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Friday, July 21, 2006 - Page updated at 12:00 AM

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F5 to restate five years of results

Seattle Times business reporter

While a federal investigation into its stock-options practices continues, F5 Networks said Thursday an internal review has found at least one instance of improperly timed options.

As a result, F5 will restate more than five years of financial results, from fiscal 2001 through the first two quarters of 2006. The company did not specify the magnitude of the restatements or provide details but said the adjustments would likely affect income statements through 2005 and balance sheets through the present.

F5, one of dozens of companies named in a widening federal investigation, has received inquiries from the U.S. attorney in New York and the Securities and Exchange Commission seeking details on how it grants stock options to executives and others.

The Seattle company, which makes hardware and software for managing Internet traffic, also faces three shareholder lawsuits alleging its top executives and directors defrauded the company and its shareholders by receiving millions of improperly backdated stock options.

F5, like many other technology companies, actively used stock options as a form of compensation.

The SEC is trying to determine whether companies manipulated the grant dates of their options so that executives and other recipients could lock in profits.

Such manipulations could include backdating options to dates when the stock price was particularly low — a practice experts have likened to betting on a horse after the race is over; "spring-loading" options by granting them before the release of positive news; or waiting to issue options until after bad news has pushed down the stock price.

In admitting at least one case of improperly timed options, F5 said, "The accounting measurement date for option awards granted to certain employees, officers and directors of the company was different from the correct accounting measurement date determined under applicable accounting rules."

Just how widespread the problem was at F5 is still not known.

"They have used options fairly aggressively historically," said Erik Suppiger, networking and security specialist at Pacific Growth Equities. He does not own F5 stock and his company has no banking relationship with F5. "My presumption is that wherever they did this violation, it probably was across a pretty wide group of people," Suppiger said.

F5 Chief Executive John McAdam said he could not comment on the federal investigation but indicated the company expects a report on the internal review by its board members, assisted by independent attorneys. The review won't be done in time for F5 to publish financial statements for the third quarter by the SEC deadline of Aug. 14.

Legal and accounting fees associated with the inquiry cost the company $1.8 million in the third quarter, which ended June 30, and they will cost $4 million to $5 million next quarter, McAdam said.

Those legal fees are worrisome, analysts said, because it's not clear how long they will continue; they add about 10 percent to F5's operating expenses, which were about $45 million in the second quarter.

Other questions remained about whether the outcome of the investigation would have longer-term damage.

"We don't know which management team was in place," said Suppiger. "We also don't know if it was a repeated violation. So it definitely hurts the company's credibility, but to what degree is still yet to be determined."

A Seattle Times analysis of the company's financial reports and stock-price history shows several instances in which options were granted on the same day the stock was at a two-month low. Such coincidences may have raised investigators' suspicions.

From 2000 to 2002, at least three option grants were made at significant dips or before a price run-up.

For example, in its public filings, F5 has said McAdam received three options grants in 2001: 100,000 options on Jan. 1; 375,000 on March 16; and 270,000 on April 27.

The first grant was on the stock's lowest day within a two-month period; the second came after a steep fall in the share price; and the third shortly after F5 stock began what turned out to be a long rise.

Despite questions about its compensation practices, F5 sales showed strong momentum, rising 37 percent in the third quarter from the same time last year, to $100 million. The company said it expects sales from $104 million to $106 million in the fourth quarter.

F5 now has 1,010 full-time employees and is adding about 50 employees each quarter. It continues to make use of stock options to reward them.

F5 said it expects option costs for stock-based compensation to rise $3 million from this quarter, resulting from awards made to non-executive employees July 1.

Seattle Times business reporter Drew DeSilver contributed to this report.

Kristi Heim: 206-464-2718 or kheim@seattletimes.com

Copyright © 2006 The Seattle Times Company

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