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Filed Pursuant to Rule 424(b)(1)
Registration No.: 333-71471
2,400,000 Shares
(ISS Logo)
ISS GROUP, INC.
Common Stock
----------------------
This is an offering of shares of common stock of ISS Group, Inc. This
prospectus relates to an offering of 1,920,000 shares in the United States. In
addition, 480,000 shares are being offered outside the United States in an
international offering.
ISS Group is offering 1,200,000 shares to be sold in the offering. The
selling stockholders identified in this prospectus are offering an additional
1,200,000 shares. ISS Group will not receive any of the proceeds from the sale
of the shares sold by the selling stockholders.
The common stock is traded on the Nasdaq National Market under the symbol
"ISSX". On March 1, 1999, the last reported sale price for our common stock on
the Nasdaq National Market was $59.25 per share.
See "Risk Factors" beginning on page 3 to read about certain factors you
should consider before buying shares of the common stock.
----------------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER REGULATORY
BODY HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ADEQUACY
OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
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<TABLE>
<CAPTION>
Per Share Total
--------- -----
<S> <C> <C>
Initial public offering price............................... $ 59.00 $141,600,000
Underwriting discount....................................... $ 2.80 $ 6,720,000
Proceeds, before expenses, to ISS Group..................... $ 56.20 $ 67,440,000
Proceeds to the selling stockholders........................ $ 56.20 $ 67,440,000
</TABLE>
The U.S. underwriters may, under certain circumstances, purchase up to an
additional 264,000 shares from ISS Group and 24,000 shares from the selling
stockholders at the initial public offering price less the underwriting
discount. The international underwriters may similarly purchase up to an
additional 66,000 shares from ISS Group and 6,000 shares from the selling
stockholders.
----------------------
The underwriters expect to deliver the shares against payment in New York,
New York on March 5, 1999.
GOLDMAN, SACHS & CO.
DAIN RAUSCHER WESSELS
A DIVISION OF DAIN RAUSCHER INCORPORATED
WARBURG DILLON READ LLC
BANCBOSTON ROBERTSON STEPHENS
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Prospectus dated March 1, 1999.
<PAGE> 2
[Inside Front Cover of Prospectus]
Picture headed "Information Risk Management" depicts a large circle with
three arrows linked together to form the circle. One arrow states the term
"monitor", the second arrow states the term "detect" and the third arrow states
the term "respond". In the center of this circle is the phrase "Enterprise
Security Policy". In the upper right hand section of the graphic outside of the
"monitor" section of the circle are the terms "Applications", "Databases",
"Operating Systems" and "Networks". In the lower right hand section of the
graphic outside of the "detect" section of the circle are the terms "Policy
Violations", "Vulnerabilities" and "Threats". In the left hand section of the
graphic outside of the "respond" section of the circle are the terms "Alarms",
"Corrective Actions", "Active Response" and "Limit Risk". In the upper left hand
corner of the page is the ISS Logo. Below that logo is rectangular text box
containing the following text: "Open computing environments have many business
advantages, but may be vulnerable to security threats. ISS' Adaptive Network
Security products enable organizations to benefit from open networks and the
Internet, while proactively managing the potential risks of a networked world.
Adaptive Network Security continuously monitors information systems for
vulnerabilities and threats, then actively responds to limit unwanted exposure."
Internet Security Systems, Database Scanner, Internet Scanner, RealSecure,
System Scanner, SAFEsuite and SAFEsuite Decisions are trademarks of the company.
All other trademarks or trade names referenced in this prospectus are the
property of their respective owners.
<PAGE> 3
PROSPECTUS SUMMARY
You should read the following summary together with the more detailed
information and consolidated financial statements and related notes appearing
elsewhere in this prospectus. Unless otherwise indicated, all information in
this prospectus, including share and per share information, assumes neither the
exercise of stock options after December 31, 1998 nor the exercise of the
underwriters' over-allotment option.
ISS GROUP, INC.
We are a leading provider of network security monitoring, detection and
response solutions that protect the security and integrity of enterprise
information systems. Our SAFEsuite family of products protects distributed
computing environments, such as internal corporate networks, inter-company
networks and the Internet, from attacks, misuse and security policy violations.
Our innovative Adaptive Network Security approach uses continuous security risk
monitoring and response to develop and enforce an active network security
policy. We also offer professional services that enable us to deliver
comprehensive solutions to our customers.
The proliferation and growth of corporate intranets and the growth of
electronic commerce have dramatically increased the use and openness of computer
networks. Their accessibility and the relative anonymity of users make these
systems, and the integrity of the information that is stored on them, vulnerable
to security threats. As a result, security breaches of corporate networks have
been increasing in recent years. According to the annual Information
Week/PricewaterhouseCoopers LLP 1998 Global Information Security Survey of
information technology managers and professionals, 59% of those surveyed who are
associated with sites selling products or services on the Web reported at least
one security breach in the past year. In a separate PricewaterhouseCoopers LLP
1998 survey of chief executive officers, 84% cited security concerns as a
barrier to deployment of information technology initiatives. Because of the
complexity of vulnerabilities in open systems and the pervasiveness of the
threats to such systems, many organizations seek out a trusted security advisor
to assist them in developing effective security policies and managing their
information risks.
We pioneered the technology for vulnerability and threat detection and we
believe that we have the most comprehensive vulnerability and threat database in
existence. Over 3,000 organizations worldwide, including firms in the Global
2000, U.S. and international government agencies and major universities, have
licensed our products. Twenty-one of the 25 largest commercial banks in the
United States, as ranked by Fortune Magazine, also have licensed our products.
Our principal executive offices are located at 6600 Peachtree-Dunwoody
Road, 300 Embassy Row, Suite 500, Atlanta, Georgia 30328, and our telephone
number is (678) 443-6000. Our address on the World Wide Web is "www.iss.net".
This prospectus does not incorporate by reference the information on our Web
site.
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THE OFFERING
The following information assumes that the underwriters do not exercise
their options to purchase additional shares in the offering from us or the
selling stockholders. This information is based on shares of common stock
outstanding as of December 31, 1998, and excludes 2,379,670 shares of common
stock issuable upon the exercise of stock options outstanding as of December 31,
1998.
<TABLE>
<S> <C>
Common stock offered by ISS Group......................... 1,200,000 shares
Common stock offered by selling stockholders.............. 1,200,000 shares
Common stock to be outstanding after the offering......... 18,492,087 shares
Nasdaq National Market symbol............................. ISSX
Use of proceeds........................................... For general corporate purposes,
including working capital and
possible acquisitions. See "Use
of Proceeds".
</TABLE>
SUMMARY CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
APRIL 19, 1994
(INCEPTION)
THROUGH YEAR ENDED DECEMBER 31,
DECEMBER 31, -------------------------------------
1994 1995 1996 1997 1998
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<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues........................................... $ 38 $ 257 $ 4,462 $13,467 $35,929
Operating income (loss)............................ 20 (140) (1,205) (4,147) (6,406)
Net income (loss).................................. 20 (140) (1,131) (3,919) (4,102)
Basic and diluted net loss per share............... $ -- $ (0.03) $ (0.14) $ (0.50) $ (0.28)
Weighted average shares used in basic and diluted
net loss per share calculation................... 4,586 5,001 7,916 7,907 14,883
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1998
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ACTUAL AS ADJUSTED(1)
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<S> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents................................... $52,632 $119,472
Working capital............................................. 54,389 121,229
Total assets................................................ 78,021 144,861
Stockholders' equity........................................ 66,315 133,155
</TABLE>
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(1) As adjusted to reflect the application of the net proceeds from the sale of
the common stock in this offering at the public offering price of $59.00 per
share and after deducting the underwriting discount and estimated offering
expenses. See "Use of Proceeds".
