Back to GetFilings.com
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
------------------
FORM 10-K
------------------
XX Annual report pursuant to Section 13 or 15(d) of theSecurities
- --------- Exchange Act of 1934, [FEE REQUIRED] for the fiscal year ended
December 31, 1997, or
Transition report pursuant to Section 13 or 15(d) of the Securities
- --------- Exchange Act of 1934, [NO FEE REQUIRED] for the transition period from
_____________ to ______________
Commission File Number 1-10139
-----------------------------
NETEGRITY, INC.
(Exact name of registrant as specified in its charter)
DELAWARE04-2911320
(State or other jurisdiction of(I.R.S. Employer
incorporation or organization)Identification No.)
245 Winter Street
Waltham, MA02154
(Address of principal executive offices)(Zip Code)
(781) 890-1700
(Registrant's Telephone Number)
Securities registered pursuant to Section 12(g) of the Act: NONE
-------------------------
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such other shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days XX Yes No
---- ----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, in
definitive proxy or information statements incorporated by reference in Part III
of this Form 10-K or any amendment to this Form 10-K [_____]
The aggregate market value of voting Common Stock held by non-affiliates of the
Registrant was approximately $16,251,106 based on the closing sale price of the
Registrant's Common Stock on March 20, 1998 as reported by the Nasdaq
Over-the-Counter Interdealer Automated Quotation System ($1.75 per share).
As of March 20, 1998 there were 9,286,346 shares of Common Stock outstanding.
PART I
ITEM 1. BUSINESS
THE COMPANY
Netegrity, Inc. ("Netegrity" or the "Company") designs, develops,
markets and supports Web security products combined with a full range of
professional services to integrate, implement and support its product offering.
The Company's customers are Fortune 2000 companies and smaller firms whose
business model is built on intensive Internet use. These companies are planning
for electronic commerce and building extranets to interact with their customers
and suppliers, or intranets to interact with their employees. Typical industries
include the financial services, high tech, manufacturing, telecommunications and
health care industries, as well as the government. Its dedicated focus on
intranet and extranet security enables the Company to help customers design
electronic business applications that allows them to securely exchange
mission-critical information. The Company also provides a broad range of
services revolving around its product offering that assist companies in securing
their overall computing environment.
Netegrity's SiteMinder -Registered Trademark- product enables
companies to securely distribute business information over the Web.
SiteMinder is an access control system for the Web that allows administrators
to centrally manage user access across multiple Web applications.
SiteMinder's tools enable Web developers to provide end-users with single
sign-on to a secure, personalized view of the information that they are
authorized to access. SiteMinder has been designed to be open and extensible
and work with leading security technologies, Web servers, and application
development platforms.
The Company has also been involved in the network security market
since 1994, when it became the first North American distributor and reseller of
Check Point Software Technologies, Ltd.'s ("Check Point") FireWall-1 -TM- Today,
the Company is a leading U. S. value-added reseller of FireWall-1,
distinguishing itself by providing comprehensive pre- and post-sales support and
consulting services.
BUSINESS STRATEGY
Netegrity's objective is to become a market leader in security
management for intranets and extranets, defined as the Web access control
market. This market is expected to grow dramatically as electronic commerce is
realized and companies begin to confidentially transact business over public
(Internet) networks. Early experience with the Internet and a clear
understanding of its customers' and their security requirements, have enabled
the Company to become a leading developer of access control products and
services. The following are key elements of the Company's strategy:
/ / Continue to enhance the SiteMinder product line. The Company
launched the latest version of SiteMinder, targeted at the Web
access control market, during the third quarter of fiscal 1997. It
plans to continue to enhance product features to meet its customers'
needs in deploying large-scale and complex transaction-based
intranets and extranets for conducting electronic business. The
Company plans to adapt the product for global markets by localizing
the product. In addition, it will continue to adopt the latest
industry standards and new technologies allowing for the deployment
of secure membership-based applications for the Web. Furthermore,
the Company expects to develop versions for other Web servers and
operating systems as market needs dictate. It plans on providing
access control for major database and commercially available lines
of business applications that are
2
integrated into intranets and extranets.
/ / Expand its product capabilities for additional Web server and
application server platforms. The Company expects to develop
versions for other Web servers and operating systems as market needs
dictate. It plans on providing access control for major business
applications that are integrated into intranets and extranets.
/ / Expand domestic distribution. The Company currently supports a
multi-channel domestic distribution strategy including a direct
sales force, a reseller/systems integrator channel and OEM
relationships. The Company plans to expand its sales force and
support organizations with the objective of gaining broad market
acceptance of its product through adoption into strategic accounts.
This will differentiate the Company's product from those of its
competitors and allow it to obtain insights into the future security
requirements of its customers. The Company is also focused on
building its reseller channel by establishing relationships with
systems integrators and consultants. The Company expects to continue
to establish strategic marketing and other third-party relationships
with vendors of Internet-related systems and application software.
/ / Expand international distribution channel. The Company began to
develop its international distribution channel in the fourth quarter
of fiscal 1997. It currently distributes its product in four major
European countries: the United Kingdom, Italy, The Netherlands, and
France. The Company is recruiting additional distributors in Europe
and intends to distribute to Asia as well.
/ / Continue to build its service offerings. The Company 's service
organization was launched in April, 1996 as a result of its
FireWall-1 customer support efforts. The Company offers fixed-price
services that assist companies in the integration, implementation
and support of the Company's products. With the addition of its
SiteMinder product, the Company plans to expand its offerings to
include system integration services to complement its product line.
/ / Maximize profitability of the firewall reseller business. The
Company will continue to sell FireWall- 1 and related services to
new and existing customers. It also plans to offer related
third-party network security products to its base of FireWall-1
customers.
MARKETS AND PRODUCTS
THE MARKET: The market for transacting business over the Internet is called the
electronic commerce market. An example of the growth of the electronic commerce
market is captured in a study by Piper Jaffray, which estimates that
Internet-based purchases will grow from under $1 million in 1996 to $228 million
by the year 2001. The business applications used in electronic commerce are
being segmented in two categories: extranets - used to do business with
customers and suppliers, and intranets - used to do business with employees.
Some of the initial business applications being developed for extranets and
intranets are in the areas of customer service and supply chain procurement.
These applications contain sensitive data that require controlled access. For
example, information such as, customer account status, financial account status,
personnel files, customer files, document distribution, and other critical
business information.
As a result of the growth in electronic commerce, the worldwide
information security market is expected to grow at a compound annual growth rate
of 55% over the next three 3 years, reaching over $5 billion. Unauthorized
access to data may go undetected by the computer user or system administrator,
especially if the information is not altered by the unauthorized party.
Companies are vulnerable not only to unauthorized access to information
resources by suppliers, customers and other third parties, but also to abuse by
employees within their own organizations. As employees change jobs and companies
change customers and partners, organizations must
3
be able to react quickly to modify or eliminate user access privileges.
To date, companies who have wanted to be on the leading edge of
deploying intranets and extranets have been forced to develop their own access
control solution. The opportunity now exists to replace these expensive and
labor-intensive proprietary solutions with a commercially developed and
supported product. With SiteMinder, the Company offers a low-cost and efficient
solution to the problem of access control of mission-critical information.
SITEMINDER -Registered Trademark-: SiteMinder is an access control system
that was developed to meet key requirements for building and managing secure
membership-based Web applications. It enables system administrators to manage
user access privileges across multiple intranet and extranet applications
from a centralized management system. As an open, standards-based platform,
SiteMinder works with leading security technologies, application development
environments, and Web servers.
SiteMinder provides Web site developers with tools to simplify the
development of these secure membership-based systems. Once an application is
SiteMinder enabled, end-users can enjoy the benefits of single sign-on to
secure, personalized content.
SiteMinder consists of two components, the SiteMinder Security
Manager and the SiteMinder Web Agent. The Security Manager is a Windows NT-based
server that provides authentication, authorization, and audit services for Web
applications. The SiteMinder Web Agent runs on industry standard Microsoft and
Netscape Web servers running on both Windows NT and Sun Solaris and extends the
SiteMinder Security Manager's services to these servers.
Pricing for the SiteMinder Security Manager is determined based on
the number of users licensed to access SiteMinder-enabled applications as well
as the number of SiteMinder Security Manager servers that a customer purchases.
Customers must also purchase the SiteMinder Web Agent for each Web server
secured by SiteMinder.
The Company receives revenue from the sale of SiteMinder from three
sources; the SiteMinder Security Manager, the SiteMinder Web Agent, as well as
add-on professional services. An initial deployment typically consists of one or
two servers and several Web Agents. The Company receives additional product and
services revenue as customers expand the number of end-users and/or the number
of SiteMinder installations.
Because the Company's plans call for SiteMinder to produce a
substantial portion of its future product and services revenue, any factor
adversely affecting sales of its products and services would have a material
adverse effect on the Company. The Company's future financial performance will
depend in part on the successful development, introduction and customer
acceptance of new and enhanced versions of its network security products and its
services. There can be no assurance that the Company will continue to be
successful in marketing its products or any new or enhanced products. In
addition, competitive pressures or other factors may result in significant price
erosion thereby having a material adverse effect on the Company's financial
condition or results of operations.
4
SALES, MARKETING AND SUPPORT
Sales: The Company directly markets its products and services domestically
through field sales and telemarketing and indirectly markets through other
resellers. Its sales strategy involves initially qualifying prospects to
determine their intranet and extranet plans and requirements, and then deploys a
solution-selling approach once customers are qualified. The Company's field
sales group conducts on-site meetings with accounts that have substantial
product and service requirements. The Company currently markets its product and
services to large, corporate customers that need to protect access to mission
critical information. A customer's decision to use Netegrity's products and
services may involve a substantial financial commitment including license costs,
maintenance fees, service fees and training, and in many cases the cost of
computer systems to implement intranets and extranets.
In addition to SiteMinder, the Company resells Check Point
Software's FireWall-1 product through a dedicated internal telesales
organization and a small group of resellers.
SUPPORT SERVICES: The Company believes that a customer's decision to purchase
products from the Company is based, in part, on the services provided by the
Company that help to quickly and effectively install, integrate and implement an
intranet/extranet solution, and to educate the customer's staff and support its
ongoing operations. It also provides another source of revenue for the Company.
Annual maintenance contracts are generally purchased for the first year of a
customer's use of the SiteMinder product and are renewable on an annual basis.
The Company offers its customers a variety of maintenance options, from
providing support during normal business hours to providing support 24-hours a
day, 7 days a week. Maintenance fees are typically equal to 20% of the list
price for the product.
The Company also offers its FireWall-1 customers a similar set of
support offerings, which has differentiated the Company from other resellers of
FireWall-1.
MARKETING: In support of its sales efforts, the Company conducts its own
marketing programs intended to position and promote its products and services.
Marketing activities include trade shows, direct mail, Internet marketing, and
public relations, as well as directing the Company's participation in industry
programs and forums. The Company also benefits from joint marketing programs
conducted with strategic partners, such as seminars, joint mailings, and lead
sharing.
MERCHANDISING AND CUSTOMERS
The Company markets its products and services to Web application
development managers of companies that need to share mission-critical
information with their customers, partners and employees. Typical industries
include the financial services, insurance, high tech, manufacturing,
telecommunications and health care industries, as well as the government to
secure information and systems against a wide range of security threats. Its
dedicated focus on intranet and extranet security enables the Company to help
clients design security solutions that effectively respond to ever-present and
constantly-arising security threats, while accommodating long-range,
enterprise-level technology goals.
The Company began shipping its SiteMinder product late in the third
quarter of 1997, and subsequently began recognizing revenues for the product
during the fourth quarter. Sales of its SiteMinder product and related
maintenance revenue represented 5% of the Company's revenues for the year ended
December 31, 1997, and 0% in 1996.
