ITEM 1. BUSINESS
INTRODUCTION
We are a leading provider of software and services that manage and control user access to web-based e-commerce applications. Our SiteMinder product is part of the software infrastructure that is used to build and manage an e-commerce web site commonly known as a portal. SiteMinder manages the complex process of identifying users and assigning those users entitlements to multiple e-commerce applications on a company's portal. These assigned entitlements determine what information a user can see and what transactions a user can perform on the web site. SiteMinder enables our customers to centrally control access to e-commerce portals requiring secure log-in, while distributing the administrative responsibilities to the most appropriate parties. SiteMinder is designed to be scalable and reliable, to integrate with our customers' existing systems and to accommodate emerging Internet technology. We offer a wide range of support services that enable our customers to successfully implement SiteMinder into their organizations. As of December 31, 1999 we had 133 customers. We sell our products through a direct sales force and through our distribution partners. To date, most of our customers' deployments of SiteMinder have supported business-to-business e-commerce applications. However, we are now expanding our markets with new product initiatives and customers in the business to consumer and service provider markets.
INDUSTRY BACKGROUND
The growth in e-commerce is driving companies to develop a new set of web-based applications accessed by a large and diverse range of corporate users, including customers, business partners and employees. In many cases, these new applications are becoming the principal business processes of an organization. These include online retail, customer service, supply chain procurement, and delivery of operational and transactional data. This new generation of applications has created a demand for new Internet security and user management solutions to handle the size and scope of these applications.
Before the advent of e-commerce and the transition to web-based computing, most large businesses deployed client/server architectures to support enterprise computing. In the client/server model, applications are generally limited to traditional enterprise resource planning functions such as accounting, human resources and material resource planning. Defined groups, limited to selected employees, access these applications through a company's internal computing resources or dedicated remote access solutions. As a result of this limited usage, controlling and securing access to these applications and administering the associated users and their rights of usage, or privileges, can be adequately handled by the organization's information technology, or IT, department. With only a limited number of applications and a small number of defined users, the assignment of entitlements to these users is accomplished by embedding the security and entitlement functions into each application.
E-commerce, however, is fundamentally changing traditional business processes because companies now need to conduct business online with their customers and business partners. According to Forrester Research, business-to-business e-commerce is expected to grow from $43 billion in 1998 to $1.3 trillion in 2003. Forrester also estimates that business-to-consumer e-commerce will grow from $8 billion in 1998 to $108 billion in 2003. Companies are developing new web-based applications that support key revenue and relationship management aspects of the companies' business processes. Companies are delivering these new services through portals which are becoming the new customer's gateway. International Data Corporation estimates that the global e-commerce application market will grow from $444 million in 1998 to over $13 billion in 2003. Companies are also attempting to leverage their existing investments in traditional enterprise applications by integrating them into their web sites. In this new e-commerce business model, applications accessed through the portal are not just supporting business operations, but, in many instances, become the focal point for companies' interactions with their constituencies, including remote and mobile employees, existing and potential customers, suppliers, vendors, distributors and other business partners.
As larger and more diverse constituencies access wider ranges of applications, the management and security of users become increasingly important and complex. The software infrastructure required to support
these applications, developed in different languages, running on different web servers and operating on different hardware platforms, dramatically adds to this complexity. Traditional security and management software solutions, whether developed in house or provided by a third party, face significant difficulties in meeting these challenges effectively. Most e-commerce portals have continued the practice of embedding security in each application. This requires users to provide a password to access each application, resulting in a cumbersome and time-consuming user experience. Lack of centralized user management also creates security issues. Companies cannot take corrective actions in a timely fashion because the security and privileges must be modified in each application. In addition, many companies find it difficult to accommodate relationships with business customers and partners because the companies' IT departments do not have the information necessary to manage the entitlements of individual customer and partner users.
Even organizations that have achieved early success with web-based e-commerce business models face challenges as their models evolve. For example, many e-commerce businesses initially focused on a direct sales relationship with their customers and therefore only needed to manage this single application. As their operations have matured, however, they have needed to deploy additional applications, such as customer service. These early e-commerce businesses had no alternative but to build their own security and user management infrastructure to manage the increased number of applications. Today, the software infrastructure that was built faces scalability and user-management issues, resulting in mounting development and support costs.
In order for e-commerce to be successful, companies require a secure and scalable portal management infrastructure for conducting business. Portal sites must be capable of managing the large numbers of users and multiple user transactions without jeopardizing the integrity of the site's security policies. As companies seek to attract customers and partners to their portal sites, and to increase the efficiency of their employees, they require a solution providing a seamless and integrated view of the applications on their web sites. The solution must provide single sign-on to personalized information based on the profile of the particular user. As the number of applications proliferates and the complexity of data increases, the solution must reduce the burden of managing these applications. Companies require a solution that easily and seamlessly integrates with their existing investments in information technology infrastructure, including web servers, application servers, directory servers and various forms of user identification. Finally, companies require an open and extensible architecture in order to accommodate the introduction of new, evolving web technologies.
THE NETEGRITY SOLUTION
We are a leading provider of software and services for secure portal management for e-commerce applications. Key benefits of our solution include:
Centralized entitlement management. SiteMinder provides centralized control of users and entitlements that extends across multiple web-based applications on a company's web site. SiteMinder manages the entitlements of customers, business partners and employees accessing applications on a company's portal. Our solution provides this centralized entitlement management as a shared service that includes all of the e-commerce applications deployed by our customers. This approach provides many benefits. Security changes can be effected swiftly and efficiently across all of a company's e-commerce applications. Moreover, it makes application developers much more productive because they are free to focus on business processes and leave security, privilege management and personalization to SiteMinder.
Superior user experience through single sign-on and personalized content. With SiteMinder, users sign-on to a web site once and gain access to all relevant information as defined by their user entitlements. Single sign- on provides access to a personalized view of content drawn from multiple applications which run on multiple servers, multiple operating systems, and across multiple Internet domains. This benefits end users by providing them with a high-quality user experience, personalized to meet their individual needs. By providing a superior user experience on its web site, a company is able to protect its brand and build customer loyalty.
Distributed and delegated administration. SiteMinder provides policy-based administration of security policies, so that administrative responsibilities can be easily delegated to individual business units, remote
trading partners or other administrators without jeopardizing control. Delegated administrators control only the users and policies for which they have been granted explicit responsibility. SiteMinder assigns administrative responsibility where the knowledge resides, while still maintaining the overall security of a site. As a result, a company's administrative burdens and associated costs are dramatically reduced.
Leverages existing investments in technology infrastructure. SiteMinder has been designed to support the existing systems currently employed by companies and to easily accommodate emerging Internet technologies. SiteMinder integrates with leading user directories, web servers, application servers and authentication technologies. SiteMinder also provides support for multiple web servers and operating platforms involving Microsoft and Netscape Web servers, and Windows NT and UNIX platforms, which facilitates cross-platform development, deployment and migration.
Scalability and high-availability. Our customers require a platform that scales as they deploy additional applications and as user traffic grows, while providing the highest level of reliability. SiteMinder provides a scalable high-availability platform to meet the requirements of demanding portals. Based on independent third-party testing, published data from other vendors and feedback from customers, we believe that SiteMinder provides significantly higher transaction rates than other competing solutions.
STRATEGY
Our objective is to become the market leader in secure portal management solutions for the business-to-business, business-to-consumer, and application hosting markets. Key elements of our strategy include:
Extend technology leadership in secure portal management market. We believe that our technology enables us to offer a complete and cost-effective secure portal management solution for web-based applications. By building upon our ability to use a company's existing directories rather than creating another database, a feature called native integration, single sign-on capabilities and our ability to scale to support millions of users, we believe we can extend our leadership in the secure portal management market by adding new features and capabilities. Specifically, we plan to offer additional platform support for our SiteMinder solution and integration with non-web-based, legacy applications. In addition, we intend to continue to incorporate industry-leading technologies such as support for eXtensible Markup Language, or XML, and Wireless Access Protocol, or WAP, protocols, into SiteMinder.
Expand applications of SiteMinder into new markets. While most of our customers' deployments have been in the business-to-business e-commerce market, our customers are beginning to deploy SiteMinder in the business-to-consumer and service provider markets. We believe that our capabilities will enable us to offer solutions that support portal and targeted community applications in the business-to-consumer market. We will continue to expand and tailor SiteMinder as necessary to meet the requirements of our customers for new e-commerce applications.
Expand strategic partnerships: We have developed strategic relationships in order to significantly increase market awareness and distribution for SiteMinder. To date we have focused primarily on key technology providers like Sun, iPlanet, and TIBCO. In addition to building strong partnerships with the technology providers we have worked with historically we are building partnerships with leading service and technology companies that provide critical infrastructure and online services for our expanded market focus on portal management for business to business, and business to consumer, and application hosting markets Service Providers.
Pursue international expansion: Although we principally focus our marketing efforts in the United States, we have begun to expand our sales force and support organizations with the objective of gaining broad international market acceptance of SiteMinder through adoption into strategic accounts. In addition, we are developing products intended to address the specific needs of international markets, with an initial focus on Europe and Asia. These include developing localized versions of our products and local consulting services.
Expand service resources: We have learned that a customer's decision to purchase our product is based, in part, on our ability to provide a high level of customer service and implementation support. As the world wide demand for our product grows, it is critical for us to build these capabilities accordingly. We have a two pronged strategy to meet this demand. First, we continue to grow our internal resources. Second, we are aggressively recruiting the industry's leading internet system integrators. We are building cooperative relationships with these companies to insure they have the product knowledge and access to Netegrity resources to enable them to easily build SiteMinder into their client's applications.
