<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, 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 000-28139
------------------------
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.
OUTSTANDING AT
CLASS November 30, 2000
----- -----------------
Common Stock, par value $0.0001 40,104,688
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
-------------
PART I. FINANCIAL INFORMATION
<S> <C> <C>
Item 1. Condensed Consolidated Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of October 31, 2000 and April
30, 2000 1
Condensed Consolidated Statements of Operations for the three and six
months ended October 31, 2000 and October 31, 1999 2
Condensed Consolidated Statements of Cash Flows for the six months
ended October 31, 2000 and October 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 9-23
Item 3. Quantitative and Qualitative Disclosures About Market Risk 23
</TABLE>
<TABLE>
<CAPTION>
PART II. OTHER INFORMATION
<S> <C>
Item 2. Changes in Securities and Use of Proceeds 23
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 6. Exhibits and Reports on Form 8-K 24
SIGNATURES 25
</TABLE>
i
<PAGE>
CACHEFLOW INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
October 31, April 30,
2000 2000
----------- ----------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 46,049 $ 91,532
Short-term investments 68,666 33,788
Accounts receivable, net 15,507 3,112
Inventories 7,520 4,741
Prepaid expenses and other current assets 1,313 1,200
------------ ----------
Total current assets 139,055 134,373
Property and equipment, net 8,133 4,721
Goodwill, net 152,419 -
Other assets 1,205 1,640
------------ ----------
Total assets $ 300,812 $140,734
============ ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 7,955 $ 2,465
Accrued payroll and related benefits 4,736 2,611
Deferred revenue 4,324 1,375
Other accrued liabilities 5,292 1,487
------------ ----------
Total current liabilities 22,307 7,938
Deferred revenue, less current portion 630 166
------------ ----------
Total liabilities 22,937 8,104
Commitments
Stockholders' equity:
Common stock 4 4
Additional paid-in capital 445,604 264,304
Treasury stock (1,055) (570)
Notes receivable from stockholders (3,756) (4,713)
Deferred stock compensation (29,155) (43,489)
Accumulated deficit (133,755) (82,805)
Accumulated other comprehensive loss (12) (101)
------------ ----------
Total stockholders' equity 277,875 132,630
------------ ----------
Total liabilities and stockholders' equity $ 300,812 $ 140,734
============ ==========
</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,
------------------------------ -------------------------
2000 1999 2000 1999
----------- ----------- --------- --------
<S> <C> <C> <C> <C>
Net sales $ 32,548 $ 4,838 $ 54,993 $ 8,450
Cost of goods sold 11,891 1,886 20,191 3,266
----------- ----------- --------- --------
Gross profit 20,657 2,952 34,802 5,184
Operating expenses:
Research and development 5,524 2,298 10,246 3,911
Sales and marketing 17,330 5,093 31,338 8,574
General and administrative 2,601 829 4,566 1,496
Stock compensation 7,790 15,243 18,565 18,235
Goodwill amortization 14,748 - 24,581 -
----------- ----------- --------- --------
Total operating expenses 47,993 23,463 89,296 32,216
----------- ----------- --------- --------
Operating loss (27,336) (20,511) (54,494) (27,032)
Interest income (expense), net 1,797 (80) 3,713 (116)
----------- ----------- --------- --------
Net loss before income tax (25,539) (20,591) (50,781) (27,148)
Provision for income tax (97) - (169) -
----------- ----------- --------- ---------
Net loss $ (25,636) $ (20,591) $ (50,950) $(27,148)
=========== =========== ========= ========
Basic and diluted net loss per
common share $ (0.75) $ (2.35) $ (1.52) $ (3.19)
=========== =========== ========= ========
Shares used in computing basic and
diluted net loss per common share 34,313 8,775 33,517 8,505
=========== =========== ========= ========
Pro forma basic and diluted net loss
per common share $ (0.75) $ (0.87) $ (1.52) $ (1.19)
=========== =========== ========= ========
Shares used in computing pro forma
basic and diluted net loss per
common share 34,313 23,790 33,517 22,878
=========== =========== ========= ========
</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,
---------------------------
2000 1999
--------- --------
<S> <C> <C>
Operating Activities
Net loss $ (50,950) $(27,148)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization 886 260
Stock compensation 18,565 18,235
Goodwill amortization 24,569 -
Interest on notes receivable from stockholders (108) (13)
Changes in operating assets and liabilities:
Accounts receivable (12,395) (731)
Inventories (2,779) (2,459)
Prepaid expenses and other current assets (93) (292)
Other assets 435 (555)
Accounts payable 5,485 2,594
Accrued liabilities (252) 1,098
--------- --------
Net cash used in operating activities (16,637) (9,011)
Investing Activities
Purchases of property and equipment (4,255) (1,377)
Purchases of investments, net (34,789) -
Cash acquired in business acquisition 333 -
--------- --------
Net cash used in investing activities (38,711) (1,377)
Financing Activities
Net proceeds from issuance of preferred stock - 19,976
Net proceeds from issuance of common stock 9,865 4,155
Proceeds from advance for preferred stock issuances - 3,090
Repurchase of employee common stock - (28)
Payments on debt obligations and line of credit - (230)
--------- --------
Net cash provided by financing activities 9,865 26,963
--------- --------
Net (decrease) increase in cash and cash equivalents (45,483) 16,575
Cash and cash equivalents at beginning of period 91,532 2,291
--------- --------
Cash and cash equivalents at end of period $ 46,049 $ 18,866
========= ========
Supplemental disclosure of cash flow information
Cash paid for interest $ - $ 275
========= ========
Non-cash 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
========= ========
Amounts related to business acquisitions:
Issuance of common stock and assumption of stock options $ 168,275 $ -
========= ========
Net liabilities assumed $ 7,013 $ -
========= ========
</TABLE>
See notes to condensed consolidated financial statements.