5
In addition to the sales and marketing of SiteMinder, the Company is
also a non-exclusive distributor of Check Point Software Technologies, Ltd.'s
FireWall-1 product. The Company sells FireWall-1 and its proprietary products
and services directly to end-users and through a channel of approximately 9
value added resellers in the U.S. These value added resellers and distributors
accounted for approximately 9% of the revenue achieved by the Company for the
year ended December 31, 1997. The Company also benefits from the marketing
programs conducted by Check Point. Many of Check Point's activities result in
the generation of qualified leads, some of which are provided to the Company.
The sale of Check Point's FireWall-1 and related maintenance revenue
represented 83% of the Company's revenues in the twelve-month period ended
December 31, 1997, and 72% for the same period in 1996. Sale of the Company's
services represented approximately 39% of revenues in the year ended December
31, 1997, and 28% in the same period in 1996.
CUSTOMERS: As of December 31, 1997, the Company licensed SiteMinder to 10
end-user customers. Its initial customers represent a broad cross-section of
industries including financial services, high-tech and the government. The
Company also signed 13 North American resellers and system integrators and
appointed distributors in four major European Countries. Its customers include
Fortune 1000 companies, telecommunication companies, major financial
institutions and large insurance companies. The Company has been able to
increase its customer base by combining post-sales support services, including
training and customer support. The Company expects that its customer base will
grow incrementally with the future releases of SiteMinder.
The Company has approximately 375 Check Point Software FireWall-1
customers and it continues to provide support to a large majority of these
customers. The Company also plans to offer related third-party network security
products to this base of customers.
No single customer, including direct end-users or resellers,
accounted for more than 10% of the Company's total revenues during each of the
years ended December 31, 1997, 1996 and 1995.
PURCHASING
The Company purchases 100% of its FireWall-1 product directly
through Check Point Software Technologies, Ltd. and purchases accompanying
hardware through various manufacturers and distributors, where it can receive
the most favorable prices. The Company has not experienced any material
difficulties or delays in acquiring any of the products that it distributes.
DISTRIBUTION AND BACKLOG
The Company generally ships product within 24 hours of the receipt
of an order from a customer. Consequently, backlog is currently not a material
factor.
6
COMPETITION
The market for Web access control will become highly competitive,
based on the anticipated growth of the market, and is subject to rapid
technological change. The Company believes that competition in this market is
likely to intensify as a result of the increasing demand for intranet and
extranet security products. Today, the main source of competition for the
Company is from its customers' internal information services departments that
have been building their own Web access solutions. The Company is also beginning
to experience competition from a number of sources including Gradient
Technologies, Inc.; Raptor Systems, Inc.; Secure Computing Corporation, and
enCommerce, Inc. Additional competition may develop as other companies in the
industry begin to offer similar security management products, and as the
Company's product offerings expand to other segments of the marketplace. Current
and potential competitors have established or may in the future establish
cooperative relationships among themselves or with third parties to increase the
availability of their products to the marketplace. Accordingly, it is possible
that new competitors or alliances may emerge and rapidly acquire significant
market share. The company's firewall reseller business experiences competition
from companies that compete with Check Point's FireWall-1 product such as Raptor
Systems, Inc.; Trusted Information Systems, Inc.; Cisco Systems, Inc.; as well
as other resellers of the FireWall-1 product. Many of the Company's current and
potential competitors have significantly greater financial, marketing, technical
and other competitive resources than the Company.
PRODUCT RESEARCH AND DEVELOPMENT
The market for Web security products is characterized by rapid
technological change, changes in customer requirements, new product
introductions and enhancements, and emerging industry standards. The Company
devotes significant time and resources analyzing and responding to changes in
the market such as changes in operating systems, application software, security
standards, networking software, and evolving customer requirements. For the year
ended December 31, 1997, the Company spent approximately $1,028,000, or 22% of
revenue, on research and development. The Company will continue its product
development efforts for its current products, as well as developing next
generation versions of its product line.
The Company believes its future success will depend in large part on
its ability to enhance and broaden its existing product line to meet the
evolving needs of the market. There can be no assurance that the Company will be
able to respond effectively to technological changes or new industry standards
or developments. In addition, the Company could be adversely affected if it were
to incur significant delays or be unsuccessful in developing new products or
enhancing its existing products, or if any such enhancements or new products do
not gain market acceptance. In addition, a number of factors, including the
timing of product introductions and enhancements by the Company or its
competitors, market acceptance of new products, or customer order deferrals in
anticipation of new products, may cause variations in the Company's future
operating results.
PROPRIETARY RIGHTS
The Company depends upon a combination of patent and trademark laws,
license agreements, non- disclosure and other contractual provisions to protect
proprietary and distribution rights in its products. In addition, the Company
attempts to protect its proprietary information and those of its vendors and
partners through confidentiality and/or license agreements with its employees
and others. Despite these precautions, it may be possible for unauthorized third
parties to obtain information that the Company regards as proprietary and/or
confidential.
Management believes that, due to the rapid pace of innovation within
the high-tech industry, factors such as technical and creative skills of its
personnel and ongoing reliable services and support are as important in
establishing and maintaining a leadership position within the industry as are
the various forms of legal protections.
7
EMPLOYEES
At December 31, 1997, the Company had a total of 40 full-time
employees, of which 8 were involved in research and development, 24 in sales,
marketing and customer support, and 8 in administration and finance. None of the
Company's employees are represented by a labor union. The Company has not
experienced any work stoppages and believes that its relationships with
employees are good.
ITEM 2. PROPERTIES
The Company's headquarters consists of two separate leased office
suites located at 245 Winter Street in Waltham, Massachusetts. The Company
occupies 5,760 square feet of space with current monthly payments of $8,880,
expiring in May, 2001. Additionally, the Company sub-leases 6,025 square feet of
office space in the same building with current monthly payments of $5,841,
expiring in May, 2001. The sub-lessor has the option to terminate the sub-lease
in March of 1998. As such, the Company has agreed to sublease additional office
space in their existing facility and plans to relocate to said space in April,
1998.
During 1997, the Company also entered into office leases in Los
Angeles, California and Chicago, Illinois to support field sales and consulting
staff. The Company believes that its present and proposed facilities are
adequate for its current needs and that suitable alternative space will be
available should it need to expand.
ITEM 3. LEGAL PROCEEDINGS
From time to time, the Company is involved in litigation relating to
claims arising out of its operations in the normal course of business.
The Company is currently a defendant in two legal proceedings. The
first case involves a suit and countersuit between the Company and Programmer's
Paradise, Inc. ("PPI") of Shrewsbury, New Jersey. The proceedings are intended
to resolve a valuation dispute of approximately $1,100,000 related to the Net
Assets Transferred to PPI during the 1996 divestiture of The Software
Developer's Company, Inc.
The Company is also a defendant in a suit brought by Lemma, Inc. a
consulting firm doing business in Massachusetts. The suit was filed over a
dispute on amounts due to Lemma, Inc. under a 1996 consulting contract of
approximately $33,000. Lemma is also claiming trebled damages.
The Company's management believes that neither of these cases will
have a material adverse effect on the Company's results of operations or
financial position. At this time, the Company cannot predict the outcome of
these cases.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders, whether
through the solicitation of proxies or otherwise, during the quarter ended
December 31, 1997.
8
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
The Company's Common Stock is traded principally on the NASDAQ
SmallCap Market(sm) tier of the NASDAQ Stock Market(sm) under the symbol "NETE"
and is also traded on the Boston Stock Exchange under the symbol "NTY." The
following table sets forth the range of quarterly high and low bid quotations
for the Company's Common Stock as reported by NASDAQ. The quotations represent
interdealer quotations without adjustment for retail markups, markdowns or
commissions, and may not necessarily represent actual transactions.
QUARTERLY 1996 QUOTATIONS HIGH TRADE LOW TRADE
------------------------- ---------- ---------
January 1, 1996- March 31, 1996 $1.938 $1.250
April 1, 1996-June 30, 1996 $5.813 $1.563
July 1, 1996-September 30, 1996 $3.625 $1.938
October 1, 1996-December 31, 1996 $3.125 $1.875
QUARTERLY 1997 QUOTATIONS HIGH TRADE LOW TRADE
------------------------- ---------- ---------
January 1, 1997- March 31, 1997 $4.000 $1.813
April 1, 1997-June 30, 1997 $2.813 $1.250
July 1, 1997-September 30, 1997 $2.688 $1.125
October 1, 1997-December 31, 1997 $2.063 $1.156
As of December 31, 1997, there were 123 holders of record and
approximately 1,400 beneficial owners of the Company's 9,279,346 shares of
Common Stock outstanding. The Company estimates that approximately 1,300
shareholders hold securities in street name.
On January 6, 1998, the Company entered into a transaction with Pequot
Private Equity Fund, L.P. and Pequot Offshore Private Equity Fund, Inc. which is
exempt from Federal Registration pursuant to Section 4(2) of the Securities Act
of 1933, as amended. See Item 7 hereof for a detailed discussion of the
transaction.
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial information should be
reviewed in conjunction with Item 7 Management's Discussion and Analysis of
Financial Condition and Results of Operations and the Consolidated Financial
Statements and Notes thereto in Item 8 of this report.
9
STATEMENT OF OPERATIONS DATA
(in thousands, except per share data)
Twelve-Month Nine-Month
Fiscal Year Transition Period Twelve-Month
Ended Ended Fiscal year
December 31, December 31, Ended March 31,
------------ ------------- ---------------------------------------
1997 1996 1996 1995 1994
------------ ------------- ------- ------- ---------
INCOME STATEMENT DATA:
Net revenues $4,733 $3,637 $3,725 $959 --
Cost of revenues 2,470 2,176 2,173 488 --
------- ------- ------- ------- ---------
Gross profit 2,263 1,461 1,552 471 --
Selling, general and administrative expenses 5,509 2,303 1,178 305 --
Research and development costs 1,028 705 -- -- --
------- ------- ------- ------- ---------
Income (loss) from operations (4,274) (1,547) 374 166 --
Interest income (expense) 203 181 20 (1) --
Share of loss from investment in
Encotone, Inc. (132) (40) -- -- --
Writeoff of investment in Encotone, Ltd. (1,049) -- -- -- --
Income (loss) from continuing operations (5,252) (1,406) 394 165 --
Income (loss) from operation of
discontinued operations -- (520) (240) 31 $(270)
Gain on sale of assets of discontinued operations -- 6,000 -- -- --
------- ------- ------- ------- ---------
Income before provision for income taxes 5,252 4,074 154 196 (270)
Provision for income taxes -- 74 25 -- --
Net income $(5,252) $4,000 $129 $196 $(270)
------- ------- ------- ------- ---------
------- ------- ------- ------- ---------
Basic Earnings Per Share:
From continuing operations $(0.57) $(0.16) $0.05 $0.02 $(0.06)
From operation of discontinued
operations -- (0.06) (0.03) -- --
Gain on sale of assets -- 0.67 -- -- --
------- ------- ------- ------- ---------
Net income (loss) per share $(0.57) $0.45 $0.02 $0.02 $(0.06)
------- ------- ------- ------- ---------
------- ------- ------- ------- ---------
Weighted average shares outstanding 9,279 8,944 8,354 8,688 4,833
Diluted Earnings Per Share:
From continuing operations $(0.57) $(0.16) $0.04 $0.02 $(0.06)
From operation of discontinued
operations -- (0.06) (0.03) -- --
Gain on sale of assets -- 0.67 -- -- --
------- ------- ------- ------- ---------
Net income (loss) per share $(0.57) $0.45 $0.01 $0.02 $(0.06)
------- ------- ------- ------- ---------
------- ------- ------- ------- ---------
Weighted average shares outstanding 9,279 8,944 8,835 8,688 4,833
10
Twelve-Month Nine-Month
Fiscal Year Transition Period Twelve-Month
Ended Ended Fiscal year
December 31, December 31, Ended March 31,
------------ ------------ ------------------------
1997 1996 1996 1995 1994
------------ ------------ ---- ---- ----
BALANCE SHEET DATA:
Working capital (deficit) $9 $4,629 $401 $651 $280
Total assets 4,849 10,259 9,170 7,127 6,929
Long-term liabilities -- -- 187 300 385
Stockholders' equity 1,016 6,149 1,903 1,950 1,701
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The Private Securities Litigation Reform Act of 1995 contains certain safe
harbors regarding forward-looking statements. In that context, the discussion in
this Item contains forward-looking statements which involve certain degrees of
risk and uncertainties, including statements relating to liquidity and capital
resources. Except for the historical information contained herein, the matters
discussed in this item are such forward-looking statements that involve risks
and uncertainties, including the impact of competitive pricing within the
software industry, the effect any reaction to such competitive pressures has on
current inventory valuations, the need for and effect of any business
restructuring, the presence of competitors with greater financial resources,
capacity and supply constraints or difficulties, and the Company's continuing
need for improved profitability and liquidity.