Strategic acquisitions: We believe that there are significant market opportunities that leverage our market position that can best be met through a strategic acquisition program. Our intention is to leverage Netegrity's valuation as well as our successful fund raising in 1999 to support these activities.
PRODUCTS AND SERVICES
SiteMinder Product
SiteMinder 3.6 was released in August 1999. SiteMinder interacts with the four main components of an e-commerce web site:
- Web Servers: SiteMinder is designed to support all major web servers and provide access control to content distributed through these servers.
- Application Servers: SiteMinder is designed to support all major application servers and provide generalized entitlement management to the content and transactions delivered through these servers.
- Authentication Services: SiteMinder provides broad support for authentication methods that enable web sites to authenticate users through a variety of methods that meet the unique security requirements of each application.
- Directory Servers: SiteMinder integrates with all industry leading directory servers and utilizes them as repositories for all user and entitlement data.
The SiteMinder product consists of three key components: Policy Servers, Agents and an Administration Console. Additionally, SiteMinder is delivered with a developer kit, which allows developers to construct web sites in both C++ and Java applications. The following briefly describes each of the primary components:
- Policy Server: The Policy Server is a generalized security policy engine, which includes processes for authentication, authorization, session management, administration and auditing. The Policy Server, which handles all requests for managing, and enforcing user entitlements, runs on Windows NT and UNIX platforms.
- Agents: Agents are distributed components deployed on web servers, application servers, or as part of an application itself. Agents communicate policies to the application governing user entitlements. SiteMinder ships with web Agents compatible with most popular web servers, including Microsoft IIS, Netscape Enterprise Server and Apache. SiteMinder also supports application server Agents compatible with most popular application servers, including those from Allaire, Bluestone, Microsoft, Oracle and the Sun-Netscape Alliance.
- Administration Console: The Administration Console is a secure Java applet that allows administrators to create and manage user entitlement policies from any Java-enabled web browser.
SiteMinder 3.6 provides the following services:
- Entitlement management infrastructure: SiteMinder provides a single location for defining the policies that specify which users may access particular e-commerce applications and content. By providing a single location for these policies, SiteMinder enables web sites to apply consistent personalized content and application access for users throughout the site.
- Single sign-on: SiteMinder provides robust single sign-on services across e-commerce sites spanning web servers and application environments running on multiple operating systems and spanning multiple Internet domains. Using encrypted cookies, SiteMinder is able to recognize a previously authenticated and authorized user and allow the user to access applications and content without being prompted repeatedly for new passwords.
- Policy-based authentication services: SiteMinder manages the entire authentication process. It supports all leading authentication technologies including basic name-password, forms based authentication, digital certificates, two-factor authentication, and method chaining. SiteMinder's policy-based approach enables customers to apply different authentication technologies depending on the value
and risk of the application being accessed. For example, companies can easily use name-passwords for most applications while requiring a digital certificate for an on-line trading system.
- Distributed administration: Using any Java-enabled browser, web administrators are able to access SiteMinder and modify user entitlement policies from anywhere on the network. The user interface supports multiple levels of delegation among administrators.
SiteMinder is the only secure portal management system on the market that provides native integration with industry-standard Lightweight Directory Access Protocol, or LDAP, Windows NT directory services, and SQL databases. As a result, customers do not need to install and manage separate and redundant user directories, which are expensive to maintain, unnecessarily complex, and therefore prone to failure. SiteMinder's native directory support works with multiple directory services from multiple vendors to provide our customers with the freedom to deploy on their preferred platforms.
SiteMinder has been developed with a scalable, highly available architecture. Key features of this robust architecture include:
- Load balancing: SiteMinder Agents can easily be configured to balance loads across multiple policy servers, as well as across multiple user directories. The result is nearly linear scaling as additional servers are deployed.
- Automatic fail-over: SiteMinder Agents can easily be configured to automatically communicate with a new Policy Server should their primary Policy Server be taken off line or fail. Likewise, SiteMinder Policy Servers can easily be configured to automatically utilize a new user directory should their primary user directory be taken off line or fail. The result is a fully redundant architecture that provides high availability.
- Local caching: Both Policy Servers and Agents can be configured to cache appropriate data thereby minimizing unnecessary traffic and processing requirements. SiteMinder's session management will automatically update cached information should policies or user profiles change.
We typically license SiteMinder based on the following categories:
- Intranets, in which all the users are employees or contractors working for our customer. Prices start at approximately $40 per user for small sites and are discounted as volumes grow.
- Extranets, in which our customers conduct transactions with their corporate customers, suppliers and partners. Prices start at approximately $30 per user for small sites and are discounted as volumes grow.
- Internet sites, in which users are consumers seeking products or information from our customers. Prices start at less than $2 per user for volumes greater than 250,000 users and are discounted as volumes grow. A multi year subscription model for an unlimited number of users in year one has been introduced in January 1, 2000.
- Service providers where our customers host applications for their customers.
Standard SiteMinder licenses include a web Agent site license and Policy Server licenses. Essentially, our customers pay us for the size of the web site they are building, as measured by the number of users of that site. Our standard product license gives the customer the right to replicate and install our SiteMinder software components throughout its web site infrastructure as needed to meet scalability and redundancy requirements.
SiteMinder Services
Our professional services organization provides consulting and integration services that aid our customers in successfully implementing SiteMinder within their organizations. Our professional services include application infrastructure planning, application prototyping and integration, SiteMinder deployment, SiteMinder extensions and custom agents, and training for developers and solutions architects.
The Netegrity Technical Services group is headquartered in Waltham, Massachusetts. We provide many Services as well as a selectable level of Support for all customer environments. Prompt response and a quality resolution are the hallmarks of our service. The Netegrity Technical Service Center is a centralized operation, offering email, fax, World Wide Web (www) or telephone access for our customers. We provide technical assistance for all Netegrity products and offer three levels of Service to meet our customer needs. Netegrity Customer Services also offers extended services such as on-site training, installations, and customized service offerings. Netegrity Technical Services is committed to resolving customer problems in a timely manner.
SiteMinder Products in Development (as of February 15, 2000)
SiteMinder 4.0 or the Portal Edition, is currently in beta and expected to be released later in Q1 2000. SiteMinder 4.0 will provide additional support for e-commerce portals and new services that enable partnerships for affiliated companies. Additional versions of SiteMinder and complimentary products are currently under development for scheduled release in the next twelve months. These will include additional support for integration with legacy applications; web and application servers; and delegating management of users and policies to trusted partners.
Other Products and Services
In addition to the sales and marketing of SiteMinder, we are a non-exclusive distributor of Check Point Software Technologies' FireWall-1 product, complementary products from other vendors and related maintenance, consulting and training services. We sell these products and services directly to end users through a small, dedicated sales organization throughout the United States.
SALES, MARKETING AND DISTRIBUTION
We directly market our SiteMinder software and services domestically through a field sales organization supported by inside sales representatives. We also indirectly market through strategic partnerships and other third-party relationships with vendors of Internet-related systems and application software as well as through resellers and systems integrators. As of December 31, 1999, our sales and marketing organization consisted of 56 individuals.
Direct Sales Force. As of December 31, 1999, our direct sales force consisted of 32 individuals, 15 of whom were field sales representatives covering six domestic regions and three international regions. Our sales organization identifies prospects that have e-commerce plans and requirements, and deploys a solution-selling approach once customers are qualified. Our inside sales representatives qualify, develop and pursue leads generated through a variety of sources. Our field sales group conducts on-site meetings with accounts that have substantial product and service requirements. We target SiteMinder software and services to large, corporate customers and smaller firms that need to protect access to mission-critical information while providing the users of their applications with a personalized, seamless experience. We generally sell to e-commerce business managers, product managers, web application development managers, Internet architects, security administrators, network/systems administrators and other people responsible for analyzing and selecting e-commerce solutions. We plan to continue to focus on building our direct sales force, especially our field sales representatives, both domestically and internationally.
Indirect Distribution. We have signed partnership agreements with several leading technology providers and systems integrators. We classify our partner companies as follows:
- Alliance partners. Through our alliance partners, we license restricted use of our versions of our SiteMinder product to sell with their platforms or applications.
- Systems integrators. We continue to develop partnerships with leading systems integrators to aid in the integration and systems design of our software at customer sites. We plan to utilize systems integrators as well as our internal service and support personnel to provide superior customer installation and support.
- Resellers. We enter into agreements with selected resellers of our product.
- ISV/Co-marketing partners. We also actively seek partnerships with companies that provide products to our customers which are complementary to SiteMinder. We work together with these vendors
to provide technical integration of our product. In many cases we also work together on sales and marketing initiatives.
Product Marketing Programs. We engage in a broad range of product marketing activities, including sponsoring seminars for prospective customers, exhibiting at targeted conferences for both the technology and financial communities, as well as providing paper and e-mail based direct mailings. We also maintain an active public relations program. This program issues press releases highlighting major customer additions, strategic partnerships and new product releases, manages relations with industry analysts and promotes coverage of the firm in the trade and business press. We devote significant resources to our web site to provide product and company information as well as customer profiles. We continue to enhance our web site with features, including interactive tours, streaming demos, presentations and seminar content online, customer and developer chat rooms and more customer application stories. In addition, we plan to launch a series of banner campaigns on leading Internet portal sites.
Our product marketing programs are aimed at informing customers of the capabilities and benefits of the SiteMinder solution and increasing demand across all industry segments. We plan to continue to devote significant resources to marketing our product and brand.
In addition to the sales and marketing of SiteMinder, we are also a non-exclusive distributor of Check Point Software Technologies' FireWall-1 product, complementary products from other vendors and related maintenance, consulting and training services. We sell these products and services directly to end-users through a small, dedicated sales organization in the United States. We also benefit from marketing programs conducted by Check Point Software Technologies.
