| SONICWALL INC ITEM 1A Risk Factors You should carefully review the following risks associated with owning our common stock |
| Our business, operating results or financial condition could be materially adversely affected in the event any of the following risks were to be realized |
| You should also refer to the other information set forth in this report and incorporated by reference herein, including our financial statements and the related notes |
| Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements |
| Rapid changes in technology, regulatory requirements and industry standards could render our products, software and services unmarketable or obsolete, and we may be unable to successfully introduce new products and services |
| To succeed, we must continually introduce new products, software and services and change and improve our products, software and services in response to new competitive product introductions, rapid technological developments, changes in regulatory requirements, 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 |
| Product and service development for Internet security appliances requires substantial engineering time and testing |
| The disparities between the laws and administrative measures adopted by various jurisdictions in which we do business create uncertainty over the 14 _________________________________________________________________ [49]Table of Contents applicability, scope and form of the regulations affecting our products and services and the timing for compliance with applicable regulations |
| Releasing new products, software 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, software and services, and we may experience delays in the future |
| We may be unable to develop new products, software and services or achieve and maintain market acceptance of them once they have come to market |
| Furthermore, when we do introduce new or enhanced products, software and services, we may be unable to manage the transition from previous generations of products or previous versions of software and services to minimize disruption in customer ordering patterns, avoid excessive inventories of older products and deliver enough new products, software and services to meet customer demand |
| If any of the foregoing were to occur, our business could be adversely affected |
| We depend on two major distributors for a significant amount of our revenue, and if they or others cancel or delay purchase orders, our revenue may decline and the price of our stock may fall |
| To date, sales to two distributors, Ingram Micro and Tech Data, have accounted for a significant portion of our revenue |
| For the fiscal years ended December 31, 2005, 2004 and 2003, substantially all of our sales were to distributors and resellers as shown in the following table, expressed as a percentage of total revenue: FY 2005 FY 2004 FY 2003 Distributors/ Resellers 97 % 98 % 96 % Sales through Ingram Micro and Tech Data for the fiscal years ended December 31, 2005, 2004 and 2003 represented the following percentages of total revenue: Customers FY 2005 FY 2004 FY 2003 Ingram Micro 18 % 17 % 23 % Tech Data 21 % 21 % 20 % In addition, for the fiscal year ended December 31, 2005, our top 10 distributors and resellers accounted for 66prca of our total revenue |
| In each of 2004 and 2003, our top 10 distributors and resellers accounted for 56prca or more of total revenue |
| We anticipate that sales of our products to relatively few distributors and resellers will continue to account for a significant portion of our revenue |
| Although we have renewable one-year agreements with Ingram Micro and Tech Data and certain other large distributors, these contracts are subject to termination at any time |
| We cannot assure you that any of these distributors or resellers will continue to place orders with us, that orders will continue at the levels of previous periods or that we will be able to obtain large orders from new distributors or resellers |
| If any of the foregoing should occur, our revenue will likely decline and our business will be adversely affected |
| In addition, Ingram Micro and Tech Data represented the following dollar amount and percentages of our accounts receivable balance (in millions, except for percentages): 2005 2004 December 31, 2003 Ingram Micro $ 2dtta0M 15 % $ |
| 8M 6 % $ 1dtta3M 14 % Tech Data $ 1dtta4M 11 % $ 3dtta8M 26 % $ 1dtta4M 15 % The failure of distributors and resellers to pay us in a timely manner could adversely affect our balance sheet, our results of operations and our creditworthiness, which could make it more difficult to conduct business |
| 15 _________________________________________________________________ [50]Table of Contents If we are unable to compete successfully in the highly competitive market for Internet security products and services, our business could be adversely affected |
| The market for Internet security products is worldwide and highly competitive |
| Competition in our market continues to increase, and we expect competition to further 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, Check Point, Microsoft, Symantec, Cisco Systems, Lucent Technologies, Nortel Networks, Nokia, WatchGuard Technologies and Juniper Networks, all of which sell worldwide or have a presence in most of the major markets for such products |
| Competitors to date have generally targeted the security needs of enterprises of every size with firewall and VPN products that range in price from approximately dlra250 to more than dlra30cmam000 |
| We may experience increased competitive pressure in some of our product lines as well as some of our software feature sets |
| This increased competitive pressure may result in both lower prices and gross profits |
| 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 |
