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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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Form 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 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:
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SonicWALL, Inc.
(Exact name of registrant as specified in its charter)
California 7372 77-0270079
(State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer
of incorporation) Classification Code Number) Identification No.)
1160 Bordeaux Drive
Sunnyvale, California 94089
(408) 745-9600
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
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Securities registered pursuant to Section 12 (b) of the Act:
Title of each class Name of Exchange on which registered
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None None
Securities registered pursuant to Section 12 (g) of the Act:
Common Stock (no par value)
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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 by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, as of December 31, 2000, was approximately $631,166,943 million
based upon the last sale price reported for December 29, 2000 on the Nasdaq
Stock Market. For purposes of this disclosure, shares of Common Stock held by
persons who hold more than 5% of the outstanding shares of Common Stock and
shares held by officers and directors of the Registrant have been excluded
because such persons may be deemed to be affiliates. This determination is not
necessarily conclusive.
The number of shares of the Registrant's Common Stock outstanding on
December 31, 2000 was 62,646,843.
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PART I
ITEM 1. BUSINESS
You should carefully review the following risks associated with owning our
common stock. Our business, operating results or financial condition could be
materially adversely affected by any of the following risks. The trading price
of our common stock could decline due to any of these risks, and you as an
investor may lose all or part of your investment. You should also refer to the
other information set forth in this report and incorporated by reference
herein, including our financial statements and the related notes. Given these
risks and uncertainties, readers are cautioned not to place undue reliance on
such forward-looking statements.
Overview
SonicWALL, Inc. designs, develops, manufactures and sells Internet security
infrastructure products designed to provide secure Internet access to our
broadband customers and process secure transactions for enterprises and service
providers. We believe our security appliances provide high performance, robust,
reliable, easy-to-use and affordable Internet security and virtual private
network ("VPN") functionalities. We also sell security services including
content filtering services and anti-virus protection on an annual subscription
basis. Our transaction security products provide high performance SSL
acceleration and offloading to enable service providers and enterprises to
deploy e-commerce applications without degrading web site performance. We sell
our products to customers in the small to medium enterprise, e-commerce,
service provider, branch office and telecommuter markets. As of December 31,
2000, we have sold more than 117,000 of our Internet security appliances
worldwide.
Our SonicWALL product line provides our customers with comprehensive
integrated security including firewall, VPN, anti-virus, content filtering and
secure sockets layer ("SSL") encryption and decryption functionality, so users
can enjoy affordable, secure Internet communications and conduct secure
Internet transactions. SonicWALL delivers plug-and-play appliance solutions
that we believe are high performance, easy to install and cost-effective. With
current suggested retail prices ranging from $495 to $6,995, our products are
designed to enable customers to reduce purchase costs and avoid hiring costly
information technology personnel for Internet security. By using an embedded
single purpose operating system and a hardware design without moving parts, our
products maximize reliability and uptime. The SonicWALL access security
products can be used in networks ranging in size from 1 to 1,000 users and are
fully compatible with VPN technology from more expensive enterprise security
solutions offered by, among others, Check Point Software Technologies, Ltd.,
Nortel Networks and Cisco Systems, Inc.
SonicWALL was initially incorporated in California in 1991 as Sonic Systems.
In August 1999, we changed our name to SonicWALL, Inc. References in this
report to "We" "Our" "Us" and "the Company" refer to SonicWALL, Inc. Our
principal executive offices are located at 1160 Bordeaux Drive, Sunnyvale,
California 94089, and our telephone number is (408) 752-9600.
Industry Background
Growth of Internet Usage By Small to Medium Enterprise, Branch Office,
Telecommuter, and Education Markets
Businesses and consumers are increasingly accessing the Internet for a wide
variety of uses including communications, information gathering and commerce.
Because it is an affordable means of achieving global reach and brand
awareness, the Internet is a particularly attractive vehicle for small and
medium size businesses as they endeavor to access and share information with a
large number of geographically dispersed customers, employees and business
partners. For example, of the 87.4 million devices estimated by International
Data Corporation ("IDC"), a market research organization, to have Internet
access in 1998, approximately 60% were used by small businesses and home
offices. IDC estimates that the proportion of small businesses, those with less
than 100 people, accessing the Internet in the United States will increase from
approximately 50% in 1998 to approximately 65% by 2001, to a total of 4.7
million businesses.
Today's large business enterprise is characterized by many branch offices,
mobile workers and telecommuters, all of whom connect electronically to the
corporate office and each other. Because of the confidential nature of business
data, these connections must be secure. VPNs provide secure Internet
connections between the business enterprise and dispersed employees and
business partners. Communicating using VPNs offers significant cost savings
over alternative solutions such as private leased line or frame relay networks.
TeleChoice, a market researcher, estimates that VPNs can cut telecommunication
costs by as much as 90% over private leased line networks, and for this reason,
their use is expected to grow rapidly. Infonetics Research projects worldwide
expenditures on VPNs will grow by 100% per year through 2001, when they are
expected to reach $11.9 billion.
The Internet has also become a vital tool of information access and
communication for schools and libraries. According to the National Center for
Education Statistics, there were over 96,000 K-12 public schools and libraries
in the United States in 1998, of which 89% of schools and 35% of libraries were
connected to the Internet. The growth in Internet connectivity in this market,
combined with the proliferation of objectionable web sites, has created a need
for Internet security products that include content filtering capabilities.
Growth of e-Commerce
The Internet Economy has grown rapidly driven by its cost effectiveness and
ease-of-use as a means of communication, collaboration and coordination between
consumers, businesses and trading partners. What started out as an alternative
marketing channel has quickly turned into a complete economic system consisting
of (i) ubiquitous, low cost communication networks using Internet technologies
and standards, (ii) applications that enable business to be conducted over this
network infrastructure, (iii) interconnected electronic markets that operate
over the network and applications infrastructure, (iv) producers and
intermediaries providing a variety of digital products and services to
facilitate market efficiency and (v) emerging policy and legal frameworks for
conducting business over the Internet. Analysts predict that within the next
ten years the value of Internet-based transactions will account for up to 10%
of the world's consumer sales. Moreover, according to e-Marketer, the business-
to-business e-commerce market will grow from an estimated $226 billion in 2000
to $2.8 trillion in 2004.
Increasing Use of Broadband Access Technologies
Many small to medium enterprises and branch offices have addressed the need
for Internet access by installing a single computer with a dial-up connection
that is shared throughout the office, or by installing a dedicated network data
connection at a significantly greater expense, such as a T-1 line. Recently,
new high-speed technologies have emerged that can better satisfy the bandwidth
requirements of small to medium enterprises at a fraction of the cost of
traditional solutions. These technologies include DSL and cable modems, which
provide access speeds of up to 100 times faster than traditional 28.8 kbps
analog modems. In addition, new generations of Internet-based applications,
such as business to business e-commerce, sales force automation and enterprise
resource planning ("ERP") continue to emerge that require higher bandwidth than
is available through dial-up solutions. As DSL and cable services become more
affordable and widely available, small to medium enterprises, branch offices
and telecommuters are increasingly deploying these technologies as their
Internet access solution. IDC estimates that in the United States, the number
of small businesses using high-speed access is expected to expand from 380,000
in 1998 to 3.3 million in 2003.
Importance of Internet Security
Secure access to the Internet is a growing concern for most Internet users.
Because broadband technologies, including DSL and cable, are always connected
to the Internet, they present greater security issues than dial-up connections
and increase the risk that proprietary data or other sensitive information
might be compromised. These types of Internet connections present ongoing
security issues for small to medium enterprises, branch offices, and
telecommuters and increase the risk that computer hackers, disgruntled
employees, contractors or competitors might successfully access proprietary
data or other sensitive information. In addition, as more web-enabled, mission-
critical business applications are developed and offered by vendors such as
Oracle Corp., PeopleSoft Inc., Siebel Systems, Inc., and SAP AG, the amount of
sensitive data
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transmitted over the Internet increases, leading organizations to look for high
performance, robust solutions to address these security needs.
Increasing Need for Anti-Virus Solutions
In a 2000 survey conducted by ICSA, companies reported an average of 9 virus
infections per 100 personal computers with the most common infections spread
through e-mail messages, floppy disks and Internet downloads. In addition to
lost productivity, corporations must concern themselves with potentially severe
financial losses to themselves and their partners and customers. This has been
highlighted by the rapid infection of many users through widespread virus
outbreaks such as the "ILOVEYOU' and "Melissa' e-mail viruses. As a result,
enterprises are spending rapidly to deploy anti-virus protection solutions
across the enterprise and expending technical resources on an ongoing basis to
keep these solutions updated against the latest virus threats. IDC, a research
organization, expects sales of anti-virus products to increase from $1.2
billion in 1999 to $2.7 billion in 2004.
Increasing Use of SSL to Secure E-Commerce Transactions
Secure Sockets Layer, or SSL, is the most widely used encryption technology
for enabling the secure transmission of confidential data in e-commerce
transactions. Industry analysts believe reliable and affordable SSL solutions
will act as a driver to rapid e-commerce growth. Data encryption provided by
SSL allows e-commerce vendors to build secure systems, and also provides the
basis from which a business can build trust with customers, suppliers, partners
and employees. Netcraft, a market research firm estimates the SSL market will
increase from 726,000 SSL-based web servers in 1999 to more than 5 million by
2001.
Rapid Overall Growth in the Internet Security Market
The market for Internet security products include a variety of applications
to address network vulnerabilities and protect confidential data during
transmission and access. These products include firewalls, VPN access products,
anti-virus solutions, content filtering, intrusion detection technologies and
SSL encryption. According to IDC, the market for Internet security products is
expected to grow at a compounded annual growth rate of 21% to $8.3 billion by
2003. IDC also estimates that the market for firewall appliances priced at less
than $10,000 will grow at a compounded annual growth rate of 88% over the same
period.
Lack of a Cost Effective, High Performance Security Solution for the Access
Security Market
Although the need for Internet security is widespread, security vendors
generally have focused on providing solutions for large enterprises with highly
complex needs and extensive information technology (IT) support organizations.
These solutions have typically involved expensive enterprise firewall software
that runs on a dedicated server or personal computer and requires extensive
support, constant monitoring and regular updates by information technology
personnel to maintain their effectiveness. The expense and complexity of these
solutions, which often require additional products to incorporate VPN, SSL and
anti-virus capabilities, internet protocol address management or content
filtering, are impractical for the majority of small to medium enterprises due
to the more limited resources of such organizations. While there are suppliers
of low cost Internet routers, which may provide limited Internet security
functionality, we believe these products are difficult to install and configure
and provide relatively low performance.
Lack of High Performance Solutions to Perform Secure Transactions
The growth of e-commerce on the Internet and the need for secure
transactions has created increased loads on typical web servers, which have
general purpose CPUs. These servers were not designed to handle the extreme
processing requirements of SSL transactions and as a result, their performance,
as measured by the number of transactions per second (or TPS) that can be
processed simultaneously, declines considerably. Studies show that server
performance declines by over 90% when processing SSL transactions versus
ordinary non-encrypted Internet traffic. The need to improve the performance of
servers processing e-commerce
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transactions has typically been addressed by installing an SSL acceleration
board within the server. While these solutions increase performance, because
they continue to utilize the host CPU for a portion of the transaction
processing, they do not fully optimize the server's performance. A more
effective solution is to install a board within the web server that fully
offloads and accelerates the SSL encryption and decryption processes, thus
leaving the server completely free to process the remainder of the transaction
and all other traffic at maximum performance. In addition, as businesses
utilize highly specialized network equipment, such as content switches, load
balancers and caching appliances, to provide maximum performance for high
traffic web sites and Internet applications, they are seeking specialized
products to address SSL encryption and decryption acceleration and offloading
within these network architectures.
The SonicWALL Solution
SonicWALL, Inc. provides Internet security products designed to provide
secure access to customers in the small to medium enterprise, branch office,
telecommuter and education markets. These products are complemented by value-
added security services such as VPN, anti-virus protection and content
filtering. We also provide products to enable high performance processing of
secure transactions for service providers and enterprises that are deploying e-
commerce applications. We believe our security appliances provide high
performance, robust, reliable, easy-to-use and cost-effective Internet
security, while our SSL appliances enable web sites to maintain optimal
performance while processing a growing number of secure transactions. As of
December 31, 2000, we have sold more than 117,000 of our Internet security
appliances worldwide. The SonicWALL product line provides our customers with
the following key benefits:
. High Performance, Robust Access Security. The SonicWALL product family
provides a comprehensive integrated security solution that includes
firewall, VPN, anti-virus and content filtering. Our access security
products protect private networks against Internet-based theft,
destruction or modification of data, and automatically notify customers
if their network is under attack. SonicWALL has been awarded the
internationally recognized International Computer Security Association,
or ICSA, Firewall Certification, the same certification awarded to
significantly more expensive products sold by Check Point Software
Technologies, Ltd. and Cisco Systems, Inc. Our VPN products enable
affordable, secure communications among remote offices, mobile employees
and business partners over the Internet. Our anti-virus service provides
comprehensive virus protection with automatic updates and minimal
administration. Our content filtering service enables businesses, schools
and libraries to restrict access to objectionable or inappropriate web
sites.
. High Performance, Robust Transaction Security. The SonicWALL product
family also includes SSL acceleration and offloading products that allow
enterprises and service providers to secure and accelerate e-commerce
transactions. By accelerating and offloading the processing of secure
e-commerce transactions, our SSL products allow web sites to handle
significantly higher volumes of customer traffic. Unlike competitive SSL
acceleration products, our products completely offload SSL processing,
enabling maximum performance of the server.
. Ease of Installation and Use. The SonicWALL product family delivers a
plug-and-play appliance designed for easy installation and use.
Installation involves simply connecting a SonicWALL device between the
private network and the broadband Internet access device for our access
security products and in front of the e-commerce web server for our
transaction security products. SonicWALL products are easily configured
and managed through a web browser-based interface. No reconfiguration of
any personal computer application is required. Our access security
products are pre-configured to interface with all major Internet access
technologies, including cable, DSL, ISDN, Frame Relay and T-1. Our
transaction security products are compatible with all major web server
and e-commerce software products and are designed to operate in the most
sophisticated and highest traffic network architectures.
. Low Total Cost of Ownership. The SonicWALL product design minimizes the
purchase, installation and maintenance costs of Internet security. The
suggested retail prices of our access security products range from $495
to $4,995, versus enterprise firewall products, which range in price from
approximately
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$5,000 to more than $15,000. The suggested retail prices of our
transaction security products range from $2,495 to $6,995. Our affordable,
easy-to-manage Internet security appliances also enable customers to avoid
the expense of hiring costly IT personnel who may otherwise be required to
implement and maintain an effective Internet security solution.
. Reliability. The SonicWALL product design maximizes reliability and
uptime. Our products use an embedded single purpose operating system and
a hardware design that contains no moving parts. Most competitors'
products consist of software installed on general-purpose host computers
that use the Windows NT or UNIX operating systems. General-purpose
operating systems such as these are designed to run multiple
applications, creating an environment with less security and in which
random system crashes are commonplace. Moreover, since general-purpose
computers contain many moving parts, such as hard disk drives, floppy
drives, fans and switching power supplies, they are more prone to
hardware failures over time. These software and hardware failures can
compromise Internet security.
. Scalability and Compatibility. SonicWALL products are designed to provide
comprehensive Internet security for networks ranging in size from 1 to
1,000 users and for e-commerce applications that handle millions of
secure transactions daily. Our access security products consist of three
separate models designed to serve the specific security needs of our
target markets. Our transaction security products include PCI add-in
boards as well as appliance-based solutions, which can be deployed in the
most sophisticated networks requiring the highest levels of transaction
performance. Our products vary with respect to the number of supported
users, the number of transactions handled, the number of ports and
feature options such as VPN, anti-virus protection or content filtering.
In addition to serving the security needs of the small to medium
enterprise market, SonicWALL access security products are a fully
compatible, perimeter security solution for large, distributed
enterprises and their branch offices and telecommuters. SonicWALL
transaction security products are an ideal solution for enterprises and
service providers who are deploying high performance e-commerce
applications. Our products are designed to interoperate with enterprise
security products offered by, among others, Check Point Software
Technologies, Ltd. and Cisco Systems, Inc.
Strategy
Our goal is to extend our leadership position and become the industry
standard Internet security solution for broadband access and e-commerce users
in our target markets and become the leader in providing high performance
processing solutions for secure transactions. Key elements of our strategy
include:
. Extend Our Leadership Position in Access Security. We believe that we
have established a market leadership position as a provider of Internet
access security products designed for our target markets by offering
robust, reliable, easy-to-use products at attractive prices. We intend to
continue to focus our product development efforts, distribution
strategies and marketing programs to satisfy the growing needs of these
markets. We believe that the current Internet security offerings of most
vendors are comparatively expensive, technically complex and generally
unable to satisfy these target markets.
. Become a Leader in the Transaction Security Market. We believe that we
can establish a leadership position in the fast growing e-commerce
transaction security market. Through our acquisition of Phobos
Corporation in November 2000, we believe we possess the highest
performance, most scaleable, reliable and easy-to-use SSL products in the
market. We intend to utilize our strategic partnerships, distribution
channels and marketing programs to deliver these products to large
enterprises and service providers that are deploying e-business
applications and processing e-commerce transactions.
. Continue to Develop New Products and Reduce Manufacturing Costs. We
intend to use our product design and development expertise to expand our
product offerings and reduce our manufacturing costs. We believe that
these new product offerings, other new products and associated cost
reductions will strengthen our market position and assist us in
penetrating new markets.
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. Strengthen the SonicWALL Brand. We believe that strong brand recognition
in our target markets is important to our long-term success. We intend to
continue to strengthen our SonicWALL brand name through industry trade
shows, our web site, advertising, direct mailings to both our resellers
and our end users, and public relations. Our reputation as a reliable,
high performance, easy-to-use and affordable Internet security vendor
contributes to our resellers' sales efforts.
. Expand Our Indirect Channel. Our target markets are generally served by a
two-tier distribution channel. We have successfully penetrated these
markets with over 7,000 value-added resellers, systems integrators and
distributors who sell our products in over 30 countries, including large
distributors such as Ingram Micro, Inc. and Tech Data Corp.. We have also
established reseller relationships with Alltel Corporation, WebMD Corp.
and myCIO.com, a Network Associates business. We intend to continue to
build and expand our base of indirect channel relationships through
additional marketing programs, hiring additional marketing staff and
increased advertising.
. Develop Strategic Original Equipment Manufacturer Relationships. By
entering into original equipment manufacturer ("OEM") arrangements to
sell our products, we intend to build upon the brand awareness and
worldwide channels of major networking and telecommunications equipment
suppliers to further penetrate our target markets. We presently have OEM
agreements with the following companies: Network Associates, a
manufacturer of security software products, Com21, Inc., a supplier of
cable modems, NetGear, Inc., a manufacturer of networking products for
small office and home office customers, and 3COM Corporation, a provider
of diversified networking products.
. Increase Services Revenue. We intend to continue to develop new services
and add on products to generate additional revenue from our installed
base. For example, we recently announced our integrated, managed anti-
virus service to our customers and had installed over 20,000 clients as
of December 31, 2000. In January 2001, we introduced SonicWALL Total
Secure, which enables our managed service provider partners to offer a
complete security service, using SonicWALL technology, for a fixed price
per user per month. We also offer fee-based customer support services and
training to our customers. We have dedicated marketing personnel and
programs that focus on selling these products and services to our
existing base of customers. We have actively sought registration of our
customers and have experienced a registration rate of nearly 65% to date.
This has enabled us to pursue cost effective, targeted marketing
campaigns to our installed base of registered users. Our Auto Update
feature encourages our customers to register their product by offering
periodic notifications via e-mail of new security threats, bug fixes and
marketing information on new features and products. Each SonicWALL model
is configured to allow end users to easily and conveniently download new
features and products that have been purchased, either through our
resellers or our web site. Such sales could include additional
functionality such as VPN or subscription services such as anti-virus and
content filtering.
Products and Services
SonicWALL provides complete Internet security solutions that include access
security products, value-added security services and transaction security
products. We believe our access security product line provides cost effective
and high performance Internet security for the small and medium size
enterprise, telecommuter, education and government markets. We also offer a
broad range of security services designed to enhance the functionality and
performance of the appliance platforms. Our transaction security products
enable our target enterprise and service provider customers to process large
volumes of secure transactions using SSL technology without compromising the
performance of their e-commerce or e-business applications.
Our Global Management System (GMS) enables distributed enterprises and
service providers to manage and monitor up to 1000 SonicWALL Internet security
appliances and deploy our security services from a central location to reduce
staffing requirements, speed deployment and lower costs. SonicWALL GMS allows
network administrators to administer and monitor security policies across
large, geographically distributed networks.
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Access Security Products:
SonicWALL access security products include high performance, solid-state
Internet security appliances that provide integrated security to meet the needs
of the individual telecommuter through the large distributed enterprise.
SonicWALL Internet security appliances share a common set of Internet security
features that have been tailored to meet the needs of our target markets:
Firewall Security. Our firewall technology protects private networks against
Internet-based theft, destruction or modification of data, and automatically
notifies customers if their networks are under attack. SonicWALL has been
awarded the internationally recognized ICSA Firewall Certification, the same
certification awarded to significantly more expensive products sold by Check
Point Software Technologies, Ltd. and Cisco Systems, Inc. In addition,
SonicWALL is pre-configured to automatically detect and thwart Denial of
Service attacks such as Ping of Death, SYN Flood, LAN Attack, and Internet
Protocol Spoofing.
Internet Protocol Address Management. SonicWALL products also include
Network Address Translation, or NAT, which allows a customer to connect
multiple users on their private network to the Internet using a single public
internet protocol, or IP, address and Dynamic Host Configuration Protocol, or
DHCP, Client and Server capabilities. DHCP Client allows the appliance to
automatically acquire its IP address settings from the Internet Service
Provider, or ISP. DHCP Server allows computers on the private network to
automatically acquire IP address settings from the appliance, simplifying
client personal computer configuration.
Web Browser-Based Management. SonicWALL appliances are easily and securely
configured and managed through a web browser-based interface. The SonicWALL
interface effectively insulates the user from the underlying complexity of
Internet security, while providing enough flexibility to meet the diverse needs
of our customers.
Logging and Reporting. SonicWALL appliances maintain an event log of
potential security concerns, which can be viewed with a web browser or
automatically sent to any e-mail address on a periodic basis. SonicWALL
appliances notify the administrator of high-priority security issues, such as
an attack on a server, by immediately sending an alert message to a priority e-
mail account such as an e-mail pager. SonicWALL also provides pre-defined
reports that show different views of Internet usage, such as the most commonly
accessed web sites.
Internet Security Appliances
Our SonicWALL line of Internet security appliances vary with respect to the
number of supported users, the number of ports, product features, processor
speed and scalability. They include:
SonicWALL TELE2. This Internet security appliance provides affordable,
complete Internet security and high performance integrated virtual private
networking (VPN) functionality for telecommuters and small offices with up to 5
users. As a complement to the SonicWALL PRO and SonicWALL PRO-VX, the SonicWALL
TELE2 allows businesses to provide cost-effective firewall security and VPN
connectivity to their branch offices and remote workers.
SonicWALL SOHO2. This Internet security appliance is a comprehensive and
affordable Internet security solution for smaller networks using broadband
connections to the Internet. SonicWALL SOHO2 is available in 10-user and 50-
user models and can be upgraded to support unlimited users.
SonicWALL XPRS2. This Internet security appliance protects an unlimited
number of users from Internet security threats and includes a De-Militarized
Zone (DMZ) port for customers with public web servers. With the DMZ port,
public web and e-commerce servers on the local network can be accessed from the
Internet without exposing the private network to Internet-based attacks.
Publicly accessible servers connected to the DMZ are also protected against
Denial of Service (DoS) attacks.
