A N N U A L R E P O R T 2 0 0 2 F5 Networks, Inc. • 401 Elliott Avenue West • Seattle, WA 98119 • 206.272.5555 • www.f5.com © 2 0 0 2 F 5 N e t w o r k s I n c . A l l r i g h t s r e s e r v e d . S e l e c t e d F i n a n c i a l D a t a 1 Net Revenue (in millions) Gross Margin (in percent) $ 30 $ 15 $ 10 $29.0 $27.1 $26.6 $27.0 $27.1 $27.3* $27.1 $24.7 Q1 2001 Q2 2001 Q3 2001 Q4 2001 Q1 2002 Q2 2002 Q3 2002 Q4 2002 75 60 50 76 73* 71 68 66* 63 59* 53 Q1 2001 Q2 2001 Q3 2001 Q4 2001 Q1 2002 Q2 2002 Q3 2002 Q4 2002 Operating Expenses (in millions) $ 25 $24.6 $21.2* $21.2* $20.8 $21.2 $21.5* $20.9* $19.7 $ 20 $ 15 Earnings Per Share (EPS) $ -0.00 0.00* -0.07 -0.08 -0.07 -0.10 -0.05* $ -0.25 -0.19* -0.41 Q1 2001 Q2 2001 Q3 2001 Q4 2001 Q1 2002 Q2 2002 Q3 2002 Q4 2002 $ -0.50 Q1 2001 Q2 2001 Q3 2001 Q4 2001 Q1 2002 Q2 2002 Q3 2002 Q4 2002 * Pro forma. A reconciliation of actual and pro forma results for each quarter is included in the company’s quarterly income statements, available on our Web site at www.f5.com/f5/ir/reports/. Selected Financial Data (in thousands) 2002 Actual 2002 Pro Forma 2001 Actual 2001 Pro Forma Net Revenues Gross Profit Operating Expenses Loss from Operations Net Loss Cash, Cash Equivalents & Investments Long-Term Debt Net loss as reported $ 108,266 $ 77,787 $ 87,328 (9,541) $ $ (8,610) $ 80,333 0 $ Return reserve (contra product revenue) Write down of inventory (cost of net revenues) Amortization of unearned compensation Bad debt recovery (general and administrative) Bad debt (general and administrative) Executive recruitment (general and administrative) Restructuring charges Income tax expense Impairment of assets due to office relocation (other income, net) Pro forma net income (loss) $ 108,509 $ 78,368 $ 84,391 (6,023) $ $ (5,092) $ 80,333 0 $ $ (8,610) 243 338 (500) 163 3,274 $ (5,092) $ 107,367 $ 61,862 $ 90,578 $ (28,716) $ (30,790) $ 69,783 0 $ $ 107,367 $ 65,057 $ 85,801 $ (20,744) $ (13,935) $ 69,783 0 $ $ (30,790) 3,195 1,300 2,000 502 975 8,683 200 $ (13,935) T h e s t a t e m e n t s c o n t a i n e d i n t h i s r e p o r t t h a t a r e n o t p u r e l y h i s t o r i c a l a r e f o r w a r d - l o o k i n g s t a t e m e n t s . T h e s e s t a t e m e n t s i n c l u d e , b u t a r e n o t l i m i t e d t o , s t a t e m e n t s a b o u t o u r p l a n s , o b j e c t i v e s , e x p e c t a t i o n s , s t r a t e g i e s a n d i n t e n t i o n s a n d a r e g e n e r a l l y i d e n t i f i e d b y t h e w o r d s “ e x p e c t s , ” “ a n t i c i p a t e s , ” “ i n t e n d s , ” “ p l a n s , ” “ b e l i e v e s , ” “ s e e k s , ” “ e s t i m a t e s , ” a n d s i m i l a r e x p r e s s i o n s . B e c a u s e t h e s e f o r w a r d - l o o k i n g s t a t e m e n t s a r e s u b j e c t t o a n u m b e r o f r i s k s a n d u n c e r t a i n t i e s , o u r a c t u a l r e s u l t s c o u l d d i ff e r m a t e r i a l l y f r o m t h o s e e x p r e s s e d o r i m p l i e d b y t h e s e f o r w a r d - l o o k i n g s t a t e m e n t s . F a c t o r s t h a t c o u l d c a u s e o r c o n t r i b u t e t o s u c h d i ff e r e n c e s i n c l u d e , b u t a r e n o t l i m i t e d t o , t h o s e d i s c u s s e d u n d e r t h e h e a d i n g “ R i s k F a c t o r s ” i n t h e c o m p a n y ’s F o r m 1 0 - K f o r f i s c a l 2 0 0 2 a n d i n o t h e r d o c u m e n t s w e f i l e f r o m t i m e t o t i m e w i t h t h e S e c u r i t i e s a n d E x c h a n g e C o m m i s s i o n . A l l f o r w a r d l o o k i n g s t a t e m e n t s i n c l u d e d i n t h i s r e p o r t a r e b a s e d o n i n f o r m a t i o n a v a i l a b l e t o u s o n t h e d a t e h e r e o f . We a s s u m e n o o b l i g a t i o n t o u p d a t e a n y s u c h f o r w a r d - l o o k i n g s t a t e m e n t s . T h e c u s t o m e r n a m e s a n d t r a d e m a r k s u s e d w i t h i n t h i s A n n u a l R e p o r t a r e r e g i s t e r e d n a m e s , t r a d e n a m e s a n d t r a d e m a r k s o f t h e r e s p e c t i v e c o m p a n i e s . ® 2 0 0 2 F 5 N e t w o r k s , I n c . A l l r i g h t s r e s e r v e d . Inventories (in millions) $ 20 $16.6 $ 10 $8.8 $4.2 $2.6 $2.8 $1.0 $0.3 $0.3 Q1 2001 Q2 2001 Q3 2001 Q4 2001 Q1 2002 Q2 2002 Q3 2002 Q4 2002 $ 10 Cash and Investments (in millions) $ 80 $68.6 $69.8 $72.4 $75.5 $78.9 $80.3 $ 40 $36.0 $30.3 $ 40 Q1 2001 Q2 2001 Q3 2001 Q4 2001 Q1 2002 Q2 2002 Q3 2002 Q4 2002 Days Sales Outstanding (DSO) (in days) 2 110 104 80 50 84 80 77 70 69 67 68 Q1 2001 Q2 2001 Q3 2001 Q4 2001 Q1 2002 Q2 2002 Q3 2002 Q4 2002 Cash Flow from Operations (in millions) $ -4 $ -0 $ -4 $ -8 $-12 $1.7 $2.2 $3.3 $2.8 $1.9 $1.5 $-4.8 $-10.9 Q1 2001 Q2 2001 Q3 2001 Q4 2001 Q1 2002 Q2 2002 Q3 2002 Q4 2002 F5 Networks is the leading provider of Application Traffic Management solutions for networks using the Internet Protocol. Built with a common software architecture (iControl™), our industry-leading products