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RISK FACTORS
You should carefully consider the risks described below before you decide
to buy our common stock. The risks and uncertainties described below are not the
only ones facing our company. Additional risks and uncertainties may also
adversely impair our business operations. If any of the following risks actually
occur, our business, financial condition or results of operations would likely
suffer. In such case, the trading price of our common stock could decline, and
you may lose all or part of your investment.
This prospectus contains forward-looking statements based on our current
expectations, assumptions, estimates and projections about ISS and our industry.
These forward-looking statements involve risks and uncertainties. Our actual
results could differ materially from those anticipated in such forward-looking
statements as a result of certain factors, as more fully described in this
section and elsewhere in this prospectus. We undertake no obligation to update
publicly any forward-looking statements for any reason, even if new information
becomes available or other events occur in the future.
WE ARE A YOUNG COMPANY THAT
HAS NEVER BEEN PROFITABLE
We were incorporated in April 1994 and have never achieved profitability.
Although our losses have narrowed recently, we cannot be certain that we will
become profitable in the future. Even if we become profitable at some point in
the future, we cannot be certain that we can sustain such profitability. You
should be aware that we have only a limited operating history upon which to
evaluate our business and prospects. In deciding to purchase our shares, you
must consider the risks, expenses and difficulties frequently encountered by
companies that are, like us, in their early stage of development and that depend
upon new and rapidly evolving markets. In order to address these risks, we must,
among other things:
- - respond to competitive developments;
- - continue to upgrade and expand our product and services offerings; and
- - continue to attract, retain and motivate our employees.
We cannot be certain that we will successfully address these risks.
OUR FUTURE OPERATING RESULTS
WILL FLUCTUATE SIGNIFICANTLY
As a result of our limited operating history, we cannot predict our future
revenues and operating results. However, we do expect our future revenues and
operating results to fluctuate due to a combination of factors, including:
- - the growth of private Internet-based networks (often referred to as
intranets);
- - the extent to which the public perceives that unauthorized access to and use
of online information is a threat to network security;
- - the volume and timing of orders, including seasonal trends in customer
purchasing;
- - our ability to develop new and enhanced products and expand our professional
services;
- - the growth in the acceptance of, and activity on, the Internet and the World
Wide Web, particularly by corporate, institutional and government users;
- - customer budgets which may limit their ability to purchase our products;
- - foreign currency exchange rates that affect our international operations;
- - the mix of distribution channels through which we sell our products;
- - product and price competition in our markets; and
- - general economic conditions, both domestically and in our foreign markets.
We increasingly focus our efforts on sales of enterprise-wide security
solutions, which consist of our entire product suite and related professional
services, rather than on
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the sale of component products. As a result, we expect that each sale may
require additional time and effort from our sales staff. In addition, the
revenues associated with particular sales vary significantly depending on the
number of products licensed by a customer, the number of devices used by the
customer and the customer's relative need for our professional services. Large
individual sales, or even small delays in customer orders, can cause significant
variation in our license revenues and results of operations for a particular
period. The timing of large orders is usually difficult to predict and, like
many software companies, our customers typically license most of our products in
the last month of a quarter.
Our future operating expenses are expected to increase in future periods as
we intend to:
- - expand our domestic and international sales and marketing operations;
- - increase our investments in product development and our proprietary threat and
vulnerability database;
- - expand our professional services capabilities;
- - seek acquisition candidates that will enhance our products and market share;
and
- - improve our internal operating and financial systems.
We cannot predict our operating expenses based on our past results.
Instead, we establish our spending levels based in large part on our expected
future revenues. As a result, if our actual revenues in any future period fall
below our expectations, our operating results likely will be adversely affected
because very few of our expenses vary with our revenues. Because of the factors
listed above, we believe that our quarterly and annual revenues, expenses and
operating results likely will vary significantly in the future. Accordingly,
period-to-period comparisons of our results of operations are not necessarily
meaningful, and investors in our common stock should not rely upon them as
indications of our future performance. For these and other reasons, our
operating results may fall below market analysts' expectations, which, in turn,
could cause the market price of our common stock to decline, and perhaps decline
significantly.
WE FACE INTENSE COMPETITION IN OUR MARKET
The market for network security monitoring, detection and response
solutions is intensely competitive, and we expect competition to increase in the
future. We cannot guarantee that we will compete successfully against our
current or potential competitors, especially those with significantly greater
financial resources or brand name recognition. Our chief competitors generally
fall within one of four categories:
- - internal information technology departments of our customers and the
consulting firms that assist them in formulating security systems;
- - relatively smaller software companies offering relatively limited applications
for network and Internet security;
- - large companies, including Axent Technologies, Cisco Systems and Network
Associates, that sell competitive products, as well as other large software
companies that have the technical capability and resources to develop
competitive products; and
- - software or hardware companies that could integrate features that are similar
to our products into their own products.
Mergers or consolidations among these competitors, or acquisitions of small
competitors by larger companies, would make such combined entities more
formidable competitors to us. In the last 18 months, both Cisco Systems and
Network Associates have acquired privately-held companies with products
competitive to ours. Large companies may have advantages over us because of
their longer operating histories, greater name recognition, larger customer
bases or greater financial, technical and marketing resources. As a result, they
may be able to adapt more quickly to new or emerging technologies and changes in
customer requirements. They can also devote
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greater resources to the promotion and sale of their products than we can. In
addition, these companies have reduced, and could continue to reduce, the price
of their security monitoring, detection and response products, which increases
pricing pressures within our market. In addition, large companies with broad
product offerings, such as Network Associates, have bundled their security
products with their other products, and we expect them to continue to do so in
the future, which makes it more difficult for us to compete with them. These
companies may develop security monitoring, detection and response products that
are better than our current or future products and this may render our products
obsolete.
Several companies currently sell software products (such as encryption,
firewall, operating system security and virus detection software) that our
customers and potential customers have broadly adopted. Some of these companies
sell products which perform the same functions as some of our products. In
addition, vendors of operating system software or networking hardware may
enhance their products to include the same kinds of functions that our products
currently provide. The widespread inclusion of comparable features to our
software in operating system software or networking hardware could render our
products obsolete, particularly if such features are of a high quality. Even if
security functions integrated into operating system software or networking
hardware are more limited than those of our software, a significant number of
customers may accept more limited functionality to avoid purchasing additional
software.
For the above reasons, we may not be able to compete successfully against
our current and future competitors. Increased competition may result in price
reductions, reduced gross margins and loss of market share, any one of which
could materially and adversely affect our business, operating results and
financial condition. See "Business -- Competition" for detailed information
about our competition.
WE FACE RAPID TECHNOLOGICAL CHANGE IN OUR INDUSTRY AND FREQUENT INTRODUCTIONS OF
NEW PRODUCTS
Rapid changes in technology pose significant risks to us. We do not control
nor can we influence the forces behind these changes, which include:
- - the extent to which businesses and others seek to establish more secure
networks;
- - the extent to which hackers and others seek to compromise secure systems;
- - evolving computer hardware and software standards;
- - changing customer requirements; and
- - frequent introductions of new products and product enhancements.
To remain successful, we must continue to change, adapt and improve our
products in response to these and other changes in technology. Our future
success hinges on our ability to both continue to enhance our current line of
products and professional services and to introduce new products that address
and respond to innovations in computer hacking, computer technology and customer
requirements. We cannot be sure that we will successfully develop and market new
products that do this. Any failure by us to timely develop and introduce new
products, to enhance our current products or to expand our professional services
capabilities in response to these changes could adversely affect our business,
operating results and financial condition.
Our products involve very complex technology, and as a consequence, major
new products and product enhancements require a long time to develop and test
before going to market. Because this amount of time is difficult to estimate, we
have had to delay the scheduled introduction of new and enhanced products in the
past and may have to delay the introduction of new products and product
enhancements in the future.