CUSTOMERS
As of December 31, 1999, we licensed SiteMinder software to 133 end-user customers. Our customer base spans multiple industry segments, focusing primarily on financial services, high tech, government, insurance, retail and telephone companies and internet service providers.
No single customer, including direct end users or resellers, accounted for more than 10% of our total revenues during the years ended December 31, 1999, 1998 and 1997.
We also sold Check Point Software Technologies' FireWall-1 to over 300 customers and continue to provide support to most of them.
PURCHASING
The Company purchases 100% of its FireWall-1 product directly through Check Point Software Technologies, Ltd. The Company also purchases firewall-related accessory products through various third-party vendors. 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.
COMPETITION
The market for secure portal management products and sources is new, rapidly evolving and highly competitive. We expect competition to continue to increase both from existing competitors and new market
entrants. We believe that our ability to compete depends on many factors both within and beyond our control, including:
- the performance, reliability, features, price and ease of use of our SiteMinder product line as compared to those of our competitors;
- our ability to secure and maintain key strategic relationships with distributors, resellers and other partners;
- our ability to expand both our domestic and international sales operations; and
- the timing and market acceptance of new solutions and enhancements to existing solutions developed by us and our competitors.
Until recently, our primary source of competition was from custom-built secure portal management software developed in-house. Many of our potential customers have the resources to establish in-house software development capabilities, and some of them, from time to time, may choose to develop their own secure portal management technology competitive with ours. Our primary competitors now include enCommerce and IBM/DASCOM. We also have faced competition from web development professional services organizations. In addition, a number of other security and software companies have indicated that they offer products which may compete with ours. Additional competition may develop as the market matures and other companies begin to offer similar products, and as our product offerings expand to other segments of the marketplace. Current and potential competitors have established, or may in the future establish, cooperative selling relationships with third parties to increase the distribution of their products to the marketplace. Accordingly, it is possible that new competitors may emerge and rapidly acquire significant market share.
We face a number of competitors in this market area. Many of our competitors have shorter operating histories, and less financial and technical resources than we have. In addition, these smaller competitors have smaller customer bases than we currently do. Some of our newer competitors, however, are larger companies who have large financial reserves, and well-established development and support teams, and large customer bases. These larger competitors may initiate pricing policies which would make it more difficult for us to maintain our competitive position against these companies.
As new participants enter the secure user management market, we will face increased competition. Potential competitors may bundle their products in a manner that discourages users from purchasing our products. It is also possible that current and potential competitors may be able to respond more quickly to new or emerging technologies or customer requirements, resulting in the acquisition of market share.
Our FireWall-1 reseller business experiences competition from companies that offer products competing with Check Point Software Technologies' FireWall-1 product, including Axent Technologies, Cisco Systems and Trusted Information Systems. We also compete with other resellers of FireWall-1.
PRODUCT RESEARCH AND DEVELOPMENT
The market for e-commerce security products is characterized by rapid technological change, changes in customer requirements, new product introductions and enhancements, and emerging industry standards. We devote significant time and resources to analyzing and responding to changes in the industry, such as changes in operating systems, application software, security standards and networking software and evolving customer requirements.
E-commerce applications have significant requirements for scalability, reliability, sophisticated security and ease of administration. These increased demands drive the need for a centralized access control model for administrators and a single point of access for end-users. With the growing implementation of standards-based user directories, such as LDAP, and the proliferation of flexible and easy-to-use security products, businesses are able to take advantage of best-of-breed solutions as they deploy e-commerce applications across heterogeneous networks. We have made, and expect to continue to make, a substantial investment in research and development. In the year ended December 31, 1999, we spent approximately $3.7 million, or 29% of
total revenues, on research and development of our SiteMinder product. We will continue our product development efforts for our current product, as well as developing next generation versions of our product line. As of December 31, 1999, we had 42 employees engaged in research and development activities.
We believe our future success depends largely on our ability to enhance and broaden our existing product line to meet the evolving needs of the market. There can be no assurance that we will be able to respond effectively to technological changes or new industry standards or developments. Our operating results and business could be adversely affected if we were to incur significant delays or be unsuccessful in developing new products or enhancing our existing products, or if any such enhancements or new products do not gain market acceptance. In addition, a number of factors may cause variations in our future operating results. These include the timing of product introductions and enhancements by us or our competitors, market acceptance of new products, or customer order deferrals in anticipation of new products.
PROPRIETARY RIGHTS
Our success and ability to compete are dependent to a significant degree on our ability to develop and maintain the proprietary aspects of our technology and operate without infringing on the proprietary rights of others. We rely on a combination of trademark, trade secret and copyright laws and licenses and contractual restrictions to protect the proprietary aspects of our technology. These legal protections afford only limited protection for our technology. We seek to protect our source code for our software, documentation and other written materials under trade secret and copyright laws. We license our software pursuant to signed license agreements, which impose restrictions on the licensee's ability to utilize the software. Finally, we seek to limit disclosure of our intellectual property by requiring employees and consultants with access to our proprietary information to execute confidentiality agreements with us and by restricting access to our source code. Due to rapid technological change, we believe that factors such as the technological and creative skills of our personnel, new product developments and enhancements to existing products are more important than the various legal protections of our technology to establishing and maintaining a technology leadership position.
Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. Policing unauthorized use of our products is difficult and while we are unable to determine the extent to which piracy of our software exists, software piracy can be expected to be a persistent problem. In addition, the laws of many countries do not protect our proprietary rights to as great an extent as do the laws of the United States. Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others or to defend against claims of infringement or invalidity. Any such resulting litigation could result in substantial costs and diversion of resources and could have a material adverse effect on our business, operating results and financial condition. There can be no assurance that our means of protecting our proprietary rights will be adequate or that our competitors will not independently develop similar technology. Any failure by us to meaningfully protect our property could have a material adverse effect on our business, operating results and financial condition.
There can be no assurance that third parties will not claim infringement with respect to our current or future products. We expect that developers of web-based application software products will increasingly be subject to infringement claims as the number of products and competitors in our industry segment grows and as the functionality of products in different segments of the software industry increasingly overlaps. Any such claims, with or without merit, could be time consuming to defend, result in costly litigation, divert management's attention and resources, cause product shipment delays or require us to enter into terms acceptable to us or at all. A successful infringement claim against us and our failure or inability to license the infringed rights or develop or license technology with comparable functionality could have a material adverse effect on our business, financial condition and operating results.
We integrate third-party software into our products. This third-party software may not continue to be available on commercially reasonable terms. We believe, however, there are alternative sources for such
technology. If we could not maintain licenses to the third-party software included in our products, however, distribution of our products could be delayed until equivalent software could be developed or licensed and integrated into our products, which could materially adversely affect our business, operating results and financial condition.
EMPLOYEES
As of December 31, 1999, we had a total of 138 full-time employees, of which 42 were involved in research and development, 72 in sales, marketing and customer support, 10 in consulting and 14 in administration and finance. None of our employees are represented by a labor union. We have not experienced any work stoppages and believe that our relationships with employees are good. Our future success will depend in part on our ability to attract, retain and motivate highly qualified technical and management personnel, for whom competition is intense.
FORWARD-LOOKING STATEMENTS AND INDUSTRY DATA
This report and the documents incorporated in it by reference contain forward-looking statements about our plans, objectives, expectations and intentions. You can identify these statements by words such as "expect," "anticipate," "intend," "plan," "believe," "seek," "estimate," "may," "will" and "continue" or similar words. You should read statements that contain these words carefully. They discuss our future expectations, contain projections of our future results of operations or our financial condition or state other forward-looking information, and may involve known and unknown risks over which we have no control. You should not place undue reliance on forward-looking statements. We cannot guarantee any future results, levels of activity, performance or achievements. Moreover, we assume no obligation to update forward-looking statements or update the reasons actual results could differ materially from those anticipated in forward-looking statements. The factors discussed in the sections captioned "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business" in this report and the documents incorporated in it by reference identify important factors that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements.
This report and the documents incorporated in it by reference contain data related to the e-commerce market. These market data have been included in studies published by the market research firms of Forrester Research and International Data Corporation. These data include projections that are based on a number of assumptions, including increasing worldwide business use of the Internet, the growth in the number of web access devices per user, the absence of any failure of the Internet, and the continued improvement of security on the Internet. If any of these assumptions is incorrect, actual results may differ from the projections based on those assumptions.
RISK FACTORS
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 section are such forward-looking statements that involve risks and uncertainties, including:
WE HAVE INCURRED SUBSTANTIAL LOSSES AND MAY NOT BE PROFITABLE IN THE FUTURE.
In recent years, we have incurred substantial operating losses in every fiscal period. We cannot predict when we will become profitable, if at all, and if we do, that we will remain profitable for any substantial period of time. Failure to achieve profitability within the time frame expected by investors may adversely affect the market price of our common stock. In the year ended December 31, 1999, we had a net loss of $5.5 million. As a result of ongoing operating losses, at December 31, 1999, we had an accumulated deficit of $20.1 million. We have generated relatively small amounts of SiteMinder revenues until recent fiscal quarters, while increasing expenditures in all areas, particularly in research and development and sales and marketing, in order to execute our business plan. Although we have experienced revenue growth in connection with SiteMinder in recent periods, the growth has been off of a small base, and it is unlikely that the recent growth rates are sustainable.
DISAPPOINTING QUARTERLY RESULTS COULD CAUSE THE MARKET PRICE OF OUR COMMON STOCK TO FALL SUBSTANTIALLY.
Our quarterly revenues and operating results are difficult to predict and may fluctuate significantly from quarter to quarter. If our quarterly revenues or operating results fall below the expectations of investors, the price of our common stock could fall substantially.