3
<PAGE>
CACHEFLOW INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 2000
-------------------
(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 October 31, 2000, 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, 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, 2000,
included in the Company's Annual Report on Form 10-K filed with the Securities
and Exchange Commission on July 28, 2000.
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 consolidated financial statements and
accompanying notes. Actual results could differ from those estimates.
Note 3. Revenue Recognition
The Company generally recognizes product revenue upon shipment assuming that
collectibility is probable, unless the Company has future obligations for
installation or must obtain customer acceptance, in which case revenue is
deferred until these obligations are met. Maintenance contract revenue is
initially deferred when the customer purchases a maintenance contract and
recorded evenly over the life of the contract. Maintenance contract revenue for
the three- and six-month periods ended October 31, 2000 and 1999 was not
material.
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>
October 31, April 30,
2000 2000
----------- ---------
(Unaudited)
<S> <C> <C>
Raw materials $2,421 $2,380
Work-in-process 3,863 317
Finished goods 1,236 2,044
------ ------
$7,520 $4,741
====== ======
</TABLE>
4
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CACHEFLOW INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 2000
----------------
(Unaudited)
Note 5. Litigation
From time to time and in the ordinary course of business, the Company is subject
to various claims, charges, and litigation. In the opinion of management, final
judgments from such pending claims, charges, and litigation against the Company
will 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 stockholders' equity section of
the balance sheet. The comprehensive net losses for the three- and six-month
periods ended October 31, 2000 were $25,596,000 and $50,861,000, respectively.
The comprehensive net loss for the three- and six-month periods ended October
31, 1999 did not differ from the reported net loss.
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, service providers 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 for the three- and six-month
periods ended October 31, 1999, 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.
Pro forma basic and diluted net loss per common share for the three- and six-
month periods ended October 31, 2000 was the same as basic and diluted net loss
per common share since all preferred stock and warrants had been converted or
exercised and were outstanding for the entire three- and six-month periods.
5
<PAGE>
CACHEFLOW INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 2000
-------------------
(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 Six Months Ended
October 31, October 31,
---------------------------- -------------------------
2000 1999 2000 1999
------------ ------------ ----------- -----------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Historical:
Net loss $(25,636) $(20,591) $(50,950) $(27,148)
============ ============ =========== ============
Weighted-average shares of common stock
outstanding 39,728 13,037 38,671 12,864
Less: Weighted-average shares subject to
repurchase (5,415) (4,262) (5,154) (4,359)
------------ ------------ ----------- ------------
Weighted-average shares used in computing basic 34,313 8,775 33,517 8,505
and diluted net loss per common share ============ ============ =========== ============
Basic and diluted net loss per common share $ (0.75) $ (2.35) $ (1.52) $ (3.19)
============ ============ =========== ============
Pro forma:
Shares used above 34,313 8,775 33,517 8,505
Pro forma adjustment to reflect the weighted
effect of the assumed conversion of preferred
stock - 14,342 - 13,700
Pro forma adjustment to reflect the weighted
effect of assumed exercise and conversion of
preferred stock warrants - 673 - 673
------------ ------------ ----------- ------------
Shares used in computing pro forma basic and
diluted net loss per common share 34,313 23,790 33,517 22,878
============ ============ =========== ============
Pro forma basic and diluted net loss per common
share $ (0.75) $ (0.87) $ (1.52) $ (1.19)
============ ============ =========== ============
</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
Common Stock
The Company has entered into Stock Purchase Agreements in connection with the
sale of common stock to employees, directors and service providers. 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 October 31, 2000 and 1999,
4,993,449 and 4,781,814 shares, respectively, of common stock issued under these
agreements were subject to repurchase.
6
<PAGE>
CACHEFLOW INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 2000
---------------------
(Unaudited)
Stock Compensation
For the three months ended October 31, 2000 and 1999, the Company recorded
deferred stock compensation of $737,000 and $33,563,000, respectively. For the
six months ended October 31, 2000 and 1999, the Company recorded deferred stock
compensation of $4,231,000 and $47,786,000, 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, 2000 and 1999, the Company recorded amortization
of stock compensation of $7,790,000 and $15,243,000, respectively. For the six
months ended October 31, 2000 and 1999, the Company recorded amortization of
stock compensation of $18,565,000 and $18,235,000, respectively. At October 31,
2000 and April 30, 2000, the Company had $29,155,000 and $43,489,000,
respectively, of remaining unamortized deferred stock compensation. Such
amounts are included as a reduction of stockholders' equity and are being
amortized using a graded method over the vesting period of each respective
option.
