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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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XX Annual report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934, [FEE REQUIRED] for the fiscal year ended
December 31, 1998, or
Transition report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934, [NO FEE REQUIRED] for the
transition period from to
Commission File Number 1-10139
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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.)
245 WINTER STREET 02154
WALTHAM, MA (Zip Code)
(Address of principal executive offices)
(781) 890-1700
(Registrant's Telephone Number)
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such other shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days Yes XX No ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, in
definitive proxy or information statements incorporated by reference in Part III
of this Form 10-K or any amendment to this Form 10-K [ ]
The aggregate market value of voting Common Stock held by non-affiliates of
the Registrant was approximately $59,692,808 based on the closing sale price of
the Registrant's Common Stock on March 9, 1999 as reported by the Nasdaq
Over-the-Counter Interdealer Automated Quotation System ($5.813 per share). As
of March 9, 1999 there were 10,268,847 shares of Common Stock outstanding.
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PART I
ITEM 1. BUSINESS
THE COMPANY
Netegrity, Inc. ("Netegrity" or the "Company") designs, develops, markets
and supports software for controlling user access to electronic commerce
(e-commerce) applications. Netegrity also offers a full range of professional
services to integrate, implement and support its software product offering.
Netegrity's customers are Global 2000 companies and smaller organizations who
possess large and dispersed numbers of customers and business partners. These
companies are using e-commerce as a means to interact with their customers,
suppliers, partners and employees. Typical industries utilizing e-commerce
include the financial services, high tech, manufacturing, telecommunications and
insurance industries, as well as educational and the governmental
organizations..
Netegrity's flagship product, SiteMinder, is the industry's first
directory-enabled secure user management system providing centralized access
control, single sign-on, distributed user management and personalized content
for e-commerce applications. SiteMinder manages the process of identifying an
individual and assigning that individual his/her privileges. These assigned
privileges control what information an individual can see and what transactions
an individual can perform. This new category of software enables Web
administrators to centrally control access to e-commerce sites requiring secure
log-in, while distributing the administrative responsibilities to various
individuals. SiteMinder's open and extensible architecture integrates easily
with leading security technologies, Web servers, and application development
platforms.
The Company has been a leader in the network security market since 1994,
when it became the first North American distributor and reseller of Check Point
Software Technologies, Ltd.'s ("Check Point") FireWall-1-TM-Today, the Company
is a leading U. S. value-added reseller for FireWall-1, distinguishing itself by
providing comprehensive pre-and post-sales support and consulting services.
BUSINESS STRATEGY
Netegrity's objective is to become the market leader in security management
for e-commerce, defined as the secure user management and access control market.
This market is expected to grow dramatically as companies adopt e-commerce and
begin to transact business over the Internet. Early experience with the Internet
and a clear understanding of its customers' and their security requirements,
have enabled Netegrity to become a leading developer of secure user management
and access control products and services. The following are key elements of the
Company's strategy:
- Continue to enhance the SiteMinder product line. In June of 1998,
Netegrity launched SiteMinder 3.0 as the first directory-enabled secure
user management solution. It plans to continue to enhance product features
to meet customer needs in deploying large-scale and complex
transaction-based e-commerce applications. The Company plans to continue
to adopt the latest industry standards and technologies allowing for the
deployment of secure e-commerce applications. Furthermore, the Company
expects to develop versions for other Web servers and operating systems as
market needs dictate. In March of 1999, Netegrity began shipping
SiteMinder 3.5 with increased scalability, support for broader
authentication methods, and expanded support for UNIX platforms. The
Company plans to expand its product line to include support for legacy
systems and business applications that are critical to future customer
requirements.
- Expand domestic distribution. The Company currently supports a
multi-channel domestic distribution strategy including a direct sales
force, a reseller/systems integrator channel and OEM relationships. The
Company plans to expand its sales force and support organizations with the
objective of gaining broad market acceptance of its product through
adoption into strategic accounts. This will differentiate the Company's
product from those of its competitors and allow it to obtain insights
1
into the future security requirements of its customers. The Company
expects to continue to establish strategic marketing and other third-party
relationships with vendors of Internet-related systems and application
software. The Company is also focused on building its reseller channel by
establishing relationships with systems integrators and consultants.
- Expand international distribution channel. It currently distributes its
product in four major European countries: the United Kingdom, Italy, The
Netherlands, and France. The Company manages its international
distribution channel through an office in France opened in the fourth
quarter of 1998. Future international plans include additional
distributors in Europe as well as Asia.
- Continue to build its service offerings. The Company's service
organization was launched in April, 1996 as a result of its FireWall-1
customer support efforts. The Company offers fixed-price services that
assist companies in the integration, implementation and support of
Netegrity's products. With the addition of its SiteMinder product, the
Company plans to expand its offerings to include system integration
services to complement its product line.
- Maximize profitability of the firewall reseller business. The Company will
continue to sell FireWall-1 and related services to new and existing
customers. It also plans to continue offering related third-party network
security products to its base of FireWall-1 customers.
MARKETS AND PRODUCTS
THE MARKET: The market for transacting business over the Internet is called
the electronic commerce market. This market has evolved significantly in 1998,
helping companies to not only redefine the way they do business, but to become
more competitive and acquire new customers and revenue streams in the process.
Recent market studies call for dramatic growth for commercial software license
revenue, and online business penetration is expected to grow exponentially. A
recent study by Forrester Research contained the following: "By the year 2002,
98% of companies with greater than 1,000 employees and 85% of companies with
greater than 100 employees will go online; Business trade will mushroom to $1.3
trillion by 2003, while online retail will hit $108 billion by 2003; The market
space for commerce license revenue is expected to grow from $121 million in 1997
to $3.8 billion in 2002; International revenue is expected to grow to over $1
billion by 2002; and Corporations will prefer buying to building."
Typical business applications being developed for e-commerce include online
retail, customer service, supply chain procurement, and delivery of operational
and transactional data. These applications contain sensitive data that require
controlled access, such as customer account status, financial account status,
personnel files, customer files, document distribution, and other critical
business information. New applications emerging include secure portal sites,
secure Web hosting, and buy-side applications such as procurement management. To
date, security on the Internet has been restrictive, focused on "keeping people
out." However, as more companies attempt to "do business" on the Internet,
e-commerce sites need to provide a secure, truly open trading environment. A
large market opportunity is evolving as products are being developed to solve
the security challenge of controlling users once they enter an e-commerce site.
SITEMINDER-REGISTERED TRADEMARK- PRODUCT: The Internet has enabled a new
generation of e-commerce applications that offer dramatic change in the way
companies do business. Companies are deploying strategic e-commerce applications
to transact business, manage customer and supplier relationships, and distribute
information to employees and partners. SiteMinder is a secure user management
system providing single sign-on, centralized control of all access, and
distributed management for those e-commerce Web sites. SiteMinder allows an
organization to easily deploy and efficiently administer e-commerce sites,
managing millions of users while leveraging the existing technology platforms
they have deployed. Its extensible, standards-based framework works across Web
servers, application servers, security technologies, and directory services from
all major vendors.
2
Four major technologies are used to build e-commerce sites: authentication
products to identify users, directory servers to store user names, application
servers to transact business, and Web servers to publish the information. These
four disparate technologies are not easily integrated, resulting in an
e-commerce site that is both difficult to navigate and to manage. SiteMinder
provides the solution to simplify the development and management of a secure
e-commerce site. Its core capabilities include centralized control of user
access, role-based delegated management, native integration with existing
directories, auditing and tracking of user access to sensitive data, and single
sign-on and personalized content delivery for users.
SiteMinder consists of two primary components, the SiteMinder Policy Server,
and the SiteMinder Web Agent. The Policy Server is a UNIX or Windows NT-based
server that provides authentication, authorization, and audit services for Web
applications. The SiteMinder Web Agent runs on industry-standard Microsoft and
Netscape Web servers for both Windows NT and major UNIX platforms and extends
the SiteMinder Policy Server's capabilities to these servers.
Pricing for the SiteMinder Policy Server is based on the number of users
licensed to access the SiteMinder-protected applications. Customers must also
purchase a SiteMinder Web Agent for each Web Server secured by the product.
The Company receives revenue from the sale of SiteMinder from four sources;
the Policy Server, the Web Agent, annual maintenance subscriptions, and add-on
professional services. An initial deployment typically consists of one or two
Policy Servers and several Web Agents. The Company receives additional product
and services revenue as customers expand the number of end-users and/or the
number of SiteMinder installations.
SALES, MARKETING AND SUPPORT
SALES: Netegrity directly markets its products and services domestically
through field sales and through telemarketing efforts. The Company also
indirectly markets 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. Netegrity's strategic
partnerships include a worldwide reseller agreement with Netscape Communications
Corporation, an OEM agreement with Network Associates, and licensing agreements
with Allaire Corporation and Banyan Systems, Inc.
Netegrity's sales strategy involves initially qualifying prospects to
determine their e-commerce plans and requirements and deploying a
solution-selling approach once customers are qualified. Netegrity's field sales
group conducts on-site meetings with accounts that have substantial product and
service requirements. Netegrity markets its product and services to large,
corporate customers and smaller firms that need to protect access to mission
critical information. A customer's decision to use Netegrity's products and
services may involve a substantial financial commitment including license costs,
maintenance fees, service fees, training, and in many cases the cost of computer
systems to implement e-commerce applications.
In addition to SiteMinder, Netegrity resells Check Point Software's
FireWall-1 product through a dedicated internal telesales organization and a
small group of resellers.
