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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 OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1999
OR
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OR 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 (Primary Standard (I.R.S. Employer
jurisdiction Industrial Identification No.)
of incorporation) Classification Code
Number)
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, 1999, was approximately $253 million based upon
the last sale price reported for such date 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, 1999 was 23,675,385.
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PART I
ITEM 1. BUSINESS
Certain statements contained in this report on From 10-K including, without
limitation, statements containing the words "believes," "anticipates,"
"estimates," "expects" and words of similar import, constitute "forward-looking
statements". Such forward-looking statements involve known and unknown risks,
uncertainties and other factors that may cause the actual results, performance
or achievements of the Company, or industry results, to be materially different
from any future results, performance or achievements expressed or implied by
such forward looking statements. Factors that could cause or contribute to such
differences include, but are not limited to, those discussed in Part I, Item 1
under the heading "Risk Factors." 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. Broadband access, such as digital subscriber line, or DSL,
and cable modems, allows users to connect to the Internet at speeds
significantly greater than analog modems. We believe our security appliances
provide high performance, robust, reliable, easy-to-use and affordable Internet
security. We also sell content filtering services on an annual subscription
basis. We sell our products to customers in the small to medium enterprise,
branch office, telecommuter and education markets. As of December 31, 1999, we
had sold more than 35,000 of our Internet security appliances worldwide.
Our SonicWALL product line provides our customers with a comprehensive
integrated security solution that includes firewall, content filtering, and
virtual private network functionality so users can enjoy affordable, secure
Internet communications. SonicWALL products deliver a plug-and-play appliance
solution that we believe is easy to install and use and minimizes the purchase,
installation and maintenance costs of Internet security. With suggested retail
prices ranging from $495 to $2,995, our products are designed to enable
customers to reduce purchase costs and avoid hiring costly IT personnel for
Internet security. By using an embedded single purpose operating system and a
hardware design without moving parts, our SonicWALL products are designed to
maximize reliability and uptime. The SonicWALL product line can be used in
networks ranging in size from 1 to 1,000 users and is fully compatible with
more expensive enterprise security solutions offered by, among others, Check
Point Software and Cisco Systems.
Industry Background
Growth of Internet Usage By Small to Medium Enterprise, Branch Office,
Telecommuter, and Education Markets
Businesses and consumers are increasingly accessing the Internet for a wide
variety of uses including communications, information gathering and commerce.
Because it is an affordable means of achieving global reach and brand
awareness, the Internet is a particularly attractive vehicle for small and
medium size businesses as they endeavor to access and share information with a
large number of geographically dispersed customers, employees and business
partners. For example, of the 87.4 million devices estimated by International
Data Corporation, or IDC, a market research organization, to have Internet
access in 1998, approximately 60% were used by small businesses and home
offices. IDC estimates that the proportion of small businesses, those with less
than 100 people, accessing the Internet in the United States will increase from
approximately 50% in 1998 to approximately 65% by 2001, to a total of 4.7
million businesses.
Today's large business enterprise is characterized by many branch offices,
mobile workers, and telecommuters, all of whom connect electronically to the
corporate office and each other. Because of the confidential nature of business
data, these connections must be secure. Virtual private networks provide secure
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Internet connections between the business enterprise and dispersed employees
and business partners. Communicating using virtual private networks offers
significant cost savings over alternative solutions such as private leased line
or frame relay networks. TeleChoice, a market researcher, estimates that
virtual private networks can cut telecommunication costs by as much as 90% over
private leased line networks, and for this reason, their use is expected to
grow rapidly. Infonetics Research projects worldwide expenditures on virtual
private networks will grow by 100% per year through 2001, when they are
expected to reach $11.9 billion.
The Internet also has become a vital tool of information access and
communication for schools and libraries. According to the National Center for
Education Statistics, there were over 96,000 K-12 public schools and libraries
in the United States in 1998, of which 89% of schools and 35% of libraries were
connected to the Internet. The growth in Internet connectivity in this market,
combined with the proliferation of objectionable Web sites, has created a need
for Internet security products that include content filtering capabilities.
Increasing Demand for Broadband Access Technologies
Many small to medium enterprises and branch offices have addressed the need
for Internet access by installing a single computer with a dial-up connection
that is shared throughout the office, or by installing a dedicated network data
connection at a significantly greater expense, such as a T-1 line. Recently,
new high-speed technologies have emerged that can better satisfy the bandwidth
requirements of small to medium enterprises at a fraction of the cost of
traditional solutions. These technologies include DSL and cable modems, which
provide access speeds of up to 100 times faster than traditional 28.8 kbps
analog modems. In addition, new generations of Internet-based applications,
such as business to business e-commerce, sales force automation and enterprise
resource planning, or ERP, continue to emerge that require higher bandwidth
than is available through dial-up solutions. As DSL and cable services have
become more affordable and widely available, small to medium enterprises,
branch offices, and telecommuters are increasingly deploying these technologies
as their Internet access solution. 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 transmitted over the Internet has increased and led
organizations to look for high performance, robust solutions to address these
security needs.
Many Internet users also seek solutions that enable control over access to
undesirable content, either to avoid potential legal liability or to eliminate
distracting activity by employees or other users. In addition, public attention
has recently focused on the advantages of using filtering software to screen
offensive material for children accessing the Internet at libraries, schools,
and other public institutions.
The market for Internet security products includes a variety of applications
to address these issues, such as firewall, content filtering, Internet
Protocol, address management and VPN. According to IDC, the market for Internet
security products increased over 45% in 1998 to $3.2 billion and is expected to
grow at a compounded annual growth rate of 21% to $8.3 billion by 2003. IDC
also estimates that in the market for firewall appliances priced at less than
$10,000, revenues will grow at an expected compounded annual growth rate of 88%
over the same period.
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Lack of a Cost Effective, High Performance Security Solution for the Broadband
Access Market
Although the need for Internet security products is widespread, security
vendors generally have focused on providing solutions for large enterprises
with highly complex needs and extensive information technology support
organizations. These solutions have typically involved expensive enterprise
firewall software that runs on a dedicated server or personal computer and
requires extensive support, constant monitoring and regular updates by IT
personnel to maintain its effectiveness. The expense and complexity of these
solutions, which often require additional products to incorporate VPN
capabilities, IP address management or content filtering, are impractical for
the majority of small to medium enterprises due to their more limited
resources. While there are suppliers of low cost Internet routers which may
provide limited Internet security functionality, we believe these products are
difficult to install and configure and provide relatively low performance.
The SonicWALL Solution
SonicWALL, Inc. provides Internet security products designed for broadband
access customers in the small to medium enterprise, branch office, telecommuter
and education markets. We believe our security appliances provide high
performance, robust, reliable, easy-to-use and affordable Internet security.
SonicWALL products enable our customers to securely utilize Internet
applications and services as an integral part of their business. As of December
31, 1999, we had sold more than 35,000 of our Internet security appliances
worldwide. The SonicWALL product line provides our customers with the following
key benefits:
. High Performance, Robust Security. The SonicWALL product family provides
a comprehensive integrated security solution that includes firewall,
content filtering and VPN functionality. Our firewall security protects
private networks against Internet-based theft, destruction, or
modification of data, and automatically notifies customers if their
network is under attack. SonicWALL has been awarded the internationally
recognized International Computer Security Association, or ICSA, Firewall
Certification, the same certification awarded to significantly more
expensive products sold by Check Point Software and Cisco Systems. Our
VPN capabilities enable affordable, secure communications among remote
offices, mobile employees and business partners over the Internet. Our
content filtering enables businesses, schools and libraries to restrict
access to objectionable or inappropriate Web sites.
. Ease of Installation and Use. The SonicWALL product family delivers a
plug-and-play appliance designed for easy installation and use.
Installation involves simply connecting SonicWALL between the private
network and the broadband Internet access device. SonicWALL is easily
configured and managed through a Web browser-based interface. No
reconfiguration of any PC application is required. Our products are pre-
configured to interface with all major Internet access technologies,
including cable, DSL, ISDN, Frame Relay, and T-1. In addition,
SonicWALL's AutoUpdate capability automatically notifies all registered
customers via e-mail when bug fixes or new features and products that
have been purchased are available for download from our Web site.
. Low Total Cost of Ownership. The SonicWALL product design minimizes the
purchase, installation and maintenance costs of Internet security. The
suggested retail prices of our products range from $495 to $2,995, versus
enterprise firewall products which range in price from approximately
$5,000 to more than $15,000. Our affordable, easy-to-manage Internet
security appliances also enable customers to avoid the expense of hiring
costly information technology personnel who may otherwise be required to
implement and maintain an effective Internet security solution.
. Reliability. The SonicWALL product design maximizes reliability and
uptime. Our product uses an embedded single purpose operating system and
a hardware design which contains no moving parts. Most competitors'
products consist of software installed on general purpose host computers
which use the Windows NT or UNIX operating systems. General purpose
operating systems such as these are designed to run multiple
applications, creating an environment in which random system crashes are
commonplace. Moreover, since general purpose computers contain many
moving parts, such as hard disk drives, floppy drives, fans and switching
power supplies, they are more prone to hardware failures over time. These
software and hardware failures can compromise Internet security.
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. Scalability and Compatibility. SonicWALL products are designed to provide
comprehensive Internet security for networks ranging in size from 1 to
1,000 users. Our products consist of three separate models designed to
serve the specific security needs of our target markets. Our products
vary with respect to the number of supported users, the number of ports
and feature options such as VPN or content filtering. In addition to
serving the security needs of the small to medium enterprise market,
SonicWALL products are a fully compatible, perimeter security solution
for large, distributed enterprises and their branch offices and
telecommuters. Our products are designed to interoperate with enterprise
security products offered by, among others, Check Point Software and
Cisco Systems.
Strategy
Our goal is to extend our leadership position and become the industry
standard Internet security solution for broadband access users in our target
markets--the small to medium enterprise, branch office, telecommuter, and
education markets. Key elements of our strategy include:
. Extend Our Leadership Position in Target Markets. We believe that we have
established a market leadership position as a provider of Internet
security products designed for our target markets by offering robust,
reliable, easy-to-use products at attractive prices. We intend to
continue to focus our product development efforts, distribution
strategies, and marketing programs to satisfy the growing needs of these
markets. We believe that the current Internet security offerings of most
vendors are relatively expensive, technically complex, and generally
unable to satisfy these target markets.
. 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. We are currently, focusing on our product
development efforts in the following areas:
--New services such as virus scanning, bandwidth management, e-mail
spam filtering, public key infrastructure and intrusion detection.
--Management applications such as global console management and event
monitoring to allow one network administrator or service provider to
configure, manage and monitor hundreds of SonicWALL units
simultaneously and remotely from one management console.
--New hardware products including new versions of SonicWALL appliances
to meet the varying price and performance requirements of our
customers' and add-in modules to allow accelerated VPN performance
for those customers who need to communicate securely with branch
offices and telecommuters over the Internet.
--ASIC Design: we are working to achieve a higher level of Application
Specific Integrated Circuit, or ASIC, design and integration to
reduce product costs and increase product performance.
. 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 1,500 value added resellers, systems integrators, and
distributors, who sell our products in over thirty countries, including
large distributors such as Ingram Micro and Tech Data. In the fourth
quarter of 1999 we established reseller relationships with Concentric
Networks, Healtheon/WebMD and Westcon. 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.
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. Develop Strategic Original Equipment Manufacturer Relationships. By
entering into original equipment manufacturer arrangements to sell our
products, we intend to build upon the brand awareness and worldwide
channels of major networking and telecommunications equipment suppliers
to further penetrate our target markets. We presently have original
equipment manufacturer agreements with the following three companies:
Ramp Networks, a manufacturer of shared Internet access devices for small
offices, Com21, a supplier of cable modems, and 3COM Corporation, a
provider of diversified networking products. The terms of our agreements
with these customers are variable but none of such purchasers is
currently required to purchase a specified amount of our products or
technology. Our 3COM agreement expires July 2002, with automatic renewal
for successive one year periods subject to either party's election to
terminate on six months prior notice. Our Com21 agreement terminates in
January 2001, with automatic renewal for successive one year periods,
subject to either party's cancellation upon not less than thirty days
prior notice. Our agreement with Ramp Networks has been renewed through
in January 2001, and is automatically renewable for successive one year
terms unless either party elects to terminate upon thirty days prior
notice. Com21 is licensed to incorporate our technology in its products.
Ramp Networks sells our products under its own name, as does 3COM
Corporation. We manufacture the products which Ramp Networks and 3COM
Corporation purchase from us for resale through their own distribution
channels. In the year ended December 31, 1999, revenue from Com21, Ramp
Networks and 3COM constituted approximately 12% of total revenue. We are
pursuing relationships with other broadband access equipment providers
with the intent of further penetrating our target markets.
. Build Upon Our Installed Base. We continue to develop new subscription
services and add on products to generate additional revenue from our
installed base. For example, we announced a strategic partnership with
myCIO.com, a Network Associates business, to sell an integrated, managed
anti-virus solution 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 we 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
AutoUpdate feature encourages our customers to register their product by
offering periodic notifications via email of new security threats, bug
fixes and marketing information on new features and products. Each
SonicWALL model is configured to allow end users to easily and
conveniently download new features and products that have been purchased,
either through our resellers or our Web site. Such sales could include
additional functionality such as virtual private networking or additional
recurring revenue opportunities such as content filtering services.
Products and Services
We believe the SonicWALL product line provides cost effective and high
performance Internet security solutions for the small and medium size
enterprise, branch office, telecommuter, and education markets. We design our
products to address the specific needs of customers within each of these market
segments. Our products vary with respect to the number of supported users, the
number of ports, product features, processor speed and scalability. All of our
products provide firewall security and are capable of delivering features such
as content filtering and virtual private networking in a single, integrated
security appliance that is managed through an intuitive and easy-to-use Web
browser-based interface.
SonicWALL SOHO. SonicWALL has two 10Base-T Ethernet ports and is designed to
provide security for smaller networks using broadband connections to the
Internet such as cable and DSL. SonicWALL SOHO provides protection against
unauthorized access to the private network, filters out objectionable Web
sites, and manages the complexity of IP addressing. It also has a virtual
private networking option to give telecommuters and small remote offices
affordable and secure connectivity to the main office. SonicWALL SOHO supports
10 or 50 user connections.
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SonicWALL DMZ. SonicWALL DMZ has three 10Base-T Ethernet ports and is
designed to meet the Internet security needs of small and medium size networks
in business and education. SonicWALL security code operates between each port's
connections to prevent unauthorized communication, regardless of its source. In
addition to the features provided by SonicWALL, SonicWALL DMZ provides a third
port, a DMZ, or De-Militarized Zone. With the additional DMZ port, public Web
and e-commerce servers can both be accessed from the Internet without exposing
the private network to Internet based attacks. SonicWALL DMZ protects the
computers on the LAN port and the public servers on the DMZ port from Internet-
based attacks. SonicWALL DMZ supports unlimited users.
SonicWALL PRO. SonicWALL PRO has three 10/100Base-T Fast Ethernet ports and
is designed to meet the Internet security needs of medium and large size
businesses and branch offices. SonicWALL PRO supports all of the features found
in other SonicWALL models, and offers a more powerful and scalable platform for
larger networks requiring faster connections, high performance virtual private
networking and future expansion options. SonicWALL PRO supports unlimited
users.
The SonicWALL product line shares a common set of Internet security features
that have been tailored to meet the needs of our target markets:
Firewall Security. Our firewall security protects private networks
against Internet-based theft, destruction, or modification of data, and
automatically notifies customers if their networks are under attack.
SonicWALL has been awarded the internationally recognized ICSA Firewall
Certification, the same certification awarded to significantly more
expensive products sold by Check Point Software and Cisco Systems. In
addition, SonicWALL is pre-configured to automatically detect and thwart
Denial of Service attacks such as Ping of Death, SYN Flood, LAND Attack,
and IP Spoofing.
Virtual Private Networking. Our virtual private networking capabilities
enable affordable and secure communications over the Internet between
branch offices, telecommuters, mobile workers and business partners.
SonicWALL virtual private networking uses industry-standard data encryption
algorithms and interoperates with other virtual private networking products
such as Check Point Software's Firewall-1.
