounts,
commissions and offering costs.
The Company has entered into Stock Purchase Agreements in connection with the
sale of common stock to employees 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 and
directors service periods. The repurchase right generally declines on a
percentage basis over four years based on the length of each respective
employee's continued employment with the Company and the director's membership
on the Board of Directors. As of January 31, 2000 and 1999, 4,721,822 and
2,844,835 shares, respectively, of common stock issued under these agreements
were subject to repurchase.
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 3,000,000
shares of common stock have been reserved for issuance under the plan. Under
the plan, eligible employees may purchase common stock through payroll
deductions, which in any event may not exceed 15% of an employee's compensation,
at a price equal to the lower of 85% of the fair market value of the common
stock at the beginning of each offering period or at the end of each purchase
period. The number of shares reserved under the Employee Stock Purchase Plan
automatically increased by 500,000 shares beginning January 31, 2000 and will
continue to do so annually. The Company's Board of Directors, at its
discretion, may reduce the automatic annual increase in reserved shares.
1999 Stock Incentive Plan
In September 1999, the Company's Board of Directors adopted the 1999 Stock
Incentive Plan (the "Incentive Plan") under which 7,850,988 shares of common
stock have been reserved for issuance. The plan became effective upon the
effective date of the Company's initial public offering of its common stock. The
number of shares reserved under the Incentive Plan automatically increased on
January 1, 2000 by 1,794,013 shares and will increase on an annual basis by the
lesser of 5% of the total amount of common stock outstanding or 2,000,000
shares. The exercise price for incentive stock options and non-qualified stock
options may not be less than 100% and 85%, respectively, of the fair market
value of common stock on the option grant date.
1999 Director Option Plan
In September 1999, the Company's Board of Directors adopted the 1999 Director
Option Plan (the "Directors' Plan") under which 600,000 shares of common stock
have been reserved for issuance. The Director's Plan became effective on the
date of its adoption. Each non-employee joining the Board of Directors following
the effective date of the initial public offering will automatically receive
options to purchase 25,000 shares of common stock. In addition, each non-
employee director will automatically receive options to purchase 5,000 shares of
common stock at each annual meeting of the Board of Directors held in the year
2000 and thereafter. Each option will have an exercise price equal to the fair
market value of the common stock on the option grant date. The number of shares
reserved under the Directors' Plan automatically increased by 100,000 shares
beginning January 1, 2000 and will continue to do so annually. The Company's
Board of Directors, at its discretion, may reduce the automatic annual increase
in reserved shares.
7
<PAGE>
CACHEFLOW INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Stock Compensation
For the three months ended January 31, 2000 and 1999, the Company recorded
deferred stock compensation of $24,062,000 and $709,000, respectively. For the
nine months ended January 31, 2000 and 1999, the Company recorded deferred stock
compensation of $71,848,000 and $4,028,000, 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 January 31, 2000 and 1999, the Company recorded amortization
of stock compensation of $8,634,000 and $871,000, respectively. For the nine
months ended January 31, 2000 and 1999, the Company recorded amortization of
stock compensation of $26,869,000 and $1,677,000, respectively. At January 31,
2000 and April 30, 1999, the Company had $55,062,000 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 9. Subsequent Events
2000 Supplemental Stock Option Plan
In February 2000, the Company's board of directors adopted the 2000 Supplemental
Stock Option Plan (the "2000 Plan") under which 3,000,000 shares of common
stock have been reserved for issuance. Employees and consultants are eligible
to participate in the 2000 Plan, and executive officers are not eligible to
participate. The 2000 Plan provides for the grant of nonstatutory stock options
to purchase shares of our common stock and restricted shares of our common
stock. The exercise price for stock options issued under the 2000 Plan may not
be less than 25% of the fair market value of common stock on the option grant
date.
8
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CACHEFLOW INC.
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 about 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 declared effective by 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 January 31, 2000 were attributable to sales of our
Internet caching appliance products. We anticipate that these products will
continue to account for a substantial portion of our net sales for the
foreseeable future.
The Company recorded deferred stock compensation of approximately $24.1 million
and $709,000 for the three months ended January 31, 2000 and 1999, and $71.8
million and $4.0 million for the nine months ended January 31, 2000 and 1999.