SUPPORT SERVICES: Netegrity believes that a customer's decision to purchase
its products is based, in part, on the services provided by the Company that
help to quickly and effectively install, integrate and implement an e-commerce
solution, and to educate the customer's staff and support its ongoing
operations. It also provides another source of revenue for the Company.
Netegrity's Professional Services organization provides consulting and
integration services that enable SiteMinder customers to successfully manage
secure access to their e-commerce applications and enhance the integration of
SiteMinder within their organization. Follow-on and Full Deployment services are
offered for organizations with multiple SiteMinder locations and centralized
multi-SiteMinder configurations. Professional Services are available for
Application Infrastructure Planning, Application Prototyping
3
and Integration, SiteMinder Deployment, SiteMinder Extensions and Custom Agents,
Self-Registration, and Onsite Training for Developers and Solution Architects.
In addition to Professional Services offerings, annual support maintenance
contracts are generally purchased for the first year of a customer's use of the
SiteMinder product and are renewable on an annual basis. The Company offers its
customers a variety of maintenance options, from providing support during normal
business hours to providing support 24-hours per day, 7 days per week.
Maintenance fees are typically equal to approximately 20% to 25% of the list
price for the product.
The Company also offers its FireWall-1 customers a similar set of support
offerings, which has differentiated the Company from other resellers of
FireWall-1.
MARKETING: In support of its sales efforts, the Company conducts its own
marketing programs intended to position and promote its products and services.
Marketing activities include trade shows, seminars, direct mail, Internet
marketing, public relations, and participation in industry programs and forums.
The Company also benefits from joint marketing programs conducted with strategic
partners, such as joint seminars, direct mailings, and lead sharing.
Because the Company's plans call for SiteMinder to produce a substantial
portion of its future product and services revenue, any factor adversely
affecting sales of its products and services would have a material adverse
effect on the Company. The Company's future financial performance will depend in
part on the successful development, introduction and customer acceptance of new
and enhanced versions of its products and its services. There can be no
assurance that the Company will continue to be successful in marketing its
products or any new or enhanced products. In addition, competitive pressures or
other factors may result in significant price erosion thereby having a material
adverse effect on the Company's financial condition or results of operations.
MERCHANDISING AND CUSTOMERS
The Company markets its products and services to large global organizations
that face tremendous pressure to transact business over the Internet. The
Company targets various people within an organization responsible for analyzing
and selecting e-commerce solutions, such as Web application development
managers, Internet architects, security administrators and network/systems
administrators. Typical industries include the financial services, publishing,
high-tech, manufacturing, telecommunications and insurance industries, as well
as educational and governmental organizations. Its dedicated focus on e-commerce
security enables Netegrity to help clients design security solutions that
effectively respond to ever-present and constantly-arising security threats,
while accommodating long-range, enterprise-level technology goals.
In June of 1998, Netegrity launched SiteMinder 3.0 as the first
directory-enabled secure user management solution. Sales of its SiteMinder
product and related services represented 41% of the Company's revenue for the
year ended December 31, 1998, and 5% in 1997.
In addition to the sales and marketing of SiteMinder, the Company is also a
non-exclusive distributor of Check Point Software Technologies, Ltd.'s
FireWall-1 product. The Company sells FireWall-1 and its proprietary products
and services directly to end-users and through a channel of value-added
resellers in the U.S. The Company also benefits from the marketing programs
conducted by Check Point. Many of Check Point's activities result in the
generation of qualified leads, some of which are provided to the Company.
CUSTOMERS: As of December 31, 1998, the Company licensed SiteMinder to 46
end-user customers. Its customers represent a broad cross-section of industries
including financial services, telecommunications, publishing, insurance,
high-tech and the government. The Company also has distributors, resellers and
system integrators around the world, including distributors in five major
European Countries. The Company has been able to increase its customer base by
combining post-sales support services, including
4
training and customer support. The Company expects that its customer base will
grow incrementally with the future releases of SiteMinder as the market matures.
Netegrity has approximately 325 Check Point Software FireWall-1 customers
and it continues to provide support to a large majority of these customers.
No single customer, including direct end-users or resellers, accounted for
more than 10% of the Company's total revenue during each of the years ended
December 31, 1998, 1997 and 1996.
PURCHASING
The Company purchases 100% of its FireWall-1 product directly through Check
Point Software Technologies, Ltd. The Company also purchases firewall-related
accessory products through various third-party vendors. The Company has not
experienced any material difficulties or delays in acquiring any of the products
that it distributes.
DISTRIBUTION AND BACKLOG
The Company generally ships product within 24 hours of the receipt of an
order from a customer. Consequently, backlog is currently not a material factor.
5
COMPETITION
The market for secure user management and access control is currently
immature and somewhat competitive. This market is expected to become highly
competitive based on the anticipated growth of the e-Commerce market. This
market is subject to rapid technological change, and competition is beginning to
intensify as a result of the increasing demand for e-commerce security products.
Up until recently, the Company's primary source of competition was from its
customers' internal information services departments that had been building
their own solutions. Today, the Company is also experiencing competition from a
number of new technologies from companies like Aventail Corporation; DASCOM;
enCommerce, Inc; Intellisoft, SecureSoft, Inc., and Sirrus Corporation.
Additional competition may develop as the market matures and other companies
begin to offer similar products, and as the Company's product offerings expand
to other segments of the marketplace. Current and potential competitors have
established or may in the future establish cooperative relationships with third
parties to increase the distribution of their products to the marketplace.
Accordingly, it is possible that new competitors or alliances may emerge and
rapidly acquire significant market share.
The Company's firewall reseller business experiences competition from
companies that compete with Check Point's FireWall-1 product such as Axent
Technologies; Trusted Information Systems, Inc.; Cisco Systems, Inc.; as well as
other resellers of the FireWall-1 product.
Significant factors such as the emergence of new products, fundamental
changes in technology and aggressive pricing and marketing strategies may also
affect the Company's competitive position. Many current and potential
competitors have significantly greater financial, marketing, technical and other
competitive resources than Netegrity. Many of these factors are out of the
Company's control, and there can be no assurance that Netegrity can maintain or
enhance its competitive position against current and future competitors.
PRODUCT RESEARCH AND DEVELOPMENT
The market for e-Commerce security products is characterized by rapid
technological change, changes in customer requirements, new product
introductions and enhancements, and emerging industry standards.
E-commerce applications have extreme requirements for scalability,
reliability, sophisticated security and ease of administration. These increased
demands, combined with the growing trend to centrally control access to formerly
isolated applications, drives the need for a unified access control model for
administrators and a single point of access for end users. With a growing need
for standards-based user directories (LDAP) and the proliferation of flexible
and easy-to-use security products, businesses are compelled to take advantage of
best-of-breed solutions as they deploy e-commerce applications across
heterogenous networks. The Company devotes significant time and resources
analyzing and responding to changes in the industry such as changes in operating
systems, application software, security standards, networking software, and
evolving customer requirements. For the year ended December 31, 1998, the
Company spent approximately $1,991,239, or 42% of revenue, on research and
development of its SiteMinder product. The Company will continue its product
development efforts for its current product, as well as developing next
generation versions of its product line.
The Company believes its future success will depend largely on its ability
to enhance and broaden its existing product line to meet the evolving needs of
the market. There can be no assurance that the Company will be able to respond
effectively to technological changes or new industry standards or developments.
In addition, the Company could be adversely affected if it were to incur
significant delays or be unsuccessful in developing new products or enhancing
its existing products, or if any such enhancements or new products do not gain
market acceptance. In addition, a number of factors, including the timing of
product introductions and enhancements by the Company or its competitors, market
acceptance of new products, or customer order deferrals in anticipation of new
products, may cause variations in the Company's future operating results.
7
PROPRIETARY RIGHTS
The Company depends upon a combination of patent and trademark laws, license
agreements, non-disclosure and other contractual provisions to protect
proprietary and distribution rights in its products. In addition, the Company
attempts to protect its proprietary information and those of its vendors and
partners through confidentiality and/or license agreements with its employees
and others. Despite these precautions, it may be possible for unauthorized third
parties to obtain information that the Company regards as proprietary and/or
confidential.
Management believes that, due to the rapid pace of innovation within the
high-tech industry, factors such as technical and creative skills of its
personnel and ongoing reliable services and support are as important in
establishing and maintaining a leadership position within the industry as are
the various forms of legal protections.
EMPLOYEES
At December 31, 1998, the Company had a total of 64 full-time employees, of
which 20 were involved in research and development, 34 in sales, marketing and
customer support, and 10 in administration and finance. None of the Company's
employees are represented by a labor union. The Company has not experienced any
work stoppages and believes that its relationships with employees are good.
ITEM 2. PROPERTIES
The Company's headquarters consists of two separate leased office suites
located at 245 Winter Street in Waltham, Massachusetts. The Company occupies
5,760 square feet of space with current monthly payments of $8,880, expiring in
May, 2001. Additionally, the Company sub-leases 8,015 square feet of office
space in the same building with current monthly payments of $11,552, expiring in
April, 1999.
The Company also leases office space in Los Angeles, California; New York,
New York; Chicago, Illinois; Reston, Virginia and Paris, France to support field
sales and consulting staff. The Company believes that its present and proposed
facilities are adequate for its current needs and that suitable alternative
space will be available should it need to expand.
ITEM 3. LEGAL PROCEEDINGS
From time to time, the Company is involved in litigation relating to claims
arising out of its operations in the normal course of business. The Company is
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,
1998.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded principally on the NASDAQ SmallCap
Market-SM- tier of the NASDAQ Stock Market-SM- under the symbol "NETE" and is
also traded on the Boston Stock Exchange under the symbol "NTY." The following
table sets forth the range of quarterly high and trade quotations for the
Company's Common Stock as reported by NASDAQ. The trade quotations represent
interdealer
8
quotations without adjustment for retail markups, markdowns or commissions, and
may not necessarily represent actual transactions.