SonicWALL PRO. This Internet security appliance meets the security demands
of medium to large networks and supports up to 100 simultaneous VPN connections
to remote offices or workers. The SonicWALL PRO allows companies to increase
productivity by establishing secure VPN connections with business partners,
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branch offices, telecommuters and mobile users. The SonicWALL High Availability
upgrade can be added to eliminate network downtime by allowing two SonicWALL
PROs to act as a redundant pair.
SonicWALL PRO-VX. This is a high-performance, scalable security and remote
access solution for the enterprise that can support up to 1000 remote offices
or workers. The SonicWALL PRO-VX includes hardware VPN acceleration to support
larger networks. It also includes our High Availability feature to eliminate
network downtime by allowing two SonicWALL PRO-VXs to act as a redundant pair.
Coupled with the SonicWALL Global Management System (GMS), the SonicWALL PRO-VX
cost effectively extends security policies across large distributed networks of
enterprises and service providers.
Security Services:
SonicWALL Internet security appliances integrate seamlessly with a
comprehensive and expanding line of value-added security services to provide
complete Internet security. With SonicWALL's integrated security services,
companies avoid the integration and maintenance problems that often result from
sourcing, installing, and maintaining security products and services from
multiple vendors.
SonicWALL Anti-Virus. Our anti-virus subscription service eliminates the
challenges of installing and maintaining anti-virus protection throughout a
business and across a distributed network. This SonicWALL service integrates
with our security appliances to deploy and maintain anti-virus software for
each user on the network without the need for desktop-by-desktop installation,
configuration and maintenance. Automatic virus updates ensure all network nodes
are protected from new virus outbreaks.
SonicWALL IPSec VPN. Our virtual private networking capabilities enable
affordable and secure communications over the Internet between geographically
dispersed offices, workers and partners. SonicWALL virtual private networking
uses the industry standard IPSec protocol to deliver state-of-the-art security
and interoperability with other virtual private networking products such as
Check Point Software Technologies, Ltd.'s Firewall-1 and Nortel Network's
Contivity VPN Switch.
Content Filtering. Our content filtering service enables businesses,
families, schools and libraries to control access to objectionable or
inappropriate web sites. SonicWALL can filter Internet content by URL, keyword
or application type. We offer a content filter subscription service that
provides a list of objectionable web sites that is automatically updated on a
weekly basis.
SonicWALL TotalSecure. Introduced in January 2001, our comprehensive
security service for small and medium-sized enterprises is offered through
Managed Service Providers (MSPs) and other service providers. TotalSecure
offers customers 24/7 Internet security, virtual private networking (VPN) and
"always current" protection against viruses, hackers and web-site attacks.
TotalSecure is provided for a monthly, per user fee, with no up-front equipment
purchase.
Transaction Security Products:
Our transaction security products utilize SSL technology and high
performance ASIC designs to ensure the highest levels of performance and
security for businesses and service providers. SonicWALL SSL products boost e-
commerce web site performance up to 50 times by completely offloading the
processing burden of SSL transactions. SonicWALL's SSL products deliver
industry-leading price/performance and guarantee transaction security for the
enterprise, e-commerce and service provider markets.
SonicWALL SSL-PCI. This cost-effective, plug-and-play SSL accelerator board
installs directly into any web server to offload all encryption and decryption
processes from the server, freeing it to perform its applications. Storing up
to 256 keys and certificates, the SonicWALL SSL-PCI ensures complete web server
independence for secure processing.
SonicWALL SSL Appliances. Our SSL appliances easily install in front of any
web server or cluster tasked with secure transaction processing, and support up
to 200 new SSL connections per second and up to
8
900 sustained SSL connections per second for high-demand SSL processing. The
SSL appliances store up to 256 keys and certificates to ensure web server
independence and eliminate configuring secure processing properties on the host
application. The SSL appliances include redundant power supplies and a fail-
over port for high availability SSL processing.
Customers
We sell over 98% of our products through distributors and original equipment
manufacturers. As of December 31, 2000, we have sold more than 117,000 Internet
security appliances. The following lists our top international and domestic
distributors based on revenues in the year ended December 31, 2000, and all of
our current original equipment manufacturers.
Top Domestic and International Distributors Original Equipment Manufacturers
. Ingram Micro, Inc. . Forval Creative, Inc. . 3COM Corp.
. Tech Data Corp. . ComputerLinks (Germany) . Com21, Inc.
. Westcon . Sumitomo Metal Systems (Japan) . Netgear, Inc.
. Access Networks AG . Tek Data (England) . Network Associates
(Switzerland) . Marubeni Solutions
. Telectronic SA
End Users
The following is a representative list of end users in each of our target
markets who have deployed one or more SonicWALL products. These include the
small to medium enterprise, the branch offices of large corporations,
telecommuter, and the education and public institution markets.
Small to Medium Branch Offices Telecommuter Education and Public Institutions
Enterprises
. BDO Seidman LLP . American Express . Compaq Computer . Albany County School District
. Becks Beer . Bank of Nova Scotia Corporation . City of Santa Cruz
. Charlotte Hornets . Centurion/Bank of Ireland . Lucent Technologies . Comision Federal de Electricidad
. Fila Sports . Commercial Bank of . Microsoft Corporation . Duke University
. Pixar Animation San Francisco . NEC . Johns Hopkins University
Studios, Inc. . Wells Fargo . PricewaterhouseCoopers LLP . Santa Clara County
. Sun Microsystems, Inc. . California Library
Sales and Marketing
Our sales and marketing efforts focus on successfully penetrating the small
to medium enterprise, branch office, telecommuter and education markets. Our
marketing programs promote SonicWALL brand awareness and reputation as a
reliable, high performance, easy-to-use, and affordable Internet security
appliance. We try to strengthen our brand through a variety of marketing
programs which include on-going public relations, our web site, advertising,
direct mail, industry and regional trade shows and seminars. We intend to
rapidly expand our indirect channel relationships through additional marketing
programs, additional marketing staff and increased advertising.
We believe that SonicWALL products are ideally suited for the indirect
channel where it is not economically efficient for us to sell directly to the
end users of our products. We primarily market and sell our products in this
indirect channel through a two-tiered distribution structure consisting of
distributors and resellers, in the United States and over 30 other countries.
Distributors accounted for approximately 84% of our total revenue for the year
ended December 31, 2000. Resellers, which include systems integrators, Internet
Service Providers, or ISPs, dealers, mail order catalogs and online catalogs,
generally purchase our products from our distributors and then sell our
products to end-users in our target markets. Except for our SonicWALL Preferred
Partner level resellers described below, we do not have purchase agreements
with or sell directly to our resellers. Our distributor and reseller agreements
are non-exclusive.
9
We divide our sales organization regionally into three areas: the United
States and Canada; the Pacific Rim and Latin America; and Europe, the Middle
East and Africa. Regional sales representatives manage our relationships with
our network of distributors, value-added resellers and customers, help our
value-added reseller network sell and support key customer accounts, and act as
a liaison between our value-added reseller network and our marketing
organization. The regional sales representative's primary responsibility is to
help the indirect channel succeed and grow within the territory. We also have
an internal sales staff that supports the indirect channel, and a dedicated
business development organization whose primary responsibilities are
identifying, promoting and managing strategic relationships to sell our
products with ISPs, industry leaders and original equipment manufacturers, as
well as to obtain technology for incorporation in our product line.
Domestic Channel. In the United States, the primary distributors of our
products to resellers are Ingram Micro, Inc. and Tech Data Corp.. Ingram Micro,
Inc. accounted for 34% of our revenue in 1998 and 1999 and 32% in 2000. Tech
Data Corp. began distributing our Internet security products in February 1999,
and in the year ended December 31, 2000, accounted for approximately 20% of
total revenue.
Domestic resellers receive various benefits and product discounts depending
on the level of purchases that the reseller commits to or achieves. The basic
program is the SonicWALL Reseller, which offers access to privileged
information and sales and marketing materials. Next, we offer a SonicWALL
Select Partner, which extends those benefits by adding access to an expanded
set of sales and marketing tools, as well as priority technical support. The
top level is SonicWALL Preferred Partner, where additional benefits such as
sales leads, access to additional discounted demonstration units and market
development funds are available. SonicWALL Reseller and Select Partner sellers
all source our products through a distributor. We sell directly to SonicWALL
Preferred Partner level resellers.
International Channel. We believe there is a strong international market for
our products. International sales represented 34% of our revenue in 1999 and
approximately 32% of revenue in 2000. Sales to Japan accounted for 11% of total
revenue in the year ended December 31, 2000.
We direct all of our international resellers to the appropriate distributor
in each territory. We support our international distributors by offering
customizable marketing materials, sales tools, leads, co-operative marketing
funds, joint advertising, discounted demonstration units and training. We also
participate in regional press tours, trade shows and seminars. Additional key
international distributors include Access Networks AG in Switzerland, Tek Data
Distribution in England, DataWorld in Hong Kong and ComputerLinks in Germany.
Original Equipment Manufacturer Channel. We enter into select original
equipment manufacturer relationships in order to take advantage of the channels
of well-established companies that sell into our target markets. We believe
these channels expand our overall market while having a minor impact on our own
indirect channel sales. We currently have agreements to sell our products or
services through several original equipment manufacturers. Com21, Inc., a
supplier of cable modems, is licensed to incorporate our technology in its
access products. Network Associates, Inc., a provider of security and anti-
virus software products, sells our firewall appliances and upgrade services
under its own name. NetGear, Inc., a provider of networking equipment for small
and medium businesses, is licensed to incorporate certain components of our
technology into its router and switching products. 3COM Corporation, a provider
of diversified networking and telecommunications equipment, resells certain
products that we manufacture and design under its own name. In addition, we
have signed agreements with myCIO.com, a Network Associates business, and All
Bases Covered(TM), a provider of outsourced information technology services, to
offer our TotalSecure security service under their own brands. The terms of our
agreements with these customers are variable and can generally be cancelled
under certain conditions. In the year ended December 31, 2000, our original
equipment manufacturer revenue accounted for approximately 15% of total
revenue.
Customer Service and Technical Support
We offer our customers a comprehensive range of support programs through a
customer service and technical support organization that provides product
maintenance and technical support services on a worldwide
10
basis. Our technical support staff is located in Sunnyvale, California. In
addition to standard support, we offer premium support services that an end
user customer located in the United States can purchase from us or our channel
partners.
Standard Support. Included during the warranty period, standard support is a
unique web-based technical support mechanism whereby distributors, channel
partners and end users can use our extensive on-line technical support resource
database. If the resource database does not answer a question, the user can
immediately enter a query or "trouble ticket" on-line and our customer service
organization will then generate a response via phone, fax or e-mail.
Per Incident Support. This support program provides priority technical
support for the duration of a single technical support issue. This program has
been designed for customers who have a single problem that they would like
resolved promptly, thereby avoiding or minimizing network down time.
Premium Support. Available for purchase only in the continental United
States, our annual, subscription-based Premium Support program offers extended
benefits to the Standard Support offering that include expedited response time,
overnight equipment replacement, and more. Premium Support is designed for
customers who rely heavily on network/Internet connectivity and cannot afford
to have network downtime.
Our products include a standard one-year warranty that can be extended at
additional cost. The warranty provides access to our standard technical support
services along with repair or replacement guarantees for units with product
defects.
Technology
We have designed our SonicWALL products using a unique combination of
proprietary hardware and software that delivers comprehensive Internet security
with what we believe is exceptional ease-of-use and industry-leading
price/performance.
Access Security Products
Our access security product line currently has two base hardware
configurations. The SonicWALL TELE2, SOHO2 and XPRS2 use the Toshiba TX3927
RISC microprocessor. The SonicWALL TELE2 and SOHO2 include two 10/100 Mbps Fast
Ethernet ports, while the XPRS2 includes three 10/100 Mbps Fast Ethernet ports.
The SonicWALL PRO and PRO-VX use Intel Corporation's 233MHz StrongARM RISC
microprocessor. They include three 10/100 Mbps Fast Ethernet ports.
Additionally, the PRO-VX incorporates custom hardware to accelerate VPN
performance up to 45 Mbps 3DES.
In addition, our global management system, SonicWALL GMS, is an enterprise
software application that enables service providers and distributed enterprises
to centrally manage all of their SonicWALL appliances from a single location.
SonicWALL GMS is available to use in Windows NT or Sun Solaris operating
environments.
The SonicWALL product line consists of the following core features:
. Firewall. The core technology is the stateful packet inspection firewall
software, which is widely accepted as the most advanced and secure method
of implementing an Internet firewall. It examines all layers of the
packet (from the physical layer up to application layer) and determines
whether to accept or reject the requested communication based on state
information derived from previous communications and the applications in
use. Stateful packet inspection dynamically adjusts based on the changing
state of the communication running across the firewall and is invisible
to users on the protected network. It therefore requires no client
personal computer reconfiguration. Our SonicWALL firewall protects
against a known set of security threats.
. IP Address Management. We have developed tools to hide the complexity of
IP addressing. Network Access Transmission, or NAT, allows networks to
share a small number of valid public Internet
11
Protocol, or IP, addresses with an equal or larger number of client
computers on the LAN. This is a common challenge in new broadband-
connected networks. Our DHCP Client and Server tools allow both the
firewall and the client computers behind it to obtain their respective IP
addresses dynamically from a server and thereby eliminate the need for
manual configuration.
. Web Browser-Based Management Interface. We believe our products have an
intuitive and easy-to-use web-based management interface for rapid
installation, configuration and maintenance, without the need for a
dedicated information technology staff to install and maintain the
solution. This interface can be easily accessed from any web browser on
the internal, private network. This interface can also be accessed
remotely in a secure manner using the virtual private networking feature
described above.
. Logging and Reporting. SonicWALL maintains an event log of potential
security concerns, which can be viewed with a web browser or
automatically sent to any e-mail address on a periodic basis. SonicWALL
notifies the administrator of high-priority security issues, such as an
attack on a server, by immediately sending an alert message to a priority
e-mail account such as an e-mail pager. SonicWALL also provides pre-
defined reports that show different views of Internet usage, such as the
most commonly accessed web sites.
Security Services
SonicWALL Internet Security Appliances integrate seamlessly with a
comprehensive and expanding line of value-added security services to provide
complete Internet security. With SonicWALL's integrated security services,
companies avoid the integration and maintenance problems that often result from
sourcing, installing, and maintaining security products from multiple vendors.
Our security services are easily enabled on the base hardware platform via a
software key.
. Anti-Virus. Our anti-virus subscription service eliminates the challenges
of installing and maintaining anti-virus protection throughout a business
and across a distributed network. This SonicWALL service integrates with
our security appliances to deploy and maintain anti-virus software for
each user on the network--without the need for desktop-by-desktop
installation, configuration and maintenance. Automatic virus updates
ensure all network nodes are protected from new virus outbreaks.
. Virtual Private Networking. We developed virtual private networking
support for the SonicWALL products to provide a means for our customers
to use the Internet for secure communication between LANs, and from
remote clients to LANs. SonicWALL virtual private networking complies
with the Internet Protocol Security (IPSec) standard and supports three
data encryption methods: 56 bit Data Encryption Standard (DES); 168 bit
Data Encryption Standard (Triple-DES); and 56 bit ARCFour (ARC4). By
building our virtual private networking technology on industry
standards--IPSec, DES and Triple-DES--we have been able to establish
virtual private networking interoperability with other leading virtual
private networking solutions from companies such as Check Point Software
Technologies, Ltd., Nortel Networks Corp. and Cisco Systems, Inc.
. Content Filtering. Our Internet content filter blocks objectionable
content using a list of forbidden URLs and keywords as well as cookies,
Java and ActiveX scripts. We license the widely respected CyberNOT list
of URLs and adapt it for our products. Each SonicWALL appliance can
automatically download an updated URL list weekly to keep pace with the
dynamic nature of Internet content by subscribing to the SonicWALL
Internet Content Filtering subscription.
Transaction Security Products
SonicWALL transaction security products boost web site performance by
completely offloading all SSL processing from the web servers to a device
optimized for handling SSL transactions. SonicWALL SSL products use a powerful
onboard processor with SonicWALL's proprietary embedded operating system to
deliver a complete end-to-end security system. Our SSL products boost e-
commerce web site performance up
12
to 50 times at a fraction of the cost of installing new web servers. Storing up
to 256 keys and certificates, SonicWALL SSL products ensure complete web server
independence for secure processing.
Our product line has the following hardware configurations:
. SonicWALL SSL-PCI. This cost effective plug-and-play SSL board installs
directly into any web server to offload all encryption, decryption and
secure processes from the server, freeing it to perform its essential web
site tasks. It supports up to 200 new SSL connections per second and up
to 900 sustained SSL connections per second for high-demand SSL
processing. In addition to performing the crypto functions, the SonicWALL
SSL-PCI can function as a 10/100 Mbps Fast Ethernet Network Interface
Card (NIC).
. SonicWALL SSL Appliances. These rack mount or appliance form factor
products are designed for data centers, e-commerce web hosting
environments and enterprise networks. The SonicWALL SSL appliances have
two 10/100 Mbps Fast Ethernet ports--one for network traffic and one for
server traffic, and support up to 200 new SSL connections per second and
up to 900 sustained SSL connections per second for high-demand SSL
processing. They also include a fail-over port and redundant power supply
for high availability SSL processing.
Research and Development
We believe that our future success will depend in large part on our ability
to develop new and enhanced Internet security solutions and our ability to meet
the rapidly changing needs of our target customers who have broadband access to
the Internet. We focus our research and development on evolving Internet
security needs. In addition, we have made substantial investments in hardware
and ASIC technologies, which are critical to drive product cost reductions and
higher performance solutions.
All of our research and development activities are conducted at our
principal facilities in Sunnyvale, California and in Salt Lake City, Utah. In
1998, 1999 and 2000 we incurred expenses of $2,051,000, $3,643,000 and
$11,359,000, respectively, on research and development.
Competition
The market for Internet security products is worldwide and highly
competitive, and we expect competition to intensify in the future. There are
few substantial barriers to entry, and additional competition from existing
competitors and new market entrants will occur in the future. Current and
potential competitors in our markets include, but are not limited to the
following, all of whom sell worldwide or have a presence in most of the major
markets for such products:
. enterprise firewall software vendors such as Check Point Software
Technologies, Ltd. and Symantec Corporation;
. network equipment manufacturers such as Cisco Systems, Inc., Lucent
Technologies, Nortel Networks Corp. and Nokia Corp.;
. encryption processing equipment manufacturers such as nCipher Corporation
and Rainbow Technologies;
. computer or network component manufacturers such as Intel Corporation;
. operating system software vendors such as Microsoft Corporation, Novell,
Inc. and Sun Microsystems, Inc.;
. security appliance suppliers such as WatchGuard Technologies, Inc.; and
. low cost Internet router suppliers which may include limited Internet
security functionality.
13
Many of our competitors to date have generally targeted large enterprises'
security needs with firewall products that are typically very complex and
expensive, ranging in price from approximately $5,000 to more than $15,000.
While there are suppliers of low cost Internet routers which may provide
limited Internet security functionality, we believe these products are
difficult to install and configure and provide relatively low performance. At
any time, any of these competitors may adapt existing products for our target
markets. Many of our current or potential competitors have longer operating
histories, greater name recognition, larger customer bases and significantly
greater financial, technical, marketing and other resources than we do. Nothing
prevents or hinders these actual or potential competitors from entering our
target markets at any time. In addition, our competitors may bundle products
competitive to ours with other products that they may sell to our current or
potential customers. These customers may accept these bundled products rather
than separately purchasing our products. If these companies were to use their
greater financial, technical and marketing resources in our target markets, it
could adversely affect our business.
Proprietary Rights
We currently rely on a combination of copyright and trademark laws, trade
secrets, confidentiality provisions and other contractual provisions to protect
our proprietary rights. Despite our efforts to protect our proprietary rights,
unauthorized parties may misappropriate or infringe on our trade secrets,
copyrights, trademarks, service marks and similar proprietary rights. Although
we are currently investigating patent protection for some of our proprietary
technology, we have not yet received any patent protection for our technology
or products. Even if we obtain such patents, that will not guarantee that our
patent rights will be valuable, create a competitive barrier, or will be free
from infringement. We face additional risk when conducting business in
countries that have poorly developed or inadequately enforced intellectual
property laws. In any event, competitors may independently develop similar or
superior technologies or duplicate the technologies we have developed, which
could substantially limit the value of our intellectual property.
U.S. Government Export Regulation Compliance
Our products are subject to federal export restrictions on encryption
strength. Recent federal legislation, however, has increased exportable
encryption strength and allows the export of any-strength encryption to
designated business sectors overseas, including U.S. subsidiaries, banks,
financial institutions, insurance companies and health and medical end users.
In addition, we have obtained a federal export license that allows us to export
encryption technology to commercial entities in approved countries. With these
expanded export rights, we may export strong encryption to a wide range of
foreign end-users, subject to limitations and record-keeping requirements. To
comply with these constraints, we obtain from our distributors and resellers
detailed information about each foreign end-user customer that will obtain
strong encryption.
Manufacturing
We currently outsource our manufacturing to one contract manufacturer, Flash
Electronics, under an agreement that may be cancelled upon 180 days prior
notice by either party. Outsourcing our manufacturing enables us to reduce
fixed overhead and personnel costs and to provide flexibility in meeting market
demand.
We design and develop all the key components of our products, including
printed circuit boards and software. In addition, we determine the components
that are incorporated in our products and select the appropriate suppliers of
these components. Product testing and burn-in is performed by our contract
manufacturers using tests that we specify.
Employees
As of January 31, 2001, we had 268 employees. Of these, 105 were employed in
sales and marketing, 42 in finance and administration, 97 in research and
development and 24 in operations. We are not party to any collective bargaining
agreements with our employees and we have not experienced any work stoppages.
We believe we have excellent relations with our employees.
14
RISK FACTORS
You should carefully review the following risks associated with owning our
common stock. Our business, operating results or financial condition could be
materially adversely affected by any of the following risks. The trading price
of our common stock could decline due to any of these risks, and you as an
investor may lose all or part of your investment. You should also refer to the
other information set forth in this report and incorporated by reference
herein, including our financial statements and the related notes. Given these
risks and uncertainties, readers are cautioned not to place undue reliance on
such forward-looking statements.
Company Risks
We have recently entered the emerging market for broadband Internet security
appliances, and we do not know if we will be successful in marketing our
products to our target customers.
We believe that many potential customers in our target markets are not fully
aware of the need for Internet security products and services. Historically,
only enterprises having substantial resources developed or purchased Internet
security solutions. Also, there is a perception that Internet security is
costly and difficult to implement. Therefore, we will not succeed unless we can
educate our target markets about the need for Internet security and convince
potential customers of our ability to provide this security in a cost-effective
and easy-to-use manner. Although we have spent, and will continue to spend,
considerable resources educating potential customers about the need for
Internet security and the benefits of our products and services, our efforts
may be unsuccessful.
Even if we convince our target markets about the importance of the need for
Internet security, we do not know if this will result in the sale of our
products. We currently expect that almost all of our future revenue will be
generated through sales of our SonicWALL products, including related services
such as subscription and license fees. Our success depends on market acceptance
of our products and services.
From inception through 1996, we derived substantially all of our revenue
from the sale of Ethernet products for Apple Macintosh computers. In October
1997, we introduced our SonicWALL line of products, and in 1998 we made a
strategic decision to concentrate our resources in the Internet security
market. As a result, we stopped shipment of Ethernet products during December
1999. In 1997, 1998 and 1999 our Ethernet revenue was $9,092,000, $5,166,000
and $1,644,000 and represented approximately 97%, 69% and 8% respectively, of
our total revenue.
Failure to successfully integrate our recent acquisition of Phobos Corporation
could harm our business.
We acquired Phobos Corporation on November 14, 2000. Our failure to
successfully address the risks associated with our acquisition of this company
could have a material adverse affect on our ability to develop and market
products based on the acquired technology. The success of this acquisition will
depend on our ability to:
. Successfully integrate and manage their operations;
. Retain their key employees; and
. Develop and market products based on the acquired technology.