reduce the cost, improve the efficiency, increase the business security and boost the overall performance of IP-based enterprise networks, servers and the applications that run on them. Features of our BIG-IP® software enable our products to read the entire contents of IP packets, identify any value in those packets, and direct, filter or persist on the data according to customized rules generated by users and applications. BIG-IP software runs on a variety of Intel-based hardware platforms, including application switches and server appliances manufactured by F5 and our OEM partners and blade servers manufactured by a number of server vendors. F5’s products and services are sold to large enterprise customers worldwide through a variety of channels, including OEMs, Distributors, Value-Added Resellers (VARs) and System Integrators (SIs). In North America, we also sell to major accounts through our own field sales force. During fiscal 2002, we generated 76 percent of our revenue from product sales and 24 percent from maintenance and related services. Based on market data for the quarter ended September 30, 2002, F5 led the Layer 4/7 Fixed Switch and Appliance Market with 29 percent of total revenue. F5 has approximately 475 employees in our Seattle, Washington, headquarters and offices throughout North America, Europe and Asia Pacific. Our address on the Web is www.f5.com. This report should be read in conjunction with the company’s Form 10-K for fiscal year 2002. F5 Networks executive team. From left to right (back) Steve Goldman, Brett Helsel, Jeff Pancottine, Julian Eames, (middle) Steve Coburn, (front) Joann Reiter, John McAdam. To O u r S h a r e h o l d e r s Fiscal 2002 was a year of significant achievement for F5 Networks. The company 4 successfully launched several new products and gained share in both the Layer 4/7 and SSL (Secure Socket Layer) markets. We expanded our base of enterprise customers and increased the volume of our business in major accounts. And we continued to fine-tune our operating model with resulting improvements in several key financial metrics. Year over year, the company’s revenue was up only slightly, from $107.4 million in fiscal 2001 to $108.3 million in fiscal 2002. During a period when many of our competitors reported declining revenues, however, I’m pleased that we were able to sustain flat revenues across all four quarters. Equally important, while we reported a net loss of $8.6 million ($0.34 share) for the year ($5.1 million or $0.20 per share pro forma), we pared our quarterly net loss to $423,000 ($0.02 per share) in the fourth quarter and achieved breakeven results on a pro forma basis*. Just weeks before the beginning of fiscal 2002, we launched our first application switch product, BIG-IP® 5000, which was followed four months later by BIG-IP 2000. By the end of the second quarter, both products had come to represent nearly half of system sales. And by September 30, our share of the Layer 4/7 fixed switch market had grown from zero a year earlier to 17 percent (source: Dell’Oro). During the same period, combined sales of BIG-IP application switches and appliances increased our share of the Layer 4/7 fixed switch and appliance market to 29 percent (source: Dell’Oro/F5). Integrated SSL acceleration on both products also helped drive our share of the market for Layer 4-7 Switch/Load Balancers with SSL to 79 percent (source: Infonetics) for the first half of calendar 2002. Weeks after the close of fiscal 2002, we upgraded and expanded our application switch family with the introduction of three new products: BIG-IP 5100 combines industry-leading Layer * Pro forma net income for the fourth quarter of fiscal 2002 excluded a one-time restructuring charge of $503 thousand related to F5’s exit from the cache business, announced on July 8, 2002. A reconciliation of annual pro forma items to actual results is provided on page 1 of this report. T o O u r S h a r e h o l d e r s 7 performance and Layer 4 traffic management with 24-port Layer 2/3 switching and integrated SSL; BIG-IP 2400 combines Layer 7 traffic management, 16-port Layer 2/3 switching and integrated SSL with a new custom- 5 designed ASIC (application specific integrated circuit) that delivers the industry’s fastest Layer 4 performance; and BIG-IP 1000 combines Layer 4/7 traffic management with 8-port Layer 2/3 switching to deliver the most cost- effective application traffic management solution on the market. These products significantly enhance our ability to meet the various needs of our enterprise customers and have received favorable reviews in the trade press and from industry analysts. In its December 2, 2002 issue, for example, InfoWorld called the new products “a real plus for companies that need to optimize their network efficiency.” A common feature of all three products is version 4.5 of BIG-IP’s Layer 7 application traffic management software. Key components of the new