Note 9. Subsequent Events
Business Acquisition
In October 2000, the Company announced its intention to acquire all of the
outstanding capital stock of Entera, Inc. ("Entera"), through a stock-for-stock
merger, pursuant to which each issued and outstanding share of common stock of
Entera will convert into the right to receive 0.107657 shares of common stock of
CacheFlow. In addition, each outstanding option to purchase Entera common stock
will be assumed by CacheFlow and converted into an option to purchase shares of
CacheFlow common stock determined pursuant to the exchange ratio in the merger
agreement. The exercise price of the options to purchase CacheFlow common stock
was also determined pursuant to the exchange ratio in the merger agreement.
Purchase consideration is expected to be approximately $440 million and includes
approximately 3.3 million shares of CacheFlow common stock, approximately $3
million of assumed liabilities and approximately $7 million in transaction
costs. This transaction will be accounted for as a purchase, and the
7
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CACHEFLOW INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 2000
----------------
(Unaudited)
purchase price will be allocated to tangible and intangible assets in proportion
to the fair value of those assets. The transaction is expected to close in
December 2000.
Departure of Chairman
On November 9, 2000, the Company's chairman of the board resigned and executed a
resignation agreement, which provides for the acceleration of certain unvested
stock options. In connection with this transaction, the Company will record a
non-cash charge of $28.1 million to stock compensation expense in the quarter
ended January 31, 2000, which is calculated as the number of accelerated shares
multiplied by the difference between the exercise price of the options and the
fair market value of the Company's common stock on November 9, 2000.
8
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CACHEFLOW INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This quarterly report contains forward-looking statements about CacheFlow's
indirect sales channels and expansion of the direct sales force, the adoption of
and the company's market leadership in content-smart networking solutions, the
acquisition of Entera and the market for streaming content delivery and
distribution solutions, the transition to, and market acceptance of the
company's new product offerings, and the company's future business and financial
prospects. These forward-looking statements involve risks and uncertainties.
Actual results could differ materially. Important factors that could cause
actual results to differ materially include the level of demand for Cacheflow's
products and services; the intensity of competition; CacheFlow's ability to
effectively manage product transitions and to continue to expand and improve
internal infrastructure; risks associated with potential acquisitions; and risks
related to the adoption of content-smart networking solutions. For a more
detailed discussion of the risks relating to CacheFlow's business, investors
should read the section later in this report entitled"Factors Affecting Future
Operating Results". All forward-looking statements included in this quarterly
report are based upon information available to CacheFlow as of the date hereof,
and CacheFlow assumes no obligation to update these forward-looking statements.
Overview
The Company is focused on content-smart networking, which is a new layer of
infrastructure for intelligently accelerating, delivering, and managing static,
streaming, and dynamic content. CacheFlow's market-leading appliances and
innovative content delivery technologies enable enterprises, service providers
and content providers to deliver the right content to the right place at the
right time. The Company began commercial shipment of it's first products, a
line of high-performance Internet caching appliances, in May 1998. Since that
time, The Company has introduced other Internet 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 these
appliances increase as they become more highly configured. Substantially all of
the Company's net sales through October 31, 2000 were attributable to sales of
our Internet appliance products. Management anticipates 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 $0.7 million
and $33.6 million for the three months ended October 31, 2000 and 1999. The
Company recorded deferred stock compensation of approximately $4.2 million and
$47.8 million for the six months ended October 31, 2000 and 1999. These amounts
represent the difference between the exercise price and the deemed fair value of
stock option and warrant grants issued to employees, consultants, directors and
third parties on the date such stock awards were granted. The Company recorded
stock compensation expense of approximately $7.8 million and $15.2 million for
the three months ended October 31, 2000 and 1999. The Company recorded stock
compensation expense of approximately $18.6 million and $18.2 million for the
six months ended October 31, 2000 and 1999. Between November 1, 2000 and
November 30, 2000, the Company recorded a non-cash deferred stock compensation
charge of $28.1 million in connection with the accelerated vesting of certain
unvested stock options held by the Company's departing chairman. 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. Given the balance of deferred stock compensation on
the balance sheet, recent grant history, and additional stock compensation which
would arise from the pending acquisition of Entera, management expects stock
compensation expense to be a significant operating expense as this deferral is
recognized.
The Company has incurred net losses in each quarter since inception. As of
October 31, 2000, the Company had an accumulated deficit of $133.8 million and
net loss for the three months ended October 31, 2000 was $25.6 million. This
loss resulted from significant costs incurred in the development and sale of
9
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CACHEFLOW INC.
the Company's products and services, and from amortization of deferred stock
compensation and goodwill. Management expects to experience significant growth
in the Company's operating expenses, particularly research and development,
sales and marketing expenses, and goodwill and stock compensation amortization.