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 $8.6 million and
$871,000 for the three months ended January 31, 2000 and 1999, and $26.9 million
and $1.7 million for the nine months ended January 31, 2000 and 1999. Between
February 1, 2000 and February 29, 1999, we recorded no additional deferred stock
compensation; however, the Company may record additional compensation in the
future if management decides to grant below-market stock options in order to
attract and retain employees in a highly competitive labor market. We expect
compensation expense, which is primarily attributable to amortization of
deferred compensation charges, to impact our reported results through April 30,
2004. Given the balance of deferred stock compensation on the balance sheet and
recent grant history, we expect stock compensation expense to be a significant
operating expense as this deferral is recognized.
We have incurred net losses in each quarter since inception. As of January 31,
2000, we had an accumulated deficit of $65.1 million. Our net loss available to
common stockholders for the three months ended January 31, 2000 was $17.8
million and our net loss available to common stockholders for the nine months
ended January 31, 2000 was $44.9 million. These losses resulted from significant
costs incurred in the development and sale of our products and services, and
from amortization of deferred stock compensation. We expect 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
9
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CACHEFLOW INC.
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 Nine Months Ended
January 31, January 31,
--------------------- ---------------------------
2000 1999 2000 1999
-------- -------- -------- ---------
<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 38.4 40.4 38.5 52.3
-------- -------- -------- ---------
Gross margin 61.6 59.6 61.5 47.7
Operating expenses:
Research and development 34.1 44.4 40.4 65.8
Sales and marketing 115.2 75.2 108.1 115.0
General and administrative 16.2 23.2 17.0 35.9
Stock compensation 107.5 39.6 163.0 41.0
-------- -------- -------- ---------
Total operating expenses 273.0 182.4 328.5 257.7
Operating loss (211.4) (122.8) (267.0) (210.0)
Interest income (expense), net 14.6 (5.2) 6.4 (0.3)
-------- -------- -------- ---------
Net loss (196.8) (128.0) (260.6) (210.3)
Accretion of preferred stock (24.4) - (11.9) -
-------- -------- -------- ---------
Net loss available to common
stockholders (221.2)% (128.0)% (272.5)% (210.3)%
======== ======== ======== =========
</TABLE>
Net Sales. Net sales increased to $8.0 million for the quarter ended January 31,
2000 from $2.2 million for the quarter ended January 31, 1999. This increase was
primarily 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, 3000 and 5000 Series products, offset by decreased unit sales of 1000
Series products. During the quarter ended January 31, 2000, no customer
accounted for more than 10% of our net sales, and during the quarter ended
January 31, 1999, two customers accounted for 24% and 19% of our net sales.
Direct and indirect channel sales accounted for 54% and 46% of our net sales for
the quarter ended January 31, 2000 and 81% and 19% of our net sales for the
quarter ended January 31, 1999. Net sales from international operations were
$3.3 million, or 41% of net sales, for the quarter ended January 31, 2000, and
$1.0 million, or 47% of net sales, for the quarter ended January 31, 1999.
Net sales increased to $16.5 million for the nine months ended January 31, 2000
from $4.1 million for the nine months ended January 31, 1999. 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 nine months ended January 31, 2000, no customer
accounted for more than
10
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CACHEFLOW INC.
10% of our net sales, and during the nine months ended January 31, 1999, three
customers accounted for 10%, 10%, and 13% of our net sales. Direct and indirect
channel sales accounted for 61% and 39% of our net sales for the nine months
ended January 31, 2000 and 65% and 35% of our net sales for the nine months
ended January 31, 1999. Net sales from international operations were $6.9
million, or 42% of net sales, for the nine months ended January 31, 2000, and
$1.3 million, or 33% of net sales, for the nine months ended January 31, 1999.
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 year-over-year growth rate in our net
sales of 265% is not likely to continue in the future.
Gross Profit. Gross profit increased to $5.0 million for the quarter ended
January 31, 2000 from $1.3 million for the quarter ended January 31, 1999.