| In addition, our competitors may bundle products, software and services that are competitive to ours with other products, software and services that they may sell to our current or potential customers |
| These customers may accept these bundled offerings rather than separately purchasing our offerings |
| If any of the foregoing were to occur, our business could be adversely affected |
| Difficulty predicting our future operating results or profitability due to volatility in general economic conditions and the Internet security market may result in a misallocation in spending, and a shortfall in revenue which would harm our operating results Changes in general economic conditions and the volatility in the demand for Internet security products are two of the 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 implement a decrease in our spending in time to compensate for any unexpected quarterly or annual shortfall in revenue |
| As a result, any shortfall in revenue would likely adversely affect our operating results |
| For the year ended December 31, 2005, we reported a net income of dlra6dtta3 million |
| For the year ended December 31, 2004, we reported a net loss of dlra313cmam000 |
| For the year ended December 31, 2003, we reported a net loss of dlra17dtta7 million |
| Our accumulated deficit as of December 31, 2005 is dlra118dtta6 million |
| We do not know if we will be able to sustain profitability in the future |
| The selling prices of our solution-based product, software and services offerings may decrease, which may reduce our gross profits |
| The average selling prices for our solution-based product, software and services offerings may decline as a result of competitive pricing pressures, a change in our mix of products, software and services, anticipation of introduction of new functionality in our products or software, promotional programs and customers who negotiate price reductions in exchange for longer-term purchase commitments |
| In addition, competition continues to increase in the market segments in which we participate and we expect competition to further increase in the future, thereby leading to increased pricing pressures |
| Furthermore, we anticipate that the average selling prices and gross profits for our products will decrease over product life cycles |
| We cannot assure you that we will be successful in developing and introducing new offerings with enhanced functionality on a timely basis, or that our product, software and service offerings , if introduced, will enable us to maintain our prices and gross profits at current levels |
| If the price of individual products, software or services decline or if the price of our solution-based offerings decline, our overall revenue may decline and our operating results may be adversely affected |
| 16 _________________________________________________________________ [51]Table of Contents 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, 2005, we estimated that approximately dlra11dtta8 million of our products in our distributors’ inventory are subject to price protection |
| We have issued approximately dlra700cmam000 and 98cmam000 of credits under our price protection policies in 2005 and 2004, respectively |
| 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 |
| 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 risk of international business and associated currency fluctuations, which might adversely affect our operating results |
| International revenue represented 34prca of total revenue for in 2005, 30prca of total revenue in 2004, and 30prca of total revenue in 2003 |
| 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 structure our distribution relationships in a manner consistent with marketplace requirements and on favorable terms, and if we are unable to do so, revenue may decrease from our international operations |
| Because our sales are denominated in US 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 |
| A weakened dollar could increase the cost of local operating expenses and procurement of raw materials |
| We are subject to the risks of conducting business internationally, including potential foreign government regulation of our technology, geopolitical risks associated with political and economic instability, changes in diplomatic and trade relationships, and changes in foreign countries’ laws affecting such areas as employment relationships, environmental regulation, intellectual property protection and the Internet generally |
| Delays in deliveries from our suppliers could cause our revenue to decline and adversely affect our results of operations |
| Our products incorporate certain components, component subassemblies or technologies that are available from single or limited sources of supply |
| Specifically, our products rely upon components from companies such as Iwill, Intel, Cavium, and Broadcom |
| We do not have long-term supply arrangements with any vendor, and any disruption in the supply of these products or technologies may adversely affect our ability to obtain necessary components or technology for our products |
| If this were to happen, our product shipments may be delayed and business lost, resulting in a decline in sales |
| 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 profit |
| We license intellectual property, including certain databases and software, and if our licensors experience delays in product updates or provide us with products of substandard quality, the revenue we receive from our products and services that use this intellectual property would be at risk |
| We have agreements to license intellectual property, including databases and software, which we incorporate as part of certain of our products and services |
