NETEGRITY INC - 10-K Annual Report

Back to GetFilings.com

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-K

FOR ANNUAL OR TRANSITION REPORTS PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

COMMISSION FILE NUMBER 1-10139

NETEGRITY, INC.
(Exact name of Registrant as specified in its charter)

DELAWARE 04-2911320
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

52 SECOND AVENUE
WALTHAM, MASSACHUSETTS 02451
(Address of principal executive offices, including Zip Code)

(781) 890-1700
(Registrant's telephone number, including area code)

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $.01 PER SHARE
(Title of Class)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [X] Yes No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). [X] Yes No [ ]

The aggregate market value of the voting Common Stock held by
non-affiliates of the registrant was $190,634,555 based on the closing price of
the registrant's Common Stock on June 30, 2002 as reported by the NASDAQ
National Market ($6.16 per share). As of February 10, 2003, there were
34,311,460 shares of Common Stock outstanding.

DOCUMENT INCORPORATED BY REFERENCE:

Portions of the registrant's definitive Proxy Statement for its Annual
Meeting of Stockholders for the year ended December 31, 2002, which will be
filed with Securities and Exchange Commission within 120 days after the end of
the registrant's fiscal year, are incorporated by reference into Part III
hereof.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

ANNUAL REPORT ON FORM 10-K
YEAR ENDED DECEMBER 31, 2002

TABLE OF CONTENTS

PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 11
Item 3. Legal Proceedings........................................... 11
Item 4. Submission of Matters to a Vote of Security Holders......... 11
Executive Officers of Registrant...................................... 11

PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 13
Item 6. Selected Financial Data..................................... 14
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 15
Item 7A. Quantitative and Qualitative Disclosure About Market Risk... 35
Item 8. Financial Statements and Supplementary Data................. 36
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 64

PART III
Item 10. Directors and Executive Officers of the Registrant.......... 64
Item 11. Executive Compensation...................................... 64
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 64
Item 13. Certain Relationships and Related Transactions.............. 64
Item 14. Controls and Procedures..................................... 64

PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form
8-K......................................................... 65

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

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, except as
required by law. The factors discussed in the sections captioned "Business,"
"Certain Factors that May Affect Future Results," and "Management's Discussion
and Analysis of Financial Condition and Results of Operations" 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.

PART I

ITEM 1. BUSINESS

Netegrity, Inc., a Delaware corporation, and its wholly-owned subsidiaries,
are referred to throughout this report as "Netegrity", "Company", "we", and "us"
or through similar expressions. For financial information about our business,
see our consolidated financial statements and the related notes thereto found in
Item 8 of this report. Netegrity(R), SiteMinder(R), IdentityMinder(TM) (formerly
Delegated Management Services ("DMS")), PortalMinder(TM) and Transaction
Minder(TM) are trademarks or registered trademarks of Netegrity, Inc. All other
brand or product names may be trademarks or registered trademarks of their
respective owners.

COMPANY OVERVIEW

We are a leading provider of security software solutions for securing
access to corporate assets and for managing and securing the identities of users
accessing those assets. Our flexible, standards-based solutions are designed to
enable companies to conduct business securely with customers, partners,
suppliers and employees across the Internet, intranets and extranets.

Our products help companies ensure that only the people or business
processes that are entitled to access corporate resources and applications
access them. Our products enable customers to manage the user population that
needs to access those resources and applications. In addition, our products
provide a more automated way to grant, modify or revoke account access to
applications and resources.

We are integrating our core products, SiteMinder, IdentityMinder, and
TransactionMinder, with our new provisioning technology into an identity and
access management solution to provide Web access control and management, user
administration, provisioning and de-provisioning of account access. Our solution
supports a broad range of technology environments, and aims to ensure that
companies optimize their existing information technology investments while
incorporating new technologies. We believe that through these solutions, we help
companies to address some of the most critical requirements for conducting
business securely.

We also offer various levels of consulting and support services that enable
our customers to successfully implement our products in their organizations.

We were formed as a Delaware corporation in 1986. Our Internet address is
www.netegrity.com. We make available free of charge through our Web site our
annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K and amendments to these reports filed or furnished pursuant to Section
13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we
electronically file such materials with the Securities and Exchange Commission.

1

INDUSTRY BACKGROUND

As more companies conduct business online, they are realizing that Internet
security is not only about keeping users out, but also about securely letting
users into their network environments and managing such users access to
appropriate business and information resources. Today, many companies accomplish
this task by managing user access within individual business applications. This
is known as a "silo approach".

While managing user access at the application level may create user level
security, the silo-style security approach is both repetitive and cumbersome to
manage. It is also challenging for the user, who is given an "identity" for each
application. A user is required to log in to a site multiple times and use
multiple user names and passwords for individual applications.

To reduce costs and compete more effectively, companies are increasing the
amount of business they conduct online. As a result, they service a growing
number of users. User populations are constantly evolving to accommodate
changing customers, partners, suppliers, employees and even automated Web
services.

This creates three management challenges for companies: 1) managing the
increasing number of users; 2) managing user entitlement to an increasing number
of applications and resources; and 3) managing frequently changing user
information. For example, employees may change assignment, requiring access to a
different set of enterprise resources. Business partners may change the terms of
their relationship with a company entitling them to different discounts or
product information. Customers may sign up for a premium support option
entitling them to higher priority status. All of these changes require updates
to users or resource access rights or entitlements, resulting in increased cost
and complexity to manage business online.

To deal with these challenges, companies require a centralized solution to
securely manage users, their identities and entitlements. They also need to
provide secure access to corporate applications and resources through the
validation of the user and his entitlements. Key requirements for this solution
include:

- Providing companies with a unified view of their relationships with all
constituents -- customers, partners, suppliers and employees -- across
enterprise applications, both internal and external

- Creating a single identity for each user to enable him to log-in only
once across multiple applications

- Creating a more streamlined way to manage large populations of users

- Creating a central place to identify users and verify their entitlements

- Providing a centralized, more automated way to grant, change or revoke
access to applications

- Providing a record of user entitlement and access history for reporting
purposes.

The security technologies needed to address these problems are access
control and management, user administration and provisioning.

THE NETEGRITY SOLUTION

Our flexible, standards-based solution is designed to enable companies to
conduct business securely with customers, partners, suppliers and employees
across the Internet, intranets and extranets.

By using our solutions, companies can ensure that only the people, devices
or applications that are entitled to access corporate resources and applications
can access them. Our solutions help companies manage the users who need access
to those resources and applications as well as the entitlements that are granted
to those users.

Our solutions are designed to address the following three critical needs of
conducting business online:

1. Web access control and management for users and Web services

2. User administration

3. Provisioning and de-provisioning of access to accounts and
resources

2

Our individual product lines include SiteMinder, TransactionMinder and
IdentityMinder software, as well as provisioning software. We are integrating
these products to provide our identity and access management solution. The key
benefits that our software provides to companies include:

- Automating and simplifying management of users and their entitlements
across heterogeneous environments. Our solution reduces the number of
tasks required to create a new user, set up or provision a user account,
modify the user's rights and de-provision a user account if needed. Our
solution is designed to run on many of the major platforms used for
e-business, including multiple operating system versions, Web servers,
directories, application servers and databases.

- Centralized access and authentication management, reducing IT complexity
and cost of administration. Our solution allows administrators to
centrally determine the type of authentication required for different
applications depending upon the sensitivity of the application data. It
also provides for a centralized location for the management and reporting
of user access. This centralization simplifies the administrative
requirements and increases a company's ability to audit user access.

- Securing distributed administrative workload with delegated
administration. Our solution allows administrative responsibilities to
be delegated as needed while maintaining compliance with corporate
policies.

- Reducing help desk contacts by enabling self-service. Our solution
allows end users to register for applications and modify their account
details themselves, rather than initiating a help desk incident. This
reduces the number of help desk incidents resulting from forgotten
passwords or the need to update user information.

- Improving security procedures and auditability. Our solution enables
companies to use consistent security procedures across their environment.
In addition, by recording which users have access to applications and
resources, companies have the ability to audit identity-related security
events more easily.

- Simplifying development of additional applications. Our solution creates
a centralized set of access control and management services that can be
easily leveraged for additional internal and external applications.