We may be unable to manage our growth, and if we cannot do so, it could have a
material adverse effect on our business.
Our business has grown rapidly in the last year. As of December 31, 1999, we
had 73 employees. As of January 31, 2000, we had 268 employees, an increase of
approximately 267%. In addition, we have experienced expansion in our
manufacturing and shipping requirements, our product line, our customer base
and our end user installed base. This rapid expansion has placed significant
strain on our administrative,
15
operational and financial resources and has resulted in ever-increasing
responsibilities for our management personnel. These changes have increased the
complexity of managing SonicWALL, Inc. If we continue to experience significant
growth, our current systems, management and resources will be inadequate, and
our organization will need to grow rapidly in order to meet the demands placed
on our business. If we cannot manage our growth effectively, our business
prospects will be materially adversely affected.
We do not know if we will be able to maintain profitability in the future.
We incurred losses of $467,000 in 1997 and $1,461,000 in 1998, which
represented 5.0% and 19.5%, respectively, of total revenue. In the year ended
December 31, 1999, we reported net income of $158,000, and we reported
$8,747,000 in net income, or approximately 12.6% of revenue, for the year ended
December 31, 2000. We do not know if we will be able to maintain profitability
in the future. If we are not able to maintain profitability, your investment in
our common stock may decline in value.
Because we recently introduced our Internet security products, we cannot
predict our future operating results or our future revenues from these
products.
Because from 1996-1998 our business focus was selling Ethernet products for
Macintosh computers, and in November 2000 we expanded our operations through
the acquisition of Phobos Corporation, our historical financial information is
of limited value in projecting future operating results. We believe that
comparing different periods of our operating results is not meaningful and you
should not rely on the results for any period as an indication of our future
performance.
Our limited three-year history of selling Internet security products is one
of many factors underlying our inability to predict our revenue for a given
period. We base our spending levels for product development, sales and
marketing, and other operating expenses largely on our expected future revenue.
A large proportion of our expenses is fixed for a particular quarter or year,
and therefore, we may be unable to decrease our spending in time to compensate
for any unexpected quarterly or annual shortfall in revenue. As a result, any
shortfall in revenue could adversely affect our operating results.
We depend on two major distributors for a significant amount of our revenue,
and if they or others cancel or delay purchase orders, our revenue may decline
and the price of our stock may fall.
To date, sales to a limited number of distributors have accounted for a
significant portion of our revenue. In 1999, Ingram Micro, Inc. and Tech Data
Corporation, both of which are global computer equipment and accessory
distributors, account for approximately 34% and 12% of our revenue,
respectively. In 2000, approximately 84% of our sales were to distributors, and
Ingram Micro, Inc. and Tech Data Corp. accounted for approximately 32% and 20%
of our revenue, respectively. We cannot assure you that either of these
existing customers will continue to place orders with us, that orders by these
existing customers will continue at the levels of previous periods or that we
will be able to obtain large orders from new customers.
We anticipate that sales of our products to relatively few customers will
continue to account for a significant portion of our revenue. If any of our
major distributors stops or delays its purchase of our products, our revenue
and profitability would be adversely affected. In addition, as of December 31,
2000, Ingram Micro, Inc. and Tech Data Corp. represented $5.2 million and $3.1
million, respectively, of our account receivable, constituting 39% and 24%,
respectively, of total receivables on such date. The failure of any of these
distributors to pay us in a timely manner could adversely affect our payments
to suppliers and our creditworthiness, which could make it more difficult to
conduct business.
Although we have limited one-year agreements with Ingram Micro, Inc. and
Tech Data Corp., these contracts are subject to termination at any time, and we
do not know if these customers will continue to place orders for our products.
16
If an original equipment manufacturer customer cancels, reduces or delays
purchases, our revenue may decline and our business could be adversely
affected.
We currently have formed original equipment manufacturer relationships with
four original equipment manufacturers including, 3Com Corporation, Com21,
Netgear, Inc., and Network Associates, Inc. If we fail to sell to such OEMs in
the quantities expected, or if any OEM terminates our relationship, this could
adversely affect our reputation, the perception of our products and technology
in the marketplace or the growth of our business, and your investment in our
common stock may decline in value.
Our sales are usually done on a purchase order basis and we have no binding
purchase commitments from our distributors or original equipment manufacturers,
which could result in a lack of sales.
We sell our products to end users through distributors, resellers and
original equipment manufacturers. Our success depends in large part on their
performance. These customers:
. Are not obligated to purchase or market our products and can stop doing
so at any time; and
. Have no exclusive arrangements with us, and are not obligated to renew
their agreements with us.
Average selling prices of our products may decrease, which may reduce our gross
margins.
The average selling prices for our products may decline as a result of
competitive pricing pressures, promotional programs and customers who negotiate
price reductions in exchange for longer term purchase commitments. The pricing
of products depends on the specific features and functions of the products,
purchase volumes and the level of sales and service support. We expect
competition to increase in the future. As we experience pricing pressure, we
anticipate that the average selling prices and gross margins for our products
will decrease over product life cycles. We cannot assure you that we will be
successful in developing and introducing on a timely basis new products with
enhanced features, or that these products, if introduced, will enable us to
maintain our average selling prices and gross margins at current levels. The
Company's gross margin has and will continue to be affected by a variety of
factors, including competition; the mix and average selling prices of products;
new product introductions and enhancements and the cost of components and
manufacturing labor. We must manage each of these factors effectively for our
gross margins to remain at current levels.
We offer retroactive price protection to our major distributors and if we fail
to balance their inventory with end user demand for our products, our allowance
for price protection may be inadequate. This could adversely affect our results
of operations.
We provide our major distributors with price protection rights for
inventories of our products held by them. If we reduce the list price of our
products, our major distributors receive refunds or credits from us that reduce
the price of such products held in their inventory based upon the new list
price. As of December 31, 2000, we estimate that approximately $6.3 million of
our products in our distributors' inventory are subject to price protection.
This amount represented approximately 9.1% of our revenue for the year ended
December 31, 2000. We have provided less than $100,000 of credits under our
price protection policies in the past three fiscal years. Future credits for
price protection will depend on the percentage of our price reductions for the
products in inventory and our ability to manage the level of our major
distributors' inventory. New product introductions or price reductions by us or
our competitors could result in significant product price adjustments. If
future price protection adjustments are higher than expected, our future
results of operation could be materially adversely affected.
Potential future acquisitions could be difficult to integrate, disrupt our
business, dilute shareholder value and adversely affect our operating results.
In November 2000, we completed the acquisition of Phobos Corporation.
Although we have no current plans, agreements or commitments with respect to
any material acquisition, we may make additional acquisitions or investments in
other companies, products or technologies in the future. We are currently in
the process of integrating the operations, products and personnel of the former
Phobos Corporation. If we acquire other businesses in the future, we will be
required to integrate operations, train, retain and motivate the
17
personnel of these entities as well. We may be unable to maintain uniform
standards, controls, procedures and policies if we fail in these efforts.
Similarly, acquisitions may cause disruptions in our operations and divert
management's attention from day-to-day operations, which could impair our
relationships with our current employees, customers and strategic partners.
We may have to incur debt or issue equity securities to pay for any future
acquisitions. The issuance of equity securities for any acquisition could be
substantially dilutive to our stockholders. In addition, our profitability has
suffered because of acquisition-related costs or amortization costs for
acquired goodwill and other intangible assets.
We are dependent on international sales for a substantial amount of our
revenue. We face the risk of international business and associated currency
fluctuations, which might adversely affect our operation results.
International revenue represented 32% of total revenue in 1998, 34% of total
revenue in 1999 and 32% of total revenue in 2000. For the year ended December
31, 2000, revenue from Japan represented 11% of our total revenue, and revenue
from all other international regions collectively represented approximately 21%
of our total revenue. We expect that international revenue will continue to
represent a substantial portion of our total revenue in the foreseeable future.
Our risks of doing business abroad include our ability to maintain distribution
relationships on favorable terms. To the extent we are unable to favorably
renew our distribution agreements or make alternative arrangements, revenue may
decrease from our international operations. We also face risks associated with
general economic conditions and regulatory uncertainties associated with our
international sales. Because our sales are denominated in United States
dollars, the weakness of the foreign country's currency against the dollar
could increase the price of our products in such country and reduce our product
unit sales by making our products more expensive in the local currency.
We are subject to the risks of conducting business internationally,
including potential foreign government regulation of our technology, general
geopolitical risks associated with political and economic instability, changes
in diplomatic and trade relationships, and foreign counties' laws affecting the
Internet generally.
Delays in deliveries from our component suppliers could cause our revenue to
decline and adversely affect our results of operations.
We outsource all of our hardware manufacturing and assembly from security
appliances to a single manufacturer. Our SonicWALL products incorporate certain
components or technologies that are only available from single or limited
sources of supply. Specifically, our products rely upon microprocessors from
Motorola, Inc. and Intel Corporation and incorporate software products from
third-party vendors. We do not have long-term supply arrangements with any
vendor, and this may adversely affect our ability to obtain necessary
components or technology for our products. If we are unable to purchase such
components or maintain licenses from these suppliers, this may delay or prevent
product shipments and result in a loss of sales. This could cause a loss of
revenue that would adversely affect our results of operations. We may not be
able to replace any of these supply sources on economically advantageous terms.
In addition, our products utilize components that have in the past been subject
to market shortages and price fluctuations. If we experience price increases in
our product components, we will experience declines in our gross margin.
We may have to defend lawsuits or pay damages in connection with any alleged or
actual failure of our products and services.
Because our products and services provide and monitor Internet security and
may protect valuable information, we may face claims for product liability,
tort or breach of warranty. Anyone who circumvents our security measures could
misappropriate the confidential information or other property of end users
using our
18
products and services or interrupt their operations. If that happens, affected
end users or others may sue us. In addition, we may face liability for breaches
caused by faulty installation of our products by resellers or end users.
Although we attempt to reduce the risk of losses from claims through
contractual warranty disclaimers and liability limitations, these provisions
may be unenforceable. Some courts, for example, have found contractual
limitations of liability in standard computer and software contracts to be
unenforceable in some circumstances. Defending a lawsuit, regardless of its
merit, could be costly and could divert management attention. Although we
currently maintain business liability insurance, this coverage may be
inadequate or may be unavailable in the future on acceptable terms, if at all.
Our business liability insurance has no specific provisions for potential
liability for Internet security breaches.
A security breach of our internal systems or those of our customers could harm
our business.
Because we provide Internet security, we may become a greater target for
attacks by computer hackers. We will not succeed unless the marketplace is
confident that we provide effective Internet security protection. Networks
protected by our products may be vulnerable to electronic break-ins. Because
the techniques used by computer hackers to access or sabotage networks change
frequently and generally are not recognized until launched against a target, we
may be unable to anticipate these techniques. Although we have not experienced
any act of sabotage or unauthorized access by a third party of our internal
network to date, if an actual or perceived breach of Internet security occurs
in our internal systems or those of our end-user customers, regardless of
whether we cause the breach, it could adversely affect the market perception of
our products and services. This could cause us to lose current and potential
customers, resellers, distributors or other business partners.
We rely primarily on one contract manufacturer for all of our product
manufacturing and assembly, and if we cannot obtain its services, we may not be
able to ship products.
We outsource all of our hardware manufacturing and assembly primarily to one
third-party manufacturer and assembly house; Flash Electronics, Inc. We do not
have a long-term manufacturing contract with this vendor. Flash Electronics has
produced products with acceptable quality, quantify and cost in the past, but
it may be unable or unwilling to meet our future demands. Our operations could
be disrupted if we have to switch to a replacement vendor or if our hardware
supply is interrupted for an extended period. This could result in loss of
customer orders and revenue.
We may be unable to adequately protect our proprietary rights, which may limit
our ability to compete effectively.
Unauthorized parties may misappropriate or infringe our trade secrets,
copyrights, trademarks and similar proprietary rights. We have not received any
patent protection for our technology or products. Even if we obtain such
patents, that will not guarantee that our patent rights will be valuable,
create a competitive barrier, or will be free from infringement. We face
additional risk when conducting business in countries that have poorly
developed or inadequately enforced intellectual property laws. In any event,
competitors may independently develop similar or superior technologies or
duplicate the technologies we have developed, which could substantially limit
the value of our intellectual property.
Potential intellectual property claims and litigation could subject us to
significant liability for damages and invalidation of our proprietary rights.
In the future, we may have to resort to litigation to protect our
intellectual property rights or trade secrets or to determine the validity and
scope of the proprietary rights of others. Any litigation, regardless of its
success, would probably be costly and require significant time and attention of
our key management and technical personnel. Litigation could also force us to:
. stop or delay selling, incorporating or using products that incorporate
the challenged intellectual property;
19
. pay damages;
. enter into licensing or royalty agreements, which may be unavailable on
acceptable terms; or
. redesign products or services that incorporate infringing technology.
We may face infringement claims from third parties in the future. The
computer industry has seen frequent litigation over intellectual property
rights. We expect that infringement claims will be more frequent for Internet
participants as the number of products, services and competitors grows and
functionality of products and services overlaps.
Undetected product errors or defects could result in loss of revenue, delayed
market acceptance and claims against us.
We offer a one-year warranty on all of our products, allowing the end user
to receive a repaired or replacement product for any defective unit.
Historically, refunds based on product warranty claims have been insignificant.
Although we have discovered few errors or defects in our products, our products
may contain undetected errors or defects. If there is a product failure, we may
have to replace all affected products without being able to book revenue for
such replacement units, or we may have to refund the purchase price for such
units. Because of our recent introduction if Internet security products, we
have little experience in gauging the risk of unexpected product failures or
defects. Despite extensive testing, some errors are discovered only after a
product has been installed and used by customers. Any errors discovered after
commercial release could result in loss of revenue and claims against us. In
the year ended December 31, 2000, refunds attributable to errors or defects in
products amounted to less than 2% of total revenue for the period.
If we do not retain our key employees and attract new employees, our ability to
execute our business strategy will be impaired.
We compete for employees in California's Silicon Valley, one of the most
difficult employer environments in the United States. Our future success will
depend largely on the efforts and abilities of our current senior management
and our ability to attract and retain additional key development, technical,
operations, information systems, customer support and sales and marketing
personnel. We do not have employment contracts with any of our key employees,
who may leave us at any time. Specifically, the services of Sreekanth Ravi,
President and Chief Executive Officer, Sudhakar Ravi, Chief Technical Officer,
and Michael Sheridan, Chief Operating Officer, would be difficult to replace.
We do not maintain life insurance for any of our key personnel.
If we are unable to meet our future capital requirements, our business will be
harmed.
We expect our cash on hand, cash equivalents and commercial credit
facilities to meet our working capital and capital expenditure needs for at
least the next 12 months. After that time, we may need to raise additional
funds and we cannot be certain that we would be able to obtain additional
financing on favorable terms, if at all. Further, if we issue equity
securities, shareholders may experience additional dilution or the new equity
securities may have rights, preferences or privileges senior to those of
existing holders of common stock. If we cannot raise funds, if needed, on
acceptable terms, we may not be able to develop or enhance our products, take
advantage of future opportunities or respond to competitive pressures or
unanticipated requirements, which could have a material adverse effect on our
business, operating results and financial condition.
20
Industry Risks
Our revenue growth is dependent on the continued growth of broadband access
services, which are currently in early stages of development, and if such
services are not widely adopted or we are unable to address the issues
associated with the development of such services, our sales will be adversely
affected.
Sales of our products depend on the increased use and widespread adoption of
broadband access services, such as cable, DSL, Integrated Services Digital
Network, or ISDN, Frame Relay and T-1. These broadband access services
typically are more expensive in terms of required equipment and ongoing access
charges than is the case with Internet dial-up access providers. Our business,
prospects, results of operations and financial condition would be adversely
affected if the use of broadband access services does not increase as
anticipated or if our customers' access to broadband services is limited.
Critical issues concerning use of broadband access services are unresolved and
will likely affect the use of broadband access services. These issues include:
. security;
. reliability;
. bandwidth;
. congestion;
. cost;
. ease of access; and
. quality of service.
Even if these are resolved, if the market for products that provide
broadband access to the Internet fails to develop, or develops at a slower pace
than we anticipate, our business, prospects, results of operations and
financial condition would be materially adversely affected.
The broadband access services market is new and is characterized by rapid
technological change, frequent enhancements to existing products and new
product introduction, changes in customer requirements and evolving industry
standards. We may be unable to respond quickly or effectively to these
developments. The introduction of new products by competitors, market
acceptance of products based on new or alternative technologies, or the
emergence of new industry standards, could render our existing or future
products obsolete, which would materially adversely affect our business,
prospects, results of operations and financial condition.
The emergence of new industry standards might require us to redesign our
products. If our products fail to comply with widely adopted industry
standards, our customers and potential customers may not purchase our products.
This would have a material adverse effect on our business, prospects, results
of operation and financial condition.
If we are unable to compete successfully in the highly competitive market for
internet security products and services, our business will fail.
The market for Internet security products is worldwide and highly
competitive, and we expect competition to intensify in the future. There are
few substantial barriers to entry, and additional competition from existing
competitors and new market entrants will likely occur in the future. Current
and potential competitors in our markets include, but are not limited to the
following, all of whom sell worldwide or have a presence in most of the major
markets for such products:
. enterprise firewall software vendors such as Check Point Software
Technologies, Ltd. and Symantec Corp.
. network equipment manufacturers such as Cisco Systems, Inc., Lucent
Technologies, Nortel Networks Corp. and Nokia Corp.;
21
. encryption processing equipment manufacturers such as nCypher
Corporation and Rainbow Technologies;
. computer or network component manufacturers such as Intel Corporation;
. operating system software vendors such as Microsoft Corporation, Novell,
Inc. and Sun Microsystems, Inc.;
. security appliance and PCI card suppliers such as WatchGuard
Technologies, Inc.; and
. low cost Internet router suppliers which may include limited Internet
security functionality.
Most of our competitors to date have generally targeted large enterprises'
security needs with firewall and Secure Socket Layer (SSL) products that range
in price from approximately $5,000 to more than $15,000, which may increase
competitive pressure on some of our products, resulting in both lower prices
and gross margins. Recently, some of our competitors have introduced products
priced at less than $1,000. Many of our current or potential competitors have
longer operating histories, greater name recognition, larger customer bases and
significantly greater financial, technical, marketing and other resources than
we do. Nothing prevents or hinders these actual or potential competitors from
entering our target markets at any time. In addition, our competitors may
bundle products competitive to ours with other products that they may sell to
our current or potential customers. These customers may accept these bundled
products rather than separately purchasing our products. If these companies
were to use their greater financial, technical and marketing resources in our
target markets, it could adversely affect our business.
Rapid changes in technology and industry standards could render our products
and services unmarketable or obsolete, and we may be unable to successfully
introduce new products and services.
To succeed, we must continually change and improve our products in response
to rapid technological developments and changes in operating systems, broadband
Internet access, application and networking software, computer and
communications hardware, programming tools, computer language technology and
other security threats. We may be unable to develop new products and services
or achieve and maintain market acceptance of them once they have come to
market. Product development for Internet security appliances requires
substantial engineering time and testing. Releasing new products and services
prematurely may result in quality problems, and delays may result in loss of
customer confidence and market share. In the past, we have on occasion
experienced delays in the schedule introduction of new and enhanced products
and services, and we may experience delays in the future. When we do introduce
new or enhanced products and services, we may be unable to manage the
transition from the older products and services to minimize disruption in
customer ordering patterns avoid excessive inventories of older products and
deliver enough new products and services to meet customer demand.
Governmental regulations affecting internet security could affect our revenue.
Any additional governmental regulation of imports or exports or failure to
obtain required export approval of our encryption technologies could adversely
affect our international and domestic sales. The United States and various
foreign governments have imposed controls, export license requirements and
restrictions on the import or export of some technologies, especially
encryption technology. In addition, from time to time governmental agencies
have proposed additional regulation of encryption technology, such as requiring
the escrow and governmental recovery of private encryption keys. Additional
regulation of encryption technology could delay or prevent the acceptance and
use of encryption products and public networks for secure communications. This,
in turn, could decrease demand for our products and services.
In addition, some foreign competitors are subject to less stringent controls
on exporting their encryption technologies. As a result, they may be able to
compete more effectively than we can in the United States and international
Internet security market.
22
Recently, political attention has resulted in legislative efforts to make
the Internet safe for children at schools and other educational institutions
receiving federal assistance by linking the receipt of federal funds to the
existence of content filtering and security software for such institutions'
Internet connections. Some have questioned the constitutionality or other
legality of such efforts. We believe that any government controls or attempts
to regulate the Internet could have a material adverse effect on our business.
For example, legislation requiring Internet security for schools receiving
federal funds would encourage purchases of our SonicWALL products; a court
ruling invalidating such legislation might reduce sales to these market
segments.
Investment Risks
Because they own approximately 38% of our stock ownership, our officers,
directors and their affiliates can significantly influence all matters
requiring shareholder approval.
As of December 31, 2000, our executive officers, directors, and entities
affiliated with them, in the aggregate, beneficially owned approximately 38% of
our outstanding common stock. These shareholders, if acting together, would be
able to significantly influence all matters requiring shareholder approval,
including the election of directors, mergers or other forms of business
combinations.
Our stock price may be volatile.
The market price of our common stock has been highly volatile and has
fluctuated significantly in the past. We believe that it may continue to
fluctuate significantly in the future in response to the following factors,
some of which are beyond our control:
. Variations in quarterly operating results;
. Changes in financial estimates by securities analysts;
. Changes in market valuations of technology and Internet infrastructure
companies;
. Announcements by us of significant contracts, acquisitions, strategic
partnerships, joint ventures or capital commitments;
. Loss of a major client or failure to complete significant license
transactions;
. Additions or departures of key personnel;
. Sales of common stock in the future; and
. Fluctuations in stock market price and volume, which are particularly
common among highly volatile securities of Internet-related companies.
Our business may be adversely affected by class action litigation due to stock
price volatility.
In the past, securities class action litigation has often been brought
against companies following periods of volatility in the market price of its
securities. We may in the future be the target of similar litigation.
Securities litigation could result in substantial costs and divert management's
attention and resources, which could have a material adverse effect on our
business, operating results and financial condition.
Charter and bylaw provisions limit the authority of our shareholders, and
therefore minority shareholders may not be able to significantly influence
Sonicwall, Inc.'s governance or affairs.
Our board of directors has the authority to issue shares of preferred stock
and to determine the price, rights, preferences, privileges, and restrictions,
including voting rights, of those shares without any further vote or action by
shareholders. The rights of the holders of common stock will be subject to, and
may be adversely affected by, the rights of the holders of any preferred stock
that may be issued in the future. The issuance of preferred stock, while
providing flexibility in connection with possible acquisitions and other
corporate purposes, could have the effect of making it more difficult for a
third party to acquire a majority of our outstanding voting stock.
23
Our charter documents also provide for limitation on the ability of
shareholders to call special meetings and act by written consent and prohibit
cumulative voting for directors. As a result, minority shareholder
representation on the board of directors may be difficult to establish. The
charter documents also limit the persons who may call special meetings of the
shareholders, prohibit shareholder actions by written consent and establish
advance notice requirements for nominations for election to the board of
directors or for proposing matters that can be acted on by shareholders at
shareholder meeting.
ITEM 2. PROPERTIES
Our headquarters are located in approximately 32,000 square feet of office
space in Sunnyvale, California under a lease that expires in October 2004. The
Company also leases approximately 34,000 square feet of office space in Salt
Lake City, Utah under a lease that expires in April 2005. Additional sales and
support offices are leased in the Netherlands, the United Kingdom, Japan and
Hong Kong. We believe that our existing facilities are adequate for our current
needs and that additional space will be available as needed.