A portion of the following overview reflects the divestiture of the
Company's catalog related business in June 1996. Any comments relating to
operating results or issues are reflective of the continuing network security
business. The Company's revenues were generated by the sale of network security
products, integration and support services to companies doing business on the
Internet and internal networks. The divestiture of the Company's catalog related
business is recorded as discontinued operations in the accompanying financial
statements contained in Item 8.
The Company plans to develop and introduce new products to address the
changing needs of the evolving network security market. There can be no
assurance that the Company will be able to develop new products or that such
products will achieve market acceptance, or, if market acceptance is achieved,
that the Company will be able to maintain such acceptance for a significant
period of time.
11
OVERVIEW
The following information should be read in conjunction with the
consolidated financial statements and notes thereto:
% To Net Revenues
---------------------------------------------------------
Twelve-Month Nine-Month
Fiscal Year Transition Period Twelve-Month
Ended Ended Fiscal Year
December 31, December 31, Ended March 31,
1997 1996 1996 1995
------------- ------------ ---- ----
Net Revenues 100% 100% 100% --
Gross Margin 48% 40% 42% 49%
Selling, general and administrative expenses 116% 63% 32% 32%
Research and development costs 22% 19% -- --
Income (loss) from operations (90%) (42%) 10% 17%
TWELVE-MONTH FISCAL YEAR ENDED DECEMBER 31, 1997 VS. NINE-MONTH TRANSITION
PERIOD ENDED DECEMBER 31, 1996
The sale of Check Point's FireWall-1 and related maintenance revenue
represented 83% of the Company's revenues in the twelve-month period ended
December 31, 1997, and 72% for the nine-month transition period ended December
31, 1996. Sale of the Company's services represented approximately 11% of
revenues in the year ended December 31, 1997, and 28% in nine-month transition
period ended December 31, 1996.
ASSET SALE: As of June 28, 1996, the Company completed the divestiture of its
catalog related business, consisting of The Programmer's SuperShop ("TPS")
catalog, the TPS Web site, the corporate sales group, SDC Germany and SDC
Communications. The Company completed the transaction for an aggregate price of
$10,035,000. The aggregate price consisted of payment of $9,300,000 in
immediately available funds and the deposit of $735,000 under an escrow
arrangement. During August, 1996, $135,000 of the escrow was returned to the
Company.
The aggregate price of $10,035,000 was in exchange for the Company's
tangible net assets of the catalog related business that at the time was
estimated at approximately $1,500,000. The values of these net assets are
currently being evaluated by a third party, and the Company expects that any
purchase price adjustments that could occur as a result of the evaluation will
have no material impact on the financial position or results of operations
presented herein.
The Company incurred $2,587,000 in expenses and write-offs related to the
divestiture. These expenses were primarily comprised of write-off of goodwill,
severance costs, professional fees, buy-outs of capital leases, and facility
shut-down costs for its corporate offices and distribution facility. The Company
reported a gain of $6,000,000 from the sale of the assets of its catalog related
business. The Company will utilize a portion of its available operating loss
carryforwards to decrease the amount of Federal and State corporate income
taxes.
CHANGE IN FISCAL YEAR: In 1996, the Company elected to change its fiscal year to
coincide with the calendar year. Prior to the change, the Company's fiscal year
ended on March 31. As a result, the Company had a nine-month transition period
from April 1, 1996 to December 31, 1996, between fiscal years.
ACTUAL AND PRO-FORMA RESULTS OF OPERATIONS: The following table presents a
comparison summary of fiscal year
12
1997 actual and twelve-months ended December 31, 1996 unaudited pro-forma
results for informational purposes only. This information is not necessarily
indicative of either financial position, or results of operations in the future,
or what would have occurred had the events described in the paragraph under
"Change in Fiscal Year" had not occurred. The following information should be
read in conjunction with the audited Consolidated Financial Statements of the
Company presented herein.
Actual Unaudited Pro-Forma
Twelve-Months Ended Twelve Months Ended
December 31, 1997 December 31, 1996
--------------------------- -----------------------
Percent to Percent to
Dollars Net Revenue Dollars Net Revenue
------- ----------- ------- -----------
Net revenue $4,732,649 100% $4,965,948 100%
Gross margin 2,262,758 48% 2,035,274 41%
Selling, general and administrative expenses 5,508,813 116% 2,702,264 54%
Research and development costs 1,028,094 22% 705,298 14%
Income (loss) from operations (4,274,149) (90%) (1,372,288) (28%)
FISCAL YEAR ENDED DECEMBER 31, 1997 VS. PRO-FORMA TWELVE MONTHS ENDED DECEMBER
31, 1996
REVENUES: Total net revenues decreased by $233,000, or 5%, to $4,733,000 in the
twelve months ended December 31, 1997 from $4,966,000 during the twelve-month
period ended December 31, 1996. The decrease in revenues resulted from Company's
decision to eliminate hardware sales and limit its Check Point FireWall-1
distribution. This decrease was offset by revenues achieved by the Company's
sale of its SiteMinder product in the fourth quarter.
GROSS MARGIN: Total gross margin increased by $227,000, or 11%, to $2,263,000 in
the fiscal year ended December 31, 1997 as compared to $2,035,000 in the
twelve-month period ended December 31, 1996. The increase in gross margin is
attributable to the Company's elimination and reduction of low-margin business
as described above and the sale of its proprietary SiteMinder product beginning
in the fourth quarter of 1997.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE: Selling, general and administrative
("SG&A") expenses increased by $2,807,000, or 104%, to $5,509,000 in the fiscal
year ended December 31, 1997 from $2,702,000 in the twelve-month period ended
December 31, 1996. This increase was a result of the Company building its
management and development staff infrastructure to bring to market its
SiteMinder product line and address the growing network security marketplace.
RESEARCH AND DEVELOPMENT COSTS: Research and Development costs (net of
capitalized software) increased by $323,000, or 46% to $1,028,000 in fiscal 1997
as compared to $705,000 in the twelve-month period ended December 31, 1996. The
Company is continuing the development of new products to address the changing
needs of the evolving network security market. Certain research and development
expenditures are incurred substantially in advance of the related revenue, and
in some cases, do not generate revenue. In fiscal 1997, $310,000 (net of
amortization) of research and development expenditures were capitalized as a
result of the Company realizing technological feasibility.
13
LIQUIDITY AND CAPITAL RESOURCES
(in thousands, except ratios)
Twelve-Month Nine-Month
Year Ended Transition Period
Ended December 31, Ended December 31,
1997 1996
---- ----
Cash and cash equivalents $2,134 $6,791
Working capital 9 4,629
Current ratio 1.00 2.13
Net cash (used for) continuing operating activities $(4,998) $(2,207)
Net cash (used for) provided by discontinued
operating activities (41) 437
Net cash provided by investing activities 276 7,928
Net cash provided by (used for) financing activities 106 (784)
For the fiscal year ended December 31, 1997, the Company's net cash flow
from continuing operations decreased by $4,998,000. This decrease was primarily
a result of the Company's loss from continuing operations, which included
research and development costs of $1,337,000.
Working capital decreased to $9,000 at December 31, 1997 from $4,629,000
at December 31, 1996. This decrease was a direct result of the Company's loss
from continuing operation.
On January 6, 1998, the Company, entered into a Preferred Stock and
Warrant Purchase Agreement (the "Agreement") with Pequot Private Equity Fund,
L.P., a Delaware limited partnership ("PPEF") and Pequot Offshore Private Equity
Fund, Inc., a British Virgin Islands corporation (together with PPEF, the
"Pequot Entities"). Pursuant to the terms of the Agreement, on January 7, 1998,
the Company sold 1,666,667 shares of Series D Preferred Stock, at $1.50 per
share, and 750,393 Warrants to the Pequot Entities for an aggregate purchase
price of $2,500,000.50. The Series D Preferred Stock is automatically
convertible into Common Stock on a one-for-one basis, subject to adjustment. In
addition, the Series D Preferred Stock is subject to mandatory conversion into
Common Stock upon certain circumstances. Pursuant to the Agreement, the Pequot
Entities intend to make a second $2.5 million investment following the next
release of the Company's SiteMinder product, subject to certain terms and
conditions as indicated in the Company's Form 8-K filed on January 15, 1998. As
part of the transaction, James McNiel is joined the Board of Directors of the
Company, as designee of the Pequot Entities, and has agreed to provide certain
consulting services to the Company. In connection with such service, the Company
granted Mr. McNiel warrants for the purchase of 100,000 shares of Common Stock.
Management believes that this financing, together with cash generated from
operations will be adequate to support the business operation for fiscal year
1998.
INFLATION: To date, management believes that inflation has not had a material
impact on operations.
ENVIRONMENTAL LIABILITY: The Company has no known environmental violations and
assessments.
YEAR 2000: The Company at present does not believe the cost of implementing any
changes to address Year 2000 issues will have a material effect on the Company's
results of operations or financial conditions. However, there can be no
assurance that there will not be a delay in, or significantly increased costs
associated with, the implementation of any necessary changes, and the Company's
inability to implement such changes could have an adverse effect on future
results of operations.
14
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's consolidated financial statements and the related auditors'
reports are presented in the following pages. The consolidated financial
statements filed in this Item 8 are as follows:
- - Report of Independent Auditors
- - Consolidated Balance Sheets - December 31, 1997 and 1996
- - Consolidated Statements of Operations for the fiscal year ended December
31, 1997, the nine-month transition period ended December 31, 1996, and
the fiscal year ended March 31, 1996
- - Consolidated Statements of Stockholders' Equity for the fiscal year ended
December 31, 1997, the nine-month transition period ended December 31,
1996, and the fiscal year ended March 31, 1996
- - Consolidated Statements of Cash Flows for the fiscal year ended December
31, 1997, the nine-month transition period ended December 31, 1996, and
the fiscal year ended March 31, 1996
- - Notes to Consolidated Financial Statements
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
Not applicable.
15
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of
Netegrity, Inc.
We have audited the accompanying consolidated balance sheets of
Netegrity, Inc. as of December 31, 1997 and December 31, 1996 and the related
consolidated statements of operations, stockholders' equity and cash flows
for the fiscal year ended December 31, 1997, the nine-month transition period
ended December 31, 1996 and the fiscal year ended March 31, 1996. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Netegrity, Inc. as of December 31, 1997 and December 31, 1996 and the
consolidated results of its operations and its cash flows for the fiscal year
ended December 31, 1997, the nine-month transition period ended December 31,
1996 and the fiscal year ended March 31, 1996 in conformity with generally
accepted accounting principles.
COOPERS & LYBRAND, L.L.P.
Boston, Massachusetts
February 13, 1998
16
NETEGRITY, INC.