software are the Universal Inspection Engine (UIE), which enables BIG- IP to identify any value of an IP packet, and iRules, which allow users to easily write custom business rules that use those values to direct, filter or persist traffic to and from servers and applications. In combination, UIE and iRules give customers unprecedented power and flexibility to manage virtually any type of IP-based application traffic, from instant messaging and voice-over-IP to database requests and XML tags used in Web services. In addition to UIE and iRules, version 4.5 incorporates a new feature called Dynamic Security Control Architecture (DSCA) that enhances the security capabilities of our products. Integrating SSL acceleration with Layer 7 traffic management has been a key driver of BIG-IP application switch sales. Encrypting and de-encrypting data on BIG-IP is faster and less costly than doing it on a server. And it allows UIE to examine the data and apply iRules before sending it on. With DSCA, BIG-IP has the capability to interface directly with intrusion detection systems and other network security devices, enabling them to block security threats quickly and eliminating the need for manual intervention. This has significantly expanded our addressable market. Within the market for Layer 7 traffic management, we believe our software-based technology offers customers a superior alternative to competing hardware-based products. Frequent 6 updates, which aren’t feasible in hardware-based solutions, allow us to keep pace with the adoption of new protocols and emerging trends such as Web services. As exemplified in UIE and iRules, our software also allows customers to adapt our traffic management solutions to their specific business needs. And through iControl™, our SOAP/XML interface, IP-based applications themselves can communicate directly with our products to control the network and optimize their performance. Throughout fiscal 2002, we continued to forge and strengthen partnerships with major software vendors such as Microsoft, Oracle, BEA, Hewlett Packard and Web Methods, who have enabled their applications to interface with iControl. During the fourth quarter, we estimate that approximately 15 percent of our system sales involved at least one iControl partner. In terms of market opportunity, the portability of our software-based solutions gives F5 an important edge over our competitors. Although 93 percent of our product revenue in fiscal 2002 was derived from system sales, 7 percent came from licensing our software to original equipment manufacturers (OEMs) and end users. The majority of licensing revenue during the year was from Dell, which resells our software on its own line of server appliances. During the second fiscal quarter, Nokia also began contributing OEM revenue, which grew modestly over the next two quarters. Going forward, we anticipate that the percentage of software sales in our revenue mix will increase as OEM revenue is augmented by software licensing revenue from sales of BIG-IP Blade Controller. Introduced in May 2002, Blade Controller is a version of the BIG-IP software modified to run on new blade server platforms from Dell, Fujitsu-Siemens, Hewlett Packard, IBM and RLX Technologies. During the second half of fiscal 2002, we sold a modest number of Blade Controller licenses into the nascent blade server market. With the first products from Dell and IBM just beginning to enter the T o O u r S h a r e h o l d e r s market, we anticipate that we will see our first significant sales of Blade Controller in the first half of calendar 2003. In the meantime, we are continuing to work closely with each vendor to develop 7 individualized marketing programs to target their customer base. In addition to broadening and enhancing our product offerings in fiscal 2002, we continued to widen our base of enterprise customers and grow our business in major accounts. In the second half, we also began to see an increase in sales to providers of wireless communications. During the year, revenue from major accounts grew significantly, with sales to our nine largest accounts approaching $13 million for the year, up from less than $3 million for those same accounts in fiscal 2001. Geographically, North America was our strongest market, with Europe up and Japan down slightly year over year. Our success in selling to enterprise customers highlights the strength of our technology in addressing their business needs. To a lesser degree, it also reflects significant improvements in the company’s operating model and balance sheet that have reinforced our strong market position. Driven largely by the consolidation of our system platforms and improved manufacturing efficiencies, pro forma* gross margin increased from 60.6% in fiscal 2001 to 72.2% in fiscal 2002 while pro forma operating expenses declined from $85.8 million to $84.4 million during the same period. Part of the improvement in