THE NETEGRITY STRATEGY

Our objective is to strengthen our position as a leading provider of
security software solutions for managing and securing users, their identities
and access to corporate applications and resources. To achieve this objective we
are pursuing the following strategies:

- Expanding our product lines and offering an integrated identity and
access management solution. One of our competitive advantages is our
leading position in the Web access control and management market that we
achieved with our SiteMinder product. We believe that we can continue to
derive revenue from this market. Furthermore, we believe that our
expanded product lines, now including IdentityMinder software,
TransactionMinder software and our provisioning software, will enable us
to sell a broader set of related products to our installed base of
approximately 700 customers, as well as to new customers.

With TransactionMinder software, our new Web services security product, we
are one of the few companies to address the emerging need that companies
have to securely incorporate and manage Web services in their business
environments. We believe that this provides us with the opportunity to
sell to customers who are early adopters of Web services.

Finally, by integrating our product lines, we will be one of the few
vendors able to offer a complete identity and access management solution
that addresses the complex problem of centralized user access,
administration and account provisioning/de-provisioning. This gives us the
opportunity to sell the integrated solution or to sell an individual
product to address a customer's specific need at a point in time, and then
sell the other products in the solution in a follow-on sale.

3

- Establishing leadership status for our identity and access management
solution and its components. We will work to establish a leadership
position for our integrated solution as well as for our individual
products. To do this we will continue to develop and expand our product
lines and to respond competitively to customer requirements. We will
continue to work with leading industry analysts to establish a leading
market position for our integrated identity and access management
solution as well as for its product components.

- Continuing to support and incorporate new technologies in key areas of
development. Our identity and access management solution, along with our
individual products, will continue to support key enterprise applications
and new resources that companies need to securely manage. Furthermore, we
will continue to support emerging and established technologies and
standards that are important to our customers including Web services,
Extensible Markup Language (XML) and XML-based standards such as Security
Assertion Markup Language (SAML).

- Leveraging and deepening existing strategic relationships. We have
established significant relationships with major global system
integrators, including PricewaterhouseCoopers, Deloitte & Touche, Ernst &
Young and Accenture. We are working closely with these firms to increase
market awareness, expand our distribution capabilities and expand
deployment and integration services for our products. We believe that
these relationships will enable us to increase penetration into our
markets and help to accelerate global customer deployments of our
solution.

- Increasing our penetration in focused geographies. In 2002, we
established several relationships to further extend our resale and
integration capabilities beyond North America, in order to better serve
customers in Europe and Asia. We will work to localize and translate our
products to enable further penetration into those markets.

- Improving customer service. We believe that a company's decision to
purchase our products is based, in part, on our ability to provide a high
level of customer service and implementation support. As the worldwide
demand for our products grows, we continue to invest in and enhance our
customer service capabilities. In addition, our relationships with
leading systems integration firms enable us to provide a wide range of
implementation services to help customers successfully deploy our
products.

- Continuing to evaluate strategic acquisitions. We will continue to
evaluate strategic opportunities and potential acquisitions where there
is a fit with our strategy. These opportunities may include companies or
technologies that broaden our market opportunity and enable us to expand
into adjacent areas, or that leverage our current solutions to extend our
position in our current markets.

THE NETEGRITY PRODUCTS

We offer a range of products that are designed to help companies to
securely conduct business by centrally managing the users with whom a company
does business as well as their accounts and access to company applications and
resources. We offer four product lines which include SiteMinder,
TransactionMinder, IdentityMinder and our provisioning software. These products
deliver access control and management, user administration and
provisioning/de-provisioning functionality. We are also integrating these
products to provide our identity and access management solution. We currently
derive most of our revenue from the SiteMinder product line.

SITEMINDER SOFTWARE

SiteMinder software enables companies to control user access to Web-based
business applications within the enterprise or across multiple partners.
SiteMinder software centrally manages user and entitlement information and
shares this information across all applications or resources being managed.
SiteMinder software includes a rules-based policy engine that enables
administrators to define policies that the SiteMinder software will use to
deliver shared services such as single sign-on, authentication management,
entitlement management, reporting and auditing.

4

SiteMinder provides a broad range of benefits including:

- Centralized control. Centrally managing users and their entitlements
eliminates the need for managing redundant "silos" of application
security. This greatly reduces the complexity and cost of managing users.

- High-quality user experience. Single sign-on enables users to log on
once to a Web site and access multiple applications thereby increasing
customer satisfaction by eliminating the need for multiple log-ons.

- Personalization based on identity. SiteMinder software delivers
personalized identity information to Web applications enabling
presentation of user specific content.

- Enterprise scalability. SiteMinder software has been designed to manage
large number of users, applications and resources. Our customers have
deployed Web applications with millions of users secured by SiteMinder
software.

- Open platform. SiteMinder software is designed to run on many of the
major platforms used for transacting business, including multiple
versions of operating systems, Web servers, directories, application
servers and databases.

IDENTITYMINDER SOFTWARE

IdentityMinder software is complementary to our SiteMinder software. It
enables companies to manage the identities of large populations of distributed
users accessing Web applications protected by SiteMinder. Using IdentityMinder
software, companies can manage user profiles, create, modify and change user
accounts for access to Active Directory or other directory-based Web
applications. With IdentityMinder software companies can establish a delegated
and distributed hierarchy of managed organizations, roles, users and groups.
Using IdentityMinder's workflow capability, companies can also automate many of
their manual user administration tasks.

Key benefits of IdentityMinder software include:

- Enabling companies to securely manage users worldwide. IdentityMinder
software allows companies to delegate user management to logically and
physically distinct business partners while ensuring the security of the
supported business system.

- Reducing costs associated with managing large numbers of
users. IdentityMinder software leverages infrastructure using existing
directories where user information is stored. This eliminates the need to
create new directories. It also enables flexible delegation of user
administration thereby reducing information technology workload and
staffing requirements. Additionally, it enables users to self-service
their profile information or passwords.

- Enabling auditability. IdentityMinder software also collects and
preserves information regarding changes to user profiles. This
information is required in most security or privacy related audits.

TRANSACTIONMINDER SOFTWARE

TransactionMinder software is one of the first products to manage Web
services access to business applications and resources, either within the
enterprise or across multiple partners. TransactionMinder software is
complementary to SiteMinder software -- SiteMinder manages user access while
TransactionMinder software manages Web services access. TransactionMinder builds
upon our shared-services vision to provide a Web services security platform. It
offers centralized, policy based authentication and access management for Web
services.

Key benefits of TransactionMinder software include:

- Reducing information technology cost and complexity. TransactionMinder
software eliminates the need for application specific security for Web
services.

5

- Enforcing security standards uniformly. TransactionMinder software also
enables companies to manage security policies consistently across all
application delivery methods -- of which Web services is one.

- Enabling auditability. TransactionMinder software assists corporate
compliance by enabling central auditing of security information related
to Web services transactions.

- Eliminating redundant data stores. TransactionMinder software supports
native directories for Web services.

- Maximizing security. TransactionMinder software uses session management
to increase Web services throughput for complex Web service interactions.

- Enabling a single Web services platform. TransactionMinder software
supports both intranet and extranet Web services solutions.

THE NETEGRITY PROVISIONING SOFTWARE

Our provisioning software allows companies to provide their employees,
business partners and customers with access to corporate applications and
resources when needed and remove that access when no longer required. By
integrating with the existing information technology infrastructure, the
provisioning software enables a company to create automated workflows that map
business processes to information technology activities using such company's
existing business rules and security policies. With this software, user accounts
can be automatically established, maintained or terminated in a consistent and
timely manner with proper authorizations, audit tracking, and escalation,
reducing or eliminating many of the previous error prone manual provisioning and
de-provisioning activities.

Key benefits of our provisioning software include:

- Enabling automated business changes. Our provisioning software automates
business changes (such as the hiring and termination of employees, or
changes to business alliances) by mapping those processes to information
technology specific activities, such as configuring access to shared
network or applications resources.

- Ensuring efficient implementation. Our provisioning software implements
business changes through dynamic workflows that automatically build and
initiate a set of manual tasks (such as installing hardware), automated
tasks (such as creating user accounts) and escalation procedures (for
approvals and task completion).

- Ensuring quick retrieval of information. Our provisioning software helps
ensure that all activities are tracked and recorded in audit logs that
can be quickly retrieved.

- Ensuring timely access to resources. Our provisioning software enables
employees and business partners to be more productive by enabling faster
access to resources.

- Ensuring deprovisioning. Our provisioning software helps ensure that
former employees and business partners are completely de-provisioned when
employment or business relationships end.

- Improving customer service. By enabling automated workflows and customer
self-service, our provisioning software helps to reduce the time required
to grant, modify or revoke access to applications and resources.