QUARTERLY 1997 QUOTATIONS HIGH TRADE LOW TRADE
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January 1, 1997- March 31, 1997...................................... $ 4.000 $ 1.813
April 1, 1997-June 30, 1997.......................................... $ 2.813 $ 1.250
July 1, 1997-September 30, 1997...................................... $ 2.688 $ 1.125
October 1, 1997-December 31, 1997.................................... $ 2.063 $ 1.156
QUARTERLY 1998 QUOTATIONS HIGH TRADE LOW TRADE
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January 1, 1998- March 31, 1998...................................... $ 2.344 $ 1.406
April 1, 1998-June 30, 1998.......................................... $ 3.000 $ 1.625
July 1, 1998-September 30, 1998...................................... $ 4.125 $ 1.500
October 1, 1998-December 31, 1998.................................... $ 4.531 $ 1.063
As of December 31, 1998, there were 122 holders of record and approximately
1,400 beneficial owners of the Company's 9,405,446 shares of Common Stock
outstanding. The Company estimates that approximately 1,300 shareholders hold
securities in street name.
On January 6, 1998, the Company entered into a transaction with Pequot
Private Equity Fund, L.P. and Pequot Offshore Private Equity Fund, Inc. which is
exempt from Federal Registration pursuant to Section 4(2) of the Securities Act
of 1933, as amended. See Item 7 hereof for a detailed discussion of the
transaction.
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial information should be reviewed
in conjunction with Item 7--Management's Discussion and Analysis of Financial
Condition and Results of Operations and the Consolidated Financial Statements
and Notes thereto in Item 8 of this report.
9
STATEMENT OF OPERATIONS DATA
(in thousands, except per share data)
TWELVE-MONTH NINE-MONTH TWELVE-MONTH
FISCAL YEAR TRANSITION PERIOD FISCAL YEAR
ENDED DECEMBER 31, ENDED ENDED MARCH 31,
-------------------- DECEMBER 31, --------------------
1998 1997 1996 1996 1995
--------- --------- ----------------- --------- ---------
INCOME STATEMENT DATA:
Net revenue............................................. $ 4,791 $ 4,733 $ 3,637 $ 3,725 $ 959
Cost of revenue......................................... 1,764 2,470 2,176 2,173 488
--------- --------- ------ --------- ---------
Gross profit............................................ 3,027 2,263 1,461 1,552 471
Selling, general and administrative expenses............ 6,395 5,509 2,303 1,178 305
Research and development costs.......................... 1,991 1,028 705 -- --
--------- --------- ------ --------- ---------
Income (loss) from operations........................... (5,359) (4,274) (1,547) 374 166
Interest income (expense)............................... 130 203 181 20 (1)
Share of loss from investment
in Encotone, Inc...................................... -- (132) (40) -- --
Writeoff of investment in Encotone, Ltd................. -- (1,049) -- -- --
Income (loss) from continuing operations................ (5,229) (5,252) (1,406) 394 165
Income (loss) from operation of discontinued
operations............................................ -- -- (520) (240) 31
Gain on sale of assets of discontinued operations....... -- -- 6,000 -- --
--------- --------- ------ --------- ---------
Income before provision for income taxes................ (5,229) (5,252) 4,074 154 196
Provision for income taxes.............................. -- -- 74 25 --
--------- --------- ------ --------- ---------
Net income........................................ $ (5,229) $ (5,252) $ 4,000 $ 129 $ 196
--------- --------- ------ --------- ---------
Basic Earnings Per Share:
From continuing operations.......................... $ (0.56) $ (0.57) $ (0.16) $ 0.05 $ 0.02
From operation of discontinued operations........... -- -- (0.06) (0.03) --
Gain on sale of assets.............................. -- -- 0.67 -- --
Net income (loss) per share....................... $ (0.56) $ (0.57) $ 0.45 $ 0.02 $ 0.02
--------- --------- ------ --------- ---------
Weighted average shares outstanding................. 9,362 9,279 8,944 8,354 8,688
Diluted Earnings Per Share:
From continuing operations.......................... $ (0.56) $ (0.57) $ (0.16) $ 0.04 $ 0.02
From operation of discontinued operations........... -- -- (0.06) (0.03) --
Gain on sale of assets.............................. -- -- 0.67 -- --
Net income (loss) per share....................... $ (0.56) $ (0.57) $ 0.45 $ 0.01 $ 0.02
--------- --------- ------ --------- ---------
Weighted average shares outstanding................. 9,362 9,279 8,944 8,835 8,688
TWELVE-MONTH
FISCAL YEAR NINE-MONTH TWELVE-MONTH
ENDED TRANSITION PERIOD FISCAL YEAR
DECEMBER 31, ENDED ENDED MARCH 31,
-------------------- DECEMBER 31, --------------------
1998 1997 1996 1996 1995
--------- --------- ----------------- --------- ---------
BALANCE SHEET DATA:
Working capital (deficit)................................. $ 47 $ 9 $ 4,629 $ 401 $ 651
Total assets.............................................. 4,225 4,849 10,259 9,170 7,127
Long-term liabilities..................................... -- -- -- 187 300
Stockholders' equity...................................... 996 1,016 6,149 1,903 1,950
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
The Private Securities Litigation Reform Act of 1995 contains certain safe
harbors regarding forward-looking statements. In that context, the discussion in
this Item contains forward-looking statements which involve certain degrees of
risk and uncertainties, including statements relating to liquidity and capital
resources. Except for the historical information contained herein, the matters
discussed in this item are such forward-looking statements that involve risks
and uncertainties, including the impact of competitive pricing within the
software industry, the effect any reaction to such competitive pressures has on
current inventory valuations, the need for and effect of any business
restructuring, the presence of competitors with greater financial resources,
capacity and supply constraints or difficulties, and the Company's continuing
need for improved profitability and liquidity.
A portion of the following overview reflects the divestiture of the
Company's catalog related business in June 1996. Any comments relating to
operating results or issues are reflective of the continuing network security
business. The Company's revenue was generated by the sale of network security
products, integration and support services to companies doing business on the
Internet and internal networks. The divestiture of the Company's catalog related
business is recorded as discontinued operations in the accompanying financial
statements contained in Item 8.
The Company plans to continue to enhance product features to meet its
customers' needs in deploying large-scale and complex transaction-based
e-commerce applications for conducting business. The Company plans to continue
to adopt the latest industry standards and new technologies allowing for the
deployment of secure applications for the Web. There can be no assurance that
the Company will be able to develop new products or that such products will
achieve market acceptance, or, if market acceptance is achieved, that the
Company will be able to maintain such acceptance for a significant period of
time.
OVERVIEW
The following information should be read in conjunction with the
consolidated financial statements and notes thereto:
% TO NET REVENUE
----------------------------------------
TWELVE-MONTH NINE-MONTH
FISCAL YEAR TRANSITION PERIOD TWELVE-MONTH
ENDED DECEMBER 31, ENDED FISCAL YEAR
DECEMBER 31, ENDED MARCH 31,
-------------------- ------------------- -------------------
1998 1997 1996 1996
--------- --------- ------------------- -------------------
Net Revenue.................................................... 100% 100% 100% 100%
Gross Margin................................................... 63% 48% 40% 42%
Selling, general and administrative expenses................... 133% 116% 63% 32%
Research and development costs................................. 42% 22% 19% --
Income (loss) from operations.................................. (112%) (90%) (42%) 10%
FISCAL YEAR ENDED DECEMBER 31, 1998 VS. FISCAL YEAR ENDED DECEMBER 31, 1997
REVENUE: Total net revenue increased by $58,000, or 1%, to $4,791,000 in the
twelve months ended December 31, 1998 from $4,733,000 in the twelve months ended
December 31, 1997. SiteMinder-related revenue increased $1,702,000, or 683%,
from $249,000 to $1,951,000 in the fiscal year ended December 31, 1998. This
increase is offset by a decline in firewall-related revenue of $1,641,000 or
37%, primarily as a result of the expected decline in the firewall reseller
business.
GROSS MARGIN: Total gross margin increased by $764,000, or 34%, to
$3,027,000 in the fiscal year ended December 31, 1998 as compared to $2,263,000
in the fiscal year ended December 31, 1997. This increase is
11
due to the higher gross margins relating to increased revenue on the Company's
proprietary SiteMinder product and maintenance.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE: Selling, general and
administrative ("SG&A") expenses increased by $886,000, or 16%, to $6,395,000 in
the fiscal year ended December 31, 1998 as compared to $5,509,000 in the fiscal
year ended December 31, 1997. This increase is primarily a result of the Company
continuing to build its sales and marketing infrastructure to support planned
growth in sales of its SiteMinder product and services.
RESEARCH AND DEVELOPMENT COSTS: Research and Development costs (net of
capitalized software) increased by $963,000, or 94% to $1,991,000 in fiscal 1998
as compared to$1,028,000 in the twelve-month period ended December 31, 1997. The
Company is continuing the development of its product line to address the
evolving e-commerce security market. Certain research and development
expenditures are incurred substantially in advance of the related revenue, and
in some cases, do not generate revenue. In fiscal 1997, $310,000 (net of
amortization) of research and development expenditures were capitalized as a
result of the Company realizing technological feasibility. The Company did not
capitalize additional research and development expenditures in 1998. Capitalized
software costs, net of amortization, is $175,629 at December 31, 1998.
