F5 Networks Dragged Down By Probes Into Stock-Option Backdating

I have a lot of admiration for F5 Networks. It is a company that made its mark initially during the Internet boom, developing and selling load-balancing switches for customers that wanted to capitalize on the tsunami that was Internet commerce. It customers were a who’s who of Web-based businesses, a few of which are still with us today.

Cisco Systems took aim at F5, concerned that the upstart might be able to parlay its toehold in load balancing into a bigger presence in network infrastructure. In most other markets, especially back then, when Cisco targeted its adversaries, it usually beat them to a bloody pulp. Witness what happened to Cabletron Networks, 3Com, and Bay Networks (subsequently subsumed by Nortel Networks) in enterprise networking.

But F5 Networks persevered, surviving not only Cisco but also enduring the deep, dark nuclear winter that followed the Internet bust. F5 diligently developed new features and functionality for its BIG-IP traffic-management switches, ensuring their usefulness for internal Web-based applications as well as for Internet storefronts.

More recently, recognizing that customers depend on its products for all facets of application availability and optimization, F5 made security and WAN-optimization acquisitions that added considerable value to its product portfolio. Security, as F5 knows, is integral to availability. If an application disrupted because of malicious traffic, enterprise continuity is broken and productivity suffers.

Cisco, which essentially folded its tent and had to lick its wounds after its first encounter with F5, is taking another run at the company, hoping to dislodge F5 from its position as the market’s leading vendor of application-acceleration equipment worldwide. Cisco, which once targeted F5 with its LocalDirector load balancer and its DistributedDirector WAN load balancer, is now competing against F5 with the Cisco Application Control Engine (ACE), a high-performance platform that integrates application delivery and security functions. If you look at presentations given by Cisco’s brass, you can see that Cisco identifies F5 as ACE’s primary competition.

So, F5 Networks deserves our respect. It has good management and products that have satisfied customers and stood the test of time, not to mention the onslaughts of an industry juggernaut.

That’s why it’s surprising to see the company temporarily staggered by the stock-option backdating phenomenon. F5 announced last night that it will restate its earnings for the past five years after an internal investigation into questionable stock-option practices turned up at least one disparity between the date options were awarded to an employee and the date those option grants should have been recorded.

As a result, F5 plans to restate earnings for fiscal years 2001 through 2005 and for the first two quarters of 2006. It also will be forced to delay the release of its fiscal third-quarter (which ended in June) financial results until its review of prior earnings is complete. The company says it is “unlikely” the review will be done in time for it to file its quarterly report by an August 14 deadline.

F5′s stock was down sharply in reaction to the news, even though the company tried to counterbalance the bad tidings by disclosing that revenue in its fiscal third quarter grew 37 percent, to $100.1 million from $73.1 million for the same period in 2005. The revenue number surpassed Wall Street’s estimate of $97.3 million, according to Thomson Financial. For it’s fourth quarter, which concludes September 30, F5 expects revenue of $104 million to $106 million, again beating analyst projections of about $103.4 million.

Good news, though, often gets overshadowed by bad news, and the uncertainty associated with stock-option backdating will hang over F5 like a black cloud. The company and its questionable stock-option practices are facing lawsuits as well as investigations by the U.S. Department of Justice and the Securities and Exchange Commission.

F5 needs to get these matters settled sooner rather than later. When you’re fighting against Cisco Systems, distractions of this magnitude are always unwelcome.

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