Content Filtering. Our content filtering feature enables businesses,
families, schools and libraries to control access to objectionable or
inappropriate Web sites. SonicWALL can filter Internet content by URL or
keyword. We offer a content filter subscription service that provides a
list of objectionable Web sites that is automatically updated on a weekly
basis.
IP Address Management. SonicWALL includes Network Address Translation,
or NAT, which allows a customer to connect multiple users on their private
network to the Internet using a single public IP address. SonicWALL also
includes Dynamic Host Configuration Protocol, or DHCP, Client and Server
capabilities. DHCP Client allows SonicWALL to automatically acquire its IP
address settings from the Internet Service Provider, or ISP. DHCP Server
allows computers on the private network to automatically acquire IP address
settings from SonicWALL, simplifying client PC configuration.
Auto Update. Our Auto Update feature automatically notifies all
registered customers via e-mail when bug fixes or new products that have
been purchased are available for download from our Web site. With Auto
Update, we give our customers an easy-to-use method to address rapidly
evolving Internet security issues.
Logging and Reporting. SonicWALL maintains an event log of potential
security concerns which can be viewed with a Web browser or automatically
sent to any e-mail address on a periodic basis. SonicWALL notifies the
administrator of high-priority security issues, such as an attack on a
server, by immediately sending an alert message to a priority e-mail
account such as an e-mail pager. SonicWALL also provides pre-defined
reports that show different views of Internet usage, such as the most
commonly accessed Web sites.
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Web Browser-Based Management. SonicWALL is easily and securely
configured and managed through a Web browser-based interface. The SonicWALL
interface effectively insulates the user from the underlying complexity of
Internet security, while providing enough flexibility to meet the diverse
needs of our customers.
Customers
We sell over 98% of our products through distributors and original equipment
manufacturers. As of December 31, 1999, we had sold more than 35,000 Internet
security appliances. The following lists our top five international and
domestic distributors based on revenues in the year ended December 31, 1999,
and all of our current original equipment manufacturers. The top five domestic
distributors each represent between 1% and 34% of our total revenue. The top
five international distributors each represent between 1% and 9% of our total
revenue.
Top 5 Domestic Top 5 International Original Equipment
Distributors Distributors Manufacturers
.Arcom .Access Networks .3COM Corp.
.Ingram Micro (Switzerland) .Com21
.Sound Business Systems .Allasso (England) .Ramp Networks
.Tech Data .Connect AS (Norway)
.Westcon .Sumitomo Metal Systems
(Japan)
.Tekdata Ltd(England)
End Users
Although we do not sell directly to end users, approximately 65% of the
products we have sold to date have been registered for use with us by our end
users in our target markets. The following is a representative list of end
users in each of our target markets who have deployed one or more SonicWALL
products. These include the small to medium enterprise, the branch offices of
large corporations, telecommuter, and the education and public institution
markets.
Small to Medium Education and
Enterprises Branch Offices Telecommuter Public Institutions
.BBDO Seidman .American Express .Compaq Computer Corporation .Albany County School District
.Becks Beer .Bank of Nova Scotia .Lucent Technologies .City of Santa Cruz
.Charlotte Hornets .Centurion/Bank of Ireland .Microsoft Corporation .Comision Federal de Electricidad
.Fila Sports .Commercial Bank of San Francisco .NEC .Duke University
.Pixar .Wells Fargo .PricewaterhouseCoopers LLP .Johns Hopkins University
.Sun Microsystems .Santa Clara County 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, both in the United States and over 30 countries.
Distributors accounted for approximately 76% of our
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total revenue for the year ended December 31, 1999. Resellers, which include
systems integrators, ISPs, dealers, mail order catalogs and online catalogs,
generally purchase our products from our distributors and then sell our
products to end-users in our target markets. Except for our Sonic Platinum
level resellers described below, we do not have purchase agreements with or
sell directly to our resellers. Our distributor and reseller agreements are
non-exclusive.
We divide our sales organization regionally into three areas: the United
States and Canada; the Pacific Rim and Latin America; and Europe, the Middle
East and Africa. Regional sales representatives manage our relationships with
our network of distributors, value added resellers and customers, help our
value added reseller network sell and support key customer accounts, and act as
a liaison between our value added reseller network and our marketing
organization. The regional sales representative's primary responsibility is to
help the indirect channel succeed and grow within the territory. We also have
an internal sales staff that supports the indirect channel, and a dedicated
business development organization whose primary responsibilities are
identifying, promoting, and managing strategic relationships to sell our
products with ISPs, industry leaders, and original equipment manufacturers as
well as to obtain technology for incorporation in our product line.
Domestic Channel. In the United States, the primary distributors of our
products to resellers are Ingram Micro and Tech Data. Ingram Micro accounted
for 34% of our revenue in 1998 and 1999. Tech Data began distributing our
Internet security products in February 1999, and in the year ended December 31,
1999, accounted for approximately 12% of total revenue.
Domestic resellers receive various benefits and product discounts depending
on the level of purchases that the reseller commits to or achieves. The basic
program is the Sonic Reseller level which offers access to privileged
information and sales and marketing materials. Next we offer a Sonic Silver
level, which extends those benefits by adding access to an expanded set of
sales and marketing tools, as well as priority technical support. The top level
is Sonic Gold, where additional benefits such as sales leads and market
development funds are available. Sonic Reseller, Silver, and Gold resellers all
source our products through a distributor. We also have a Sonic Platinum level
program for selected resellers which includes sales leads, access to additional
discounted demonstration units and market development funds. We sell directly
to these Platinum level resellers.
International Channel. We believe there is a strong international market for
our products. International sales represented 32% of our revenue in 1998 and
approximately 34% of revenue in 1999. Sales to Japan accounted for 11% of total
revenue in the year ended December 31, 1999.
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 in Switzerland, Tekdata
Distribution in England, DataWorld in Hong Kong and Allasso in England.
Original Equipment Manufacturer Channel. We enter into select original
equipment manufacturer relationships in order to take advantage of the channels
of well established companies that sell into our target markets. We believe
these channels expand our overall market while having a minor impact on our own
indirect channel sales. We currently have agreements to sell our products or
services through the following original equipment manufacturers: Com21, a
supplier of cable modems, Ramp Networks, a provider of networking equipment to
small businesses, and 3COM Corporation. The terms of our agreements with these
customers are variable. Com21 is licensed to incorporate our technology in its
cable modem products. Ramp Networks sells our products under its own name, as
does 3COM Corporation. We manufacture the products which Ramp Networks and 3COM
Corporation purchase from us for resale through their own distribution
channels. In the year ended December 31, 1999, our original equipment
manufacturer revenue accounted for approximately 12% of total revenue.
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Customer Service and Technical Support
We offer our customers a comprehensive range of support programs through a
customer service and technical support organization which provides product
maintenance and technical support services on a worldwide basis. Our technical
support staff is located in Santa Clara, California. In addition to standard
support, we offer premium support services which an end user customer located
in the United States can purchase from us or our channel partners.
Standard Support. Included during the warranty period, standard support is a
unique Web-based technical support mechanism whereby distributors, channel
partners, and end users can use our extensive on-line technical support
resource database. If the resource database does not answer a question, the
user can immediately enter a query or "trouble ticket" on-line and our customer
service organization will then generate a response via phone, fax, or e-mail.
Premium Support. Available for purchase only in the continental United
States, our annual subscription-based Premium Support program offers extended
benefits to the Standard Support offering. Premium Support benefits include:
. expedited response time;
. access to a dedicated toll-free support telephone number;
. overnight replacement of defective units; and
. free shipping for units which we authorize for return.
Our products include a standard one-year warranty, which can be extended at
additional cost. The warranty provides access to our standard technical support
services along with repair or replacement guarantees for units with product
defects.
Technology
We have designed our SonicWALL products using a unique combination of
proprietary hardware and software that delivers comprehensive Internet security
with what we believe are exceptional ease-of-use and industry-leading
price/performance.
The SonicWALL product line currently has two base hardware configurations:
. SonicWALL SOHO and SonicWALL DMZ. These SonicWALL products use the 33MHz
Motorola 68360 microprocessor. Both products have two 10 megabits per
second (Mbps) Ethernet ports. A LAN port connects the SonicWALL to the
user's internal, private network. A Wide Area Network, or WAN, port
connects to the external, public network. The SonicWALL DMZ has a third
10 Mbps Ethernet port (DMZ) which connects to public servers that are
separated from both the public and private networks but still protected
from security breaches.
. SonicWALL PRO. The SonicWALL PRO product uses Intel's 233MHz StrongARM
110 microprocessor, and has three 10/100 Mbps Fast Ethernet ports. These
three ports function just like the SonicWALL DMZ. For feature expansion,
the SonicWALL PRO has an internal Peripheral Component Interconnect, or
PCI, interface, upgradeable RAM, and flash memory.
The SonicWALL product line consists of the following core modules:
. Firewall. The core technology is the stateful packet inspection firewall
software. Stateful packet inspection is generally accepted as the most
advanced and secure method of implementing an Internet firewall. It
examines all layers of the packet (from the physical layer up to
application layer) and 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
10
adjusts based on the changing state of the communication running across
the firewall and is invisible to users on the protected network. It
therefore requires no client PC configuration. Our SonicWALL firewall
protects against a known set of security threats.
. Content Filter. The SonicWALL Internet content filter blocks
objectionable content using a list of forbidden URLs and keywords. We
license Microsystems Software's CyberNOT list of URLs and adapt it for
our products. Each SonicWALL appliance can automatically download an
updated URL list weekly to keep pace with the dynamic nature of Internet
content.
. IP Address Management. We have developed tools to hide the complexity of
IP addressing. NAT allows networks to share a small number of valid
public IP addresses with an equal or larger number of client computers on
the LAN. This is a common challenge in new broadband-connected networks.
Our DHCP Server and Client tools allow both the firewall and the client
computers behind it to obtain their respective IP addresses dynamically
from a server and thereby eliminate the need for manual configuration.
. Virtual Private Networking. We developed virtual private networking
support for the SonicWALL products to provide a means for our customers
to use the Internet for secure communication between LANs, and from
remote clients to LANs. SonicWALL virtual private networking complies
with the Internet Protocol Security (IPSec) standard and supports three
data encryption methods: 56 bit Data Encryption Standard (DES); 168 bit
Data Encryption Standard (Triple-DES); and 56 bit ARCFour (ARC4). By
building our virtual private networking technology on industry
standards--IPSec, DES and Triple-DES--we have been able to establish
virtual private networking interoperability with other leading virtual
private networking solutions such as Check Point Software's FW-1.
. Web Browser-Based Management Interface. We believe our products have an
intuitive and easy-to-use Web-based management interface for rapid
installation, configuration and maintenance, without the need for a
dedicated information technology staff to install and maintain the
solution. This interface can be easily accessed from any Web browser on
the internal, private network. This interface can also be accessed
remotely in a secure manner using the virtual private networking feature
described above.
Research and Development
We believe that our future 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. Current activities include:
. Development of new security services including virus scanning, bandwidth
management, e-mail spam filtering, pubic key infrastructure and intrusion
detection.
. Development of a global console management and event monitoring system to
allow one network administrator or service provider to configure, manage
and monitor hundreds of SonicWALL units simultaneously and remotely from
one management console.
. Development of new versions of the SonicWALL hardware to meet the varying
price and performance requirements of our customers and add-in modules to
increase VPN performance for those customers who need to communicate to
branch offices and telecommuters over the Internet.
All of our research and development activities are conducted at our
principal facility in Sunnyvale, California. In 1997, 1998, and 1999 we
incurred expenses of $1,983,000, $2,051,000 and $3,643,000, respectively, on
research and development.
11
Competition
The market for Internet security products is world-wide and highly
competitive, and we expect competition to intensify in the future. There are
few substantial barriers to entry, and additional competition from existing
competitors and new market entrants will occur in the future. Current and
potential competitors in our markets include, but are not limited to the
following, all of whom sell world-wide or have a presence in most of the major
markets for such products:
. enterprise firewall software vendors such as Check Point Software and
Axent Technologies;
. network equipment manufacturers such as Cisco Systems, Lucent
Technologies, Nortel Networks, 3COM and Nokia;
. computer or network component manufacturers such as Intel Corporation;
. operating system software vendors such as Microsoft Corporation, Novell
and Sun Microsystems;
. security appliance suppliers such as Watchguard Technologies; and
. low cost Internet router suppliers which may include limited Internet
security functionality.
Most of our competitors to date have generally targeted large enterprises'
security needs with firewall products that are typically very complex and
expensive, ranging in price from approximately $5,000 to more than $15,000.
Recently, some of our competitors have introduced products priced at less than
$1,000 which may increase competitive pressure on some of our products,
resulting in both lower prices and gross margins. While there are suppliers of
low cost Internet routers which may provide limited Internet security
functionality, we believe these products are difficult to install and configure
and provide relatively low performance. At any time, any of these competitors
may adapt existing products for our target markets. Many of our current or
potential competitors have longer operating histories, greater name
recognition, larger customer bases and significantly greater financial,
technical, marketing and other resources than we do. Nothing prevents or
hinders these actual or potential competitors from entering our target markets
at any time. In addition, our competitors may bundle products competitive to
ours with other products that they may sell to our current or potential
customers. These customers may accept these bundled products rather than
separately purchasing our products. If these companies were to use their
greater financial, technical and marketing resources in our target markets, it
could adversely affect our business.
Proprietary Rights
We currently rely on a combination of copyright and trademark laws, trade
secrets, confidentiality provisions and other contractual provisions to protect
our proprietary rights. Despite our efforts to protect our proprietary rights,
unauthorized parties may misappropriate or infringe on our trade secrets,
copyrights, trademarks, service marks and similar proprietary rights. Although
we are currently investigating patent protection for some of our proprietary
technology, we have not yet received any patent protection for our technology
or products. Even if we obtain such patents, that does not guarantee that our
patent rights are valuable, create a competitive barrier, or will be free from
infringement. We face additional risk when conducting business in countries
that have poorly developed or inadequately enforced intellectual property laws.
In any event, competitors may independently develop similar or superior
technologies or duplicate the technologies we have developed, which could
substantially limit the value of our intellectual property.
U.S. Government Export Regulation Compliance
Our products are subject to federal export restrictions on encryption
strength. Recent federal legislation, however, has increased exportable
encryption strength and allows the export of any-strength encryption to
designated business sectors overseas, including U.S. subsidiaries, banks,
financial institutions, insurance companies and health and medical end users.
In addition, we have obtained a federal export license that allows us to export
encryption technology to commercial entities in approved countries. With these
expanded export rights, we may export strong encryption to a wide range of
foreign end-users, subject to limitations and record-
12
keeping requirements. To comply with these constraints, we obtain from our
distributors and resellers detailed information about each foreign end-user
customer that will obtain strong encryption.
Manufacturing
We currently outsource our manufacturing to one contract manufacturer, Flash
Electronics, under an agreement which may be cancelled upon 180 days prior
notice by either party. Outsourcing our manufacturing enables us to reduce
fixed overhead and personnel costs and to provide flexibility in meeting market
demand.
We design and develop all the key components of our products, including
printed circuit boards and software. In addition, we determine the components
that are incorporated in our products and select the appropriate suppliers of
these components. Product testing and burn-in is performed by our contract
manufacturers using tests that we specify.
Employees
As of December 31, 1999, we had 73 employees. Of these, 38 were employed in
sales and marketing, 8 in finance and administration, 19 in research and
development and 8 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 good relations with our employees.
13
RISK FACTORS
Company Risks
We have just recently entered the emerging market for broadband Internet
security appliances, and we do not know if we will be successful in marketing
our products to our target customers.
From inception through 1996, we derived substantially all of our revenue
from the sale of Ethernet products for Apple Macintosh computers. In October
1997, we introduced our SonicWALL line of products, and in 1998 we made a
strategic decision to concentrate our resources in the Internet security
market. As a result, we 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.