these metrics resulted from our decision to exit the cache business and scale back our workforce in July. In terms of asset utilization, the quality of our enterprise accounts was a key factor in reducing days sales outstanding (DSOs) from 77 days a year ago to 68 days at year end. As a result of this and other factors, including aggressive inventory management, we generated nearly $10 million in cash flow from operations during the year, increasing our cash and investments from $69.8 at the end of fiscal 2001 to $80.3 million at the end of fiscal 2002. As a result of these improvements and our increasing market share, we believe F5 is well positioned * A reconciliation of annual pro forma items to actual results is provided on page 1 of this report. to weather a continuation of the current business cycle and to benefit from any upturn in corporate spending. With or without any improvement in the economy, however, our primary goal during fiscal 2003 is to 8 drive the company’s revenue growth by focusing on those market opportunities for which our technology is best suited. In addition to our unique position in the blade server market, those opportunities include the continued rollout of IP-enabled enterprise applications, the ongoing development of wireless Internet infrastructure, the growing need for improvements in network security, and the accelerating development of Web services. On behalf of the entire company, thanks for your support of our efforts to make F5 Networks the undisputed market leader in Application Traffic Management for the enterprise. John McAdam President and Chief Executive Officer November 30, 2002 10 Application Traffic Management F5 Networks pioneered the category of load balancing with the introduction of BIG-IP® in 1997. At that time, the issue of managing traffic associated with the rapid deployment of Web servers was a major challenge and BIG-IP was the answer. Through subsequent enhancements to BIG-IP, F5 helped transform the industry by adding network intelligence and the ability to manage Web-enabled applications. Today, BIG-IP can manage traffic for any type of application over any network that uses the Internet Protocol (IP). We call this capability Application Traffic Management and it is already changing the way people and applications view the network. BIG-IP products perform basic switching and routing functions, monitor the health of networks, enhance network security, ensure high availability of applications and servers, simplify the deployment of new applications and reduce the cost and complexity of network administration. As a result, F5 is strategically aligned with several emerging trends—such as Web-enabled enterprise applications, mobile Internet applications, and Web services—that industry analysts expect to drive the growth of Internet-related technology for the next three to five years. In terms of the Open Systems Interconnect (OSI) Reference Model, the framework that describes and defines how networked systems communicate with one another, the core of BIG-IP is sophisticated software that manages IP traffic at Layer 7, also known as the application layer. The F5 BIG-IP application switches also perform Layer 2/3 switching and industry-leading Layer 4 switching. But it is the superior performance and functionality of the BIG-IP Layer 7 traffic management software that has distinguished them from competing products sold by Cisco Systems, Nortel Networks, and others. In contrast to the tasks associated with Layers 2 - 4, Layer 7 functionality is complex and variable. Switching devices for Layers 2 - 4 merely ensure that packets of information sent over the Internet arrive at the destination to which they are addressed, and that they are reassembled in the correct sequence. In many ways, the kinds of functions carried out at Layers 2 - 4 are analogous to those carried out by the postal service in picking up and delivering mail. Layer 7 corresponds to preparing and reading the contents of the mail and to the interaction between the sender and receiver. Ap p l i cat ion Traff ic M an agement When mail is sent through the postal system, different kinds of documents and packages Intelligent Delivery of Mail 11 from various sources can be designated for Invitation delivery to a single individual at a specific address; for example, Abigail Baker Chief Financial Officer Charlie Company 123 D Street Emerald City, Kansas 64321 On a typical day, a number of individuals and organizations—including those within Charlie Company—might send Ms. Baker many different types of mail: • An invitation to a partner’s product launch • A subscription renewal notice from the Wall Street Journal • An invitation to attend an investment seminar • The monthly statement for her corporate credit card • This week’s copy of the Economist magazine • A copy of a new report on the company by a brokerage firm analyst • The final draft of a job offer to a new Controller