ITEM 3. LEGAL PROCEEDINGS
We are party to routine litigation incident to our business. Management
believes that none of these legal proceedings will have a material adverse
effect on our consolidated financial statements taken as a whole or our results
of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Annual Meeting of Shareholders held on December 15, 2000, (the
"December Stockholders Meeting") the stockholders of the Company voted on and
approved the following proposals:
Proposal 1. To elect six directors to the Board of Directors;
Proposal 2. To approve an amendment to the 1999 Employee Stock Purchase
Plan to increase the number of shares of Common Stock reserved
for issuance by 200,000 shares of Common Stock to an aggregate
of 700,000 shares;
Proposal 3. To approve an amendment to the 1998 Stock Option Plan to
increase the number of shares of Common Stock reserved for
issuance thereunder to 12,610,678; and
Proposal 4. To ratify the selection of PricewaterhouseCoopers LLP as
independent accountants of the Company's financial statements
for the year ending December 31, 2000.
Information on the Board of Directors.
The following directors were elected at the December Stockholders Meeting:
- Sreekanth Ravi, Chairman
- Sudhakar Ravi
- Charles D. Kissner
- David A. Shrigley
- Ronald E. Heinz
- Robert M. Williams
24
December Stockholders Meeting Results.
Proposal 1. Election of Directors
Broker
Director In favor Withheld non-votes
-------- -------- -------- ---------
Sreekanth Ravi................................. 47,840,272 297,441 n/a
Sudhakar Ravi.................................. 47,840,272 297,441 n/a
Charles D. Kissner............................. 47,908,719 228,994 n/a
David A. Shrigley.............................. 47,909,174 228,539 n/a
Ronald E. Heinz................................ 47,748,665 389,048 n/a
Robert M. Williams............................. 47,909,174 228,539 n/a
Proposal 2. Amendment to 1999 Employee Stock Purchase Plan
Broker
For Against Withheld non-votes
--- ------- -------- ---------
47,340,126 723,271 74,316 0
Proposal 3. Amendment to the 1998 Stock Option Plan
Broker
For Against Withheld non-votes
--- ------- -------- ---------
38,442,552 9,618,143 77,018 0
Proposal 4. Ratification of Independent Public Accountants
Broker
For Against Withheld non-votes
--- ------- -------- ---------
48,064,952 11,686 61,075 0
25
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock commenced trading on the Nasdaq National Market on November
11, 1999 and is traded under the symbol "SNWL". As of December 31, 2000, there
were approximately 174 holders of record of the common stock. The high and low
sale prices for the common stock as reported on the Nasdaq National Market
were:
High Low
-------- --------
Fiscal 1999
Fourth Quarter*.......................................... $ 21.75 $ 12.125
Fiscal 2000
First Quarter............................................ $ 66.25 $17.6875
Second Quarter........................................... $ 46.625 $22.0625
Third Quarter............................................ $54.3125 $26.8125
Fourth Quarter........................................... $ 24.375 $ 12.00
- --------
* Commencing November 11, 1999
We have never paid a cash dividend on our capital stock. We currently
anticipate that we will retain all available funds for use in our business and
we do not anticipate paying any cash dividends.
In March 2000, the Company completed a secondary offering of 7,000,000
shares of its common stock at a price of $50 per share, of which 3,500,000
shares were sold by the Company and 3,500,000 shares were sold by selling
shareholders. The Company received approximately $166 million in net proceeds
after deducting underwriting discounts and commissions and offering expenses.
The Company expects to use the proceeds from the offering to support growth,
working capital and potential acquisitions of complementary products and
technologies.
In September 2000, the Company effected a two-for-one stock split effective
September 15, 2000. All share and per share amounts have been adjusted
accordingly throughout this document to reflect the stock split.
In November 2000, the Company issued approximately 9,906,000 shares of its
common stock in connection with the acquisition of Phobos Corporation.
26
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with our consolidated financial statements and related notes
thereto and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" included in this Form 10-K. The consolidated statements
of operations data for each of the years in the three-year period ended
December 31, 2000, and the balance sheet data at December 31, 2000 and 1999 are
derived from the audited consolidated financial statements included elsewhere
in this Form 10-K. The consolidated statement of operations data for the years
ended December 31, 1997 and 1996 and the balance sheet data at December 31,
1998, 1997 and 1996 are derived from audited financial statements which are not
included in this Form 10-K. Prior year revenue balances have been reclassified
to be consistent with the current year presentation. The historical results are
not necessarily indicative of the operating results to be expected in the
future.
Year Ended December 31,
------------------------------------------
1996 1997 1998 1999 2000
------ ------ ------- ------- --------
(in thousands, except per share data)
Statement of Operations Data:
Revenue
Product......................... $9,356 $9,342 $ 7,480 $19,130 $ 60,101
License and subscription........ -- -- 35 1,917 9,347
------ ------ ------- ------- --------
Total revenue................. 9,356 9,342 7,515 21,047 69,448
------ ------ ------- ------- --------
Cost of revenue...................
Product......................... 5,915 4,842 3307 5,884 17,310
License and subscription........ -- -- 1 77 262
------ ------ ------- ------- --------
Total cost of revenue......... 5,915 4,842 3,308 5,961 17,572
------ ------ ------- ------- --------
Gross margin...................... 3,441 4,500 4,207 15,086 51,876
------ ------ ------- ------- --------
Operating expenses
Research and development........ 1,048 1,983 2,051 3,634 11,359
Sales and marketing............. 1,665 2,468 2,870 5,342 15,662
General and administrative...... 432 644 753 1,761 5,745
In-process research and
development.................... -- -- -- -- 2,300
Amortization of goodwill and
intangibles.................... -- -- -- -- 4,961
Deferred stock compensation..... -- -- 42 2,895 3,315
------ ------ ------- ------- --------
Total operating expenses...... 3,145 5,095 5,716 13,632 43,342
------ ------ ------- ------- --------
Income (loss) from operations..... 296 (595) (1,509) 1,454 8,534
Interest income and other expense,
net.............................. 22 29 54 536 10,136
------ ------ ------- ------- --------
Income (loss) before income
taxes............................ 318 (566) (1,455) 1,990 18,670
Benefit from (provision for)
income taxes..................... (350) 99 (6) (1,832) (9,923)
------ ------ ------- ------- --------
Net income (loss)................. $ (32) $ (467) $(1,461) $ 158 $ 8,747
====== ====== ======= ======= ========
Basic net income (loss) per
share............................ $(0.00) $(0.03) $ (0.06) $ 0.00 $ 0.16
====== ====== ======= ======= ========
Diluted net income (loss) per
share............................ $(0.00) $(0.03) $ (0.06) $ 0.00 $ 0.14
====== ====== ======= ======= ========
Shares used in calculation of
basic net income (loss) per
share............................ 16,920 16,922 22,502 34,668 54,879
====== ====== ======= ======= ========
Shares used in calculation of
diluted net income (loss) per
share............................ 16,920 16,922 22,502 42,392 60,496
====== ====== ======= ======= ========
As of December 31,
------------------------------------------
1996 1997 1998 1999 2000
------ ------ ------- ------- --------
(in thousands)
Consolidated Balance Sheet Data:
Cash and cash equivalents......... $1,036 $ 787 $ 1,051 $62,589 $140,287
Short term investments............ -- -- -- -- 79,257
Total assets...................... 3,448 2,374 4,751 71,239 488,117
Total shareholders' equity........ 932 465 1,488 60,750 435,758
27
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following commentary should be read in conjunction with the financial
statements and related notes contained elsewhere in this Form 10-K. The
discussion contains forward-looking statements that involve risks and
uncertainties. These statements relate to future events or our future financial
performance. In many cases, you can identify forward-looking statements by
terminology such as "may," "will," "should," "expect," "plan," "anticipate,"
"believe," "estimate," "predict," "potential," "intend" or "continue," or the
negative of such terms and other comparable terminology. These statements are
only predictions. Our actual results may differ materially from those
anticipated in these forward-looking statements as a result of a variety of
factors, including, but not limited to, those set forth under "Risk Factors"
and elsewhere in this documents.
Overview
From inception through 1996, we derived substantially all of our revenue
from the development and marketing of networking products for Apple Macintosh
computers. These products enabled Apple Macintosh computers to connect to
computer networks using Ethernet communications standards. The Ethernet
standard was developed in the 1970s by Xerox Corporation and is the most widely
used technology to facilitate communication between computers on local area
networks. The Ethernet standard is defined by the Institute of Electrical and
Electronics Engineers and specifies the speed and other characteristics of a
computer network. In 1998, we made a strategic business decision to concentrate
our resources in the Internet security market due to our belief that this
market had better long-term growth prospects. As a result, we stopped shipments
of our Ethernet product line during December 1999. In October 1997, we
introduced our first Internet security appliance, the SonicWALL DMZ, and began
volume shipments in 1998. In 1998, we began offering content filtering
subscriptions to our SonicWALL customers. Customers can purchase subscriptions
for one to four years, and they receive weekly updated lists of objectionable
web site addresses to which they can block access. We now focus all our
development, marketing and sales efforts on the Internet security appliance
market. Our shift to selling Internet security products has not required any
significant restructuring of our personnel, facilities, manufacturing or
operations. We have not experienced, and do not expect, any significant charges
related to our Ethernet product inventories or warranty obligations. In 1999,
our Internet security products represented approximately 92% of our total
revenue and in 2000 they represented 100% of our total revenue. In 1999, our
Ethernet products represented 8% of our total revenue and in 2000, Ethernet
products are no longer being sold.
Our SonicWALL products are sold primarily through distributors who then
resell our products to resellers and selected retail outlets. These resellers
then sell our products to end-users. Two of our distributors, Ingram Micro,
Inc. and Tech Data Corp., both of which are global computer equipment and
accessory distributors, account for approximately 46% and 52% of our revenue in
1999 and 2000, respectively. In 1999, sales to Ingram Micro, Inc. and Tech Data
Corp. accounted for 34% and 12% of our revenue, respectively. In 2000, sales to
Ingram Micro, Inc. and Tech Data Corp. accounted for 32% and 20% of our
revenue, respectively.
Our revenue consists of product sales and license and subscription revenue.
License and subscription fees include virtual private networking ("VPN"),
global management system, content filtering services, anti-virus and extended
warranty contract fees. Product sales comprised approximately 87% of total
revenue for the year ended December 31, 2000. Product revenue is generally
recognized at the time of shipment if collectibility is probable and no
significant obligations remain. Revenue from software products is recognized in
accordance with SOP 97-2. Specifically, revenue is generally recognized when
delivery of the software has occurred, persuasive evidence of an arrangement
exists, collectibility of the fee is probable and the fee is fixed and
determinable. Revenue from extended warranty programs, premium technical
assistance, and subscriptions to content filtering and anti-virus services is
recognized ratably over the term of the contract or subscription. Ingram Micro,
Inc.'s right to return or rotate its stock on-hand is unlimited, and therefore
we recognize revenue for product sales to Ingram Micro, Inc. when it has sold
the product to its customers. Ingram Micro, Inc. does not have the right to
return non-defective products to us if a customer of Ingram Micro, Inc. returns
such a
28
product to Ingram Micro, Inc. For all other distributors, the value of stock
that can be rotated is generally limited to 15% of the prior quarter's
purchases. Co-op advertising rights provide a distributor the right to be
reimbursed up to 3% of the prior quarter's sales for costs it has incurred
associated with advertising our products. For all of our distributors, we
provide an allowance for sales returns, price protection rights and reserves
for warranty and co-op advertising costs at the time of revenue recognition.
Price reductions which may result in price protection require the approval of
our president, chief financial officer, and vice president of sales.
To date, a significant portion of our revenue has been dependent on large
purchase orders from a limited number of distributors. These purchase orders
typically have short lead times and are subject to delay or cancellation
without penalty. We anticipate that our operating results for a given period
will continue to depend on a small number of customers. If we experience a
decline in revenue from any of our significant distributors in a given quarter,
our revenue for that quarter, or following quarters, will be adversely
affected. This could adversely affect our business, prospects, results of
operations and financial condition. Furthermore, if any of our significant
customers experiences financial difficulties, our sales to these customers may
be reduced, and we may have difficulty collecting accounts receivable from
these customers. Any delay in large customer orders or customer financial
difficulties could have a material adverse effect on our business, prospects,
results of operations and financial condition.
We primarily use one contract manufacturer to manufacture our products. We
also rely on single or limited source suppliers to provide key components of
our products. A significant portion of our cost of revenue is related to these
suppliers. These relationships are subject to a variety of risks.
In August 1998, we acquired all the partnership interest of AckFin Networks,
a California general partnership, in exchange for an aggregate of 10,852,368
shares of all common stock with an estimated value of $0.45 per share, or
$4,883,000, and the assumption of $150,000 in liabilities. The controlling
partners of AckFin, Sreekanth Ravi and Sudhakar Ravi, two of our executive
officers and principal shareholders, were also the majority shareholders of
SonicWALL, Inc. and, therefore, were deemed to be a control group for purposes
of determining the amount of purchase price to be "stepped-up." The value of
the exchanged shares for AckFin was accounted for as a reorganization of
entities under common control. Accordingly, net assets acquired were valued by
applying carryover basis to the control group interest and a stepped-up basis
to the minority interest. The step-up of the minority interest resulted in an
intangible asset of $2,517,000. This intangible asset was attributed to
acquired completed technology and will be amortized over a period of three
years. Amortization expense was $350,000, $839,000 and $839,000 for the years
ended December 31, 1998, 1999 and 2000, respectively. The intangible assets
acquired by the Company were rights to the completed core technology developed
by AckFin that provides the foundation for our Internet products. Since this
transaction occurred between entities that were under common control, the
financial results of AckFin have been combined with our results for the period
since the inception of AckFin, April 1997, through the date of exchange,
August 1998. Expenses totaling $775,000 for the year ended December 31, 1998,
were included in the accompanying statements of operations. AckFin did not have
any revenue transactions with unrelated third parties. Except for the expenses
noted above, all other financial transactions for AckFin were eliminated upon
combination with SonicWALL, Inc.
On October 17, 2000, the Company announced its agreement to acquire Phobos
Corporation ("Phobos") for $216.5 million in a transaction accounted for as a
purchase. Phobos designs, develops and sells scaleable Internet traffic
management ("ITM") solutions for Internet service providers, application
service providers, e-commerce companies and web hosting and enterprise network
operations centers. Under the terms of the merger, 0.615 shares of the
Company's common stock were exchanged for each share of outstanding Phobos
common stock at November 14, 2000, the closing date of the merger. In
connection with the merger, the Company issued 9,906,000 shares of its common
stock, and options and warrants to purchase 2,294,000 shares of its common
stock. In addition, the Company paid $30 million in cash to the shareholders of
Phobos based upon their pro-rata ownership percentage in Phobos. The merger
agreement also provides for up to an additional $20 million in cash to be
payable upon achievement of certain future quarterly revenue targets
29
during 2001. The quarterly amounts, representing additional purchase
consideration, will be recorded when payable as adjustments to goodwill.
In 1998, we recorded total deferred stock compensation of approximately
$48,000 in connection with stock and stock options granted during 1998 at
prices subsequently deemed to be below fair market value on the date of grant.
Options granted are typically subject to a four-year vesting period. Restricted
stock acquired through the exercise of unvested stock options is subject to our
right to repurchase the unvested stock at the price paid, which right lapses
over a four-year period. We are amortizing the deferred stock compensation over
the vesting periods of the applicable options and the repurchase periods for
the restricted stock. In 1999, we recorded approximately $6.1 million in
additional deferred stock compensation for stock options granted in the year
ended December 31, 1999, at prices subsequently deemed to be below fair market
value on the date of grant. We amortized approximately $2.9 million of deferred
stock compensation for the year ended December 31, 1999, including amortization
for granted options to certain consultants in exchange for services rendered.
These options are subject to variable plan accounting with fair value re-
measurements at the end of each quarterly reporting period. In 2000, we
recorded approximately $4.6 million in additional deferred stock compensation,
of which $3.9 million related to the assumption of options in connection with
the acquisition of Phobos, and amortized approximately $3.3 million of deferred
stock compensation for the year ended December 31, 2000.
Results of Operations
The following table sets forth financial data for the years indicated as a
percentage of total revenue:
Year Ended December 31,
--------------------------
1998 1999 2000
------- ------- -------
Revenue:
Product 100.0% 90.9% 86.5%
License and subscription........................ 0 9.1 13.5
------- ------- -------
Total revenue.................................. 100.0 100.0 100.0
Cost of revenue:
Product......................................... 44.0 27.9 24.9
License and subscription........................ -- 0.4 0.4
------- ------- -------
Total cost of revenue.......................... 44.0 28.3 25.3
------- ------- -------
Gross margin..................................... 56.0 71.7 74.7
Operating expenses:
Research and development........................ 27.3 17.2 16.3
Sales and marketing............................. 38.2 25.4 22.6
General and administrative...................... 10.0 8.4 8.3
In-process research and development............. -- -- 3.3
Amortization of goodwill and intangibles........ -- -- 7.1
Deferred stock compensation..................... 0.6 13.8 4.8
------- ------- -------
Total operating expenses....................... 76.1 64.8 62.4
------- ------- -------
Income (loss) from operations.................... (20.1) 6.9 12.3
Interest income and other expense, net........... 0.7 2.6 14.6
------- ------- -------
Income (loss) before income taxes................ (19.4) 9.5 26.9
Provision for income taxes....................... (0.1) (8.7) (14.3)
------- ------- -------
Net income (loss)................................ (19.5)% 0.8% 12.6%
======= ======= =======
30
2000 compared to 1999
Product revenue. Revenue from sales of our products increased to $60.1
million for the year ended December 31, 2000 from $19.1 million in the year
ended December 31, 1999. This increase was attributable to a higher volume of
products shipped, expansion of our distribution channel, expansion of our
product offerings to include the SonicWALL ProVX, SonicWALL XPRS, and SonicWALL
Telecommuter, and increasing demand in our target markets. The increase in
shipping volume resulted primarily from increased market acceptance of the
SonicWALL products over the prior year. We also increased shipments under an
OEM relationship that was entered in July 1999 and a new OEM relationship
entered in October 2000. In December 1999, we stopped shipment of legacy
Ethernet products which contributed $1.6 million in the year ended December 31,
1999 and $0 in the year ended December 31, 2000. This decrease was directly
related to our 1997 decision to focus on development, sales and marketing
efforts on our Internet security appliance products.
License and subscription revenue. Revenue from sales of our licenses and
subscriptions increased to $9.3 million in the year ended December 31, 2000
from $1.9 million in the year ended December 31, 1999. This increase relates to
increased sales of our VPN and content filtering products and the introduction
of our anti-virus subscription service in June 2000.
There can be no assurance that the Company's net sales will continue to
increase in absolute dollars or at the rate at which they have grown in recent
fiscal periods.
Cost of revenue; gross margin. Cost of revenue includes all costs associated
with the production of our products, including cost of materials, manufacturing
and assembly costs paid to contract manufacturers and related overhead costs
associated with our manufacturing operations personnel. Additionally, all
warranty costs and any inventory provisions or write-downs are expensed as cost
of revenue. Cost of revenue increased to $17.6 million in the year ended
December 31, 2000 from $6.0 million in the year ended December 31, 1999,
primarily as a result of increased product sales. Gross margin increased to
$51.9 million, or 75% of total revenue, in the year ended December 31, 2000
from $15.1 million, or 72% of total revenue, in the year ended December 31,
1999. The increase in gross margin was primarily attributable to the increase
in sales of higher gross margin security appliance products and license
subscription revenues, and the Company's decision to cease shipping of the
lower gross margin Ethernet products in December 1999. In addition, we
experienced increased manufacturing efficiencies and lower overhead and
component costs per unit due to economies of scale. Gross margin was also
favorably impacted by growth in licenses and subscription revenues due to a
larger installed base. Our gross margins are affected by fluctuations in
manufacturing volumes, component costs and the mix of products sold. Factors
contributing to the gross margin growth were partially offset by the effect of
increased sales of OEM products, which generate lower gross margins.
The Company's gross margin has been and will continue to be affected by a
variety of factors, including competition; the mix and average selling prices
of products; new product introductions and enhancements and the cost of
components and manufacturing labor. We must manage each of these factors
effectively for our gross margins to remain at current levels.
Research and development. Research and development expenses primarily
consist of personnel costs related to engineering and technical support,
contract consultants, outside testing services and equipment and supplies
associated with enhancing existing products and developing new products.
Research and development expenses increased by 213% from $3.6 million in the
year ended December 31, 1999 to $11.4 million in the year ended December 31,
2000. These expenses represented 17.2% and 16.3%, respectively, of total
revenue for such periods. These increases were primarily attributable to
increased personnel costs, increased facility expenses related to the new
leased facility entered in October 1999, prototype expenses associated with the
development of new products and ongoing support of current and future product
development and enhancement efforts. The Company believes that significant
investments in research and development will be required to remain competitive
and expects that such expenditures will continue to increase in absolute
dollars.
31
Sales and marketing. Sales and marketing expenses primarily consist of
personnel costs, including commissions, costs associated with the development
of our business and corporate identification, and costs related to customer
support, travel, trade shows, promotional and advertising costs. Sales and
marketing expenses increased 193% from $5.3 million in the year ended December
31, 1999 to $15.7 million for the year ended December 31, 2000. These expenses
were 25.4% and 22.6% of total revenue for such periods, respectively. The
increases in absolute dollars were primarily related to the expansion of the
Company's sales and marketing organization, including growth in the domestic
and international sales force, increased commission and bonus expenses related
to higher sales volumes and increased travel expenses. Facility expenses,
depreciation and amortization also increased over the corresponding period of
the prior year due to the move to a larger facility in October 1999 and to
related leasehold improvements. The Company expects to continue to increase its
sales and marketing expenses in an effort to expand domestic and international
markets, introduce new products and establish and expand new distribution
channels and OEM relationships.
General and administrative. General and administrative expenses were $5.7
million for the year ended December 31, 2000, compared to $1.8 million for the
year ended December 31, 1999. These expenses represented 8.3% and 8.4% of total
revenue for such periods, respectively. The increases in absolute dollars were
primarily related to increased personnel costs, increased facility expenses
related to the new leased facility in October 1999, and increased costs related
to investor relations and shareholder matters. The Company believes that its
general and administrative expenses will increase in absolute dollars as the
Company continues to build its infrastructure.
Deferred stock compensation. Amortization of deferred stock compensation was
$3.3 million and $2.9 million for the years ended December 31, 2000 and 1999,
respectively. This amortization relates to deferred compensation of $ 4.6
million and $6.1 million, related to stock options granted in the years ended
December 31, 2000 and 1999, respectively. The December 31, 2000 amount includes
$3.9 million relating to deferred stock compensation associated with employee
stock options issued in connection with the Phobos acquisition. We are
amortizing deferred stock compensation over the vesting periods of the
applicable options.
In-process research and development and Amortization of goodwill and
intangibles. On November 14, 2000, SonicWALL finalized its acquisition of
Phobos. As a result of the acquisition, $234 million was allocated to goodwill
and other intangibles. This amount is being amortized on a straight-line basis
over a period ranging from three to six years from the date of acquisition. For
the year ended December 31, 2000, we recorded $5.0 million in amortization. In
connection with the acquisition of Phobos net intangibles of $2.3 million were
allocated to in-process research and development. This intangible had not
reached technological feasibility and, in management's opinion had no probable
alternative future use, thus the associated amount was expensed.
Interest income and other expense, net. Interest income and other expense,
net consists primarily of interest income on the Company's cash, cash
equivalents and short-term investments, and increased to $10.1 million for the
year ended December 31, 2000 from $0.5 million in the year ended December 31,
1999. This increase related primarily to higher interest earnings on cash, cash
equivalents and short-term investments that increased in total from $62.6
million at December 31, 1999 to $219.5 million at December 31, 2000. Cash, cash
equivalents and short-term investments increased primarily as a result of the
follow-on offering in March 2000 in which 3,500,000 shares were sold by the
Company, generating $166.6 million of net proceeds.