Gross profit increased to $10.1 million for the nine months ended January 31,
2000 from $2.0 for the nine months ended January 31, 1999. 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 61.6% for the quarter ended January 31, 2000 from 59.6% for
the quarter ended January 31, 1999. Gross margin increased to 61.5% for the
nine months ended January 31, 2000 from 47.7% for the nine months ended January
31, 1999. 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 $2.7 million for the quarter ended January 31,
2000 from $978,000 for the quarter ended January 31, 1999. Research and
development expenses increased to $6.7 million for the nine months ended January
31, 2000 from $2.7 million for the nine months ended January 31, 1999. 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 59 at January 31, 2000 from 22 at January 31,
1999. As a percentage of net sales, research and development expenses decreased
to 34.1% for the quarter ended January 31, 2000 from 44.4% for the quarter ended
January 31, 1999. As a percentage of net sales, research and development
expenses decreased to 40.4% for the nine months ended January 31, 2000 from
65.8% for the nine months ended January 31, 1999. 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 in future
periods. Through January 31, 2000, all research and development costs have been
expensed as incurred.
Sales and Marketing. Sales and marketing expenses consist primarily of salaries
and benefits, commissions, advertising and promotional expenses, and customer
service and support costs. Sales and marketing expenses increased to $9.3
million for the quarter ended January 31, 2000 from $1.7 million for the quarter
ended January 31, 1999. Sales and marketing expenses increased to $17.8 million
for the nine months ended January 31, 2000 from $4.7 million for the nine months
ended January 31, 1999. 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 143 at January 31, 2000
from 27 at January 31, 1999. As a percentage of net sales, sales and marketing
expenses increased to 115.2% for the quarter ended January 31, 2000 from 75.2%
for the quarter ended January 31, 1999. This increase in sales and marketing
expenses as a percentage of net sales reflects the fact that our sales and
marketing expenses during this period increased more rapidly than our net sales.
As a percentage of net sales, sales and marketing expenses decreased to 108.1%
for the nine months ended January 31, 2000 from 115.0% for the nine months ended
January 31, 1999. This decrease in sales and marketing expenses as a percentage
of net sales reflects the fact that our net sales during this period increased
more rapidly than our sales and marketing expenses. We expect to continue to
increase
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CACHEFLOW INC.
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
$1.3 million for the quarter ended January 31, 2000 from $510,000 for the
quarter ended January 31, 1999. General and administrative expenses increased
to $2.8 million for the nine months ended January 31, 2000 from $1.5 million for
the nine months ended January 31, 1999. 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 25 at January 31,
2000 from 9 at January 31, 1999. As a percentage of net sales, general and
administrative expenses decreased to 16.2% for the quarter ended January 31,
2000 from 23.2% for the quarter ended January 31, 1999. As a percentage of net
sales, general and administrative expenses decreased to 17.0% for the nine
months ended January 31, 2000 from 35.9% for the nine months ended January 31,
1999. These decreases in general and administrative expenses as a percentage of
net sales reflect the fact that our net sales during these periods increased
more rapidly than our general and administrative expenses. We expect general
and administrative expenses to increase in absolute dollars as we continue to
increase 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 $8.6 million for the
quarter ended January 31, 2000 from $871,000 for the quarter ended January 31,
1999. Stock compensation expense increased to $26.9 million for the nine months
ended January 31, 2000 from $1.7 million for the nine months ended January 31,
1999.
Other Income (Expense), Net. Other income (expense), net increased to net other
income of $1.2 million for the quarter ended January 31, 2000, from net other
expense of $115,000 for the quarter ended January 31, 1999. Other (expense)
income, net increased to net other income of $1.1 million for the nine months
ended January 31, 2000, from net other expense of $11,000 for the nine months
ended January 31, 1999. These increases were primarily attributable to
increased interest income earned on the Company's cash equivalents and short-
term investments, which grew significantly following the completion of the
Company's initial public offering in November 1999.
Accretion of Preferred Stock. Accretion of preferred stock increased to $2.0
million for the three- and nine- month periods ended January 31, 2000, from zero
for the three- and nine-month periods ended January 31, 1999. This charge was
recorded in connection with the November 1999 issuance of 280,953 shares of
Series D preferred stock at $11.00 per share to accrete the value of the
preferred stock to its fair value.
Liquidity and Capital Resources
From inception through November 1999, we financed our operations and the
purchase of property and equipment through private sales of preferred stock,
with net proceeds of $37.9 million, as well as through bank loans and equipment
leases. In November 1999, we financed our operations through an initial public
offering of our common stock, with net proceeds of $126.5 million, net of
underwriting discounts, commissions and offering costs. At January 31, 2000, we
had $109.1 million in cash and cash equivalents, $18.7 million in short-term
investments, and $129.1 million in working capital.