The techniques computer hackers use to gain unauthorized access to or to
sabotage networks and intranets are constantly evolving and increasingly
sophisticated.
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Furthermore, because new hacking techniques are usually not recognized until
used against one or more targets, we are unable to anticipate most new hacking
techniques. To the extent that new hacking techniques harm our customers'
computer systems or businesses, affected customers may believe that our products
are ineffective, which may cause them or prospective customers to reduce or
avoid purchases of our products. In such event, we may lose customer goodwill,
which could adversely affect our business.
WE MUST EFFECTIVELY MANAGE
OUR RAPID GROWTH
Our business has grown rapidly in the last three years, with total revenues
increasing from $4.5 million in 1996 to $35.9 million in 1998. During this
period, our workforce has also rapidly expanded, increasing from seven employees
in January 1996 to 328 in December 1998. This growth has strained, and if
continued, will further strain our management resources and systems. We intend
to continue to expand both our business and workforce for the foreseeable future
to pursue existing and potential market opportunities. However, if the market
for our solutions fails to grow or grows more slowly than we currently
anticipate, our business, operating results and financial condition would be
materially and adversely affected.
In addition, our ability to manage future growth will require us to
continually improve our financial and management controls, reporting systems and
procedures, to implement new systems as necessary and to expand, train and
manage our employees. We cannot assure investors in our common stock that we
will be able to manage successfully any future expansion. Our inability to do so
would materially and adversely affect our business, operating results and
financial condition.
RISKS ASSOCIATED WITH OUR GLOBAL OPERATIONS
We derived approximately 21% and 19% of our total revenues from sales to
customers outside of North America in 1997 and 1998, respectively. The expansion
of our international operations includes the maintenance of sales offices in
dispersed locations throughout the world, including throughout Europe and the
Asia/Pacific and Latin America regions. Our international presence and expansion
exposes us to risks not present in our U.S. operations, such as:
- - the difficulty in managing an organization spread over various countries
located across the world;
- - unexpected changes in regulatory requirements in countries where we do
business;
- - excess taxation due to overlapping tax structures;
- - fluctuations in foreign currency exchange rates, which may be aggravated in
European markets by the recent introduction of the Euro currency;
- - import and export licensing requirements;
- - trade restrictions;
- - changes in tariff and freight rates; and
- - depressed regional and economic conditions, such as those currently affecting
many regions in Asian markets.
Despite these risks, we believe that we must continue to expand our
operations in international markets to support our growth. To this end, we
intend to establish additional foreign sales operations, expand our existing
offices, hire additional personnel, expand our international sales channels and
customize our products for local markets. If we fail to execute this strategy,
our international sales growth will be limited, which, in turn, could materially
and adversely affect our business, operating results and financial condition.
To date, we have primarily denominated our revenues from international
operations in United States dollars; however, we will increasingly denominate
sales in local foreign currencies in the future. An increase in the
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value of the United States dollar relative to foreign currencies would make our
products more expensive and, therefore, potentially less competitive in foreign
markets. In addition, even if we successfully expand our international
operations, we may not be able to maintain or increase international market
demand for our products.
WE INCREASINGLY RELY ON
INDIRECT DISTRIBUTION CHANNELS
Although our direct sales have accounted for a majority of our revenues in
1998, we expect to continue to license a significant percentage of our products
to end users through indirect distribution channels in the future. Our indirect
distribution channel partners include:
- - original equipment manufacturers that bundle our products with products that
they sell to their customers;
- - managed service providers, such as telecommunications companies and Internet
service providers, that host networking and Internet operations for business
customers; and
- - consultants and systems integrators that incorporate our products into
customized solutions that they have implemented for their customers.
We have established our relationships with many of our channel partners
only within the last three years. We cannot predict whether our channel partners
will continue to market and sell our products successfully. We have little or no
control over the manner in which our channel partners sell our products or
integrate our products with their own products or solutions. In addition, many
of our channel partners also market and sell our competitors' products. While no
one channel partner accounted for more than 10% of our consolidated revenues in
1998, a loss of several of our major channel partners without replacement would
adversely affect our business, operating results and financial condition.
Our future performance will also depend, in part, on our ability to attract
new channel partners to market and support our products effectively, especially
in new markets. We cannot assure you that revenue from channel partners that
accounted for significant revenues in past periods will continue or, if
continued, will reach or exceed past performance levels. In addition, we often
depend upon our channel partners to install and support our products for end
users. If our channel partners fail to provide adequate installation and
support, end users of our products could cease using, or improperly implement
and operate, our products. Such a failure could substantially increase our
customer support costs and materially and adversely affect our business,
operating results and financial condition.
POTENTIAL FUTURE ACQUISITIONS OR INVESTMENTS
As part of our growth strategy, we have acquired, and may continue to
acquire or make investments in, companies with products, technologies or
professional services capabilities complementary to our solutions. In acquiring
companies in the future, we could encounter difficulties in assimilating their
personnel and operations into our company. These difficulties could disrupt our
ongoing business, distract our management and employees, increase our expenses
and adversely affect our results of operations. These difficulties could also
include accounting requirements, such as amortization of goodwill or in-process
research and development expense. We cannot be certain that we will successfully
overcome these risks with respect to any future acquisitions or that we will not
encounter other problems in connection with our prior or any future
acquisitions. In addition, any future acquisitions may require us to incur debt
or issue equity securities. The issuance of equity securities could dilute the
investment of our existing stockholders.
WE DEPEND ON OUR KEY PERSONNEL
We rely, and will continue to rely, on our senior executive officers and
other key management personnel, especially Thomas E. Noonan (our Chairman of the
Board, President and Chief Executive Officer) and Christopher Klaus (our founder
and Chief Technology Officer). We do not have an
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employment agreement with either Mr. Noonan or Mr. Klaus. A departure by either
of these individuals or any of our other key employees could significantly
diminish our level of management, technical, marketing and sales expertise and
we would need to find replacements who have these skills. We believe that hiring
replacements for key personnel, if necessary, will be difficult.
Our future success also depends on our continuing ability to attract and
retain highly qualified engineers, managers and sales and professional services
personnel. The competition for employees at all levels of the software industry,
especially those with experience in the relatively new discipline of security
software, is increasingly intense. If we do not succeed in attracting new
employees or retaining and motivating our current employees, our business could
suffer significantly.
WE DEPEND ON OUR INTELLECTUAL PROPERTY RIGHTS AND USE LICENSED TECHNOLOGY
We rely primarily on copyright and trademark laws, trade secrets,
confidentiality procedures and contractual provisions to protect our proprietary
rights. We also believe that the technological and creative skills of our
personnel, new product developments, frequent product enhancements, our name
recognition, our professional services capabilities and delivery of reliable
product maintenance are essential to establishing and maintaining our technology
leadership position. We cannot assure you that our competitors will not
independently develop technologies that are similar to ours.
We seek to protect our software, documentation and other written materials
under the trade secret and copyright laws, which afford only limited protection.
We have also submitted two United States patent applications. Patents may not
issue from these applications or, if issued, may not provide any meaningful
competitive advantages to us.
We generally license our products to end users in a machine-readable
format. However, certain customers have required us to place the source code for
our products in an escrow account with a third-party software escrow agent.
Under these escrow arrangements, our insolvency or our failure to perform our
obligations under certain license and maintenance agreements could cause the
release of our source code to such customers. Such an event could significantly
compromise our ability to protect the use of our software by our competitors or
potential competitors.
Despite our efforts to protect our proprietary rights, unauthorized parties
may attempt to copy aspects of our products or to obtain and use information
that we regard as proprietary. Policing unauthorized use of our products is
difficult. While we cannot determine the extent to which piracy of our software
products occurs, we expect software piracy to be a persistent problem. In
addition, the laws of some foreign countries do not protect our proprietary
rights to as great an extent as do the laws of the United States and many
foreign countries do not enforce these laws as diligently as U.S. government
agencies and private parties.