Our quarterly revenues may fluctuate for several reasons, including the following:
- market acceptance of our SiteMinder products;
- our success in obtaining follow-on sales to existing customers;
- the long sales and deployment cycle for sales of SiteMinder licenses;
- our ability to hire and retain personnel, particularly in services and sales and marketing;
- the release of new versions of SiteMinder or other products; and
- the development of our direct and indirect sales channels.
In addition, because our revenues from services are largely correlated with our SiteMinder software revenues, a decline in SiteMinder software revenues could also cause a decline in our SiteMinder services revenues in the same quarter or in subsequent quarters. Other factors, many of which are outside our control, could also cause variations in our quarterly revenues and operating results.
Most of our expenses, such as employee compensation and rent, are relatively fixed. Moreover, our expense levels are based, in part, on our expectations regarding future revenue increases. As a result, any shortfall in revenues in relation to our expectations could cause significant changes in our operating results from quarter to quarter and could result in increased quarterly losses.
OUR FUTURE SUCCESS WILL DEPEND ON OUR ABILITY TO MARKET SITEMINDER AND RELATED SERVICES SUCCESSFULLY.
The sale of SiteMinder licenses and related services provides a substantial majority of our total revenues. These sales accounted for 76% of our total revenues for the year ended December 31, 1999. We expect that our future financial performance will depend on SiteMinder sales. Prior to the release of SiteMinder 3.0 in June 1998, there had been very few commercial installations of SiteMinder. Since June 1998, all commercial deployments of SiteMinder have supported business-to-business web applications. Broad market acceptance of SiteMinder will depend on the development of the market for secure portal management, including usage of
SiteMinder for business-to-consumer applications, and customer demand for the specific functionality of SiteMinder. We cannot be sure that either will occur. Like most technology products at an early stage of development, SiteMinder may require extensive reengineering or upgrading if it fails to meet the performance needs or expectations of our customers when shipped or contains significant software defects or bugs. If we fail in marketing SiteMinder products and services, for whatever reason, our business would be harmed.
OUR SUCCESS IS DEPENDENT ON OUR ABILITY TO ENHANCE OUR SITEMINDER PRODUCT LINE AND DEVELOP NEW PRODUCTS.
We believe our success is dependent, in large part, on our ability to enhance and broaden our SiteMinder product line to meet the evolving needs of both the business-to-business and business-to-consumer market. We cannot be sure that we will be able to respond effectively to technological changes or new industry standards or developments. In the past, we have been forced to delay introduction of several new product versions. In the future, we could be adversely affected if we incur significant delays or are unsuccessful in enhancing our SiteMinder product line or developing new products, or if any of our enhancements or new products do not gain market acceptance.
OUR PERFORMANCE DEPENDS ON OUR ABILITY TO OBTAIN FOLLOW-ON SALES.
Customers typically place small initial orders for SiteMinder installations to allow them to evaluate its performance. Our strategy is to pursue more significant follow-on sales after these initial installations. Our financial performance depends on successful initial deployments of SiteMinder that, in turn, lead to follow-on sales. We cannot be sure that initial deployments of SiteMinder by our customers will be successful, or that we will be able to obtain follow-on sales.
WE FACE SIGNIFICANT COMPETITION FROM THE INTERNAL EFFORTS OF POTENTIAL CUSTOMERS AND FROM OTHER TECHNOLOGY COMPANIES AND WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY.
The market for secure user management products and services is relatively immature and highly competitive. We expect the level of competition to increase as a result of the anticipated growth of e-commerce. Until recently, our primary source of competition was from secure user management software developed in-house. Many of our potential customers have the resources to establish in-house software development capabilities, and some of them, from time to time, may choose to develop their own secure user management technology that is competitive with ours. In addition, we have faced competition from web development professional services organizations. Today our primary competitors include enCommerce and the partnership between IBM and DASCOM. In addition, a number of other security and software companies have indicated that they offer products which may compete with ours. We expect that additional competitors will emerge in the future. Current and potential competitors have established, or may in the future establish, cooperative relationships with third parties to increase the availability of their products to the marketplace. It is possible that new competitors or alliances may emerge and rapidly acquire significant market share. Potential competitors may have significantly greater financial, marketing, technical and other competitive resources than we have. If, in the future, a competitor chooses to bundle a competing secure user management product with other e-commerce applications, the demand for our products might be substantially reduced. Many of these factors are out of our control, and there can be no assurance that we can maintain or enhance our competitive position against current and future competitors.
THE DEVELOPMENT OF A MARKET FOR SITEMINDER IS UNCERTAIN.
We provide secure user management solutions for web-based e-commerce applications. Our market is new and rapidly evolving. If the market for secure user management solutions does not grow at a significant rate, this will have a material adverse effect on our business, operating results and financial condition. As is typical for new and rapidly evolving industries, customer demand for recently introduced secure user management products is highly uncertain.
OUR BUSINESS WILL BE ADVERSELY AFFECTED IF THE INTERNET DOES NOT BECOME A VIABLE AND SUBSTANTIAL COMMERCIAL MEDIUM.
Our future success depends heavily on the acceptance and wide use of the Internet for e-commerce. If e-commerce does not continue to grow or grows more slowly than expected, significant demand for SiteMinder and related services may fail to develop. Consumers and businesses may reject the Internet as a viable commercial medium for a number of reasons, including potentially inadequate network infrastructure, slow development of enabling technologies, insufficient commercial support or privacy concerns. In addition, delays in the development or adoption of new standards and protocols required to handle increased levels of e-commerce, or increased government regulation or taxation, could cause the Internet to lose its viability as a commercial medium.
REGULATIONS OR CONSUMER CONCERNS REGARDING THE USE OF "COOKIES" ON THE INTERNET COULD REDUCE THE FUNCTIONALITY OF SITEMINDER.
SiteMinder uses cookies to support its single sign-on functionality. A cookie is information keyed to a specific user that is stored on the hard drive of the user's computer, typically without the user's knowledge. Cookies are generally removable by the user, and can be refused by the user at the point at which the information would be stored on the user's hard drive. A number of governmental bodies and commentators in the United States and abroad have urged passage of laws limiting or abolishing the use of cookies. The passage of laws limiting or abolishing the use of cookies, or the widespread deletion or refusal of cookies by web site users, could reduce or eliminate the effectiveness of single sign-on and could reduce market demand for SiteMinder.
WE MUST HIRE AND RETAIN SKILLED PERSONNEL IN A TIGHT LABOR MARKET.
Qualified personnel are in great demand throughout the software industry. Our success depends, in large part, upon our ability to attract, train, motivate and retain highly skilled employees, particularly software engineers, professional services personnel, sales and marketing personnel, and other senior personnel. Our failure to attract and retain the highly trained technical personnel that are integral to our product development, professional services and direct sales teams may limit the rate at which we can generate sales and develop new products or product enhancements. This could have a material adverse effect on our business, operating results and financial condition.
OUR SUCCESS DEPENDS ON OUR ABILITY TO DEVELOP OUR DIRECT SALES AND INDIRECT DISTRIBUTION CHANNELS.
To increase our revenues, we must develop our direct sales channel and increase the number of our indirect channel partners. A failure to do so could have a material adverse effect on our business, operating results and financial condition. There is intense competition for sales personnel in our business, and we cannot be sure that we will be successful in attracting, integrating, motivating and retaining sales personnel. In addition, we must increase the number of strategic partnerships and other third-party relationships with vendors of Internet-related systems and application software, resellers and systems integrators. Our existing or future channel partners may choose to devote greater resources to marketing and supporting the products of other companies. In addition, we will need to resolve potential conflicts among our sales force and channel partners.
OUR FAILURE TO EXPAND OUR PROFESSIONAL SERVICES RESOURCES COULD LIMIT THE SUCCESS OF SITEMINDER.
Our professional services organization provides critical support to our customers' installation and deployment of SiteMinder. If we fail to expand our professional services resources, our ability to increase sales of SiteMinder may be limited. In addition, if we cannot adequately support SiteMinder installations, our customers' use of our products may fail, which could harm our reputation and hurt our business.
OUR LENGTHY SALES CYCLE MAKES IT DIFFICULT TO PREDICT OUR QUARTERLY OPERATING RESULTS.
We have a long sales cycle because we generally need to educate potential customers regarding the use and benefits of SiteMinder. Our sales cycle varies depending on the size and type of customer contemplating a purchase and whether we have conducted business with a potential customer in the past. These potential customers frequently need to obtain approvals from multiple decision makers prior to making purchase decisions. Our long sales cycle, which can range from several weeks to several months or more, makes it difficult to predict the quarter in which sales will occur. Delays in sales could cause significant variability in our revenues and operating results for any particular period.
OUR FAILURE TO MANAGE OUR RAPID GROWTH EFFECTIVELY COULD HURT OUR BUSINESS.
Our failure to manage our rapid growth effectively could have a material adverse effect on the quality of our products, our ability to retain key personnel and our business, operating results and financial condition. We have been experiencing a period of rapid growth that has been placing a significant strain on all of our resources. From December 31, 1998 to December 31, 1999, the number of our employees increased from 64 to 138. To manage future growth effectively we must maintain and enhance our financial and accounting systems and controls, integrate new personnel and manage expanded operations.
IF WE LOSE THE SERVICES OF BARRY BYCOFF OR ANY OTHER MEMBER OF OUR MANAGEMENT TEAM, OUR BUSINESS COULD SUFFER.
Our future success depends, to a significant degree, on the skill, experience and efforts of Barry Bycoff, our chief executive officer, and the rest of our management team. The loss of any member of our management team could have a material adverse effect on our business, operating results and financial condition. We also depend on the ability of our officers and key employees to work effectively as a team.