Net cash used in operating activities was $17.8 million for the nine months
ended January 31, 2000 and $9.3 million for the nine months ended January 31,
1999. We used cash primarily to fund our net losses from operations.
Net cash used in investing activities was $26.3 million for the nine months
ended January 31, 2000 and $592,000 for the nine months ended January 31, 1999.
Net cash used in investing activities was primarily attributable to purchases of
short-term securities, and to a lesser extent, to purchases of property, plant
and equipment. We expect that, in the future, any cash in excess of current
requirements will continue to be invested in investment grade, interest-bearing
securities.
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CACHEFLOW INC.
Net cash provided by financing activities was $150.9 million for the nine months
ended January 31, 2000 and $5.2 million for the nine months ended January 31,
1999. During May 1999, we raised approximately $20.0 million in gross proceeds
from the sale of Series C Preferred Stock at $4.575 per share. During October
1999, we raised approximately $2.8 million through the cash exercise of options
granted to a board member and consultant to purchase 702,380 shares of common
stock at $4.00 per share. During November 1999, we raised approximately $3.1
million through the sale of 280,953 shares of Series D Preferred Stock at $11.00
per share. We also raised approximately $126.5 million, net of underwriting
discounts, commissions and offering costs through the sale of 5,750,000 shares
of our common stock in an initial public offering at $24.00 per share. During
December 1999, $4.5 million of these proceeds were used to repay all of the
Company's outstanding debt.
Capital expenditures were $2.7 million for the nine months ended January 31,
2000 and $592,000 for the nine months ended January 31, 1999. Our capital
expenditures consisted of purchases of plant, equipment and software. Current
capital commitments are approximately $440,000, principally for a new enterprise
resource planning system and office furniture and equipment. We expect that our
capital expenditures will continue to increase in the future.
We currently have a $2.5 million credit facility, which expires in April 2000.
The facility bears interest at the prime interest rate plus 0.50%. In December
1999, the outstanding balance on this line of credit was repaid, so the full
$2.5 million facility is currently available for borrowing. This credit
facility requires 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. Our second credit facility, which included a
$3.5 million three-year term loan and a $350,000 equipment line of credit, was
repaid in full during December 1999 and was terminated.
We believe that working capital will be sufficient to meet our working capital
and capital expenditure requirements for at least the next twelve months.
Thereafter, we may find it necessary to obtain additional equity or debt
financing. Furthermore, if cash is used for acquisitions or other unanticipated
uses, we may need additional capital sooner than expected. In the event
additional financing is required, we may not be able to raise it on acceptable
terms or at all.
Year 2000 Readiness
In the prior year, the Company discussed the nature and progress of its plans to
become Year 2000 ready. In late 1999, the Company completed its assessment and
testing of systems. As a result of those planning and assessment efforts, the
Company experienced no significant disruptions in mission critical information
technology and non-information technology systems and believes those systems
successfully responded to the year 2000 date change. To date, Year 2000
compliance costs have not been material. The Company is not aware of any
material problems resulting from Year 2000 issues, either with its products, its
internal systems, or the products and services of third parties. The Company
will continue to monitor its mission critical computer applications and those of
its suppliers and vendors throughout the Year 2000 to ensure that any latent
Year 2000 matters that may arise are addressed promptly.
If it comes to our attention that there are any Year 2000 problems with our
products or that some of our third-party hardware and software used in our
internal systems are not Year 2000 compliant, then we will endeavor to make
modifications to our products and internal systems, or purchase new internal
systems, to quickly respond to the problem. At the present time, however, we do
not anticipate incurring additional material costs related to Year 2000
compliance.
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CACHEFLOW INC.
FACTORS AFFECTING FUTURE OPERATING RESULTS
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 risks are described in more
detail in this "Factors Affecting Future Operating Results" section. Our
business will be seriously harmed if we do not successfully execute our business
strategy or if we do not successfully address the risks we face.
We have a history of losses, expect to incur future losses and may never achieve
profitability, which could result in the decline of the market price of our
common stock.
We incurred net losses available to common stockholders of $17.8 million and
$2.8 million for the three months ended January 31, 2000 and 1999. We incurred
net losses available to common stockholders of $44.9 million and $8.6 million
for the nine months ended January 31, 2000 and 1999. As of January 31, 2000, we
had an accumulated deficit of $65.1 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 January 31, 2000,
we had an aggregate of $55.1 million of deferred compensation to be amortized.