| Licensors of such databases and software may fail to provide us with updated products or may experience delays in providing us with updated products |
| In addition, our licensors may provide us with products of substandard quality |
| If either of these events happens, we may be unable to provide our customers with the appropriate level of functionality in our solution based offerings |
| In that event, our customers may purchase similar offerings from one of our competitors, or sales to our customers may be delayed |
| In either case, our revenue would be adversely affected |
| 17 _________________________________________________________________ [52]Table of Contents We rely primarily on contract manufacturers for our product manufacturing and assembly, and if these operations are disrupted for any reason, we may not be able to ship our products |
| We outsource our hardware manufacturing and assembly to contract manufacturers |
| Flash Electronics manufactures and assembles many of our products at facilities in both the US and China |
| Our agreement with Flash Electronics, effective June 4, 2004, specifies an initial term of one (1) year with automatic yearly renewal terms unless the agreement is terminated by either party upon 90 days prior written notice |
| SerComm Corporation of Taiwan manufactures and assembles certain of our products at facilities located in Taiwan |
| Our agreement with SerComm, effective on January 20, 2005, specifies an initial term of one (1) year with automatic yearly renewal terms unless terminated by either party upon 90 days prior written notice |
| Our operations could be disrupted if we have to switch to a replacement vendor or if our hardware supply is interrupted for any reason |
| In addition, we provide forecasts of our demand to our contract manufacturers nine months prior to scheduled delivery of products to our customers |
| If we overestimate our requirements, our contract manufacturers may have excess inventory, which would increase our costs |
| If we underestimate our requirements, our contract manufacturers may have an inadequate component inventory, which could interrupt manufacturing of our products and result in delays in shipments and revenue |
| In addition, lead times for materials and components that we order vary significantly and depend on factors such as the specific supplier, contract terms and demand for each component at a given time |
| Financial problems of our contract manufacturers or reservation of manufacturing capacity by other companies, inside or outside of our industry, could either limit supply or increase costs |
| We may also experience shortages of components from time to time, which also could delay the manufacturing of our products |
| If any of the foregoing occurs we could lose customer orders and revenue could decline |
| Sales of our products may be adversely affected by various factors which would adversely affect our revenue |
| Sales of our products may be adversely affected in the future by changes in the geopolitical environment and global economic conditions; sales and implementation cycles of our products; changes in our product mix; structural variations in sales channels; ability of our channel to absorb new product introductions; acceptance of our products in the market place; and changes in our supply chain model |
| These changes may result in corresponding variations in order backlog |
| A variation in backlog levels could result in less predictability in our quarter-to-quarter net sales and operating results |
| Sales of our products may also be adversely affected by fluctuations in demand for our products, price and product competition in the markets we service, introduction and market acceptance of new technologies and products, and financial difficulties experienced by our distributors, resellers or end-users |
| We may, from time to time, experience manufacturing issues that create a delay in our suppliers’ ability to provide specific components resulting in delayed shipments |
| To the extent that manufacturing issues and any related component shortages result in delayed shipments in the future, and particularly in periods when we and our suppliers are operating at higher levels of capacity, it is possible that revenue could be adversely affected for a quarter or longer |
| Environmental regulations enacted in various jurisdictions in which we do business may increase the component costs of our products and if we experience delays in shipment of complaint products our revenue would decline and our operating results would be adversely affected |
| Various jurisdictions in which we do business are promulgating environmental directives that impact manufacturers doing business in those jurisdictions |
| The disparities between the regulatory frameworks adopted create uncertainty over the applicability, scope and form of the regulations affecting our products and the timing for compliance with the applicable regulations |
| Certain of these regulations may necessitate changes to the components used in our products which could result in an increase in product cost and a decrease in our gross profit |
| Further, while we and our contract manufacturers constantly review environmental regulations in the jurisdictions in which we do business, the timetable for implementation of these regulations may result in delays in our ability to provide compliant products in a timely manner to those markets which would cause our revenues to decline and our operating results to be adversely affected |
| 18 _________________________________________________________________ [53]Table of Contents If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results |
| As a result, current and potential stockholders could lose confidence in our financial reporting which would harm our business and the trading price of our stock |