CONSOLIDATED BALANCE SHEETS
December 31,
1997 1996
---- ----
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $2,133,586 $6,791,057
Escrow receivable (Note G) 600,000 600,000
Accounts receivable-trade, net of allowance for doubtful
accounts of $64,460 and $67,797 at December 31, 1997
and 1996, respectively 791,369 787,780
Other current assets 312,971 559,230
----------- -----------
TOTAL CURRENT ASSETS 3,837,926 8,738,067
EQUIPMENT AND LEASEHOLD IMPROVEMENTS, NET (Note B) 585,055 287,323
Capitalized software costs, net 309,891 --
OTHER ASSETS:
Investment in Encotone, LTD (Note C) -- 1,000,000
Investment in Encotone, Inc. (Note C) 78,199 210,000
Other 37,438 23,360
----------- -----------
TOTAL OTHER ASSETS 115,637 1,233,360
----------- -----------
TOTAL ASSETS $4,848,509 $10,258,750
----------- -----------
----------- -----------
The accompanying notes are an integral part of the consolidated financial
statements.
17
NETEGRITY, INC.
CONSOLIDATED BALANCE SHEETS (CONT.)
December 31,
1997 1996
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable-trade $1,507,071 $2,099,436
Other accrued expenses 2,022,949 1,895,685
Accrued compensation 279,722 114,205
Current portion of capitalized lease obligations 19,068 --
------------ ------------
TOTAL CURRENT LIABILITIES 3,828,810 4,109,326
LONG-TERM CAPITAL LEASE OBLIGATIONS 3,653 --
------------ ------------
TOTAL LIABILITIES 3,832,463 4,109,326
COMMITMENTS AND CONTINGENCIES (Note E) -- --
STOCKHOLDERS' EQUITY:
Common stock, voting, $.01 par value, authorized 25,000,000 shares: 9,279,346
shares issued and 9,254,245 shares outstanding at December 31, 1997;
9,204,946 shares issued
and 9,179,845 shares outstanding at December 31, 1996 92,793 92,049
Additional paid-in capital 10,578,330 10,460,554
Cumulative translation adjustment 28,028 28,028
Cumulative deficit (9,399,448) (4,147,550)
Loan to officer (Note F) (200,000) (200,000)
------------ ------------
1,099,703 6,233,081
Less - Treasury Stock, at cost: 25,101 shares (83,657) (83,657)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 1,016,046 6,149,424
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $4,848,509 $10,258,750
------------ ------------
------------ ------------
The accompanying notes are an integral part of the consolidated financial
statements.
18
NETEGRITY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
December 31, December 31, March 31,
1997 1996 1996
(Twelve Months) (Nine Months) (Twelve Months)
--------------- ------------- ---------------
Net revenues $4,732,649 $3,637,037 $3,724,757
Cost of revenues 2,469,891 2,175,626 2,172,734
----------- ----------- -----------
Gross profit 2,262,758 1,461,411 1,552,023
Selling, general and administrative expenses 5,508,813 2,303,478 1,177,438
Research and development costs 1,028,094 705,298 --
----------- ----------- -----------
Income (loss) from operations (4,274,149) (1,547,365) 374,585
Interest income (expense) 203,205 181,881 20,010
Share of loss from investment in Encotone, Inc. (131,801) (40,000) --
Write off of investment in Encotone LTD (1,049,151) -- --
----------- ----------- -----------
Income (loss) from continuing operations (5,251,896) (1,405,484) 394,595
Income (loss) from discontinued operations -- (520,245) (240,477)
Gain on sale of assets of discontinued operations -- 6,000,000 --
----------- ----------- -----------
Income before provision for income taxes (5,251,896) 4,074,271 154,118
Provision for income taxes -- 74,300 25,200
----------- ----------- -----------
NET INCOME (LOSS) $(5,251,896) $3,999,971 $128,918
----------- ----------- -----------
----------- ----------- -----------
Basic Earnings Per Share:
From continuing operations $(0.57) $(0.16) $0.05
From operation of discontinued
operations -- (0.06) (0.03)
Gain on sale of assets -- 0.67 --
----------- ----------- -----------
Net income (loss) per share $(0.57) $0.45 $0.02
----------- ----------- -----------
----------- ----------- -----------
Weighted average shares outstanding 9,279,000 8,944,000 8,354,000
Diluted Earnings Per Share:
From continuing operations $(0.57) $(0.16) $0.04
From operation of discontinued
operations -- (0.06) (0.03)
Gain on sale of assets -- 0.67 --
----------- ----------- -----------
Net income (loss) per share $(0.57) $0.45 $0.01
----------- ----------- -----------
----------- ----------- -----------
Weighted average shares outstanding 9,279,000 8,944,000 8,835,000
The accompanying notes are an integral part of the consolidated financial
statements.
19
NETEGRITY, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Series C Additional Cumulative Total
Preferred Common Paid-in Translation Cumulative Loan to Treasury Stockholders'
Stock Stock Capital Adjustment Deficit Officer Stock Equity
-------- ------- ----------- ----------- ----------- --------- -------- -----------
BALANCE AT MARCH 31, 1995 $9,060 $77,875 $9,944,908 $22,242 $(8,020,439) -- $(83,657) $1,949,989
Net income -- -- -- -- 128,918 -- -- 128,918
Conversion of Preferred Stock
(277,638 shares) - Series C (2,777) 2,777 -- -- -- -- -- --
Issuance of Common Stock
(410,450 shares) -- 1,327 79,802 -- -- -- -- 81,129
Translation adjustment -- -- -- (673) -- -- -- (673)
Distributions -- -- -- -- (256,000) -- -- (256,000)
-------- ------- ----------- ----------- ----------- --------- -------- -----------
BALANCE AT MARCH 31, 1996 $6,283 $81,979 $10,024,710 $21,569 $(8,147,521) -- $(83,657) $1,903,363
Net income -- -- -- -- 3,999,971 -- -- 3,999,971
Conversion of Preferred Stock
(628,330 shares) - Series C (6,283) 6,283 -- -- -- -- -- --
Issuance of Common Stock
(378,729 shares) -- 3,787 435,844 -- -- -- -- 439,631
Translation adjustment -- -- -- 6,459 -- -- -- 6,459
Loan to officer (Note F) -- -- -- -- -- $(200,000) -- (200,000)
------- ----------- ----------- ----------- --------- -------- -----------
BALANCE AT DECEMBER 31, 1996 -- $92,049 $10,460,554 $28,028 $(4,147,550) $(200,000) $(83,657) $6,149,424
-------- ------- ----------- ----------- ----------- --------- -------- -----------
-------- ------- ----------- ----------- ----------- --------- -------- -----------
Net income -- -- -- -- (5,251,896) -- -- (5,251,896)
Issuance of Common Stock
(74,400 shares) -- 744 117,776 -- -- -- -- 118,520
Translation adjustment -- -- -- -- -- -- -- --
------- ----------- ----------- ----------- --------- -------- -----------
BALANCE AT DECEMBER 31, 1997 -- $92,793 $10,578,330 $28,028 $(9,399,446) $(200,000) $(83,657) $1,016,048
-------- ------- ----------- ----------- ----------- --------- -------- -----------
-------- ------- ----------- ----------- ----------- --------- -------- -----------
The accompanying notes are an integral part of the consolidated financial
statements.
20
NETEGRITY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
December 31, December 31, March 31,
1997 1996 1996
(Twelve Months) (Nine Months) (Twelve Months)
--------------- ------------- ---------------
OPERATING ACTIVITIES
Net (loss) income from continuing operations $(5,251,896) $(1,405,484) $394,595
Adjustments to reconcile income (loss) to
net cash provided by (used for) operating activities:
Share of loss from investment 131,801 40,000 --
Write off of investment in Encotone, LTD 1,049,151 -- --
Depreciation and amortization 116,187 26,487 7,646
Provision for doubtful accounts receivable, net (3,337) 56,771 11,026
Change in operating assets and liabilities:
Escrow receivable -- (600,000) --
Accounts receivable (252) 137,935 (671,897)
Inventory -- 21,400 (21,400)
Other current assets 246,259 389,156 (117,249)
Other assets (14,078) 52,053 (20,204)
Accounts payable (592,364) 622,784 989,922
Other accrued expenses 292,781 (1,542,083) 465,796
Intangible assets -- -- 134,014
----------- ----------- -----------
Total adjustments 1,226,148 (801,497) 783,654
----------- ----------- -----------
Net cash (used for) provided by
continuing operating activities (4,025,748) (2,206,981) 1,188,249
Net cash provided by discontinued
operating activities (46,241) 436,859 779,625
----------- ----------- -----------
Net cash (used for) provided by
operating activities $(4,071,989) $(1,770,122) $1,967,874
----------- ----------- -----------
The accompanying notes are an integral part of the consolidated financial
statements.
21
NETEGRITY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONT.)
December 31, December 31, March 31,
1997 1996 1996
(Twelve Months) (Nine Months) (Twelve Months)
--------------- ------------- ---------------
INVESTING ACTIVITIES:
Proceeds from sale of certain assets -- $9,435,000 --
Capitalized software costs $(309,891) -- --
Capital expenditures for equipment and
leasehold improvements (384,458) (256,886) $(239,824)
Investment in Encotone, LTD -- (1,000,000) --
Investment in Encotone, Inc. -- (250,000) --
----------- ----------- -----------
Net cash provided by (used for)
investing activities $(694,349) $7,928,114 $(239,824)
----------- ----------- -----------
FINANCING ACTIVITIES:
Net proceeds from issuance of stock 118,520 239,631 8,485
Payment on notes payable-related party -- (300,000) --
Net payments on line of credit -- (723,470) (700,000)
Principal debt payments -- -- (22,092)
Principal payments under capital leases (9,653) -- (44,711)
Distributions to ISC shareholder -- -- (231,000)
----------- ----------- -----------
Net cash used for financing activities 108,867 (783,839) (989,318)
----------- ----------- -----------
Effect of exchange rate changes on cash -- 6,459 (673)
NET INCREASE IN CASH AND
CASH EQUIVALENTS (4,657,471) 5,380,612 738,059
Cash and cash equivalents at beginning of year 6,791,057 1,410,445 672,386
----------- ----------- -----------
CASH AND CASH EQUIVALENTS
AT END OF YEAR $2,133,586 $6,791,057 $1,410,445
----------- ----------- -----------
----------- ----------- -----------
Supplemental Disclosures of Cash Flow Information:
Interest paid 3,143 17,778 162,887
Income taxes paid $63,557 -- --
----------- ----------- -----------
----------- ----------- -----------
Supplemental Disclosure of Non-Cash Activities:
Loan to officer in exchange for common stock -- $200,000 --
Write-off of investment in Encotone LTD $1,049,151 -- --
Non-cash distributions to ISC shareholder -- -- $25,000
Property purchased under capital leases 32,374 -- 317,847
Collection of products in satisfaction of accounts
receivable-product -- -- $693,273
----------- ----------- -----------
----------- ----------- -----------
The accompanying notes are an integral part of the consolidated financial
statements.
22
NETEGRITY, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A: NATURE OF THE BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
OPERATIONS: The Company currently operates in the network security market.
During June, 1996, the Company completed a full divestiture of its catalog
business and changed its name from The Software Developer's Company, Inc. to
Netegrity, Inc. The results of operations of the divested catalog business is
presented as discontinued operations herein.
PRINCIPLES OF CONSOLIDATION: The financial statements of the Company also
include the accounts and operations of its subsidiaries, Software Developers
Company, GmbH ("SDC Germany") and Personal Computing Tools (PCT). The Company
acquired 94% of the outstanding capital stock of PCT on June 29, 1993. The 6%
equity interest in PCT not acquired by the Company would be shown as minority
interest in the December 31, 1996 and March 31, 1996 consolidated balance sheets
and the statements of operations for the nine-month transition period ended
December 31, 1996 and the fiscal years ended March 31, 1996 and 1995,
respectively. As of June 30, 1996, the Company discontinued all operations
related to its SDC Germany and PCT catalog operation. The operating loss
incurred in 1996 is accounted for in loss from discontinued operations.