The Company may record additional compensation in the future if management
decides to grant below-market stock options in order to attract and retain
employees in a highly competitive labor market.
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;
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. 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.
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, Dell 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
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their overall purchase activity. Large customers typically require approvals at
a number of management levels within their organizations, and, therefore,
frequently have longer sales cycles.
We are entirely dependent on market acceptance of our Internet caching appliance
product family and, as a result, a decline in sales or lack of market acceptance
of these products could cause our sales to fall.
To date, our Internet caching appliance product family and related services have
accounted for all of our net sales. We anticipate that revenues from our current
product family and services will continue to constitute substantially all of our
net sales for the foreseeable future. As a result, a decline in the prices of,
or demand for, our current product family and services, or their failure to
achieve broad market acceptance, would seriously harm our business. The
CacheFlow 100 Series, 500 Series, 3000 Series and 5000 Series products are the
only products that we currently sell. Our CacheFlow 1000 Series and 2000 Series
products, which have historically accounted for a substantial portion of our net
sales, have been discontinued and replaced by our recently introduced CacheFlow
3000 Series products. We introduced our 3000 Series product in September 1999
and our 5000 Series product in June 1999. We cannot be certain that our
CacheFlow 3000 Series or 5000 Series products will continue to achieve any
significant degree of market acceptance.
If we are unable to introduce new products and services that achieve market
acceptance quickly, we could lose existing and potential customers and our sales
would decrease.
We need to develop and introduce new products and enhancements to existing
products on a timely basis that keep pace with technological developments and
emerging industry standards and address the increasingly sophisticated needs of
our customers. We intend to extend the offerings under our product family in the
future, both by introducing new products and by introducing enhancements to our
existing products. However, we may experience difficulties in doing so, and our
inability to timely and cost-effectively introduce new products and product
enhancements, or the failure of these new products or enhancements to achieve
market acceptance, could seriously harm our business. Life cycles of our
products are difficult to predict, because the market for our products is new
and evolving and characterized by rapid technological change, frequent
enhancements to existing products and new product introductions, changing
customer needs and evolving industry standards. The introduction of competing
products that employ new technologies and emerging industry standards could
render our products and services obsolete and unmarketable or shorten the life
cycles of our products and services. The emergence of new industry standards
might require us to redesign our products. If our products are not in
compliance with industry standards that become widespread, our customers and
potential customers may not purchase our products.
Because we depend on several third-party manufacturers to build portions of our
products, we are susceptible to manufacturing delays and sudden price increases,
which could prevent us from shipping customer orders on time, if at all, and may
result in the loss of sales and customers.
We rely on several third-party manufacturers to build portions of our products.
If we are unable to manage our relationships with these manufacturers
effectively or if these manufacturers fail to meet our future requirements for
timely delivery, our business would be seriously harmed. We have no written
agreement with any of these manufacturers and they fulfill our supply
requirements on the basis of individual purchase orders from us. Accordingly,
these manufacturers are not obligated to continue to fulfill our supply
requirements, and the prices we are charged for these components could be
increased on short notice. Any interruption in the operations of any one of
these manufacturers would adversely affect our ability to meet our scheduled
product deliveries to our customers, which could cause the loss of existing or
potential customers and would seriously harm our business. In addition, the
products that these manufacturers build for us may not be sufficient in quality
or in quantity to meet our needs. Our delivery requirements could exceed the
capacity of these manufacturers, which would likely result in manufacturing
delays, which could result in lost sales and the loss of existing and potential
customers. We cannot be certain that these manufacturers or any other
manufacturer will be able to meet the technological or delivery requirements of
our current products or any future products that we may develop and introduce.
The inability of these manufacturers or any other of our contract manufacturers
in the future to provide us with adequate supplies of high-quality products, or
the loss of any of our contract manufacturers in the future, would cause a delay
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in our ability to fulfill customer orders while we attempt to obtain a
replacement manufacturer. Delays associated with our attempting to replace or
our inability to replace one of our manufacturers would seriously harm our
business.
We may experience production delays, quality control problems and assembly
capacity constraints in assembling our products, which could result in a decline
of sales.
We currently conduct 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
17
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business. We are particularly dependent on hiring additional personnel to
increase our direct sales and research and development organizations.
Competition for personnel is intense, especially in the San Francisco Bay Area,
and we may fail to retain our key employees, or attract, assimilate or retain
other highly qualified personnel in the future. If so, our business would be
seriously harmed.