that requires her review and signature (sent from HR via inter-office mail) • The first draft of a letter of intent for a joint venture, sent by the prospective partner’s attorneys via overnight courier Although each item is prepared in a specific way for a specific purpose, they all go through a similar process to get to Ms. Baker. Each is packaged and addressed using a standard format. Postage or a delivery fee is determined and paid. Then, each packaged and addressed Delivery Method Subscription W STREET $$ Invoice Intelligent Delivery of IP Packets Clients Application Servers Layer 2/3/4 Network/Switching Internet item is handed off directly, or indirectly, to a postal or delivery service employee. Legal Counsel Once in the postal or delivery service system, 12 Administrative Assistant W STREET $$ JUNK CFO each piece is physically transported over various distances, working its way through a series of processes that aggregate thousands of pieces addressed to employees of Charlie Company before delivering them to the company’s mail room. Finally, mail that has been sorted by department or mail stop and combined with special deliveries and interdepartmental mail is delivered to employees who place it in individual mailboxes. Director of IR Ms. Baker doesn’t open or respond directly to JUNK JUNK JUNK Recycle Bin Layer 7 - Application Traffic Management BIG-IP Controllers Application Servers Web Servers Databases all the mail sent to her. Her administrative assistant opens most of it and handles each piece according to a set of variable rules that reflect his knowledge of Ms. Baker and her preferences, specific instructions she has given him, and any special circumstances that arise. As he sorts through the mail, Ms. Baker’s assistant turns his attention first to the final draft of the job offer and the letter of intent. He knows Ms. Baker is expecting both of these documents, but this morning she told him she wanted George Fox, the company’s in-house counsel, to review the job offer one more time before she signs it. Accordingly, he carries it over to Mr. Fox and hands it to him. Ms. Baker is away from her desk, so he places the letter of intent face down on her chair. Next, he checks Ms. Baker’s calendar to see if she is free to attend the partner launch. Since Ap p l i cat ion Traff ic M an agement she is, he blocks out the date and time on her Under Ms. Baker’s working definition of “junk calendar, attaches a note to the invitation asking mail”, the invitation to the investment seminar 13 if she wants to attend, and puts the invitation qualifies and is consigned to the recycling bin. in her inbox. Since he already knows she wants to continue her subscription to the Wall Street Journal, he signs her up for a one-year renewal, billing it to her corporate credit card and making a note to add it to this week’s expense report that he will prepare for her. Ordinarily, Ms. Baker’s assistant would put this week’s Economist on her credenza, along with other recent magazines. But since one of the stories in this week’s issue is about one of Charlie Company’s largest customers, he marks the page with a sticky note and puts it in her inbox. Although the correspondence is far from exact, there are a number of parallels that can be drawn between this example and application traffic management. The senders of all the pieces intended for Ms. Baker correspond to various client systems connected to the Internet or to Charlie Company’s Intranet. Ms. Baker herself corresponds to several different applications running on a group of servers. The preparation of each piece by the sender and the response it generates in Ms. Baker’s office are analogous to what goes on at the application layer (Layer 7) Even though the analyst report is addressed to when data is exchanged between clients and Ms. Baker, she has instructed her assistant to applications over IP-based networks. The route all investor relations materials directly to functions performed by Ms. Baker’s assistant the Director of IR. Accordingly, he puts the correspond to the application traffic management report in the Director’s mailbox. functions of BIG-IP. Ms. Baker could perform E n te rp ri s e A p p l i c a t i o n : Da t a b a s e S c a l i n g A large transportation/logistics company in the US needs a cost-effective way to scale and provide high availability for its customer record databases. Since 90 percent of the traffic represents read-only requests, adding more large servers with the kind of sophisticated replication software needed for write transactions is an expensive option. Instead, they could install BIG-IP application switches in front of the database servers and scale their read-only databases with less expensive servers and replication software. Because UIE can recognize and distinguish between read and write commands, an iRule could be Internet BIG-IPs Web Servers Read or Write written to direct each to the