The Company accounts for its investment in Encotone, Inc. under the equity
method of accounting (see Note C), and accordingly, the Company's share of the
equity and net loss from operations for the periods ended December 31, 1997 and
1996 are consolidated into these financial statements.
CASH AND CASH EQUIVALENTS: Cash and cash equivalents include time deposits with
a maturity of three months or less at the date of purchase.
CONCENTRATION OF CREDIT RISK: Financial instruments that potentially subject the
Company to concentration of credit risk consist primarily of cash and cash
equivalents and trade receivables. The Company restricts investment of temporary
cash investments to financial institutions with high credit standing. Credit
risk on trade receivables is minimal.
REVENUE RECOGNITION: The Company's revenues from continuing operations are
primarily generated from the sale of its proprietary SiteMinder products and
services and from licensing the rights to use software products developed by
Checkpoint Software Technologies, Ltd. to end users and resellers. The Company
generates its services revenue from consulting and training services performed
for customers and from support and software update rights (i.e., maintenance).
Revenues from perpetual software license agreements are recognized as revenue
upon delivery of the software as long as there are no significant post-delivery
obligations.
Revenues for maintenance are recognized ratably over the term of the
support period. If maintenance is included in a license agreement, such amounts
are unbundled from the license fee at their fair market value based on the value
established by independent sale of such maintenance to customers. Consulting
revenues are primarily related to implementation services performed under
separate service arrangements related to the installation of software products.
Such services do not include customization or modification of the underlying
software code. If included in a license agreement, such services are unbundled
at their fair market value based on the value established by the independent
sale of such services to customers. Revenues from consulting and training
services are recognized as the services are performed.
In October, 1997, the American Institute of Certified Public Accountants
issued a Statement of Position (SOP) 97-2, "Software Revenue Recognition." The
Company intends to adopt this pronouncement and does not
23
expect it to have a material affect on the revenue recognition practices of the
Company.
CAPITALIZATION OF SOFTWARE COSTS: The Company capitalizes certain internally
generated software development costs after technological feasibility of the
product has been established. Such costs are amortized over the estimated life
of the product. The Company continually compares the unamortized costs of
capitalized software to the expected future revenues for the products. If the
unamortized costs exceed the expected future net realizable value, the excess
amount is written off. At December 31, 1997, the Company amortized $34,298 of
software development costs.
EQUIPMENT AND LEASEHOLD IMPROVEMENTS: Equipment and leasehold improvements are
stated at cost, less accumulated depreciation and amortization. Depreciation is
provided using the straight-line method over estimated useful lives from five to
seven years. Amortization of leasehold improvements is provided using the
straight-line method over the lives of the respective leases or the useful lives
of the improvements, whichever is shorter.
Maintenance and repairs are charged to operations as incurred. Renewals
and betterments which materially extend the life of assets are capitalized and
depreciated. Upon disposal, the asset cost and related accumulated depreciation
are removed from their respective accounts. Any resulting gain or loss is
reflected in earnings.
CUSTOMER ADVANCES: Prepayments made by customers are included as customer
advances and recorded as sales when shipments are made.
INCOME TAXES: The Company follows Statement of Financial Accounting Standards
("SFAS") No. 109 "Accounting for Income Taxes." Under SFAS No. 109, deferred tax
assets and liabilities are recognized for the unexpected future tax consequences
of events that have been included in the financial statements or tax returns.
The amount of deferred tax asset or liability is based on the difference between
the financial statement and tax bases of assets and liabilities using enacted
tax rates in effect for the year in which the differences are expected to
reverse.
INVESTMENTS: Investments in equity securities, other than investments accounted
for by the equity method are recorded at cost. Management determines the
appropriate classification of its investments at the time of purchase and
reevaluates such determinations, as well as potential impairments of value on a
periodic basis, but at a minimum, quarterly.
MARKETING EXPENSES: Marketing expenses are charged to sales & marketing expenses
as incurred.
SUPPORT SERVICES: The Company provides, free of charge, pre-sale telephone
technical support and product literature. The Company provides post-sales
support to its customers who are covered under maintenance agreements. The costs
relating to these services are expensed as incurred and included in Selling,
General & Administrative expenses.
EARNINGS (LOSS) PER SHARE: The Company has adopted Statement of Financial
Accounting Standards (SFAS) No. 128 "Earnings Per Share" and has retroactively
restated the earnings per share (EPS) for 1996 and 1995. SFAS 128 requires
presentation of basic and diluted EPS. Basic EPS is computed by dividing net
income by the number of weighted average common shares outstanding. Diluted EPS
reflects potential dilution from outstanding stock options, using the treasury
stock method. For the years that options are anti-dilutive, they are not
included in the calculation of earnings per share.
EXPORT SALES: The Company generates some revenues from international business.
For all periods reported herein, the Company's export sales are deemed
immaterial.
FOREIGN CURRENCY TRANSLATION: The functional currency of the Company's former
foreign subsidiary is the local currency. Balance sheet accounts of the
Company's former foreign subsidiary are translated into U.S. dollars at current
exchange rates. Income statement items are translated at the average rates
during the year. Net translation
24
gains or losses are recorded directly to a separate component of stockholders'
equity. Foreign currency transaction gains and losses are included in the
determination of net income for the fiscal year ended December 31, 1996.
POST-RETIREMENT BENEFITS OTHER THAN PENSIONS: The Company does not offer
post-employment benefits to its retirees and as a result, is unaffected by
Statement of Financial Accounting Standards No. 106 or 112 issued in December
1990 and November 1992, respectively.
401K PLAN: The Company maintains a 401K Plan for its employees. The Plan is
intended as a retirement and tax deferred savings vehicle. All employees of the
Company whose customary employment is for more than 20 hours per week are
eligible to participate in the 401K Plan. Employees make their contributions
through semi-monthly payroll deductions which are invested in any combination of
several investment funds. The Company has made no matching contributions and has
no current plans to do so.
FAIR VALUE OF FINANCIAL INSTRUMENTS: Statement of Financial Accounting Standards
No. 107, "Disclosures About Fair Value of Financial Instruments," requires the
Company to disclose estimated fair values for its financial instruments,
exclusive of leases, for which it is practicable to estimate fair value.
For financial instruments including cash, accounts receivable and payable,
and accrued expenses it is assumed that the carrying amount approximates fair
value due to their short maturities.
RISKS AND UNCERTAINTIES: The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amount of assets and
liabilities and disclosures of contingent assets and liabilities at the date of
the financial statements and the reported amount of revenues and expenses during
the reported period. Actual results could differ from those estimates.
RECLASSIFICATIONS: Certain items on the December 31, 1996 financial statement
presented herein have been reclassified to conform to the presentation used at
December 31, 1997.
NEW ACCOUNTING PRONOUNCEMENTS: In June 1997, the Financial Accounting Standards
Board (FASB) issued Statements of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income," which requires that an enterprise report by
major components and as a single total the change in its net assets during the
period from nonowner sources, and No. 131, "Disclosures about Segments of an
Enterprise and Related Information," which establishes annual and interim
reporting standards for an enterprise's business segments and related
disclosures about its products, services, geographic areas, and major customers.
Adoption of these statements will not impact the Company's consolidated
financial position, results of operations or statements of cash flows. Both FASB
statements are effective for the Company in 1998.
25
NOTE B: EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements are stated at cost and consist of the
following:
December 31,
1997 1996
-------- --------
Computer equipment and software $582,464 $240,714
Leasehold improvements 30,248 10,650
Furniture and fixtures 124,987 72,467
-------- --------
Less accumulated depreciation and amortization (152,644) (36,508)
$585,055 $287,323
-------- --------
-------- --------
The depreciation expense recognized for the fiscal year ended December 31,
1997 and the nine-month transition period ended December 31, 1996, and the
fiscal year ended March 31, 1996 was $116,187 $26,487, and $7,646, respectively.
Included in furniture and fixtures are items under a two-year capital lease
amounting to $32,374 and $0 at December 31, 1997 and 1996, respectively. At
December 31, 1997, and 1996, there was accumulated amortization of $3,469 and $0
on capital lease at December 31, 1997 and 1996, respectively.
NOTE C: INVESTMENT AND JOINT VENTURE
In October of 1996, the Company invested $1,000,000 for a 10% equity
interest in Encotone, LTD., a Jerusalem, Israel high-technology firm which
develops technology and products that provide enhanced security for both voice
and data network transactions. Its first product, TeleIDTM is a credit
card-sized acoustical smart card. Since the Company has a 10% equity interest in
Encotone, LTD., it accounts for its investment in Encotone, LTD. under the cost
method. The Company evaluates the value of its investments on an ongoing basis
relying on a number of factors including operating results, business plans,
budgets and economic projections. In addition, the Company's evaluation
considers non-financial data such as market trends, customer relationships,
technology developments and product development cycles. As a result of such
analysis, in the quarter ended September 30, 1997, the Company wrote off the
entire amount of the investment.
In October of 1996, the Company and Encotone, LTD. formed a joint venture
in the U.S., Encotone, Inc., which was equally funded by both companies.
Encotone, Inc. markets Encotone, LTD's smart card technology products in North,
Central and South America. Since it is a 50% shareholder, the Company accounts
for its investment in Encotone, Inc. under the equity method, and as of December
31, 1997, has reduced its investment by $131,801, its share of Encotone, Inc.'s
operating loss for the initial period ended December 31, 1997.
In January, 1998, the Company sold to Encotone, LTD. its full interest in
Encotone, Inc. In return, the Company received an additional 9.9% of the common
stock of Encotone, LTD., providing the Company with an equity position of 19.9%.
The Company also received $81,656 in cash.
NOTE D: BORROWINGS
During March 1995, the Company entered into a working capital line of
credit (the "Line") with Silicon Valley Bank. Under the agreement, the Company
could have borrowed up to a maximum of $2,000,000 based upon the availability of
eligible accounts receivable. The Line's interest was set at Prime plus 2.5%.
The Line has been paid in full and was allowed to expire on July 31, 1996.
26
On October 19, 1993, the Company exchanged and extended a term loan (the
"Loan") with Stephen L. Watson, the Company's Chairman of the Board of
Directors. The Loan was collateralized by all assets of the Company. The Loan
was due and payable in December 1993 with interest payable monthly at 16% per
annum. The principal of $300,000 was extended to December 1996, with interest
accruing at 12% per annum, interest payable monthly in arrears. The Loan was
subordinated to any commercial bank or other financial institution debt up to
$4,000,000. As of September 30, 1996, the Company had repaid the Loan in full.
As of December 31, 1997, the Company had no outstanding debt agreements.
NOTE E: COMMITMENTS AND CONTINGENCIES
The Company leases certain facilities under noncancellable operating
leases. For the years ended December 31, 1997, 1996 and March 31, 1996, the
Company incurred total operating lease expense of $173,600, $55,440 and
$585,469, respectively. Future minimum lease payments under these leases are as
follows:
Year ending December 31,
------------------------
1998 $134,200
1999 100,800
2000 100,800
2001 42,000
2002 --
--------
$377,800
--------
--------
NOTE F: LOAN TO OFFICER
In May, 1996, Barry N. Bycoff, the Company's President and CEO, exercised
an option to purchase 200,000 shares of the Company's common stock at a price of
$1.00 per share. The Company's Board of Directors approved a loan to Mr. Bycoff
as payment for this transaction. Mr. Bycoff issued the Company a full recourse
note that is secured by the 200,000 shares of common stock. This note has an
interest rate of 7% per annum.
NOTE G: ASSET SALE
As of June 28, 1996, the Company completed the divestiture of its catalog
related business, consisting of The Programmer's SuperShop ("TPS") catalog, the
TPS web site, the corporate sales group, SDC Germany and SDC Communications. The
Company completed the transaction for an aggregate price of $10,035,000. The
aggregate price consisted of payment of $9,300,000 in immediately available
funds and the deposit of $735,000 under an escrow arrangement. During August,
1996, $135,000 of the escrow was returned to the Company.