Our management team is new, and our business could be seriously harmed if
integration of our management team into our company is not successful.
We have recently experienced significant transition in our management team.
Brian NeSmith, our President and Chief Executive Officer, joined us in March
1999. 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. Susan Thornton, our Vice President,
General Counsel, and Assistant Secretary, joined us in January 2000. Our
business could be seriously harmed if integration of our management team into
our company is not successful. We expect that it will take time for our new
management team to integrate into our company and it is too early to predict
whether these changes will be successful.
In order to manage our growth and expansion, we will need to improve and
implement new systems, procedures and controls, which could be time-consuming
and costly.
We have expanded our operations rapidly since the inception of our company and
we currently intend to continue this expansion. This expansion of our operations
has placed and is expected to continue to place a significant strain upon our
management systems and financial and operational resources. If we are unable to
effectively manage future growth and expansion, our business will be seriously
harmed. We currently have research and development facilities in Sunnyvale,
California; Redmond, Washington and Waterloo, Ontario, Canada. The coordination
and management of these product development organizations that are located at
different sites requires significant management attention and coordination,
particularly from our managerial and engineering organizations. If we are unable
to coordinate and manage these separate development organizations, our business
will be seriously harmed.
Our ability to compete effectively and to manage future expansion of our
operations will require us to continue to improve our financial and management
controls, reporting systems and procedures on a timely basis, and expand, train
and manage our employee work force. The number of our employees increased from
40 at April 30, 1998 to 245 at January 31, 2000, and we plan to further increase
our headcount. We recently implemented a new enterprise resource planning
software system that replaced substantially all of our business and
manufacturing systems. While we have not had significant problems to date, we
may encounter difficulties in transitioning to the new enterprise resource
planning software system. Even after we implement this system, our personnel,
systems, procedures and controls may be inadequate to support our future
operations.
If we fail to expand our direct and indirect sales channels, our sales will not
grow.
We need to substantially expand our direct sales operations, both domestically
and internationally, in order to increase market awareness and sales of our
products and services. Our products and services require a sophisticated sales
effort targeted at senior management of our customers. We have recently expanded
our direct sales force and plan to hire additional sales personnel. New hires
will require extensive training and typically take several months to achieve
productivity. Competition for qualified sales personnel is intense, and we might
not be able to hire the kind and number of sales personnel we are targeting. If
we fail to increase our direct sales capabilities as we have planned, our
business will be seriously harmed.
We also need to expand our indirect sales channels, and if we fail to do so our
ability to market and sell our products could be seriously harmed. We depend on
our indirect sales channels, which include resellers, systems integrators and
original equipment manufacturers, for a significant percentage of our net sales.
For
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example, for the quarter ended January 31, 2000, approximately 46% 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 January 31, 2000, sales to customers outside of the United
States and Canada accounted for approximately 41% of our net sales. We expect
international customers to continue to account for a significant percentage of
net sales in the future, but we may fail to maintain or increase international
market demand for our products. Also, because our international sales are
currently denominated in United States dollars, an increase in the value of the
United States dollar relative to foreign currencies could make our products more
expensive and, therefore, potentially less competitive in international markets,
and this would decrease our international sales. Our ability to expand
international sales depends on our ability to expand our international
operations, including establishing manufacturing assembly capabilities overseas,
hire international personnel and recruit additional international resellers. To
the extent we are unable to do so in a timely manner, our growth, if any, in
international sales will be limited and our business could be seriously harmed.
In addition, if we fail to expand and improve our worldwide operating systems,
our ability to accurately forecast sales demand, manage our supply chain and
record and report financial and management information will be adversely
affected, seriously harming our business.
Undetected software or hardware errors could cause us to incur significant
warranty and repair costs and negatively impact the market acceptance of our
products.
Our products may contain undetected software or hardware errors. These errors
may cause us to incur significant warranty and repair costs, divert the
attention of our engineering personnel from our product development efforts and
cause significant customer relations problems. The occurrence of these problems
could result in the delay or loss of market acceptance of our products and would
likely seriously harm our business. All of our products operate on our
internally developed CacheOS operating system. As a result, any error in CacheOS
will affect all of our products. We have experienced minor errors in the past in
connection with new products. We expect that errors will be found from time to
time in new or enhanced products after commencement of commercial shipments.