TWELVE-MONTH FISCAL YEAR ENDED DECEMBER 31, 1997 VS. NINE-MONTH TRANSITION
PERIOD ENDED
DECEMBER 31, 1996
The sale of Check Point's FireWall-1 and related maintenance and service
revenue represented 95% of the Company's revenue in the twelve-month period
ended December 31, 1997, and 100% for the nine-month transition period ended
December 31, 1996.
ASSET SALE: As of June 28, 1996, the Company completed the divestiture of
its catalog related business, consisting of The Programmer's SuperShop ("TPS")
catalog, the TPS Web site, the corporate sales group, SDC Germany and SDC
Communications. The Company completed the transaction for an aggregate price of
$10,035,000. The aggregate price consisted of payment of $9,300,000 in
immediately available funds and the deposit of $735,000 under an escrow
arrangement. During August, 1996, $135,000 of the escrow was returned to the
Company.
The aggregate price of $10,035,000 was in exchange for the Company's
tangible net assets of the catalog related business that at the time was
estimated at approximately $1,500,000. The values of these net assets are
currently being evaluated by a third party, and the Company expects that any
purchase price adjustments that could occur as a result of the evaluation will
have no material impact on the financial position or results of operations
presented herein.
The Company incurred $2,587,000 in expenses and write-offs related to the
divestiture. These expenses were primarily comprised of write-off of goodwill,
severance costs, professional fees, buy-outs of capital leases, and facility
shut-down costs for its corporate offices and distribution facility. The Company
reported a gain of $6,000,000 from the sale of the assets of its catalog related
business. The Company utilized a portion of its available operating loss
carryforwards to decrease the amount of Federal and State corporate income
taxes.
CHANGE IN FISCAL YEAR: In 1996, the Company elected to change its fiscal
year to coincide with the calendar year. Prior to the change, the Company's
fiscal year ended on March 31. As a result, the Company had a nine-month
transition period from April 1, 1996 to December 31, 1996, between fiscal years.
ACTUAL AND PRO-FORMA RESULTS OF OPERATIONS: The following table presents a
comparison summary of fiscal year 1997 actual and twelve-months ended December
31, 1996 unaudited pro-forma results for informational purposes only. This
information is not necessarily indicative of either financial position, or
results of operations in the future, or what would have occurred had the events
described in the paragraph
12
under "Change in Fiscal Year" had not occurred. The following information should
be read in conjunction with the audited Consolidated Financial Statements of the
Company presented herein.
ACTUAL UNAUDITED PRO-FORMA
TWELVE-MONTHS ENDED TWELVE MONTHS ENDED
DECEMBER 31, 1997 DECEMBER 31, 1998
------------------------------ ------------------------------
PERCENT TO PERCENT TO
DOLLARS NET REVENUE DOLLARS NET REVENUE
------------- --------------- ------------- ---------------
Net revenue............................................. $ 4,732,649 100% $ 4,965,948 100%
Gross margin............................................ 2,262,758 48% 2,035,274 41%
Selling, general and administrative expenses............ 5,508,813 116% 2,702,264 54%
Research and development costs.......................... 1,028,094 22% 705,298 14%
Income (loss) from operations........................... (4,274,149) (90%) (1,372,288) (28%)
FISCAL YEAR ENDED DECEMBER 31, 1997 VS. PRO-FORMA TWELVE MONTHS ENDED DECEMBER
31, 1996
REVENUE: Total net revenue decreased by $233,000, or 5%, to $4,733,000 in
the twelve months ended December 31, 1997 from $4,966,000 during the
twelve-month period ended December 31, 1996. The decrease in revenue resulted
from Company's decision to eliminate hardware sales and limit its Check Point
FireWall-1 distribution. This decrease was partially offset by revenue achieved
by the Company's sale of its SiteMinder product in the fourth quarter of
$249,000.
GROSS MARGIN: Total gross margin increased by $227,000, or 11%, to
$2,263,000 in the fiscal year ended December 31, 1997 as compared to $2,035,000
in the twelve-month period ended December 31, 1996. The increase in gross margin
is attributable to the Company's elimination and reduction of low-margin
business as described above and the sale of its proprietary SiteMinder product
beginning in the fourth quarter of 1997.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE: Selling, general and
administrative ("SG&A") expenses increased by $2,807,000, or 104%, to $5,509,000
in the fiscal year ended December 31, 1997 from $2,702,000 in the twelve-month
period ended December 31, 1996. This increase was a result of the Company
building its sales and marketing infrastructure to bring to market its
SiteMinder product.
RESEARCH AND DEVELOPMENT COSTS: Research and Development costs (net of
capitalized software) increased by $323,000, or 46% to $1,028,000 in fiscal 1997
as compared to $705,000 in the twelve-month period ended December 31, 1996. The
Company is continuing the development of new products to address the changing
needs of the evolving network security market. Certain research and development
expenditures are incurred substantially in advance of the related revenue, and
in some cases, do not generate revenue. In fiscal 1997, $310,000 (net of
amortization) of research and development expenditures were capitalized as a
result of the Company realizing technological feasibility.
LIQUIDITY AND CAPITAL RESOURCES
FISCAL YEAR ENDED
DECEMBER 31,
--------------------
1998 1997
--------- ---------
(IN THOUSANDS,
EXCEPT RATIOS)
Cash and cash equivalents.................................................................... $ 1,175 $ 2,134
Working capital.............................................................................. 47 9
Current ratio................................................................................ 1.01 1.00
Net cash used for continuing operating activities............................................ $ (5,843) $ (4,336)
Net cash used for discontinued operating activities.......................................... -- (46)
Net cash provided by investing activities.................................................... (301) (384)
Net cash provided by financing activities.................................................... 5,186 109
13
For the fiscal year ended December 31, 1998, the Company's net cash used for
continuing operations increased by $1,507. This increase was primarily a result
of the Company's increased investment in sales, marketing and development
infrastructure for its SiteMinder product of approximately $1,849.
Working capital increased to $47,000 at December 31, 1998 from $9,000 at
December 31, 1997. This increase was a direct result of financing activities
during fiscal 1998.
On January 6, 1998, the Company, entered into a Preferred Stock and Warrant
Purchase Agreement (the "Agreement") with Pequot Private Equity Fund, L.P., a
Delaware limited partnership ("PPEF") and Pequot Offshore Private Equity Fund,
Inc., a British Virgin Islands corporation (together with PPEF, the "Pequot
Entities"). Pursuant to the terms of the Agreement, on January 7, 1998, the
Company sold 1,666,667 shares of Series D Preferred Stock, at $1.50 per share,
and 750,393 Warrants to the Pequot Entities for an aggregate purchase price of
$2,500,000.50. The Series D Preferred Stock is automatically convertible into
Common Stock on a one-for-one basis, subject to adjustment. In addition, the
Series D Preferred Stock is subject to mandatory conversion into Common Stock
upon certain circumstances.
The Company entered into an amendment on June 5, 1998 to the Preferred Stock
and Warrant Purchase Agreement with the Pequot Entities. Pursuant to the terms
of the amended Agreement, on June 5, 1998, the Company sold 833,333 shares of
Series D Preferred Stock, at $1.50 per share, and 375,197 Warrants to the Pequot
Entities for an aggregate purchase price of $1,250,001. On June 30, 1998, the
Company sold an additional 833,333 shares of Series D Preferred Stock, at $1.50
per share, and 375,197 Warrants to the Pequot Entities for an aggregate purchase
price of $1,250,000.
As part of the Agreement with the Pequot Entities, James McNiel joined the
Board of Directors of the Company, as designee of the Pequot Entities, and has
agreed to provide certain consulting services to the Company. In addition to
consulting fees in connection with such service, the Company granted Mr. McNiel
warrants for the purchase of 100,000 shares of Common Stock.
On February 8, 1999, the Company entered into a Stock Purchase Agreement
(the "Stock Purchase Agreement") with an institutional investor and the Pequot
Entities. Pursuant to the terms of the Stock Purchase Agreement, the Company
sold 795,651 shares of Common Stock, at $5.75 per share. The Company has agreed
to file a registration statement on Form S-3 for a public resale offering on
behalf of the institutional investor.
Management believes that this financing, together with cash generated from
operations, will be adequate to support the business operation for fiscal year
1999.
INFLATION: To date, management believes that inflation has not had a
material impact on operations.
ENVIRONMENTAL LIABILITY: The Company has no known environmental violations
or assessments.
YEAR 2000 COMPLIANCE DISCLOSURE: The Year 2000 issue is the result of
computer programs being written using two digits rather than four digits to
define the applicable year. This could result in a system failure or
miscalculations if a computer program recognizes a date of "00" as the year 1900
instead of 2000. If not corrected, many computer systems could fail or create
erroneous results in 2000. The following disclosure is as required by SEC
Release No. 33-7558.
COMPANY'S STATE OF READINESS
The Company is in the process of completing a preliminary assessment of all
of its internal and external systems and processes with respect to the "Year
2000" issue. The Company plans to continuously test all of its internal and
external systems and processes (and the associated Year 2000 "fixes") for Year
2000 compliance during 1999. As part of this process, the Company has
preliminarily assessed the potential impact of Year 2000 failures from vendors
and outside parties upon its business and is currently taking steps to minimize
that risk. Based on the Company's current state of readiness and the steps
currently
14
being taken (i.e., developing backup processes), the Company does not believe
that the Year 2000 problem will have a material adverse effect on the Company's
financial position, liquidity, or operations.
In addition to computers and related systems, the operation of office and
facilities equipment, such as fax machines, photocopiers, telephone switches,
security systems, and other common devices may be affected by the Year 2000
problem. The Company is currently assessing the potential effect of, and costs
of remedying the Year 2000 problem on its office and facilities equipment.