AS WE EXPAND OUR INTERNATIONAL OPERATIONS, WE WILL FACE NEW RISKS TO OUR SUCCESS.
Historically, we have not derived a significant portion of our total revenues from sales to customers outside the United States. However, we intend to expand our international operations in the future. This expansion will require additional resources and management attention, and will subject us to new regulatory, economic and political risks. We have very little experience in international markets. As a result, we cannot be sure that our expansion into global markets will be successful. In addition, we will face new risks in doing business internationally. These risks could reduce demand for our products and services, increase the prices at which we can sell our products and services, or otherwise have an adverse effect on our operating results. Among the risks we believe are most likely to affect us are:
- longer payment cycles and problems in collecting accounts receivable;
- adverse changes in trade and tax regulations, including restrictions on the import and export of sensitive technologies, such as encryption technologies, that we use or may wish to use in our software products;
- the absence or significant lack of legal protection for intellectual property rights;
- difficulties in managing an organization spread over several countries, including complications arising from cultural, language and time differences that may lengthen sales and implementation cycles;
- currency risks, including fluctuations in exchange rates; and
- political and economic instability.
OUR SUCCESS DEPENDS ON OUR ABILITY TO PROTECT OUR PROPRIETARY RIGHTS.
Our success depends to a significant degree upon the protection of our software and other proprietary technology. The unauthorized reproduction or other misappropriation of our proprietary technology could enable third parties to benefit from our technology without paying us for it. This could have a material adverse effect on our business, operating results and financial condition. We depend upon a combination of
trademark, trade secret and copyright laws, license agreements and non-disclosure and other contractual provisions to protect proprietary and distribution rights in our products. In addition, we attempt to protect our proprietary information and the proprietary information of our vendors and partners through confidentiality and/or license agreements with our employees and others. Although we have taken steps to protect our proprietary technology, they may be inadequate. Existing trade secret, copyright and trademark laws offer only limited protection. Moreover, the laws of other countries in which we market our products may afford little or no effective protection of our intellectual property. If we resort to legal proceedings to enforce our intellectual property rights, the proceedings could be burdensome and expensive, even if we were to prevail.
CLAIMS BY OTHER COMPANIES THAT WE INFRINGE THEIR PROPRIETARY TECHNOLOGY COULD HURT OUR FINANCIAL CONDITION.
If we discover that any of our products violated third party proprietary rights, there can be no assurance that we would be able to reengineer our product or to obtain a license on commercially reasonable terms to continue offering the product without substantial reengineering. We do not conduct comprehensive patent searches to determine whether the technology used in our products infringes patents held by third parties. In addition, product development is inherently uncertain in a rapidly evolving technology environment in which there may be numerous patent applications pending, many of which are confidential when filed, with regard to similar technologies. Any claim of infringement could cause us to incur substantial costs defending against the claim, even if the claim is invalid, and could distract our management from our business. Furthermore, a party making such a claim could secure a judgment that requires us to pay substantial damages. A judgment could also include an injunction or other court order that could prevent us from selling our products. Any of these events could have a material adverse effect on our business, operating results and financial condition.
OUR BUSINESS COULD BE ADVERSELY AFFECTED IF OUR PRODUCTS CONTAIN ERRORS.
Software products as complex as ours may contain undetected errors or "bugs" that result in product failures. The occurrence of errors could result in loss of or delay in revenues, loss of market share, failure to achieve market acceptance, diversion of development resources, injury to our reputation, or damage to our efforts to build brand awareness, any of which could have a material adverse effect on our business, operating results and financial condition.
WE COULD INCUR SUBSTANTIAL COSTS RESULTING FROM PRODUCT LIABILITY CLAIMS RELATING TO OUR CUSTOMERS' USE OF OUR PRODUCTS.
Many of the e-commerce applications supported by our products are critical to the operations of our customers' businesses. Any failure in a customer's web site or application caused or allegedly caused by our products could result in a claim for substantial damages against us, regardless of our responsibility for the failure. Although we maintain general liability insurance, including coverage for errors and omissions, there can be no assurance that our existing coverage will continue to be available on reasonable terms or will be available in amounts sufficient to cover one or more large claims, or that the insurer will not disclaim coverage as to any future claim.
IF WE ACQUIRE OTHER COMPANIES OR BUSINESSES, WE WILL BE SUBJECT TO RISKS THAT COULD HURT OUR COMPANY.
In the future, we may pursue acquisitions to obtain complementary products, services and technologies. An acquisition may not produce the revenues, earnings or business synergies that we anticipated, and an acquired product, service or technology might not perform as we expected. If we pursue any acquisition, our management could spend a significant amount of time and effort in identifying and completing the acquisition. If we complete an acquisition, we would probably have to devote a significant amount of management resources to integrate the acquired business with our existing business.
To pay for an acquisition, we might use our stock or cash. Alternatively, we might borrow money from a bank or other lender. If we use our stock, our stockholders would experience dilution of their ownership interests. If we use cash or debt financing, our financial liquidity will be reduced.
THE MARKET PRICE OF OUR COMMON STOCK HAS BEEN AND MAY CONTINUE TO BE VOLATILE.
Our stock price, like that of other technology companies, has been extremely volatile. The announcement of new products, services, technological innovations or distribution partners by us or our competitors, quarterly variations in our operating results, changes in revenues or earnings estimates by securities analysts and speculation in the press or investment community are among the factors affecting our stock price.
The stock market in general, and the market prices for Internet-related companies in particular, have experienced extreme volatility that often has been unrelated to the operating performance of these companies. These broad market and industry fluctuations may adversely affect the market price of our common stock, regardless of our operating performance. Recently, when the market price of a stock has been volatile, holders of that stock have often instituted securities class action litigation against the company that issued the stock. If any of our stockholders brought a lawsuit against us, we could incur substantial costs defending the lawsuit. The lawsuit could also divert the time and attention of our management.
WE MAY LOSE MONEY ON FIXED-PRICE CONSULTING CONTRACTS.
In the future, an increased portion of our SiteMinder services revenues may be derived from fixed-price contracts. We work with complex technologies in compressed time frames and it can be difficult to judge the time and resources necessary to complete a project. If we miscalculate the resources or time we need to complete work under fixed-price contracts, our operating results could be materially harmed.
LOSS OF OUR FIREWALL-1 RESELLER BUSINESS WOULD ADVERSELY AFFECT OUR OPERATING RESULTS.
While we recently have focused our resources on developing and marketing our SiteMinder software and services, we continue to generate a significant portion of our revenues from our sales of Check Point Software Technologies' FireWall-1 product. Our FireWall-1 reseller business experiences competition from companies that compete with FireWall-1, including Axent Technologies, Cisco Systems and Trusted Information Systems, as well as from other resellers of FireWall-1. As a result, we may not be able to maintain the current revenue levels generated by our FireWall-1 reseller business.
CERTAIN PROVISIONS OF OUR CHARTER AND OF DELAWARE LAW MAKE A TAKEOVER OF OUR COMPANY MORE DIFFICULT.
Our corporate documents and Delaware law contain provisions that might enable our management to resist a takeover of our company. These provisions might discourage, delay or prevent a change in the control of Netegrity or a change in our management. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors and take other corporate actions. The
existence of these provisions could limit the price that investors might be willing to pay in the future for shares of our common stock.
ITEM 2.
ITEM 2. PROPERTIES
The Company's headquarters consist of two separate leased office suites located at 245 Winter Street and 200 West Street in Waltham, Massachusetts. We occupy 5,760 square feet of space for current monthly payments of $8,400 under a lease expiring in May 2001 and 12,600 square feet of space for current monthly payments of $30,450 under a lease expiring in December 2001. We anticipate that in the near future we will lease office space that will house our new headquarters.
In order to support our field sales and consulting staff, we lease office space in Los Angeles and San Jose, California; New York, New York; Chicago, Illinois; Reston, Virginia; Atlanta, Georgia; Paris, France; London, England; Ngee Ann City, Singapore.
ITEM 3.
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 not presently a party to any legal proceedings, the adverse outcome of which, in management's opinion, would have a material adverse effect on the Company's results of operations or financial position.
ITEM 4.
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, 1999 except for a special meeting of stockholders held October 7, 1999 which is described in Item 3 in the Company's Form 10-Q for the period ending September 30, 1999.
Part II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is traded on the Nasdaq National Market under the symbol "NETE." It was traded on the Nasdaq SmallCap Market prior to September 28, 1999. The following table sets forth, for the periods indicated, the range of high and low sales prices per share of our common stock, as reported on the Nasdaq SmallCap Market for the period prior to September 28, 1999 and on the Nasdaq National Market for the time period from September 28, 1999 through December 31, 1999.
As of December 31, 1999, there were 162 holders of record of common stock.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data set forth below should be read in conjunction with our consolidated financial statements and related notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing elsewhere herein.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with "Selected Financial Data" appearing in Item 6 of this report and our consolidated financial statements and related notes appearing under Item 8 of this report. This discussion and analysis contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements, as described under "Forward-Looking Statements and Industry Data" under Item 1 of this report.
OVERVIEW
We are a leading provider of software and services for managing and controlling user access to web-based e-commerce applications. We introduced our flagship product, SiteMinder, with the first commercial release of SiteMinder 2.0 in November 1997. In June 1998, we began shipment of SiteMinder 3.0, the first commercially available directory-enabled secure user management solution for web-based e-commerce applications. We changed our fiscal year end from March 31 to December 31, effective with the fiscal period ending December 31, 1996.