Due to this growth in expenses, and the impact of stock compensation expense and
goodwill amortization, management expects to incur losses for the foreseeable
future.
The Company's limited operating history makes the prediction of future operating
results difficult. Management believes that period-to-period comparisons of the
Company's operating results should not be relied upon as predictive of future
performance. The Company's 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. The
Company 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,
--------------------- ----------------------
2000 1999 2000 1999
------- ------- ------- --------
<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 36.5 39.0 36.7 38.7
------- ------- ------- --------
Gross margin 63.5 61.0 63.3 61.3
Operating expenses:
Research and development 17.0 47.5 18.6 46.3
Sales and marketing 53.2 105.3 57.0 101.5
General and administrative 8.0 17.1 8.3 17.7
Stock compensation 23.9 315.0 33.8 215.8
Goodwill amortization 45.3 - 44.7 -
------- ------- ------- --------
Total operating expenses 147.4 484.9 162.4 381.3
Operating loss (83.9) (423.9) (99.1) (320.0)
Interest income (expense), net 5.5 (1.7) 6.8 (1.4)
Provision for income taxes (0.3) - (0.3) -
------- ------- ------- --------
Net loss (78.7) % (425.6) % (92.6) % (321.4)%
======= ======= ======= ========
</TABLE>
Net Sales. Net sales increased to $32.5 million for the quarter ended October
31, 2000 from $4.8 million for the quarter ended October 31, 1999. This
increase was primarily attributable to higher sales volumes resulting from the
introduction of new products, the continued market acceptance of existing
products, and growth in the Company's customer base as management expanded the
Company's sales force. During the quarter ended October 31, 2000, no customer
accounted for more than 10% of our net sales, and during the quarter ended
October 31, 1999, one customer accounted for 17% of our net sales. Net sales
from international operations were $19.4 million, or 60% of net sales, for the
quarter ended October 31, 2000, and $1.9 million, or 40% of net sales, for the
quarter ended October 31, 1999.
10
<PAGE>
CACHEFLOW INC.
Net sales increased to $55.0 million for the six months ended October 31, 2000
from $8.5 million for the six months ended October 31, 1999. This increase was
primarily attributable to higher sales volumes resulting from the introduction
of new products, the continued market acceptance of existing products, and
growth in the Company's customer base as management expanded the Company's sales
force. During the six months ended October 31, 2000, no customer accounted
for more than 10% of our net sales, and during the six months ended October 31,
1999, one customer accounted for 14% of our net sales. Net sales from
international operations were $29.9 million, or 54% of net sales, for the six
months ended October 31, 2000, and $3.6 million, or 43% of net sales, for the
six months ended October 31, 1999.
Management expects net sales to increase as a result of continued growth in the
Company's sales force, broader acceptance of the Company's products in the
marketplace, and the introduction of new products, although the quarter-over-
quarter growth rate in the Company's net sales of 573% will not continue in the
future.
Gross Profit. Gross profit increased to $20.7 million for the quarter ended
October 31, 2000 from $3.0 million for the quarter ended October 31, 1999.
Gross profit increased to $34.8 million for the six months ended October 31,
2000 from $5.2 million for the six months ended October 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 63.5% for the quarter ended October 31, 2000
from 61.0% for the quarter ended October 31, 1999. Gross margin increased to
63.3% for the six months ended October 31, 2000 from 61.3% for the six months
ended October 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 manufacturing of certain of the Company's products.
Gross margin has been and will continue to be affected by a variety of factors,
including competition, fluctuations in demand for the Company's products, the
timing and size of customer orders and product implementations, the mix of
direct and indirect sales, 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 $5.5 million for the quarter ended October 31,
2000 from $2.3 million for the quarter ended October 31, 1999. Research and
development expenses increased to $10.2 million for the six months ended October
31, 2000 from $3.9 million for the six months ended October 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. As a percentage
of net sales, research and development expenses decreased to 17.0% for the
quarter ended October 31, 2000 from 47.5% for the quarter ended October 31,
1999. As a percentage of net sales, research and development expenses decreased
to 18.6% for the six months ended October 31, 2000 from 46.3% for the six months
ended October 31, 1999. These decreases in research and development expenses as
a percentage of net sales reflect the fact that net sales during these periods
increased more rapidly than research and development expenses. Management
believes 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
October 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 $17.3
million for the quarter ended October 31, 2000 from $5.1 million for the quarter
ended October 31, 1999. Sales and marketing expenses increased to $31.3 million
for the six months ended October 31, 2000 from $8.6 million for the six months
ended October 31, 1999. These increases in sales and marketing expense in
absolute dollars were related to the expansion of the Company's sales and
marketing organization as management hired people and added sales and support
facilities worldwide. As a percentage of net sales, sales and marketing
expenses decreased to 53.2% for the quarter ended October 31, 2000 from 105.3%
for the quarter ended October 31, 1999. As a percentage of net sales, sales and
marketing expenses decreased to 57.0% for the six months ended October 31, 2000
from 101.5% for the six months ended October 31, 1999. These decreases in sales
and marketing expenses
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CACHEFLOW INC.