| Section 404 of the Sarbanes-Oxley Act of 2002 requires our management to report on, and our independent registered public accounting firm to attest to, the effectiveness of our internal control over financial reporting |
| We have an ongoing program to perform the system and process evaluation and testing necessary to comply with these requirements |
| We have incurred increased expense and have devoted additional management resources to on going Section 404 compliance activity |
| Effective internal controls are necessary for us to provide reliable financial reports |
| If we cannot provide reliable financial reports, our business and operating results could be harmed |
| Acquisitions could be difficult to integrate, disrupt our business, dilute shareholder value and the products and services acquired may not be accepted by the market |
| As a result, our operating results would be adversely affected |
| On November 28, 2005, we announced that we had acquired Lasso Logic, Inc, an early stage company providing continuous data protection for backup and recovery solutions for the small and medium business market |
| At the same time, we also announced that we had acquired certain assets of enKoo, a developer of remote access technology |
| On February 8, 2006, we announced that we had acquired Mail Frontier, Inc, a company providing message security solutions to mid-tier businesses |
| We are continually reviewing possible corporate opportunities and we may announce acquisitions or investments in other companies, products or technologies in the future |
| As part of each transaction, we will be required to integrate operations, train, retain and motivate the personnel of these entities |
| We may be unable to maintain uniform standards, controls, procedures and policies across our entire enterprise and if the products and services released as a result of these acquisitions experience quality problems or are otherwise not accepted by the market, we may suffer a loss of confidence by our distributors and resellers and sales of these products and services will not meet expectations |
| As a consequence, these 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 shareholders |
| In addition, due to acquisitions made in the past our profitability has suffered because of acquisition-related costs, amortization costs and impairment losses for acquired goodwill and other intangible assets |
| We have been unable to predict accurately the costs associated with evaluating our internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act of 2002 and may continue to be unable to do so in the future |
| We have been unable to accurately predict the costs, including the costs of both internal assessments and external auditor assessments, associated with complying with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 and in evaluating our internal control over financial reporting |
| Costs of compliance have been significantly greater than anticipated, and costs of compliance in future periods may continue to be unpredictable, which could have an adverse effect on our financial results |
| We cannot be certain that the remediation efforts concerning our internal control over financial reporting will be effective or sufficient |
| In the course of our ongoing evaluation and testing of our internal controls over financial reporting, we have identified areas requiring improvement |
| We either have implemented, or are in the process of implementing, enhanced processes and controls designed to address the issues identified during our ongoing evaluation and testing process |
| We cannot be certain that our remediation efforts will be effective or sufficient for us to conclude that such remediation efforts are successful |
| 19 _________________________________________________________________ [54]Table of Contents Our Financial Statements could be affected by the need to restate previously issued annual or interim financial statements |
| In the event an error in our financial statements requires us to report that previously reported financial statements should no longer be relied upon, amended financial statements for such previously reported periods would be required |
| Furthermore, we may be unable to certify the adequacy of our internal controls over financial reporting and our independent registered public accounting firm may be unable to attest thereto |
| In such circumstances, investors could lose confidence in our internal controls over financial reporting, our disclosure controls and the reliability of our financial statements, which could result in a decrease in the value of our common stock and could cause serious harm to our business, financial condition and results of operations |
| We cannot be certain that our internal controls over financial reporting will be effective or sufficient when tested by increased scale of growth or the impact of acquisitions |
| It may be difficult to design and implement effective internal controls over financial reporting for combined operations and differences in existing controls of acquired businesses may result in weaknesses that require remediation when internal controls over financial reporting are combined |
| Our ability to manage our operations and growth will require us to improve our operations, financial and management controls, as well as our internal reporting systems and controls |
| We may not be able to implement improvements to our internal reporting systems and controls in an efficient and timely manner and may discover deficiencies and weaknesses in existing systems and controls; especially when such systems and controls are tested by increased scale of growth or the impact of acquisitions |