SERVICES AND SUPPORT

PROFESSIONAL SERVICES

Our professional services organization provides consulting and integration
services that aid our customers in implementing our products. Our professional
services offerings include Web infrastructure planning, application prototyping
and integration, custom development of application agents, user administration
utilities, and monitoring utilities. We also have relationships with global
systems integrators, such as PricewaterhouseCoopers, Deloitte &

6

Touche, Ernst & Young, and Accenture, who play a major role in deploying our
products to customers. These partners also help promote our products.

TRAINING

Our worldwide training organization teaches SiteMinder, IdentityMinder,
TransactionMinder and provisioning skills to customers, partners, and employees.
We offer comprehensive training for our products, and bring our courses to
market in parallel with the general release of new products. Our courseware is
varied and modular, allowing us to customize a training program to meet the
instructional objectives and time constraints of our customers.

MAINTENANCE AND SUPPORT

Our technical support organization is headquartered in Waltham,
Massachusetts. To ensure the availability of customer service on a 24-hour per
day, seven-day per week basis, the Company also operates a technical support
center in Kuala Lumpur, Malaysia. We provide a range of services as well as
various levels of support for all customer environments. Our technical support
centers offer email, fax, Web-based, and telephone access options for our
customers. Our technical support organization also offers extended services such
as on-site training, installation, and customized service offerings.

ADDITIONAL PRODUCTS AND SERVICES

In addition to selling and marketing Netegrity's SiteMinder,
IdentityMinder, TransactionMinder and provisioning products, we also distribute,
on a non-exclusive basis, Check Point Software Technologies Ltd.'s FireWall-1
product. We sell this product directly to end users throughout the United States
through a small, dedicated sales organization.

SALES, MARKETING AND DISTRIBUTION

We directly market our SiteMinder, IdentityMinder, TransactionMinder and
provisioning 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, 2002, our sales, marketing
and customer support organizations consisted of 175 individuals.

Direct Sales Force. Our direct sales force consists of field sales
representatives covering three geographical regions. Our sales organization
identifies prospects that have identity and access management plans and
requirements. Upon prospect qualification they use a solution-selling approach.
Our inside sales representatives qualify, develop and pursue leads generated
through a variety of sources. Our field sales group conduct on-site meetings
with accounts that have substantial product and service requirements. We market
software and services to large, corporate customers in the major vertical
markets of the Global 1500 companies 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
Chief Information Officers, Vice Presidents/Directors of Information Technology
Operations, and other people responsible for analyzing and selecting identity
and access management solutions.

Indirect Distribution. One of our strategic initiatives has been to
further our relationships with systems integrators and technology partners to
increase the leverage of our partner channel. We classify our partners as
follows:

- Systems Integrators. We have established significant partnerships with
major global systems integrators who play a major role in deploying the
Company's products and who may also recommend our products to prospective
customers. We are investing in training our systems integration partners
to enhance their effectiveness in integrating and selling our products.
As of December 31, 2002, we had trained over 1,000 consultants at partner
companies.

7

- Alliance Partners and Resellers. Alliance partners license our software
and bundle our products into their product offerings. Resellers sell
licenses to the Company's products and have played a significant role in
the expansion of our distribution network, particularly in Europe and
Asia.

- Technology Partners. Technology partners integrate their product
offerings to ensure that they interoperate with our software and bundle
our products into their product offerings. We work together with these
vendors to provide technical integration of our products. In many cases
we also work together on sales and marketing initiatives. There were over
200 members in the Netegrity Technology Partner Program as of December
31, 2002.

Product Marketing Programs. We engage in a broad range of product
marketing activities, including sponsoring seminars for prospective customers,
exhibiting at targeted conferences for the technology and investment
communities, as well as deploying paper and e-mail based awareness and lead
generation activities. We maintain an active public relations program through
which we issue press releases that highlight major customer additions, strategic
partnerships and new product releases. We develop relationships with industry
analysts, and promote coverage of the Company 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 online presentations and seminar content and customer
application success stories. Our product marketing programs are aimed at
informing customers of the capabilities and benefits of our solutions and
increasing the demand of such solutions across major industry segments. We plan
to continue to devote significant resources to marketing our products and brand.

CUSTOMERS

As of December 31, 2002, we licensed Netegrity software to approximately
700 customers. Our customer base spans multiple industry segments, including
financial services, government, manufacturing and telecommunications.

We operate in one business segment. Our total revenues from customers in
the years ended December 31, 2002, 2001 and 2000 were $69.3 million, $88.1
million and $55.2 million, respectively. No single customer, including direct
end users or resellers, accounted for more than 10% of our total revenues during
the years ended December 31, 2002, 2001 or 2000.

PURCHASING

The Company purchases the FireWall-1 product directly through Check Point
Software Technologies, Ltd. The Company also purchases firewall-related
accessory products from various third-party vendors. Additionally, the Company
licenses various third party software products to enhance, enable or provide
additional functionality to our products. The Company has not experienced any
material difficulties or delays in acquiring any of the products that it
distributes or licenses.

COMPETITION

The identity and access management market 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 products as
compared to those of our competitors; our ability to secure and maintain key
strategic relationships; our ability to expand both our domestic and
international sales operations; and the timing and market acceptance of new
products and enhancements to existing products developed by us and our
competitors.

Our primary competitor in the identity and access management market is the
Tivoli Division of IBM. We also compete against other security companies such as
Oblix, RSA, Waveset, Novell and Open Network Technology. In addition, a number
of other security and software companies have indicated that they plan to offer
products that may compete with our identity and access management solution in
the future. Competition may also develop as the market matures and other
companies begin to offer similar products, and as our

8

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 acquire significant market share.

Today, some of our competitors have shorter operating histories, and fewer
financial and technical resources than we have. In addition, these smaller
competitors have smaller customer bases. Several of our competitors, however,
are larger companies who have significant financial resources, well-established
development and support teams, and large customer bases. These larger
competitors may initiate pricing policies that would make it more difficult for
us to maintain our competitive position.

As new participants enter the identity and access 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
increased market share for these companies.

Our FireWall-1 reseller business competes with companies that offer
products competitive with Check Point Software Technologies' FireWall-1 product,
including Symantec Technologies, Cisco Systems and Trusted Information Systems.
We also compete with other resellers of the FireWall-1 product.

PRODUCT RESEARCH AND DEVELOPMENT

The market for identity and access management 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, networking software and evolving customer requirements.

Identity and access management solutions have significant requirements for
scalability, reliability, sophisticated security and ease of administration.
These demands drive the need for a centralized management model for
administrators, a single point of access for users and centralized means of
managing users, their access rights and identities. 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 business
applications across heterogeneous networks. We have made, and expect to continue
to make, a substantial investment in research and development. In the years
ended December 31, 2002, 2001 and 2000, we spent approximately $22.7 million,
$15.8 million, and $9.1 million, respectively (exclusive of approximately $3.0
million of non-recurring acquired in-process research and development in
connection with the acquisition of DataChannel in December 2001) or 33%, 18%,
and 16% of total revenues on research and development. We will continue our
product development efforts for our current products, as well as for next
generation products for new markets. As of December 31, 2002, we had 114
employees engaged in research and development activities.

We believe the future success of the Company depends largely on our ability
to enhance and broaden our existing product lines 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 including the timing of product
introductions and enhancements by us or our competitors, market acceptance of
new products, or the delay of customer orders 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 patent, trademark, trade secret and copyright laws and licenses
and

9

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 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, consultants and customers 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.

We have filed patent applications on three inventions embodied in the
software products that we have developed and that may be useful in the field of
identity and access management. There can be no assurance that any of these
applications will result in an issued patent.

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, it 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 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 other 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 marginally acceptable to us. 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 are
unable to 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. This delay could materially adversely affect our business, operating
results and financial condition.

EMPLOYEES

As of December 31, 2002, we had a total of 363 full-time employees, of
which 114 were involved in research and development, 175 in sales, marketing and
customer support, 36 in consulting and training and 38 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 our
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.

10

ITEM 2. PROPERTIES

The Company's current headquarters consist of a leased office suite located
at 52 Second Avenue in Waltham, Massachusetts. We occupy 50,345 square feet of
space at that location under a lease expiring in March 2003. We also occupy
50,665 square feet of office space in Bellevue, Washington under three separate
leases expiring in April 2004. In addition, we lease 4,127 square feet of space
to house our technical service center in Kuala Lumpur, Malaysia, under a lease
expiring in June 2004. In August 2002, the Company entered into a five year
non-cancelable lease for office space for its new corporate headquarters. The
Company anticipates moving to the new facility in March 2003. In connection with
the lease agreement, the Company delivered an irrevocable, unconditional,
negotiable letter of credit in the amount of $760,000 as a security deposit. The
Company anticipates that it will spend approximately $1.0 million in leasehold
improvements to build out the new facility. As of December 31, 2002,
approximately $725,000 had been spent.