as a percentage of net sales reflect the fact that net sales during these
periods increased more rapidly than sales and marketing expenses. Management
expects to continue to increase 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
$2.6 million for the quarter ended October 31, 2000 from $829,000 for the
quarter ended October 31, 1999. General and administrative expenses increased
to $4.6 million for the six months ended October 31, 2000 from $1.5 million for
the six months ended October 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. As a percentage of net sales, general and administrative expenses
decreased to 8.0% for the quarter ended October 31, 2000 from 17.1% for the
quarter ended October 31, 1999. As a percentage of net sales, general and
administrative expenses decreased to 8.3% for the six months ended October 31,
2000 from 17.7% for the six months ended October 31, 1999. These decreases in
general and administrative expenses as a percentage of net sales reflect the
fact that net sales during these periods increased more rapidly than general and
administrative expenses. Management expects general and administrative expenses
to increase in absolute dollars as they 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 decreased to $7.8 million for the
quarter ended October 31, 2000 from $15.2 million for the quarter ended October
31, 1999. This decrease in stock compensation in absolute dollars primarily
reflects the fact that during the quarter ended October 31, 1999, the Company
recorded a $8.1 million charge to stock compensation expense to reflect a grant
of fully vested stock options to a consultant. Stock compensation expense
increased to $18.6 million for the six months ended October 31, 2000 from $18.2
million for the six months ended October 31, 1999. Excluding the $8.1 million
charge, the increase in stock compensation in absolute dollars during the three-
and six-month periods ended October 31, 2000 primarily reflects the amortization
of deferred compensation incurred on options granted below fair value during the
two-month period prior to the Company's November 1999 initial public offering.
Goodwill Amortization. Goodwill amortization increased to $14.7 million and
$24.6 million, respectively, for the three- and six-month periods ended October
31, 2000 from none in the comparable prior periods. These increases were
attributable to the Company's acquisition of SpringBank Networks, Inc. on June
5, 2000, which was accounted for as a purchase business combination. The $177
million of goodwill that resulted from the transaction is being amortized over
three years on a straight-line basis. Management expects goodwill amortization
to increase in the future since additional goodwill would arise from the
Company's pending acquisition of Entera, Inc., which is expected to close in
December 2000.
Interest Income (Expense), Net. Net interest income increased to $1.8 million
for the quarter ended October 31, 2000, from net interest expense of $80,000 for
the quarter ended October 31, 1999. Interest income increased to $3.7 million
for the six months ended October 31, 2000, from net interest expense of $116,000
for the six months ended October 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
receipt of proceeds upon completion of the Company's initial public offering in
November 1999.
Liquidity and Capital Resources
From inception through November 1999, management financed the Company's
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, management financed the Company's
operations through an initial public offering of our common stock, with proceeds
of $126.5 million, net of underwriting discounts, commissions and estimated
offering costs. At October 31, 2000, the Company had $46.0 million in cash and
cash equivalents, $68.7 million in short-term investments, and $116.7 million in
working capital.
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CACHEFLOW INC.
Net cash used in operating activities was $16.6 million for the six months ended
October 31, 2000 and $9.0 million for the six months ended October 31, 1999.
Management used cash primarily to fund the Company's net losses from operations.
Net cash used in investing activities was $38.7 million for the six months ended
October 31, 2000 and was $1.4 million for the six months ended October 31, 1999.
Net cash used in investing activities for the six months ended October 31, 2000
was primarily attributable to net purchases of short-term securities, as well as
purchases of property, plant and equipment. Management expects that, in the
future, any cash in excess of current requirements will continue to be invested
in high quality, interest-bearing securities.
Capital expenditures were $4.3 million for the six months ended October 31, 2000
and $1.4 million for the six months ended October 31, 1999. Capital expenditures
consisted of purchases of plant, equipment and software. Management expects
that capital expenditures will continue to increase in the future.
Net cash provided by financing activities was $9.9 million for the six months
ended October 31, 2000 and $27.0 million for the six months ended October 31,
1999. Financing activities for the six months ended October 31, 2000 were
primarily attributable to the exercise of employee stock options. For the six
months ended October 31, 1999, the Company raised approximately $20.0 million in
net proceeds from the sale of Series C Preferred Stock at $4.575 per share
during May 1999, and approximately $3.1 million in net proceeds from the sale of
Series D Preferred Stock at $11.00 per share that was subsequently issued in
November 1999.
Management believes that working capital will be sufficient to meet working
capital and capital expenditure requirements for at least the next twelve
months. Thereafter, management may find it necessary to obtain additional
equity or debt financing. Furthermore, if cash is used for acquisitions or
other unanticipated uses, the Company may need additional capital sooner than
expected. In the event additional financing is required, the Company may not be
able to raise it on acceptable terms or at all.