The aggregate price of $10,035,000 was in exchange for the Company's
tangible net assets of the catalog related business that at the time was
estimated at approximately $1,500,000. The values of these net assets are
currently being evaluated by a third party, and the Company expects that any
purchase price adjustments that could occur as a result of the evaluation will
have no material impact on the financial position or results of operations
presented herein. The revenues of the divested catalog business were $11,800,000
for the nine month transition period ended December 31, 1996 and $52,382,000 and
$39,698,000 for the fiscal years ended March 31, 1996 and 1995, respectively.
These revenues are a component of the net income (loss) from discontinued
operations.
27
The Company incurred $2,587,000 in expenses and write-offs related to the
divestiture. These expenses were primarily comprised of write-off of goodwill,
severance costs, professional fees, buy-outs of capital leases, and facility
shut-down costs for its corporate offices and distribution facility. The Company
reported a gain of $6,000,000 from the sale of the assets of its catalog related
business. The Company utilized a deferred tax benefit related to net operating
loss carryforwards of approximately $2,200,000 to offset Federal and State
corporate income taxes.
The companies are currently in legal proceedings related to the
remaining $600,000 escrow balance. The case involves a suit and countersuit
between the Company and Programmer's Paradise, Inc. ("PPI") of Shrewsbury,
New Jersey. The proceedings are intended to resolve a valuation dispute of
approximately $1,100,000 related to the Net Assets Transferred to PPI during
the 1996 divestiture of The Software Developer's Company, Inc.
NOTE H: INCOME TAXES
As discussed in Note A, the Company follows Statement of Financial
Accounting Standards ("SFAS") No. 109 "Accounting for Income Taxes." Under SFAS
No. 109, deferred tax assets and liabilities are recognized for the unexpected
future tax consequences of events that have been included in the financial
statements or tax returns. The amount of deferred tax asset or liability is
based on the difference between the financial statement and tax bases of assets
and liabilities using enacted tax rates in effect for the year in which the
differences are expected to reverse.
The components of the provision for income taxes are as follows:
For the Year Ended
December 31,
1997 1996
---- ----
Current tax expense:
Federal -- $74,300
State -- --
--- -------
Total -- $74,300
Deferred tax expense (benefit):
Federal -- --
State -- --
--- -------
Total -- $74,300
--- -------
--- -------
28
Significant components of the deferred tax assets are as follows:
For the Year Ended
December 31,
1997 1996
---- ----
Net operating loss carryforward $2,842,447 $1,726,954
Loss on investment 1,324,650 --
Accruals and reserves 138,517 458,357
Research and development tax credits 254,739 193,375
Depreciation (17,890) --
Other, net -- 79,339
Alternative minimum tax credit 74,773 --
Valuation allowance (4,617,236) (2,458,025)
----------- -----------
$ -- $ --
----------- -----------
----------- -----------
The provision for income taxes differs from the federal statutory rate of
34% as follows:
For the Year Ended
December 31,
1997 1996
---- ----
Federal provision at 34% ($1,785,645) $1,385,160
Alternative minimum tax on asset sale - Federal -- 74,300
Meals and entertainment 9,962 3,482
Foreign loss, not benefitted -- --
Current year Federal loss, not benefitted 1,775,683 --
Goodwill -- --
Utilization of previously unrecognized NOL -- (1,388,642)
S-Corporation income not subject to tax -- --
----------- ----------
$ -- $74,300
----------- ----------
----------- ----------
Due to the uncertainty surrounding the realization of tax benefits in
future tax returns of the continuing business, the net deferred tax assets at
December 31, 1997 and 1996 have been offset by a valuation allowance.
At December 31, 1997, the Company has available for Federal income tax
purposes net operating tax loss carryforwards of approximately $7,060,000 that
are available to offset future taxable income at various dates through fiscal
2012. Certain provisions in the Internal Revenue Code may limit the net
operating loss available for use in any given year in the event of any
significant change of ownership.
29
NOTE I: ACQUISITION OF INTERNET SECURITY CORPORATION
On November 16, 1995, the Company acquired 100% of the outstanding capital
stock of Internet Security Corporation ("ISC") in exchange for 465,838 shares of
the Company's Common Stock. ISC, a Massachusetts corporation, markets and
distributes certain software products and services under distribution and
reseller agreements with third party software companies. A Form 8-K was duly
filed with the Securities and Exchange Commission on November 30, 1995, a Form
8-KA was subsequently filed on January 30, 1996.
Prior to the consummation of the transaction, ISC made an allowable
distribution of $256,000 to its sole shareholder. The distribution consisted of
cash of $231,000 and a vehicle with a net book value of $25,000. ISC was a
Subchapter S Corporation prior to the consummation of the transaction, and
therefore did not pay U.S. Federal income taxes. ISC was included in the
Company's U.S. Federal income tax return effective November 16, 1995, and
therefore, a corresponding charge to income tax expense was recorded to reflect
the anticipated tax due on net income generated from the date of consummation
through March 31, 1996.
The acquisition was accounted for as a "pooling of interest" transaction
and, accordingly, the Company's March 31, 1996 financial statements reflect the
results of ISC in "continuing operations."
NOTE J: CAPITAL STOCK AND CAPITAL STOCK WARRANTS
COMMON STOCK: On January 13, 1993 the Company completed a private placement of
537,898 shares of Common Stock for net proceeds of approximately $992,173.
On June 29, 1993 the Company acquired 94% of the outstanding capital stock
of Personal Computing Tools, Inc. (PCT) of Campbell, California in exchange for
392,996 shares of the Company's Common Stock. This agreement became effective on
June 29, 1993 and was accounted for under the purchase method of accounting. If
the actual selling price of the Company's Common Stock failed to average less
than two dollars ($2.00) per share (adjusted for stock splits or stock dividends
or other similar events) for any consecutive thirty-day period within eighteen
months of the June 29, 1993 closing date, additional shares of the Company's
Common Stock would have been issued to the PCT selling stockholders (on a
pro-rata basis) such that the total aggregate number of shares of the Company's
Common Stock to be issued to the PCT selling stockholders (including the initial
shares) would be the number of shares calculated by dividing $850,000 by the
average actual selling price per share of the Company's Common Stock during the
thirty-day period immediately prior to the completion of eighteen months from
the June 29, 1993 closing date.
The actual selling price of the Company's Common Stock did fail to average
less than two dollars ($2.00) per share for a consecutive thirty-day period
within the eighteen-month period ended December 29, 1994. Per the terms of the
Agreement, the amount of additional shares that would have been issued equaled
575,000 shares. On June 26, 1995 the Company and representatives of the former
PCT shareholders signed a Stock Issuance and Settlement Agreement whereby only
an additional 79,460 shares of Common Stock would be issued.
SERIES C PREFERRED STOCK: On October 19, 1993, the Company completed a private
placement of Series C Preferred Stock and a recapitalization transaction.
Private investors purchased 905,968 shares of Series C Preferred Stock at a
price of $1.00 per share, resulting in net proceeds of approximately $781,000.
The Series C Preferred Stock was convertible into Common Stock on a one-for-one
basis and voted with the Common Stock on the same basis. The Series C Preferred
Stock contained a number of features including a fixed liquidation preference of
$2.00 per share, anti-dilution rights and two Board of Director positions. The
Company used the net proceeds from the private placement for working capital and
general corporate purposes.
The recapitalization transaction involved the exchange of all of the
Company's Series A Preferred Stock and
30
Series B Senior Preferred Stock for 4,288,890 shares of Common Stock, increasing
the total number of shares of Common Stock outstanding to 7,292,453. This
recapitalization removed the liquidation preference, including cumulative
dividends, payable to the preferred holders of approximately $7,000,000. In the
recapitalization, holders of the Company's previously existing preferred stock
exchanged their shares for Common Stock, terminating all prior agreements, but
retaining certain registration rights.
Included in the aggregate of 905,968 shares of Series C Preferred Stock
issued by the Company were 26,877 shares of Series C Preferred Stock issued in
complete satisfaction of a $25,000 note payable plus $1,877 of accrued interest
to Trinity Ventures I, L.P. The note was acquired in the Company's prior
purchase of the capital stock of Personal Computing Tools, Inc.
As of September 30, 1996 all of the Company's Series C Preferred Stock has
been converted into Common Stock on a one-to-one basis.
WARRANTS: As of December 31, 1997, the Company did not have any warrants
outstanding.
SUBSEQUENT EVENT: On January 6, 1998, the Company, entered into a Preferred
Stock and Warrant Purchase Agreement (the "Agreement") with Pequot Private
Equity Fund, L.P., a Delaware limited partnership ("PPEF") and Pequot Offshore
Private Equity Fund, Inc., a British Virgin Islands corporation (together with
PPEF, the "Pequot Entities"). Pursuant to the terms of the Agreement, on January
7, 1998, the Company sold 1,666,667 shares of Series D Preferred Stock, at $1.50
per share, and 750,393 Warrants to the Pequot Entities for an aggregate purchase
price of $2,500,000.50. The Series D Preferred Stock is automatically
convertible into Common Stock on a one-for-one basis, subject to adjustment. In
addition, the Series D Preferred Stock is subject to mandatory conversion into
Common Stock upon certain circumstances. Pursuant to the Agreement, the Pequot
Entities intend to make a second $2.5 million investment subject to certain
terms and contingencies in the Agreement, including the Company's release of its
SiteMinder 3.0 product and having the product attain an acceptable level of
quality and satisfaction as determined by the Pequot Entities. As part of the
transaction, James McNiel is joined the Board of Directors of the Company, as
designee of the Pequot Entities, and has agreed to provide certain consulting
services to the Company. In connection with such service, the Company granted
Mr. McNiel warrants for the purchase of 100,000 shares of Common Stock.
Management believes that this financing, together with cash from operations
will be adequate to support the business operation for fiscal year 1998.
NOTE K: STOCK OPTION PLANS
The Company has stock option plans as described hereunder. Options are
granted at fair market value at the date of grant being the average of the
closing bid and asked prices of the Common Stock on the day preceding the date
of grant.
1986 NONSTATUTORY STOCK OPTION PLAN: The 1986 Nonstatutory Stock Option Plan
provides for the issuance of options to purchase shares of Common Stock, up to
an aggregate of 52,500 shares which are reserved for issuance. Options can be
granted to employees, consultants or others as approved by the Board of
Directors. These options have exercise prices of 100% of the fair market value
of Common Stock on the date of grant. The options terminate for employees with
respect to all shares of stock not previously purchased within 30 days upon the
date of termination of the employee's employment or for non-employees at the end
of ten years from the date of grant.
31
1987 STOCK PLAN: The 1987 Stock Plan reserves for issuance 750,000 shares of
Common Stock for the benefit of all employees as authorized by the Board of
Directors. Incentive stock options may be granted to employees and officers, and
non-qualified options may be granted to directors, officers, employees and
consultants of the Company under the 1987 Stock Plan. The exercise price is set
at 100% of the fair market value of Common Stock on the date of grant. The
aggregate fair market value of shares issuable under the 1987 Stock Plan due to
the exercising of incentive stock options by an employee or officer may not
exceed $100,000 in any calendar year.
1988 NON-EMPLOYEE DIRECTOR STOCK OPTION PLAN: The 1988 Non-Employee Director
Stock Option Plan ("1988 Director Plan") offers options to members of the Board
of Directors who are neither employees nor officers of the Company in
appreciation of their service. The 1988 Director Plan is administered by the
Compensation Committee of the Company. No more shares are available under the
1998 Director Plan.
This plan authorizes the grant of options for 70,000 shares of Common
Stock. Each newly elected non-employee director will automatically receive an
option to purchase 8,750 shares. The exercise price per share of options granted
under the 1988 Director Plan is 100% of the fair market value of Common Stock on
the date of grant. The options shall expire six years from the date of the
option grant. They terminate thirty days (or one hundred and eighty days if due
to disability or death) following the date on which the optionee ceases to be a
member of the Board of Directors. They are exercisable in installments, with 20%
becoming exercisable on each anniversary of the date of grant.