| We must attract and retain qualified financial personnel to maintain effective controls over the application of generally accepted accounting principles within the financial reporting process |
| In order to maintain effective controls over the application of certain generally accepted accounting principles within the financial reporting process the Company must attract and retain a sufficient complement of personnel with a level of financial reporting expertise commensurate with the Company’s financial reporting requirements |
| Competition for qualified personnel with a level of financial reporting expertise commensurate with our financial reporting requirements is particularly intense in our marketplace and in our location |
| We have experienced, and may continue to experience, difficulty in hiring candidates and retaining employees with appropriate qualifications |
| If our estimates or judgments relating to our critical accounting policies are based on assumptions that change or prove to be incorrect, our operating results could fall below expectations of securities analysts and investors, resulting in a decline in our stock price |
| Our discussion and analysis of financial condition and results of operations in this report is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States |
| The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes |
| On an ongoing basis, we evaluate significant estimates used in preparing our financial statements, including those related to: sales returns and allowances; bad debt; inventory reserves; bonus and commission accruals, warranty reserves; restructuring reserves; intangible assets; and deferred taxes |
| We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, as provided in our discussion and analysis of financial condition and results of operations in this annual report, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources |
| Examples of such estimates include, but are not limited to, those associated with valuation allowances and accrued liabilities, specifically sales returns and other allowances, allowances for doubtful accounts and warranty reserves |
| SFAS Nodtta 142 requires that goodwill and other indefinite lived intangibles no longer be amortized to earnings, 20 _________________________________________________________________ [55]Table of Contents but instead be reviewed for impairment on an annual basis or on an interim basis if circumstances change or if events occur that would reduce the fair value of a reporting unit below its carrying value |
| We did not incur a goodwill impairment charge in 2005, 2004 or 2003 |
| Actual results may differ from these and other estimates if our assumptions change or if actual circumstances differ from those in our assumptions, which could cause our operating results to fall below the expectations of securities analysts and investors, resulting in a decline in our stock price |
| Changes to our senior management may have an adverse effect on our ability to execute our business strategy |
| Our future success will depend largely on the efforts and abilities of our senior management to execute our business plan |
| Changes in our senior management and any future departures of key employees may be disruptive to our business and may adversely affect our operations |
| We must be able to hire and retain sufficient qualified employees or our business will be adversely affected |
| Our success depends in part on our ability to hire and retain key engineering, operations, finance, information systems, customer support and sales and marketing personnel |
| Our employees may leave us at any time |
| The loss of services of any of our key personnel, the inability to retain and attract qualified personnel in the future, or delays in hiring required personnel, particularly engineering and sales personnel, could delay the development and introduction of, and negatively impact our ability to sell, our products, software and services |
| We cannot assure you that we will be able to hire and retain a sufficient number of qualified personnel to meet our business needs |
| We may be unable to adequately protect our intellectual property proprietary rights, which may limit our ability to compete effectively |
| We currently rely on a combination of patent, trademark, copyright, and trade secret laws, confidentiality provisions and other contractual provisions to protect our intellectual property |
| Our intellectual property program consists of an on-going patent disclosure and application process, the purchase of intellectual property assets from others and the licensing of intellectual property from others |
| We plan to continue our aggressive plan to build our intellectual property portfolio |
| Despite our efforts to protect our intellectual property, unauthorized parties may misappropriate or infringe our intellectual property |
| We plan to aggressively pursue any such misappropriation or infringement of our intellectual property |
| Our patent applications may not result in the issuance of any patents |
| Even if we obtain the patents we are seeking, that will not guarantee that our patent rights will be valuable, create a competitive barrier, or will be free from infringement |
| Furthermore, if any patent is issued, it might be invalidated or circumvented or otherwise fail to provide us any meaningful protection |
| 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 |
| Litigation over intellectual property rights is not uncommon in our industry |
| We may face infringement claims from third parties in the future, or we may have to resort to litigation to protect our intellectual property rights |
| We expect that infringement or misappropriation claims will be more frequent as the number of products, feature sets in software and services and the number of competitors grows in the market segments in which we do business |