Accounting Pronouncements
In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements." SAB 101 summarizes certain of the SEC's views in applying
generally accepted accounting principles to revenue recognition in financial
statements. In June 2000, the SEC issued SAB No. 101B to defer the effective
date of implementation of SAB No. 101 until the fourth quarter of fiscal year
2000. Management does not expect the adoption of SAB 101 to have a material
effect on the Company's financial position or results of operations.
In June 1998, the Financial Account Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" (FAS 133). The effective date of implementation of FAS
133 was deferred until the fourth quarter of fiscal year 2000. Management does
not expect the adoption of FAS 133 to have a material effect on the Company's
financial position or results of operations.
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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 of $25.6 million and $20.6 million for the three months
ended October 31, 2000 and October 31, 1999. As of October 31, 2000, we had an
accumulated deficit of $133.8 million. We have not had a profitable quarter
since our inception and we expect to continue to incur net losses in the future.
To date, we have funded our operations from the sale of equity securities and
through bank loans and equipment leases.
We expect to continue to incur significant operating expenses and, as a result,
we will need to generate significant revenues if we are to achieve
profitability. We may never achieve profitability. We expect to incur
substantial non-cash costs relating to the amortization of deferred compensation
and goodwill, which will contribute to our net losses. As of October 31, 2000,
we had an aggregate of $29.2 million of deferred compensation and $152.4 million
of goodwill to be amortized. The Company may record additional compensation
expense in the future if management decides to grant below-market stock options
in order to attract and retain employees in a highly competitive labor market or
make acquisitions that result in the recording of deferred stock compensation.
Furthermore, the Company many record additional goodwill amortization and stock
compensation in the future if management acquires additional complementary
businesses.
Because we expect our sales to fluctuate and our costs are relatively fixed in
the short term, our ability to forecast our quarterly operating results is
limited, and if our quarterly operating results are below the expectations of
analysts or investors, the market price of our common stock may decline.
Our net sales and operating results are likely to vary significantly from
quarter to quarter. We believe that quarter-to-quarter comparisons of our
operating results should not be relied upon as indicators of future performance.
It is likely that in some future quarter or quarters, our operating results will
be below the expectations of public market analysts or investors. When this
occurs, the price of our common stock could decrease significantly. A number of
factors are likely to cause variations in our net sales and operating results,
including factors described in this "Factors Affecting Future Operating Results"
section.
We cannot reliably forecast our future quarterly sales for several reasons,
including:
. we have a limited operating history, and the market in which we
compete is relatively new and rapidly evolving;
. 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 and goodwill, 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 content-smart networking 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, we expect
additional competition from other established and emerging companies as the
market for content-smart networking 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 content-smart networking solutions 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 content-smart networking solutions, 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
nine 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. 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.
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CACHEFLOW INC.
We are entirely dependent on market acceptance of our content-smart networking
solutions and, as a result, a decline in sales or lack of market acceptance of
these solutions could cause our sales to fall.
To date, our content-smart networking products 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. As of
November 30, 2000, the CacheFlow 600, 700, 3000, 5000, 6000, and 7000 Series
products are the only products that we currently sell. Our CacheFlow 100 and 500
Series products, which have historically accounted for a substantial portion of
our net sales, have been discontinued and replaced by our CacheFlow 600 and 700,
Series products that were introduced in September 2000. The 6000 and 7000
Series products that were introduced in November 2000 will eventually replace
our CacheFlow 3000 and 5000 Series products, which have also historically
accounted for a significant portion of our net sales. We cannot be certain that
our CacheFlow 600, 700, 6000 or 7000 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 or our suppliers are unable to manage the 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
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CACHEFLOW INC.
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 capacity
constraints in manufacturing and assembling our products, which could result in
a decline of sales.
We currently conduct some of the final assembly and testing of our products at
our headquarters in Sunnyvale, California. We have transitioned manufacturing
and assembly for some of our products to third parties and we may transition
additional manufacturing and assembly in the future. If we were unable to
identify vendors for manufacturing and assembly, we would be required to make
additional capital investments in new or existing 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. We or our vendors 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 products from limited sources of supply. For example, we purchase custom
power supplies and Intel hardware for use in all of our products. 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
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CACHEFLOW INC.
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.
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 430 at October 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.
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.
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CACHEFLOW INC.
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, 2000, sales to customers outside of the United
States and Canada accounted for approximately 60% 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,
hiring international personnel and recruiting 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 content-smart networking solutions directly into their
network infrastructures. Any errors, defects or other performance problems with
our products could negatively impact the networks of our customers or other
Internet users, resulting in financial or other damages to these groups. These
groups may then seek damages from us for their losses. If a claim were brought
against us, we may not have sufficient protection from statutory limitations, or
license or contract terms with our customers and any unfavorable judicial
decisions could seriously harm our business. 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.
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CACHEFLOW INC.