appropriate group of servers. BIG-IPs Database Servers DB 1 Write DB 2 Write DB 3 Read DB 4 Read those functions herself. But it’s a much more packets to ensure that transmissions are sent efficient use of her time to have her assistant to the most appropriate resource. In addition, do them for her. In the same way, many Layer BIG-IP’s iControl architecture enables it to 14 7 functions can be performed on a server or communicate directly with applications through written into an application, but it’s much more a SOAP/XML interface that lets the applications cost-effective to deploy BIG-IP. In addition, BIG- control the network dynamically, saving time, IP performs many functions that would be money and resources. impractical to host on a server or build into an application. The decisions made by BIG-IP are based on a new feature of the software called iRules, which As IP packets from various sources arrive at includes a set of standard rules for routing their destination and are reassembled, BIG-IP’s traffic and allowing customers to add their own Universal Inspection Engine (UIE), enables it business rules. Standard rules include checking to read the contents of the packets and make the target server and application to make sure intelligent decisions about where and how to that both are available and operating correctly send each transmission to optimize the before sending traffic to them. Custom rules performance of the network, network servers can govern how traffic is to be managed with and the applications running on them. reference to virtually any element or group of Integrated SSL (secure socket layer) acceleration elements within a transmission. At one US enables BIG-IP to decrypt secure transmissions airline, for example, BIG-IP is used to manage before deciding where and how to send them the flow of traffic to and from servers that on, and BIG-IP can also insert other data into We b S e r v i c e s A p p l i c a t i o n : S e c u r i t y A US manufacturer with approximately 50 suppliers worldwide wants to develop a secure Web service to replace the current process of communicating with them via paper, fax, phone and email. A major stumbling block is that secure Web services transactions require 11 separate steps (generate the request; insert a digital signature; insert a client certificate; encrypt the traffic; decrypt the traffic; validate the client certificate; validate the digital signature; authorize the transaction; log the event; direct traffic to the appropriate resource; respond to the request) that would have to be built into the application at the customer site and at each supplier site. The cost and difficulty of doing this and maintaining the degree of consistency and reliability necessary to make the application work is prohibitive. However, the manufacturer could remove this obstacle by using BIG-IP application switches to manage the flow of traffic between them and their suppliers and offloading 8 of the 11 steps to BIG-IP. This would make deployment and maintenance of the Web service feasible and concentrate security in a centralized resource. Enterprise B Enterprise A 8 of 11 steps offloaded to BIG-IP Internet 8 of 11 steps offloaded to BIG-IP Enterprise C Ap p l i cat ion Traff ic M an agement provide online services for frequent fliers. As for any type of IP-based application, including transmissions come in, BIG-IP can identify the enterprise applications such as CRM (customer 15 status of users from their member ID and send relationship management), database traffic from premier members to a special server applications, mobile and wireless applications where they receive priority service. At a major and Web services. At a large transportation Japanese provider of wireless Internet company in the US, for example, BIG-IP might communications, all traffic between the network be used to distinguish between read and write and its 30 million users passes through BIG-IP traffic to its database servers, enabling the devices that can identify the cell phone number company to save money by purchasing less of the caller. iRules uses this information and expensive servers to handle the read traffic. a feature called “persistence” to ensure that For a US semiconductor manufacturer, BIG-IP’s once a user begins a transaction on a particular ability to read XML data could enable it to server, he will stay connected to that server implement a secure, centrally-managed Web until the transaction is complete. If he should service to communicate with approximately 50 become disconnected before he is finished, suppliers world wide. In Northern Europe, BIG-IP allows him to reconnect to the same BIG-IP’s ability to manage wireless traffic could server and resume the transaction where he permit a government agency to expand a left off. Because UIE can recognize any element of a packet, BIG-IP can be used to manage traffic popular lottery game by ensuring that two players