We believe that many potential customers in our target markets are not fully
aware of the need for Internet security products and services. Historically,
only enterprises having substantial resources developed or purchased Internet
security solutions. Also, there is a perception that Internet security is
costly and difficult to implement. Therefore, we will not succeed unless we can
educate our target markets about the need for Internet security and convince
potential customers of our ability to provide this security in a cost-effective
and easy-to-use manner. Although we have spent, and will continue to spend,
considerable resources educating potential customers about the need for
Internet security and the benefits of our products and services, our efforts
may be unsuccessful.
Even if we convince our target markets about the importance of and need for
Internet security, we do not know if this will result in the sale of our
products. We currently expect that almost all of our future revenue will be
generated through sales of our SonicWALL products, including related services
such as subscription and license fees. Our success depends on market acceptance
of our products and services.
We may be unable to manage our growth, and if we cannot do so, it could have a
material adverse effect on our business.
Our business has grown rapidly in the last year. At the end of 1998, we had
26 employees. As of December 31, 1999, we had 73 employees, an increase of
approximately 181%. In addition, we have experienced expansion in our
manufacturing and shipping requirements, our product lines, our customer base
and our end user installed base. This rapid expansion has placed significant
strain on our administrative, operational and financial resources and has
resulted in ever-increasing responsibilities for our management personnel.
These changes have increased the complexity of managing SonicWALL, Inc. If we
continue to experience significant growth, our current systems, management and
resources will be inadequate, and our organization will need to grow rapidly in
order to meet the demands placed on our business. If we cannot manage our
growth effectively, our business prospects will be materially adversely
affected.
We 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. We made $158,000 in
net income, or approximately 1% of revenue, for the year ended December 31,
1999. As of December 31, 1999 we had an accumulated deficit of $850,000. 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 we recently changed our business focus from Ethernet products for
Macintosh computers to Internet security products, our historical financial
information is of limited value in projecting future operating
14
results. We believe that comparing different periods of our operating results
is not meaningful and you should not rely on the results for any period as an
indication of our future performance.
Our limited experience with sales of Internet security products is one of
many factors underlying our inability to predict our revenue for a given
period. We base our spending levels for product development, sales and
marketing, and other operating expenses largely on our expected future revenue.
A large proportion of our expenses are 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.
In 1999, approximately 86% of our sales were to distributors. 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 Corp., both of which are
global computer equipment and accessory distributors, accounted for
approximately 34% and 12% of our revenue, respectively. In 1998, sales to
Ingram Micro accounted for 34% of our revenue. 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,
1999, Ingram Micro and Tech Data represented $2.1 million and $0.6 million,
respectively, of our accounts receivable, constituting 49% and 14%,
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 and Tech
Data, 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.
If an OEM customer cancels, reduces or delays purchases, our revenue may
decline and our business could be adversely affected.
To date, we have formed OEM relationships with three OEMs including, most
recently, 3COM Corporation. 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.
15
Average selling prices of our products may decrease, which may reduce our gross
margins.
The average selling prices for our products may decline as a result of
competitive pricing pressures, promotional programs and customers who negotiate
price reductions in exchange for longer term purchase commitments. The pricing
of products depends on the specific features and functions of the products,
purchase volumes and the level of sales and service support. We expect
competition to increase in the future. As we experience pricing pressure, we
anticipate that the average selling prices and gross margins for our products
will decrease over product life cycles. We cannot assure you that we will be
successful in developing and introducing on a timely basis new products with
enhanced features, or that these products, if introduced, will enable us to
maintain our average selling prices and gross margins at current levels.
We offer retroactive price protection to our major distributors and if we fail
to balance their inventory with end user demand for our products, our allowance
for price protection may be inadequate. This could adversely affect our results
of operations.
We provide our major distributors with price protection rights for
inventories of our products held by them. If we reduce the list price of our
products, our major distributors receive refunds or credits from us that reduce
the price of such products held in their inventory based upon the new list
price. As of December 31, 1999, we estimate that approximately $1.2 million of
our products were in our distributors' inventory and therefore subject to price
protection. This amount represented approximately 5.7% of our revenue for the
year ending December 31, 1999. We have provided less than $100,000 of credits
under our price protection policies in the past three fiscal years. Future
credits for price protection will depend on the percentage of our price
reductions for the products in inventory and our ability to manage the level of
our major distributors' inventory. New product introductions or price
reductions by us or our competitors could result in significant product price
adjustments. If future price protection adjustments are higher than expected,
our future results of operations could be materially adversely affected.
We are dependent on international sales for a substantial amount of our
revenue. We face the risks of international business and associated currency
fluctuations, which might adversely affect our operating results.
International revenue represented 32% of total revenue in 1998 and 34% of
total revenue in 1999. For the year ended December 31, 1999, revenue from Japan
represented 11% of our total revenue, and revenue from Europe, the Middle East
and Africa collectively represented approximately 17% of our total revenue. We
expect that international revenue will continue to represent a substantial
portion of our total revenue in the foreseeable future. Our risks of doing
business abroad include our ability to maintain distribution relationships on
favorable terms. To the extent we are unable to favorably renew our
distribution agreements or make alternative arrangements, revenue may decrease
from our international operations. We also face risks associated with general
economic conditions and regulatory uncertainties associated with our
international sales. Because our sales are denominated in United States
dollars, the weakness of a foreign country's currency against the dollar could
increase the price of our products in such country and reduce our product unit
sales by making our products more expensive in the local currency.
We are subject to the risks of conducting business internationally,
including potential foreign government regulation of our technology, general
geopolitical risks associated with political and economic instability, changes
in diplomatic and trade relationships, and foreign countries' laws affecting
the Internet generally.
Delays in deliveries from our component suppliers could cause our revenue to
decline and adversely affect our results of operations.
We outsource all of our hardware manufacturing and assembly from security
appliances to a single manufacturer. Our SonicWALL products incorporate certain
components or technologies which are only available from single or limited
sources of supply. Specifically, our products rely upon microprocessors from
16
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 which 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 endusers using
our products and services or interrupt their operations. If that happens,
affected endusers or others may sue us. In addition, we may face liability for
breaches caused by faulty installation of our products by resellers or
endusers. Although we attempt to reduce the risk of losses from claims through
contractual warranty disclaimers and liability limitations, these provisions
may be unenforceable. Some courts, for example, have found contractual
limitations of liability in standard computer and software contracts to be
unenforceable in some circumstances. Defending a lawsuit, regardless of its
merit, could be costly and could divert management attention. Although we
currently maintain business liability insurance, this coverage may be
inadequate or may be unavailable in the future on acceptable terms, if at all.
Our business liability insurance has no specific provisions for potential
liability for Internet security breaches.
A security breach of our internal systems or those of our customers could harm
our business.
Because we provide Internet security, we may become a greater target for
attacks by computer hackers. We will not succeed unless the marketplace is
confident that we provide effective Internet security protection. Networks
protected by our products may be vulnerable to electronic break-ins. Because
the techniques used by computer hackers to access or sabotage networks change
frequently and generally are not recognized until launched against a target, we
may be unable to anticipate these techniques. Although we have not experienced
any act of sabotage or unauthorized access by a third party of our internal
network to date, if an actual or perceived breach of Internet security occurs
in our internal systems or those of our end-user customers, regardless of
whether we cause the breach, it could adversely affect the market perception of
our products and services. This could cause us to lose current and potential
customers, resellers, distributors or other business partners.
We rely primarily on one contract manufacturer for all of our product
manufacturing and assembly, and if we cannot obtain its services, we may not be
able to ship products.
We outsource all of our hardware manufacturing and assembly primarily to one
third-party manufacturer and assembly house--Flash Electronics, Inc. We do not
have a long-term manufacturing contract with this vendor. Flash Electronics has
produced products with acceptable quality, quantity and cost in the past, but
it may be unable or unwilling to meet our future demands. Our operations could
be disrupted if we have to switch to a replacement vendor or if our hardware
supply is interrupted for an extended period. This could result in loss of
customer orders and revenue.
Acquisitions of products and technologies may result in disruptions to our
business and management due to difficulties integrating personnel and
operations.
Although we have no current plans, agreements or commitments with respect to
any acquisition, we may make acquisitions or investments in other companies,
products or technologies. If we make any acquisitions, we will be required to
integrate the operations, products and personnel of the acquired businesses and
train, retain and motivate key personnel from the acquired businesses. We may
be unable to maintain uniform
17
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 may
suffer because of acquisition-related costs or amortization costs for acquired
goodwill and other intangible assets.
We may be unable to adequately protect our proprietary rights, which may limit
our ability to compete effectively.
Unauthorized parties may misappropriate or infringe our trade secrets,
copyrights, trademarks and similar proprietary rights. We have not received any
patent protection for our technology or products. Even if we obtain such
patents, that does not guarantee that our patent rights are valuable, create a
competitive barrier, or will be free from infringement. We face additional risk
when conducting business in countries that have poorly developed or
inadequately enforced intellectual property laws. In any event, competitors may
independently develop similar or superior technologies or duplicate the
technologies we have developed, which could substantially limit the value of
our intellectual property.
Potential intellectual property claims and litigation could subject us to
significant liability for damages and invalidation of our proprietary rights.
In the future, we may have to resort to litigation to protect our
intellectual property rights or trade secrets or to determine the validity and
scope of the proprietary rights of others. Any litigation, regardless of its
success, would probably be costly and require significant time and attention of
our key management and technical personnel. Litigation could also force us to:
. stop or delay selling, incorporating or using products that incorporate
the challenged intellectual property;
. pay damages;
. enter into licensing or royalty agreements, which may be unavailable on
acceptable terms; or
. redesign products or services that incorporate infringing technology.
We may face infringement claims from third parties in the future. The
computer industry has seen frequent litigation over intellectual property
rights. We expect that infringement claims will be more frequent for Internet
participants as the number of products, services and competitors grows and
functionality of products and services overlaps.
Undetected product errors or defects could result in loss of revenue, delayed
market acceptance and claims against us.
We offer a one-year warranty on all of our products, allowing the end user
to receive a repaired or replacement product for any defective unit.
Historically, refunds based on product warranty claims have been insignificant.
Although we have discovered few errors or defects in our products, our products
may contain undetected errors or defects. If there is a product failure, we may
have to replace all affected products without being able to book revenue for
such replacement units, or we may have to refund the purchase price for such
units. Because of our recent introduction of Internet security products, we
have little experience in gauging the risk of unexpected product failures or
defects. Despite extensive testing, some errors are discovered only after a
product has been installed and used by customers. Any errors discovered after
commercial release could result in loss of revenue and claims against us. In
the year ended December 31, 1999, refunds attributable to errors or defects in
products amounted to less than 1% of total revenue for the period.
18
If we do not retain our key employees and attract new employees, our ability to
execute our business strategy will be impaired.
We compete for employees in California's Silicon Valley, one of the most
difficult employer environments in the United States. Our future success will
depend largely on the efforts and abilities of our current senior management
and our ability to attract and retain additional key development, technical,
operations, information systems, customer support and sales and marketing
personnel. We do not have employment contracts with any of our key employees,
who may leave us at any time. Specifically, the services of Sreekanth Ravi,
President and Chief Executive Officer, and Sudhakar Ravi, Chief Technical
Officer, would be difficult to replace. We do not maintain life insurance for
any of our key personnel. See "Management" for detailed information on our key
personnel.
Industry Risks
Our revenue growth is dependent on the continued growth of broadband access
services, which are currently in early stages of development, and if such
services are not widely adopted or we are unable to address the issues
associated with the development of such services, our sales will be adversely
affected.
Sales of our products depend on the increased use and widespread adoption of
broadband access services, such as cable, DSL, Integrated Services Digital
Network, or ISDN, Frame Relay and T-1. These broadband access services
typically are more expensive in terms of required equipment and ongoing access
charges than is the case with Internet dial-up access providers. Our business,
prospects, results of operations and financial condition would be materially
adversely affected if the use of broadband access services does not increase as
anticipated or if our customers' access to broadband services is limited.
Critical issues concerning use of broadband access services are unresolved and
will likely affect the use of broadband access services. These issues include:
. security;
. reliability;
. bandwidth;
. congestion;
. cost;
. ease of access; and
. quality of service.
Even if these issues are resolved, if the market for products that provide
broadband access to the Internet fails to develop, or develops at a slower pace
than we anticipate, our business, prospects, results of operations and
financial condition would be materially adversely affected.
The broadband access services market is new and is characterized by rapid
technological change, frequent enhancements to existing products and new
product introductions, changes in customer requirements and evolving industry
standards. We may be unable to respond quickly or effectively to these
developments. The introduction of new products by competitors, market
acceptance of products based on new or alternative technologies, or the
emergence of new industry standards, could render our existing or future
products obsolete, which would materially adversely affect our business,
prospects, results of operations and financial condition.
The emergence of new industry standards might require us to redesign our
products. If our products fail to comply with widely adopted industry
standards, our customers and potential customers may not purchase our products.
This would have a material adverse effect on our business, prospects, results
of operations and financial condition.
19
If we are unable to compete successfully in the highly competitive market for
Internet security products and services, our business will fail.
The market for Internet security products is world-wide and highly
competitive, and we expect competition to intensify in the future. There are
few substantial barriers to entry, and additional competition from existing
competitors and new market entrants will likely occur in the future. Current
and potential competitors in our markets include, but are not limited to the
following, all of whom sell world-wide or have a presence in most of the major
markets for such products:
. enterprise firewall software vendors such as Check Point Software and
Axent Technologies, Inc.;
. network equipment manufacturers such as Cisco Systems, Lucent
Technologies, Inc., Nortel Networks Corp., 3COM Corporation and Nokia
Corp.;
. computer or network component manufacturers such as Intel Corporation;
. operating system software vendors such as Microsoft Corporation, Novell,
Inc. and Sun Microsystems, Inc.;
. security appliance suppliers such as WatchGuard Technologies, Inc. and
NetScreen Technologies, Inc.; and
. low cost Internet router suppliers which may include limited Internet
security functionality.
Most of our competitors to date have generally targeted large enterprises'
security needs with firewall products that range in price from approximately
$5,000 to more than $15,000, 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 scheduled introduction of new and enhanced products
and services, and we may experience delays in the future. When we do introduce
new or enhanced products and services, we may be unable to manage the
transition from the older products and services to minimize disruption in
customer ordering patterns, avoid excessive inventories of older products and
deliver enough new products and services to meet customer demand.
Governmental regulations affecting Internet security could affect our revenue.
Any additional governmental regulation of imports or exports or failure to
obtain required export approval of our encryption technologies could adversely
affect our international and domestic sales. The United States and various
foreign governments have imposed controls, export license requirements and
restrictions on the import or export of some technologies, especially
encryption technology. In addition, from time to time
20
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.
Recently, political attention has resulted in legislative efforts to make
the Internet safe for children at schools and other educational institutions
receiving federal assistance by linking the receipt of federal funds to the
existence of content filtering and security software for such institutions'
Internet connections. Some have questioned the constitutionality or other
legality of such efforts, but we believe that any government controls or
attempts to regulate the Internet could have a material effect on our business.
A government requirement of Internet security for schools receiving federal
funds would encourage purchases of our SonicWALL products; a court ruling that
prohibited such a requirement after the requirement was in place might reduce
sales to these market segments.
Our failure or the failure of our key suppliers and customers to be year 2000
compliant could negatively impact our business.
We believe that we have successfully rendered our products, internal
management and other administrative systems and external information systems
year 2000 compliant. In addition, we have surveyed the vendors of the third-
party technologies we incorporate into our products and services and applied
updates or arrangements to correct potential year 2000 compliance problems.
Since January 1, 2000, we have experienced no disruptions in our business
operations as a result of year 2000 compliance problems or otherwise, and we
have received no reports of any year 2000 problems with our products and
services. We are continuing to monitor third-party vendors of incorporated
technologies for additional recommended year 2000 upgrades, which we will apply
as soon as they become available. To date, the total cost of our efforts to
address year 2000 compliance has not been material.
Nonetheless, some problems related to year 2000 risks may not appear until
several months after January 1, 2000. Year 2000 issues could include problems
with our own products and services or with third-party products or technology
that we use or with which our products exchange data. Any problems that are not
identified and corrected successfully and completely could adversely affect our
business. We expect that the cost to fix any year 2000 problems that may be
identified, however, will involve internal labor-hours and will not be
material.