We are not aware that any of our products infringes the proprietary rights
of others, but it is conceivable that our current or future products may
infringe the proprietary rights of others. In fact, in July 1998 Network
Associates, which is one of our competitors, filed a lawsuit against us alleging
that our RealSecure product violates a patent claim for intrusion detection
technology held by Network Associates. We believe that the lawsuit is without
merit and are vigorously defending against Network Associates' claims. However,
should Network Associates prevail in the suit, it could materially and adversely
affect our business, operating results and financial condition.
We expect the number of intellectual property infringement lawsuits against
software companies to increase. Any such claims, with or without merit, could be
time consuming, result in costly litigation, cause product shipment delays or
require us to enter into royalty or licensing agreements. Such royalty or
licensing agreements may not be made available on terms acceptable to us, which
could materially and adversely affect
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our business, operating results and financial condition.
WE LACK CERTAIN TRADEMARK PROTECTION
We currently cannot obtain trademark protection on the name "Internet
Security Systems" due to its general use in a variety of security-related
applications. We have in the past asserted and intend to continue to assert our
rights to the name "Internet Security Systems". In addition, we have in the past
taken and will continue to take action against any use of that name in a manner
that may create confusion for our products in our current or future markets.
However, we may not be successful in these efforts, which could have a material
adverse effect upon our business, operating results and financial condition.
WE FACE POTENTIAL PRODUCT LIABILITY EXPOSURE AND PRODUCT DEFECTS
Many organizations use our products for critical functions of monitoring
and enhancing network security. As a result, we risk product liability and
related claims for our products if they do not adequately perform this function.
In our licensing agreements, we typically seek to limit our liability for
special, consequential or incidental damages, but these provisions may not in
all cases be enforceable under applicable laws. In addition, we currently have
$2.0 million of product liability insurance coverage that, subject to customary
exclusions, covers claims resulting from failure of our products or services to
perform their intended function or to serve their intended purpose. A product
liability claim, to the extent not covered by our insurance, could materially
and adversely affect our business, operating results and financial condition.
Complex software products such as ours may contain undetected "bugs" that,
despite our testing, are discovered only after installation and use by our
customers. The occurrence of these bugs could result in adverse publicity, loss
of or delay in market acceptance or claims by customers against us, any of which
could have a material adverse effect upon our business, operating results and
financial condition. Customers who deploy or use our products improperly or
incompletely may experience temporary disruptions to their computer networking
systems, which could damage our relationship with them and our reputation. Our
current products may not be error-free and it is extremely doubtful that our
future products will be error-free. Furthermore, computers are manufactured in a
variety of different configurations with different operating systems (such as
Windows, Unix, Macintosh and OS/2) and embedded software. As a result, it is
very difficult to comprehensively test our software products for programming or
compatibility errors. Errors in the performance of our products, whether due to
our design or their compatibility with products of other companies, could hinder
the acceptance of our products, which, in turn, would impair our business,
operating results and financial condition. See "Business -- Products" and
"-- Product Development".
HACKERS MAY TARGET US
As a producer of leading security software, we may represent an attractive
target for hacker attacks. Should hackers infiltrate our internal network system
and obtain sensitive data and information, or create bugs or viruses in an
attempt to sabotage the functionality of our products, we may receive negative
publicity, or incur direct damage to our systems or liability to our customers.
We cannot guarantee our ability to respond to such attacks in a timely or
effective manner and any failure to do so could materially and adversely affect
our business, operating results and financial condition.
GOVERNMENTS MAY REGULATE OUR
TECHNOLOGY EXPORTS
Governments, including the United States government, from time to time have
imposed controls, export license requirements and restrictions on the export of
certain technology, especially encryption technology. Certain of our products
incorporate advanced encryption technology and, as a consequence, we have been
required to modify the relative sophistication of the
9
<PAGE> 12
encryption technology used in these products in order to license them to
customers in certain foreign markets. Our inability to export our domestic
version of these products to such customers may reduce our competitiveness in
such markets, which may adversely affect our sales. Moreover, any further
expansion of export regulations would further restrict our ability to export our
products, which may materially and adversely affect our business, operating
results and financial condition.
YEAR 2000 RISKS
Many currently installed computer systems and software products accept only
two-digit entries in the date code field. These date code fields will need to
accept four digit entries to distinguish 21st century dates from 20th century
dates. As a result, computer systems and software used by many companies and
governmental agencies may need to be upgraded to comply with such "Year 2000"
requirements. Noncompliant computer systems or software may cause system failure
or result in miscalculations that will cause disruptions of normal business
activities. Although we have designed all of the products that we currently
offer to be Year 2000 compliant, we cannot assure you that our products contain
all necessary date code changes, or that, in the year 2000, our products will be
compatible with third-party software that may be integrated or used in
conjunction with our products. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Year 2000".
LIMITED PRIOR MARKET FOR OUR
COMMON STOCK AND POSSIBLE VOLATILITY
OF OUR STOCK PRICE
Our common stock has only been publicly traded since our initial public
offering on March 24, 1998. We cannot guarantee to purchasers of our shares that
the market price of our common stock will be maintained after the offering or
that the volume of trading in our shares will increase.
The risks detailed in this prospectus may significantly adversely affect
the market price of our common stock after the offering. In particular, the
stock prices for many high technology companies, especially those that base
their businesses on the Internet, recently have experienced wide fluctuations
and extreme volatility which have often been unrelated to the operating
performance of such companies. Such fluctuations have adversely affected and may
in the future adversely affect the market price of our common stock.
Furthermore, following periods of volatility in the market price of a
company's securities, securities class action claims frequently are brought
against the subject company. To the extent that the market price of our shares
falls dramatically in any period of time, stockholders likely will bring claims,
with or without merit, against us. Such litigation would be very expensive to
defend and would divert management attention and resources regardless of
outcome.
ANTI-TAKEOVER PROVISIONS
Our certificate of incorporation and bylaws contain the following
provisions that may deter a takeover, including one on terms that many of our
stockholders might consider favorable:
- - authority of our board of directors to issue common stock and preferred stock
and to determine the price, rights (including voting rights), preferences,
privileges and restrictions of each series of preferred stock, without any
vote or action by our stockholders;
- - the existence of large amounts of authorized but unissued common stock and
preferred stock;
- - staggered, three-year terms for our board of directors;
- - supermajority voting requirements to effect certain amendments to our
certificate of incorporation and bylaws;
- - limitations on who may call special meetings of stockholders;
- - prohibition of stockholder action by written consent; and
10
<PAGE> 13
- - advance notice requirements for board of directors nominations and for
stockholder proposals.
The rights and preferences of any series of preferred stock could include a
preference over the common stock on the distribution of our assets upon a
liquidation or sale of our company, preferential dividends, redemption rights,
the right to elect one or more directors and other voting rights. The rights of
the holders of any series of preferred stock that may be issued in the future
may adversely affect the rights of the holders of the common stock. We have no
current plans to issue preferred stock. In addition, certain provisions of
Delaware law and our stock option plan may also discourage, delay or prevent a
change in control of our company or unsolicited acquisition proposals.
SHARES ELIGIBLE FOR FUTURE SALE AND
REGISTRATION RIGHTS
If our stockholders sell substantial amounts of common stock (including
shares issued upon the exercise of outstanding stock options) in the public
market following this offering, the market price of our common stock could fall.
Such sales also could make it more difficult for us to sell equity or equity-
related securities in the future at a time and price that we deem appropriate.