In order to support our field sales and consulting staff, we lease office
space domestically in Los Angeles and San Jose, California; Orlando, Florida;
Atlanta, Georgia; Chicago, Illinois; Methuen, Massachusetts; New York, New York;
Reston, Virginia; and Bellevue, Washington. Internationally, we lease office
space in Sydney and Melbourne, Australia; Toronto, Canada; Marlow, England;
Helsinki, Finland; Paris, France; Frankfurt and Munich, Germany; Hong Kong,
China; Milan, Italy; Tokyo, Japan; Seoul, Korea; Ngee Ann City, Singapore; and
Stockholm, Sweden.

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. 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,
2002.

EXECUTIVE OFFICERS OF THE REGISTRANT

Below are the name, age and principal occupations for at least the last
five years of our current executive officers. All such persons have been
appointed to serve until their successors are appointed or until their earlier
resignation or removal.

BARRY N. BYCOFF, 54 years old, was appointed President and Chief Executive
Officer and Director of the Company in April 1993. In November 1999, Mr. Bycoff
was also appointed Chairman of the Board.

REGINA O. SOMMER, 44 years old, joined the Company as Vice President, Chief
Financial Officer and Treasurer in December 2001. From 1999 to 2001, she was
Vice President and CFO for Revenio, Inc. a privately-held customer relationship
management software company. From 1995 to 1999, she served as Senior Vice
President and CFO for Open Market, Inc., an Internet infrastructure software
company.

WILLIAM C. BARTOW, 39 years old, joined the Company in October 1999 and
presently serves as Vice President of Engineering. From August 1998 to October
1999, he was Vice President of Marketing and Engineering at the internet
division of Powersoft Corporation, a subsidiary of Sybase, Inc. Mr. Bartow was
employed by Powersoft Corporation as Director of the Power Builder Product Line
from July 1996 to July 1998.

THOMAS THIMOT, 36 years old, joined the Company in September 2002 and
presently serves as Vice President Worldwide Sales and Services. From February
2001 to June 2002, he was President and Chief Operating Officer of Enigma, a
privately-held provider of support chain solutions. From November 1994 to
January 2001, he served in multiple sales and service leadership roles at Oracle
where he was most recently

11

area Vice President of Sales for the central U.S. Prior to his tenure at Oracle,
Mr. Thimot held management and consulting positions at Price Waterhouse and
Accenture.

STEPHANIE FERADAY, 43 years old, joined the Company in November 2002 and
presently serves as Vice President of Marketing. From October 2001 to November
2002, she ran her own strategy consulting firm for emerging technology
companies. From September 2000 to October 2001, she served as Executive Vice
President of Virtusa, Inc., a privately-held advanced technology services firm.
From July 1992 to 1997, she was general manager at Symantec, where she launched
their Networking Business Unit, which was acquired by Hewlett Packard in 1997.
At Hewlett Packard, she was responsible for developing HP OpenView's business
strategy until September 2000.

JAMES E. ROSEN, 49 years old, is the Company's Vice President of Corporate
and Business Development. Mr. Rosen joined the Company as Vice President
Marketing in April 1997. From 1995 to 1997, he was Director of Business
Alliances at BBN Planet Corporation, an internet services provider, now Genuity.

DEEPAK TANEJA, 42 years old, joined the Company in January 1998 and
presently serves as Chief Technology Officer. From January 1998 until November
2001, Mr. Taneja served the Company as Vice President Engineering and
Development. From 1996 to 1998, he was Director of Development for Switchboard,
Incorporated, an Internet directory services firm.

12

PART II

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." As of February 10, 2003, there were 190 holders of record of our common
stock, some of whom are holders in nominee name for the benefit of different
shareholders. The following table sets forth, for the periods indicated, the
range of high and low closing prices per share of our common stock, as reported
on the NASDAQ National Market during each of the quarters indicated.

13

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.

The following consolidated data includes the results of operations (from
the date of acquisition) of the Company's acquisition of DataChannel, Inc., on
December 14, 2001. See Note 3 to the Company's consolidated financial statements
for further information concerning this acquisition.

The Company has historically accounted for reimbursements received for
out-of-pocket expenses incurred as a reduction to the cost of service revenues
in the statement of operations to offset the costs incurred. The Company adopted
EITF 01-14 effective January 1, 2002 and reclassified approximately $1.6
million, $1.2 million and $200,000 into revenues from cost of revenues for the
years ended December 31, 2001, 2000 and 1999, respectively, to comply with this
guidance. There were no reimbursable out-of-pocket expenses in 1998.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION

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 "Special
Note Regarding Forward-Looking Statements" above Item 1 of this report.

OVERVIEW

Netegrity is a leading provider of security software solutions for securing
access to corporate assets and for managing and securing the identities of users
accessing those assets. Netegrity's flexible, standards-based solutions are
designed to enable companies to conduct business securely with customers,
partners, suppliers and employees across the Internet, intranets and extranets.

Netegrity's products help companies ensure that only the people or business
processes that are entitled to access corporate resources and applications
access them. Netegrity's products enable customers to manage the user population
that needs to access those resources and applications. In addition, Netegrity's
products provide a more automated way to grant, modify or revoke account access
to applications and resources.

The Company is integrating its core products, SiteMinder, IdentityMinder,
and TransactionMinder, with its new provisioning technology into an identity and
access management solution to provide Web access control and management, user
administration, provisioning and de-provisioning of account access. Netegrity's
solution supports a broad range of technology environments, and aims to ensure
that companies optimize their existing information technology investments while
incorporating new technologies. The Company believes that through these
solutions, it helps companies to address some of the most critical requirements
for conducting business securely.

We also offer various levels of consulting and support services that enable
our customers to successfully implement our products in their organizations.

On December 14, 2001, the Company acquired all of the outstanding stock of
DataChannel, Inc., a Washington corporation and a provider of enterprise portal
solutions. As a result of the acquisition, DataChannel became a wholly-owned
subsidiary of the Company. The acquisition was accounted for using the purchase
method of accounting. Accordingly, the excess of the purchase price over the
fair value of the assumed tangible net liabilities of approximately $71.4
million was allocated to acquired technology, in-process research and
development, and goodwill in the amounts of approximately $11.0 million, $3.0
million and $57.4 million, respectively. Subsequently, during the quarter ended
September 30, 2002, the Company recorded a charge of $57.4 million classified as
an impairment charge in the accompanying consolidated statements of operations,
to write down the remaining goodwill to its implied fair value of zero.

15

CRITICAL ACCOUNTING POLICIES AND SIGNIFICANT JUDGMENTS AND ESTIMATES

Netegrity's discussion and analysis of its financial condition and results
of operations are based on the Company's consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States of America. The preparation of these financial
statements requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and the disclosure of contingent
assets and liabilities at the date of the financial statements as well as the
reported revenues and expenses during the reporting periods. On an ongoing
basis, management evaluates its estimates and judgments, including those related
to revenue recognition, accounts receivable reserves, marketable securities,
valuation of long-lived and intangible assets and goodwill, income taxes and
stock based compensation. Management bases its estimates on historical
experience and on various other factors that are believed to be reasonable under
the circumstances, the results of which form the basis for making judgments
about the carrying value of assets and liabilities that are not readily apparent
from other sources. Actual results may differ from these estimates under
different assumptions or conditions.

The significant accounting policies that management believes are most
critical to aid in fully understanding and evaluating our reported financial
results include the following:

REVENUE RECOGNITION

The Company's revenues have been primarily generated from the sale of
perpetual licenses for its proprietary SiteMinder and DMS (renamed
IdentityMinder in the fourth quarter of 2002) products and services. In the
future, the Company anticipates generating its revenue primarily from the sale
of perpetual licenses for SiteMinder, IdentityMinder, TransactionMinder and the
provisioning products and services, as well as from new product offerings. The
Company generates its services revenue from consulting and training services
performed for customers and from maintenance and support services. As described
below, significant management judgments and estimates must be made and used in
connection with the revenue recognized in any accounting period. Management
analyzes various factors, including a review of specific transactions,
historical experience, credit worthiness of customers and current market and
economic conditions. Changes in judgments based upon these factors could impact
the timing and amount of revenue and cost recognized.