Investment Risk
Because they own approximately 55.3% of our stock ownership, our officers,
directors and their affiliates can elect the board of directors and control all
matters requiring shareholder approval.
Executive officers, directors, and entities affiliated with them, in the
aggregate, beneficially own approximately 55.3% 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.
The price of our common stock has been volatile and may continue to experience
volatility.
The trading price of our shares may fluctuate widely as a result of a number
of factors, most of which are outside our control. Some of these factors
include:
. quarter-to-quarter variations in our operating results;
. our announcements about the performance of our products and our
competitors' announcements about performance of their products; and
. changes in earnings estimates by, or failure to meet the expectations of,
analysts.
21
In addition, the stock market has experienced extreme price and volume
fluctuations, which have particularly affected the market prices of many
technology and computer software companies and which have often been unrelated
to the operating performance of these companies.
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.
Our charter documents also provide for limitations on the ability of
shareholders to call special meetings and act by written consent and prohibit
cumulative voting for directors. As a result, minority shareholder
representation on the board of directors may be difficult to establish. The
charter documents also limit the persons who may call special meetings of the
shareholders, prohibit shareholder actions by written consent and establish
advance notice requirements for nominations for election to the board of
directors or for proposing matters that can be acted on by shareholders at
shareholder meetings.
ITEM 2. PROPERTIES
Our headquarters are located in approximately 32,000 square feet of office
space in Sunnyvale, California under a lease which expires in October 2004. 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 its 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
Not applicable.
22
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, 1999, there
were approximately 65 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*.............................................. $43.50 $24.25
- --------
*Commencing November 11, 1999
We have never paid a cash dividend on its 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. Our line of credit arrangement
prohibits us from paying dividends without the lender's prior consent.
SonicWall, Inc. filed a registration statement on Form S-1 (File No. 333-
85997) which became effective on November 9, 1999 to register our shares of
common stock, no par value. The offering pursuant to this registration
statement terminated after all shares of common stock registered on the
registration statement were sold. The managing underwriters of the offering
were Bear, Stearns & Co. Inc., Hambrecht & Quist LLC. and Thomas Weisel
Partners, LLC. Of the shares registered and sold, 4,000,000 shares were sold
for the account of SonicWall, Inc. and 600,000 shares were sold by certain
selling shareholders. The offering price per share was $14.00 and the aggregate
offering price to SonicWall, Inc. was $56 million and to the selling
shareholders $8.4 million.
SonicWall, Inc. incurred expenses of $5,143,938 for its account in
connection with the issuance and distribution as follows:
Underwriting discounts and commissions......................... $3,920,000
Finders fees................................................... $ 0
Underwriter expenses........................................... $ 0
Other expenses................................................. $1,239,000
----------
Total........................................................ $5,159,000
==========
Of the foregoing expenses, $350,000 was paid to Manatt, Phelps & Phillips,
LLP for legal services rendered. Jerold F. Petruzzelli, a director of
SonicWall, Inc. is a partner of Manatt, Phelps & Phillips, LLP.
Net offering proceeds to SonicWall, Inc. was $50.9 million. From the
effective date of the registration statement to December 31, 1999, SonicWall,
Inc. has used net offering proceeds to invest in short-term investments which
were cash and cash equivalents at December 31, 1999.
23
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, 1999 and the balance sheet data at December 31, 1998 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, 1995 and 1996 and the balance sheet data at December 31,
1995, 1996 and 1997 are derived from audited financial statements which are not
included in this Form 10-K. The historical results are not necessarily
indicative of the operating results to be expected in the future.
Year Ended December 31,
-----------------------------------------
1995 1996 1997 1998 1999
------- ------ ------ ------- -------
(in thousands, except per share data)
Statement of Operations Data:
Revenue
Internet security................ $ -- $ -- $ 250 $ 2,349 $19,403
Ethernet......................... 10,482 9,356 9,092 5,166 1,644
------- ------ ------ ------- -------
Total revenue.................. 10,482 9,356 9,342 7,515 21,047
Cost of revenue.................... 6,411 5,915 4,842 3,308 5,961
------- ------ ------ ------- -------
Gross margin....................... 4,071 3,441 4,500 4,207 15,086
Operating expenses
Research and development......... 1,241 1,048 1,983 2,051 3,634
Sales and marketing.............. 1,856 1,665 2,468 2,870 5,342
General and administrative....... 529 432 644 753 1,761
Deferred stock compensation...... -- -- -- 42 2,895
------- ------ ------ ------- -------
Total operating expenses....... 3,626 3,145 5,095 5,716 13,632
------- ------ ------ ------- -------
Income (loss) from operations...... 445 296 (595) (1,509) 1,454
Other income (expense), net........ (30) 22 29 54 536
------- ------ ------ ------- -------
Income (loss) before income taxes.. 415 318 (566) (1,455) 1,990
Benefit from (provision for) income
taxes............................. (164) (350) 99 (6) (1,832)
------- ------ ------ ------- -------
Net income (loss).................. $ 251 $ (32) $ (467) $(1,461) $ 158
======= ====== ====== ======= =======
Basic net income (loss) per share.. $ 0.03 $ -- $(0.06) $ (0.13) $ 0.01
======= ====== ====== ======= =======
Diluted net income (loss) per
share............................. $ 0.02 $ -- $(0.06) $ (0.13) $ 0.01
======= ====== ====== ======= =======
Shares used in calculation of basic
net income (loss) per share....... 9,626 8,460 8,461 11,251 17,334
======= ====== ====== ======= =======
Shares used in calculation of
diluted net income (loss) per
share............................. 11,224 8,460 8,461 11,251 21,196
======= ====== ====== ======= =======
December 31,
-----------------------------------------
1995 1996 1997 1998 1999
------- ------ ------ ------- -------
Consolidated Balance Sheet Data:
Cash and cash equivalents.......... $ 145 $1,036 $ 787 $ 1,051 $62,589
Total assets....................... 2,810 3,448 2,374 4,751 71,239
Total shareholders' equity......... $ 963 $ 932 $ 465 $ 1,488 $60,750
See Note 1 of Notes to Consolidated Financial Statements for information
concerning the calculation of basic and diluted net income (loss) per share.
24
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," "expects," "plans," "anticipates,"
"believes," "estimates," "predicts," "potential," "intend" or "continue," or
the negative of such terms and other comparable terminology. These statements
are only predictions. Our actual results may differ materially from those
anticipated in these forward-looking statements as a result of a variety of
factors, including, but not limited to, those set forth under "Risk Factors"
and elsewhere in this 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 enable Apple Macintosh computers to connect to
computer networks using Ethernet communications standards. The Ethernet
standard was developed in the 1970s by Xerox Corporation and is the most widely
used technology to facilitate communication between computers on local area
networks. The Ethernet standard is defined by the Institute of Electrical and
Electronics Engineers and specifies the speed and other characteristics of a
computer network. In 1998, we made a strategic business decision to concentrate
our resources in the Internet security market due to our belief that this
market had better long-term growth prospects. As a result, we 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 do not expect any significant charges related to our Ethernet
product inventories or warranty obligations. In 1998, our Internet security
products represented approximately 31% of our total revenue and in 1999 they
represented 92% of our total revenue. In 1998, our Ethernet products
represented 69% of our total revenue and in 1999, Ethernet products represented
approximately 8% of our total revenue.
Our SonicWALL products are sold primarily through distributors who then
resell our products to resellers and selected retail outlets. These resellers
then sell our products to end-users. Two of our distributors, Ingram Micro,
Inc. and Tech Data Corp., both of which are global computer equipment and
accessory distributors, account for approximately 46% of our revenue. In 1998,
sales to Ingram Micro accounted for 34% of our revenue. In 1999, sales to
Ingram Micro and Tech Data accounted for 34% and 12% of our revenue,
respectively.
Our revenue consists primarily of product sales and, to a lesser extent,
subscription fees from content filtering services and extended warranty
contract fees. Product sales comprised approximately 95% of total revenue for
the year ended December 31, 1999. We generally recognize revenue when we ship
products to our customers. Agreements with many of our distributors provide for
stock rotation, price protection and co-op advertising rights. Stock rotation
rights provide a distributor the right to exchange unsold inventory for
alternative products. Ingram Micro's right to return or rotate its stock on-
hand is unlimited, and therefore we recognize revenue for product sales to
Ingram Micro when it has sold the product to its customers. Ingram Micro does
not have the right to return non-defective products to us if a customer of
Ingram Micro returns such a product to Ingram Micro. For all other
distributors, the value of stock that can be rotated is generally limited to
15% of the prior quarter's purchases. Co-op advertising rights provide a
distributor the right to be reimbursed up to 3% of the prior quarter's sales
for costs it has incurred associated with advertising our products. For all of
our distributors, we provide an allowance for sales returns, price protection
rights and
25
reserves for warranty and co-op advertising costs at the time of revenue
recognition. Price reductions which may result in price protection require the
approval of our president, chief financial officer, and vice president of
sales. Subscription fees and extended warranty fees are deferred and amortized
over the period of the related contracts. Subscription and extended warranty
fees to date have not been material.
To date, a significant portion of our revenue has been dependent on large
purchase orders from a limited number of distributors. These purchase orders
typically have short lead times and are subject to delay or cancellation
without penalty. We anticipate that our operating results for a given period
will continue to depend on a small number of customers. If we experience a
decline in revenue from any of our significant distributors in a given quarter,
our revenue for that quarter, or following quarters, will be adversely
affected. This could adversely affect our business, prospects, results of
operations and financial condition. Furthermore, if any of our significant
customers experiences financial difficulties, our sales to these customers may
be reduced, and we may have difficulty collecting accounts receivable from
these customers. Any delay in large customer orders or customer financial
difficulties could have a material adverse effect on our business, prospects,
results of operations and financial condition.
We primarily use one contract manufacturer to manufacture our products. We
also rely on single or limited source suppliers to provide key components of
our products. A significant portion of our cost of revenue is related to these
suppliers. These relationships are subject to a variety of risks.
In August 1998, we acquired all the partnership interest of AckFin Networks,
a California general partnership, in exchange for an aggregate of 5,426,184
shares of all common stock with an estimated value of $0.90 per share, or
$4,883,000, and the assumption of $150,000 in liabilities. The controlling
partners of AckFin, Sreekanth Ravi and Sudhakar Ravi, two of our executive
officers and principal shareholders, were also the majority shareholders of
SonicWALL, Inc. and, therefore, were deemed to be a control group for purposes
of determining the amount of purchase price to be "stepped-up." The value of
the exchanged shares for AckFin was accounted for as a reorganization of
entities under common control. Accordingly, net assets acquired were valued by
applying carryover basis to the control group interest and a stepped-up basis
to the minority interest. The step-up of the minority interest resulted in an
intangible asset of $2,517,000. This intangible asset was attributed to
acquired completed technology and will be amortized over a period of three
years. Amortization expense was $350,000 and $839,000 for the years ended 1998
and 1999, respectively. The intangible assets acquired by us 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 $150,000 and
$775,000 for the years ended December 31, 1997 and 1998, respectively, were
included in the accompanying statements of operations. AckFin did not have any
revenue transactions with unrelated third parties. Except for the expenses
noted above, all other financial transactions for AckFin were eliminated upon
combination with SonicWALL, Inc.
In 1998, we recorded total deferred stock compensation of approximately
$48,000 in connection with stock and stock options granted during 1998 at
prices subsequently deemed to be below fair market value on the date of grant.
Options granted are typically subject to a four-year vesting period. Restricted
stock acquired through the exercise of unvested stock options is subject to our
right to repurchase the unvested stock at the price paid, which right lapses
over a four-year period. We are amortizing the deferred stock compensation over
the vesting periods of the applicable options and the repurchase periods for
the restricted stock. In 1999, we have recorded approximately $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. Additionally, in 1999,
the Company granted options to purchase common stock 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.
26
Results of Operations
The following table sets forth financial data for the years indicated as a
percentage of total revenue:
Year Ended December 31,
---------------------------
1997 1998 1999
------- ------- -------
Revenue
Internet security......... 2.7 % 31.3 % 92.2 %
Ethernet.................. 97.3 68.7 7.8
------- ------- -------
Total revenue........... 100.0 100.0 100.0
Cost of revenue............. 51.8 44.0 28.3
------- ------- -------
Gross margin................ 48.2 56.0 71.7
Operating expenses
Research and development.. 21.3 27.3 17.3
Sales and marketing....... 26.4 38.2 25.4
General and
administrative........... 6.9 10.0 8.4
Deferred stock
compensation............. -- 0.6 13.7
------- ------- -------
Total operating
expenses............... 54.6 76.1 64.8
------- ------- -------
Income (loss) from
operations................. (6.4) (20.1) 6.9
Other income (expense),
net........................ 0.3 0.7 2.6
------- ------- -------
Income (loss) before income
taxes...................... (6.1) (19.4) 9.5
Benefit from (provision for)
income taxes............... 1.1 (0.1) (8.7)
------- ------- -------
Net income (loss)........... (5.0)% (19.5)% 0.8 %
======= ======= =======
1999 compared to 1998
Internet security 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 security appliance products increased to $ 19.4 million in the
year ended December 31, 1999 from $2.3 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.
Ethernet revenue. Revenue from our Ethernet products declined to $1.6
million in the year ended December 31, 1999 from $5.2 million in the year ended
December 31, 1998. This decrease was directly related to our 1997 decision to
focus our development, sales and marketing efforts on our Internet security
appliance products. We stopped shipment of Ethernet products during December
1999.
Cost of revenue; gross margin. Cost of revenue includes all costs associated
with the production of our products, including cost of materials, manufacturing
and assembly costs paid to contract manufacturers and related overhead costs
associated with our manufacturing operations personnel. Additionally, all
warranty costs and any inventory provisions or write-downs are expensed as cost
of revenue. Cost of revenue increased to $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. Our gross margins are affected by fluctuations in manufacturing volumes,
component costs and the mix of products sold. In addition, an increase in total
sales to
27
original equipment manufacturers compared to total sales to our distribution
partners will result in a decrease in gross margins. We must manage each of
these factors effectively for our gross margins to remain at current levels.
Research and development. Research and development expenses primarily
consist of personnel costs related to engineering and technical support,
contract consultants, outside testing services, amortization of acquired
technology from AckFin, and equipment and supplies associated with enhancing
existing products and developing new products. Research and development
expenses increased to $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,
increased travel and attendance at trade shows, increases in customer support
personnel and expanded sales and marketing efforts in international markets. We
intend to increase sales and marketing expenses as we add personnel to support
our domestic and international sales and marketing efforts.
General and administrative. General and administrative expenses primarily
consist of personnel costs for administrative officers and support personnel,
legal, accounting and consulting fees, and facility expenses. Our general and
administrative expenses increased to $1.8 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.
Other income (expense), net. Other income (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 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.
1998 compared to 1997
Internet security revenue. Internet security revenue increased to $2.3
million in 1998 from $0.3 million in 1997 and related primarily to a full year
of shipments of our expanded SonicWALL product offerings in 1998.
28
Ethernet revenue. Ethernet revenue declined to $5.2 million in 1998 from
$9.1 million in 1997. This decline in Ethernet revenue related to our 1997
decision to focus development, sales and marketing efforts on our Internet
security appliance products. Our development, marketing and sales efforts are
now entirely focused on the Internet security appliance market.
Gross margin. In 1998, gross margin was $4.2 million, or 56% of revenue,
compared to $4.5 million, or 48% of revenue, in 1997. The percentage increase
in gross margin from 1997 to 1998 relates primarily to the increase in sales of
higher margin Internet security appliance products.
Research and development. Research and development expenses increased to
$2.1 million in 1998 from $2.0 million in 1997. This increase from 1997 to 1998
relates primarily to amortization of acquired technology offset in part by a
reduction in compensation paid to a founder.
Sales and marketing. Sales and marketing expenses increased to $2.9 million
in 1998 from $2.5 million in 1997. These increases were primarily due to the
hiring of additional sales and marketing personnel, as well as increases in
travel, trade shows, promotional and advertising costs.