Upon completion of this offering, we will have outstanding 18,576,587 shares of
common stock (assuming no exercises of options after the date of this
prospectus). Of these shares, the 3,450,000 shares sold in our initial public
offering in March 1998, the 2,400,000 shares being offered hereby and 5,229,997
shares that have been sold pursuant to Rule 144 under the Securities Act of
1933, as amended, or that are eligible under paragraph (k) of that rule, are
freely tradeable. This leaves 7,496,590 shares eligible for sale in the public
market as follows:
<TABLE>
<CAPTION>
NUMBER OF SHARES DATE
- ---------------- ----
<S> <C>
514,192............ At various times after the date of
this prospectus pursuant to Rule
144
6,982,398............ At various times after 90 days
from the date of this prospectus
pursuant to Rule 144
</TABLE>
In addition, we have registered for resale the 3,000,000 shares of our
common stock reserved for issuance under our Restated 1995 Stock Incentive Plan,
as well as 100,000 shares of common stock that were subject to options granted
pursuant to written compensation agreements separate from the plan. As of
December 31, 1998, options to purchase 244,643 shares of our common stock were
outstanding and will be eligible for sale in the public market from time to time
subject to vesting and, in the case of certain options, the expiration of 90-day
lock-up agreements with the underwriters of this offering. These stock options
generally have exercise prices significantly below the current price of our
common stock. The possible sale of a significant number of these shares may
cause the price of our common stock to fall.
Certain stockholders, representing approximately 7,189,177 shares of common
stock, may have the right, subject to certain conditions, to include their
shares in certain registration statements relating to our securities. By
exercising their registration rights and causing a large number of shares to be
registered and sold in the public market, these holders may cause the price of
our common stock to fall. In addition, any demand by holders of registration
rights to include shares of common stock held by them in a registration
initiated by us could adversely affect our ability to raise needed capital. See
"Management -- Our Stock Option Plan", "Principal and Selling Stockholders",
"Description of Securities -- Registration Rights", "Shares Eligible for Future
Sale" and "Underwriting".
BROAD DISCRETION IN USE OF PROCEEDS
We have not yet decided how we will use the proceeds from this offering.
Therefore, our management will retain broad discretion
to allocate the net proceeds from this offering to uses with which our
stockholders may not agree. We cannot assure you that any use of proceeds can or
will yield a significant return. See "Use of Proceeds".
11
<PAGE> 14
USE OF PROCEEDS
Based on the public offering price of $59.00 per share, we estimate that
the net proceeds from our sale of shares of common stock in this offering will
be approximately $66.8 million (approximately $85.4 million if the underwriters
exercise their over-allotment option in full), after deducting the underwriting
discounts and commissions and estimated offering expenses payable by us. We will
not receive any proceeds from the sale of common stock by the selling
stockholders.
We currently intend to use the net proceeds of this offering for working
capital and general corporate purposes, including financing accounts receivable
and funding capital expenditures made in the ordinary course of our business. We
also may use a portion of the proceeds to fund possible acquisitions of
businesses, products and technologies that are complementary to ours. Although
we have no current agreements with respect to such transactions, we from time to
time evaluate such acquisition opportunities and may engage in negotiations with
respect to them. Pending such uses, we will invest the net proceeds from this
offering in government securities and other short-term, investment-grade,
interest-bearing instruments.
PRICE RANGE OF COMMON STOCK
The common stock has been quoted on the Nasdaq National Market under the
symbol "ISSX" since our initial public offering on March 24, 1998. Prior to that
offering there had been no public market for the common stock. The following
table sets forth, for the periods indicated, the high and low sale prices per
share of our common stock as reported on the Nasdaq National Market:
<TABLE>
<CAPTION>
1998: HIGH LOW
- ----- ------ ------
<S> <C> <C>
First Quarter (from March 24, 1998)..................... $41.50 $37.00
Second Quarter.......................................... 56.63 31.63
Third Quarter........................................... 50.50 25.38
Fourth Quarter.......................................... 60.63 17.00
</TABLE>
On March 1, 1999, the last reported sale price of the common stock on the
Nasdaq National Market was $59.25 per share. As of December 31, 1998, there were
201 holders of record of the common stock.
DIVIDEND POLICY
We have never declared or paid any cash dividends on our capital stock
other than a $10,000 dividend paid in each of 1994 and 1995, and we do not
intend to pay any cash dividends on our common stock in the foreseeable future.
12
<PAGE> 15
CAPITALIZATION
The table below sets forth our capitalization as of December 31, 1998 on an
actual basis, and as adjusted to reflect our sale of 1,200,000 shares of common
stock in the offering at the public offering price of $59.00 per share, after
deducting underwriting discounts and commissions and estimated offering expenses
payable by us. This table should be read in conjunction with our consolidated
financial statements and the other financial information included in this
prospectus.
<TABLE>
<CAPTION>
DECEMBER 31, 1998
---------------------
ACTUAL AS ADJUSTED
------- -----------
(IN THOUSANDS)
<S> <C> <C>
Stockholders' equity:
Preferred Stock, $0.001 par value, 20,000,000 shares
authorized and none issued, actual and as adjusted..... $ -- $ --
Common Stock, $0.001 par value, 50,000,000 shares
authorized; 17,292,087 shares issued and outstanding;
18,492,087 shares issued and outstanding as adjusted
(1).................................................... 17 18
Additional paid-in capital................................ 76,110 142,949
Deferred compensation..................................... (662) (662)
Cumulative adjustment for currency revaluation............ 142 142
Accumulated deficit....................................... (9,292) (9,292)
------- --------
Total stockholders' equity........................ 66,315 133,155
------- --------
Total capitalization.............................. $66,315 $133,155
======= ========
</TABLE>
- ---------------
(1) Excludes 2,379,670 shares of common stock issuable upon exercise of options
outstanding as of December 31, 1998, with exercise prices ranging from $0.15
to $48.12 per share and with a weighted average exercise price of $10.98 per
share. See "Management -- Our Stock Option Plan" and Note 5 of Notes to
Consolidated Financial Statements.
13
<PAGE> 16
DILUTION
Our net tangible book value as of December 31, 1998 was $58.5 million, or
$3.38 per share of common stock. Net tangible book value per share represents
the amount of our total tangible assets less total liabilities, divided by the
number of shares of our common stock outstanding. After giving effect to the
sale of the 1,200,000 shares of common stock offered by us in this offering at
the public offering price of $59.00 per share and the application of the
estimated net proceeds therefrom, our net tangible book value as of December 31,
1998 would have been $125.4 million, or $6.78 per share of common stock. This
represents an immediate increase in the net tangible book value of $3.40 per
share to our existing stockholders and an immediate dilution in the net tangible
book value of $52.22 per share to new investors of common stock in this
offering. The following table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Public offering price per share............................. $59.00
------
Net tangible book value per share as of December 31,
1998................................................... $3.38
Increase per share attributable to new investors.......... 3.40
-----
Net tangible book value per share after this offering....... 6.78
------
Dilution per share to new investors......................... $52.22
======
</TABLE>
14
<PAGE> 17
SELECTED CONSOLIDATED FINANCIAL DATA
The financial data set forth below for each of the three years in the
period ended December 31, 1998, and as of December 31, 1997 and 1998, has been
derived from the audited consolidated financial statements appearing elsewhere
in this prospectus and should be read in conjunction therewith. The financial
data for the periods from inception (April 19, 1994) through December 31, 1994,
for the year ended December 31, 1995, and as of December 31, 1994, 1995 and
1996, has been derived from audited financial statements not included in this
prospectus. Historical results are not necessarily indicative of the results
that may be expected in the future. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations".