1990 EMPLOYEE STOCK PURCHASE PLAN: The 1990 Employee Stock Purchase Plan ("Stock
Purchase Plan") is intended as an incentive to, and to encourage stock ownership
by, all eligible employees of the Company and participating subsidiaries and to
encourage them to remain in the employ of the Company. Substantially all
employees of the Company and any participating subsidiary who have completed six
months of employment with the Company or any subsidiary and whose customary
employment is for more than 20 hours per week and more than five months per
calendar year are eligible to participate in the Stock Purchase Plan.
The Stock Purchase Plan presently authorizes the issuance of 100,000
shares of Common Stock (subject to adjustment for capital changes) pursuant to
the exercise of nontransferable options granted to participating employees.
During the years ended December 31, 1997 and 1996, 2,400 and 1,216, shares,
respectively, of the Company's Common Stock were issued under the Stock Purchase
Plan.
1991 NON-EMPLOYEE DIRECTOR STOCK OPTION PLAN: The 1991 Non-Employee Director
Stock Option Plan authorizes the grant of options for up to 70,000 shares of
Common Stock. This plan is identical to the 1988 Director Plan, except that
options shall expire ten years from the date of the option grant. On May 15,
1991, each of the non-employee directors was granted options to purchase 8,750
shares of Common Stock. After May 15, 1991, each new director also received an
option to purchase 8,750 shares of Common Stock. No more shares are available
under the 1991 Non-Employee Director Stock Option Plan.
1993 NON-EMPLOYEE DIRECTOR STOCK OPTION PLAN: The 1993 Non-Employee Director
Stock Option Plan authorizes the grant of options of up to 60,000 shares of
Common Stock. This plan is identical to the 1988 and 1991 Director Plans, except
the options shall expire ten years from the date of the option grant and options
are granted after the performance of services. On each of April 1, 1993 (fiscal
year 1994), April 1, 1994 (fiscal year 1995), and April 1, 1995 (fiscal year
1996) each of the non-employee directors was granted 3,500 shares of Common
Stock. No more shares are available under the 1993 Non-Employee Director Stock
Option Plan.
1994 STOCK PLAN: The 1994 Stock Plan is authorized to grant up to 1,813,000
options to purchase shares of Common Stock as incentives to officers, directors,
employees and consultants of the Company, as approved by the Board of Directors.
The options have an exercise price of 100% of the fair market value of Common
Stock on the date of the grant and vest over periods as determined by the Board
of Directors. A total of 1,813,000 shares are issuable under the 1994 Stock
Plan, of which 168,000 shares were available for grant at December 31, 1997.
32
1994 NON-EMPLOYEE DIRECTOR PLAN: The 1994 Non-Employee Director Plan authorizes
the grant of up to 105,000 shares to directors who are not employees or officers
of the Company as an inducement to obtain and retain the services of qualified
persons. Each director who is neither an officer nor employee of the Company was
automatically granted an option to purchase 17,500 shares of the Company's
Common Stock at an exercise price equal to 100% of the fair market value of the
Company's Common Stock on the date of grant. Options vest ratably over five
years from the date of grant and expire ten years from the date of grant. During
fiscal 1994, each of the six (6) qualified directors received an option to
purchase 17,500 shares of the Company's Common Stock. No more shares are
available under the 1994 Non-Employee Director Plan.
1997 STOCK OPTION PLAN: The 1997 Stock Option Plan is authorized to grant up to
500,000 options to purchase shares of Common Stock as incentives to officers and
other employees of the company. Incentive stock options may be granted to
officers and employees, and non-qualified stock options may be granted to
directors, officers, employees or consultants of the Company under the 1997
Stock Option Plan. The exercise prices and the vesting periods of the options
are determined by the Compensation Committee of the Company. A total of 500,000
shares are issuable under the 1997 Stock Plan, of which 49,250 shares were
available for grant at December 31, 1997.
1997 NON-EMPLOYEE DIRECTOR STOCK OPTION PLAN: On September 10, 1997, the Board
of Directors approved the 1997 Non-Employee Director Stock Option Plan. The 1997
Non-Employee Director Stock Option Plan authorizes the grant of up to 125,000
shares to directors who are not employees or officers of the Company as
inducement to obtain and retain the services of qualified persons. Each current
director who is neither an officer or employee of the Company was automatically
granted an option to purchase 12,500 shares of the Company's Common Stock at an
exercise price of $2.19 per share. Each person elected as a member of the Board
after the adoption of the plan will be granted an option to purchase shares of
Common Stock ("New Director Options") as determined by the Board. The exercise
price of New Director Options shall be the mean between the high and low sales
prices of the Company's Common Stock on the Nasdaq National Market System as
reported in the Wall Street Journal on the date of the grant for the immediately
preceding business day, provided that if the Common Stock is not listed on the
Nasdaq National Market System, the exercise price shall be the fair market value
as determined by the Board of Directors.
Information as to the Company's stock options is as follows:
In October, 1995, the FASB issued SFAS 123, "Accounting for Stock-Based
Compensation." SFAS 123 is effective for periods beginning after December 15,
1995. SFAS 123 requires that companies either recognize compensation expense for
grants of stock, stock options, and other equity instruments based on fair
value, or provide pro-forma disclosure of net income and earnings per share in
the notes to the financial statements.
Had compensation cost for the Company's stock-based compensation plans
been determined based on the fair value at the grant dates as calculated in
accordance with SFAS 123, the Company's net income and earnings per share for
the years ended December 31, 1997 and December 31, 1996 would have been reduced
to the pro-forma amounts indicated below:
Fiscal Year Ended Nine-Months Ended
December 31, 1997 December 31, 1996
-------------------------- -------------------------
Earnings Earnings
Net (loss) Per Share Net Income Per Share
---------- --------- ---------- ---------
As reported $(5,251,898) $(0.57) $3,999,971 $0.40
Pro-Forma (5,500,386) (0.59) 3,868,522 0.43
The effects of applying SFAS 123 in this pro-forma disclosure are not
indicative of future amounts. SFAS
33
123 does not apply to awards prior to fiscal 1996 and additional awards in
future years are anticipated.
The fair value of each stock option is estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions: an expected life of four years, expected volatility of 80%, no
dividends, and risk-free interest rates ranging from 5.7% to 7.4%.
A summary of the status of the Company's stock option plans as of December
31, 1997 and 1996, and March 31, 1996 and changes during the years ending on
those dates is presented below:
Options Outstanding Options Exercisable
- ----------------------------------------------------------------- ----------------------------------
Weighted Average
Range of Number Contractual Weighted Average Number Weighted Average
Exercise Prices Outstanding Life Exercise Price Exercisable Exercise Price
- --------------- ----------- ---- -------------- ----------- --------------
4.00 2,500 3.2 4.00 2,500 4.00
3.38 19,250 3.4 3.38 19,250 3.38
3.50-4.00 21,750 3.6 3.54 21,750 3.54
2.88 17,500 4.7 2.88 17,500 2.88
2.13 40,000 5.0 2.13 40,000 2.13
4.00 2,500 5.2 4.00 2,500 4.00
1.00-1.50 264,000 5.3 1.03 264,000 1.03
1.25 17,500 5.6 1.25 17,500 1.25
0.88-1.00 315,592 6.3 1.00 315,592 1.00
0.78 87,500 6.5 0.78 87,500 0.78
0.63 35,000 6.8 0.63 35,000 0.63
1.56 1,000 7.4 1.56 1,000 1.56
1.37 35,000 7.6 1.37 35,000 1.37
1.71 85,000 7.8 1.71 85,000 1.71
2.62-2.63 605,000 8.4 2.63 1,667 2.62
2.63 41,000 8.6 2.63 40,000 2.63
2.09 262,500 8.9 2.09 9,000 2.09
1.38-2.50 101,000 9.1 1.39 ---------
1.38-2.38 151,500 9.3 1.55
1.63 4,000 9.4 1.63
2.19 89,000 9.7 2.19
1.59 22,500 9.8 1.59
1.38 32,500 9.9 1.38
1.25-1.50 150,250 10.0 1.26
---------
2,403,342 994,759
--------- ---------
--------- ---------
34
For the Period Ended
--------------------------------------
December 31, December 31, March 31,
1997 1996 1996
---------- ---------- ----------
Options outstanding at beginning of year 2,196,095 1,523,845 1,389,404
Option activity during the year:
Granted 640,750 1,125,250 417,500
Exercised (72,000) (374,360) (75,450)
Canceled (361,503) (78,640) (207,600)
---------- ---------- ----------
Options outstanding at end of year 2,403,342 2,196,095 1,523,854
---------- ---------- ----------
---------- ---------- ----------
Price range of outstanding options $0.63-4.00 $0.78-4.50 $0.50-8.13
---------- ---------- ----------
---------- ---------- ----------
Price range of options exercised $0.50-1.71 $0.50-1.72 $0.50-1.25
---------- ---------- ----------
---------- ---------- ----------
Options exercisable at end of year 994,759 1,179,937 852,636
---------- ---------- ----------
---------- ---------- ----------
35
NOTE L: COMPARATIVE FINANCIAL INFORMATION
As reported on Form 8-K, dated August 21, 1996, the Company's Board of
Directors approved on August 14, 1996 a change in the Company's fiscal year from
March 31 to December 31. The following represents unaudited comparative
financial information for the period January 1, 1996 to December 31, 1996, which
may be read in conjunction with the audited fiscal year ended December 31, 1997,
presented on the consolidated statements of operations.
Pro-Forma
Twelve-Months Ended
December 31, 1996
(Unaudited)
-----------
Net revenue $4,965,948
Cost of revenues 2,930,674
-----------
Gross profit 2,035,274
Selling, general and administrative expenses 2,702,264
Research and development costs 705,298
Income (loss) from operations (1,372,288)
-----------
Interest income 188,215
Share of loss from investment (40,000)
-----------
Income (loss) from continuing operations (1,224,073)
Income (loss) from discontinued operations (734,698)
Gain on sale of assets of discontinued operations 6,000,000
-----------
Income before provision for income taxes 4,041,229
Provision for income taxes 74,300
-----------
Net income $3,966,929
-----------
-----------
36
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
The information required by this item is incorporated by reference to the
information under the caption "Election of Directors" contained in the Company's
definitive Proxy Statement filed on or before April 15, 1998 with the Securities
and Exchange Commission in connection with the solicitation of proxies for the
Company's Annual Meeting of Stockholders to be held on May 13, 1998 (the "Proxy
Statement").
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to the
information under the caption "Executive Compensation and Other Information
Concerning Directors and Officers" contained in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT
The information required by this item is incorporated by reference to the
information under the caption "Management and Principal Holders of Voting
Securities" contained in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to the
information under the caption "Certain Relationships and Related Transactions"
contained in the Proxy Statement.
37
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS
ON FORM 8-K
A. THE FOLLOWING DOCUMENTS ARE FILED AS PART OF THIS REPORT:
1. FINANCIAL STATEMENTS
The following financial statements are included in Item 8:
a. Report of Independent Auditors
b. Consolidated Balance Sheets - December 31, 1997 and 1996
c. Consolidated Statements of Operations for the fiscal years
ended December 31, 1997 and 1996
d. Consolidated Statements of Stockholders' Equity (Deficit) for
the fiscal years ended December 31, 1997 and 1996
e. Consolidated Statements of Cash Flows for the fiscal years
ended December 31, 1997 and 1995
f. Notes to Consolidated Financial Statements
2. FINANCIAL STATEMENT SCHEDULES
The following financial statement schedules are included in Item
14(d):
a. Report of Independent Auditors
b. Schedule VIII: Valuation of Qualifying Accounts and Reserves
Schedules other than those listed above have been omitted since they
are either not required or the information is otherwise included.