will remain connected to the same server for the duration of the game. As a result, the agency could accommodate more players GSM Network Internet Player 2 Defense M o b i l e A p p l i c a t i o n : Re l i a b i l i t y a n d S c a l e A popular European lottery game allows two individuals to compete for a lottery ticket by playing a game of football (soccer) over their cell phones. In order for the game to work, the two players must connect and persist (stay connected) to the same server. With a limited number of players, this did not present a problem, but as the number of players has increased the agency and its mobile operator need to figure out a cost effective way to scale the application and still ensure that every pair of players remains on the same server until the conclusion of their game. One option is to buy a much larger and more expensive server. A more cost-effective option that would allow far greater scalability is to install an array of inexpensive servers with the same application running on each, and a BIG-IP application switch to manage traffic in front of the servers. Because UIE can recognize any value in a transmission, network administrators could write an iRule forcing transmissions from any two players to persist to the same server. In addition, BIG-IP could balance the load of incoming calls and ensure high-availability by constantly monitoring the health of servers and applications. Application Servers (SME) Player 1 Offense BIG-IPs BIG-IPs SMSC by replicating the game on many small servers, is limited, preventing them from interacting rather than hosting it on a single, large server dynamically with network applications. with limited capacity. In the area of security enforcement, iControl™ and a feature of BIG- IP called Dynamic Security Control Architecture (DSCA) allow BIG-IP to work in conjunction with intrusion detection systems (IDS) that monitor the network for security threats. Rather than notify network managers when a security threat is detected, the IDS can communicate directly with BIG-IP which instantly generates a dynamic iRule to block or divert all traffic from the source of the detected threat. BIG-IP application switches use commodity 16 components for Layer 2/3 switching and a custom ASIC (application specific integrated circuit) we developed ourselves for Layer 4 switching. Since the company was founded, however, we have been committed to the development of a software solution as the only way to address the dynamic and increasingly complex requirements of application traffic management for Layer 7. With the recent introduction of BIG-IP version 4.5, we have BIG-IP’s superior ability to manage the complex continued to widen the gap between F5 and decision-making required at Layer 7 competing vendors of traffic management distinguishes it from other traffic management solutions. products. Because the majority of competing products are based on proprietary hardware and do not have the flexible software features of BIG-IP, their traffic management functionality E n t e r p r i s e A p p l i c a t i o n : S e c u r i t y E n fo r c e m e n t Intrusion Detection Systems (IDS) are deployed in enterprise networks to monitor traffic and detect security threats such as denial-of-service attacks. In most implementations, the IDS responds to a perceived threat by identifying the source and sending an alert to a network administrator who must then issue a command shutting off traffic from that source. In the case of a real attack, this process can take several minutes under the best circumstances. In addition, the IDS frequently mistakes malformed packets for malicious transmissions, resulting in a number of false alerts. By deploying BIG-IP in conjunction with the IDS, false alerts could be eliminated and the process of shutting down an attack could be sped up significantly. BIG-IP screens all incoming traffic and could identify and drop all malformed packets before they reached the IDS. If an actual threat were detected, the IDS could alert BIG-IP directly through the iControl interface, and BIG-IP could instantly generate an iRule to drop all traffic coming from the source of the attack. Attack detected block traffic from 198.133.219.25 BIG-IPs Intrusion Detection Systems Web & Application Servers Internet Load New iRule: Drop packets from 198.133.219.25 iControl Message S h a r e h o l d e r s ’ I n f o r m a t i o n C o r p o r a t e O f f i c e r s B o a r d o f D i r e c t o r s John McAdam President and Chief Executive Officer Steve Coburn Senior Vice President of Finance and Chief Financial Officer Steve Goldman Senior Vice President of Sales and Services Brett Helsel Senior Vice President of Product Development and Chief Technology Officer Jeff Pancottine Jeffrey Hussey Founder John McAdam President and Chief Executive Officer Alan Higginson President and CEO, Hubspan, Inc. Karl Guelich Certified Public Accountant Keith Grinstein