We could be subject to product liability claims, which are time-consuming and
costly to defend.
Our customers install our Internet caching appliances directly into their
network infrastructures. Any errors, defects or other performance problems with
our Internet caching appliance products could negatively impact our customers'
internal networks, resulting in financial or other damages to our customers. Our
customers may then seek damages from us for their losses. 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.
19
<PAGE>
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 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 eight United States patent applications on file and pending
before the United States Patent and Trademark Office. We also currently have
eight 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 January 31, 2000, we had approximately $109.1 million in cash and cash
equivalents. In November 1999, we raised $126.5 million, net of underwriting
discounts, commissions and offering costs in our initial public offering. We
believe that these amounts will enable us to meet our capital requirements for
at least
20
<PAGE>
the next twelve months. However, if cash is used for acquisitions or other
unanticipated uses, we may need additional capital. The development and
marketing of new products and the expansion of indirect channels and associated
support personnel will require a significant commitment of resources. In
addition, if the market for Internet caching appliances develops at a slower
pace than anticipated or if we fail to establish significant market share and
achieve a meaningful level of sales, we could be required to raise substantial
additional capital. We cannot be certain that additional capital will be
available to us on favorable terms, or at all. If we were unable to raise
additional capital when we require it, our business would be seriously harmed.
Risks Related to the Internet Caching Appliance Industry
The market for Internet caching appliances is new and unpredictable, and if this
market does not develop as we anticipate, our sales may not grow.
Sales of our products depend on increased demand for Internet caching
appliances. The market for Internet caching appliances is a new and rapidly
evolving market. If the market for Internet caching appliances fails to grow as
we anticipate, or grows more slowly than we anticipate, our business will be
seriously harmed. Because this market is new, we cannot predict its potential
size or future growth rate. Our ability to generate net sales in this emerging
market will depend on, among other things, our ability to:
. educate potential end users and indirect channel partners about the
benefits of Internet caching appliances;
. continue to develop our direct sales channel; and
. establish and maintain relationships with leading indirect channel
partners.
The legal environment in which we operate is uncertain and claims against us
could cause our business to suffer.
Our Internet caching appliances operate in part by storing material available on
the Internet and making this material available to end users from our appliance.
This creates the potential for claims to be made against us, either directly or
through contractual indemnification provisions with customers, for defamation,
negligence, copyright or trademark infringement, personal injury, invasion of
privacy or other legal theories based on the nature, content or copying of these
materials. It is also possible that if any information provided through any of
our products contains errors, third parties could make claims against us for
losses incurred in reliance on this information. Our insurance may not cover
potential claims of this type or be adequate to protect us from all liability
that may be imposed.
The adoption of laws that impose taxes on Internet commerce could adversely
affect our business.
Tax authorities at the international, federal, state and local levels are
currently reviewing the appropriate tax treatment of companies engaged in
Internet commerce. Many of our customers are engaged in Internet commerce, and
any taxes imposed on them may adversely impact their businesses and may result
in order cancellations or postponements of product purchases by them, which
would seriously harm our business. Laws regarding the Internet remain largely
unsettled and the adoption or modification of laws or regulations relating to
the Internet, or interpretations of existing law, could seriously harm our
business.
Because the sales of our products are dependent on the increased use and
widespread adoption of the Internet, if use of the Internet does not develop as
we anticipate, our sales may not grow.
Sales of our products depend on the increased use and widespread adoption of the
Internet. Our business would be seriously harmed if the use of the Internet does
not increase as anticipated or if our ISP customers' Internet-related services
are not well received by the marketplace. The acceptance and use of the Internet
in international markets, where we derive a large portion of our net sales, are
in earlier stages of development
21
<PAGE>
than in the United States. If the Internet fails to gain sufficient acceptance
in international markets, our business could be seriously harmed. The resolution
of various issues concerning the Internet will likely affect the use and
adoption of the Internet. These issues include security, reliability, capacity,
congestion, cost, ease of access and quality of service. For example, recently
certain popular websites experienced denial-of-service attacks, which called
into question the ability of these and other websites to ensure the security and
reliability of their on-line businesses. Even if these issues are resolved, if
the market for Internet-related products and services fails to develop, or
develops at a slower pace than anticipated, our business would be seriously
harmed.
Governmental regulation of the communications industry may negatively affect our
customers and result in decreased demand for our products, which would cause a
decline in our sales.