We derive our revenues from the sale of SiteMinder software and services and from revenues related to the resale of Check Point Software Technologies' FireWall-1 software product. SiteMinder software revenues are derived from the sale of SiteMinder product licenses. SiteMinder service revenues are derived from fees related to the implementation and maintenance of SiteMinder and training on the SiteMinder product. Other revenues are derived from the resale, through a dedicated sales organization, of FireWall-1, complementary products from other vendors and related maintenance, consulting and training services. SiteMinder software revenues accounted for 59% of total revenues in the year ended December 31, 1999 and 31% of total revenues in the year ended December 31, 1998. SiteMinder services revenues accounted for 17% of total revenues in the year ended December 31, 1999 and 10% of total revenues in the year ended December 31, 1998. Other revenues accounted for 24% of total revenues in the year ended December 31, 1999 and 59% of total revenues in the year ended December 31, 1998. We expect SiteMinder software and services revenues to increase as a percentage of total revenues.
We currently sell our SiteMinder products through a combination of our direct sales force, worldwide resellers and licensees. We anticipate that the percentage of our revenues derived outside of North America will increase. Increasing our international sales may subject us to risks, many of which are outside
our control, including economic uncertainties, currency fluctuations, political instability and uncertain cultural and regulatory environments.
Our cost of sales includes, among other things, royalties due to third parties for technology included in our products, product fulfillment costs, and salaries and related expenses for our consulting, education and technical support services organizations, and the associated cost of training facilities.
Our operating expenses are classified into two general categories: selling, general and administrative and research and development. Selling, general and administrative expenses consist primarily of salaries and other related costs for selling, administrative and marketing personnel, sales commissions, travel, legal and accounting services, public relations, marketing materials, trade shows and certain facilities-related expenses. Research and development expenses consist primarily of personnel costs to support product development.
Since 1996, we have incurred substantial costs to develop our technology and products, to recruit and train personnel for our research and development, sales, marketing and professional services departments, and to establish an administrative organization. We have incurred net losses in each fiscal quarter since 1996 and had an accumulated deficit of $20.1 million as of December 31, 1999. We anticipate that our operating expenses will increase substantially in future quarters as we increase sales and marketing operations, expand distribution channels, increase research and development, broaden professional services, expand facilities and support, and improve operational and financial systems. Accordingly, we expect to incur additional losses through at least 2000.
Although we have experienced significant growth in revenues in recent periods, that growth has been from a relatively small base, and there can be no assurance that those growth rates are sustainable. Therefore, historical growth rates should not be considered indicative of future operating results. There can also be no assurance that we will be able to continue to increase our revenues or attain profitability or, if increases in revenue and profitability are achieved, that they can be sustained. We believe that the period-to-period comparisons of our historical operating results are not meaningful and should not be relied upon as an indication of future performance.
RESULTS OF OPERATIONS
The following table presents statement of operations data as percentages of total revenues for the periods indicated:
Year Ended December 31, 1999 Compared to Year Ended December 31, 1998
Revenues. Total revenues increased by $8.0 million, or 166%, to $12.7 million in the year ended December 31, 1999, from $4.8 million in the year ended December 31, 1998.
SiteMinder software revenues increased by $6.0 million, or 407%, to $7.5 million in the year ended December 31, 1999, from $1.5 million in the year ended December 31, 1998. This increase is due to the continued increase in market awareness and the acceptance of the SiteMinder product and expansion of our sales organization. There were no significant revenues from SiteMinder prior to the release of SiteMinder 3.0 in June 1998.
SiteMinder services revenues increased by $1.7 million, or 373%, to $2.2 million in the year ended December 31, 1999, from $468,000 in the year ended December 31, 1998. This increase reflected the continued growth in the installed base of SiteMinder software licenses and the increasing demand to provide installation and integration services for customers.
Other revenues increased by $167,000, or 6%, to $3.0 million in the year ended December 31, 1999, from $2.8 million in the year ended December 31, 1998.
Cost of revenues. Total cost of revenue increased by $1.7 million or 97%, to $3.5 million in the year ended December 31, 1999, from $1.8 million in the year ended December 31, 1998.
Cost of SiteMinder software increased by $428,000, or 211%, to $631,000 in the year ended December 31, 1999 from $203,000 in the year ended December 31, 1998. The increase is primarily due to increases in royalties due to third parties for technology included in our product as SiteMinder software revenues continue to increase.
Cost of SiteMinder services increased by $1.1 million or 1,020%, to $1.2 million in the year ended December 31, 1999 from $110,000 in the year ended December 31, 1998. The increase is due to increases in salaries and related expenses for our consulting and education organizations as a result of increased SiteMinder service revenues.
Cost of other increased by $169,000 or 12%, to $1.6 million in the year ended December 31, 1999 from $1.5 million in the year ended December 31, 1998. The increase is due to increases in product fulfillment costs principally as a result of increased other revenues.
Selling, general and administrative expenses. Selling, general and administrative expenses increased by $5.4 million, or 85%, to $11.8 million in the year ended December 31, 1999, from $6.4 million in the year ended December 31, 1998. This increase was primarily a result of the continued development of our sales and marketing infrastructure to support planned growth in sales of our SiteMinder product and services.
Research and development costs. Research and development costs increased by $1.8 million, or 88%, to $3.7 million in the year ended December 31, 1999, from $2.0 million in the year ended December 31, 1998. The increase was primarily due to our continued development of SiteMinder and our increase in research and development personnel. We expect to continue to increase the amount spent on research and development in the foreseeable future as we continue to develop and enhance our product line to address the evolving needs of customers deploying large-scale and transaction-based e-commerce applications.
Interest income (expense), net. Net interest income increased by $694,000, or 533%, to $824,000 in the year ended December 31, 1999, from $130,000 in the year ended December 31, 1998. This increase was mainly attributable to a higher cash balance in the year ended December 31, 1999. There were no borrowings outstanding during the years ended December 31, 1998 or 1999.
Provision for income taxes. For the years ended December 31, 1999 and 1998 we had no provision for income taxes due to the net losses incurred. As of December 31, 1999, we had net operating loss carryforwards of $28 million available for federal purposes to reduce future taxable income expiring on various dates through 2019. Provisions of the Internal Revenue Code may limit the net operating loss available for use in any given year, based upon significant past or future changes of our ownership.
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Revenues. Total revenues increased by $58,000, or 1%, to $4.8 million in the year ended December 31, 1998, from $4.7 million in the year ended December 31, 1997.
SiteMinder software revenues increased by $1.2 million, or 525%, to $1.5 million in the year ended December 31, 1998, from $237,000 in the year ended December 31, 1997. The first commercial release of SiteMinder was version 2.0 in November 1997. SiteMinder 3.0 was released in June 1998, after which revenues increased each quarter.
SiteMinder services revenues increased by $456,000, 3793% to $468,000 in the year ended December 31, 1998, from $12,000 in the year ended December 31, 1997. As the number of SiteMinder software customers grew in 1998, support and consulting services grew accordingly.
Other revenues decreased by $1.6 million, or 37%, to $2.8 million in the year ended December 31, 1998, from $4.5 million in the year ended December 31, 1997. This decrease is a result of our de-emphasis on the FireWall-1 related products and services as we shifted resources to SiteMinder products and services.
Cost of revenues. Total cost of revenues decreased by $706,000 or 29%, to $1.8 million in the year ended December 31, 1998, from $2.5 million in the year ended December 31, 1997.
Cost of Siteminder software increased by $156,000, or 333%, to $203,000 in the year ended December 31, 1998 from $47,000 in the year ended December 31, 1997. The increase is due to increases in royalties due to third parties for technology included in our product, fulfillment costs, and amortization of software development costs as Siteminder software revenue increased.
Cost of Siteminder services increased by $110,000 to $110,000 in the year ended December 31, 1998 from the year ended December 31, 1997. The increase is due to salaries and related expenses for our consulting and education organizations as a result of increased SiteMinder service revenues.
Cost of other decreased by $972,000, or 40%, to $1.5 million in the year ended December 31, 1998 from $2.4 million in the year ended December 31, 1997. The decrease is due to decreases in product fulfillment costs principally as a result of decreased other revenues noted above.
Selling, general and administrative expenses. Selling, general and administrative expenses increased by $886,000, or 16%, to $6.4 million in the year ended December 31, 1998, from $5.5 million in the year ended December 31, 1997. This increase was primarily a result of our continuing to build our sales and marketing infrastructure to support planned growth in sales of our SiteMinder product and services.
Research and development costs. Research and development costs increased by $963,000, or 94%, to $2.0 million in the year ended December 31, 1998, from $1.0 million in the year ended December 31, 1997.
Interest income (expense), net. Net interest income decreased $73,000, or 36%, to $130,000 in the year ended December 31, 1998, from $203,000 in the year ended December 31, 1997. This decrease was mainly attributable to a lower average cash balance in 1998.
LIQUIDITY AND CAPITAL RESOURCES
In recent years, we have funded our operations primarily from sales of securities.
Cash used for operating activities in the year ended December 31, 1999 was $7.7 million, primarily due to a net loss of $5.5 million and an increase in accounts receivable, partially offset by increases in accounts payable, accrued expenses and deferred revenue.
Cash used for investing activities was $1.5 million in the year ended December 31, 1999. Investing activities for the period consisted primarily of the purchases of equipment, consisting largely of office furniture and equipment, telephone and computer equipment.
Cash provided by financing activities in the year ended December 31, 1999 was approximately $110.9 million, primarily as a result of the sale of 2,500,000 shares of Common Stock at a price of $40.00 per share in a follow-on public offering on November 10, 1999. On December 9, 1999 the Company sold an additional 12,500 shares of Common Stock at a price of $40.00 per share pursuant to the exercise of the underwriter overallotment option. We received net proceeds of approximately $94.3 million from this follow-on offering. In addition, we received net proceeds of $10.3 million from the sale of 534,242 shares of common stock at a price of $20.59 per share to certain investors in a private placement on September 9, 1999 and net proceeds of $4.6 million from the sale of 795,651 shares of common stock to certain investors from a private placement on February 8, 1999.