We generally license our software products on a perpetual basis. We apply
the provisions of Statement of Position No. 97-2, "Software Revenue
Recognition," as amended by Statement of Position No. 98-9, "Software Revenue
Recognition, with Respect to Certain Transactions," to all transactions
involving the sale of software products. We recognize revenue from the sale of
software licenses when persuasive evidence of an arrangement exists, the product
has been delivered, the fees are fixed or determinable and collection of the
resulting receivable is reasonably assured. This policy is applicable to all
sales, including sales to resellers and end users. The Company does not offer a
right of return on its products.

For all sales, we use either a binding purchase order or signed license
agreement as evidence of an arrangement. For arrangements with multiple
obligations (for example, product, undelivered maintenance and support, and
training and consulting), we allocate revenue to each component of the
arrangement using the residual value method based on the fair value of the
undelivered elements. We defer revenue from the arrangement equivalent to the
fair value of the undelivered elements. Fair values for the ongoing maintenance
and support obligations are based upon separate sales of renewals of maintenance
contracts. Fair value of services, such as training or consulting, is based upon
separate sales of these services to other customers.

At the time of the transaction, we assess whether the fee associated with
the transaction is fixed or determinable based on the payment terms associated
with the transaction. If a significant portion of the fee is due after our
normal payment terms, which are generally 30 to 90 days from invoice date, we
account for the fee as not being fixed or determinable. In these cases, we
recognize revenue as the fees become due. In addition, we assess whether
collection is probable or not based on the credit worthiness of the customer.
Initial credit worthiness is assessed through Dun & Bradstreet or similar credit
rating agencies. Credit worthiness for follow-on transactions is assessed
through a review of the transaction history with the customer. We do not request
collateral from our customers. If we determine that collection of a fee is not
reasonably assured, we

16

defer the fee and recognize revenue at the time collection becomes reasonably
assured, which is generally upon receipt of cash.

Installation by Netegrity is not considered essential to the functionality
of our products as these services do not alter the product capabilities, do not
require specialized skills and may be performed by the customer or other
vendors. Revenues for maintenance and support are recognized ratably over the
term of the support period. Revenues from consulting and training services are
recognized as the services are performed.

ACCOUNTS RECEIVABLE RESERVES

Accounts receivable are reduced by an allowance for amounts that may become
uncollectible in the future. The estimated allowance for uncollectible amounts
is based primarily on a specific analysis of accounts in the receivable
portfolio and a general reserve based on the aging of receivables and historical
write-off experience. While management believes the allowance to be adequate, if
the financial condition of the Company's customers were to deteriorate,
resulting in impairment of their ability to make payments, additional allowances
may be required and could materially impact our financial position and results
of operations.

MARKETABLE SECURITIES

Investments, which primarily consist of debt securities, are accounted for
under Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting
for Certain Investments in Debt and Equity Securities" issued by the Financial
Accounting Standards Board (FASB). Pursuant to the provisions of SFAS No. 115,
the Company has classified its investment portfolio as "trading",
"available-for-sale" or "held to maturity". "Trading" securities are bought and
held principally for the purpose of selling them in the near term and are
recorded at fair value. Fair value is based upon quoted market prices.
Unrealized gains and losses on trading securities are included in the
determination of net earnings. "Available-for-sale" securities include debt
securities that are being held for an unspecified period of time and may be used
for liquidity or other corporate purposes and are recorded at fair value.
Unrealized gains and losses on available-for-sale securities are reported as a
separate component of comprehensive income (loss) in stockholders' equity. "Held
to maturity" securities are debt securities that the Company intends to hold to
maturity and are recorded at amortized cost. As of December 31, 2002, all of the
Company's investments have been classified as available-for-sale.

VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS AND GOODWILL

Effective January 1, 2002, the Company adopted the provisions of SFAS No.
142, "Goodwill and Other Intangible Assets". Under SFAS No. 142, goodwill is
required to be tested for impairment annually in lieu of being amortized.
Furthermore, goodwill is required to be tested for impairment on an interim
basis if an event or circumstance indicates that it is more likely than not that
an impairment loss has been incurred. An impairment loss shall be recognized to
the extent that the carrying amount of goodwill exceeds its implied fair value.
Impairment losses shall be recognized in operations.

The acquisition of DataChannel, Inc. on December 14, 2001 was accounted for
in accordance with the transition provisions of SFAS No. 141 and No. 142. The
Company adopted SFAS No. 142 during the first quarter of 2002 without a material
impact on its financial position or results of operations. Intangible assets
other than goodwill that are not deemed to have indefinite lives are amortized
over their useful lives. The Company chose to perform the annual impairment test
in the fourth quarter of each fiscal year. If the Company had accounted for
goodwill and other intangibles in accordance with SFAS 142 during the years
ended December 31, 2001 and 2000, the results of operations would not be
materially different from those previously reported.

During the third quarter of 2002, the Company determined that a significant
decline in our stock price as a result of underperformance relative to recent
and expected operating results and the overall adverse change in the business
climate had resulted in a triggering event that warranted an interim impairment
review in accordance with SFAS No. 142. As a result, the Company tested for
impairment based on a two-step approach. The first step was to test for
indicators of impairment of goodwill by comparing the fair value of the
17

Company with its carrying value. Since the Company operates as an
enterprise-wide reporting unit, it was determined that the market value of the
Company represented an approximation of its fair value as of September 30, 2002.
Furthermore, it was determined that the fair value of the Company as of
September 30, 2002 was less than its carrying value and therefore, an indication
of impairment existed. The second step was to measure the amount of the
impairment of goodwill. As a result of the second step, we determined that the
implied fair value of the goodwill determined using the market capitalization of
the Company on September 30, 2002 was lower than its carrying value and
therefore, goodwill had been impaired. The Company recorded a charge of $57.4
million in the third quarter of fiscal 2002, classified as impairment charge in
the accompanying consolidated statements of operations, to write down goodwill
to its implied fair value of zero.

The Company reviews the valuation of long-lived assets, including property
and equipment and capitalized software, under the provisions of SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets" and SFAS No.
86, "Accounting for the Costs of Computer Software to Be Sold, Leased, or
Otherwise Marketed". The Company is required to assess the recoverability of
long-lived assets and purchased software on an interim basis whenever events and
circumstances indicate that the carrying value may not be recoverable. Factors
we consider important that could trigger an interim impairment review include
the following:

- significant underperformance relative to expected historical or projected
future operating results;

- significant changes in the manner of our use of the acquired assets or
the strategy of our overall business;

- significant negative industry or economic trends;

- significant decline in our stock price for a sustained period; and

- our market capitalization relative to net book value.

In accordance with SFAS No. 144, when we determine that the carrying value
of applicable long-lived assets may not be recoverable based upon the existence
of one or more of the above indicators of impairment, we evaluate whether the
carrying amount of the asset exceeds the sum of the undiscounted cash flows
expected to result from the use and eventual disposition of that asset. If such
a circumstance exists, we would measure an impairment loss to the extent the
carrying amount of the particular long-lived asset or group exceeds its fair
value. We would determine the fair value based on a projected discounted cash
flow method using a discount rate determined by our management to be
commensurate with the risk inherent in our current business model. In accordance
with SFAS No. 86, when we determine that the carrying value of certain other
types of long-lived assets may not be recoverable we evaluate whether the
unamortized cost exceeds 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. Changes in judgments on
any of these factors could impact the value of the asset being evaluated.

The Company adopted SFAS No. 144 during the first quarter of fiscal year
2002 without a material impact on its financial position or results of
operations.

During the fourth quarter of 2002, the Company made the decision to remove
certain technology acquired in the DataChannel acquisition from its products. It
is expected that the first version of its products that do not include the
portal technology will be released in August 2003 and will be the only version
sold in the third quarter of 2003. As a result of this decision, the Company
determined that there has been a change in the estimated useful life of the
acquired technology and therefore it is now appropriate to be amortized over a
nine month period starting at the beginning of the fourth quarter (the period
during which the change in estimated life was identified). Prior to this change,
the acquired technology long-lived asset was being amortized on a straight line
basis over three years. Therefore, the quarterly amortization increased from
approximately $916,000 in each of the first three quarters of 2002 to
approximately $2.7 million in the fourth quarter of 2002. It is currently
expected that the acquired technology will be fully amortized at the end of the
second quarter of 2003.