<TABLE>
<CAPTION>
APRIL 19, 1994
(INCEPTION)
THROUGH
DECEMBER 31, YEAR ENDED DECEMBER 31,
--------------- -------------------------------------------
1994 1995 1996 1997 1998
--------------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues:
Perpetual licenses............................... $ 38 $ 246 $ 4,233 $10,936 $25,936
Subscriptions.................................... -- -- 219 2,465 7,406
Professional services............................ -- 11 10 66 2,587
------ ------- ------- ------- -------
38 257 4,462 13,467 35,929
Costs and expenses:
Cost of revenues................................. -- 4 18 676 4,831
Research and development......................... 5 97 1,225 3,434 9,321
Charges for in-process research and development.. -- -- -- -- 802
Sales and marketing.............................. 11 252 3,768 11,731 22,762
General and administrative....................... 2 44 656 1,773 4,389
Amortization..................................... -- -- -- -- 230
------ ------- ------- ------- -------
18 397 5,667 17,614 42,335
------ ------- ------- ------- -------
Operating income (loss)............................ 20 (140) (1,205) (4,147) (6,406)
Interest income, net............................... -- -- 74 228 2,366
------ ------- ------- ------- -------
Income (loss) before income taxes.................. 20 (140) (1,131) (3,919) (4,040)
Provision for income taxes......................... -- -- -- -- 62
------ ------- ------- ------- -------
Net income (loss).................................. $ 20 $ (140) $(1,131) $(3,919) $(4,102)
------ ------- ------- ------- -------
Basic and diluted net loss per share(1)............ $ -- $ (0.03) $ (0.14) $ (0.50) $ (0.28)
====== ======= ======= ======= =======
Weighted average shares used in basic and diluted
net loss per share calculation(2)................ 4,586 5,001 7,916 7,907 14,883
====== ======= ======= ======= =======
Unaudited pro forma net loss per share(1).......... $ (0.29) $ (0.25)
======= =======
Unaudited weighted average shares used in unaudited
pro forma net loss per share calculation(2)...... 13,644 16,189
======= =======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------------------------
1994 1995 1996 1997 1998
---- ------- ------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents.......................... $ 9 $ 6 $ 2,007 $ 3,929 $52,632
Working capital (working capital deficit).......... 10 (26) 2,298 2,272 54,389
Total assets....................................... 10 176 4,380 9,866 78,021
Long-term debt, net of current portion............. -- -- 140 70 --
Redeemable, convertible preferred stock............ -- -- 3,614 8,878 --
Stockholders' equity (deficit)..................... 10 (7) (1,160) (5,058) 66,315
</TABLE>
- ---------------
(1) Computed on the basis described in Note 1 of Notes to Consolidated Financial
Statements.
(2) See Note 1 of Notes to Consolidated Financial Statements for the
determination of shares used in computing basic and diluted net income per
share.
15
<PAGE> 18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the
consolidated financial statements and related notes thereto included elsewhere
in this prospectus. This discussion contains forward-looking statements that
involve risks and uncertainties. Our actual results may differ materially from
those anticipated in these forward-looking statements as a result of certain
factors, including, but not limited to, those set forth under "Risk Factors" and
elsewhere in this prospectus.
OVERVIEW
We are the leading provider of network security monitoring, detection and
response software that protects the security and integrity of enterprise
information systems according to market share reports by Aberdeen Group, Gartner
Group and The Yankee Group. Our SAFEsuite family of products protects
distributed computing environments, such as internal corporate networks,
inter-company networks and the Internet, from attacks, misuse and security
policy violations. Our business is focused on maintaining the latest security
threat and vulnerability checks within our existing products, creating new
products and providing technical and professional services that are consistent
with our goal of providing enterprise solutions to address network security.
We generate a substantial portion of our revenues from our SAFEsuite family
of products in the form of perpetual licenses and subscriptions. We recognize
perpetual license revenues upon delivery of software or, if the customer has
evaluation software, delivery of the software key and issuance of the related
license, assuming that no significant vendor obligations or customer acceptance
rights exist. Where payment terms are extended over periods greater than 12
months, revenue is recognized as such amounts are billable. Annual renewable
maintenance is a separate component of each perpetual license agreement with
revenue recognized ratably over the maintenance term. Subscription revenues
include maintenance and term licenses. Term licenses allow customers to use the
product and receive maintenance coverage for a specified period, generally 12
months. We recognize revenues from each subscription agreement ratably over the
subscription term.
In 1998, training and implementation services represented an increasing
portion of our revenues. These professional services, which typically are billed
on a time-and-materials basis, assist in the successful deployment of our
products within customer networks, the development of customers' security
policies and the assessment of security policy decisions. We recognize
professional services revenues as such services are performed.
We believe that each of our current products and products in development,
together with maintenance and professional services, will represent important
sources of revenue in the future.
Generally, we base our prices on the number of devices or engines being
managed by the customer, scaled to provide discounts for either larger systems
or the simultaneous license of several SAFEsuite products. We offer annual
maintenance for a separate fee. Our customers virtually always purchase
maintenance when they initially license a product. Maintenance fees generally
equal 20% of the perpetual license fee. Maintenance packages typically include
telephone support, product updates, access to our security advisory notices and
error corrections. We recommend that our customers renew their maintenance
contracts and, to date, most customers have done so. Because of the dynamic
nature of vulnerabilities and threats to computer networks, we expect that a
substantial majority of our customers will continue to renew their maintenance
contracts.
We sell our products and services primarily through our direct sales force
and telephone sales operations, and we also sell through indirect sales
channels, including resellers, security consultants, Internet service
16
<PAGE> 19
providers, and other providers of network management services. We generate less
revenue per license from indirect channels than direct sales, as we typically
sell our products to channel partners at a 25% to 50% discount from list price.
In addition, we have entered into several contracts with original equipment
manufacturers, or OEMs, in 1998 that contemplate the incorporation of our
products into their product offerings. We expect this OEM channel to be an
additional important source of revenue for us in the future.
We expense research and development costs as incurred. Although we have not
capitalized any internal development costs under Statement of Financial
Accounting Standards No. 86, we have capitalized core and developed technology
assets in connection with two acquisitions that we completed in 1998. The
primary assets acquired in these acquisitions were security assessment
technologies for Windows NT, Unix and databases. While we expect the expansion
of our product offerings to originate primarily from internal development, our
strategy includes acquiring products and technologies that fit within our
product strategy and that potentially accelerate the timing of the commercial
introduction of such products and technologies as integrated components of our
enterprise network security solutions.
Our business has grown rapidly in the last three years, with total revenues
increasing from $4.5 million in 1996 to $35.9 million in 1998. However, we have
experienced net losses in each of these years and, as of December 31, 1998, had
an accumulated deficit of $9.3 million. These losses resulted from significant
costs incurred in the development and sale of our products and professional
services. During this period, we went from seven employees at January 1, 1996 to
328 employees at December 31, 1998. We expect to expand our domestic and
international sales and marketing operations, increase investment in product
development and our proprietary threat and vulnerability database, seek
acquisition candidates that will enhance our products and market share, and
improve our internal operating and financial infrastructure in support of our
strategic goals and objectives. All of these initiatives will increase operating
expenses. As a result, while operating losses have narrowed over the course of
1998, we cannot be certain that we will become profitable in the future. Even if
we become profitable in the future, we cannot be certain that we can sustain
such profitability.
Due to our fast growth over the past several years in an emerging market,
period-to-period comparisons of our operating results are not meaningful.
Although we recently have experienced significant revenue growth, we cannot
assume that we can sustain such growth and, therefore, investors should not rely
on our past growth as a predictor of future performance. Rather, our prospects
must be considered in light of the risks and difficulties frequently encountered
by companies in new and rapidly evolving markets. There can be no assurance that
we will be successful in addressing such risks and difficulties. See "Risk
Factors -- We Are a Young Company That Has Never Been Profitable", "-- Our
Future Operating Results Will Fluctuate Significantly" and "-- We Must
Effectively Manage Our Rapid Growth".