Risks Associated with Potential Acquisitions
We consummated a merger with SpringBank Networks in June 2000. If we fail to
develop and integrate SpringBank Networks' technology into our products and
services, our quarterly and annual operating results may be adversely affected.
Other risks we may face with respect to our merger with SpringBank Networks
include the potential disruption of our ongoing business and distraction of
management; the difficulty of assimilating SpringBank Networks' personnel; and
the maintenance of uniform standards, corporate cultures, controls, procedures
and policies. Our inability to address any of these risks successfully could
harm our business.
We expect to consummate a merger with Entera, Inc. in the quarter ended January
31, 2001. There are a number of conditions that must be satisfied by the
Company and Entera in order to close this merger and the Company can not be
certain that those conditions will be met. If those conditions are not
satisfied, one or both of the parties to the transaction may have the right to
terminate the merger agreement. We may also make additional acquisitions in the
future. Acquisitions of companies, products or technologies entail numerous
risks, including an inability to successfully assimilate acquired operations and
products, diversion of management's attention, loss of key employees of acquired
companies and substantial transaction costs. Some of the products acquired may
require significant additional development before they can be marketed and may
not generate revenue at levels anticipated by us. Moreover, future acquisitions
by us may result in dilutive issuances of equity securities, the incurrence of
additional debt, large one-time write-offs and the creation of goodwill or other
intangible assets that could result in significant amortization expense. Any of
these problems or factors could seriously harm our business.
If the protection of our proprietary technology is inadequate, our competitors
may gain access to our technology, and our market share could decline.
We depend significantly on our ability to develop and maintain the proprietary
aspects of our technology. To protect our proprietary technology, we rely
primarily on a combination of contractual provisions, confidentiality
procedures, trade secrets, copyright and trademark laws and patents. Despite our
efforts to protect our proprietary rights, unauthorized parties may attempt to
copy aspects of our products or obtain and use information that we regard as
proprietary. Policing unauthorized use of our products is difficult. In
addition, the laws of some foreign countries do not protect our proprietary
rights to as great an extent as do the laws of the United States. Our means of
protecting our proprietary rights may not be adequate and our competitors may
independently develop similar technology, duplicate our products or design
around patents that may be issued to us or our other intellectual property.
We presently have several pending United States patent applications and several
pending patent applications in foreign patent offices. Several patent
applications pending before the United States Patent Office have been allowed
and are expected to issue as United States patents.
We cannot assure you that any U.S. or international patent will be issued from
these applications. Even if patents are issued, we cannot assure you that we
will be able to detect any infringement or, if infringement is detected, that
patents issued will be enforceable or that any damages awarded to us will be
sufficient to adequately compensate us.
There can be no assurance or guarantee that any products, services or
technologies that we are presently developing, or will develop in the future,
will result in intellectual property that is protectable under law, whether in
the United States or a foreign jurisdiction, that this intellectual property
will produce competitive advantage for us or that the intellectual property of
competitors will not restrict our freedom to operate, or put us at a competitive
disadvantage.
We rely on technology that we license from third parties, including software
that is integrated with internally developed software and used in CacheOS to
perform key functions. For example, we license subscription filtering technology
from Secure Computing. If we are unable to continue to license any of this
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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, 2000, we had approximately $46.0 million in cash and cash
equivalents and $68.7 million in short-term investments. We believe that these
amounts will enable us to meet our capital requirements for at least the next
twelve months. However, if cash is used for acquisitions or other unanticipated
uses, we may need additional capital. The development and marketing of new
products and the expansion of indirect channels and associated support personnel
will require a significant commitment of resources. In addition, if the market
for content-smart networking solutions 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 Content-Smart Networking Industry
The market for content-smart networking solutions 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 content-smart networking
solutions. The market for content-smart networking solutions is a new and
rapidly evolving market. If the market for content-smart networking solutions
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 content-smart networking solutions;
. 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 products 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,
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content or copying of these materials. It is also possible that if any
information provided through any of our products contains errors, third parties
could make claims against us for losses incurred in reliance on this
information. Our insurance may not cover potential claims of this type or be
adequate to protect us from all liability that may be imposed.
The adoption of laws that impose taxes on Internet commerce could adversely
affect our business.
Tax authorities at the international, federal, state and local levels are
currently reviewing the appropriate tax treatment of companies engaged in
Internet commerce. Many of our customers are engaged in Internet commerce, and
any taxes imposed on them may adversely impact their businesses and may result
in order cancellations or postponements of product purchases by them, which
would seriously harm our business. Laws regarding the Internet remain largely
unsettled and the adoption or modification of laws or regulations relating to
the Internet, or interpretations of existing law, could seriously harm our
business.
Because the sales of our products are dependent on the increased use and
widespread adoption of the Internet, if use of the Internet does not develop as
we anticipate, our sales may not grow.