18

ACCOUNTING FOR INCOME TAXES

The preparation of our consolidated financial statements require us to
estimate our income taxes in each of the jurisdictions in which we operate,
including those outside the United States which may be subject to certain risks
that ordinarily would not be expected in the United States. The income tax
accounting process involves our estimating our actual current exposure together
with assessing temporary differences resulting from differing treatment of
items, such as deferred revenue, for tax and accounting purposes. These
differences result in the recognition of deferred tax assets and liabilities.
The Company must then record a valuation allowance to reduce its deferred tax
assets to the amount that is more likely than not to be realized.

Significant management judgment is required in determining our provision
for income taxes, our deferred tax assets and liabilities and any valuation
allowance recorded against deferred tax assets. The Company has recorded a
valuation allowance of $75.9 million as of December 31, 2002, due to
uncertainties related to our ability to utilize some of our deferred tax assets,
primarily consisting of certain net operating losses carried forward before they
expire. The valuation allowance is based on our estimates of taxable income by
jurisdiction in which we operate and the period over which our deferred tax
assets will be recoverable. In the event that actual results differ from these
estimates or we adjust these estimates in future periods we may need to adjust
our valuation allowance, which could materially impact our financial position
and results of operations.

STOCK BASED COMPENSATION

Netegrity's stock option program is a broad-based, long-term retention
program that is intended to contribute to the success of the Company by
attracting, retaining and motivating talented employees and to align employee
interests with the interests of our existing stockholders. Stock options are
typically granted to employees when they first join the Company and typically on
an annual basis thereafter. Stock options are also granted when there is a
significant change in an employee's responsibilities and, occasionally, to
achieve equity within a peer group. The Compensation Committee of the Board of
Directors may, however, grant additional options to executive officers and key
employees for other reasons. Under the stock option plans, the participants may
be granted options to purchase shares of Netegrity stock and substantially all
of our employees and directors participate in at least one of our plans. Options
issued under these plans generally are granted at fair market value at the date
of grant, become exercisable at varying rates, generally over three or four
years and generally expire seven to ten years from the date of grant.

We recognize that stock options dilute existing shareholders and have
attempted to control the number of options granted while remaining competitive
with our compensation packages. At December 31, 2002, approximately 71% of our
stock options had exercise prices in excess of the closing market price on that
day.

All stock option grants are made after a review by, and with the approval
of, the Compensation Committee of the Board of Directors. All members of the
Compensation Committee are independent directors, as defined in the applicable
rules for issuers traded on The NASDAQ Stock Market. See the "Report of the
Compensation Committee" in our 2003 proxy statement for further information
regarding the policies and procedures of Netegrity and the Compensation
Committee regarding the grant of stock options.

The Company accounts for its stock option plans under the recognition and
measurement principles of APB Opinion No. 25, Accounting for Stock Issued to
Employees, and related Interpretations. No stock-based compensation cost is
reflected in net income for these plans, as all options granted under these
plans had an exercise price equal to the market value of the underlying common
stock on the date of grant. The following table illustrates the effect on net
income (loss) and earnings (loss) per share if the Company had applied the

19

fair value recognition provisions of FASB Statement No. 123, Accounting for
Stock Based Compensation, to stock based compensation.

The pro-forma net loss for the years ended December 31, 2002 and 2001
includes the effects of options that were canceled by the Company in connection
with the tender offers described in Note 10 to the consolidated financial
statements. The remaining unamortized pro-forma compensation expense at the date
of cancellation for these options in the amount of approximately $51.9 million
and $63.0 million, respectively, is reflected as an expense in these pro-forma
amounts.

RESULTS OF OPERATIONS

The following table presents statement of operations data as percentages of
total revenues for the periods indicated:

20

YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001

Revenues. Total revenues decreased by $18.8 million or 21%, to $69.3
million in the year ended December 31, 2002, from $88.1 million in the year
ended December 31, 2001. The decrease was primarily due to decreases in software
license revenues for the SiteMinder product, partially offset by an increase in
service revenues and the impact of the acquisition of DataChannel in December
2001, which contributed approximately 6% of total revenues in 2002.
Additionally, revenues in both Europe and Asia have continued to decline
throughout 2002. Overall, we believe that revenue growth will be modest over the
next couple of quarters as constraints on technology spending continue. However,
we believe that the continued build-out of the leveraged model with our partners
and our focus on expanding our leadership position in the identity and access
management market with our new product offerings will help to drive new account
acquisition and increase deal size in the future.

Software license revenues decreased by $19.2 million or 35%, to $36.1
million in the year ended December 31, 2002, from $55.3 million in the year
ended December 31, 2001. The decrease is due to broad based economic weakness in
all geographic regions and reduced technology spending, which resulted in deals
being delayed or reduced in size. The number of new name deals decreased from
220 in 2001 to 163 in 2002 and the average size of new name deals decreased from
approximately $148,000 in 2001 to approximately $107,000 in 2002. The number of
follow-on deals also decreased from 204 in 2001 to 191 in 2002 and the average
size of follow-on deals decreased from approximately $204,000 in 2001 to
approximately $191,000 in 2002. The primary reason for the decrease in deal size
in 2002 was that customers bought licenses for a smaller number of users.

Services revenues increased by $1.0 million or 3%, to $30.2 million in the
year ended December 31, 2002, from $29.2 million in the year ended December 31,
2001. The increase is primarily attributable to an increase of $6.4 million in
2002 in maintenance and support revenue resulting from maintenance renewals by
our existing customer base and, to a lesser extent, the impact of the
acquisition of DataChannel in December 2001, which contributed approximately 9%
of services revenues in 2002. The increase was partially offset by a decrease of
$5.5 million in 2002 in consulting and training revenue as a result of (1) broad
based economic weakness and decreased technology spending that resulted in a
reduction in our customers' need for installation and integration services and
(2) the Company's decision to leverage its partners to provide integration
services directly to our customers. In connection with this leveraged model, the
cumulative number of third party consultants the Company had trained increased
from approximately 590 in 2001 to over 1,000 in 2002.

Other revenues decreased by $0.6 million or 17%, to $3.0 million in the
year ended December 31, 2002, from $3.6 million in the year ended December 31,
2001. Other revenues are derived from the Firewall legacy business. This
business has declined in 2002 and is not expected to have a significant impact
in future periods.

Cost of revenues. Total cost of revenues increased by $3.6 million or 19%,
to $23.0 million in the year ended December 31, 2002, from $19.4 million in the
year ended December 31, 2001. Our cost of revenues includes, among other things,
royalties due to third parties for technology included in our products,
amortization of acquired software, product fulfillment costs, salaries and
related expenses for our consulting, education and technical support services
organizations, and the associated cost of training facilities. Overall, we
believe that the cost of revenues, and particularly the cost of software
licenses, will increase over the short term primarily as a result of (1) the
cost of third party software products that enhance and enable additional
functionality in our products, (2) increased amortization of acquired technology
due to an acceleration of the amortization period of the capitalized software,
and (3) increased investment in our technical support organization.

Total cost of software license revenue, which includes non-cash cost of
software licenses, increased by $5.4 million or 257%, to $7.5 million in the
year ended December 31, 2002 from $2.1 million in the year ended December 31,
2001. This increase is primarily due to the amortization of purchased software
recorded in connection with the acquisition of DataChannel of approximately $5.4
million, partially offset by a decrease in cost of license software in 2002 that
is in relative proportion to the decrease in software license revenue. During
the fourth quarter of 2002, the Company accounted for a change in accounting
estimates to reflect a change in the useful economic life of certain technology
acquired in the DataChannel acquisition in December 2001. Prior to this change,
the acquired technology long-live asset was being amortized on a straight line
basis over three years. As a result of this change, beginning in the fourth
quarter of 2002, the acquired technology is

21

being amortized over its current estimated useful life of nine months starting
at the beginning of the quarter in which the change in estimated useful life was
identified. Therefore, the quarterly amortization increased from approximately
$916,000 in each of the first three quarters of 2002 to approximately $2.7
million in the fourth quarter of 2002. It is currently expected that the
acquired technology will be fully amortized by the end of the second quarter of
2003.

Cost of services decreased by $1.4 million or 9%, to $13.7 million in the
year ended December 31, 2002, from $15.1 million in the year ended December 31,
2001. The decrease is primarily due to the leveraging of our system integrator
partner relationships. The cumulative number of consultants we have trained at
our affiliated partners increased from approximately 590 in 2001 to over 1,000
in 2002. This leveraging allowed us to reduce the headcount in our professional
services organization by over 50% from December 31, 2001 to December 31, 2002.
This decrease was partially offset by increased investment in the technical
support organization during 2002 in order to enhance overall customer
satisfaction.