3. LIST OF EXHIBITS
The following exhibits, required by Item 601 of Regulation S-K, are
filed as a part of this Annual Report on Form 10-K. Exhibit numbers,
where applicable, in the left column correspond to those of Item 601
of Regulation S-K.
38
EXHIBIT
ITEM NO. ITEM AND REFERENCE
- -------- ------------------
3)01 Restated Certificate of Incorporation, as amended, of the Registrant
(filed as Exhibit 3.01 to Registrant's Registration Statement of
Form S-18, No. 33-24446-B, and incorporated by reference).
3)02 Certificate of Designations, Preferences and Rights of the Series C
Preferred Stock of the Registrant (filed as Exhibit 7.03 to Report
on Form 8-K on November 12, 1993, and incorporated by reference).
3)03 Amended By-Laws of the Registrant (filed herewith).
4)01 Specimen certificate for shares of Common Stock of the Registrant
(filed as Exhibit 4.01 to the Registrant's Registration Statement on
Form S-18, No. 33-24446-B, and incorporated by reference).
4)02 Series C Preferred Stock Purchase, Recapitalization and Exchange
Agreement among the Registrant and the persons named therein
regarding the issuance of the Series C Preferred Stock and the
retirement of the Series A Preferred Stock and Series B Senior
Preferred Stock (filed as Exhibit 7.01 to Report on Form 8-K filed
on November 12, 1993, and incorporated by reference).
4)03 Voting Agreement among the Registrant and the holders of Series C
Preferred Stock (filed as Exhibit 7.02 to Report on Form 8-K filed
on November 12, 1993, and incorporated by reference).
10)01 1986 Nonstatutotry Stock Option Plan of the Registrant (filed as
Exhibit 10.01 to the Registrant's Registration Statement on Form
S-18, No. 33-24446-B, and incorporated by reference).
10)02 Form of Nonstatutory Stock Option Agreement under the Registrant's
1986 Nonstatutory Stock Option Plan (filed as Exhibit 10.02 to the
Registrant's Registration Statement on Form S-18, No. 33-24446-B,
and incorporated by reference).
10)03 1987 Amended Stock Plan of the Registrant (filed as Exhibit 4.1 to
Registration Statement on Form S-18, No. 33-24446-B, and
incorporated by reference).
10)04 Form of Incentive Stock Option Agreement under the Registrant's 1987
Amended Stock Plan (filed as Exhibit 10.04 to Annual Report on Form
10-K for the fiscal year ended March 31, 1991, and incorporated by
reference).
39
10)05 Form of Non-Qualified Stock Option Agreement under the Registrant's
1987 Amended Stock Plan (filed as Exhibit 10.05 to Annual Report on
Form 10-K for the fiscal year ended March 31, 1991, and incorporated
by reference).
10)06 1988 Amended Non-Employee Director Stock Option Plan (filed as
Exhibit 10.22 to Annual Report on Form 10-K for the fiscal year
ended March 31, 1990, and incorporated by reference).
10)07 Form of Non-Qualified Stock Option Agreement for the Registrant's
1988 Amended Non- Employee Director Stock Option Plan (filed as
Exhibit 10.07 to Annual Report on Form 10-K for the fiscal year
ended March 31, 1991, and incorporated by reference).
10)08 1990 Employee Stock Purchase Plan of the Registrant (filed as
Exhibit 4.1 to Registration Statement No. 33-35225, and incorporated
by reference).
10)1 1991 Director Stock Plan (filed as Exhibit 10.10 to Annual Report on
Form 10-K for the fiscal year ended March 31, 1991, and incorporated
by reference).
10)11 1993 Non-Employee Director Stock Option Plan (filed as Exhibit 10.11
to Annual Report on Form 10-K for the fiscal year ended March 31,
1993, and incorporated by reference).
10)12 Form of Non-Qualified Stock Option Agreement for the Registrant's
1993 Non-Employee Director Stock Option Plan (filed as Exhibit 10.12
to Annual Report on Form 10-K for the fiscal year ended March 31,
1993, and incorporated by reference).
10)13 1994 Stock Plan (filed as Exhibit 4 to Registration Statement on
Form S-8, filed on January 26, 1998, and incorporated by reference).
10)14 1994 Non-Employee Director Plan (filed as Exhibit 10.14 to Annual
Report on Form 10-K for the fiscal year ended March 31, 1994, and
incorporated by reference).
10)15 1997 Stock Option Plan (filed as Exhibit 4 to Registration Statement
on Form S-8 filed on January 26, 1998, and incorporated by
reference).
10)16 1997 Non-Employee Director Stock Option Plan (filed herewith).
10)17 Commercial Lease dated as of June 1, 1996 between the Registrant and
K/B Fund c/o Koll Management Services, Inc. (filed as Exhibit 10.15
to Annual Report on Form 10-K for the fiscal year ended March 31,
1996, and incorporated by reference).
40
10)18 Credit Agreement dated as of March 16, 1995 between the Registrant
and Silicon Valley Bank (filed as Exhibit 10.16 to Annual Report on
Form 10-K for the fiscal year ended March 31, 1995, and incorporated
by reference).
10)19 Promissory Note of the Registrant issued to Silicon Valley Bank in
the principal amount of $2,000,000 due June 5, 1996 (filed as
Exhibit 10.17 to Annual Report on Form 10-K for the fiscal year
ended March 31, 1995, and incorporated by reference).
10)2 Promissory Note of the Registrant issued to Silicon Valley Bank in
the principal amount of $200,000 due June 5, 1998 (filed as Exhibit
10.18 to Annual Report on Form 10-K for the fiscal year ended March
31, 1995, and incorporated by reference).
10)21 Security Agreement dated as of March 16, 1996 between the Registrant
and Silicon Valley Bank (filed as Exhibit 10.19 to Annual Report on
Form 10-K for the fiscal year ended March 31, 1995, and incorporated
by reference).
10)22 Subordination Agreement dated as of March 16, 1995 among the
Registrant, Silicon Valley Bank, and Stephen L. Watson and Beverly
F. Watson as Joint Tenants with the Right of Survivorship (filed as
Exhibit 10.20 to Annual Report on Form 10-K for the fiscal year
ended March 31, 1995, and incorporated by reference).
10)23 Amended and Restated Security Agreement dated as of March 16, 1995
among the Registrant and Stephen L. Watson and Beverly F. Watson as
Joint Tenants with the Right of Survivorship (filed as Exhibit 10.21
to Annual Report on Form 10-K for the fiscal year ended March 31,
1995, and incorporated by reference).
10)24 Secured Subordinated Term Note of the Registrant in the principal
amount of $300,000 dated as of October 19, 1993 (filed as Exhibit
10.18 to Annual Report on Form 10-K for the fiscal year ended March
31, 1994, and incorporated by reference).
10)25 Agreement of Purchase and Sale of Assets by and between Programmer's
Paradise, Inc. and The Software Developer's Company, Inc. and
Software Developer's Company GmbH, as Selling Parties dated May 16,
1996 (filed as Appendix A to Consent Solicitation Statement dated
June 4, 1996, and incorporated by reference).
10)26 Agreement and Plan of Merger among the Registrant, ISC Acquisition
Corporation, Internet Security Corporation and Richard J. Kosinski
dated as of October 17, 1995 (filed as Exhibit 7.01 to Report on
Form 8-K filed on November 30, 1995, and incorporated by reference).
10)27 Amendment No. 1 to the Agreement and Plan of Merger among the
Registrant, ISC Acquisition Corporation, Internet Security
Corporation and Richard J. Kosinski, dated as of November 16, 1995
(filed as Exhibit 7.02 to Report on Form 8-K filed on November 30,
1995, and incorporated by reference).
41
10)28 Employment and Noncompetition Agreement by and among Richard J.
Kosinski and the Registrant and Internet Security Corporation (filed
as Exhibit 7.03 to Report on Form 8-K filed on November 30, 1995,
and incorporated by reference).
10)29 Holdback Agreement by and among the Registrant and Richard J.
Kosinski dated November 16, 1995 (filed as Exhibit 7.04 to Report on
Form 8-K filed on November 30, 1995, and incorporated by reference).
10)3 Preferred Stock and Warrant Purchase Agreement among the Company,
Pequot Private Equity Fund L.P. and Pequot Offshore Private Equity
Fund, Inc. (filed as Exhibit 4 to Report on Form 8-K filed on
January 15, 1998, and incorporated by reference).
11)01 Computation of Earnings Per Share (filed herewith).
22)01 Subsidiaries of the Registrant (filed herewith).
24)01 Consent of Coopers & Lybrand (filed herewith).
B. REPORTS ON FORM 8-K:
The Company filed a Report on Form 8-K on January 15, 1998 in connection
with the Preferred Stock and Warrant Purchase Agreement among Pequot
Private Equity Fund, L.P., Pequot Offshore Private Equity Fund, Inc. and
the Company dated January 6, 1998 (see Exhibit 10.30 above).
C. EXHIBITS:
The Company hereby files as part of this Form 10-K the exhibits listed in
14 (A)(3) above.
D. FINANCIAL STATEMENT SCHEDULES:
The Company hereby files as part of this Form 10-K in Item 14(d) attached
hereto the financial statement schedules listed in Item 14 (A)(2) above.
42
NETEGRITY, INC.
ANNUAL REPORT ON FORM 10-K
YEAR ENDED MARCH 31, 1996
ITEM 14(d)
FINANCIAL STATEMENT SCHEDULES
43
NETEGRITY, INC.
SCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS
Allowance for Allowance for
doubtful accounts doubtful accounts Reserve
receivable receivable--product for inventory
---------- ------------------- -------------
Balance as of March 31, 1995 $ 347,432 $ 60,745 $ 142,114
--------- --------- ---------
Additions charged to costs and expenses (A)597,515 124,900 267,030
Charge offs (670,675) (111,931) (268,986)
--------- --------- ---------
Balance as of March 31, 1996 $ 274,272 $ 73,714 $ 140,158
--------- --------- ---------
--------- --------- ---------
Amount transferred through divestiture (184,663) (73,714) (140,158)
Charge offs (21,812) -- --
--------- --------- ---------
Balance as of December 31, 1996 $ 67,797 -- --
--------- --------- ---------
--------- --------- ---------
Charge offs (3,337) -- --
---------
Balance as of December 31, 1997 $ 64,460 -- --
--------- --------- ---------
--------- --------- ---------
(A) Additions to the valuation and qualifying accounts are reflected either as
reductions in net marketing services income for accounts
receivable-products, as reductions in selling, general and administrative
expenses for accounts receivable-trade, or as charges to cost of
sales-product for inventory.
45
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report on Form 10-K to be
signed on its behalf by the undersigned, thereunto duly authorized.
NETEGRITY, INC.
/s/ Barry N. Bycoff
---------------------------------------
March 27, 1998 Barry N. Bycoff, President,
Chief Executive Officer and Director
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
on Form 10-K has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
March 27, 1998 /s/ Barry N. Bycoff
---------------------------------------
Barry N. Bycoff, President,
Chief Executive Officer and Director
(Principal Executive Officer)
March 27, 1998 /s/ James O'Connor, Jr
---------------------------------------
James O'Connor, Jr., Vice President,
Chief Financial Officer and Treasurer
(Principal Accounting and Financial Officer)
March 27, 1998 /s/ Eric R. Giler
---------------------------------------
Eric R. Giler, Director
March 27, 1998 /s/ Michael L. Mark
---------------------------------------
Michael L. Mark, Director
March 27, 1998 /s/ James P. McNiel
---------------------------------------
James P. McNiel, Director
March 27, 1998 /s/ Milton J. Pappas
---------------------------------------
Milton J. Pappas, Director
March 27, 1998 /s/ Ralph B. Wagner
---------------------------------------
Ralph B. Wagner, Director
March 27, 1998 /s/ Stephen L. Watson
---------------------------------------
Stephen L. Watson
Chairman of the Board of Directors
46