| Any litigation, regardless of its success, would probably be costly and require significant 21 _________________________________________________________________ [56]Table of Contents time and attention of our key management and technical personnel |
| An adverse result in 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 |
| If any of the above occurs, our revenue could decline and our business could suffer |
| We have been named as defendant in litigation matters that could subject us to liability for significant damages |
| We are a defendant in on-going litigation matters |
| No estimate can be made of the possible loss or possible range of loss, if any, associated with the resolution of these litigation matters |
| Failure to prevail in these matters could have a material adverse effect on our consolidated financial position, results of operations, and cash flows in the future |
| In addition, the results of litigation are uncertain and the litigation process may utilize a significant portion of our cash resources and divert management’s attention from the day-to-day operations, all of which could harm our business |
| We may have to defend lawsuits or pay damages in connection with any alleged or actual failure of our products and services |
| Our products and services provide and monitor Internet security |
| If a third party were able to circumvent our security measures, such a person or entity could misappropriate the confidential information or other property or interrupt the operations of end- users using our products, software and services |
| If that happens, affected end- users or others may file actions against us alleging product liability, tort or breach of warranty claims |
| Although we attempt to reduce the risk of losses from claims through contractual warranty disclaimers and liability limitations, these provisions may not be enforceable |
| 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 |
| 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, software and services 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 significant damages from acts 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, software and services |
| This could cause us to lose current and potential customers, resellers, distributors or other business partners |
| If any of the above occurs, our revenue could decline and our business could suffer |
| 22 _________________________________________________________________ [57]Table of Contents If our products do not interoperate with our end customers’ networks, installations could be delayed or cancelled, which could significantly reduce our revenue |
| Our products and software are designed to interface with existing networks of our end-users, each of which have different specifications and utilize multiple protocol standards |
| Many of the networks of our end- user’s contain multiple generations of products that have been added over time as these networks have grown and evolved |
| Our products and software must interoperate with the products within these networks as well as with future products that might be added to these networks in order to meet the requirements of our end-users |
| If we find errors in the existing software used in the networks of our end-users, we may elect to modify our software to fix or overcome these errors so that our products will interoperate and scale with their existing software and hardware |
| If our products and software do not interoperate properly, installations could be delayed or orders for our products could be cancelled, which could significantly reduce our revenue |
| Product errors or defects could result in loss of revenue, delayed market acceptance and claims against us |
| We offer a one and two year warranty periods on our products |
| During the warranty period end users may receive a repaired or replacement product for any defective unit subject to completion of certain procedural requirements |
| 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 record revenue for the replacement units, or we may have to refund the purchase price for such units if the defect cannot be resolved |
| 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 |
| Such product defects can negatively impact our products’ reputation and result in reduced sales |
| Industry consolidation may lead to increased competition and may harm our operating results |
| There has been a trend toward industry consolidation in our market |
| We expect this trend toward industry consolidation to continue as companies attempt to strengthen or hold their market positions in an evolving industry and as companies are acquired or are unable to continue operations |
| We believe that industry consolidation may result in stronger competitors that are better able to compete with us |
| This could lead to more variability in operating results and could have a material adverse effect on our business, operating results, and financial condition |
| If we are unable to meet our future capital requirements, our business will be harmed |
| We expect our cash on hand, cash equivalents to meet our working capital and capital expenditure needs for at least the next twelve months |
| However, at any time, we may decide to raise additional capital to take advantage of strategic opportunities available or attractive financing terms |
| If we issue equity securities, shareholders may experience additional dilution or the new equity securities may have rights, preferences or privileges senior to those of existing holders of common stock |
| If we cannot raise funds, if needed, on acceptable terms, we may not be able to develop or enhance our products, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements, which could have a material adverse effect on our business, operating results, and financial condition |