As of December 31, 1999, our primary financial commitments consisted of obligations outstanding under operating leases.
As of December 31, 1999, we had cash and cash equivalents totaling $102.9 million.
In recent years, we have significantly increased our operating expenses. We anticipate that we will continue to experience significant growth in our operating expenses for the foreseeable future and that our operating expenses and capital expenditures will constitute a material use of our cash resources. In addition, we may utilize cash resources to fund acquisitions or investments in businesses, technologies, products or services that are complementary to our business. We believe that our existing cash and cash equivalent balances will be sufficient to meet our anticipated cash requirements for working capital and capital expenditures for at least the next twelve months.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, or SFAS 133, "Accounting for Derivative Instruments and Hedging Activities." This statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. The statement requires companies to recognize all derivatives as either assets or liabilities, with the instruments measured at fair value. The accounting for changes in fair value, gains or losses, depends on the intended use of the derivative and its resulting designation. The statement initially was to be effective for all fiscal quarters of fiscal years beginning after June 15, 1999. In July 1999, the Financial Accounting Standards Board issued SFAS 137, "Accounting for Derivative Instruments and Hedging Activities Deferral of the Effective Date of FASB Statement No. 133 -- An amendment of FASB Statement No. 133." SFAS 137 defers the implementation of SFAS 133 by one year. SFAS 133, as amended by SFAS 137, is effective for our fiscal quarters beginning after January 1, 2000. We do not expect our adoption of SFAS 133 to have a material effect on our financial position or results of operations.
In December 1998, the Accounting Standards Executive Committee, or AcSEC, issued SOP 98-9, "Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions." SOP 98-9 amends SOP 97-2 to require that an entity recognize revenue for multiple element arrangements by means of the "residual method" when (1) there is vendor-specific objective evidence of the fair values of all the undelivered elements that are not accounted for by means of long-term contract accounting and (2) vendor-specific objective evidence of fair value does not exist for one or more of the delivered elements. We do not expect SOP 98-9 to have a material effect on our financial position or results of operations.
In December 1999, the Securities and Exchange Commission released Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements." This bulletin summarizes certain views of the staff on applying generally accepted accounting principles to revenue recognition in financial statements. The Company is currently determining the impact that SAB 101 will have on our financial position or results of operations.
YEAR 2000 UPDATE
We have not experienced any disruptions related to the "Year 2000" issue. Nevertheless, we are continuing to evaluate risks associated with a potential delayed impact of Year 2000 related failures. Any such failure could result in an interruption in, or a failure of, normal business activities which could materially and adversely affect our results of operations, liquidity and financial condition. Due to the general uncertainty inherent in the Year 2000 issue, resulting in part from the uncertainty of the Year 2000 readiness of third party vendors, we are unable to predict whether any future failure related to the Year 2000 issue will have a material adverse impact on our results of operations, liquidity or financial position. We believe that our efforts to identify and resolve issues related to the Year 2000 problem have reduced, but not eliminated, the possibility that we will in the future encounter any significant interruptions to normal operations related to the Year 2000 issue.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's consolidated financial statements and the related auditors' report are presented in the following pages. The consolidated financial statements filed in this Item 8 are as follows:
- Report of Independent Accountants
- Consolidated Balance Sheets--December 31, 1999 and 1998
- Consolidated Statements of Operations for the years ended December 31, 1999, 1998, and 1997
- Consolidated Statements of Stockholders' Equity for the years ended December 31, 1999, 1998, and 1997
- Consolidated Statements of Cash Flows for the years ended December 31, 1999, 1998, and 1997
- Notes to Consolidated Financial Statements
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of Netegrity, Inc.
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of stockholders' equity and of cash flows present fairly, in all material respects, the financial position of Netegrity, Inc. and its subsidiaries at December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. 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 of these statements in accordance with auditing standards generally accepted in the United States, which require that we plan and perform the audit 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Boston, Massachusetts March 14, 2000
NETEGRITY, INC.
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of the consolidated financial statements.
NETEGRITY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of the consolidated financial statements.
NETEGRITY, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
The accompanying notes are an integral part of the consolidated financial statements.
NETEGRITY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of the consolidated financial statements.
NETEGRITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A: NATURE OF THE BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
The Company currently operates in the secure user management market.
Principles of Consolidation
The financial statements of the Company also include the accounts and operations of its subsidiaries, Netegrity Europe SLR and Netegrity Asia, Pte Ltd. From the effective date of their formation all significant intercompany accounts and transactions have been eliminated in these consolidated financial statements.
Cash and Cash Equivalents
Cash and cash equivalents include time deposits and highly liquid investments with a maturity of three months or less at the date of purchase.
Concentration of Credit Risk and Fair Value of Financial Instruments
The amounts reflected in the consolidated balance sheets for cash and cash equivalents, accounts receivable and accounts payable approximate their fair value due to their short maturities. Our cash and cash equivalents are held with financial institutions with high credit standings. Financial instruments that potentially subject us to concentration of credit risk consist primarily of trade receivables. Our customer base consists of large numbers of customers dispersed across many industries. As a result, concentration of credit risk with respect to trade receivables is not significant except for one receivable which accounted for 17% of total receivables as of December 31, 1999.
Revenue Recognition
The Company's revenues 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 (i.e., maintenance). Revenues from software license agreements are recognized upon contract execution, provided all shipment obligations have been met, fees are fixed or determinable and collection is probable. Revenue derived from arrangements with resellers of our product are not recognized until the software is shipped to the end user.
Revenues for maintenance are recognized ratably over the term of the support period. Revenues from consulting and training services are recognized as the services are performed. If such services are included in a license agreement, such amounts are unbundled from the license fee based on the value established by independent sale of such service to customers.
NETEGRITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Research and Development and Software Development Costs
Research and development expenditures are charged to operations as incurred. Software development costs subsequent to the establishment of technological feasibility are capitalized and amortized to cost of software. Based on the Company's product development process, technological feasibility is established upon completion of a working model. Such costs are amortized over the estimated economic life of the product. Costs incurred by the Company between completion of the working model and the point at which the product is ready for general release have been insignificant. The Company regularly compares the unamortized costs of capitalized software to the expected future net realizable value of the products. If the unamortized costs exceed the expected future net realizable value of the products, the excess amount is written off. For the years ended December 31, 1997, 1998 and 1999, the Company amortized $0, $134,262 and $175,629 of software development costs.
Comprehensive Income
Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources, including foreign currency translation adjustments and unrealized gains and losses on marketable securities. For the years ended December 31, 1999, 1998 and 1997, comprehensive income (loss) was not materially different from net income (loss).
Property and Equipment
Property and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation is provided using straight-line method, based upon the following asset lives:
Computer equipment and purchased software 3-5 years Furniture office equipment 5 years Leasehold improvements Shorter of lease term or useful life of asset
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.
Income Taxes
The Company accounts for income taxes using the asset and liability method, pursuant to which deferred income taxes are recognized based on temporary differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the temporary differences are expected to reverse. Valuation allowances are provided if, based upon the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.
Marketing Expenses
Marketing expenses are charged to selling, general and administrative expenses as incurred.
NETEGRITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Net Loss Per Share
Basic net loss per share is computed using the weighted average number of shares of common stock outstanding. Diluted EPS is based upon the weighted average number of common and common equivalent shares outstanding during the period. Diluted net loss per share does not differ from basic net loss per share since potential common shares from stock options and warrants and convertible preferred stock which are convertible into common stock are anti-dilutive for all periods presented.
Export Sales
The Company generates revenues from international business. For all periods reported herein, the Company's export sales were immaterial.
401(k) Plan
The Company maintains a 401(k) Plan for its employees. The Plan is intended as a retirement and tax deferred savings vehicle. The Company has made no matching contributions to date.
NETEGRITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates.
Reclassifications
Certain items in the prior year financial statements have been reclassified to conform to the current year presentation.
New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, or SFAS 133, "Accounting for Derivative Instruments and Hedging Activities." This statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. The statement initially was to be effective for all fiscal quarters of fiscal years beginning after June 15, 1999. In July 1999, the Financial Accounting Standards Board issued SFAS 137, "Accounting for Derivative Instruments and Hedging Activities Deferral of the Effective Date of FASB Statement No. 133 -- An amendment of FASB Statement No. 133." SFAS 137 defers the implementation of SFAS 133 by one year to June 15, 2000. The Company does not expect the adoption of SFAS 133 to have a material effect on its financial position or results of operations.
In December 1998, the Accounting Standards Executive Committee, or AcSEC, issued SOP 98-9, "Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions." SOP 98-9 amends SOP 97-2 to require that an entity recognize revenue for multiple element arrangements by means of the "residual method" when (1) there is vendor-specific objective evidence of the fair values of all the undelivered elements that are not accounted for by means of long-term contract accounting and (2) vendor-specific objective evidence of fair value does not exist for one or more of the delivered elements. All revenue recognition criteria of SOP 97-2 and SOP 98-9 will be effective for our transactions entered into beginning in our year ending December 31, 2000. We do not expect SOP 98-9 to have a material effect on our financial position or results of operations.
In December 1999, the Securities and Exchange Commission released Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements." This bulletin summarizes certain views of the staff on applying generally accepted accounting principles to revenue recognition in financial statements. The Company is currently determining the impact that SAB 101 will have on our financial position or results of operations.
NETEGRITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE B: PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and consist of the following:
The depreciation expense for the years ended December 31, 1997, 1998 and 1999, was $116,187, $231,713 and $313,907, 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. The Company accounted for its investment in Encotone, LTD. under the cost method. In the quarter ended September 30, 1997, the Company determined that the value of the investment was permanently impaired and wrote off the entire amount of $1,049,151.