The Company is in the process of developing a plan to reduce the probability
of operational difficulties due to Year 2000 related failures. The Company
believes it is on track towards a timely completion of this task. Overall,
management estimates that it has completed approximately 75% of the Year 2000
issue identification process with no remediating required.
INTERNAL SYSTEMS (IT)
The process the Company will follow to achieve Year 2000 compliance for
internal IT systems is as follows:
1. Develop an inventory of all IT components (hardware, software)
2. Determine the Year 2000 compliance status of each component.
3. Determine the importance of Year 2000 compliance for each component
(implications of failure).
4. Prioritize non-compliant components based on importance.
5. Determine method to be used to achieve compliance for each component
(modify, replace, cease use).
6. Complete planned action.
7. Test each component.
COMPANY'S COSTS OF YEAR 2000 COMPLIANCE
All costs related to Year 2000 issues will be expensed as incurred and the
Company does not expect the total costs of evaluation and testing to be
material. Other potential costs may include updating of computer software and
hardware, as well as other out-of-pocket costs.
COMPANY'S RISKS OF YEAR 2000 ISSUES
The Company believes that its current internally developed products, as well
as third-party products with which the Company has material relationships are
Year 2000 compliant. Therefore, the Company does not believe that its products
will be adversely affected by date changes in the Year 2000. However, there can
be no assurances that the Company's current products do not contain undetected
errors or defects associated with Year 2000 date functions that may result in
material costs to the Company.
While the Company believes that its products, as well as third-party
products with which the Company has material relationships are Year 2000
compliant, certain factors may result in a third-party application used in
conjunction with the Company's products may not be Year 2000 compliant. Users
must test their unique combination of hardware, system software, and transaction
and application software in order for Year 2000 compliance to be achieved.
Additionally, the Company has begun assessing the Year 2000 issue with
regard to its internal financial and operational systems and is not currently
aware of any material issues or costs associated with preparing its internal
systems for the Year 2000. There can be no assurance that the Company will not
experience unanticipated negative consequences or costs caused by undetected
errors or defects in the technology used in its internal operation.
15
COMPANY'S CONTINGENCY PLANS
The Company has not yet developed a detailed contingency plan, but intends
to evaluate the necessity of such plans based on the outcome of its assessment
and testing of its Year 2000 readiness that will be completed in 1999. Any
vendors found not to be Year 2000 compliant will be replaced with vendors that
are Year 2000 compliant.
NEW ACCOUNTING PRONOUNCEMENTS: In June 1998, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities." This statement
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives), and for hedging activities. The
statement requires companies to recognize all derivatives as either assets or
liabilities, with the instruments measured at fair value. The accounting for
changes in fair value, gains or losses, depends on the intended use of the
derivative and its resulting designation. The statement is effective for all
fiscal quarters of fiscal years beginning after June 15, 1999. Adoption of this
standard will not impact the financial results of the Company.
In March 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use". SOP 98-1 requires computer software
costs associated with internal use software to be charged to operations as
incurred until certain capitalization criteria are met. SOP 98-1 is effective
beginning January 1, 1999. We do not expect adoption of this statement to have a
material effect on consolidated financial position or results of operations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's consolidated financial statements and the related auditors'
reports are presented in the following pages. The consolidated financial
statements filed in this Item 8 are as follows:
- Report of Independent Auditors
- Consolidated Balance Sheets--December 31, 1998 and 1997
- Consolidated Statements of Operations for the fiscal years ended December
31, 1998 and 1997, and the nine-month transition period ended December 31,
1996
- Consolidated Statements of Stockholders' Equity for the fiscal years ended
December 31, 1998 and 1997, and the nine-month transition period ended
December 31, 1996
- Consolidated Statements of Cash Flows for the fiscal years ended December
31, 1998 and 1997, and the nine-month transition period ended December 31,
1996
- Notes to Consolidated Financial Statements
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
Not applicable.
16
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors
and Stockholders of Netegrity, Inc.
In our opinion, the accompanying balance sheets and the related statements
of operations, of shareholders' equity and of cash flows present fairly, in all
material respects, the financial position of Netegrity, Inc. (the "Company") at
December 31, 1998 and 1997, and the results of its operations and its cash flows
for the years ended December 31, 1998 and 1997, and the nine-month transition
period ended December 31, 1996, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.
PricewaterhouseCoopers LLP
Boston, Mass.
February 8, 1999
17
NETEGRITY, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
--------------------------
1998 1997
------------ ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents........................................................... $ 1,174,625 $ 2,133,586
Escrow receivable (Note F).......................................................... -- 600,000
Accounts receivable-trade, net of allowance for doubtful accounts of $247,063 and
$64,460 at December 31, 1998 and 1997, respectively............................... 1,746,645 791,369
Deferred maintenance asset.......................................................... 308,926 304,721
Prepaid rent........................................................................ 30,163
---
Other current assets................................................................ 15,848 8,250
------------ ------------
TOTAL CURRENT ASSETS............................................................ 3,276,207 3,837,926
EQUIPMENT AND LEASEHOLD IMPROVEMENTS, NET (Note B).................................... 736,341 585,055
OTHER ASSETS:
Capitalized software costs, net....................................................... 175,629 309,891
Investment in Encotone, Inc. (Note C)............................................... -- 78,199
Other............................................................................... 37,114 37,438
------------ ------------
TOTAL OTHER ASSETS.............................................................. 37,114 115,637
------------ ------------
TOTAL ASSETS.......................................................................... $ 4,225,291 $ 4,848,509
------------ ------------
The accompanying notes are an integral part of the consolidated financial
statements.
18
NETEGRITY, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
--------------------------
1998 1997
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable-trade.............................................................. $ 897,734 $ 1,507,071
Deferred revenue.................................................................... 285,857 --
Accrued bonus....................................................................... 160,687 215,000
Accrued commissions................................................................. 180,328 64,722
Other accrued expenses.............................................................. 766,908 1,355,533
Deferred maintenance liability...................................................... 938,004 667,416
Current portion of capitalized lease obligations.................................... -- 19,068
------------ ------------
TOTAL CURRENT LIABILITIES....................................................... 3,229,508 3,828,810
LONG-TERM CAPITAL LEASE OBLIGATIONS................................................... -- 3,653
TOTAL LIABILITIES..................................................................... 3,229,508 3,832,463
------------ ------------
COMMITMENTS AND CONTINGENCIES (Note D)................................................ -- --
STOCKHOLDERS' EQUITY:
Preferred stock, Series D voting, $.01 par value, 3,333,333 shares issued and
outstanding at December 31, 1998 (aggregate liquidation value, $4,999,999.50)..... 33,333 --
Common stock, voting, $.01 par value, authorized 25,000,000 shares: 9,425,446 shares
issued and 9,400,345 outstanding at December 31, 1998; 9,279,346 shares issued and
9,254,245 shares outstanding at December 31, 1997................................. 94,254 92,793
Additional paid-in capital.......................................................... 15,780,049 10,578,330
Cumulative translation adjustment................................................... -- 28,028
Cumulative deficit.................................................................. (14,628,196) (9,399,448)
Loan to officer (Note E)............................................................ (200,000) (200,000)
------------ ------------
1,079,440 1,099,703
Less--Treasury Stock, at cost: 25,101 shares........................................ (83,657) (83,657)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY............................................................ 995,783 1,016,046
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY............................................ $ 4,225,291 $ 4,848,509
------------ ------------
The accompanying notes are an integral part of the consolidated financial
statements.
19
NETEGRITY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1998 1997 1996
(TWELVE MONTHS) (TWELVE MONTHS) (NINE MONTHS)
--------------- --------------- --------------
Net revenues................................................... $ 4,791,117 $ 4,732,649 $ 3,637,037
Cost of revenues 1,763,825 2,469,891 2,175,626
--------------- --------------- --------------
Gross profit................................................... 3,027,292 2,262,758 1,461,411
Selling, general and administrative expenses................... 6,394,918 5,508,813 2,303,478
Research and development costs................................. 1,991,239 1,028,094 705,298
--------------- --------------- --------------
Income (loss) from operations.................................. (5,358,865) (4,274,149) (1,547,365)
Interest income (expense)...................................... 130,115 203,205 181,881
Share of loss from investment in Encotone, Inc................. -- (131,801) (40,000)
--------------- --------------- --------------
Write off of investment in Encotone LTD........................ -- (1,049,151) --
Income (loss) from continuing operations....................... (5,228,750) (5,251,896) (1,405,484)
Income (loss) from discontinued operations..................... -- -- (520,245)
Gain on sale of assets of discontinued operations.............. -- -- 6,000,000
--------------- --------------- --------------
Income (loss) before provision for income taxes................ (5,228,750) (5,251,896) 4,074,271
Provision for income taxes..................................... -- -- 74,300
--------------- --------------- --------------
NET INCOME (LOSS).......................................... $ (5,228,750) $ (5,251,896) $ 3,999,971
--------------- --------------- --------------
Basic and Diluted Earnings Per Share:
From continuing operations................................... $ (0.56) $ (0.57) $ (0.16)
From operation of discontinued
operations................................................. -- -- (0.06)
Gain on sale of assets....................................... -- -- 0.67
--------------- --------------- --------------
Net income (loss) per share................................ $ (0.56) $ (0.57) $ 0.45
--------------- --------------- --------------
Weighted average shares outstanding............................ 9,362,000 9,279,000 8,944,000
Diluted Earnings Per Share:
From continuing operations................................... $ (0.56) $ (0.57) $ (0.16)
From operations of discontinued
operations................................................. -- -- (0.06)
Gain on sale of assets......................................... -- -- 0.67
--------------- --------------- --------------
Net income (loss) per share................................ $ (0.56) $ (0.57) $ (0.45)
--------------- --------------- --------------
Weighted average shares outstanding............................ 9,362,000 9,279,000 8,944,000
The accompanying notes are an integral part of the consolidated financial
statements.