General and administrative. General and administrative expenses increased to
$0.8 million in 1998 from $0.6 million in 1997. These increases were due mainly
to the addition of administrative personnel, professional services fees and
facility expenses to support the growth of our operations.
Deferred stock compensation. During 1998, we recorded deferred compensation
of $48,000 in connection with stock option grants of which $42,000 was
amortized in the year ended December 31, 1998. We are amortizing this amount
over the vesting periods of the applicable options.
29
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, 1999. 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,
1998 1998 1998 1998 1999 1999 1999 1999
--------- -------- ------------- ------------ --------- -------- ------------- ------------
(in thousands)
Revenue
Internet security.......... $ 157 $ 248 $ 519 $1,425 $2,251 $3,223 $5,203 $8,726
Ethernet................... 1,546 1,355 1,555 710 813 403 258 170
------ ------ ------ ------ ------ ------ ------ ------
Total revenue.............. 1,703 1,603 2,074 2,135 3,064 3,626 5,461 8,896
------ ------ ------ ------ ------ ------ ------ ------
Cost of revenue............. 833 819 833 823 943 1,055 1,464 2,499
------ ------ ------ ------ ------ ------ ------ ------
Gross margin................ 870 784 1,241 1,312 2,121 2,571 3,997 6,397
Operating expenses
Research and development... 385 437 595 634 658 723 817 1,436
Sales and marketing........ 661 739 682 788 811 1,043 1,554 1,934
General and administrative.. 184 125 232 212 332 362 495 572
Deferred stock compensation.. -- -- -- 42 15 768 518 1,594
------ ------ ------ ------ ------ ------ ------ ------
Total operating expenses... 1,230 1,301 1,509 1,676 1,816 2,896 3,384 5,536
------ ------ ------ ------ ------ ------ ------ ------
Income (loss) from
operations................. (360) (517) (268) (364) 305 (325) 613 861
Other income (expense),
net........................ 9 13 14 18 41 91 73 331
------ ------ ------ ------ ------ ------ ------ ------
Income (loss) before income
taxes...................... (351) (504) (254) (346) 346 (234) 686 1,192
Provision for income taxes.. -- -- -- 6 135 200 452 1,045
------ ------ ------ ------ ------ ------ ------ ------
Net income (loss)........... $ (351) $ (504) $ (254) $ (352) $ 211 $ (434) $ 234 $ 147
====== ====== ====== ====== ====== ====== ====== ======
As a Percentage of Revenue
-----------------------------------------------------------------------------------------------
March 31, June 30, September 30, December 31, March 31, June 30, September 30, December 31,
1998 1998 1998 1998 1999 1999 1999 1999
--------- -------- ------------- ------------ --------- -------- ------------- ------------
Revenue
Internet security.......... 9.2 % 15.5 % 25.0 % 66.7 % 73.5 % 88.9 % 95.3 % 98.1 %
Ethernet................... 90.8 84.5 75.0 33.3 26.5 11.1 4.7 1.9
------ ------ ------ ------ ------ ------ ------ ------
Total revenue.............. 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
------ ------ ------ ------ ------ ------ ------ ------
Cost of revenue............. 48.9 51.1 40.2 38.5 30.8 29.1 26.8 28.1
------ ------ ------ ------ ------ ------ ------ ------
Gross margin................ 51.1 48.9 59.8 61.5 69.2 70.9 73.2 71.9
Operating expenses
Research and development... 22.6 27.3 28.7 29.7 21.5 19.9 15.0 16.2
Sales and marketing........ 38.8 46.1 32.9 36.9 26.4 28.8 28.5 21.7
General and
administrative............ 10.8 7.8 11.2 9.9 10.8 10.0 9.0 6.4
Deferred stock compensation.. -- -- -- 2.0 0.5 21.2 9.5 17.9
------ ------ ------ ------ ------ ------ ------ ------
Total operating expenses... 72.2 81.2 72.8 78.5 59.2 79.9 62.0 62.2
------ ------ ------ ------ ------ ------ ------ ------
Income (loss) from operations.. (21.1) (32.3) (13.0) (17.0) 10.0 (9.0) 11.2 9.7
Other income (expense),
net........................ 0.5 0.8 0.7 0.8 1.3 2.5 1.3 3.7
------ ------ ------ ------ ------ ------ ------ ------
Income (loss) before income
taxes...................... (20.6) (31.5) (12.3) (16.2) 11.3 (6.5) 12.5 13.4
Provision for income taxes.. -- -- -- 0.3 4.4 5.5 8.3 11.7
------ ------ ------ ------ ------ ------ ------ ------
Net income (loss)........... (20.6)% (31.5)% (12.3)% (16.5)% 6.9 % (12.0)% 4.2% 1.7 %
====== ====== ====== ====== ====== ====== ====== ======
30
Internet security revenue. Internet security revenue has increased in each
of the eight quarters ended December 31, 1999, 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.
Ethernet revenue. Ethernet revenue remained relatively flat through the
first three quarters of 1998, and decreased significantly in the fourth quarter
of 1998 and the four quarters of 1999. The overall decline in Ethernet revenue
relates primarily to our decision to focus our development, sales and marketing
resources exclusively on the security appliance product family. We stopped
shipment of Ethernet products during December 1999.
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. Gross margin decreased in the quarter ended
December 31, 1999 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, 1999 to $5.5 million in the quarter ended
December 31, 1999 from $1.2 million in the quarter ended March 31, 1998. These
increases related primarily to development of new products, increased marketing
of new products, and increased investments in our internal infrastructure to
support our growth.
Liquidity and Capital Resources
Since our inception, we have financed our operations through cash flows from
operations, private sales of securities and, to a lesser extent, bank
borrowings. During the year ended December 31, 1999, we generated $5.8 million
in cash from operating activities. This increase resulted from a significant
increase in Internet security revenue, offset in part by a $3.4 million
increase in accounts receivable and $1.0 million increase in prepaids and other
current assets. We expect that accounts receivable will continue to increase if
our revenue continues to rise and that we will continue to increase our
investment in capital assets to expand our operations. During 1998, we
generated $0.4 million in cash from operating activities, compared to a $0.4
million decrease from operating activities in 1997. Investing activities
related to purchases of property and equipment used cash of $0.1 million in
1998 and $0.5 million in the year ended December 31, 1999. In 1997 purchases of
property and equipment were immaterial.
In February 1999, we completed a private placement of approximately $5.0
million of redeemable Series A convertible preferred stock. SonicWALL, Inc.
conducted no significant financing activities in 1997 or 1998. In November
1999, we completed our initial public offering of 4,000,000 primary shares of
common stock at $14.00 per share which generated net proceeds to us of
approximately $50.9 million. In connection with the initial public offering,
all outstanding shares of preferred stock automatically converted into common
stock.
Our principal source of liquidity as of December 31, 1999 consisted of $62.6
million in cash and cash equivalents. As of December 31, 1999 we have a credit
facility with Comerica Bank of California that provides for borrowings up to
the lesser of $1.0 million or 80% of eligible accounts receivable, as defined
in the credit facility. Our line of credit bears interest at the bank's
reference rate plus 1.75%, which equaled 10.25% at December 31, 1999 and
borrowings are secured by accounts receivable, inventories, property and
equipment. The credit facility may be terminated by the lender or us on thirty
days prior notice. As of December 31, 1999, there were no borrowings
outstanding under this credit facility.
We believe that the market risk arising from our holdings of financial
instruments is not material.
31
We believe our existing cash balances and available line of credit will be
sufficient to meet our cash requirements at least through the next twelve
months. However, we may be required, or could elect, to seek additional funding
prior to that time. Our future capital requirements will depend on many
factors, including our rate of revenue growth, the timing and extent of
spending to support product development efforts and expansion of sales and
marketing, the timing of introductions of new products and enhancements to
existing products, and market acceptance of our products. We cannot assure you
that additional equity or debt financing will be available on acceptable terms
or at all. As of the date of this offering, our sources of liquidity beyond
twelve months, in management's opinion, will be our then current cash balances,
funds from operations and whatever long-term credit facilities we can arrange.
We have no other agreements or arrangements with third parties to provide us
with sources of liquidity and capital resources beyond twelve months.
We do not have any other debt, long-term obligations or long-term capital
commitments.
Year 2000 Readiness Disclosure
We believe that we have successfully rendered our products, internal
management and other administrative systems and external information systems
year 2000 compliant. In addition, we have surveyed the vendors of the third-
party technologies we incorporate into our products and services and applied
updates or arrangements to correct potential year 2000 compliance problems.
Since January 1, 2000, we have experienced no disruption in our business
operations as a result of year 2000 compliance problems or otherwise, and we
have received no reports of any year 2000 compliance problems with our products
and services. To date, the total cost of our efforts to address year 2000
compliance has not been material.
Nonetheless, some problems related to year 2000 risks may not appear until
several months after January 1, 2000. Year 2000 issues could include problems
with our own products and services or with third party products or technology
that we use or with which or products exchange data. Any problems that are not
identified and corrected successfully and completely could adversely affect our
business.
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.
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.
32
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Report of Independent Accountants.......................................... 34
Consolidated Balance Sheets................................................ 35
Consolidated Statements of Operations...................................... 36
Consolidated Statements of Shareholders' Equity............................ 37
Consolidated Statements of Cash Flows...................................... 38
Notes to Consolidated Financial Statements................................. 39
33
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
SonicWALL, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of shareholders' equity and of cash
flows present fairly, in all material respects, the financial position of
SonicWALL, Inc. and its subsidiary at December 31, 1999 and 1998, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1999, in conformity with accounting principles
generally accepted in the United States. 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, which require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
PricewaterhouseCoopers LLP
San Jose, California
January 13, 2000
34
SONICWALL, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
December 31,
----------------
1998 1999
------- -------
ASSETS
Current Assets:
Cash and cash equivalents.................................. $ 1,051 $62,589
Accounts receivable, net of allowance for doubtful accounts
of $193 and $548.......................................... 677 3,687
Inventories................................................ 331 558
Deferred income taxes...................................... 366 1,556
Prepaid expenses and other current assets.................. 31 1,015
------- -------
Total current assets..................................... 2,456 69,405
Property and equipment, net.................................. 107 435
Intangibles and other assets................................. 2,188 1,399
------- -------
Total assets........................................... $ 4,751 $71,239
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable........................................... $ 549 $ 2,692
Accrued payroll and related benefits....................... 145 1,205
Other accrued liabilities.................................. 748 1,839
Deferred revenue........................................... 1,512 3,732
Income taxes payable....................................... 309 1,021
------- -------
Total current liabilities................................ 3,263 10,489
------- -------
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;
16,272,164 and 23,675,385 shares issued and outstanding... 2,732 65,109
Deferred stock compensation................................ (6) (3,209)
Notes receivable from shareholders......................... (230) (300)
Accumulated deficit........................................ (1,008) (850)
------- -------
Total shareholders' equity............................... 1,488 60,750
------- -------
Total liabilities and shareholders' equity............. $ 4,751 $71,239
======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
35
SONICWALL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
Year Ended December 31,
-------------------------
1997 1998 1999
------- ------- -------
Revenue
Internet security......... $ 250 $ 2,349 $19,403
Ethernet.................. 9,092 5,166 1,644
------- ------- -------
Total revenue........... 9,342 7,515 21,047
------- ------- -------
Cost of revenue
Internet security......... 225 1,035 5,254
Ethernet.................. 4,617 2,273 707
------- ------- -------
Total cost of revenue... 4,842 3,308 5,961
------- ------- -------
Gross margin................ 4,500 4,207 15,086
Operating expenses
Research and development.. 1,983 2,051 3,634
Sales and marketing....... 2,468 2,870 5,342
General and
administrative........... 644 753 1,761
Deferred stock
compensation............. -- 42 2,895
------- ------- -------
Total operating
expenses............... 5,095 5,716 13,632
------- ------- -------
Income (loss) from
operations................. (595) (1,509) 1,454
Other income (expense),
net........................ 29 54 536
------- ------- -------
Income (loss) before income
taxes...................... (566) (1,455) 1,990
Benefit from (provision for)
income taxes............... 99 (6) (1,832)
------- ------- -------
Net income (loss)........... $ (467) $(1,461) $ 158
======= ======= =======
Net income (loss) per share
Basic..................... $ (0.06) $ (0.13) $ 0.01
======= ======= =======
Diluted................... $ (0.06) $ (0.13) $ 0.01
======= ======= =======
Shares used in computing net
income (loss) per share
Basic..................... 8,461 11,251 17,334
======= ======= =======
Diluted................... 8,461 11,251 21,196
======= ======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
36
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,
1996................... 8,461,100 $ 12 $ -- $ -- $ 920 $ 932
Net loss................ -- -- -- -- (467) (467)
---------- ------- ------- ----- ------- -------
Balance at December 31,
1997................... 8,461,100 12 -- -- 453 465
Issuance of common stock
upon exercise of stock
options................ 2,384,880 230 -- (230) -- --
Issuance of common stock
for acquisition........ 5,426,184 2,442 -- -- -- 2,442
Deferred stock
compensation........... -- 48 (48) -- -- --
Amortization of deferred
stock compensation -- -- 42 -- -- 42
Net loss................ -- -- -- -- (1,461) (1,461)
---------- ------- ------- ----- ------- -------
Balance at December 31,
1998................... 16,272,164 2,732 (6) (230) (1,008) 1,488
Issuance of common stock
upon exercise of stock
options................ 526,467 467 -- (300) -- 167
Issuance of common stock
in connection with the
Company's initial
public offering, net of
issuance costs......... 4,000,000 50,841 -- -- -- 50,841
Conversion of preferred
stock into common
stock.................. 2,876,754 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................... 23,675,385 $65,109 $(3,209) $(300) $ (850) $60,750
========== ======= ======= ===== ======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
37
SONICWALL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Year Ended December
31,
------------------------
1997 1998 1999
------ ------- -------
Cash flows from operating activities:
Net income (loss).................................. $ (467) $(1,461) $ 158
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization.................... 63 413 905
Loss on disposal of fixed assets................. -- -- 53
Liabilities acquired............................. -- (75) --
Provision for allowance for doubtful accounts.... 52 122 366
Amortization of deferred stock compensation...... -- 42 2,895
Changes in operating assets and liabilities:
Accounts receivable............................ (252) (235) (3,375)
Inventories.................................... 1,031 20 (228)
Prepaid expenses and other current assets...... (235) 270 (984)
Deferred income taxes.......................... 38 (89) (1,190)
Other assets................................... (19) 18 (50)
Accounts payable............................... (150) (114) 2,143
Accrued payroll and related benefits........... 107 (12) 1,060
Other accrued liabilities...................... (43) 438 1,091
Deferred revenue............................... (362) 828 2,220
Income taxes payable........................... (158) 214 712
------ ------- -------
Net cash provided by (used in) operating
activities.................................. (395) 379 5,776
------ ------- -------
Cash flows from investing activities:
Purchase of property and equipment................. (11) (115) (447)
------ ------- -------
Cash flows from financing activities:
Proceeds from exercise of stock options............ -- -- 167
Proceeds from issuance of redeemable Series A
convertible preferred stock -- -- 4,971
Proceeds from issuance of common stock with initial
public offering, net of issuance costs............ -- -- 50,841
Payments of notes receivable from shareholders..... 157 -- 230
------ ------- -------
Net cash provided by financing activities.... 157 -- 56,209
------ ------- -------
Net increase (decrease) in cash and cash
equivalents......................................... (249) 264 61,538
Cash and cash equivalents at beginning of year....... 1,036 787 1,051
------ ------- -------
Cash and cash equivalents at end of year............. $ 787 $ 1,051 $62,589
====== ======= =======
Supplemental disclosure of cash flow information:
Cash paid for income taxes......................... $ 151 $ 1 $ 2,310
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
Acquisition of minority interest in AckFin
Networks.......................................... $ -- $ 2,517 $ --
The accompanying notes are an integral part of these consolidated financial
statements.
38
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1--The Company and Summary of Significant Accounting Policies:
SonicWALL, Inc. (the "Company") was incorporated in California in February
1991. SonicWALL, Inc. is a leading provider of Internet security solutions
designed for broadband access customers in the small to medium enterprise, or
SME, branch office, telecommuter and education markets. The Company's SonicWALL
solution is a high-performance, solid state appliance that provides robust,
reliable, easy-to-use and affordable Internet security. The Company's products
enable its customers to securely utilize Internet applications and services as
an integral part of their business.