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. The Company accounted 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: COMMITMENTS AND CONTINGENCIES
On June 4, 1999, a suit was brought in the Delaware Court of Chancery, purportedly on behalf of the Company's common stockholders, alleging that certain amendments to the Company's certificate of incorporation previously adopted by the Company's stockholders increasing the authorized shares of various classes of stock were invalid because the Company did not obtain the required statutory votes. On August 5, 1999, the parties entered into a settlement agreement, subject to court approval and approval from the holders of the Company's preferred stock and common stock, in separate class votes, of the previously adopted amendments. The settlement was approved by the Court of Chancery on September 24, 1999 and the appeal period for this approval expired, without any appeal being filed, on October 25, 1999. The holders of the Company's preferred and common stock approved the previously adopted amendments at a meeting of the Company's stockholders held on October 7, 1999. The effect of the settlement was not material.
The Company leases certain facilities under noncancellable operating leases. For the years ended December 31, 1997, 1998 and 1999 the Company incurred total operating
NETEGRITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
lease expense of $173,600, $299,825 and $549,490, respectively. Future minimum lease payments under these leases are as follows:
NOTE E: LOAN TO OFFICER
In May, 1996, an Officer of the Company 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 the Officer as payment for this transaction. The Officer issued the Company a full recourse note that is also secured by the 200,000 shares of common stock. This note has an interest rate of 7% per annum.
NETEGRITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE F: INCOME TAXES
Significant components of the deferred tax assets and liabilities are as follows:
The provision for income taxes differs from the federal statutory rate of 34% as follows:
Management of the Company has evaluated the positive and negative evidence impacting the realizability of its deferred tax assets. Based on the weight of the available evidence, it is more likely than not that all of the deferred tax assets will not be realized, and accordingly the deferred tax assets have been fully reserved. Management re-evaluates the positive and negative evidence on a quarterly basis.
At December 31, 1999, the Company has available for Federal income tax purposes net operating loss carryforwards of approximately $28,071,000 that are available to offset future taxable income, expiring at various dates through fiscal 2019. 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.
The net operating loss carryforwards of $28,071,000 include $10,262,000 of tax deductions relating to stock options and warrants. The benefit of these deductions included in net operating loss carryforwards will be credited to additional paid in capital when realized.
NOTE G: CAPITAL STOCK AND CAPITAL STOCK WARRANTS
Preferred Stock: 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.
NETEGRITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company entered into an amendment on June 5, 1998 to the Preferred Stock and Warrant Purchase Agreement with the Pequot Entities. Pursuant to the terms of the amended Agreement, on June 5, 1998, the Company sold 833,334 shares of Series D preferred stock, at $1.50 per share, and 375,197 warrants to the Pequot Entities for an aggregate purchase price of $1,250,001. On June 30, 1998, the Company sold an additional 833,333 shares of Series D preferred stock, at $1.50 per share, and 375,197 warrants to the Pequot Entities for an aggregate purchase price of $1,250,000. The Series D Preferred Stock converted one for one to common stock in September 1999.
In conjunction with the Pequot Agreement as described above, warrants to purchase a total of 1,500,787 shares of common stock exercisable at $2.00 were issued to Pequot expiring on January 7, 2003.
As part of the Agreement with the Pequot Entities described above, James McNiel joined the Board of Directors of the Company, as designee of the Pequot Entities and the Company granted Mr. McNiel warrants for the purchase of 100,000 shares exercisable at $1.50 expiring on January 7, 2003 for his services as a director.
Common Stock: On February 8, 1999 the Company sold 795,651 shares of common stock at $5.75 per share. On September 9, 1999, the Company sold 534,242 shares of common stock to certain investors in a private placement at a price of $20.59 per share. On November 10, 1999, the Company sold 2,500,000 shares of common stock at a price of $40.00 per share in a follow on public offering. On December 9, 1999 the Company sold an additional 12,500 shares of common stock at a price of $40.00 per share pursuant to the exercise of the underwriter overallotment option.
NOTE H: STOCK PLANS
The Company has stock option plans as described hereunder. All options issued under the plans are granted at fair market value at the date of grant, and become exercisable at varying rates, generally over three or four years, as determined by the Board of Directors, and generally expire ten years from the date of grant.
Stock Option Plans for Outside Directors: The Company's stock option plans for outside directors provide for the granting of options to members of the Board of Directors who are neither employees nor officers of the Company. The timing, amounts, recipients and other terms of the option grants are determined by the provisions of or formulas in, the directors' option plans. At December 31, 1999, options for 45,000 shares were available for future grant.
Stock Option Plans for Employees and Officers: The Company's stock option plans for employees, consultants and officers provide for the granting of options as inducement to obtain and retain the services of qualified persons. Incentive stock options may be granted to officers and employees, and non-qualified stock options may be granted to directors, officers, employees or consultants. At December 31, 1999, options for 1,125 shares were available for 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. All employees of the Company who have completed six months of employment are eligible to participate in the Stock Purchase Plan.
NETEGRITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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. The weighted average of the fair value of purchase rights for the years ended December 31, 1997, 1998, and 1999 are $0.74, $0.72 and $6.64, respectively. During the years ended December 31, 1997, 1998 and 1999 2,400, 14,100 and 21,282 shares of the company's common Stock were issued under the Stock Purchase Plan.
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 loss and loss per share for the years ended December 31, 1997, 1998 and 1999 would have been increased to the pro-forma amounts indicated below:
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:
The weighted average of the fair value of stock options for the years ended December 31, 1997, 1998 and 1999 was $1.50, $1.94 and $26.72, respectively.
Stock options outstanding at December 31, 1999:
- ------------ (a) Average contractual life remaining in years.
NETEGRITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A summary of the status of the Company's stock option plans as of December 31, 1997, 1998 and 1999 and changes during the periods ending on those dates is presented below:
- ------------
Note I: SEGMENT REPORTING
The Company considers that it has the following five reportable operating segments based on differences in products and services. Operating segments are defined as components of the enterprise about which separate financial information is available that is reviewed regularly by the chief operating decision maker, or decision-making group, in deciding how to allocate resources and in assessing their performance.
Certain expenses related to maintenance are included in operating expenses based upon the Company's management reporting practice and it has not been practical to allocate these expenses to cost of maintenance.
PART III
ITEM 10.
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 for the annual meeting of stockholders to be held in 2000.
ITEM 11.
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.
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.
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.
PART IV
ITEM 14.
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 Accountants
b. Consolidated Balance Sheets -- December 31, 1999 and 1998
c. Consolidated Statements of Operations for the years ended December 31, 1999, 1998 and 1997
d. Consolidated Statements of Stockholders' Equity for the fiscal years ended December 31, 1999, 1998 and 1997
e. Consolidated Statements of Cash Flows for the years ended December 31, 1999, 1998 and 1997
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 Accountants
b. Schedule II: 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.
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 Amended and Restated By-Laws of the Registrant (filed as exhibit 3.03 to the Registrant's annual report on form 10-K for the year ended December 31, 1998, and incorporated by reference).
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).
10.01 1986 Nonstatutory 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).
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).
10.10 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 with the Definitive Proxy Statement filed on March 19, 1999, and incorporated herein by reference January 26, 1998, and incorporated by reference).
10.16 1997 Non-Employee Director Stock Option Plan (filed as Exhibit 10.16 to Annual Report on Form 10-K for the fiscal year ended December 1977, and incorporated by reference).
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).
10.30 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).
10.31 Employment Agreement between Netegrity, Inc. and Barry Bycoff dated as of May 31, 1996 (filed as Exhibit 10.1 to Annual Report on Form 10-K/A for the year ended December 31, 1998, and incorporated by reference).
21.1 Subsidiaries of the Registrant (filed herewith).
23.1 Consent of PricewaterhouseCoopers LLP (filed herewith).
27.0 Financial Data Schedule (filed herewith).
B. REPORTS ON FORM 8-K
There were no reports on Form 8-K filed during the fourth quarter ended December 31, 1999.
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(A) attached hereto the financial statement schedule listed in Item 14 (A)(2) above.
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.
By: /s/ Barry N. Bycoff ---------------------------------- Barry N. Bycoff President, Chief Executive Officer, Director (Principal Executive March 17, 2000 Officer) and Chairman of the Board
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.
SIGNATURE TITLE DATE
/s/ Barry N. Bycoff President, Chief Executive March 17, 2000 - ------------------------- Officer, Director and Barry N. Bycoff Chairman of the Board
/s/ James E. Hayden Chief Financial Officer, March 17, 2000 - ------------------------- Vice President of Finance James E. Hayden and Administration and Treasurer
Director March 17, 2000 - ------------------------- Paul F. Deninger
/s/ Eric R. Giler Director March 17, 2000 - ------------------------- Eric R. Giler
/s/ Michael L. Mark Director March 17, 2000 - ------------------------- Michael L. Mark
/s/ James P. McNiel Director March 17, 2000 - ------------------------- James P. McNiel
/s/ Ralph B. Wagner Director March 17, 2000 - ------------------------- Ralph B. Wagner
REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES
To the Board of Directors of Netegrity, Inc:
Our audits of the consolidated financial statements referred to in our report dated March 14, 2000 appearing in this Annual Report on Form 10-K of Netegrity, Inc. also included an audit of the financial statement schedule listed in Item 14(A)(2) of this Form 10-K. In our opinion, this financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.
PricewaterhouseCoopers LLP Boston, Massachusetts March 14, 2000
NETEGRITY, INC. SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
- ----------------- (1) Uncollectible accounts written off, net of recoveries.
S-1