| Governmental regulations of imports or exports affecting Internet security could affect our revenue |
| Any additional governmental regulation of imports or exports or failure to obtain required export approval of our encryption technologies could adversely affect our international and domestic sales |
| The United States and various foreign governments have imposed controls, export license requirements and restrictions on the import or export of some technologies, especially encryption technology |
| In addition, from time to time, governmental agencies have proposed additional regulation of encryption technology, such as requiring the escrow and governmental recovery of private encryption keys |
| In response to terrorist activity, governments could enact additional regulation or restriction on the use, import or export of encryption technology |
| This additional regulation of encryption technology could delay or prevent the acceptance and use of encryption 23 _________________________________________________________________ [58]Table of Contents products and public networks for secure communications resulting in decreased 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 the international Internet security market |
| Our stock price may be volatile |
| The market price of our common stock has been highly volatile and has fluctuated significantly in the past |
| We believe that it may continue to fluctuate significantly in the future in response to the following factors, some of which are beyond our control: • general economic conditions and the effect that such conditions have upon customers’ purchasing decisions; • variations in quarterly operating results; • changes in financial estimates by securities analysts; • changes in market valuations of technology and Internet infrastructure companies; • announcements by us of significant contracts, acquisitions, strategic partnerships, joint ventures or capital commitments; • the accretive or dilutive effects of acquisitions on operating results; • loss of a major client or failure to complete significant license transactions; • additions or departures of key personnel; • our ability to remediate material weaknesses and/or significant deficiencies, if any, in internal controls over financial reporting in an effective and timely manner; • receipt of an adverse or qualified opinion from our independent auditors regarding our internal controls over financial reporting; • sales of common stock in the future; and • fluctuations in stock market price and volume, which are particularly common among highly volatile securities of Internet-related companies |
| The long sales and implementation cycles for our products may cause revenue and operating results to vary significantly |
| The decision of an end-user to purchase our products, software and services often involves a significant commitment of resources and a lengthy evaluation and product qualification process |
| Throughout the sales cycle, we often spend considerable time educating our channel partners and providing information for prospective end-users regarding the use and benefits of our products |
| Budget constraints and the need for multiple approvals within enterprises, carriers and government entities may delay purchase decisions |
| Failure to obtain the required approval for a particular project or purchase decision may delay the purchase of our products from our channel partners |
| Even after making the decision to purchase our products, software and services, end-users may not deploy these solutions broadly within their networks |
| The timing of implementation can vary widely and depends on the skill set of the end-user, the size of the network deployment, the complexity of the network environment and the degree of specialized hardware and software configuration necessary to deploy our products |
| End-users with large networks usually expand their networks in large increments on a periodic basis |
| Large deployments and purchases of our security solutions also require a significant outlay of capital by the end-user |
| If the deployment of our products in these complex network environments is slower than expected, sales through our 24 _________________________________________________________________ [59]Table of Contents distributors to our resellers would slow, our revenue could be below our expectations and our operating results could be adversely affected |
| The inability to obtain any third-party license required developing new products and product enhancements could require us to obtain substitute technology of lower quality or performance standards or at greater cost, which could seriously harm our business, financial condition and results of operations |
| We license technology from third parties to develop new products or software or enhancements to existing products or software |
| Third-party licenses may not be available to us on commercially reasonable terms or at all |
| The inability to obtain third-party licenses required developing new products or software or enhancements to existing products or software could require us to obtain substitute technology of lower quality or performance standards or at greater cost, any of which could seriously harm our business, financial condition and results of operations |
| Seasonality and concentration of revenue at the end of the quarter could cause our revenue to fall below the expectations of securities analysts and investors, resulting in a decline in our stock price |
| The rate of our domestic and international sales has been and may continue to be lower in the summer months or be adversely affected by other seasonal factors, both domestically and internationally |
| During these periods, businesses often defer purchasing decisions |