17
<PAGE> 20
RESULTS OF OPERATIONS
The following table sets forth our consolidated historical operating
information, as a percentage of total revenues, for the periods indicated.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------
1996 1997 1998
CONSOLIDATED STATEMENT OF OPERATIONS DATA: ----- ----- -----
<S> <C> <C> <C>
Revenues:
Perpetual licenses........................................ 94.9% 81.2% 72.2%
Subscriptions............................................. 4.9 18.3 20.6
Professional services..................................... 0.2 0.5 7.2
----- ----- -----
100.0 100.0 100.0
Costs and expenses:
Cost of revenues.......................................... 0.4 5.0 13.5
Research and development.................................. 27.5 25.5 25.9
Charges for in-process research and development........... -- -- 2.2
Sales and marketing....................................... 84.4 87.1 63.4
General and administrative................................ 14.7 13.2 12.2
Amortization.............................................. -- -- 0.6
----- ----- -----
127.0 130.8 117.8
----- ----- -----
Operating loss.............................................. (27.0)% (30.8)% (17.8)%
===== ===== =====
</TABLE>
REVENUES
Our revenues increased from $4.5 million in 1996, to $13.5 million in 1997
and to $35.9 million in 1998. Revenues from perpetual licenses increased during
these periods from $4.2 million in 1996, to $10.9 million in 1997 and to $25.9
million in 1998. Historically, we have generated most of our revenues from
perpetual licenses, but perpetual license revenues have decreased as a
percentage of total revenues from 95% in 1996, to 81% in 1997 and to 72% in
1998. Subscription revenues have increased substantially during these periods,
from $219,000 in 1996, to $2.5 million in 1997 and to $7.4 million in 1998,
representing 5%, 18% and 21%, respectively, of total revenues. We continue to
diversify our mix of sales within the SAFEsuite family of products, especially
due to the significant increases in the sale of licenses for RealSecure, our
intrusion detection product. As a result, sales of licenses for our initial
product, Internet Scanner, continued to grow in absolute dollars but decreased
as a percentage of license revenues from 93% in 1996, to 57% in 1998, and to
less than 45% of license revenues in the fourth quarter of 1998. With the
continued introduction of new product offerings, both from internal development
and acquisitions consummated in 1998, we expect this trend to continue.
A key initiative in 1998 was to address the demand from customers for
implementation, training and consulting services. As a result, professional
services revenues increased from less than 1% of revenues in each of 1996 and
1997 to 7% of total revenues in 1998. Professional services revenues increased
principally in the latter half of 1998 and comprised 12% of our total revenues
in the fourth quarter of 1998.
On a geographic basis, we derived the majority of our revenues from sales
to customers within North America. However, international operations continue to
contribute significantly to revenues. Sales to customers outside of North
America represented 19% of our total revenues in 1998 compared with 21% in 1997
and 4% in 1996. No customer represented more than 10% of total revenues in any
of these periods.
COSTS AND EXPENSES
COST OF REVENUES
Cost of revenues includes packaging and distribution costs for our software
licenses. Since we use the Internet to distribute product updates and keys
necessary to
18
<PAGE> 21
activate a customer's software, this is a minor cost. Cost of revenues also
includes costs associated with a technical support group that provides
assistance to maintenance customers. Finally, the category includes the costs we
incur to provide professional services to customers. During the first half of
1998, we built up our professional services management team who then developed a
billable consulting staff over the balance of the year. The growth in
professional services has caused gross margin, represented by total revenues
less cost of revenues expressed as a percentage of total revenues, to trend
downward from 99% and 95% in 1996 and 1997, respectively, to 87% in 1998. We
expect gross margin to settle at a few percentage points below the 1998 level.
RESEARCH AND DEVELOPMENT
Research and development expenses consist of salary and related costs of
research and development personnel, including costs for employee benefits and
depreciation of related computer equipment. Research and development expenses
include costs associated with maintaining the "X-Force", a team composed of
security experts dedicated to understanding new vulnerabilities and real-time
threats and attacks and developing solutions to address these security issues.
We continue to increase research and development expenditures because we regard
primary research and product development as a requirement for retaining our
leadership position in the market. We also increased the number of our
development personnel as we expanded our suite of products, upgraded our
existing products with enhanced functionality and began development efforts in
connection with OEM arrangements that were executed in the last half of 1998 but
for which no revenues have yet been generated. Accordingly, research and
development expenses increased in absolute dollars from $1.2 million in 1996, to
$3.4 million in 1997 and to $9.3 million in 1998. These costs remained at a
relatively constant percentage of revenues, although we anticipate that this
percentage will trend downward in future periods.
We have reflected a charge of $802,000 in our 1998 statement of operations
for identified in-process research and development in connection with our
October 1998 acquisitions of two companies engaged in Windows NT, Unix and
database security assessment technologies. The charge was based on a valuation
of products under development using estimated future cash flows, reduced for the
core technology component of such products and the percentage of product
development remaining at the time of the acquisition.
SALES AND MARKETING
Sales and marketing expenses consist of salaries, travel expenses,
commissions, advertising, maintenance of our Web site, trade show expenses,
costs of recruiting sales and marketing personnel and costs of marketing
materials. Sales and marketing expenses were $3.8 million in 1996, $11.7 million
in 1997 and $22.8 million in 1998. Sales and marketing expenses increased during
these periods primarily from a significant increase in the number of regional
United States sales locations and personnel, increased commissions commensurate
with increased direct sales revenues and expanded international operations in
Europe and the Asia/Pacific region. Sales and marketing expenses were 84% and
87% of our total revenues in 1996 and 1997, respectively, but decreased to 63%
of revenues in 1998. This decrease occurred because we had employed a larger
proportion of our sales force for a sufficient period of time to enable them to
achieve greater levels of productivity. If we are able to maintain low rates of
attrition within our sales force, we expect this trend to continue.
GENERAL AND ADMINISTRATIVE
General and administrative expenses of $656,000 in 1996, $1.8 million in
1997 and $4.4 million in 1998, represented approximately 15%, 13% and 12%,
respectively, of our total revenues. General and administrative expenses consist
of personnel-related costs for executive, administrative, finance and human
resources, information systems and other support
19
<PAGE> 22
services and legal, accounting and other professional services fees. During
1998, we upgraded our internal financial reporting and information systems, and
we expect to continue to expend resources to enhance our management's ability to
obtain and analyze information about our domestic and international operations.
In addition, we incurred approximately $720,000 of amortization of deferred
compensation in 1998, the majority of which is recorded in the general and
administrative category. This charge is related to the valuation of stock
options to employees and directors granted around the time of our initial public
offering of our common stock in March 1998.
INCOME TAXES
No provision for federal or state income taxes has been recorded because we
have experienced cumulative net losses since inception. We recorded a minor
amount of income tax expense in 1998 related to our European operations. At
December 31, 1998, we had net operating loss carryforwards of approximately
$13.6 million for federal tax purposes which will expire, if not utilized, in
2011 through 2018. These carryforwards include $7.7 million related to exercises
of stock options for which the income tax benefit, if realized, would increase
additional paid-in-capital. We also had approximately $800,000 of net operating
loss carryforwards related to certain foreign operations which will expire, if
not utilized, in 2002 and 2003. We have not recognized any benefit from the
future use of loss carryforwards for these periods or any other periods since
inception because management's evaluation of all the available evidence in
assessing realizability of the tax benefits of such loss carryforwards indicates
that the underlying assumptions of future profitable operations contain risks
that do not provide sufficient assurance to recognize such benefits currently.
20
<PAGE> 23
QUARTERLY RESULTS OF OPERATIONS
The following tables set forth certain unaudited consolidated quarterly
statement of operations data for the eight quarters ended December 31, 1998, as
well as such data expressed as a percentage of our total revenues for the
periods indicated. This data has been derived from unaudited consolidated
financial statements that, in our opinion, include all adjustments (consisting
only of normal recurring adjustments) necessary for a fair presentation of such
information when read in conjunction with our consolidated financial statements
and related notes appearing elsewhere in this prospectus. The operating results
for any quarter are not necessarily indicative of results for any future period.