Cost of other revenues decreased by $0.4 million or 18%, to $1.8 million in
the year ended December 31, 2002 from $2.2 million in the year ended December
31, 2001. The decrease in cost of other revenues in 2002 is in relative
proportion to the decrease in revenue in 2002. Cost of other revenues is not
expected to have a significant impact in future periods.

Selling, general and administrative expenses. Selling, general and
administrative expenses increased by $0.8 million, or 1%, to $52.8 million in
the year ended December 31, 2002 from $52.0 million in the year ended December
31, 2001. 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. The increase is primarily attributable to increased salaries and wages
associated with the DataChannel acquisition, increased legal expenses,
consulting and accounting fees, marketing program costs and insurance expenses
(primarily directors and officer's insurance premiums) and facility rent and
depreciation expense primarily related to office space and fixed assets acquired
from DataChannel. These increases were partially offset by reduced compensation
and bonus expenses and as a result of recording reduced bad debt expense in
2002. The reduction in bad debt expense was primarily due to improved credit
reviews, strong cash collections and fewer write-offs than anticipated. We will
continue to scrutinize all discretionary expenses and evaluate reductions in
non-strategic programs. In the immediate future, we anticipate selling, general
and administrative expenses will decrease slightly as we realize the economic
impact of the restructuring initiatives completed during 2002.

Research and development costs. Research and development costs increased
by $6.9 million or 44%, to $22.7 million in the year ended December 31, 2002,
from $15.8 million in the year ended December 31, 2001. Research and development
expenses consist primarily of personnel and outside contractor costs to support
product development. The increase was primarily due to the addition of
approximately 65 employees (including 40 from the acquisition of DataChannel in
the fourth quarter of 2001), the increased use of approximately 22 contractors
in India between 2001 and 2002 and other incremental expenses associated with
the research and development of our new product offerings which were released
for general availability during the fourth quarter of 2002. The increase was
partially offset by the reduction of approximately 35 employees during 2002,
primarily as a result of the Company's decision in the fourth quarter to stop
developing, marketing or selling its portal product. We believe that our
investment in research and development is required to remain competitive and
therefore, expect that research and development expenses may increase in future
periods due to the continued development of our products and services.

Impairment charges. Impairment charges recorded in the year ended December
31, 2002 were $57.4 million. There were no impairment charges recorded in the
year ended December 31, 2001. In the third quarter of 2002, management
determined that a significant decline in our stock price as a result of
underperformance relative to recent and expected operating results and the
overall adverse change in the business climate had resulted in a triggering
event that warranted an interim impairment review in accordance with SFAS No.
142. As a result, the Company tested for impairment based on a two-step
approach. The first step was to test for indicators of impairment of goodwill by
comparing the fair value of the Company with its

22

carrying value. Since the Company operates as an enterprise-wide reporting unit,
it was determined that the market value of the Company represents an
approximation of its fair value as of September 30, 2002. Furthermore, it was
determined that the fair value of the Company as of September 30, 2002 was less
than its carrying value and therefore, an indication of impairment existed. The
second step was to measure the amount of the impairment of goodwill. As a result
of the second step, we determined that the implied fair value of the goodwill
determined using the market capitalization of the Company on September 30, 2002
was lower than its carrying value and therefore, goodwill had been impaired. The
Company has recorded a charge of $57.4 million in the third quarter of fiscal
2002, classified as impairment charge in the consolidated statements of
operations, to write down goodwill to its implied fair value of zero.

Acquired in-process research and development. In the year ended December
31, 2001, we recorded non-recurring charges of $3.0 million or 3% of total
revenue for acquired in-process research and development resulting from the
acquisition of DataChannel. This amount was expensed on the date of acquisition
because the acquired technology had not yet reached technological feasibility
and had no future alternative uses. There can be no assurance that acquisitions
of businesses, products or technologies by us in the future will not result in
substantial charges for acquired in-process research and development. Such
charges may cause fluctuations in our quarterly and annual operating results.

Restructuring and other non-recurring expenses. In the year ended December
31, 2002, the Company, as a result of changing market dynamics and economic
factors, reduced its workforce through restructurings by approximately 138
positions, or 32%. The reductions in workforce were primarily in the development
group as well as in the sales and services departments, both domestically and
internationally. The majority of the reductions in the development group were
concurrent with the Company's decision to stop developing, marketing or selling
its portal product. As a result of the restructurings, the Company recorded
restructuring charges, which related primarily to severance payments and the
closing of several sales offices, of approximately $2.1 million during the year
ended December 31, 2002. Approximately $1.3 million was paid as of December 31,
2002. The remainder is expected to be paid prior to March 31, 2003.

During 2001, the Company reduced its workforce by approximately 8% in order
to reduce expenses and realign its cost structure. The reductions in workforce
were primarily in the sales, development and general and administrative groups.
The Company recorded a charge of $303,000 during the year ended December 31,
2001, for severance payments and the consolidation of excess facilities.
Additionally, the Company recorded non-recurring charges of $226,000 during the
year ended December 31, 2001 primarily attributable to a contribution to the
James Hayden Memorial Fund, established in the memory of the Company's former
Chief Financial Officer, and the acceleration of 15,300 of his options that
would have vested by December 31, 2001.

Other income. Other income decreased by approximately $2.4 million, or
50%, to $2.4 million in the year ended December 31, 2002, from $4.8 million in
the year ended December 31, 2001. This decrease was primarily attributable to
declines in the both the balances of and interest rates for cash and cash
equivalents and marketable securities.

Provision for income taxes. Provision for income taxes for the year ended
December 31, 2002 was approximately $70,000 compared with a provision of
approximately $607,000 for the year ended December 31, 2001. This decrease
relates to federal alternative minimum taxes, and larger state taxes and foreign
taxes in 2001. The provision for the year ended December 31, 2002 differs from
the expected tax rate due to nondeductible goodwill impairment and an increase
in the Company's valuation allowance. As of December 31, 2002, we had a deferred
tax asset related to net operating loss carryforwards of approximately $70.8
million, against which a full valuation allowance has been provided, available
for federal purposes to reduce future taxable income expiring on various dates
through 2022. Of the $177.0 million of net operating loss carryforwards, $98.2
million is attributable to tax deductions relating to stock options and $53.5
million is related to the acquisition of DataChannel. The benefit of the stock
option deductions included in the net operating loss carryforward will be
credited to additional paid-in capital when realized or recognized. The benefit
of the acquired net operating loss carryforward will first reduce non-current
intangible assets and the remaining will be recorded to reduce income tax
expense. The acquired loss carryforwards are subject to an annual limitation
under Internal Revenue Code Section 382 of approximately $3.1 million. Under the
Tax

23

Reform Act of 1986, the utilization of a corporation's net operating loss
carryforward is limited following a greater than 50% change in ownership over a
three-year period. As of December 31, 2002, no change in ownership has occurred,
although such a change can occur in a future period. If a change occurs, it
could substantially limit the utilization of the loss carryforwards of the
Company.

YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000

Revenues. Total revenues increased by $32.9 million, or 60%, to $88.1
million in the year ended December 31, 2001, from $55.2 million in the year
ended December 31, 2000.

Software license revenues increased by $17.6 million, or 47%, to $55.3
million in the year ended December 31, 2001, from $37.7 million in the year
ended December 31, 2000. This increase was due to the continued increase in
market awareness and the acceptance of the SiteMinder product, the expansion of
our sales organization and the leveraging of our strategic partner
relationships. For the year ended December 31, 2001, the Company added 220 new
SiteMinder software customers.

Service revenues increased by $15.3 million, or 110%, to $29.2 million in
the year ended December 31, 2001, from $13.9 million in the year ended December
31, 2000. This increase was attributable to maintenance and services
arrangements for a growing customer base coupled with increasing demand to
provide installation and integration services for our new customers.

Other revenues remained relatively unchanged at $3.7 million for the year
ended December 31, 2001 compared to the year ended December 31, 2000.

Cost of revenues. Total cost of revenues increased by $6.1 million or 46%,
to $19.4 million in the year ended December 31, 2001, from $13.3 million in the
year ended December 31, 2000.

Cost of software licenses decreased by $0.4 million, or 16%, to $2.1
million in the year ended December 31, 2001 from $2.5 million in the year ended
December 31, 2000. The decrease was primarily due to favorable revisions of
royalty contracts with third-party licensors slightly offset by increases in
amortization on acquired software.

Cost of services increased by $6.5 million or 76%, to $15.1 million in the
year ended December 31, 2001 from $8.6 million in the year ended December 31,
2000. The increase was primarily due to increases in payroll and related
personnel expenses for our consulting and training organizations as a result of
increased SiteMinder service revenues. During 2001, the Company opened a
technical service center in Kuala Lumpur, Malaysia.