Provision for income taxes. The provision for income taxes in the year ended
December 31, 2000 was $10 million. The provision for income taxes in the year
ended December 31, 1999 was $1.8 million. In both periods, the provision for
income taxes is based on an estimated effective rate for each of the respective
calendar years. The effective tax rates in the years ended December 31, 2000
and 1999 were 34% and 37.5%, respectively, before the effect of amortization of
deferred compensation, goodwill and intangibles, and in-process research and
development, which are permanent, non-deductible book/tax differences. This
effective rate reflects statutory federal and state tax rates net of the
estimated realization of deferred tax assets. The lower tax rate in fiscal 2000
is a result of the implementation of a foreign sales corporation in February
2000 and tax benefits related to investments in tax exempt securities.
32
The Company's annual operating results have in the past varied and may in
the future vary significantly depending on a number of factors including the
level of competition; the size and timing of significant orders; product mix;
market acceptance of new products and product enhancements; new product
announcements or introductions by the Company or its competitors; deferrals of
customer orders in anticipation of new products or product enhancement; changes
in pricing by the Company or its competitors; the ability of the Company to
develop, introduce and market new products and product enhancements on a timely
basis; hardware component costs; supply constraints; the Company's success in
expanding its sales and marketing programs; technological changes in the
Internet security market; the mix of sales among the Company's sales channels;
levels of expenditure on research and development; changes in Company strategy;
personnel changes; the Company's ability to successfully expand domestic and
international operations; general economic trends and other factors.
1999 compared to 1998
Product revenue. We shipped our first Internet security appliance product,
the SonicWALL DMZ, near the end of 1997, and in 1998 we were in the early
stages of our sales and marketing efforts for this product. Revenue from sales
of our products increased to $ 19.1 million in the year ended December 31, 1999
from $7.5 million in the year ended December 31, 1998. This revenue growth was
due primarily to the introduction of our SonicWALL PRO product, the expansion
of our distribution channel and increasing demand in the security appliance
market. Revenue from our Ethernet products represented $1.6 million in the year
ended December 31, 1999 and $5.2 million in the year ended December 31, 1998.
The decrease in sales of Ethernet products was directly related to our 1997
decision to focus our development, sales and marketing efforts on our Internet
security appliance products. We stopped shipment of Ethernet products during
December 1999.
License and subscription revenue. Our license and subscription revenues
increased to $1.9 million in 1999 from $35,000 in 1998, primarily due to
increased shipping of our content filtering and VPN upgrades.
Cost of revenue; gross margin. Cost of revenue includes all costs associated
with the production of our products, including cost of materials, manufacturing
and assembly costs paid to contract manufacturers and related overhead costs
associated with our manufacturing operations personnel. Additionally, all
warranty costs and any inventory provisions or write-downs are expensed as cost
of revenue. Cost of revenue increased to $6.0 million in the year ended
December 31, 1999 from $3.3 million in the year ended December 31, 1998,
primarily as a result of increased product sales. Gross margin increased to
$15.1 million, or 72% of total revenue, in the year ended December 31, 1999
from $4.2 million, or 56% of total revenue, in the year ended December 31,
1998. The increase in gross margin relates primarily to the increase in sales
of higher gross margin security appliance products, and a decrease in sales of
lower gross margin Ethernet products. In addition, as the volume of units
shipped has increased, our cost of revenue has declined as a percentage of
revenue as a result of lower component costs due to higher purchase volumes,
and lower manufacturing and overhead costs per unit related to economies of
scale.
Research and development. Research and development expenses primarily
consist of personnel costs related to engineering and technical support,
contract consultants, outside testing services and equipment and supplies
associated with enhancing existing products and developing new products.
Research and development expenses increased to $3.6 million in the year ended
December 31, 1999 from $2.1 million in the year ended December 31, 1998.
Research and development spending increased during 1999 by approximately $1.0
million related to the hiring of additional personnel, amortization of acquired
technology of approximately $0.8 million and increased overhead and consulting
costs.
Sales and marketing. Sales and marketing expenses primarily consist of
personnel costs, including commissions, costs associated with the development
of our business and corporate identification, and costs related to customer
support, travel, trade shows, promotional and advertising costs. Sales and
marketing expenses increased to $5.3 million in the year ended December 31,
1999 from $2.9 million in the year ended December 31, 1998. This increase
primarily relates to increased hiring of sales and marketing personnel,
33
increased travel and attendance at trade shows, increases in customer support
personnel and expanded sales and marketing efforts in international markets.
General and administrative. General and administrative expenses primarily
consist of personnel costs for administrative officers and support personnel,
legal, accounting and consulting fees, and facility expenses. Our general and
administrative expenses increased to $1.8 million for the year ended December
31, 1999 from $0.8 million in the year ended December 31, 1998. This increase
was primarily due to increases in staffing and related personnel costs to
support our growth, as well as increased professional services costs.
Deferred stock compensation. Amortization of deferred stock compensation was
$2.9 million in the year ended December 31, 1999. This amortization relates to
deferred compensation of $6.1 million, related to stock options granted in the
year ended December 31, 1999. We are amortizing this amount over the vesting
periods of the applicable options. Amortization of deferred stock compensation
in the year ended December 31, 1998 was $42,000.
Interest income and other expense, net. Interest income and other expense,
net consists primarily of interest income on our cash and cash equivalents, and
increased to $0.5 million for the year ended December 31, 1999 from $54,000 in
the year ended December 31, 1998. This increase was related primarily to higher
interest earnings on cash that increased in amount from $1.1 million to $62.6
million in the comparable period.
Provision for income taxes. The provision for income taxes in the year ended
December 31, 1999 was $1.8 million. The provision for income taxes in the year
ended December 31, 1998 was $6,000. In both periods, the provision for income
taxes is based on an estimated effective rate for each of the respective
calendar years. The effective tax rate in the year ended December 31, 1999 was
37.5% before the effect of amortization of deferred stock compensation, a
permanent, non-deductible book/tax difference. This effective rate reflects
statutory federal and state tax rates net of the estimated realization of
deferred tax assets. In determining this effective rate, we concluded that it
was more likely than not that we would realize the full value of this deferred
tax asset based upon our estimate of profitability and our assessment of tax
refunds available from net loss carrybacks in the event future profitability
was less than our estimates.
34
Quarterly Results of Operations
The following tables set forth our unaudited quarterly results of
operations, in dollars and as a percentage of total revenue, for the eight
quarters ended December 31, 2000. You should read the following tables in
conjunction with the financial statements and related notes contained elsewhere
in this Form 10-K. We have prepared this unaudited information on the same
basis as our audited financial statements. These tables include all
adjustments, consisting only of normal recurring adjustments, that we consider
necessary for a fair presentation of our financial position and operating
results for the quarters presented. You should not draw any conclusions about
our future results from the results of operations for any quarter.
Three Months Ended
--------------------------------------------------------------------------------------------
March 31, June 30, September 30, December 31, March 31, June 30, September 30, December 31,
1999 1999 1999 1999 2000 2000 2000 2000
--------- -------- ------------- ------------ --------- -------- ------------- ------------
Revenue:
Product................ $2,853 $3,316 $4,923 $8,038 $12,047 $14,463 $15,798 $17,793
License and
subscription.......... 211 310 538 858 1,360 2,010 2,607 3,370
------ ------ ------ ------ ------- ------- ------- -------
Total revenue.......... 3,064 3,626 5,461 8,896 13,407 16,473 18,405 21,163
------ ------ ------ ------ ------- ------- ------- -------
Cost of revenue:
Product................ 935 1,042 1,441 2,467 3,623 4,005 4,259 5,423
License and
subscription.......... 8 13 23 33 37 56 78 91
------ ------ ------ ------ ------- ------- ------- -------
Total cost of revenue.. 943 1,055 1,464 2,500 3,660 4,061 4,337 5,514
------ ------ ------ ------ ------- ------- ------- -------
Gross margin............ 2,121 2,571 3,997 6,396 9,747 12,412 14,068 15,649
Operating expenses:
Research and
development........... 658 723 817 1,436 1,985 2,516 2,533 4,324
Sales and marketing.... 811 1,043 1,554 1,934 2,602 3,553 3,816 5,690
General and
administrative........ 332 362 495 572 861 1,206 1,414 2,265
In-process research and
development........... -- -- -- -- -- -- -- 2,300
Amortization of
goodwill and
intangibles........... -- -- -- -- -- -- -- 4,961
Deferred stock
compensation.......... 15 768 518 1,594 1,801 1,194 330 (11)
Total operating
expenses.............. 1,816 2,896 3,384 5,536 7,249 8,469 8,093 19,529
------ ------ ------ ------ ------- ------- ------- -------
Income (loss) from
operations............. 305 (325) 613 860 2,498 3,943 5,975 (3,880)
Interest income and
other expense, net..... 41 91 73 331 1,209 3,097 2,897 2,932
------ ------ ------ ------ ------- ------- ------- -------
Income (loss) before
income taxes........... 346 (234) 686 1,191 3,707 7,040 8,872 (948)
Provision for income
taxes.................. (135) (200) (452) (1,044) (1,928) (2,882) (3,129) (1,985)
------ ------ ------ ------ ------- ------- ------- -------
Net income (loss)....... $ 211 $ (434) $ 234 $ 147 $ 1,779 $ 4,158 $ 5,743 $(2,933)
====== ====== ====== ====== ======= ======= ======= =======
35
Three Months Ended
--------------------------------------------------------------------------------------------
March 31, June 30, September 30, December 31, March 31, June 30, September 30, December 31,
1999 1999 1999 1999 2000 2000 2000 2000
--------- -------- ------------- ------------ --------- -------- ------------- ------------
Revenue:
Product................ 93.1% 91.5% 90.1% 90.4% 89.9% 87.8% 85.8% 84.1%
License and
subscription.......... 6.9 8.5 9.9 9.6 10.1 12.2 14.2 15.9
----- ----- ----- ----- ----- ----- ----- -----
Total revenue.......... 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
----- ----- ----- ----- ----- ----- ----- -----
Cost of revenue:
Product................ 30.5 28.7 26.4 27.7 27.0 24.3 23.1 25.6
License and
subscription.......... 0.3 0.4 0.4 0.4 0.3 0.4 0.5 0.5
----- ----- ----- ----- ----- ----- ----- -----
Total cost of revenue.. 30.8 29.1 26.8 28.1 27.3 24.7 23.6 26.1
----- ----- ----- ----- ----- ----- ----- -----
Gross margin............ 69.2 70.9 73.2 71.9 72.7 75.3 76.4 73.9
Operating expenses:
Research and
development........... 21.5 19.9 15.0 16.2 14.8 15.3 13.8 20.4
Sales and marketing.... 26.4 28.8 28.5 21.7 19.4 21.6 20.7 26.9
General and
administrative........ 10.8 10.0 9.0 6.4 6.4 7.3 7.7 10.7
In-process research and
development........... -- -- -- -- -- -- -- 10.8
Amortization of
goodwill and
intangibles........... -- -- -- -- -- -- -- 23.4
Deferred stock
compensation.......... 0.5 21.2 9.5 17.9 13.4 7.2 1.8 0.0
----- ----- ----- ----- ----- ----- ----- -----
Total operating
expenses.............. 59.2 79.9 62.0 62.2 54.0 51.4 44.0 92.2
----- ----- ----- ----- ----- ----- ----- -----
Income (loss) from
operations............. 10.0 (9.0) 11.2 9.7 18.7 23.9 32.4 (18.3)
Interest income and
other expense, net..... 1.3 2.5 1.3 3.7 9.0 18.8 15.7 13.8
----- ----- ----- ----- ----- ----- ----- -----
Income (loss) before
income taxes........... 11.3 (6.5) 12.5 13.4 27.7 42.7 48.1 (4.5)
Provision for income
taxes.................. (4.4) (5.5) (8.2) (11.7) (14.4) (17.5) (17.0) (9.4)
----- ----- ----- ----- ----- ----- ----- -----
Net income (loss)....... 6.9% (12.0)% 4.3% 1.7% 13.3% 25.2% 31.1% (13.9)%
===== ===== ===== ===== ===== ===== ===== =====
Product revenue. Internet security revenue has increased in each of the
eight quarters ended December 31, 2000, due to increasing market acceptance of
our security appliance products and the expansion of our product line to
include the SonicWALL SOHO in August 1998 and SonicWALL PRO in May 1999.
License and subscription revenue. License and subscription revenue increased
quarter over quarter since March 31, 1999 due to increased services and an
increasing installed base. New services in 1999 and 2000 included global
management services, anti-virus and most recently authentication services.
Gross margin. Our gross margin has generally increased each quarter since
the quarter ended March 31, 1998. These increases have been due to the
introduction of our new security appliance products, which have higher average
selling prices and higher gross margins, the reduction of production costs on a
per unit basis as manufacturing volumes have increased, the reduction in
materials costs due to increased purchase volumes, and improved absorption of
manufacturing infrastructure costs. In addition, the introduction of new
license and subscription revenues during 2000, including anti-virus,
authentication services, and global management services have higher gross
margins and increased volumes quarter over quarter. Gross margin decreased in
the quarters ended December 31, 1999 and December 31, 2000 due to the increased
shipments of OEM products which have lower gross margins.
Operating expenses. Our operating expenses have increased in each of the
eight quarters ended December 31, 2000 to $19.5 million in the quarter ended
December 31, 2000 from $1.8 million in the quarter ended March 31, 1999. These
increases related primarily to development of new products, increased marketing
of new products, and increased investments in our internal infrastructure to
support our growth. During the quarter ended December 31, 2000 the Company
acquired Phobos and recognized amortization of goodwill and wrote off $2.3
million of in-process research and development.
36
Liquidity and Capital Resources
For the year ended December 31, 2000, the Company's cash, cash equivalents
and short-term investments increased by $157 million to $219.5 million. This
increase related primarily to the follow-on offering in March 2000 which
generated $166.6 million in net proceeds to the Company. The Company's working
capital increased for the year ended December 31, 2000 by $164.1 million to
$223.0 million. For the year ended December 31, 2000, the Company generated
cash from operating activities totaling $30 million, principally related to net
income of $8.7 million and an increase in deferred revenue, other accrued
liabilities and income taxes payable, partially offset by increases in accounts
receivable, inventories and accrued payroll.
The Company purchased $79 million of short-term investments and used $3.1
million to purchase property and equipment during the year ended December 31,
2000. In November 2000, the Company purchased Phobos Corporation for $216.5
million, of which $30 million was paid in cash to shareholders, $177.8 million
was paid in common stock, assumed options and warrants and $9 million was
incurred in closing costs.
Financing activities provided $169 million for the year ended December 31,
2000. In March 2000, the Company successfully completed its follow-on offering
of common stock which generated approximately $166.6 million in net proceeds
after deducting underwriting discounts and commissions and estimated offering
expenses.
We believe that the market risk arising from our holdings of financial
instruments is not material.
We believe our existing cash, cash equivalents and short-term investment
will be sufficient to meet our cash requirements at least through the next
twelve months. However, we may be required, or could elect, to seek additional
funding prior to that time. Our future capital requirements will depend on many
factors, including our rate of revenue growth, the timing and extent of
spending to support product development efforts and expansion of sales and
marketing, the timing of introductions of new products and enhancements to
existing products, and market acceptance to our products. We cannot assure you
that additional equity or debt financing will be available on acceptable terms
or at all. As of the date of this offering, our sources of liquidity beyond
twelve months, in management's opinion, will be our then current cash balances,
funds from operations and whatever long-term credit facilities we can arrange.
We have no other agreements or arrangements with third parties to provide us
with sources of liquidity and capital resources beyond twelve months.
We do not have any other debt, long-term obligations or long-term capital
commitments.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk for changes in interest rates relates primarily
to our cash and cash equivalents. We do not use derivative financial
instruments in our investment portfolio. As stated in our investment policy, we
are averse to principal loss and ensure the safety and preservation of our
invested funds by limiting default and market risk. We mitigate default risk by
investing in only investment-grade instruments. As of December 31, 2000, our
cash, cash equivalents and short-term investments included money-markets
securities, corporate bonds, municipal bonds and commercial paper which are
subject to no interest rate risk when held to maturity, but may increase or
decrease in value if interest rates changes prior to maturity. Due to the short
duration of our investment portfolio, an immediate 10% change in interest rates
would be immaterial to the Company's financial condition or results of
operations.
We invoice all of our foreign customers from the United States in U.S.
dollars and all revenue is collected in U.S. dollars. In addition, we do not
have any cash balances denominated in foreign currencies. As a result, we do
not have significant market risks associated with foreign currencies or related
to sales and collections.
37
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Report of Independent Accountants.......................................... 39
Consolidated Balance Sheets................................................ 40
Consolidated Statements of Operations...................................... 41
Consolidated Statements of Shareholders' Equity............................ 42
Consolidated Statements of Cash Flows...................................... 43
Notes to Consolidated Financial Statements................................. 44
38
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
SonicWALL, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of shareholders' equity and of cash
flows present fairly, in all material respects, the financial position of
SonicWALL, Inc. and its subsidiaries at December 31, 2000 and 1999, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2000, in conformity with accounting principles
generally accepted in the United States of America. These financial statements
are the responsibility of the Company's management; our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States of America, which require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
Pricewaterhousecoopers LLP
San Jose, California
January 19, 2001
39
SONICWALL, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
December 31,
-----------------
1999 2000
------- --------
ASSETS
Current Assets:
Cash and cash equivalents................................. $62,589 $140,287
Short term investments.................................... -- 79,257
Accounts receivable, net of allowance for doubtful
accounts of $548 and $1,771.............................. 3,687 11,541
Inventories............................................... 558 2,509
Deferred income taxes..................................... 1,556 19,171
Prepaid expenses and other current assets................. 1,015 2,192
------- --------
Total current assets.................................... 69,405 254,957
Property and equipment, net................................. 435 3,831
Intangibles and other assets................................ 1,399 229,329
------- --------
Total assets.......................................... $71,239 $488,117
======= ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable.......................................... $ 2,692 $ 7,867
Accrued payroll and related benefits...................... 1,205 4,561
Other accrued liabilities................................. 1,839 8,501
Deferred revenue.......................................... 3,732 8,812
Income taxes payable...................................... 1,021 2,192
------- --------
Total current liabilities............................... 10,489 31,933
Deferred income taxes....................................... -- 20,426
------- --------
Total liabilities..................................... 10,489 52,359
======= ========
Commitments and contingencies (Note 9)
Shareholders' Equity:
Preferred stock, no par value; 10,000,000 shares
authorized; none issued and outstanding.................. -- --
Common stock, no par value; 200,000,000 shares authorized;
47,350,770 and 62,646,843 shares issued and outstanding.. 65,109 432,383
Deferred stock compensation............................... (3,209) (4,522)
Notes receivable from shareholders........................ (300) --
Retained earnings (accumulated deficit)................... (850) 7,897
------- --------
Total shareholders' equity.............................. 60,750 435,758
------- --------
Total liabilities and shareholders' equity............ $71,239 $488,117
======= ========
The accompanying notes are an integral part of these consolidated financial
statements.
40
SONICWALL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
Year Ended December 31,
-------------------------
1998 1999 2000
------- ------- -------
Revenue:
Product........................................... $ 7,480 $19,130 $60,101
License and subscription.......................... 35 1,917 9,347
------- ------- -------
Total revenue................................... 7,515 21,047 69,448
------- ------- -------
Cost of revenue:
Product, excluding amortization of stock-based
compensation of $0, $9 and $19................... 3,307 5,884 17,310
License and subscription.......................... 1 77 262
------- ------- -------
Total cost of revenue........................... 3,308 5,961 17,572
------- ------- -------
Gross margin........................................ 4,207 15,086 51,876
------- ------- -------
Operating expenses:
Research and development, excluding amortization
of stock-based compensation of $0, $33, and
$136............................................. 2,051 3,634 11,359
Sales and marketing, excluding amortization of
stock-based compensation of $41, $2,313, and
$2,581........................................... 2,870 5,342 15,662
General and administrative, excluding amortization
of stock-based compensation of $1, $540, and
$579............................................. 753 1,761 5,745
In-process research and development............... -- -- 2,300
Amortization of goodwill and intangibles.......... -- -- 4,961
Deferred stock compensation....................... 42 2,895 3,315
------- ------- -------
Total operating expenses........................ 5,716 13,632 43,342
------- ------- -------
Income (loss) from operations....................... (1,509) 1,454 8,534
Interest income and other expense, net.............. 54 536 10,136
------- ------- -------
Income (loss) before income taxes................... (1,455) 1,990 18,670
Provision for income taxes.......................... (6) (1,832) (9,923)
------- ------- -------
Net income (loss)................................... $(1,461) $ 158 $ 8,747
======= ======= =======
Net income (loss) per share:
Basic............................................. $ (0.06) $ 0.00 $ 0.16
======= ======= =======
Diluted........................................... $ (0.06) $ 0.00 $ 0.14
======= ======= =======
Shares used in computing net income (loss) per
share:
Basic............................................. 22,502 34,668 54,879
======= ======= =======
Diluted........................................... 22,502 42,392 60,496
======= ======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
41
SONICWALL, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(In thousands, except share data)
Notes Retained
Common Stock Deferred Receivable Earnings Total
------------------- Stock From (Accumulated Shareholders'
Shares Amount Compensation Shareholders Deficit) Equity
---------- -------- ------------ ------------ ------------ -------------
Balance at December 31,
1997................... 16,922,200 $ 12 $ -- $ -- $ 453 $ 465
Issuance of common stock
upon exercise of stock
options................ 4,769,760 230 -- (230) -- --
Issuance of common stock
for acquisition........ 10,852,368 2,442 -- -- -- 2,442
Deferred stock
compensation........... -- 48 (48) -- -- --
Amortization of deferred
stock compensation..... -- -- 42 -- -- 42
Net loss................ -- -- -- -- (1,461) (1,461)
---------- -------- ------- ----- ------ --------
Balance at December 31,
1998 .................. 32,544,328 2,732 (6) (230) (1,008) 1,488
Issuance of common stock
upon exercise of stock
options................ 1,052,934 467 -- (300) -- 167
Issuance of common stock
in Connection with the
Company's initial
public offering, net of
issuance costs......... 8,000,000 50,841 -- -- -- 50,841
Conversion of preferred
stock into common
stock.................. 5,753,508 4,971 -- -- -- 4,971
Payments of notes
receivable from
shareholders........... -- -- -- 230 -- 230
Deferred stock
compensation........... -- 6,098 (6,098) -- -- --
Amortization of deferred
stock compensation..... -- -- 2,895 -- -- 2,895
Net income.............. -- -- -- -- 158 158
---------- -------- ------- ----- ------ --------
Balance at December 31,
1999................... 47,350,770 65,109 (3,209) (300) (850) 60,750
Issuance of common stock
upon exercise of stock
options................ 1,803,800 1,657 -- -- -- 1,657
Common stock issued in
the acquisition of
Phobos Corporation..... 9,905,537 155,520 -- -- -- 155,520
Assumption of stock
options and warrants in
the acquisition of
Phobos Corporation..... -- 22,230 (3,900) -- -- 18,330
Issuance of common stock
in connection with the
Employee Stock Purchase
Plan................... 86,736 533 -- -- -- 533
Payments of notes
receivable from
shareholder............ -- -- -- 300 -- 300
Issuance of common stock
in connection with the
Company's follow-on
offering, net of
issuance costs......... 3,500,000 166,553 -- -- -- 166,553
Deferred stock
Compensation........... -- 728 (728) -- -- --
Amortization of deferred
stock Compensation..... -- -- 3,315 -- -- 3,315
Income tax benefit from
stock option
exercises.............. -- 20,053 -- -- -- 20,053
Net income.............. -- -- -- -- 8,747 8,747
---------- -------- ------- ----- ------ --------
Balance at December 31,
2000................... 62,646,843 $432,383 $(4,522) $ -- $7,897 $435,758
========== ======== ======= ===== ====== ========
The accompanying notes are an integral part of these consolidated financial
statements.