20
NETEGRITY, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
ADDITIONAL CUMULATIVE TOTAL
PREFERRED COMMON PAID-IN TRANSLATION CUMULATIVE LOAN TO TREASURY STOCKHOLDERS'
STOCK STOCK CAPITAL ADJUSTMENT DEFICIT OFFICER STOCK EQUITY
----------- ----------- ---------- ----------- ----------- --------- ----------- ------------
BALANCE AT
MARCH 31, 1996............ $ 6,283 $ 81,979 $10,024,710 $ 21,569 $(8,147,521) -- $ (83,657) $1,903,363
Net income.................. -- -- -- -- 3,999,971 -- -- 3,999,971
Conversion of Preferred
Stock (628,330
shares)--Series C......... (6,283) 6,283 -- -- -- -- -- --
Issuance of Common Stock
(378,729 shares).......... -- 3,787 435,844 -- -- -- -- 439,631
Translation adjustment...... -- -- -- 6,459 -- -- -- 6,459
Loan to officer (Note F).... -- -- -- -- -- $(200,000) -- (200,000)
----------- ----------- ---------- ----------- ----------- --------- ----------- ------------
BALANCE AT
DECEMBER 31, 1996......... -- $ 92,049 $10,460,554 $ 28,028 $(4,147,550) $(200,000) $ (83,657) $6,149,424
----------- ----------- ---------- ----------- ----------- --------- ----------- ------------
Net income.................. -- -- -- -- (5,251,896) -- -- (5,251,896)
Issuance of Common Stock
(74,400 shares)........... -- 744 117,776 -- -- -- -- 118,520
Translation adjustment...... -- -- -- -- -- -- -- --
----------- ----------- ---------- ----------- ----------- --------- ----------- ------------
BALANCE AT DECEMBER 31,
1997...................... -- $ 92,793 $10,578,330 $ 28,028 $(9,399,446) $(200,000) $ (83,657) $1,016,048
----------- ----------- ---------- ----------- ----------- --------- ----------- ------------
Net income.................. -- -- -- -- (5,228,750) -- -- (5,228,750)
Issuance of Preferred Stock
(3,333,333 shares) Series
D......................... 33,333 -- 4,916,668 -- -- -- -- 4,950,001
Issuance of Common Stock
(146,100 shares).......... -- 1,461 257,023 -- -- -- -- 258,484
Translation adjustment...... -- -- 28,028 (28,028) -- -- -- --
----------- ----------- ---------- ----------- ----------- --------- ----------- ------------
BALANCE AT
DECEMBER 31, 1998......... 33,333 $ 94,254 $15,780,049 -- $(14,628,196) $(200,000) $ (83,657) $ 995,783
----------- ----------- ---------- ----------- ----------- --------- ----------- ------------
The accompanying notes are an integral part of the consolidated financial
statements.
21
NETEGRITY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1998 1997 1996
(TWELVE MONTHS) (TWELVE MONTHS) (NINE MONTHS)
--------------- --------------- --------------
OPERATING ACTIVITIES
Net loss from continuing operations............................ $ (5,228,750) $ (5,251,896) $ (1,405,484)
Adjustments to reconcile loss to net cash provided by (used
for) operating activities:
Share of loss from investment.............................. -- 131,801 40,000
Write off of investment in Encotone, LTD................... -- 1,049,151 --
Depreciation and amortization.............................. 365,975 (193,704) 26,487
Provision for doubtful accounts receivable, net............ 182,603 (3,337) 56,771
Change in operating assets and liabilities:
Escrow receivable.......................................... 600,000 -- (600,000)
Accounts receivable........................................ (1,137,879) (252) 137,935
Other current assets....................................... (41,966) 246,259 389,156
Inventory.................................................. -- -- 21,400
Other assets............................................... 324 (14,078) 52,053
Accounts payable........................................... (609,337) (592,364) 622,784
Other accrued expenses..................................... 25,646 292,781 (1,542,083)
Total adjustments........................................ (614,634) 916,257 (801,497)
--------------- --------------- --------------
Net cash used for continuing operating activities........ (5,843,384) (4,335,639) (2,206,981)
Net cash (used for) provided by discontinuing operating
activities............................................. -- (46,241) 436,859
--------------- --------------- --------------
Net cash used for operating activities................... $ (5,843,384) $ (4,381,880) $ (1,770,122)
--------------- --------------- --------------
The accompanying notes are an integral part of the consolidated financial
statements.
22
NETEGRITY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1998 1997 1996
(TWELVE MONTHS) (TWELVE MONTHS) (NINE MONTHS)
--------------- --------------- --------------
INVESTING ACTIVITIES:
Proceeds from sale of certain assets........................... $ 25,863 -- $ 9,435,000
Capitalized software costs..................................... 134,262 $ (309,891) --
Capital expenditures for equipment and leasehold
improvements................................................. (408,860) (384,458) (256,886)
Investment in Encotone, LTD.................................... -- -- (1,000,000)
Investment in Encotone, Inc.................................... 81,656 -- (250,000)
--------------- --------------- --------------
Net cash (used for) provided by investing activities....... $ (301,341) $ (384,458) $ 7,928,114
FINANCING ACTIVITIES:
Net proceeds from issuance of preferred stock.................. 4,950,001 -- --
Net proceeds from issuance of stock............................ 258,484 118,520 239,631
Payment on notes payable-related party......................... -- -- (300,000)
Net payments on line of credit................................. -- -- (723,470)
Principal payments under capital leases........................ (22,721) (9,653) --
--------------- --------------- --------------
Net cash used for (provided by) financing activities....... 5,185,764 108,867 (783,839)
--------------- --------------- --------------
Effect of exchange rate changes on cash........................ -- -- 6,459
NET CHANGE IN CASH AND CASH EQUIVALENTS.................... (958,961) (4,657,471) 5,380,612
Cash and cash equivalents at beginning of year................. 2,133,586 6,791,057 1,410,445
--------------- --------------- --------------
CASH AND CASH EQUIVALENTS AT END OF YEAR................... $ 1,174,625 $ 2,133,586 $ 6,791,057
--------------- --------------- --------------
Supplemental Disclosures of Cash Flow Information:
Interest paid................................................ $ 872 $ 3,143 $ 17,778
Income taxes paid............................................ -- 63,557 --
--------------- --------------- --------------
Supplemental Disclosure of Non-Cash Activities:
Loan to officer in exchange for common stock................. -- -- $ 200,000
Write-off of investment in Encotone LTD...................... -- $ 1,049,151 --
Property purchased under capital leases...................... -- 32,374 --
Collection of products in satisfaction of accounts
receivable-product......................................... -- -- --
--------------- --------------- --------------
The accompanying notes are an integral part of the consolidated financial
statements.
23
NETEGRITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A: NATURE OF THE BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
OPERATIONS: The Company currently operates in the network security market.
During June, 1996, the Company completed a full divestiture of its catalog
business and changed its name from The Software Developer's Company, Inc. to
Netegrity, Inc. The results of operations of the divested catalog business is
presented as discontinued operations herein.
PRINCIPLES OF CONSOLIDATION: The financial statements of the Company also
include the accounts and operations of its subsidiaries, Software Developers
Company, GmbH ("SDC Germany") and Personal Computing Tools (PCT). The Company
acquired 94% of the outstanding capital stock of PCT on June 29, 1993. The 6%
equity interest in PCT not acquired by the Company would be shown as minority
interest in the December 31, 1996 consolidated balance sheets and the statements
of operations for the nine-month transition period ended December 31, 1996 and
the fiscal years ended March 31, 1996, respectively. As of June 30, 1996, the
Company discontinued all operations related to its SDC Germany and PCT catalog
operation. The operating loss incurred in 1996 is accounted for in loss from
discontinued operations.
CASH AND CASH EQUIVALENTS: Cash and cash equivalents include time deposits
with a maturity of three months or less at the date of purchase.
CONCENTRATION OF CREDIT RISK: Financial instruments that potentially
subject the Company to concentration of credit risk consist primarily of cash
and cash equivalents and trade receivables. The Company restricts investment of
temporary cash investments to financial institutions with high credit standing.
Credit risk on trade receivables is minimal.
REVENUE RECOGNITION: The Company's revenues from continuing operations are
primarily generated from the sale of its proprietary SiteMinder products and
services and from licensing the rights to use software products developed by
Checkpoint Software Technologies, Ltd. to end users and resellers. The Company
generates its services revenue from consulting and training services performed
for customers and from support and software update rights (i.e., maintenance).
Revenues from perpetual software license agreements are recognized as revenue
upon delivery of the software as long as there are no significant post-delivery
obligations.
Revenues for maintenance are recognized ratably over the term of the support
period. If maintenance is included in a license agreement, such amounts are
unbundled from the license fee at their fair market value based on the value
established by independent sale of such maintenance to customers. Consulting
revenues are primarily related to implementation services performed under
separate service arrangements related to the installation of software products.
Such services do not include customization or modification of the underlying
software code. If included in a license agreement, such services are unbundled
at their fair market value based on the value established by the independent
sale of such services to customers. Revenues from consulting and training
services are recognized as the services are performed.