The following is a summary of the Company's significant accounting policies:
Consolidation
The consolidated financial statements include those of the Company and its
wholly-owned subsidiary Sonic Systems International, Inc., a Delaware
corporation. Sonic Systems International, Inc. is intended to be a sales office
but to date has not had any significant transactions. All significant
intercompany accounts and transactions are eliminated in consolidation.
In August 1998, the Company acquired all the partnership interest of AckFin
Networks ("AckFin"), a California general partnership, in exchange for an
aggregate of 5,426,184 shares of the Company's common stock (estimated value of
$0.90 per share, or $4,883,000) and the assumption of $150,000 in liabilities.
The controlling partners of AckFin, Sreekanth Ravi and Sudhakar Ravi, two of
the Company's executive officers and majority shareholders, were deemed to be a
control group for purposes of determining the amount of purchase price to be
"stepped-up." The value of the exchanged shares for AckFin was accounted for as
a reorganization of entities under common control. Accordingly, net assets
acquired were valued by applying carryover basis to the control group interest
and a stepped-up basis to the minority interest. The step-up of the minority
interest resulted in an intangible asset of $2,517,000. This intangible asset
was attributed to acquired completed technology and will be amortized over a
period of three years. Amortization expense was $350,000 and $839,000 for the
years ended 1998 and 1999, 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, since the inception
of AckFin, the financial results of AckFin have been combined with the results
of the Company for the period since the inception of AckFin (April 1997)
through the date of exchange (August 1998). Expenses totaling $150,000 and
$775,000 for the years ended December 31, 1997 and 1998, respectively, were
included in the accompanying statements of operations. AckFin did not have any
revenue transactions with unrelated third parties. Except for the expenses
noted above, all other financial transactions for AckFin were eliminated upon
combination with the Company.
Use of estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the
reporting period. Actual results could differ from those estimates.
Cash and cash equivalents
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents.
39
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Fair value
The carrying value of the Company's financial instruments, including cash
and cash equivalents, accounts receivable, accounts payable and accrued
liabilities approximate their fair values due to their relatively short
maturities. The Company does not hold or issue financial instruments for
trading purposes.
Concentration of credit risk, foreign operations and significant customers
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of cash and cash equivalents
and accounts receivable. The Company places its temporary cash investments in
corporate 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, 1997, 1998 and 1999 all of
which were denominated in U.S. dollars, accounted for 36%, 32% and 34% of total
revenue, respectively. The Company performs ongoing credit evaluations of its
customers' financial condition and requires no collateral from its customers.
The Company maintains an allowance for doubtful accounts receivable based upon
the expected collectibility of accounts receivable.
During the year ended December 31, 1998, one customer accounted for 34% of
the Company's revenue and at December 31, 1998, this one customer accounted for
39% of total gross receivables. During the year ended December 31, 1999, two
customers accounted for 46% of the Company's revenue and at December 31, 1999,
and three customers accounted for 74% of total gross receivables.
The Company is dependent on a third party contract manufacturers and some of
the key components in the Company's product come from single or limited sources
of supply.
Inventories
Inventories are stated at the lower of cost or market with cost being
determined on a first-in, first-out basis.
Property and equipment
Property and equipment are stated at cost. Depreciation is computed using
the straight-line method over their estimated useful lives, which range from
three to five years. Depreciation expense for the years ended December 31,
1997, 1998 and 1999 was $63,000, $55,000 and $66,000, respectively.
Intangibles and other assets
Acquired technology is amortized to expense on a straight-line basis over
three years.
Long-lived assets
The Company periodically evaluates the recoverability of its long-lived
assets based on expected undiscounted cash flows and recognizes impairment from
the carrying value of long-lived assets, if any, based on the fair value of
such assets. To date, the Company has not recorded any impairment charges
against the value of its long-lived assets.
40
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Stock-based compensation
The Company accounts for stock-based employee compensation arrangements in
accordance with the provisions of Accounting Principles Board Opinion ("APB")
No. 25, "Accounting for Stock Issued to Employees," and complies with the
disclosure provisions of Statement of Financial Accounting Standards ("SFAS")
No. 123, "Accounting for Stock-Based Compensation." Under APB No. 25,
compensation costs is determined based on the difference, if any, on the grant
date between the fair value of the Company's stock and the amount an employee
must pay to acquire the stock. Compensation expense is recognized over the
vesting period.
The Company accounts for equity instruments issued to non-employees in
accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force
96-18.
Revenue recognition
Revenue is generally recognized at the time of shipment if collectibility is
probable and no significant obligations remain. Sales to distributors are
subject to agreements allowing certain rights of return, cooperative
advertising, stock balancing rights and price protection. The largest
distributor has the right to return products that have not been sold to end
users for full credit subject to a restocking fee. Revenue from sales to this
distributor is deferred at the time of shipment and is recognized when the
distributor has sold the product to its customers. Certain other distributors
have limited rights of return which allow them to return a percentage of the
prior quarter's purchases by these distributors. Accordingly, reserves for
estimated returns and exchanges are provided at the time of shipment. These
reserves are estimated and adjusted periodically based upon historical rates of
returns and allowances, inventory levels at the distributors and other related
factors. Reserves for credits for price protection are provided at the time
list prices are reduced by the Company. In the years ended December 31, 1997,
1998 and 1999 the Company provided approximately $300,000, $400,000 and
$1,046,000, respectively, of revenue reserves related to risks of product
returns, stock rotation rights and price protection rights. As of December 31,
1998 and 1999, deferred revenues included approximately $0.8 million and $1.7
million, respectively, related to these reserves.
Revenue from extended warranty programs, premium technical assistance, and
subscriptions to content filtering services is recognized ratably over the term
of the contract or subscription.
The standard warranty provisions include technical assistance, insignificant
bug fixes and feature updates and repair or replacement guarantees for units
with product defects. The standard warranty period is one year. The estimated
costs associated with the standard warranty provisions are accrued at the time
of revenue recognition. In the years ended December 31, 1997, 1998 and 1999 ,
the Company provided approximately $25,000, $100,000 and $425,000 of warranty
reserves, respectively. As of December 31 1998 and 1999, the accompanying
balance sheets include a warranty accrual of approximately $130,000 and
$555,000, respectively.
The Company has co-operative advertising agreements with certain of its
distributors. These agreements allow the distributors to be reimbursed by the
Company for approved promotional activities. The amounts available for
reimbursement are related to a percentage of the distributor's eligible
purchases from the Company. The Company accrues for co-operative advertising as
the related revenue is recognized. In the years ended December 31, 1997, 1998
and 1999, the Company recorded provisions for co-op advertising costs of
$664,000, $502,000 and $554,000, respectively. As of December 31, 1998 and
1999, the accompanying balance sheets include an accrual for co-op advertising
costs of $125,000 and $410,000, respectively.
41
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Income taxes
The Company accounts for income taxes under the liability method, which
requires, among other things, that deferred income taxes be provided for
temporary differences between the tax bases of the Company's assets and
liabilities and their financial statement reported amounts. In addition,
deferred tax assets are recorded for the future benefit of utilizing net
operating losses, research and development credit carryforwards and temporary
differences. A valuation allowance is provided against deferred tax assets
unless it is more likely than not that they will be realized.
Research and development and capitalized software development costs
Software development costs incurred prior to the establishment of
technological feasibility are charged to research and development expense as
incurred. Technological feasibility is established upon completion of a working
model, which is typically demonstrated by initial beta shipment. Software
development costs incurred subsequent to the time a product's technological
feasibility has been established, through the time the product is available for
general release to customers, are capitalized if material. To date, software
development costs incurred subsequent to the establishment of technological
feasibility have been immaterial and accordingly have not been capitalized.
Advertising Costs
The Company expenses advertising costs as incurred. Advertising expense
totaled $774,000, $515,000 and $1,036,000 for the years ended December 31,
1997, 1998 and 1999, respectively.
Comprehensive income
Effective January 1, 1998, the Company adopted the provisions of SFAS No.
130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards for
reporting comprehensive income and its components in financial statements.
Comprehensive income, as defined, includes all changes in equity during a
period from non-owner sources. To date, the Company has not had any
transactions that are required to be reported in comprehensive income.
Computation of net income (loss) per share
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 December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in Financial
Statements." SAB 101 provides guidance for revenue recognition under certain
circumstances. The Company does not believe it will have a material impact on
the financial statements. The accounting and disclosures prescribed by SAB 101
will be effective for the Company's quarter ended March 31, 2000.
42
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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,
-------------------------
1997 1998 1999
------ -------- -------
Numerator:
Net income (loss).................................. $ (467) $ (1,461) $ 158
------ -------- -------
Denominator:
Weighted average common shares outstanding......... 8,461 11,251 17,503
Weighted average unvested common shares subject to
repurchase........................................ -- -- 169
------ -------- -------
Denominator for basic calculation.................. 8,461 11,251 17,334
Common stock equivalents........................... -- -- 3,862
------ -------- -------
Denominator for diluted calculation................ 8,461 11,251 21,196
Basic net income (loss) per share.................... $(0.06) $ (0.13) $ 0.01
====== ======== =======
Diluted net income (loss) per share.................. $(0.06) $ (0.13) $ 0.01
====== ======== =======
Outstanding options to purchase 2,494,880 and 1,163,676 shares of common
stock at an average exercise price of $0.10 and $0.13 per share have not been
considered in the computation of diluted net loss per share for the years ended
December 31, 1997 and 1998, respectively, as their effect would have been anti-
dilutive.
In May 1999, the Company issued 300,000 shares upon the exercise of certain
stock options. At December 31, 1999, 256,250 common shares are subject to
repurchase at the option of the Company for $1.00 per share. These shares vest
ratably over a 48 month period.
43
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Note 2--Balance Sheet Components:
December 31,
----------------
1998 1999
------- -------
(in thousands)
Inventories:
Raw materials............................................... $ 49 $ 25
Work-in-process............................................. 13 --
Finished goods.............................................. 269 533
------- -------
$ 331 $ 558
======= =======
Property and equipment:
Equipment................................................... $ 161 $ 442
Leasehold improvements...................................... 5 103
Software.................................................... 53 60
Transportation.............................................. 94 24
------- -------
313 629
Less: accumulated depreciation.............................. (206) (194)
------- -------
$ 107 $ 435
======= =======
Intangibles and other assets:
Acquired technology......................................... $ 2,517 $ 2,517
Other assets................................................ 21 71
------- -------
2,538 2,588
Less: amortization.......................................... (350) (1,189)
------- -------
$ 2,188 $ 1,399
======= =======
Note 3--Line of Credit:
At December 31, 1999, the Company had a line-of-credit agreement with a bank
which allows the Company to borrow up to $1,000,000. Borrowings under the line
of credit bear interest at the bank's reference rate plus 1.75% (which equaled
10.25% at December 31, 1999), and are secured primarily by accounts receivable,
inventories, and property and equipment. The line of credit can be utilized at
a percentage of eligible receivables, as defined in the loan agreement. The
agreement contains certain covenants requiring the Company to maintain certain
levels of profitability, minimum tangible net worth, working capital and other
financial ratios and prohibits the payment of cash or stock dividends on common
stock over the life of the agreement. This line of credit will be in force
until terminated by either party by notice of not less than 30 days prior to
the effective date of such termination. No amounts were outstanding under the
line of credit at December 31, 1999.
Note 4--Redeemable Series A Convertible Preferred Stock:
In February 1999, the Company issued 1,438,377 shares of redeemable Series A
convertible preferred stock ("Preferred Stock") at $3.48 per share for net
proceeds of $4,971,000. Each share of Preferred Stock converts into two shares
of Common Stock. In November 1999, the Company completed its initial public
offering of 4,000,000 shares of Common Stock at $14.00 per share. In connection
with the initial public offering, all outstanding shares of Preferred Stock
automatically converted into Common Stock.
44
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Note 5--Shareholders' Equity:
Stock split
Share information for all periods presented has been retroactively adjusted
to reflect a 2 for 1 stock split effected on August 25, 1999.
1999 Employee Stock Purchase Plan
The 1999 Employee Stock Purchase Plan was adopted by the board of directors
in August 1999. A total of 250,000 shares of common stock have been reserved
for issuance under the plan.
The Company's Stock Option Plans (the "Plans"), as amended, authorize the
Board of Directors to grant incentive stock options and nonstatutory stock
options to employees, directors and consultants to purchase up to a total of
7,358,324 shares of the Company's common stock. Under the Plans, incentive
stock options are granted at an exercise price that is not to be less than 100%
of the fair market value of the Company's common stock on the date of grant, as
determined by the Company's Board of Directors. Nonqualified stock options are
granted at a price that is not to be less than 85% of the fair market value of
the common stock on the date of grant, as determined by the Board of Directors.
Generally, options granted under the Plans are exercisable for a period of
ten years after the date of grant, and vest over four years.
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, 1996.. 549,612 2,396,880 $ 0.08-0.09 $0.09
Granted....................... (204,000) 204,000 $ 0.25 $0.25
Exercised..................... -- -- $ -- $ --
Canceled...................... 106,000 (106,000) $ 0.08 $0.08
---------- ---------- ----------- -----
Balance at December 31, 1997.. 451,612 2,494,880 $ 0.08-0.25 $0.10
Authorized.................... 2,000,000 -- $ -- $ --
Granted....................... (1,015,000) 1,015,000 $ 0.13 $0.13
Exercised..................... -- (2,134,880) $ 0.09 $0.09
Canceled...................... 211,324 (211,324) $ 0.08-0.25 $0.19
---------- ---------- ----------- -----
Balance at December 31, 1998.. 1,647,936 1,163,676 $ 0.08-0.25 $0.13
Authorized.................... 2,358,324 -- $ -- $ --
Granted....................... (3,259,500) 3,259,500 $0.50-29.87 $5.58
Exercised..................... -- (526,467) $ 0.08-1.50 $0.89
Canceled...................... 102,501 (102,501) $ 0.13-9.00 $7.25
---------- ---------- ----------- -----
Balance at December 31, 1999
............................. 849,261 3,794,208 $0.08-29.87 $4.51
========== ==========
45
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table summarizes information regarding stock options
outstanding at December 31, 1999:
Options
Options Outstanding Exercisable
------------------------------- ----------------
Weighted
Weighted Average Weighted
Average Remaining Average
Exercise Contractual Exercise
Exercise Prices Price Shares Life (Years) Shares Price
--------------- -------- --------- ------------ ------- --------
$0.08-$0.08................. $ 0.08 82,000 5.6 79,472 $0.08
$0.13-$0.13................. $ 0.13 912,271 8.6 345,891 $0.13
$0.25-$0.25................. $ 0.25 60,844 7.1 54,140 $0.25
$0.50-$0.75................. $ 0.73 246,128 9.3 43,418 $0.73
$1.00-$1.50................. $ 1.30 393,966 9.5 51,098 $1.25
$2.50-$3.50................. $ 3.12 419,000 9.6 -- --
$7.50-$11.00................ $ 3.12 1,663,999 9.7 29,658 $8.30
$29.87-$29.87............... $29.87 16,000 9.9 -- --
--------- ------- -----
$ 4.51 3,794,208 9.2 603,677 $0.68
========= =======
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 was
$19,127,000 which exceeded the aggregate exercise price of these options by
$4,214,000. This difference is considered deferred stock compensation and is
amortized over the vesting periods of the applicable options and the
repurchase periods for the restricted stock.
Based upon the above assumptions, the weighted average fair value per share
of options granted in 1998 and 1999 were $0.05 and $6.01, respectively.
During the year ended December 31, 1999, the Company granted approximately
52,500 options to purchase common stock to certain consultants in exchange for
services rendered. The options vest over four years. These options are subject
to variable plan accounting with fair value re-measurements at the end of each
quarterly reporting period. During the year ended December 31, 1999, the
Company recorded deferred stock-based compensation expense related to these
grants of $1,884,000. Of this amount $1,066,000 was recognized as stock-based
compensation expense in the year ended December 31, 1999.