42
SONICWALL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Year Ended December 31,
-----------------------------
1998 1999 2000
-------- -------- ---------
Cash flows from operating activities:
Net income (loss).............................. $ (1,461) $ 158 $ 8,747
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization................ 413 905 6,373
Loss on disposal of fixed assets............. -- 53 --
Liabilities acquired......................... (75) -- --
Income tax benefit for exercise of employee
stock options............................... -- -- 6,126
In-process research and development.......... -- -- 2,300
Provision for allowance for doubtful
accounts.................................... 122 366 1,111
Amortization of deferred stock compensation.. 42 2,895 3,315
Changes in operating assets and liabilities:
Accounts receivable........................ (235) (3,375) (8,909)
Inventories................................ 20 (228) (1,401)
Deferred income taxes...................... (89) (1,190) 1,581
Prepaid expenses and other current assets.. 270 (984) (655)
Other assets............................... 18 (50) (58)
Accounts payable........................... (114) 2,143 426
Accrued payroll and related benefits....... (12) 1,060 (1,881)
Other accrued liabilities.................. 438 1,091 7,050
Deferred revenue........................... 828 2,220 4,729
Income taxes payable....................... 214 712 1,171
-------- -------- ---------
Net cash provided by operating
activities............................... 379 5,776 30,025
-------- -------- ---------
Cash flows from investing activities:
Purchase of property and equipment............. (115) (447) (3,108)
Acquisition of Phobos, net of cash acquired.... -- -- (39,005)
Purchase of short-term investments............. -- -- (79,257)
-------- -------- ---------
Net cash used in investing activities..... (115) (447) (121,370)
-------- -------- ---------
Cash flows from financing activities:
Proceeds from exercise of stock options........ -- 167 2,190
Proceeds from issuance of redeemable Series A
convertible preferred stock................... -- 4,971 --
Proceeds from issuance of common stock, net of
issuance costs................................ -- 50,841 166,553
Payments of notes receivable from
shareholders.................................. -- 230 300
-------- -------- ---------
Net cash provided by financing
activities............................... -- 56,209 169,043
-------- -------- ---------
Net increase in cash and cash equivalents....... 264 61,538 77,698
Cash and cash equivalents at beginning of year.. 787 1,051 62,589
-------- -------- ---------
Cash and cash equivalents at end of year........ $ 1,051 $ 62,589 $ 140,287
======== ======== =========
Supplemental disclosure of cash flow
information:
Cash paid for income taxes..................... $ 1 $ 2,310 $ 1,320
Supplemental disclosure of noncash investing and
financing activities:
Issuance of notes receivable upon the exercise
of stock options.............................. $ 230 $ 300 $ --
Conversion of preferred stock into common
stock......................................... $ -- $ 4,971 $ --
Deferred stock compensation.................... $ 48 $ 6,098 $ 4,628
Acquisition of minority interest in AckFin
Networks...................................... $ 2,517 $ -- $ --
Income tax benefit from stock option
exercises..................................... $ -- $ -- $ 13,927
Issuance of common stock and assumption of
stock options and warrants in connection with
the acquisition of Phobos Corporation......... $ -- $ -- $ 177,750
The accompanying notes are an integral part of these consolidated financial
statements.
43
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1--The Company and Summary of Significant Accounting Policies:
SonicWALL, Inc. (the "Company") was incorporated in California in February
1991. SonicWALL, Inc. is a leading provider of Internet security solutions
designed for broadband access customers in the small to medium enterprise, or
SME, branch office, telecommuter and education markets. The Company's SonicWALL
solution is a high-performance, solid state appliance that provides robust,
reliable, easy-to-use and affordable Internet security. The Company's products
enable its customers to securely utilize Internet applications and services as
an integral part of their business.
The following is a summary of the Company's significant accounting policies:
Consolidation
The consolidated financial statements include those of the Company and its
wholly-owned subsidiaries Sonic Systems International, Inc., a Delaware
corporation, and SonicWALL B.V., a subsidiary in the Netherlands. Sonic Systems
International, Inc. is intended to be a sales office but to date has not had
any significant transactions. All significant intercompany accounts and
transactions are eliminated in consolidation.
In August 1998, the Company acquired all the partnership interest of AckFin
Networks ("AckFin"), a California general partnership, in exchange for an
aggregate of 10,852,368 shares of the Company's common stock (estimated value
of $0.45 per share, or $4,883,000) and the assumption of $150,000 in
liabilities. The controlling partners of AckFin, Sreekanth Ravi and Sudhakar
Ravi, two of the Company's executive officers and majority shareholders, were
deemed to be a control group for purposes of determining the amount of purchase
price to be "stepped-up." The value of the exchanged shares for AckFin was
accounted for as a reorganization of entities under common control.
Accordingly, net assets acquired were valued by applying carryover basis to the
control group interest and a stepped-up basis to the minority interest. The
step-up of the minority interest resulted in an intangible asset of $2,517,000.
This intangible asset was attributed to acquired completed technology and will
be amortized over a period of three years. Amortization expense was $350,000,
$839,000 and $839,000 for the years ended 1998, 1999 and 2000, respectively.
The intangible assets acquired by the Company were rights to the completed core
technology developed by AckFin that provides the foundation for our products.
Since this transaction occurred between entities that were under common
control, the financial results of AckFin have been combined with the results of
the Company for the period since the inception of AckFin (April 1997) through
the date of exchange (August 1998). Expenses totaling $775,000 for the year
ended December 31, 1998 was included in the accompanying statements of
operations. AckFin did not have any revenue transactions with unrelated third
parties. Except for the expenses noted above, all other financial transactions
for AckFin were eliminated upon combination with the Company.
In November 2000, the Company acquired Phobos Corporation ("Phobos") in a
transaction accounted for as a purchase (Note 3).
Use of estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the
reporting period. Actual results could differ materially from those estimates.
44
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Cash and cash equivalents and short-term investments
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents, and
investments maturing in 3 to 12 months to be short-term investments. Cash
equivalents and short-term investments consist of money market funds, corporate
bonds, municipal bonds and commercial paper. The Company classifies, at the
date of acquisition, its short-term investments into categories in accordance
with the provisions of Statement of Financial Accounting Standards ("SFAS") No.
115, "Accounting for Certain Investments in Debt and Equity Securities."
Currently, the Company classifies its short-term investments as available-for-
sale, which are reported at fair market value with the related unrealized gains
and losses included in shareholders' equity. Unrealized gains and losses at
December 31, 2000 were not material. Realized gains and losses, declines in
value of securities judged to be other than temporary, and interest and
dividends on all securities are included in interest and other income, net. The
fair value of the Company's investments are based on quoted market prices.
Realized gains and losses are computed using the specific identification
method.
Fair value
The carrying value of the Company's financial instruments, including cash
and cash equivalents, short-term investments, accounts receivable, accounts
payable and accrued liabilities approximate their fair values due to their
relatively short maturities. The Company does not hold or issue financial
instruments for trading purposes.
Concentration of credit risk, foreign operations and significant customers
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of cash and cash equivalents,
short-term investments and accounts receivable. The Company places its
temporary cash and short-term investments in corporate bonds, municipal bonds,
commercial paper and money market accounts with high credit quality financial
institutions. The Company's accounts receivable are derived from revenue earned
from customers located in the U.S. and certain foreign countries and regions,
including Europe, Canada, Japan and Australia. Sales to foreign customers for
the year ended December 31, 1998, 1999 and 2000, all of which were denominated
in U.S. dollars, accounted for 32%, 34%, and 32% of total revenue,
respectively. The Company performs ongoing credit evaluations of its customers'
financial condition and requires no collateral from its customers. The Company
maintains an allowance for doubtful accounts receivable based upon the expected
collectibility of accounts receivable.
During the year ended December 31, 1998, one customer accounted for 34% of
the Company's revenue. During the year ended December 31, 1999, two customers
accounted for 46% of the Company's revenue and at December 31, 1999, three
customers accounted for 74% of gross accounts receivables. During the year
ended December 31, 2000, two customers accounted for 52% of the Company's
revenue and at December 31, 2000, these two customers accounted for 63% of
gross accounts receivables.
The Company is dependent on third party contract manufacturers and some of
the key components in the Company's product come from single or limited sources
of supply.
Inventories
Inventories are stated at the lower of cost or market with cost being
determined on a first-in, first-out basis.
45
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Property and equipment
Property and equipment are stated at cost. Depreciation is computed using
the straight-line method over their estimated useful lives, which range from
three to five years. Leasehold improvements are amortized over the lesser of
the related lease term or the life of the improvement. Depreciation expense for
the years ended December 31, 1998, 1999 and 2000 was $55,000, $66,000 and
$574,000, respectively.
Intangibles and other assets
Acquired technology is amortized to expense on a straight-line basis over
three to six years. Goodwill and other intangible assets recorded in connection
with the acquisition of Phobos are amortized on a straight-line basis over the
estimated periods of benefit, which range from three to six years.
Long-lived assets
The Company periodically evaluates the recoverability of its long-lived
assets based on expected undiscounted cash flows and recognizes impairment from
the carrying value of long-lived assets, if any, based on the fair value of
such assets. To date, the Company has not recorded any impairment charges
against the value of its long-lived assets.
Stock-based compensation
The Company accounts for stock-based employee compensation arrangements in
accordance with the provisions of Accounting Principles Board Opinion ("APB")
No. 25, "Accounting for Stock Issued to Employees," and complies with the
disclosure provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation." Under APB No. 25, compensation costs is determined based on the
difference, if any, on the grant date between the fair value of the Company's
stock and the amount an employee must pay to acquire the stock. Compensation
expense is recognized over the vesting period.
The Company accounts for equity instruments issued to non-employees in
accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force
96-18.
Revenue recognition
Product revenue represents sales of security appliances and printed circuit
boards. Product revenue is generally recognized at the time of shipment if
collectibility is probable and no significant obligations remain. Sales to
distributors are subject to agreements allowing certain rights of return,
cooperative advertising, stock balancing rights and price protection. The
largest distributor has the right to return products that have not been sold to
end users for full credit subject to a restocking fee. Revenue from sales to
this distributor is deferred at the time of shipment and is recognized when the
distributor has sold the product to its customers. Certain other distributors
have limited rights of return which allow them to return a percentage of the
prior quarter's purchases by these distributors. Accordingly, reserves for
estimated returns and exchanges are provided at the time of shipment. These
reserves are estimated and adjusted periodically based upon historical rates of
returns and allowances, inventory levels at the distributors and other related
factors. Reserves for credits for price protection are provided at the time
list prices are reduced by the Company. In the years ended December 31, 1998,
1999 and 2000 the Company provided approximately $400,000, $1,046,000 and
$900,000, respectively, of revenue reserves related to risks of product
returns, stock rotation rights and price protection rights. As of December 31,
1999 and 2000, deferred revenues included approximately $1.7 million and $3.0
million, respectively, related to these reserves.
46
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
License and subscription revenue primarily represents sales of various
software products, such as virtual private networking and global management
system, and subscription services including content filtering, anti-virus
services, and extended warranty contracts. Revenue from software products is
recognized in accordance with SOP 97-2. Specifically, revenue is generally
recognized when delivery of the software has occurred, persuasive evidence of
an arrangement exists, collectibility of the fee is probable and the fee is
fixed and determinable. Revenue from extended warranty programs, premium
technical assistance, and subscriptions to content filtering and anti-virus
services is recognized ratably over the term of the contract or subscription.
The Company's revenue recognition policy is consistent with Staff Accounting
Bulletin No. 101 ("SAB 101") which provides guidance for revenue recognition,
presentation and disclosure of revenues in financial statements filed with the
SEC. The adoption of SAB 101 did not have a material impact on the Company's
financial statements.
The standard warranty provisions include technical assistance, insignificant
bug fixes and feature updates and repair or replacement guarantees for units
with product defects. The standard warranty period is one year. The estimated
costs associated with the standard warranty provisions are accrued at the time
of revenue recognition. In the years ended December 31, 1998, 1999 and 2000,
the Company provided approximately $100,000, $425,000 and $1,030,000 of
warranty reserves, respectively. As of December 31 1999 and 2000, the
accompanying balance sheets include a warranty accrual of approximately
$555,000 and $1,080,000, respectively.
Income taxes
The Company accounts for income taxes under the liability method, which
requires, among other things, that deferred income taxes be provided for
temporary differences between the tax bases of the Company's
assets and liabilities and their financial statement reported amounts. In
addition, deferred tax assets are recorded for the future benefit of utilizing
net operating losses, research and development credit carryforwards and
temporary differences. A valuation allowance is provided against deferred tax
assets unless it is more likely than not that they will be realized.
Research and development and capitalized software development costs
Software development costs incurred prior to the establishment of
technological feasibility are charged to research and development expense as
incurred. Technological feasibility is established upon completion of a working
model, which is typically demonstrated by initial beta shipment. Software
development costs incurred subsequent to the time a product's technological
feasibility has been established, through the time the product is available for
general release to customers, are capitalized if material. To date, software
development costs incurred subsequent to the establishment of technological
feasibility have been immaterial and accordingly have not been capitalized.
Reclassifications
Certain prior year balances have been reclassified to be consistent with
current year presentation.
Advertising Costs
The Company expenses advertising costs as incurred. Advertising expense
totaled $515,000, $1,036,000 and $3,415,000 for the years ended December 31,
1998, 1999 and 2000, respectively.
47
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company has co-operative advertising agreements with certain of its
distributors. These agreements allow the distributors to be reimbursed by the
Company for approved promotional activities. The amounts available for
reimbursement are related to a percentage of the distributors' eligible
purchases from the Company. The Company accrues for co-operative advertising as
the related revenue is recognized. In the years ended December 31, 1998, 1999,
and 2000, the Company recorded provisions for co-op advertising costs of
$502,000, $554,000, and $1,944,000, respectively. As of December 31, 1999 and
December 31, 2000, the accompanying balance sheets include an accrual for co-op
advertising costs of $410,000 and $1,221,000, respectively.
Comprehensive income (loss)
Effective January 1, 1998, the Company adopted the provisions of SFAS No.
130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards for
reporting comprehensive income and its components in financial statements.
Comprehensive income (loss), as defined, includes all changes in equity during
a period from non-owner sources. To date, the Company has not had any material
transactions that are required to be reported in comprehensive income (loss).
Computation of net income (loss) per share
The Company computes net income (loss) per share in accordance with SFAS No.
128, "Earnings per Share" and SEC Staff Accounting Bulletin No. 98 ("SAB 98").
Under the provisions of SFAS No. 128 and SAB 98, basic net income (loss) per
share is computed by dividing the net income (loss) for the period by the
weighted average number of common shares outstanding during the period.
Weighted average shares exclude shares subject to repurchase ("restricted
shares"). Diluted net income (loss) per share is computed by dividing the net
income (loss) for the period by the weighted average number of common and
common equivalent shares outstanding during the period, if dilutive. Common
equivalent shares are composed of unvested restricted shares and incremental
common shares issuable upon the exercise of stock options.
Recent accounting pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities." The
new statement established accounting and reporting standards for derivative
instruments and for hedging activities and is effective for all fiscal quarters
of fiscal years beginning after June 15, 2000. The Company does not expect the
adoption of Statement 133 to have a material impact on the Company's financial
statements.
In March 2000, the FASB issued "Accounting for Certain Transactions
Involving Stock Compensation: An interpretation of APB Opinion No. 25". This
interpretation has provisions that are effective on staggered dates, some of
which began after December 15, 1998 and others that became effective after June
30, 2000. The adoption of this interpretation did not have a material impact on
the Company's financial statements.
48
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Earnings per share
The following table sets forth the computation of basic and diluted net
income (loss) per share for the periods indicated (in thousands, except per
share data):
Year Ended December 31,
---------------------------
1998 1999 2000
-------- -------- --------
Numerator:
Net income (loss)................................ $ (1,461) $ 158 $ 8,747
-------- ------- -------
Denominator:
Weighted average common shares outstanding....... 22,502 35,006 55,324
Weighted average unvested common shares subject
to repurchase................................... -- (338) (445)
-------- ------- -------
Denominator for basic calculation................ 22,502 34,668 54,879
Common stock equivalents......................... -- 7,724 5,617
-------- ------- -------
Denominator for diluted calculation.............. 22,502 42,392 60,496
======== ======= =======
Basic net income (loss) per share.................. $ (0.06) $ 0.00 $ 0.16
======== ======= =======
Diluted net income (loss) per share................ $ (0.06) $ 0.00 $ 0.14
======== ======= =======
Outstanding options to purchase 2,327,352 shares of common stock at an
exercise price of $0.06 per share have not been considered in the computation
of diluted net loss per share for the year ended December 31, 1998, as their
effect would have been anti-dilutive.
At December 31, 2000, outstanding options to purchase 2,148,200 shares of
common stock at exercises prices ranging from $17.26 to $52.06 per share have
not been considered in the computation of diluted net income per share as their
effect would have been anti-dilutive.
In May 1999, the Company issued 600,000 shares upon the exercise of certain
stock options. At December 31, 2000, 444,590 common shares are subject to
repurchase at the option of the Company for $.50 per share. These shares vest
ratably over a 48 month period.
49
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Note 2--Balance Sheet Components:
December 31,
-----------------
1999 2000
------- --------
(in thousands)
Inventories:
Raw materials.............................................. $ 25 $ 1,421
Finished goods............................................. 533 1,088
------- --------
$ 558 $ 2,509
======= ========
Property and equipment:
Equipment.................................................. $ 442 $ 2,789
Leasehold improvements..................................... 103 644
Software................................................... 60 1,062
Transportation............................................. 24 24
------- --------
629 4,519
Less: accumulated depreciation............................. (194) (688)
------- --------
$ 435 $ 3,831
======= ========
Intangibles and other assets:
Goodwill and other intangibles............................. $ -- $233,672
Acquired technology........................................ 2,517 2,517
Other assets............................................... 71 128
------- --------
2,588 236,317
Less: amortization......................................... (1,189) (6,988)
------- --------
$ 1,399 $229,329
======= ========
Other accrued liabilities:
Accrued acquisition costs.................................. $ -- $ 5,625
Other accrued liabilities.................................. 1,839 2,876
------- --------
$ 1,839 $ 8,501
======= ========
Note 3--Acquisition of Phobos Corporation:
On October 17, 2000, the Company announced its agreement to acquire Phobos
Corporation ("Phobos") in a transaction accounted for as a purchase. Phobos
designed, developed and sold scaleable Internet traffic management ("ITM")
solutions for Internet service providers, application service providers, e-
commerce companies and web hosting and enterprise network operations centers.
Under the terms of the merger, 0.6152475 shares of the Company's common stock
were exchanged for each share of outstanding Phobos common stock at November
14, 2000, the closing date of the merger. In connection with the merger, the
Company issued 9,906,000 shares of its common stock, and options and warrants
to purchase 2,294,000 shares of its common stock. In addition, the Company paid
$30 million in cash to the shareholders of Phobos based upon their pro-rata
ownership percentage in Phobos. The merger agreement also provides for up to an
additional $20 million in cash to be payable upon achievement of certain future
quarterly revenue targets during 2001. The quarterly amounts, representing
additional purchase consideration, will be recorded when payable as adjustments
to goodwill.
50
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The consolidated financial statements include the results of operations of
Phobos commencing on November 14, 2000. The purchase price was based on actual
shares of common stock and options issued by the Company on the closing date.
The average market price per share of the Company's common stock of $15.70 is
based on the average closing market price as of October 17, 2000, the date the
proposed merger was announced, and for the two trading days prior to and two
trading days subsequent to October 17, 2000. The options and warrants were
valued by applying the Black-Scholes valuation model.
The purchase price consideration is as follows (in thousands):
Common stock....................................................... $155,520
Assumption of Phobos options and warrants.......................... 22,230
Cash............................................................... 30,000
Transaction costs.................................................. 8,700
--------
Total consideration.............................................. $216,450
========
The purchase price allocation is as follows (in thousands):
Tangible assets acquired........................................... $ 4,310
Deferred tax assets................................................ 5,611
Intangible assets acquired:
Existing technology.............................................. 26,220
Non-compete agreements........................................... 6,960
Workforce........................................................ 2,390
Customer base.................................................... 16,740
Goodwill......................................................... 184,092
Deferred compensation of unvested options.......................... 3,900
In-process research and development................................ 2,300
Liabilities assumed................................................ (14,969)
Restructuring costs................................................ (300)
Deferred tax liabilities........................................... (20,804)
--------
Total consideration.............................................. $216,450
========
Amounts allocated to the non-compete agreements and workforce are being
amortized over their estimated useful lives of three and four years,
respectively. Amounts allocated to existing technology and goodwill are being
amortized over their estimated useful lives of six years.
The Company recorded a $2.3 million charge for in-process research and
development related to the merger with Phobos during the fourth quarter of
2000. The amount allocated to in-process research and development represents
the purchased in-process technology for projects that, as of the date of the
merger, had not yet reached technological feasibility and had no alternative
future use. The value of these projects was determined by estimating the
resulting net cash flows from the sale of the products resulting from the
completion of the projects, reduced by the portion of the revenue attributable
to developed technology and the percentage completion of the projects. The
resulting cash flows were then discounted back to their present value at
discount rates ranging from 28% to 33%. As of the date of the acquisition,
Phobos had four projects in process that ranged from 80%-95% complete.
The nature of the efforts to develop the purchased in-process research and
development into commercially viable products principally relates to the
completion of all planning, designing, prototyping and testing
51
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
activities that are necessary to establish that the product can be produced to
meet its design specification including function, features and technical
performance requirements.
The following unaudited pro forma net revenues, net loss and net loss per
share data for the years ended December 31, 2000 and 1999 are based on the
respective historical financial statements of the Company and Phobos. The pro
forma data reflects the consolidated results of operations as if the
acquisition of Phobos occurred at the beginning of each of the years indicated
and includes the amortization of the resulting goodwill and other intangible
assets. The pro forma data excludes the charge for in-process research and
development. The pro forma financial data presented are not necessarily
indicative of the Company's results of operations that might have occurred had
the transaction been completed at the beginning of the years specified, and do
not purport to represent what the Company's consolidated results of operations
might be for any future period.
Years Ended
December 31,
------------------
1999 2000
-------- --------
(in thousands)
(Unaudited)
Revenues................................................... $ 22,424 $ 71,547
Net loss................................................... $(49,266) $(29,598)
Net loss per share--basic and diluted...................... $ (1.11) $ (0.47)
Shares used in per share calculation--basic and diluted.... 44,574 63,536
Note 4--Redeemable Series A Convertible Preferred Stock:
In February 1999, the Company issued 1,438,377 shares of redeemable Series A
convertible preferred stock ("Preferred Stock") at $3.48 per share for net
proceeds of $4,971,000. Each share of Preferred Stock converts into two shares
of Common Stock. In November 1999, the Company completed its initial public
offering of 8,000,000 shares of Common Stock at $7.00 per share. In connection
with the initial public offering, all outstanding shares of Preferred Stock
automatically converted into Common Stock.
Note 5--Shareholders' Equity:
Stock splits
Share information for all periods presented has been retroactively adjusted
to reflect two-for-one stock splits effected on August 25, 1999 and September
15, 2000.
Follow-on offering
In March 2000, the Company completed a follow-on offering of 7,000,000
shares of its common stock at a price of $50 per share, of which 3,500,000
shares were sold by the Company and 3,500,000 shares were sold by selling
shareholders. The Company received approximately $166.6 million in net proceeds
after deducting underwriting discounts and commissions and offering expenses.
The Company expects to use the proceeds from the offering to support growth,
working capital and potential acquisitions of complementary products and
technologies.
1999 Employee Stock Purchase Plan
The 1999 Employee Stock Purchase Plan was adopted by the board of directors
in August 1999. A total of 700,000 shares of common stock have been reserved
for issuance under the plan.
52
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Stock Option Plans
The Company's Stock Option Plans (the "Plans"), as amended, authorize the
Board of Directors to grant incentive stock options and nonstatutory stock
options to employees, directors and consultants to purchase up to a total of
20,732,298 shares of the Company's common stock. Under the Plans, incentive
stock options are granted at an exercise price that is not to be less than 100%
of the fair market value of the Company's common stock on the date of grant, as
determined by the Company's Board of Directors. Nonqualified stock options are
granted at a price that is not to be less than 85% of the fair market value of
the common stock on the date of grant, as determined by the Board of Directors.