| As a result of customer buying patterns and the efforts of our sales force to meet or exceed quarterly and year-end quotas, we have historically received a substantial portion of a quarter’s sales orders and earned a substantial portion of a quarter’s revenue during its last month of each quarter |
| If expected revenue at the end of any quarter is delayed, our revenue for that quarter could fall below the expectations of securities analysts and investors, resulting in a decline in our stock price |
| The requirement to record compensation expense for the value of stock options or other stock-based awards that we issue to our employees will harm our earnings |
| We believe that stock options are a key element in our ability to attract and retain employees in the markets in which we operate |
| In December 2004, the Financial Accounting Standards Board issued FASB Statement Nodtta 123 (revised 2004), Share-based Payment, which requires public companies to recognize, as an expense, the fair value of stock option and other stock-based compensation to employees |
| This requirement becomes effective in the annual reporting period which commences January 1, 2006 |
| Prior to this reporting period, we used the intrinsic value method to measure compensation expense for stock-based awards to our employees |
| Under this standard, we did not consider stock option grants issued under our employee stock option plans to be compensation when the exercise price of stock option is equal to or greater than the fair market value on the date of grant |
| For 2006 and thereafter, we will be required to record a compensation charge as stock options or other stock-based compensation awards are issued or as they vest, including the compensation related to the unvested portion of options that were granted prior to 2006 |
| This compensation charge will be based on a calculated value of the option or other stock-based award using the modified prospective transition method and the Black-Scholes model |
| Our business is especially subject to the risks of earthquakes, floods and other natural catastrophic events, and to interruption by manmade problems such as computer viruses or terrorism |
| Our corporate headquarters, including certain of our research and development operations and some of our contract manufacturer’s facilities, are located in the Silicon Valley area of Northern California, a region known for seismic activity |
| Additionally, certain of our facilities, which include one of our contracted manufacturing facilities, are located near rivers that have experienced flooding in the past |
| A significant natural disaster, such as an earthquake or a flood, could have a material adverse impact on our business, operating results, and financial condition |
| In addition, despite our implementation of network security measures, our servers are vulnerable to computer viruses, break-ins, and similar disruptions from unauthorized tampering with our computer systems |
| Any such event could have a material adverse effect on our business, operating results, and financial condition |
| In addition, the effects of war or acts of terrorism could have a 25 _________________________________________________________________ [60]Table of Contents material adverse effect on our business, operating results, and financial condition |
| The continued threat of terrorism and heightened security and military action in response to this threat, or any future acts of terrorism, may cause further disruptions to these economies and create further uncertainties |
| To the extent that such disruptions or uncertainties result in delays, curtailment or cancellations of customer orders, or the manufacture or shipment of our products, our revenue, gross profits and operating profits may decline and we may not achieve our financial goals and achieve or maintain profitability |
| We face risks associated with changes in telecommunications regulation and tariffs |
| Changes in telecommunications requirements in the United States or other countries could affect the sales of our products |
| We believe it is possible that there may be changes in US telecommunications regulations in the future that could slow the expansion of the service providers’ network infrastructures and materially adversely affect our business, operating results, and financial condition |
| Future changes in tariffs by regulatory agencies or application of tariff requirements to currently untariffed services could affect the sales of our products for certain classes of customers |
| Additionally, in the United States, our products must comply with various Federal Communications Commission requirements and regulations |
| In countries outside of the United States, our products must meet various requirements of local telecommunications authorities |
| Due to the global nature of our business, economic or social conditions or changes in a particular country or region could adversely affect our sales or increase our costs and expenses, which would have a material adverse impact on our financial condition |
| We conduct significant sales and customer support operations in countries outside of the United States |
| Accordingly, our future results could be materially adversely affected by a variety of uncontrollable and changing factors including, among others, political or social unrest or economic instability in a specific country or region; macro economic conditions adversely affecting geographies where we do business; trade protection measures; environmental directives and other regulatory requirements which may affect our ability to import or export our products from various countries; government spending patterns affected by political considerations; and difficulties in staffing and managing international operations |