The jurisdiction of the Federal Communications Commission, or FCC, extends to
the communications industry, to our customers and to the products that our
customers sell. Future regulations set forth by the FCC or other regulatory
bodies may adversely affect Internet-related industries. Regulation of our
customers may seriously harm our business. For example, FCC regulatory policies
that affect the availability of data and Internet services may impede our
customers' penetration into some markets. In addition, international regulatory
bodies are beginning to adopt standards for the communications industry. The
delays that these governmental processes entail may cause order cancellations or
postponements of product purchases by our customers, which would seriously harm
our business.
Risks Related to Securities Markets
Our stock price 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 throughout the world. As
a result, our financial results could be affected by factors such as changes in
foreign currency exchange rates or weak economic
22
<PAGE>
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 41% and 42% of total net sales for the
three- and nine-month periods ended January 31, 2000.
As of January 31, 2000, we had approximately $126.1 million invested primarily
in fixed-rate, short-term corporate and U.S. government debt securities which
are subject to interest rate risk and will decrease in value if market U.S.
interest rates increase. A hypothetical increase or decrease in market interest
rates of 10% from the market interest rates at January 31, 2000 would cause the
fair value of our investments to change by an immaterial amount due to the
short-term nature of our investment holdings, the majority of which have
maturities of three months or less and are classified as cash and cash
equivalents on our balance sheet. We do not hold any equity securities or
derivative investments.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
See footnote 5 in the notes to the condensed consolidated financial statements
for a discussion and update of the Company's legal proceedings.
Item 2. Changes in Securities and Use of Proceeds
(c) Changes in Securities
During the quarter ended January 31, 2000, the Company granted options to
purchase 1,975,250 shares of common stock to employees of the Company under the
1996 Stock Option Plan. During this period, the Company also granted options to
purchase 526,000 shares of common stock to employees under the 1999 Stock
Incentive Plan and granted options to purchase 300,000 shares of common stock to
certain executives outside of these option plans.
Between February 1 and February 29, 2000, the Company granted options to
purchase 199,750 shares of common stock to employees, consultants, and other
service providers of the Company under the 1999 Stock Incentive Plan.
During the quarter ended January 31, 2000, employees, consultants and other
service providers of the Company exercised options to purchase 564,331 shares of
common stock.
During the quarter ended January 31, 2000, the Company authorized and issued
280,953 shares of series D preferred stock at $11.00 per share.
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.
23
<PAGE>
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 and
approximately $1.8 million has been paid for costs and expenses related to the
offering. None of the costs and expenses related to the offering were 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.
After deducting the underwriting discounts and commissions and the offering
expenses, the net proceeds to the Company from the offering were approximately
$126.5 million, which have been invested in investment grade securities.
Approximately $4.5 million was used to repay outstanding debt obligations and
the remaining balance was invested primarily in corporate and U.S. government
debt securities and will be used for general corporate purposes.
Item 4. Submission of Matters to a Vote of Security Holders
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 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.
24
<PAGE>
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 January 31,
2000.
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: March 16, 2000
25
<PAGE>
EXHIBIT INDEX
Number Exhibit Description
------ -------------------
27.1 Financial Data Schedule.
26
<TABLE> <S> <C>
<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 JANUARY 31, 2000 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> APR-30-2000
<PERIOD-START> MAY-01-1999
<PERIOD-END> JAN-31-2000
<CASH> 109,089
<SECURITIES> 18,651
<RECEIVABLES> 3,670
<ALLOWANCES> (904)
<INVENTORY> 4,248
<CURRENT-ASSETS> 135,211
<PP&E> 4,539
<DEPRECIATION> (844)
<TOTAL-ASSETS> 145,127
<CURRENT-LIABILITIES> 6,087
<BONDS> 0
0
0
<COMMON> 3
<OTHER-SE> 139,037
<TOTAL-LIABILITY-AND-EQUITY> 145,127
<SALES> 16,483
<TOTAL-REVENUES> 16,483
<CGS> 6,348
<TOTAL-COSTS> 27,282
<OTHER-EXPENSES> 28,836
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (1,063)
<INCOME-PRETAX> (44,920)
<INCOME-TAX> 0
<INCOME-CONTINUING> (44,920)
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<NET-INCOME> (44,920)
<EPS-BASIC> (3.02)
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