In October, 1997, the American Institute of Certified Public Accountants
issued a Statement of Position (SOP) 97-2, "Software Revenue Recognition." The
Company intends to adopt this pronouncement and does not expect it to have a
material affect on the revenue recognition practices of the Company.
CAPITALIZATION OF SOFTWARE COSTS: The Company capitalizes certain
internally generated software development costs after technological feasibility
of the product has been established. Such costs are amortized over the estimated
life of the product. The Company continually compares the unamortized costs of
capitalized software to the expected future revenues for the products. If the
unamortized costs
24
NETEGRITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE A: NATURE OF THE BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
exceed the expected future net realizable value, the excess amount is written
off. At December 31, 1998, the Company amortized $134,262 of software
development costs.
EQUIPMENT AND LEASEHOLD IMPROVEMENTS: Equipment and leasehold improvements
are stated at cost, less accumulated depreciation and amortization. Depreciation
is provided using the straight-line method over estimated useful lives from five
to seven years. Amortization of leasehold improvements is provided using the
straight-line method over the lives of the respective leases or the useful lives
of the improvements, whichever is shorter.
Maintenance and repairs are charged to operations as incurred. Renewals and
betterments which materially extend the life of assets are capitalized and
depreciated. Upon disposal, the asset cost and related accumulated depreciation
are removed from their respective accounts. Any resulting gain or loss is
reflected in earnings.
CUSTOMER ADVANCES: Prepayments made by customers are included as customer
advances and recorded as sales when shipments are made.
INCOME TAXES: Deferred tax assets and liabilities are recognized for the
expected future tax consequences of events that have been included in the
financial statements which are temporarily different than the tax basis. The
amount of deferred tax asset or liability recognized, net of valuation
allowances, is based on the difference between the financial statement and tax
basis of assets and liabilities using enacted tax rates in effect for the year
in which the differences are expected to reverse.
INVESTMENTS: Investments in equity securities, other than investments
accounted for by the equity method are recorded at cost. Management determines
the appropriate classification of its investments at the time of purchase and
reevaluates such determinations, as well as potential impairments of value on a
periodic basis, but at a minimum, quarterly.
MARKETING EXPENSES: Marketing expenses are charged to sales & marketing
expenses as incurred.
SUPPORT SERVICES: The Company provides, free of charge, pre-sale telephone
technical support and product literature. The Company provides post-sales
support to its customers who are covered under maintenance agreements. The costs
relating to these services are expensed as incurred and included in Selling,
General & Administrative expenses.
EARNINGS (LOSS) PER SHARE: The Company has adopted Statement of Financial
Accounting Standards (SFAS) No. 128 "Earnings Per Share" and has retroactively
restated the earnings per share (EPS) for 1996 and 1995. SFAS 128 requires
presentation of basic and diluted EPS. Basic EPS is computed by dividing net
income by the number of weighted average common shares outstanding. Diluted EPS
reflects potential dilution from outstanding stock options, using the treasury
stock method. Potentially dilutive securities at December 31, 1998 include stock
options outstanding to purchase 4,704,229 common shares, warrants to purchase
1,600,787 common shares and 3,333,333 shares of convertible preferred stock (see
Note I); however, such securities have not been included in the net loss per
share calculation because their effect would be anti-dilutive.
SEGMENT REPORTING: The Company is in one business segment, the design,
development, marketing and support of software for controlling user access to
electronic commerce. The Company follows the
25
NETEGRITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE A: NATURE OF THE BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
requirements of Statement of Financial Accounting Standards No. 131, "Disclosure
about Segments of an Enterprise and Related Information."
EXPORT SALES: The Company generates some revenues from international
business. For all periods reported herein, the Company's export sales are deemed
immaterial.
FOREIGN CURRENCY TRANSLATION: The functional currency of the Company's
former foreign subsidiary is the local currency. Balance sheet accounts of the
Company's former foreign subsidiary are translated into U.S. dollars at current
exchange rates. Income statement items are translated at the average rates
during the year. Net translation gains or losses are recorded directly to a
separate component of stockholders' equity. Foreign currency transaction gains
and losses are included in the determination of net income for the fiscal year
ended December 31, 1996.
POST-RETIREMENT BENEFITS OTHER THAN PENSIONS: The Company does not offer
post-employment benefits to its retirees and as a result, is unaffected by
Statement of Financial Accounting Standards No. 106 or 112 issued in December
1990 and November 1992, respectively.
401K PLAN: The Company maintains a 401K Plan for its employees. The Plan is
intended as a retirement and tax deferred savings vehicle. All employees of the
Company whose customary employment is for more than 20 hours per week are
eligible to participate in the 401K Plan. Employees make their contributions
through semi-monthly payroll deductions which are invested in any combination of
several investment funds. The Company has made no matching contributions and has
no current plans to do so.
FAIR VALUE OF FINANCIAL INSTRUMENTS: Statement of Financial Accounting
Standards No. 107, "Disclosures About Fair Value of Financial Instruments,"
requires the Company to disclose estimated fair values for its financial
instruments, exclusive of leases, for which it is practicable to estimate fair
value.
For financial instruments including cash, accounts receivable and payable,
and accrued expenses it is assumed that the carrying amount approximates fair
value due to their short maturities.
RISKS AND UNCERTAINTIES: The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amount of assets and
liabilities and disclosures of contingent assets and liabilities at the date of
the financial statements and the reported amount of revenues and expenses during
the reported period. Actual results could differ from those estimates.
RECLASSIFICATIONS: Certain items on the prior year financial statements
presented herein have been reclassified to conform to the current year
presentation.
NEW ACCOUNTING PRONOUNCEMENTS: In June 1998, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities." This statement
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives), and for hedging activities. The
statement requires companies to recognize all derivatives as either assets or
liabilities, with the instruments measured at fair value. The accounting for
changes in fair value, gains or losses, depends on the intended use of the
derivative and its resulting designation. The
26
NETEGRITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE A: NATURE OF THE BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
statement is effective for all fiscal quarters of fiscal years beginning after
June 15, 1999. Adoption of this standard will no impact the financial results of
the Company.
In March 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use". SOP 98-1 requires computer software
costs associated with internal use software to be charged to operations as
incurred until certain capitalization criteria are met. SOP 98-1 is effective
beginning January 1, 1999. We do not expect adoption of this statement to have a
material effect on consolidated financial position or results of operations.
NOTE B: EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements are stated at cost and consist of the
following:
DECEMBER 31,
----------------------
1998 1997
---------- ----------
Computer equipment and software....................................... $ 944,555 $ 582,464
Leasehold improvements................................................ 73,557 30,248
Furniture and fixtures................................................ 97,577 124,987
Less accumulated depreciation and amortization........................ (379,348) (152,644)
---------- ----------
$ 736,341 $ 585,055
Depreciation is computed on the straight-line method based upon estimated
useful lives ranging from three to seven years. The depreciation expense
recognized for the fiscal years ended December 31, 1998 and 1997, and the
nine-month transition period ended December 31, 1996, was $231,713, $116,187 and
$26,487, respectively.
NOTE C: INVESTMENT AND JOINT VENTURE
In October of 1996, the Company invested $1,000,000 for a 10% equity
interest in Encotone, LTD., a Jerusalem, Israel high-technology firm which
develops technology and products that provide enhanced security for both voice
and data network transactions. The Company accounted for its investment in
Encotone, LTD. under the cost method. In the quarter ended September 30, 1997,
the Company determined that the value of the investment was permanently impaired
and wrote off the entire amount.
In October of 1996, the Company and Encotone, LTD. formed a joint venture in
the U.S., Encotone, Inc., which was equally funded by both companies. The
Company accounted for its investment in Encotone, Inc. under the equity method,
and as of December 31, 1997, has reduced its investment by $131,801, its share
of Encotone, Inc.'s operating loss for the initial period ended December 31,
1997.
In January, 1998, the Company sold to Encotone, LTD. its full interest in
Encotone, Inc. In return, the Company received an additional 9.9% of the common
stock of Encotone, LTD., providing the Company with an equity position of 19.9%.
The Company also received $81,656 in cash.
27
NETEGRITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE D: COMMITMENTS AND CONTINGENCIES
The Company leases certain facilities under noncancellable operating leases.
For the years ended December 31, 1998, 1997 and 1996, the Company incurred total
operating lease expense of $299,825, $173,600, and $55,440, respectively. Future
minimum lease payments under these leases are as follows:
YEAR ENDING DECEMBER 31,
- --------------------------------------------------------------
1999...................................................... $ 171,400
2000...................................................... 100,800
2001...................................................... 42,000
----------
$ 314,200
----------
----------
NOTE E: LOAN TO OFFICER
In May, 1996, an Officer of the Company exercised an option to purchase
200,000 shares of the Company's common stock at a price of $1.00 per share. The
Company's Board of Directors approved a loan to the Officer as payment for this
transaction. The Officer issued the Company a full recourse note that is secured
by the 200,000 shares of common stock. This note has an interest rate of 7% per
annum.
NOTE F: ASSET SALE
As of June 28, 1996, the Company completed the divestiture of its catalog
related business, consisting of The Programmer's SuperShop ("TPS") catalog, the
TPS web site, the corporate sales group, SDC Germany and SDC Communications. The
Company completed the transaction for an aggregate price of $10,035,000. The
aggregate price consisted of payment of $9,300,000 in immediately available
funds and the deposit of $735,000 under an escrow arrangement. During August,
1996, $135,000 of the escrow was returned to the Company.
The aggregate price of $10,035,000 was in exchange for the Company's
tangible net assets of the catalog related business that at the time was
estimated at approximately $1,500,000. The revenues of the divested catalog
business were $11,800,000 for the nine month transition period ended December
31, 1996. These revenues are a component of the net income (loss) from
discontinued operations.