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,
---------------------
1997 1998 1999
----- ------- -----
Net income (loss)--as reported....................... $(467) $(1,461) $ 158
Net income (loss)--pro forma......................... $(471) $(1,469) $(109)
The pro forma amounts reflect compensation expense related to 1997, 1998
and 1999 stock option grants only. In future years, the annual compensation
expense will increase relative to the fair value of the stock options granted
in those future years. The weighted average fair value of the options granted
in 1997, 1998 and 1999 of $0.13, $0.05 and $2.27, respectively.
46
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The fair value of each grant is estimated on the date of grant using the
minimum value method with the following assumptions:
1997 1998 1999
------- ------------ -------------
Expected volatility.................... 0% 0% 80%
Risk-free interest rate................ 6.0% 4.5% to 5.64% 4.79% to 5.83%
Expected life.......................... 5 years 5 years 4 years
Dividend yield......................... 0% 0% 0%
Note 6--Notes Receivable from Shareholders:
In December 1998, the Company issued notes receivable in connection with the
exercise of 2,134,880 shares of incentive stock options held by two
shareholders. The full recourse notes totaling $192,000, accrue interest at a
rate of 8% per annum. Principal and accrued interest shall be paid one-fourth
on the first anniversary date of the note, and one-fourth every year thereafter
for a total of four years. The notes principal and interest were paid in full
during 1999.
In May 1999, the Company issued a full recourse note for $300,000 in
connection with the exercise of 300,000 shares of incentive stock options by
one shareholder. The note accrues interest at a rate of 8% per annum. Principal
and accrued interest shall be paid one-fourth on the first anniversary date of
the note, and one-fourth every year thereafter for a total of four years.
Note 7--Income Taxes:
The (benefit from) provision for income taxes consist of the following (in
thousands):
Year Ended
December 31,
--------------------
1997 1998 1999
----- ---- -------
Current tax expense (benefit):
Federal.............................................. $(138) $ 94 $ 3,178
State................................................ 1 1 708
----- ---- -------
(137) 95 3,886
----- ---- -------
Deferred tax expense (benefit):
Federal.............................................. 32 (89) (1,598)
State................................................ 6 -- (456)
----- ---- -------
38 (89) (2,054)
----- ---- -------
$ (99) $ 6 $ 1,832
===== ==== =======
The following is a reconciliation of pre-tax income (loss) per the financial
statements to taxable income (loss) (in thousands):
Year Ended December
31,
-----------------------
1997 1998 1999
------ ------- ------
Pre-tax income (loss) per books..................... $ (566) $(1,455) $1,990
Differences between book and tax:
Distributor revenue deferral (net)................ 166 13 1,432
Changes in non-deductible reserves and accruals... (181) 672 2,270
Non-deductible deferred stock compensation........ -- 42 2,895
Other............................................. 59 (6) 53
------ ------- ------
Taxable income (loss)............................... $ (522) $ (734) $8,640
====== ======= ======
47
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Deferred tax assets comprise the following (in thousands):
December 31,
--------------
1998 1999
------ ------
Inventory reserves........................................... $ 93 $ --
Deferred revenue............................................. 560 830
Other reserves & accruals.................................... 372 1,590
------ ------
1,025 2,420
Valuation allowance.......................................... (659) --
------ ------
$ 366 $2,420
====== ======
In assessing the realizability of deferred tax assets, management has
allocated, to the extent the Company does not have carryback rights, a
valuation allowance at December 31, 1998. The ultimate realization of deferred
tax assets at December 31, 1999 is dependent upon the generation of future
taxable income during the periods in which temporary differences representing
net future deductible amounts become deductible.
Note 8--Segment Reporting
The Company adopted SFAS No. 131, "Disclosures About Segments of an
Enterprise and Related Information." SFAS No.131 requires publicly held
companies to report financial and other information about key revenue segments
of the entity for which such information is available and is utilized by the
chief operating decision maker. The Company conducts its business within one
business segment.
Revenue by geographic region is presented as follows (in thousands):
Year Ended December
31,
---------------------
1997 1998 1999
------ ------ -------
United States.......................................... $5,986 $5,080 $13,859
Other.................................................. 3,356 2,435 7,188
------ ------ -------
Total.................................................. $9,342 $7,515 $21,047
====== ====== =======
Revenue to any one foreign country did not exceed 10% of total revenue in
1997 and 1998. Revenue attributed to Japan accounted for 11% of total revenue
for the year ended December 31, 1999.
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 $118,000, $163,000 and $383,000,
for the years ended December 31, 1997, 1998 and 1999, respectively.
Future minimum lease commitments at December 31, 1999 were as follows (in
thousands):
Year ending December 31,
------------------------
2000................................................................ $ 527
2001................................................................ 547
2002................................................................ 566
2003................................................................ 585
2004................................................................ 450
------
$2,675
======
48
SONICWALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
49
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, 1999.
Name Age Position
---- --- --------
Sreekanth Ravi(1).......... 33 Chairman of the Board, President and Chief
Executive Officer
Sudhakar Ravi(1)........... 34 Chief Technical Officer, Director
Vice President, Finance, Chief Financial
Michael J. Sheridan(1)..... 35 Officer and Secretary
Steven R. Perricone........ 39 Vice President, Sales
Richard Pearce............. 39 Vice President, Business Development
Warren Smith............... 49 Vice President, Engineering
Fara Zarrabi............... 58 Vice President, Operations
Jerrold F. Petruzzelli(2).. 46 Director
David A. Shrigley(3)....... 51 Director
Robert M. Williams(2)(3)... 44 Director
- --------
(1) Executive officer
(2) Member of audit committee
(3) Member of compensation committee
We have no employment agreements with our executive officers or key
employees. All are subject to termination at will. The board of directors is
elected annually by shareholders, and members of the board serve until the next
annual meeting of shareholders unless they resign before such meeting. The last
annual shareholders meeting was held in September 1999.
Sreekanth Ravi has served as our Chairman of the Board, President and Chief
Executive Officer since co-founding SonicWALL, Inc. in February 1991. Prior to
SonicWALL, Inc., Mr. Ravi was the founder and Chief Executive Officer of
Generation Systems, a manufacturer of high performance video products, which he
later sold to a publicly held computer products company in 1990. Mr. Ravi
received a bachelor of science degree in electrical engineering from the
University of Illinois, Champaign-Urbana. Sreekanth Ravi and Sudhakar Ravi are
brothers.
Sudhakar Ravi has served as our 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 has served as our Chief Financial Officer since joining
SonicWALL, Inc. in May 1999, and became Secretary in September 1999. Mr.
Sheridan joined SonicWALL, Inc. from Genesys Telecommunications Laboratories,
Inc., an enterprise software company in the call center automation industry,
where he served as Vice President of Finance from January 1998 to May 1999, and
served as Corporate Controller from November 1996 to December 1997. From August
1995 to November 1996, Mr. Sheridan was the Corporate Controller for Network
Appliance, Inc., a network file server manufacturer. From 1986 to 1995, Mr.
Sheridan was an audit professional with Arthur Andersen LLP, where he was
involved primarily with technology clients. Mr. Sheridan received a bachelor
degree in commerce from Santa Clara University and is a Certified Public
Accountant.
Steven R. Perricone has served as our Vice President, Sales since joining
SonicWALL, Inc. in April 1998. Mr. Perricone joined SonicWALL, Inc. from
Structured Internetworks, an IP bandwidth management company, where he served
as Vice President of Worldwide Sales and Support from July 1997 to April 1998.
From July
50
1994 to June 1997, Mr. Perricone was Vice President of Worldwide Sales at
Network TeleSystems, a provider of TCP/IP client and server technology for
Internet access. Prior to Network TeleSystems, Mr. Perricone held various sales
management positions at Emulex and Xylogics (now part of Nortel Networks
Corp.). Mr. Perricone received a bachelor degree in business from California
State University.
Richard Pearce, Ph.D. has served as our Vice President, Business Development
since joining SonicWALL, Inc. in June 1999. Dr. Pearce joined SonicWALL, Inc.
from WinNet MCS, Inc., a high-bandwidth wireless communications company where
he served as Vice President of Marketing from November 1998 to June 1999. Prior
to joining WinNet, Dr. Pearce was Director of Business Development for Bay
Networks (a Nortel Networks Corp. company) from August 1996 to November 1998,
responsible for defining and managing programs to add IP technology to Nortel's
product lines. He was also responsible for identifying and developing market
opportunities enabled by the innovative mixing of Nortel products and
technologies. Prior to Bay Networks' acquisition by Nortel, Dr. Pearce was
responsible for developing emerging market opportunities for Bay Networks. From
July 1994 to August 1996, Dr. Pearce was Senior Manager, Technology Alliances
for Bay Networks. Dr. Pearce received a bachelor of science degree in applied
physics & electronics and a Ph.D. in data networking from Durham University in
the United Kingdom.
Warren Smith has served as our Vice President, Engineering since joining
SonicWALL, Inc. in September 1999. Mr. Smith joined SonicWALL, Inc. from
Concentric Network Corporation where he was Chief Information Officer and Vice
President of Software Engineering from April 1996 to September 1999. Prior to
Concentric Networks, Mr. Smith was the Director of Engineering for NetManage,
Inc. which he joined in October 1992 and produced the Chameleon product line of
PC networks applications. Prior to Netmanage, Mr. Smith held engineering
positions at Sun Microsystems Inc., SEI Information Technology and Sacramento
Municipal Utility District. Mr. Smith received a bachelor degree in computer
science from California State University, Sacramento.
Fara Zarrabi has served as our Vice President, Operations since joining
SonicWALL, Inc. in July 1999. Mr. Zarrabi joined SonicWALL, Inc. from Genesys
Telecommunications Laboratories, Inc., where he was Director of Operations from
February 1997 to June 1999. Prior to Genesys Telecommunications, Mr. Zarrabi
was the Director of Operations at Network Appliance, Inc., from February 1996
to February 1997. From May 1994 to February 1996, Mr. Zarrabi was Director of
Manufacturing Operations at Radius, Inc., a manufacturer of computer graphics
and video hardware. Mr. Zarrabi received a bachelor degree in electronic
engineering from the University of California, Berkeley.
Jerrold F. Petruzzelli has served as a director since October 1993. From
October 1993 through September 1999, Mr. Petruzzelli also was our Secretary.
Mr. Petruzzelli has been a partner of Manatt, Phelps & Phillips, LLP, legal
counsel to SonicWALL, Inc., since June 1999 and previously was a partner of
Holtzmann Wise & Shepard, legal counsel to the Company, from January 1990 to
July 1995, and a partner of Wise & Shepard LLP, legal counsel to the Company,
from July 1995 to June 1999, at which time Wise & Shepard LLP merged with
Manatt, Phelps & Phillips, LLP. Mr. Petruzzelli received a bachelor of arts
degree from Yale University and a J.D. degree from the University of Chicago.
David 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.
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
51
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.
Committees of the Board of Directors
The compensation committee of our board of directors consists of Messrs.
Shrigley and Williams. The compensation committee:
. reviews and approves the compensation and benefits for our executive
officers and grants stock options under our stock option plan; and
. makes recommendations to the board of directors regarding these matters.
The audit committee consists of Messrs. Petruzzelli and Williams. The audit
committee:
. makes recommendations to the board of directors regarding the selection
of independent auditors;
. reviews the results and scope of the audit and other services provided by
our independent auditors; and
. reviews and evaluates our audit and control functions.
We established these committees in August 1999.
Director Compensation
We do not pay cash compensation to our directors for their services as
directors or members of committees of the board of directors, but we do
reimburse them for reasonable expenses they incur in attending meetings of the
board of directors. Directors of SonicWALL, Inc. are eligible to participate in
our stock option plans.
Director and Officer Indemnification and Liability
Our articles of incorporation limit the liability of directors to the full
extent permitted by California law. California law provides that a
corporation's articles of incorporation may eliminate or limit the personal
liability of directors for monetary damages for breach of their fiduciary
duties as directors, except liability for:
. acts or omissions that involve intentional misconduct or a knowing and
culpable violation of law;
. acts or omissions that a director believes to be contrary to the best
interest of 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
52
law. We have entered into indemnification agreements with our directors and
officers containing provisions that are in some respects broader than the
specific indemnification provisions contained in the California Corporations
Code. The indemnification agreements may require us:
. to indemnify our directors and officers against liabilities that may
arise by reason of their status or service as directors or officers,
other than liabilities arising from willful misconduct of a culpable
nature;
. to advance their expenses incurred as a result of any proceeding against
them as to which they could be indemnified; and
. to obtain directors' and officers' insurance if available on reasonable
terms.
At present, there is no pending litigation or proceeding involving any
director, officer, employee or agent of ours in which indemnification would be
required or permitted. We are not aware of any threatened litigation or
proceeding that might result in a claim for indemnification. We believe that
our charter provisions and indemnification agreements are necessary to attract
and retain qualified persons as directors and officers.
The Securities and Exchange Commission has advised us that, in its opinion,
any indemnification of our directors and officers for liabilities arising under
the Act is against public policy as expressed in the Act and is therefore
unenforceable.
Compensation Committee Interlocks and Insider Participation
Our board of directors' compensation committee currently consists of Messrs.
Shrigley and Williams. None of these individuals has at any time been an
employee or officer of SonicWALL, Inc. Until the compensation committee was
formed in August 1999, the full board of directors made all decisions regarding
executive compensation. No member of our board of directors or of its
compensation committee serves as a member of the board of directors or
compensation committee of any entity that has one or more executive officers
serving as members of its board of directors or its compensation committee.
53
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, 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 $100,000 in fiscal 1999.
Summary Compensation Table
Long-Term
Annual Compensation
Compensation Awards
----------------- ------------
Securities
Name and Principal Salary Bonus Other Annual Underlying All Other
Position Year ($) ($) Compensation ($) Options (#) Compensation ($)
------------------ ---- -------- -------- ---------------- ------------ ----------------
Sreekanth Ravi......... 1999 $240,000 $224,983 -- 400,000 --
President and Chief 1998 $240,000 $732,345 -- -- $13,846(1)
Executive Officer
Sudhakar Ravi.......... 1999 $240,000 $232,214 -- 400,000 --
Chief Technical
Officer 1998 $240,000 $816,871 -- -- $13,846(1)
Steven R. Perricone.... 1999 $120,000 $246,089 -- -- --
Vice President, Sales 1998 $ 78,231 $ 23,389 -- 600,000 $ 1,538(1)
Michael J. Sheridan
(2)................... 1999 $150,000 $100,000 -- 300,000 --
Vice President, 1998 -- -- -- -- --
Finance,
Chief Financial
Officer
and Secretary
- --------
(1) Cash payment in lieu of vacation days
(2) Hired in May 1999
Options Grants in Last Fiscal Year
The following table provides information regarding stock options we granted
in fiscal 1999 to named executive officers and key employees whose compensation
exceeded $100,000 in fiscal 1999. The table includes the potential realizable
value over the ten-year term of the options, based on assumed rates of stock
appreciation of 5% and 10%, compounded annually. The assumed rates of
appreciation are prescribed by the Securities and Exchange Commission for
illustrative purposes only and are not intended to forecast or predict future
stock prices. Any actual gains on option exercises will depend on the future
performance of our stock. The year end value of realized and the value of
unexercised in-the-money options is calculated at December 31, 1999.
Option Grants in Last Fiscal Year
Potential Realizable
Value at Assumed Annual
Rates of Stock Price
Appreciation for Option
Individual Grants Term
------------------------- -----------------------
Number of Percent of
Securities Total Options
Underlying Granted to Exercise
Options Employees in Price Expiration
Name Granted (#) Fiscal Year ($/Sh) Date 5%($) 10%($)
---- ----------- ------------- -------- ---------- ----------- -----------
Sreekanth Ravi.......... 400,000 12.3% $8.25 8/24/04 $22,762,314 $38,199,879
Sudhakar Ravi........... 400,000 12.3% $8.25 8/24/04 $22,762,314 $38,199,879
Steven R. Perricone..... -- -- -- -- -- --
Michael J.