Generally, options granted under the Plans are exercisable for a period of
ten years after the date of grant, and vest over four years.
The following table summarizes option activity under the stock option plans:
Options Outstanding
--------------------------------
Weighted
Average
Available Exercise Exercise
for Grant Shares Price Price
---------- ---------- ----------- --------
Balance at December 31, 1997.. 903,224 4,989,760 $ 0.04-0.12 $ 0.05
Authorized.................... 4,000,000 -- $ -- $ --
Granted....................... (2,030,000) 2,030,000 $ 0.06 $ 0.06
Exercised..................... -- (4,269,760) $ 0.04 $ 0.04
Canceled...................... 422,648 (422,648) $ 0.04-0.12 $ 0.09
---------- ---------- ----------- ------
Balance at December 31, 1998.. 3,295,872 2,327,352 $ 0.04-0.12 $ 0.06
Authorized.................... 4,716,648 -- $ -- $ --
Granted....................... (6,519,000) 6,519,000 $0.25-14.93 $ 2.79
Exercised..................... -- (1,052,934) $ 0.04-0.75 $ 0.44
Canceled...................... 205,002 (205,002) $ 0.06-4.50 $ 3.62
---------- ---------- ----------- ------
Balance at December 31, 1999
............................. 1,698,522 7,588,416 $0.04-14.93 $ 2.25
Authorized.................... 6,015,650 -- -- --
Granted....................... (6,365,620) 6,365,620 $0.82-52.06 $17.52
Exercised..................... -- (1,803,800) $0.38-18.00 $ 0.92
Canceled...................... 1,003,670 (1,003,670) $0.63-52.06 $12.94
---------- ---------- ----------- ------
Balance at December 31, 2000
............................. 2,352,222 11,146,566 $0.04-52.06 $10.22
========== ========== =========== ======
53
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table summarizes information regarding stock options
outstanding at December 31, 2000:
Options
Options Outstanding Exercisable
-------------------------------- ------------------
Weighted
Weighted Average Weighted
Average Remaining Average
Exercise Contractual Exercise
Exercise Prices Price Shares Life (Years) Shares Price
--------------- -------- ---------- ------------ --------- --------
$0.04-$0.13.............. $ 0.06 1,118,246 7.56 479,254 $ 0.06
$0.25-$0.38.............. $ 0.37 321,854 8.30 53,202 $ 0.38
$0.50-$0.82.............. $ 0.72 758,768 7.83 417,960 $ 0.81
$1.22-$1.75.............. $ 1.35 515,869 8.36 203,952 $ 1.33
$3.26-$6.51.............. $ 4.38 3,344,511 8.52 1,185,080 $ 4.38
$10.57-$10.57............ $10.57 1,213,568 9.51 623,183 $10.57
$12.75-$18.81............ $16.26 2,399,750 9.80 26,328 $16.99
$20.75-$29.75............ $23.99 991,000 9.40 11,666 $29.75
$31.94-$45.56............ $40.23 242,000 9.30 12,499 $45.56
$52.06-$52.06............ $52.06 241,000 9.50 -- $ --
---------- ---------
$10.22 11,146,566 3,013,124 $ 4.58
========== =========
For financial reporting purposes, the Company has determined that the
deemed fair value on the date of grant of certain stock options granted in
1998 and 1999 was in excess of the exercise price of the options. The deemed
fair value for options granted in the year ended December 31, 1999, exceeded
the aggregate exercise price of these options by $4,214,000. Additionally, in
conjunction with the acquisition of Phobos in 2000, the Company allocated $3.9
million to deferred stock compensation which represents the portion of the
intrinsic value of unvested stock options held by the employees of Phobos that
were exchanged for SonicWALL options. These amounts are considered deferred
stock compensation and are being amortized over the vesting periods of the
applicable options and the repurchase periods for the restricted stock.
Based upon the above assumptions, the weighted average fair value per share
of options granted in 1999 and 2000 were $3.00 and $15.76, respectively.
During the years ended December 31, 1999 and 2000, the Company granted
approximately 105,000 and 20,000, respectively, options to purchase common
stock to certain consultants in exchange for services rendered. The options
vest over two years. These options are subject to variable plan accounting
with fair value re-measurements at the end of each quarterly reporting period.
During the years ended December 31, 1999 and 2000, the Company recorded
deferred stock-based compensation expense related to these grants of
$1,884,000 and $176,000, respectively. Of this amount $1,066,000 and
$1,800,000 were recognized as stock-based compensation expense in the years
ended December 31, 1999 and 2000, respectively.
54
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Pro forma stock compensation
The Company has adopted the disclosure-only provisions of SFAS No. 123.
Accordingly, no compensation cost has been recognized for the Company's stock
option plan in the accompanying statements of operations. Had compensation cost
for the Company's stock option plan been determined based on the fair market
value at the grant dates for stock options granted in 1998 and 1997 consistent
with the provisions of SFAS No. 123, the Company's net income (loss) would have
been changed to the pro forma amounts indicated below, in thousands:
Year Ended December
31,
----------------------
1998 1999 2000
------- ----- ------
Net income (loss)
As reported........................................ $(1,461) $ 158 $8,747
Pro forma.......................................... $(1,469) $(109) $ 656
Net income (loss) per share--basic:
As reported........................................ $ (0.06) $0.00 $ 0.16
Pro forma.......................................... $ (0.06) $0.00 $ 0.01
Net income (loss) per share--diluted:
As reported........................................ $ (0.06) $0.00 $ 0.14
Pro forma.......................................... $ (0.06) $0.00 $ 0.01
The pro forma amounts reflect compensation expense related to 1998, 1999 and
2000 stock option grants only. In future years, the annual compensation expense
will increase relative to the fair value of the stock options granted in those
future years. The weighted average fair value of the options granted in 1998,
1999 and 2000 of $0.02, $1.13 and $12.82, respectively.
The fair value of each grant is estimated on the date of grant using the
minimum value method with the following assumptions:
1998 1999 2000
------------ ------------- -------------
Expected volatility.............. 0% 80% 110%
Risk-free interest rate.......... 4.5% to 5.64% 4.79% to 5.83% 5.28% to 6.56%
Expected life.................... 5 years 4 years 3-4 years
Dividend yield................... 0% 0% 0%
Note 6--Notes Receivable from Shareholders:
In May 1999, the Company issued a full recourse note for $300,000 in
connection with the exercise of 600,000 shares of incentive stock options by
one shareholder. The note had an interest rate of 8% per year and was payable
over four years. The principal and interest on these notes were paid in full
during 2000.
55
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Note 7--Income Taxes:
The (benefit from) provision for income taxes consist of the following (in
thousands):
Year Ended December 31,
-------------------------
1998 1999 2000
--------------- --------
Current tax expense:
Federal......................................... $ 94 $ 3,178 $ 9,996
State........................................... 1 708 2,485
----- -------- --------
95 3,886 12,481
----- -------- --------
Deferred tax expense (benefit):
Federal......................................... (89) (1,598) (2,301)
State........................................... -- (456) (257)
----- -------- --------
(89) (2,054) (2,558)
----- -------- --------
$ 6 $ 1,832 $ 9,923
===== ======== ========
The following is a reconciliation of pre-tax income (loss) per the financial
statements to taxable income (loss) (in thousands):
Year Ended December 31,
------------------------
1998 1999 2000
------- ------ --------
Pre-tax income (loss) per books.................. $(1,455) $1,990 $ 18,670
Differences between book and tax:
Distributor revenue deferral (net)............. 13 1,432 3,605
Changes in non-deductible reserves and
accruals...................................... 672 2,270 2,744
Non-deductible deferred stock compensation..... 42 2,895 3,052
Goodwill amortization.......................... -- -- 5,020
In-process research and development............ -- -- 2,300
Stock option deduction......................... -- -- (50,633)
Tax exempt interest............................ -- -- (3,420)
Other.......................................... (6) 53 455
------- ------ --------
Taxable income (loss)........................ $ (734) $8,640 $(18,207)
======= ====== ========
56
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Deferred tax assets and liabilities comprise the following (in thousands):
December 31,
---------------
1999 2000
------ --------
Deferred tax assets:
Net operating loss carryforwards......................... $ -- $ 20,235
Inventory reserves....................................... -- 1,314
Deferred revenue......................................... 830 2,277
Other reserves & accruals................................ 1,590 3,890
------ --------
Total deferred tax assets.............................. 2,420 27,716
Valuation allowance...................................... -- (8,545)
------ --------
Net deferred tax assets................................ $2,420 $ 19,171
====== ========
Deferred tax liabilities:
Intangibles.............................................. $ -- $(20,426)
------ --------
Total deferred tax liabilities......................... -- (20,426)
------ --------
Total net deferred tax (liabilities)/assets............ $2,240 $ (1,255)
====== ========
As of December 31, 2000, the Company has net operating loss carryforwards of
approximately $52,500,000 to offset future federal taxable income, which expire
at various dates through the year 2020. This amount includes approximately
$33,000,000 of net operating loss carryforwards from the acquisition of Phobos.
The net operating loss carryforward also includes approximately $45,000,000
resulting from employee exercises of non-qualified stock options or
disqualifying dispositions, the tax benefits of which, when realized, will be
recorded as an addition to common stock rather than a reduction of the
provision for income taxes.
The deferred tax assets related to the acquisition of Phobos, approximately
$14,000,000 as of November 14, 2000, if and when realized, will be used to
reduce the amount of goodwill and intangibles recorded at the date of
acquisition. A valuation allowance of approximately $8,500,000 has been
recorded for a portion of the Phobos deferred tax assets as a result of the
uncertainties regarding realization of the assets based upon the limitation on
the use of the net operating losses in the future.
Note 8--Segment Reporting
The Company adopted SFAS No. 131, "Disclosures About Segments of an
Enterprise and Related Information." SFAS No.131 requires publicly held
companies to report financial and other information about key revenue segments
of the entity for which such information is available and is utilized by the
chief operating decision maker. The Company conducts its business within one
business segment.
57
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Revenue by geographic region is presented as follows (in thousands):
Year Ended December 31,
-------------------------
1998 1999 2000
------- -------- --------
United States...................................... $ 5,080 $ 13,859 $ 47,080
Other.............................................. 2,435 7,188 22,368
------- -------- --------
Total.............................................. $ 7,515 $ 21,047 $ 69,448
======= ======== ========
Revenue to any one foreign country did not exceed 10% of total revenue in
1998. Revenue attributed to Japan accounted for 11% for the years ended
December 31, 1999 and 2000.
Note 9--Commitments and Contingencies:
In September 1999 the Company entered into a 5-year operating lease
agreement for a new location for its facility which it began occupying in
October 1999. Rent expense was approximately $163,000, $383,000, and $782,000
for the years ended December 31, 1998, 1999 and 2000, respectively.
Future minimum lease commitments at December 31, 2000 were as follows (in
thousands):
Year ending December 31,
------------------------
2001................................................................ $1,327
2002................................................................ 1,327
2003................................................................ 1,359
2004................................................................ 1,247
2005................................................................ 431
------
$5,691
======
The Company is involved in various threatened legal actions arising in the
ordinary course of business. Management believes that the outcome of these
actions will not have a material adverse effect on the Company's financial
position, cash flows or results of operations.
Note 10--Employee Benefits:
The Company has a defined contribution retirement plan covering
substantially all of its eligible United States employees. The Company's
contribution to this plan is discretionary. For the years ended December 31,
1998, 1999 and 2000, the Company did not make any contributions to the plan.
58
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Executive Officers, Directors and Key Employees
The following table lists the executive officers, directors and key
employees of SonicWALL as of December 31, 2000.
Name Age Position
---- --- --------
Sreekanth Ravi.......... 34 Chairman of the Board, President and Chief Executive Officer
Sudhakar Ravi........... 35 Chief Technical Officer, Director
Michael J. Sheridan..... 36 Chief Operating Officer and Chief Financial Officer
Ronald E. Heinz Jr...... 42 Senior Vice President, Worldwide Sales, Director
Raj Dhingra............. 39 Senior Vice President, Worldwide Marketing
Zachary Abrams.......... 34 Vice President, Corporate and Business Development
David A. Shrigley(2).... 52 Director
Charles D. Kissner (1).. 53 Director
Robert M.
Williams(1)(2)......... 45 Director
- --------
(1) Member of audit committee
(2) Member of compensation committee
We have no employment agreements with our executive officers or key
employees, except with Mr. Heinz. All are subject to termination at will. The
board of directors is elected annually by shareholders, and members of the
board serve until the next annual meeting of shareholders unless they resign
before such meeting. The last annual shareholders meeting was held in December
2000.
Sreekanth Ravi has served as our Chairman of the Board, President and Chief
Executive Officer since co-founding SonicWALL, Inc. in February 1991. Prior to
SonicWALL, Inc., Mr. Ravi was the founder and Chief Executive Officer of
Generation Systems, a manufacturer of high performance video products, which he
later sold to a publicly held computer products company in 1990. Mr. Ravi
received a bachelor of science degree in electrical engineering from the
University of Illinois, Champaign-Urbana. Sreekanth Ravi and Sudhakar Ravi are
brothers.
Sudhakar Ravi has served as our Chief Technical Officer since September
1999. Prior to that Mr. Ravi served as our Vice President, Engineering. He has
served as a director since co-founding SonicWALL, Inc. in February 1991. Prior
to SonicWALL, Inc., Mr. Ravi was involved in semiconductor research at Stanford
University. Mr. Ravi received a bachelor of science degree from the University
of Illinois, Champaign-Urbana and a masters of science degree in computer
science from Stanford University. Sudhakar Ravi and Sreekanth Ravi are
brothers.
Michael J. Sheridan was named our Chief Operating Officer in January 2001.
Prior to that, he served as our Chief Financial Officer since joining
SonicWALL, Inc. in May 1999. Mr. Sheridan will continue as SonicWALL's Chief
Financial Officer until his successor is found. Mr. Sheridan became Secretary
in September 1999. Mr. Sheridan joined SonicWALL, Inc. from Genesys
Telecommunications Laboratories, Inc., an enterprise software company in the
call center automation industry, where he served as Vice President of Finance
from January 1998 to May 1999, and served as Corporate Controller from November
1996 to December 1997. From August 1995 to November 1996, Mr. Sheridan was the
Corporate Controller for Network Appliance, Inc., a network file server
manufacturer. From 1986 to 1995, Mr. Sheridan was an audit professional with
Arthur Andersen LLP, where he was involved primarily with technology clients.
Mr. Sheridan received a bachelor degree in commerce from Santa Clara University
and is a Certified Public Accountant.
59
Ronald E. Heinz Jr. was named Senior Vice President of Worldwide Sales in
January 2001. Prior to that, since joining SonicWALL on November 14, 2000, Mr.
Heinz served as our Chief Operating Officer, Salt Lake City Division. Mr. Heinz
has been a director since November 14, 2000. Mr. Heinz served as President,
Chief Executive Officer and a director of Phobos Corporation from June 2000
through November 14, 2000 when SonicWALL acquired Phobos Corporation. From 1989
through June 2000, Mr. Heinz worked for Novell, Inc. where he served as Senior
Vice President of Worldwide Sales and held various management positions.
Mr. Heinz received a bachelor degree in finance from Virginia Polytechnic
Institute and an MBA from American University.
Raj Dhingra was named Senior Vice President of Worldwide Marketing in
January 2001. Prior to that, since joining SonicWALL in September 2000, he
served as our Chief Operating Officer. Mr. Dhingra joined SonicWALL, Inc. from
3Com where he served as Vice President of Business Development and held various
management positions from 1990 through September 2000. Prior to 3Com, Mr.
Dhingra worked for Apple Computer, Systemhouse, Inc. and The Z Corporation. Mr.
Dhingra received a bachelor degree in electrical engineering from Birla
Institute of Technology and Science and an MBA from Stanford University.
Zachary Abrams has served as our Vice President, Corporate and Business
Development since April 2000. Mr. Abrams joined SonicWALL, Inc. from Bear,
Stearns & Co. Inc., an investment bank, where he served as a Vice President in
the Corporate Finance Division from June 1997 to April 2000. Prior to Bear,
Stearns & Co. Inc., Mr. Abrams worked in the Technology Investment Banking
Group at Merrill Lynch & Co. from August 1995 to June 1997. Previously, Mr.
Abrams held various financial management positions at GE and GE Capital. Mr.
Abrams received a bachelor degree in economics from Colby College and an MBA
from The Wharton School at the University of Pennsylvania.
David A. Shrigley has been a director since July 1999. Since July 1999, Mr.
Shrigley has been a venture partner of Sevin Rosen Funds, a venture capital
firm. From November 1996 to April 1999, Mr. Shrigley was Executive Vice
President, Sales and Services of Nortel Networks Corp., a network
telecommunications company. From December 1978 to November 1996, Mr. Shrigley
was an employee of Intel Corporation, a semiconductor manufacturing company,
where he was last employed as Vice President, Corporate Marketing. Mr. Shrigley
received a bachelor of science degree in business administration from Franklin
University.
Charles D. Kissner has served as a director since July 2000. He is currently
Chairman of the Board of DMC Stratex Networks, Inc., a broadband wireless
equipment company. He was also CEO of DMC Stratex from July 1995 until May
2000. Previously, Mr. Kissner was Vice President/General Manager of M/A-Com,
Inc., a manufacturer of radio and microwave communication products, and
President, Chief Executive Officer, and a Director of Aristacom International,
Inc., a communications software company. He also founded Fujitsu Network
Switching, Inc., and held several key positions at AT&T (now Lucent
Technologies). Mr. Kissner is also a Director of Spectrian, Inc., a wireless
components manufacturer, Littlefeet, Inc., a wireless infrastructure company,
and American Medical Flight Support, a non-profit medical transportation
organization. Mr. Kissner holds a Bachelor of Science degree from California
State Polytechnic University and an MBA from Santa Clara University.
Robert M. Williams has been a director since May 1999. Since January 1998,
Mr. Williams has been a general partner of Bay Partners, a venture capital
firm, and an affiliate of Bay Partners SBIC II, L.P. and Bay Sonic Investors,
shareholders of SonicWALL, Inc. From May 1993 to December 1997, Mr. Williams
was Vice President, Marketing and Business Development of NetManage, Inc., a
networking software product development and sales company. Before then, Mr.
Williams held various marketing positions at several companies, including
Verity, Inc., an Internet text engine developer, and Ingres Corp., a developer
of relational database management software. Mr. Williams received a bachelor of
arts degree from Dartmouth College and a MBA from the Stanford Graduate School
of Business.
60
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Security Exchange Act of 1934, requires the Company's
directors executive officers and persons who own more than ten percent of a
registered class of the Company's equity securities, to file with the
Securities and Exchange Commission (the "SEC") initial reports of ownership and
reports of changes in ownership of common stock and other equity securities of
the Company. Officers, directors and greater-than-ten-percent beneficial owner
are required by SEC regulations to furnish the Company with copies of all
Section 16(a) reports they file.
Based solely upon review of the copies of such reports furnished to the
Company and written representations that no other reports were required, the
Company believes that there was compliance for the fiscal year ended December
31, 2000, with all Section 16(a) filing requirements applicable to the
Company's officers, directors and greater-than-ten-percent beneficial owners.
Board of Directors Meetings
During fiscal year 2000, the Board met 5 times, including telephone
conference meetings, and acted by written consent 8 times. No director attended
fewer than 75% of the aggregate of the total number of meetings of the Board
(held during the period for which he was a director) and the total number of
meetings held by all committees of the Board on which director served (held
during the period that such director served).
Committees of the Board of Directors
The compensation committee of our board of directors consists of Messrs.
Shrigley and Williams. The compensation committee:
. reviews and approves the compensation and benefits for our executive
officers and grants stock options under our stock option plan; and
. makes recommendations to the board of directors regarding these matters.
The audit committee consists of Messrs. Kissner and Williams. The audit
committee:
. makes recommendations to the board of directors regarding the selection
of independent auditors;
. reviews the results and scope of the audit and other services provided by
our independent auditors; and
. reviews and evaluates our audit and control functions.
We established these committees in August 1999. The compensation committee
met 2 times during fiscal year 2000. The audit committee met 4 times during
fiscal year 2000.
Director Compensation
We do not pay cash compensation to our directors for their services as
directors or members of committees of the board of directors, but we do
reimburse them for reasonable expenses they incur in attending meetings of the
board of directors. Directors of SonicWALL, Inc. are eligible to participate in
our stock option plans.
61
Director and Officer Indemnification and Liability
Our articles of incorporation limit the liability of directors to the full
extent permitted by California law. California law provides that a
corporation's articles of incorporation may eliminate or limit the personal
liability of directors for monetary damages for breach of their fiduciary
duties as directors, except liability for:
. acts or omissions that involve intentional misconduct or a knowing and
culpable violation of law;
. acts or omissions that a director believes to be contrary to the best
interest of SonicWALL, Inc. or our shareholders or that involve the
absence of good faith on the part of the director;
. any transaction from which a director derived an improper personal
benefit;
. acts or omissions that show a reckless disregard for the director's duty
to SonicWALL, Inc. or our shareholders in circumstances in which the
director was aware, or should have been aware, in the ordinary course of
performing a director's duties, of a risk of serious injury to SonicWALL,
Inc. or our shareholders;
. acts or omissions that constitute an unexcused pattern of inattention
that amounts to an abdication of the director's duty to SonicWall, Inc.
or our shareholders;
. unlawful payments of dividends or unlawful stock repurchases or
redemptions, unlawful distribution of assets to shareholders or unlawful
loans or guarantees to directors, officers and others; or
. any transaction between a director and SonicWALL, Inc.
Our bylaws provide that we will indemnify our directors and officers to the
fullest extent permitted by California law, including circumstances in which
indemnification is otherwise discretionary under California law. We have
entered into indemnification agreements with our directors and officers
containing provisions that are in some respects broader than the specific
indemnification provisions contained in the California Corporations Code. The
indemnification agreements may require us:
. to indemnify our directors and officers against liabilities that may
arise by reason of their status or service as directors or officers,
other than liabilities arising from willful misconduct of a culpable
nature;
. to advance their expenses incurred as a result of any proceeding against
them as to which they could be indemnified; and
. to obtain directors' and officers' insurance if available on reasonable
terms.
At present, there is no pending litigation or proceeding involving any
director, officer, employee or agent of ours in which indemnification would be
required or permitted. We are not aware of any threatened litigation or
proceeding that might result in a claim for indemnification. We believe that
our charter provisions and indemnification agreements are necessary to attract
and retain qualified persons as directors and officers.
The Securities and Exchange Commission has advised us that, in its opinion,
any indemnification of our directors and officers for liabilities arising under
the Act is against public policy as expressed in the Act and is therefore
unenforceable.
62
ITEM 11. EXECUTIVE COMPENSATION
The following table provides information concerning the compensation
received for services rendered to SonicWALL, Inc. in all capacities during the
years ended December 31, 2000, 1999, and 1998, by our Chief Executive Officer
and each of the other most highly compensated executive officers or key
employees of SonicWALL, Inc. whose aggregate compensation exceeded $100,000 in
fiscal 2000.