Partner, Second Avenue Partners Senior Vice President of Marketing and Business Development Kenny Frerichs Julian Eames Senior Vice President of Business Operations and Vice President of Global Services Vice President, Business Development, Nokia Internet Communications N A S D A Q L i s t i n g NASDAQ Symbol – FFIV Joann Reiter Vice President and General Counsel I n v e s t o r R e l a t i o n s N o t i c e o f A n n u a l M e e t i n g Our annual shareholders meeting will be held: 206.272.6677 info@f5.com F5 Networks Corporate Headquarters I n d e p e n d e n t A c c o u n t a n t s February 13, 2003 10:00 AM C o r p o r a t e H e a d q u a r t e r s 401 Elliott Avenue West Seattle, WA 98119 206.272.5555 www.f5.com PricewaterhouseCoopers LLP Seattle, WA T r a n s f e r A g e n t American Stock Transfer 212.936.5100 S e l e c t e d F i n a n c i a l D a t a 1 Net Revenue (in millions) Gross Margin (in percent) $ 30 $ 15 $ 10 $29.0 $27.1 $26.6 $27.0 $27.1 $27.3* $27.1 $24.7 Q1 2001 Q2 2001 Q3 2001 Q4 2001 Q1 2002 Q2 2002 Q3 2002 Q4 2002 75 60 50 76 73* 71 68 66* 63 59* 53 Q1 2001 Q2 2001 Q3 2001 Q4 2001 Q1 2002 Q2 2002 Q3 2002 Q4 2002 Operating Expenses (in millions) $ 25 $24.6 $21.2* $21.2* $20.8 $21.2 $21.5* $20.9* $19.7 $ 20 $ 15 Earnings Per Share (EPS) $ -0.00 0.00* -0.07 -0.08 -0.07 -0.10 -0.05* $ -0.25 -0.19* -0.41 Q1 2001 Q2 2001 Q3 2001 Q4 2001 Q1 2002 Q2 2002 Q3 2002 Q4 2002 $ -0.50 Q1 2001 Q2 2001 Q3 2001 Q4 2001 Q1 2002 Q2 2002 Q3 2002 Q4 2002 * Pro forma. A reconciliation of actual and pro forma results for each quarter is included in the company’s quarterly income statements, available on our Web site at www.f5.com/f5/ir/reports/. Selected Financial Data (in thousands) 2002 Actual 2002 Pro Forma 2001 Actual 2001 Pro Forma Net Revenues Gross Profit Operating Expenses Loss from Operations Net Loss Cash, Cash Equivalents & Investments Long-Term Debt Net loss as reported $ 108,266 $ 77,787 $ 87,328 (9,541) $ $ (8,610) $ 80,333 0 $ Return reserve (contra product revenue) Write down of inventory (cost of net revenues) Amortization of unearned compensation Bad debt recovery (general and administrative) Bad debt (general and administrative) Executive recruitment (general and administrative) Restructuring charges Income tax expense Impairment of assets due to office relocation (other income, net) Pro forma net income (loss) $ 108,509 $ 78,368 $ 84,391 (6,023) $ $ (5,092) $ 80,333 0 $ $ (8,610) 243 338 (500) 163 3,274 $ (5,092) $ 107,367 $ 61,862 $ 90,578 $ (28,716) $ (30,790) $ 69,783 0 $ $ 107,367 $ 65,057 $ 85,801 $ (20,744) $ (13,935) $ 69,783 0 $ $ (30,790) 3,195 1,300 2,000 502 975 8,683 200 $ (13,935) T h e s t a t e m e n t s c o n t a i n e d i n t h i s r e p o r t t h a t a r e n o t p u r e l y h i s t o r i c a l a r e f o r w a r d - l o o k i n g s t a t e m e n t s . T h e s e s t a t e m e n t s i n c l u d e , b u t a r e n o t l i m i t e d t o , s t a t e m e n t s a b o u t o u r p l a n s , o b j e c t i v e s , e x p e c t a t i o n s , s t r a t e g i e s a n d i n t e n t i o n s a n d a r e g e n e r a l l y i d e n t i f i e d b y t h e w o r d s “ e x p e c t s , ” “ a n t i c i p a t e s , ” “ i n t e n d s , ” “ p l a n s , ” “ b e l i e v e s , ” “ s e e k s , ” “ e s t i m a t e s , ” a n d s i m i l a r e x p r e s s i o n s . B e c a u s e t h e s e f o r w a r d - l o o k i n g s t a t e m e n t s a r e s u b j e c t t o a n u m b e r o f r i s k s a n d u n c e r t a i n t i e s , o u r a c t u a l r e s u l t s c o u l d d i ff e r m a t e r i a l l y f r o m t h o s e e x p r e s s e d o r i m p l i e d b y t h e s e f o r w a r d - l o o k i n g s t a t e m e n t s . F a c t o r s t h a t c o u l d c a u s e o r c o n t r i b u t e t o s u c h d i ff e r e n c e s i n c l u d e , b u t a r e n o t l i m i t e d t o , t h o s e d i s c u s s e d u n d e r t h e h e a d i n g “ R i s k F a c t o r s ” i n t h e c o m p a n y ’s F o r m 1 0 - K f o r f i s c a l 2 0 0 2 a n d i n o t h e r d o c u m e n t s w e f i l e f r o m t i m e t o t i m e w i t h t h e S e c u r i t i e s a n d E x c h a n g e C o m m i s s i o n . A l l f o r w a r d l o o k i n g s t a t e m e n t s i n c l u d e d i n t h i s r e p o r t a r e b a s e d o n i n f o r m a t i o n a v a i l a b l e t o u s o n t h e d a t e h e r e o f . We a s s u m e n o o b l i g a t i o n t o u p d a t e a n y s u c h f o r w a r d - l o o k i n g s t a t e m e n t s . T h e c u s t o m e r n a m e s a n d t r a d e m a r k s u s e d w i t h i n t h i s A n n u a l R e p o r t a r e r e g i s t e r e d n a m e s , t r a d e n a m e s a n d t r a d e m a r k s o f t h e r e s p e c t i v e c o m p a n i e s . ® 2 0 0 2 F 5 N e t w o r k s , I n c . A l l r i g h t s r e s e r v e d . A N N U A L R E P O R T 2 0 0 2 F5 Networks, Inc. • 401 Elliott Avenue West • Seattle, WA 98119 • 206.272.5555 • www.f5.com © 2 0 0 2 F 5 N e t w o r k s I n c . A l l r i g h t s r e s e r v e d .