Cost of other revenue remained relatively unchanged at $2.2 million in the
year ended December 31, 2001 compared to the year ended December 31, 2000.

Selling, general and administrative expenses. Selling, general and
administrative expenses increased by $15.9 million, or 44%, to $52.0 million in
the year ended December 31, 2001, from $36.1 million in the year ended December
31, 2000. This increase was attributable to several factors. Approximately $8.1
million (including $1.0 million related to the DataChannel acquisition), or 51%,
of this increase relates to increased payroll and related costs including the
addition of approximately 42 employees in the sales and marketing organization
of the Company during 2001 and the full-year effect of approximately 33
employees hired during the second half of fiscal year 2000 and $1.0 million, or
6%, in costs for additional administrative support personnel. Approximately $2.9
million, or 18%, of the increase relates to increased costs for promotional
initiatives including attendance at trade shows, advertising, public relations
and related printing and postage expenses. Approximately $2.0 million, or 13%,
of the increase relates to increases in rent, telephone and travel related
expenses primarily attributable to adding sales and marketing personnel and the
opening of additional sales offices in the Pacific Rim and Europe. Approximately
$1.5 million, or 9%, of the increase relates to increases in depreciation and
amortization connected with the Company's growth.

Research and development expenses. Research and development expenses
increased by $6.7 million, or 73%, to $15.8 million in the year ended December
31, 2001, from $9.1 million in the year ended December 31,

24

2000. Approximately $5.2 million, or 78%, of this increase was related to the
addition of approximately 70 employees (including 40 related to the DataChannel
acquisition) in the research and development organization during 2001 and the
full-year effect of approximately 19 employees hired during the second half of
fiscal year 2000 to support continued development of SiteMinder, DMS and other
related products. The remaining increase relates to increased general expenses
in support of the additional head count added to research and development for
the year ended December 31, 2001.

Acquired in-process research and development. In the year ended December
31, 2001, we recorded non-recurring charges of $3.0 million or 3% of total
revenue for acquired in-process research and development resulting from the
acquisition of DataChannel. This amount was expensed on the date of acquisition
because the acquired technology had not yet reached technological feasibility
and had no future alternative uses.

Restructuring and other non-recurring expenses. In the year ended December
31, 2001, we recorded other non-recurring charges of approximately $529,000 or
less than 1% of total revenue for expenses associated with the Company's
restructuring plan and other non-recurring expenses.

Other income. Other income decreased by approximately $1.3 million, or
21%, to $4.8 million in the year ended December 31, 2001, from $6.1 million in
the year ended December 31, 2000. This decrease was primarily attributable to
declines in interest rates for cash and cash equivalents and marketable
securities coupled with larger foreign currency translation losses during the
year ended December 31, 2001.

Provision for income taxes. Provision for income taxes for the year ended
December 31, 2001 was $607,000 compared with a provision of $75,000 for the year
ended December 31, 2000. This increase relates to federal alternative minimum
taxes, state taxes and foreign taxes. The provision for the year ended December
31, 2001 differs from the expected tax rates due to nondeductible acquired
in-process research and development expenses offset by a reduction in the
Company's valuation allowance. As of December 31, 2001, we had a net operating
loss carryforward of approximately $158.5 million, against which a full
valuation allowance has been provided, available for federal and state purposes
to reduce future taxable income expiring on various dates through 2020. Of the
$158.5 million of net operating loss carryforwards, $96.2 million is
attributable to tax deductions relating to stock options and $54.9 million is
related to the acquisition of DataChannel. The benefit of the stock option
deductions included in the net operating loss carryforward will be credited to
additional paid-in capital when realized. The benefit of the acquired net
operating loss carryforward will reduce goodwill when realized. Under the Tax
Reform Act of 1986, the utilization of a corporation's net operating loss
carryforward is limited following a greater than 50% change in ownership over a
three-year period. As a result of the DataChannel acquisition $54.9 million of
the net operating loss carryforwards are subject to an annual limitation of
approximately $3.1 million.

LIQUIDITY AND CAPITAL RESOURCES

Cash used in operating activities for the year ended December 31, 2002 was
$19.5 million, primarily due to a net loss of $86.3 million, a decrease in
accrued expenses (including approximately $1.9 million in payments made in
connection with the December 2001 acquisition of DataChannel), and a decrease in
accrued compensation and benefits, offset by non-cash charges for depreciation,
amortization and impairment of $67.5 million, a decrease in accounts receivable
and an increase in deferred revenue.

Cash provided by investing activities was $15.1 million for the year ended
December 31, 2002. Investing activities for the year consisted primarily of net
sales and maturities of marketable securities of approximately $181.5 million,
offset by the purchases of marketable securities of approximately $162.9
million, and the purchase of approximately $3.1 million of property and
equipment, primarily computer related, and leasehold improvements for the new
corporate headquarters.

Cash provided by financing activities in the year ended December 31, 2002
was approximately $776,000, primarily related to the exercise of stock options
and issuance of shares in connection with the employee stock purchase plan.

As of December 31, 2002, our primary financial commitments consisted of
obligations outstanding under operating leases as well as potential royalty
payments to certain system integrators.
25

The Company has commitments that expire at various times through 2010.
Operating leases shown below are primarily for facility costs for the Company's
corporate headquarters and world-wide sales offices. Other contractual
obligations primarily consist of minimum royalty fees payable by the Company in
connection with a software license and distribution agreement which the Company
entered into in January 2003.

Included in the operating lease commitments above is approximately $1.1
million related to excess facilities which have been accrued in purchase
accounting.

In April 2002, the Company entered into an agreement with a system
integrator to assist the Company in the development and launch of one of its
products. Under the terms of the agreement, for consideration of the system
integrator's time in assisting with the development of the product, the Company
agreed to promote the system integrator as an integrator of the developed
product. The Company's obligation under the agreement will be considered
satisfied once the system integrator receives consulting revenues totaling
approximately $3.9 million from the Company's customers, or by April 2004,
whichever occurs first. In the event that the Company recommends a competitor of
the system integrator to perform the integration work for a customer, the
Company could potentially owe a royalty to the system integrator based on the
net license fee. As of December 31, 2002 no royalties were due under this
agreement to the system integrator.

In August 2002, the Company entered into a five year non-cancelable
operating lease for an office building for its corporate headquarters. The
Company anticipates moving to the new facility in March 2003. In connection with
the lease agreement, the Company delivered an irrevocable, unconditional,
negotiable letter of credit in the amount of $760,000 as a security deposit. The
Company anticipates that it will spend approximately $1.0 million in leasehold
improvements to build out the new facility. As of December 31, 2002,
approximately $725,000 had been spent.

The Company has entered into indemnification agreements with the
non-employee members of its Board of Directors. Additionally, the Company has
entered into employment and executive retention agreements with certain
employees and executive officers which, among other things, include certain
severance and change of control provisions.

Under the terms of the Company's standard software license contracts, the
Company indemnifies its customers for the potential liability associated with
the infringement of other parties' technology based upon the Company's software
products. There is a possibility that the Company may be liable to its customers
in the event that there is infringement occurring. The Company is not aware of
any infringement related to the Company's technology, and therefore has not
accrued any amounts for the replacement or refund of any software products sold
through December 31, 2002.

In January 2003, the Company entered into a software license and
distribution agreement under which the Company was granted the right to
sublicense the use of a provisioning application software program. In addition,
the Company was granted certain rights to integrate or combine the software into
its existing products. In exchange for these rights, the Company has agreed to
pay a quarterly royalty fee based on a percentage of the net license fees
charged by Netegrity for the software. The minimum royalty fees due in the
first, second and third years of the agreement are approximately $1.0 million,
$1.4 million and $1.6 million. The initial term of this agreement is three
years.

26

As of December 31, 2002, we had cash and cash equivalents totaling $25.7
million, short-term marketable securities of approximately $48.4 million and
working capital of $64.7 million.

Any increase or decrease in our accounts receivable balance and accounts
receivable days outstanding (calculated as net accounts receivable divided by
revenue per day) will affect our cash flow from operations and liquidity. Our
accounts receivable and accounts receivable days outstanding may increase due to
changes in factors such as the timing of when sales are invoiced and length of
customer's payment cycle. We also record deferred maintenance billings as
accounts receivable, and the timing of these billings affects the accounts
receivable days outstanding. Historically, international and indirect customers
pay at a slower rate than domestic and direct customers. An increase in revenue
generated from international and indirect custom