Summary Compensation Table
Long-Term
Compensation
Annual Compensation Awards
---------------------- ------------
Securities All Other
Salary Bonus Underlying Compensation ($)
Name and Principal Position Year ($) ($) Options (#) ----------------
- --------------------------- ---- -------- -------- ------------
Sreekanth Ravi........... 2000 $240,000 $234,000 100,000 --
President and Chief 1999 $240,000 $224,983 800,000 --
Executive Officer
1998 $240,000 $732,345 -- $13,846(1)
Sudhakar Ravi............ 2000 $240,000 $233,000 100,000 --
Chief Technical Officer 1999 $240,000 $232,214 800,000 --
1998 $240,000 $816,871 -- $13,846(1)
Michael J. Sheridan (2).. 2000 $202,677 $233,000 100,000 --
Chief Financial Officer,
and 1999 $150,000 $100,000 600,000 --
Secretary 1998 -- -- -- --
Steven R. Perricone...... 2000 $120,007 $573,317(3) 50,000 --
Vice President, Sales 1999 $120,000 $246,089 -- --
1998 $ 78,231 $ 23,389 1,200,000 $ 1,538(1)
Zachary Abrams (4)....... 2000 $100,963 $190,000 550,000 --
Vice President,
Corporate, and 1999 -- -- -- --
Business Development 1998 -- -- -- --
- --------
(1) Includes cash payment in lieu of vacation days
(2) Commenced employment in May 1999
(3) Represents commissions
(4) Commenced employment in April 2000
63
Options Grants in Last Fiscal Year
The following table provides information regarding stock options we granted
in fiscal 2000 to named executive officers whose compensation exceeded $100,000
in fiscal 2000. The table includes the potential realizable value over the ten-
year term of the options, based on assumed rates of stock appreciation of 5%
and 10%, compounded annually. The assumed rates of appreciation are prescribed
by the Securities and Exchange Commission for illustrative purposes only and
are not intended to forecast or predict future stock prices. Any actual gains
on option exercises will depend on the future performance of our stock.
Option Grants in Last Fiscal Year
Potential Realizable Value at
Assumed Annual Rates of
Stock Price Appreciation for
Individual Grants Option Term(4)
-------------------------- ------------------------------
Number of Percent of
Securities Total Options
Underlying Granted to
Options Employees in Exercise
Granted Fiscal Price Expiration
Name (#)(1) Year(2) ($/Sh)(3) Date 5%($) 10%($)
---- ---------- ------------- --------- ---------- -------------- ---------------
Sreekanth Ravi.......... 100,000 1.57% 17.26 11/5/05 1,085,472 2,750,799
Sudhakar Ravi........... 100,000 1.57% 17.26 11/5/05 1,085,472 2,750,799
Michael J. Sheridan..... 100,000 1.57% 15.688 11/5/10 986,610 2,500,263
Steven R. Perricone..... 50,000 .79% 15.688 11/5/10 493,305 1,250,132
Zachary Abrams.......... 500,000(5) 7.85% 23.69 4/23/10 7,449,257 18,877,879
Zachary Abrams.......... 50,000(6) .79% 14.56 10/19/10 457,835 1,160,245
- --------
(1) 25% of the option shares vest after one year of service and the remaining
shares vest monthly over the following three years, provided the employee
remains employed at SonicWALL, Inc. We granted all options under our stock
option plans at exercise prices at the fair market value of our common
stock on the date of grant.
(2) In 2000, we granted options to purchase up to an aggregate of 6,365,620
shares to employees, directors and consultants.
(3) The exercise price may be paid in cash, in shares of Common Stock valued at
fair market value on the exercise date, or through a cashless exercise
procedure involving a same-day sale of the purchased shares.
(4) The 5% and 10% assumed annual rates of compounded stock price appreciation
are mandated by rules of the Securities and Exchange Commission. There can
be no assurance provided to any executive officer or any other holder of
the Company's securities that the actual stock price appreciation over the
ten year option term will be at the assumed 5% and 10% levels or at any
other defined level. Unless the market price of the Common Stock
appreciates over the option term, no value will be realized from the option
grants made to the executive officers.
(5) 25% of the option shares vest after one year of continuous service and the
remaining 75% vest monthly over the following three years. In addition, if
Mr. Abrams's employment is involuntarily terminated within 12 months of a
change in control of the Company, then 50% of his unvested shares shall
vest. If Mr. Abrams is involuntarily terminated within his first year of
employment, 25% of his option shares shall vest.
(6) 25% of the option shares vest after one year of continuous service and the
remaining 75% vest monthly over the following three years.
64
The following table provides information regarding value realized of options
exercised during 2000 and unexercised options held as of December 31, 2000 by
our Chief Executive Officer and the other executive officers whose compensation
exceeded $100,000 in fiscal 2000. The value of unexercised in-the-money options
is calculated at December 31, 2000.
Aggregate Option Exercises Fiscal Year-End Option Values
Number of
Number of Securities Underlying Value of Unexercised
Shares Unexercised Options at In-the-Money Options at
Acquired Value Fiscal Year End (#) Fiscal Year-End ($)
on Realized ------------------------- -------------------------
Name Exercise (#) ($) Exercisable Unexercisable Exercisable Unexercisable
---- ------------ ---------- ----------- ------------- ----------- -------------
Sreekanth Ravi.......... -- -- 266,656 633,344 3,233,204 --
Sudhakar Ravi........... -- -- 266,656 633,344 3,233,204 --
Michael J. Sheridan..... -- -- -- 100,000 -- 56,200
Steven R. Perricone..... 490,000 18,208,125 375,000 345,000 6,070,313 4,803,413
Zachary Abrams.......... -- -- -- 550,000 -- 84,500
We have entered into an employment agreement with Ronald Heinz, our Senior
Vice President, Worldwide Sales, dated November 2000. The agreement provides
that if Mr. Heinz's service is involuntarily terminated prior to the first
anniversary of his employment with the Company, he will vest 50% of the options
he received under the Phobos Corp. 1999 Stock Plan and if his service is
involuntarily terminated prior to December 31, 2002, he will vest in an
additional 25% of the options.
Compensation Committee Interlocks and Insider Participation
Our board of directors' compensation committee currently consists of Messrs.
Shrigley and Williams. None of these individuals has at any time been an
employee or officer of SonicWALL, Inc. Until the compensation committee was
formed in August 1999, the full board of directors made all decisions regarding
executive compensation. No member of our board of directors or of its
compensation committee serves as a member of the board of directors or
compensation committee of any entity that has one or more executive officers
serving as members of its board of directors or its compensation committee.
Employee Benefit Plans
1998 and 1994 Stock Option Plans
The 1998 stock option plan provides for the grant of incentive stock
options, as defined in Section 422 of the Internal Revenue Code, to employees
and the grant of nonstatutory stock options to employees, non-employee
directors and consultants. The purposes of the 1998 stock option plan are:
. to attract and retain the best available personnel;
. to provide additional incentives to our employees and consultants; and
. to promote the success of our business.
The 1998 stock option plan was adopted by our board of directors in July
1998, approved by our stockholders in July 1998, and amended by the
shareholders to increase the number of shares available for grant thereunder in
February 1999 and December 2000. Unless terminated earlier by the board of
directors, the 1998 stock option plan will terminate in July 2008. The 1998
stock option plan was amended by our board of directors in August 1999 to
include some of the provisions provided below. These amendments were approved
by our shareholders in August 1999. The number of shares reserved for issuance
under the 1998 stock option plan will be subject to an automatic annual
increase in the first day of 2001 through 2008 equal to the lesser of:
. 4,000,000 shares;
65
. 4% of our outstanding common stock on the last day of the immediately
preceding fiscal year; or
. a number of shares determined by the administrator.
The compensation committee currently administers the 1998 stock option plan.
The administrator of the 1998 stock option plan determines numbers of shares
subject to options, vesting schedules and exercise prices for options granted
under the 1998 stock option plan.
The exercise price of incentive stock options must be at least equal to 100%
of the fair market value of our common stock on the date of grant, and at least
equal to 110% of the fair market value in the case of incentive stock options
granted to an employee who holds, at the time the option is granted, more than
10% of the total voting power of all classes of our stock or any parent's or
subsidiary's stock. Nonstatutory stock options will have an exercise price of
at least 85% of the fair market value of our stock. Payment of the exercise
price may be made in cash or other form of consideration approved by the
administrator. The administrator determines the term of options, which may not
exceed ten years, or five years in the case of an incentive stock option
granted to an employee who holds, at the time the option is granted, more than
10% of the total voting power of all classes of our stock or any parent's or
subsidiary's stock. No option may be transferred by the optionee other than by
will or the laws of descent or distribution, provided, however, that the
administrator may in its discretion provide for the transferability of
nonstatutory stock options. The administrator determines when options become
exercisable. Options granted under the 1998 stock option plan become
exercisable at a rate not less than 20% per year. To the extent an optionee
would have the right in any calendar year to exercise for the first time one or
more incentive stock options for shares having an aggregate fair market value
in excess of $100,000 as of the date the options were granted, the excess
options will be treated as nonstatutory stock options.
Generally, in the event of a change of control of SonicWALL, Inc.,
outstanding options may be assumed or substituted by the successor corporation.
If the successor corporation does not agree to this assumption or substitution,
the options will terminate upon the closing of the transaction.
The board of directors may amend, modify or terminate the 1998 stock option
plan if any amendments, modification or termination does not impair existing
rights of plan participants. Additionally, shareholder approval is required for
an amendment to the extent required by applicable law, regulations or rules.
Options outstanding under the 1994 stock option plan are subject to
substantially the same terms as options under the 1998 stock option plan.
As of December 31, 2000:
. a total of 18,610,678 shares have been authorized for issuance under the
1994 and 1998 stock option plans;
. options to purchase an aggregate of 9,024,946 shares of common stock were
outstanding under the 1994 stock option plan and 1998 stock option plan
at a weighted average exercise price of $10.972;
. 7,233,510 shares had been issued upon exercise of outstanding options,
net of repurchases, under the 1994 and 1998 stock option plans; and
. 2,352,222 shares remained available for future grant under the 1994 and
1998 stock option plans.
Phobos Corporation 1998 and 1999 Stock Plans
Upon the close of the merger between Phobos Corporation and SonicWALL,
SonicWALL assumed 942,104 outstanding options under the Phobos Corporation 1998
Stock Plan and 1,179,516 outstanding options under the Phobos Corporation 1999
Stock Plan.
66
1999 Employee Stock Purchase Plan
Our 1999 employee stock purchase plan was adopted by the board of directors
and shareholders in August 1999. The 1999 employee stock purchase plan became
effective on the effective date of our initial public offering. A total of
700,000 shares of common stock has been reserved for issuance under the 1999
employee stock purchase plan.
The 1999 employee stock purchase plan, which is intended to qualify under
Section 423 of the Internal Revenue Code, provides our employees with an
opportunity to purchase our common stock through accumulated payroll
deductions. The 1999 employee stock purchase plan is administered by the board
of directors or by a committee appointed by the board of directors. The 1999
employee stock purchase plan permits an eligible employee to purchase common
stock through payroll deductions of up to 15% of that employee's compensation.
Employees, including officers and employee directors, of SonicWALL, Inc., or of
any majority-owned subsidiary designated by the board of directors, are
eligible to participate in the 1999 employee stock purchase plan if they are
employed by SonicWALL, Inc. or any designated subsidiary for at least 20 hours
per week and more than five months per year. Unless the board of directors or
its committee determines otherwise, the 1999 employee stock purchase plan is
implemented by a series of overlapping offering periods generally of 24 months'
duration with new offering periods commencing on February 1 and August 1 of
each year. Each offering period is divided into four consecutive purchase
periods of approximately six months' duration. The first offering period
commenced on the date of our initial public offering and will end on July 31,
2001; the initial purchase period ends six months after our initial public
offering date. The price at which common stock will be purchased under the 1999
employee stock purchase plan is equal to 85% of the fair market value of the
common stock on the first day of the applicable offering period or the last day
of the applicable purchase period, whichever is lower. Employees may end their
participation in an offering period at any time, and participation
automatically ends on termination of employment.
Under the 1999 employee stock purchase plan, no employee may be granted an
option if immediately after the grant the employee would own stock and/or hold
outstanding options to purchase stock equaling 5% or more of the total voting
power or value of all classes of our stock or that of our subsidiaries. In
addition, no employee may be granted an option under the 1999 employee stock
purchase plan if the option would permit the employee to purchase stock under
all of our employee stock purchase plans in an amount that exceeds $25,000 of
fair market value for each calendar year in which the option is outstanding at
any time. In addition, no employee may purchase more than 2,000 shares of
common stock under the 1999 employee stock purchase
plan in any one purchase period. If the fair market value of the common stock
on a purchase date other than the final purchase date of an offering period is
less than the fair market value at the beginning of the offering period, each
participant in the 1999 employee stock purchase plan will automatically be
withdrawn from the offering period as of the purchase date and re-enrolled in a
new 24-month offering period on the first business day following the purchase
date.
The 1999 employee stock purchase plan provides that, in the event of a
change of control of SonicWALL, Inc. each right to purchase stock under the
1999 employee stock purchase plan will be assumed or an equivalent right
substituted by the successor corporation. However, our board of directors will
shorten any ongoing offering period so that employees' rights to purchase stock
under the 1999 employee stock purchase plan are exercised prior to the
transaction if the successor corporation refuses to assume each purchase right
or to substitute an equivalent right.
The 1999 employee stock purchase plan will terminate in August 2009 unless
terminated earlier in accordance with its provisions. The board of directors
has the power to amend or terminate the 1999 employee stock purchase plan if
its action does not adversely affect any outstanding rights to purchase stock
thereunder. However, our board of directors may amend or terminate the 1999
employee stock purchase plan or an offering period even if it would adversely
affect options in order to avoid our incurring adverse accounting charges.
67
401(k) Plan
We maintain a 401(k) plan that covers all our employees who satisfy the
plan's eligibility requirements relating to minimum age, length of service and
hours worked. We may make an annual contribution for the benefit of eligible
employees in an amount determined by our board of directors. We have not made
any contribution to date and have no current plans to do so. Eligible employees
may make pretax elective contributions of up to 15% of their compensation,
subject to maximum limits on contributions prescribed by law.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table provides information regarding the actual beneficial
ownership of our outstanding common stock as of December 31, 2000, for:
. each person or group that we know beneficially owns more than 5% of our
common stock;
. each of our directors;
. our chief executive officer;
. the other executive officers whose compensation exceeded $100,000 in
fiscal 2000; and
. all of our directors and executive officers as a group.
Beneficial ownership has been determined in accordance with rule 13d-3 under
the Securities Exchange Act of 1934. Percentage of beneficial ownership is
based on 62,646,843 shares of common stock outstanding as of December 31, 2000,
together with options that are exercisable within 60 days of December 31, 2000
for each shareholder. Under the rules of the Securities and Exchange
Commission, beneficial ownership includes shares over which the indicated
beneficial owner exercises voting and/or investment power. Shares of common
stock subject to options that are currently exercisable or will become
exercisable within 60 days are deemed outstanding for computing the percentage
ownership of the person holding the option, but are not deemed outstanding for
purposes of computing the percentage ownership of any other person. Unless
otherwise indicated in the footnotes below, we believe that the persons and
entities named in the table have sole voting and investment power with respect
to all shares beneficially owned, subject to applicable community property
laws. Unless otherwise indicated, the following beneficial owners can be
reached at our principal offices.
Number of Shares
of Common Stock Percentage of Shares
Beneficially Owned of Common Stock
Name as of December 31, 2000 Outstanding
---- ----------------------- --------------------
Sreekanth Ravi(1)................ 8,576,354 13.62%
Sudhakar Ravi(2)................. 8,586,562 13.64%
Steven R. Perricone(3)........... 597,548 *%
Michael J. Sheridan.............. 483,130 *%
GMS Capital Partners, L.P.(4).... 3,523,918 5.62%
Ronald Heinz(5).................. 256,896 *%
Charles Kissner(6)............... 14,582 *%
David Shrigley(7)................ 121,600 *%
Robert M. Williams(8)............ 1,793,708 2.86%
Zachary Abrams................... 725 *%
All directors and executive
officers as a group (9
persons)........................ 20,431,105 31.99%
- --------
* Less than 1%.
(1) Includes 1,100,000 shares held by a family trust, also includes 299,990
shares of common stock issuable upon exercise of immediately exercisable
options.
(2) Includes 1,100,000 shares held by a family trust, also includes 299,990
shares of common stock issuable upon exercise of immediately exercisable
options.
68
(3) Includes 345,000 shares of common stock issuable upon exercise of
immediately exercisable options.
(4) The address for GMS is 405 Park Avenue, 16th Floor, New York, NY 10022.
(5) Includes 256,866 shares of common stock issuable upon exercise of
immediately exercisable options.
(6) Includes 14,582 shares of common stock issuable upon exercise of
immediately exercisable options.
(7) Includes 1,600 shares held by children residing in the same household as
Mr. Shrigley.
(8) Represents 190,908 shares held by Robert Williams. Robert Williams, a
director of SonicWALL, Inc. is a partner of Bay Management Company 1997,
the general partner of Bay Partners SBIC II, L.P. Bay Partners SBIC II,
L.P. currently holds 1,602,800 shares of SonicWALL, Inc., which is less
than 5%, and therefore Bay Partners is not included in the table above.
However, Robert Williams shares voting and investment power with respect to
the shares held by this entity, and disclaims beneficial ownership of
shares in which he has no pecuniary interest. The address for Bay Partners
SBIC II, L.P. is 10600 N. De Anza Boulevard, Suite 100, Cupertino,
California 95014.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Since January 1, 1999, SonicWALL, Inc. has not been a party to any
transaction or series of similar transactions in which the amount involved
exceeds $60,000 and in which any director, executive officer, or holder of more
than 5% of our common stock had or will have a direct or indirect material
interest other than
. normal compensation arrangements which are described under "Item 11--
Executive Compensation" above; and
. the transactions described below.
Transactions with Executive Officers, Directors and Significant Shareholders
(1) On February 19, 1999, we issued an aggregate of 1,438,377 shares of our
redeemable Series A convertible preferred stock at a purchase price of
$3.48 per share to several investors, including 14,384 shares issued to
Robert Williams, a director of the Company, 1,150,700 shares to Bay
Partners SBIC II, L.P. Mr. Williams is a partner of Bay Management Company
1997, the general partner of Bay Partners SBIC II, L.P. At the closing of
our initial public offering, all outstanding shares of redeemable Series A
convertible preferred stock were converted into common stock.
(2) On May 26, 1999, we extended a loan in the amount of $300,000 to Michael
Sheridan, Chief Operating Officer, Chief Financial Officer, and Secretary
of SonicWALL, Inc. to pay the exercise price of options to purchase 600,000
shares of our common stock. Mr. Sheridan has purchased the optioned shares,
and SonicWALL, Inc. has the right to repurchase the optioned shares for the
purchase price paid, which right
69
lapses over four years. The loan had an interest rate of 8% per year and was
payable over four years. The loan was payable in full if Mr. Sheridan ceased
to be an employee, officer, director or consultant of SonicWALL, Inc. On
June 30, 2000, Mr. Sheridan paid the aggregate principal of the loan plus
interest in full.
(3) On August 6, 1999, Sreekanth Ravi, Chairman of the Board, Chief Executive
Officer and President, and Sudhakar Ravi, Chief Technical Officer and a
director, sold an aggregate of 3,664,728 shares of common stock to Bay
Sonic Investors, LLC at a purchase price of $3.26 per share. On August 11,
1999, two shareholders also sold an aggregate of 800,000 shares of common
stock to Bay Sonic Investors, LLC at a purchase price of $3.26 per share.
Robert Williams, a director of the Company, is a managing member of Bay
Sonic Investors, LLC. In addition, on August 6, 1999, Sreekanth Ravi sold
76,708 shares of common stock to David Shrigley, a director of the Company,
at a purchase price of $3.26 per share and 61,364 shares of common stock to
John McNulty at a purchase price of $3.26 per share.
70
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) Financial Statements
The consolidated financial statements of the registrant as set forth
under Item 8 are filed as part of this Annual Report on Form 10-K.
(2) Schedule II Valuation and Qualifying Accounts and Reserves
(b) Reports on Form 8-K
On August 8, 2000, SonicWALL filed a report on Form 8-K, which reported
under Item 5 that our Board of Directors approved a two-for-one stock
split, in the form of a stock dividend, which would result in the issuance
on September 15, 2000 of one additional share of SonicWALL common stock for
every share of common stock outstanding for stockholders of record as of
the close of business on August 25, 2000.
A current report on Form 8-K was filed with the Securities and Exchange
Commission by SonicWALL on October 27, 2000 and November 27, 2000, as
amended on January 26, 2001, to report the announcement of the signing of a
definitive agreement to merge with Phobos Corporation.
(c) Exhibits
Number Description
------ -----------
2.1* Agreement and Plan of Merger and Reorganization dated October 16,
2000
2.2* Amendment to Agreement and Plan of Merger and Reorganization dated
November 6, 2000
3.1** Registrant's Amended and Restated Articles of Incorporation.
3.2** Registrant's Restated Bylaws.
4.1** Registrant's specimen common stock certificate.
4.2** Investor Rights Agreement dated February 19, 1999 by and between
Registrant and the investors named therein.
10.1** Registrant's 1994 Stock Option Plan.
10.2** Registrant's 1998 Stock Option Plan.
10.3** Registrant's 1999 Employee Stock Option Plan.
10.4** Form of Indemnity Agreement entered into by Registrant with each
of its executive officers and directors.
10.5** Loan and Security Agreement dated May 26, 1995 between Registrant
and Comerica Bank.
10.6++** OEM License Agreement dated January 27, 1999 between Registrant
and Com21, Inc. Incorporated.
10.7++** OEM Purchase Agreement dated January 5, 1999 between Registrant
and Ramp Networks.
10.8++** Distribution Agreement dated February 9, 1999 between Registrant
and Tech Data Product Management, Inc.
10.9++** Distribution Agreement dated July 5, 1998 between Registrant and
Sumitomo Metal Systems Development Co.
10.10++** Distribution Agreement dated November 11, 1992 between Registrant
and Ingram Micro, Inc.
10.11** Agreement of Sublease dated as of October 26, 1998 between
Registrant and AMP Incorporated.
10.12++** OEM Purchase and Development Agreement between 3COM Corporation
and Registrant effective July 1, 1999.
10.13** Purchase Agreement dated September 28, 1999 between Registrant and
Flash Electronics, Inc.
10.14** Lease dated September 27, 1999 by and between AMB Property, L.P.
as Landlord and SonicWALL, Inc. as tenant.
71
Number Description
------ -----------
10.15++*** Amendment Number Two to the OEM Purchase and Development
Agreement between Registrant and 3Com Europe, Ltd. effective
March 15, 2000.
21.1 Subsidiaries
- --------
* Incorporated by reference to the Registrant's Current Report on Form 8-K,
filed on November 27, 2000.
** Incorporated by reference to the Registrant's Registration Statement on
Form S-1 (No. 333-85997), which became effective on November 9, 1999.
*** Incorporated by reference to the Registrant's Quarterly Report on Form 10-
Q (No. 000-27723), filed on May 15, 2000.
++ Confidential treatment has been requested for portions of this exhibit.
The omitted material has been separately filed with the Securities and
Exchange Commission.
(d) Schedules
Schedule I
Schedule II--Valuation and Qualifying Accounts is filed on page 81 of
this Report on Form 10-K.
All financial statement schedules not listed are omitted because they are
inapplicable or the requested information is shown in the financial statements
of the registrant or in the related notes to the financial statements.
72
SCHEDULE I
Report of Independent Accountants on
Financial Statement Schedule
To the Board of Directors
of SonicWALL, Inc.:
Our audits of the consolidated financial statements referred to in our report
dated January 19, 2001 appearing in the 2000 Annual Report to Shareholders of
SonicWALL, Inc. also included an audit of the financial statement schedule
listed in Item 14(a)(2) of this Form 10-K. In our opinion, this financial
statement schedule presents fairly, in all material respects, the information
set forth therein when read in conjunction with the related consolidated
financial statements.
PricewaterhouseCoopers LLP
San Jose, California
January 19, 2001
Schedule II
SonicWALL, Inc.
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
Balance at Charged to Balance
Beginning Cost and Write-off at End
of Year Other Expenses of Accounts of Year
---------- ----- ---------- ----------- -------
Year ended December 31,
1998
Allowance for doubtful
accounts $121 -- $ 122 $ 50 $ 193
Year ended December 31,
1999
Allowance for doubtful
accounts 193 -- 366 11 548
Year ended December 31,
2000
Allowance for doubtful
accounts 548 173 1,194 144 1,771