Sheridan(1)............ 300,000 9.2% $1.00 5/26/09 $19,246,735 $30,824,909
- --------
(1) Hired in May 1999
54
Options vest and become exercisable over four years, provided the employee
remains employed at SonicWALL, Inc. In 1999, we granted options to purchase up
to an aggregate of 3,259,500 shares to employees, directors and consultants. We
granted all options under our stock option plans at exercise prices at the fair
market value of our common stock on the date of grant, as determined in good
faith by our board of directors.
The following table provides information regarding options exercised during
1999 and unexercised options held as of December 31, 1999 by our Chief
Executive Officer and the other executive officers or key employees whose
compensation exceeded $100,000 in fiscal 1999. The value of realized and the
value of unexercised in-the-money options is calculated at December 31, 1999.
Aggregate Option Exercises Fiscal Year-End Option Values
Number of
Securities Underlying Value of Unexercised
Number of Unexercised Options at In-the-Money Options at
Shares Value Fiscal Year End (#) Fiscal Year-End ($)
Acquired on Realized ------------------------- -------------------------
Name Exercise (#) ($) Exercisable Unexercisable Exercisable Unexercisable
---- ------------ ----------- ----------- ------------- ----------- -------------
Sreekanth Ravi.......... -- -- -- -- -- --
Sudhakar Ravi........... -- -- -- -- -- --
Steven R. Perricone..... 20,000 $ 797,500 242,500 337,500 $9,669,688 $13,457,813
Michael J. Sheridan..... 306,000 $11,700,000 -- -- -- --
55
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, 1999, 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 1999; and
. all of our directors and executive officers as a group.
Percentage of beneficial ownership is based on 23,675,385 shares of common
stock outstanding as of December 31, 1999, together with options that are
exercisable within 60 days of December 31, 1999 for each shareholder. Under the
rules of the Securities and Exchange Commission, beneficial ownership includes
shares over which the indicated beneficial owner exercises voting and/or
investment power. Shares of common stock subject to options that are currently
exercisable or will become exercisable within 60 days are deemed outstanding
for computing the percentage ownership of the person holding the option, but
are not deemed outstanding for purposes of computing the percentage ownership
of any other person.. 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
Beneficially Owned Percentage of Shares
as of December 31, of Common Stock
Name And Address 1999 Outstanding
---------------- ------------------ --------------------
Sreekanth Ravi(1)..................... 4,893,286 20.7%
Sudhakar Ravi(2)...................... 4,893,286 20.7%
Steven R. Perricone(3)................ 287,500 1.2%
Michael J. Sheridan................... 300,000 1.3%
Bay Partners SBIC II, L.P.(4)......... 2,301,400 9.8%
Bay Sonic Investors, LLC(5)........... 2,232,364 9.5%
Ravi Anne............................. 1,156,546 4.9%
Bruce Wonnacott....................... 1,111,546 4.7%
Jerrold F. Petruzzelli(6)............. 100,000 *%
David Shrigley(7)..................... 84,354 *%
Robert M. Williams(8)................. 28,768 *%
All directors and executive officers
as a group (7 persons)(9)............ 15,120,958 63.9%
- --------
* Less than 1%.
(1) Includes 600,000 shares transferred to a family trust.
(2) Includes 600,000 shares transferred to a family trust.
(3) Includes 267,500 shares of common stock issuable upon exercise of
immediately exercisable options.
(4) Represents 2,301,400 shares held by Bay Partners SBIC II, L.P. Robert
Williams, a director of SonicWALL, Inc. is a partner of Bay Management
Company 1997, the general partner of Bay Partners SBIC II, L.P. He shares
voting and investing power with respect to the shares held by this entity,
and disclaims beneficial ownership of shares in which he has no pecuniary
interest. The address for Bay Partners SBIC II, L.P. is 10600 N. De Anza
Boulevard, Suite 100, Cupertino, California 95014.
(5) On August 6, 1999, Sreekanth Ravi and Sudhakar Ravi sold an aggregate of
1,832,364 shares of common stock to Bay Sonic Investors, LLC, and Ravi Anne
and Bruce Wonnacott sold an aggregate of 400,000 shares of common stock to
Bay Sonic Investors, LLC. See Note (6) in Certain Transactions and Business
Relationships above. Bay Sonic Investors, LLC is an affiliate of Robert
Williams, a director of
56
SonicWALL, Inc. Mr. Williams is a managing member of Bay Sonic Investors and
as such may be deemed to have voting control of the shares held by Bay Sonic
Investors, LLC.
(6) Includes 5,000 shares held on behalf of a minor child in an irrevocable
trust of which Mr. Petruzzelli is the sole trustee. The address for Mr.
Petruzzelli is 3030 Hansen Way, Suite 100, Palo Alto, California 94304.
(7) Includes 4,000 shares held by children residing in the same household as
Mr. Shrigley. The address for Mr. Shrigley is 471 Santa Rosa Drive, Los
Gatos, California 95032.
(8) See note (4) above. The address for Mr. Williams is 10600 N. De Anza
Boulevard, Suite 100, Cupertino, California 95014.
(9) Includes 248,000 shares of common stock issuable upon exercise of
immediately exercisable options.
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. Unless terminated earlier by the board of directors, the 1998
stock option plan will terminate in July 2008. The 1998 stock option plan was
amended by our board of directors in August 1999 to include some of the
provisions provided below. These amendments were approved by our shareholders
in August 1999. The number of shares reserved for issuance under the 1998 stock
option plan will be subject to an automatic annual increase in the first day of
2000 through 2008 equal to the lesser of:
. 2,000,000 shares;
. 4% of our outstanding common stock on the last day of the immediately
preceding fiscal year; or
. a number of shares determined by the administrator.
The compensation committee currently administers the 1998 stock option plan.
The administrator of the 1998 stock option plan determines numbers of shares
subject to options, vesting schedules and exercise prices for options granted
under the 1998 stock option plan.
The exercise price of incentive stock options must be at least equal to 100%
of the fair market value of our common stock on the date of grant, and at least
equal to 110% of the fair market value in the case of incentive stock options
granted to an employee who holds, at the time the option is granted, more than
10% of the total voting power of all classes of our stock or any parent's or
subsidiary's stock. Nonstatutory stock options will have an exercise price of
at least 85% of the fair market value of our stock. Payment of the exercise
price may be made in cash or other form of consideration approved by the
administrator. The administrator determines the term of options, which may not
exceed ten years, or five years in the case of an incentive stock option
granted to an employee who holds, at the time the option is granted, more than
10% of the total voting power of all classes of our stock or any parent's or
subsidiary's stock. No option may be transferred by the optionee other than by
will or the laws of descent or distribution, provided, however, that the
administrator may in its discretion provide for the transferability of
nonstatutory stock options. The administrator determines when options become
exercisable. Options granted under the 1998 stock option plan become
exercisable at a rate not less than 20% per year. To the extent an optionee
would have the right in any calendar year to exercise for the first time one or
more incentive stock options for shares having an aggregate
57
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, 1999:
. a total of 7,358,324 shares have been authorized for issuance under the
1994 and 1998 stock option plans;
. options to purchase an aggregate of 3,794,208 shares of common stock were
outstanding under the 1994 stock option plan and 1998 stock option plan
at a weighted average exercise price of $4.51;
. 2,714,855 shares had been issued upon exercise of outstanding options,
net of repurchases, under the 1994 and 1998 stock option plans; and
. 849,261 shares remained available for future grant under the 1994 and
1998 stock option plans.
1999 Employee Stock Purchase Plan
Our 1999 employee stock purchase plan was adopted by the board of directors
and shareholders in August 1999. The 1999 employee stock purchase plan became
effective on the effective date of our initial public offering. A total of
250,000 shares of common stock has been reserved for issuance under the 1999
employee stock purchase plan.
The 1999 employee stock purchase plan, which is intended to qualify under
Section 423 of the Internal Revenue Code, provides our employees with an
opportunity to purchase our common stock through accumulated payroll
deductions. The 1999 employee stock purchase plan 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
58
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.
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 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Since January 1, 1996, SonicWALL, Inc. has not been a party to any
transaction or series of similar transactions in which the amount involved
exceeds $60,000 and in which any director, executive officer, or holder of more
than 5% of our common stock had or will have a direct or indirect material
interest other than
. normal compensation arrangements which are described under "Management--
Executive Compensation" above; and
. the transactions described below.
Transactions with Executive Officers, Directors and Significant Shareholders
(1) In August 1998, SonicWALL, Inc. acquired all the partnership interest of
AckFin Networks ("AckFin"), a California general partnership, in exchange
for an aggregate of 5,426,184 shares of common stock and the assumption of
$150,000 in liabilities. The controlling partners of AckFin were Sreekanth
Ravi and Sudhakar Ravi, executive officers and directors of SonicWALL, Inc.
Additional partners were Ravi Anne and Bruce Wonnacott. The deemed fair
market value of our common stock on the date of acquisition was $0.90 per
share, resulting in an aggregate value of $4.9 million of common stock
issued in this transaction. The intangible assets acquired by the Company
were rights to the completed core technology developed by AckFin that
provides the foundation for our Internet products.
(2) On December 23, 1998, we extended two loans in the aggregate amount of
$96,069.60 to Sreekanth Ravi, Chairman of the Board, Chief Executive
Officer, President and a director of SonicWALL, Inc. to pay the
59
exercise price of options to purchase 1,067,440 shares of our common stock.
Each loan had an interest rate of 8% per year, payable over four years and
was secured by the shares of common stock purchased upon the exercise of
Mr. Ravi's stock options. These loans were repaid in full in August 1999.
(3) On December 23, 1998, we extended two loans in the aggregate amount of
$96,069.60 to Sudhakar Ravi, Chief Technical Officer and a director of
SonicWALL, Inc. to pay the exercise price of options to purchase 1,067,440
shares of our common stock. Each loan had an interest rate of 8% per year,
payable over four years and was secured by the shares of common stock
purchased upon the exercise of Mr. Ravi's stock options. These loans were
repaid in full in August 1999.
(4) On February 19, 1999, we issued an aggregate of 1,438,377 shares of our
redeemable Series A convertible preferred stock at a purchase price of
$3.48 per share to several investors, including 14,384 shares issued to
Robert Williams, a director of the Company, 1,150,700 shares to Bay
Partners SBIC II, L.P. Mr. Williams is a partner of Bay Management Company
1997, the general partner of Bay Partners SBIC II, L.P. The purchasers of
redeemable Series A convertible preferred stock are entitled to
registration rights in respect of the common stock issued or issuable upon
conversion of the redeemable Series A convertible preferred stock.
(5) On May 26, 1999, we extended a loan in the amount of $300,000 to Michael
Sheridan, Vice President Finance, Chief Financial Officer, and Secretary
of SonicWALL, Inc. to pay the exercise price of options to purchase
300,000 shares of our common stock. Mr. Sheridan has purchased the
optioned shares, and SonicWALL, Inc. has the right to repurchase the
optioned shares for the purchase price paid, which right lapses over four
years. The loan has an interest rate of 8% per year and is payable over
four years. The loan is payable in full if Mr. Sheridan is no longer an
employee, officer, director or consultant of SonicWALL, Inc. As of
December 31, 1999, aggregate principal and interest of approximately
$314,000 were outstanding under the loan.
(6) On August 6, 1999, Sreekanth Ravi, Chairman of the Board, Chief Executive
Officer and President, and Sudhakar Ravi, Chief Technical Officer and a
director, sold an aggregate of 1,832,364 shares of common stock to Bay
Sonic Investors, LLC at a purchase price of $6.52 per share. On August 11,
1999, two shareholders also sold an aggregate of 400,000 shares of common
stock to Bay Sonic Investors, LLC at a purchase price of $6.52 per share.
Robert Williams, a director of the Company, is a managing member of Bay
Sonic Investors, LLC. In addition, on August 6, 1999, Sreekanth Ravi sold
38,354 shares of common stock to David Shrigley, a director of the
Company, at a purchase price of $6.52 per share and 30,682 shares of
common stock to John McNulty at a purchase price of $6.52 per share. The
purchasers of common stock in these transactions are entitled to
registration rights in respect of the common stock purchased.
(7) Jerrold F. Petruzzelli, a director of SonicWALL, Inc. is a partner of
Manatt, Phelps & Phillips, LLP, legal counsel to SonicWALL, Inc. In 1998,
SonicWALL, Inc. paid Wise & Shepard LLP, a law firm of which Mr.
Petruzzelli was then a partner, $88,772 in legal fees and expenses. In
June 1999, Wise & Shepard LLP merged into Manatt, Phelps & Phillips, LLP
and Mr. Petruzzelli became a partner of Manatt, Phelps & Phillips, LLP.
For the year ended December 31, 1999, SonicWALL, Inc. had paid Wise &
Shepard LLP and Manatt, Phelps & Phillips LLP an aggregate of $465,115 in
legal fees and expenses.
Indemnification Agreements
We have entered into indemnification agreements with our executive officers
and directors. See "Management--Director and Officer Indemnification and
Liability."
Registration Rights Agreements
Some of our shareholders are entitled to have their shares registered by us
for resale. See "Description of Capital Stock--Registration Rights."
60
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Financial Statements
Consolidated Balance Sheets at December 31, 1999 and 1998.
Consolidated Statements of Operations for each of the three years in the
period ended December 31, 1999.
Consolidated Statement of Shareholders' Equity for each of the three
years in the period ended December 31, 1999.
Consolidated Statements of Cash Flows for each of the three years in the
period ended December 31, 1999.
Notes to Consolidated Financial Statements.
Report of PricewaterhouseCoopers LLP, Independent Accountants.
(b) Reports on Form 8-K
None.
(c) Exhibits
Number Description
------ -----------
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, 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.
27.1 Financial Data Schedule.
(d) Schedules
Schedule I.
61
- --------
* Incorporated by reference to the Registrant's Registration Statement on Form
S-1 ( No. 333-85997) which became effective on November 9, 1999.
++ Confidential treatment has been requested for portions of this exhibit. The
omitted material has been separately filed with the Securities and Exchange
Commission.
(d) Financial Statement Schedules
Schedule II--Valuation and Qualifying Accounts and Reserves
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.
62
SIGNATURES
Pursuant to the requirements of Sections 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized, in the City of
Sunnyvale, State of California, on the 23rd day of February, 2000.
SonicWALL, Inc.
/s/ Sreekanth Ravi
By: _________________________________
Sreekanth Ravi,
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report to has been signed below by the following persons on behalf of the
registrant in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Sreekanth Ravi President, Chief Executive February 23, 2000
______________________________________ Officer and Director
Sreekanth Ravi (Principal Executive
Officer)
/s/ Sudhakar Ravi Chief Technical Officer February 23, 2000
______________________________________ and Director
Sudhakar Ravi
/s/ Robert M. Williams Director February 23, 2000
______________________________________
Robert M. Williams
/s/ David A. Shrigley Director February 23, 2000
______________________________________
David A. Shrigley
/s/ Jerrold F. Petruzzelli Director February 23, 2000
______________________________________
Jerrold F. Petruzzelli
/s/ Michael J. Sheridan Vice President, Finance February 23, 2000
______________________________________ and Chief Financial
Michael J. Sheridan Officer
and Secretary (Principal
Financial and Accounting
Officer)
63
SCHEDULE I
REPORT OF INDEPENDENT ACCOUNTANTS
Our audits of the consolidated financial statements referred to in our
report dated January 13, 2000 appearing in the 1999 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.
/s/ PricewaterhouseCoopers LLP
San Jose, California
January 13, 2000
64
SCHEDULE II
SONICWALL, INC.
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
Balance at Charged to Balance at
Beginning Cost and Write-off End of
of Year Expenses of Accounts Year
---------- ---------- ----------- ----------
Year ended December 31,
1997
Allowance for doubtful
accounts............... $ 69 $ 52 $ -- $ 121
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
65
INDEX TO EXHIBITS
Number Description
------ -----------
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, 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.
27.1 Financial Data Schedule.
- --------
* Incorporated by reference to the Registrant's Registration Statement on Form
S-1 (No. 333-85997), which became effective on November 9, 1999.
++ Confidential treatment has been requested for portions of this exhibit. The
omitted material has been separately filed with the Securities and Exchange
Commission.
66