The Company incurred $2,587,000 in expenses and write-offs related to the
divestiture. These expenses were primarily comprised of write-off of goodwill,
severance costs, professional fees, buy-outs of capital leases, and facility
shut-down costs for its corporate offices and distribution facility. The Company
reported a gain of $6,000,000 from the sale of the assets of its catalog related
business. The Company utilized a deferred tax benefit related to net operating
loss carryforwards of approximately $2,200,000 to offset Federal and State
corporate income taxes.
In September of 1998, the Company reached a settlement with Programmers
Paradise, Inc. ("Programmer's") with regard to a valuation dispute arising from
the 1996 divestiture of Software Developer's Company. The case was settled with
the release of the escrow account ($600,000) to Programmer's and a payment of
$50,000. The full amount was charged to a reserve maintained specifically for
this purpose.
28
NETEGRITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE G: INCOME TAXES
The components of the provision for income taxes are as follows:
FOR THE YEAR ENDED DECEMBER
31,
----------------------------
1998 1997
------------- -------------
Current tax expense:
Federal....................................................... -- --
State......................................................... -- --
------------- -------------
Total....................................................... -- --
Deferred tax expense (benefit):
Federal....................................................... -- --
State......................................................... -- --
------------- -------------
Total....................................................... -- --
------------- -------------
Significant components of the deferred tax assets are as follows:
FOR THE YEAR ENDED
DECEMBER 31,
--------------------------
1998 1997
------------ ------------
Net operating loss carryforward................................... $ 5,188,919 $ 2,842,447
Loss on investment................................................ 971,562 1,324,650
Accruals and reserves............................................. 232,625 138,517
Deferred revenue.................................................. 115,115 --
Software development costs........................................ (70,726) --
Research and development tax credits.............................. 318,450 254,739
Depreciation...................................................... (25,346) (17,890)
Other, net........................................................ -- --
Alternative minimum tax credit.................................... 74,773 74,773
Valuation allowance............................................... (6,805,372) (4,617,236)
------------ ------------
$ -- $ --
------------ ------------
29
NETEGRITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE G: INCOME TAXES (CONTINUED)
The provision for income taxes differs from the federal statutory rate of 34% as
follows:
FOR THE YEAR ENDED DECEMBER
31,
----------------------------
1998 1997
------------- -------------
Federal provision at 34%........................................ $ (1,777,775) $ (1,785,645)
Alternative minimum tax on asset sale--Federal.................. -- --
Meals and entertainment......................................... 13,829 9,962
Foreign loss, not benefitted.................................... -- --
Current year Federal loss, not benefitted....................... 1,763,946 1,775,683
Goodwill........................................................ -- --
Utilization of previously unrecognized NOL...................... -- --
S-Corporation income not subject to tax......................... -- --
------------- -------------
$ -- $ --
------------- -------------
Due to the uncertainty surrounding the realization of tax benefits in future
tax returns of the continuing business, the net deferred tax assets at December
31, 1998 and 1997 have been offset by a valuation allowance.
At December 31, 1998, the Company has available for Federal income tax
purposes net operating tax loss carryforwards of approximately $12,885,000 that
are available to offset future taxable income at various dates through fiscal
2018. Certain provisions in the Internal Revenue Code may limit the net
operating loss available for use in any given year in the event of any
significant change of ownership.
NOTE H: CAPITAL STOCK AND CAPITAL STOCK WARRANTS
SERIES D PREFERRED STOCK: On January 6, 1998, the Company, entered into a
Preferred Stock and Warrant Purchase Agreement (the "Agreement") with Pequot
Private Equity Fund, L.P., a Delaware limited partnership ("PPEF") and Pequot
Offshore Private Equity Fund, Inc., a British Virgin Islands corporation
(together with PPEF, the "Pequot Entities"). Pursuant to the terms of the
Agreement, on January 7, 1998, the Company sold 1,666,667 shares of Series D
Preferred Stock, at $1.50 per share, and 750,393 Warrants to the Pequot Entities
for an aggregate purchase price of $2,500,000.50. The Series D Preferred Stock
is automatically convertible into Common Stock on a one-for-one basis, subject
to adjustment. Series D Preferred Stock has one-for-one voting rights and has
preferential distribution in the event of any voluntary or involuntary
liquidation. When and if declared by the Board of Directors, Series D Preferred
Stock shall have preference to receive cumulative dividends in the form of
Common Stock at an annual rate of 7.5% from and after the Issue Date. The
Company did not declare dividends in fiscal year 1998. In addition, the Series D
Preferred Stock is subject to mandatory conversion into Common Stock upon
certain circumstances.
The Company entered into an amendment on June 5, 1998 to the Preferred Stock
and Warrant Purchase Agreement with the Pequot Entities. Pursuant to the terms
of the amended Agreement, on June 5, 1998, the Company sold 833,333 shares of
Series D Preferred Stock, at $1.50 per share, and 375,197 Warrants to the Pequot
Entities for an aggregate purchase price of $1,250,001. On June 30, 1998, the
Company sold an additional 833,333 shares of Series D Preferred Stock, at $1.50
per share, and 375,197 Warrants to the Pequot Entities for an aggregate purchase
price of $1,250,000.
30
NETEGRITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE H: CAPITAL STOCK AND CAPITAL STOCK WARRANTS (CONTINUED)
WARRANTS: In conjunction with the Pequot Agreement as described above,
1,500,787 shares of common stock exercisable at $2.00 were issued to Pequot
expiring on January 7, 2003.
As part of the Agreement with the Pequot Entities, described above, James
McNiel joined the Board of Directors of the Company, as designee of the Pequot
Entities, and has agreed to provide certain consulting services to the Company.
In addition to consulting fees in connection with such service, the Company
granted Mr. McNiel warrants for the purchase of 100,000 shares exercisable at
$1.50 expiring on January 7, 2003.
SUBSEQUENT EVENT: On February 8, 1999, the Company entered into a Stock
Purchase Agreement (the "Stock Purchase Agreement") with an institutional
investor and the Pequot Entities. Pursuant to the terms of the Stock Purchase
Agreement, the Company sold 795,651 shares of Common Stock, at $5.75 per share.
The Company has agreed to file a registration statement on Form S-3 for a public
resale offering on behalf of the institutional investor.
NOTE I: STOCK PLANS
The Company has stock option plans as described hereunder. Options are
granted at fair market value at the date of grant being the average of the
closing bid and asked prices of the Common Stock on the day preceding the date
of grant.
STOCK OPTION PLANS FOR OUTSIDE DIRECTORS: The Company's stock option plans
for outside directors provide for the granting of options to members of the
Board of Directors who are neither employees nor officers of the Company in
appreciation of their service. The timing, amounts, recipients and other terms
of the option grants are determined by the provisions of or formulas in, the
directors' option plans. The exercise price of the options is equal to the fair
market value of Common Stock on the date of the grant. The options have a term
of 10 years from the date of the grant and become exercisable per the terms of
option plan. Total outstanding grants as of December 31, 1998 and 1997 are
572,542. Total options exercisable at December 31, 1998 and 1997 are 478,259 and
371,859, respectively. At December 31, 1998, options for 62,500 shares were
available for grant.
STOCK OPTION PLANS FOR EMPLOYEES AND OFFICERS: The Company's stock option
plans for employees, consultants and officers provide for the granting of
options as inducement to obtain and retain the services of qualified persons.
Incentive stock options may be granted to officers and employees, and
non-qualified stock options may be granted to directors, officers, employees or
consultants. The Compensation Committee of the Company determines the exercise
price and vesting period of the options. Total outstanding grants as of December
31, 1998 and 1997 are 2,530,900 and 1,830,800. Total options exercisable at
December 31, 1998 and 1997 are 639,168 and 622,900 respectively. At December 31,
1998, options for 932,315 shares were available for grant.
1990 EMPLOYEE STOCK PURCHASE PLAN: The 1990 Employee Stock Purchase Plan
("Stock Purchase Plan") is intended as an incentive to, and to encourage stock
ownership by, all eligible employees of the Company and participating
subsidiaries and to encourage them to remain in the employ of the Company.
Substantially all employees of the Company and any participating subsidiary who
have completed six months of employment with the Company or any subsidiary and
whose customary employment is for more than 20 hours per week and more than five
months per calendar year are eligible to participate in the Stock Purchase Plan.
31
NETEGRITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE I: STOCK PLANS (CONTINUED)
The Stock Purchase Plan presently authorizes the issuance of 100,000 shares
of Common Stock (subject to adjustment for capital changes) pursuant to the
exercise of nontransferable options granted to participating employees. During
the years ended December 31, 1998 and 1997, 14,100 and 2,400, shares,
respectively, of the Company's Common Stock were issued under the Stock Purchase
Plan.
Information as to the Company's stock options is as follows:
In October, 1995, the FASB issued SFAS 123, "Accounting for Stock-Based
Compensation." SFAS 123 is effective for periods beginning after December 15,
1995. SFAS 123 requires that companies either recognize compensation expense for
grants of stock, stock options, and other equity instruments based on fair
value, or provide pro-forma disclosure of net income and earnings per share in
the notes to the financial statements.
Had compensation cost for the Company's stock-based compensation plans been
determined based on the fair value at the grant dates as calculated in
accordance with SFAS 123, the Company's net income and earnings per share for
the years ended December 31, 1998 and 1997 would have been reduced to the
pro-forma amounts indicated below:
FISCAL YEAR ENDED FISCAL YEAR ENDED
DECEM