Sales of our products depend on the increased use and widespread adoption of the
Internet. Our business would be seriously harmed if the use of the Internet does
not increase as anticipated or if our ISP customers' Internet-related services
are not well received by the marketplace. The acceptance and use of the Internet
in international markets, where we derive a large portion of our net sales, are
in earlier stages of development than in the United States. If the Internet
fails to gain sufficient acceptance in international markets, our business could
be seriously harmed. The resolution of various issues concerning the Internet
will likely affect the use and adoption of the Internet. These issues include
security, reliability, capacity, congestion, cost, ease of access and quality of
service. For example, recently certain popular websites experienced denial-of-
service attacks, which called into question the ability of these and other
websites to ensure the security and reliability of their on-line businesses.
Even if these issues are resolved, if the market for Internet-related products
and services fails to develop, or develops at a slower pace than anticipated,
our business would be seriously harmed.
Governmental regulation of the communications industry may negatively affect our
customers and result in decreased demand for our products, which would cause a
decline in our sales.
The jurisdiction of the Federal Communications Commission, or FCC, extends to
the communications industry, to our customers and to the products that our
customers sell. Future regulations set forth by the FCC or other regulatory
bodies may adversely affect Internet-related industries. Regulation of our
customers may seriously harm our business. For example, FCC regulatory policies
that affect the availability of data and Internet services may impede our
customers' penetration into some markets. In addition, international regulatory
bodies are beginning to adopt standards for the communications industry. The
delays that these governmental processes entail may cause order cancellations or
postponements of product purchases by our customers, which would seriously harm
our business.
Risks Related to Securities Markets
Our stock price is volatile and, as a result, you may have difficulty evaluating
the value of our stock, and the market price of our stock may decline.
Since our initial public offering in November 1999 through November 30, 2000,
the closing market price of our common stock has fluctuated significantly
between $30.50 and $164.69. 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;
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CACHEFLOW INC.
. 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 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 60% of total net sales for the three-month period ended October 31,
2000.
As of October 31, 2000, we had approximately $103.4 million invested primarily
in fixed-rate, short-term corporate and U.S. government debt securities which
are subject to interest rate risk and will decrease in value if market U.S.
interest rates increase. We do not hold any equity securities or derivative
investments. As of October 31, 2000, no significant changes have occurred in
interest rates since our Annual Report on Form 10-K for the year ended April 30,
2000.
PART II. OTHER INFORMATION
Item 2. Changes in Securities
(c) Changes in Securities
During the quarter ended October 31, 2000, the Company granted options to
purchase 1,532,550 shares of common stock to employees and directors of the
Company under the 1999 Stock Option Plan, the 2000 Supplemental Stock Option
Plan, and the Director's Plan.
During the quarter ended October 31, 2000, employees, consultants, directors and
other service providers of the Company exercised options to purchase 899,676
shares of common stock.
(d) Use of Proceeds.
On November 19, 1999, the Company completed the initial public offering of its
common stock. 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 offering closed on November 24, 1999 after we had
sold all of the 5,750,000 shares of common stock registered under the
Registration Statement. The initial public offering price was $24 per share for
an aggregate initial public offering of $138 million.
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CACHEFLOW INC.
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. During
the three months ended October 31, 2000, net proceeds were not used for general
corporate purposes.
Item 4. Submission of Matters to a Vote of Security Holders
The Company's Annual Meeting of Shareholders was held on Wednesday, August 30,
2000 at the Company's corporate headquarters in Sunnyvale, California. Of the
39,045,680 shares outstanding as of the record date, 30,846,769 shares were
present or represented by proxy at the meeting. The following matters were
submitted to a vote of security holders:
(1) To elect the following six directors of the Board of Directors to serve
until the next Annual Meeting or until their successors have been duly elected
and qualified :
Votes For Votes Withheld
Brian M. NeSmith 30,803,773 42,996
Michael A. Malcolm 30,768,237 78,532
Andrew S. Rachleff 30,819,333 27,436
David W. Hanna 30,811,461 35,308
Mark Andreessen 30,811,408 35,361
Stuart G. Phillips 30,819,333 27,436
(2) To approve an amendment to the Company's 1999 Stock Incentive Plan to
increase the total number of shares of Common Stock reserved for issuance
thereunder by 2,000,000 shares.
Votes for: 22,981,499
Votes against: 2,046,696
Votes abstaining: 8,774
Non-vote: 5,809,800
(3) To ratify the Company's appointment of Ernst & Young LLP as independent
accountants for the Company for the fiscal year ending April 30, 2001.
Votes for: 30,836,707
Votes against: 5,184
Votes abstaining: 4,878
Item 6. Exhibits and Reports on Form 8-K
(a) List of Exhibits:
Number Exhibit Description
------ -------------------
10.18 Michael Malcolm Resignation Agreement
27.1 Financial Data Schedule
(b) One Form 8-K/A was filed during the quarter ended October 31, 2000
related to the acquisition of SpringBank Networks.
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CACHEFLOW INC.
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 and Accounting Officer
Dated: December 15, 2000
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CACHEFLOW INC.
EXHIBIT INDEX
Number Exhibit Description
------ -------------------
10.18 Michael Malcolm Resignation Agreement
27.1 Financial Data Schedule
26