<TABLE>
<CAPTION>
QUARTER ENDED
-----------------------------------------------------------------------------------------------
MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31,
1997 1997 1997 1997 1998 1998 1998 1998
--------- --------- ---------- --------- --------- --------- ---------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Revenues:
Perpetual licenses...... $1,872 $2,150 $ 2,767 $ 4,147 $ 4,875 $ 5,559 $ 6,596 $ 8,906
Subscriptions........... 349 513 691 912 1,169 1,487 2,152 2,598
Professional services... 4 8 15 39 29 285 682 1,591
--------- --------- ---------- --------- --------- --------- ---------- ---------
2,225 2,671 3,473 5,098 6,073 7,331 9,430 13,095
Costs and expenses:
Cost of revenues........ 87 137 176 276 513 892 1,559 1,867
Research and
development........... 493 569 895 1,477 1,636 1,832 2,541 3,312
Charge for in-process
research and
development........... -- -- -- -- -- -- -- 802
Sales and marketing..... 1,754 2,342 3,051 4,584 4,648 5,431 5,632 7,051
General and
administrative........ 320 301 443 709 981 1,100 1,046 1,262
Amortization............ -- -- -- -- -- -- -- 230
--------- --------- ---------- --------- --------- --------- ---------- ---------
2,654 3,349 4,565 7,046 7,778 9,255 10,778 14,524
--------- --------- ---------- --------- --------- --------- ---------- ---------
Operating loss............ (429) (678) (1,092) (1,948) (1,705) (1924) (1,348) (1,429)
Interest income, net...... 35 68 66 59 66 841 765 694
--------- --------- ---------- --------- --------- --------- ---------- ---------
Loss before income
taxes................. (394) (610) (1,026) (1,889) (1,639) (1,083) (583) (735)
Provision for income
taxes................. -- -- -- -- -- -- -- 62
--------- --------- ---------- --------- --------- --------- ---------- ---------
Net loss.................. $ (394) $ (610) $(1,026) $(1,889) $(1,639) $(1,083) $ (583) $ (797)
========= ========= ========== ========= ========= ========= ========== =========
</TABLE>
<TABLE>
<CAPTION>
QUARTER ENDED
-----------------------------------------------------------------------------------------------
MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31,
1997 1997 1997 1997 1998 1998 1998 1998
--------- --------- ---------- --------- --------- --------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
AS A PERCENTAGE OF TOTAL
REVENUES:
Revenues:
Perpetual licenses...... 84.1% 80.5% 79.7% 81.3% 80.3% 75.8% 70.0% 68.0%
Subscriptions........... 15.7 19.2 19.9 17.9 19.2 20.3 22.8 19.8
Professional services... 0.2 0.3 0.4 0.8 0.5 3.9 7.2 12.2
--------- --------- ---------- --------- --------- --------- ---------- ---------
100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Costs and expenses:
Cost of revenues........ 3.9 5.1 5.1 5.4 8.5 12.2 16.5 14.3
Research and
development........... 22.2 21.3 25.8 29.0 26.9 25.0 27.0 25.3
Charge for in-process
research and
development........... -- -- -- -- -- -- -- 6.1
Sales and marketing..... 78.8 87.7 87.8 89.9 76.5 74.1 59.7 53.8
General and
administrative........ 14.4 11.3 12.7 13.9 16.2 15.0 11.1 9.6
Amortization............ -- -- -- -- -- -- -- 1.8
--------- --------- ---------- --------- --------- --------- ---------- ---------
119.3 125.4 131.4 138.2 128.1 126.2 114.3 110.9
--------- --------- ---------- --------- --------- --------- ---------- ---------
Operating loss............ (19.3) (25.4) (31.4) (38.2) (28.1) (26.2) (14.3) (10.9)
Net loss.................. (17.7)% (22.8)% (29.5)% (37.1)% (27.0)% (14.8)% (6.2)% (6.1)%
========= ========= ========== ========= ========= ========= ========== =========
</TABLE>
21
<PAGE> 24
As a result of our limited operating history, we are unable to predict our
future revenues and operating results. See "Risk Factors -- Our Future Operating
Results Will Fluctuate Significantly".
LIQUIDITY AND CAPITAL RESOURCES
We have financed our operations to date primarily through sales of our
equity securities. The net proceeds of $61.5 million from our March 1998 initial
public offering were the primary source of cash provided by financing activities
in 1998. In February 1996 and February 1997, we received aggregate net proceeds
of $8.9 million from the sale of our preferred stock, all of which automatically
converted into common stock when we completed our initial public offering.
Net cash used in operations of approximately $4.3 million in 1998 included
$4.1 million of net loss. This loss, however, included $3.8 million of non-cash
expense for depreciation of equipment, amortization of acquisition related
intangibles and deferred compensation, and a charge for the write-off of
acquired in-process research and development. The other use of cash in
operations was working capital associated with our growth. An increase in
accounts receivable of $8.1 million was only partially offset by an increase in
deferred revenues of $4.5 million. Growth in annual maintenance contracts, the
upfront billing of multi-year maintenance arrangements with certain customers
and an increase in term licenses increased the deferred revenues balance.
Our primary investing activity of 1998 was our acquisitions of March
Information Systems Limited and the technology assets of DbSecure. The $5.2
million cash component of these acquisitions included cash consideration and
direct transaction costs. We also invested in equipment totaling $3.6 million in
1998 as we provided existing and new personnel with the computer hardware and
software necessary to perform their job functions. This included engineering lab
equipment, expanded information systems and a telephone switch installed in
connection with our relocation to our new headquarters facilities. We expect a
similar level of equipment investment in 1999, assuming continued growth in our
number of employees.
At December 31, 1998, we had $52.6 million of cash and cash equivalents,
consisting primarily of money market accounts and short-term, commercial paper
carrying the highest investment grade rating. We believe that these investments,
together with the proceeds from this offering, will be sufficient to fund any
operating losses and capital expenditures and meet our working capital needs for
the foreseeable future. We currently intend to use the net proceeds of this
offering for general corporate purposes, including possible acquisitions of or
investments in businesses, products and technologies that are complementary to
ours. Although we have not identified any specific businesses, products or
technologies that we intend to acquire or invest in, and there are not any
current agreements or negotiations with respect to any such transactions, from
time to time we evaluate such opportunities. Pending such uses, we will invest
the net proceeds in government securities and other short-term,
investment-grade, interest-bearing instruments.
YEAR 2000
We have reviewed our products and believe that they are designed to
properly function through and beyond the year 2000. Furthermore, we only support
the current and most recent prior version of our products. While we have
conducted tests of our software and have informed our customers that our
products are Year 2000 compliant, we cannot guarantee that our products,
particularly when they incorporate third-party software, will contain all date
code changes necessary to ensure Year 2000 compliance.
In addition, we use several internal management and other information
systems in the operation of our business. Since we have experienced most of our
growth in systems and personnel since January 1, 1997, purchases and upgrades of
systems have occurred principally during 1997 and 1998. Internal systems for
financial, human resources and sales reporting, as well as
22
<PAGE> 25
telephone, voice mail and other office support systems, were purchased during
1998 and are reflected either on the balance sheet as capital purchases or
expensed under our standard policy. We used our best efforts to ensure that
these new systems are Year 2000 compliant.
We are in the process of contacting providers of various tools used in our
product development process and the providers of desktop systems (primarily
Microsoft) to determine that these recognized systems, such as Windows NT and
Windows 95/98, will be Year 2000 compliant with appropriate fixes. We do not
depend on any suppliers or manufacturers whose failure to be Year 2000 compliant
would have any significant impact on our financial condition or results of
operations. We expect to complete our Year 2000 project for these remaining
items by the middle of 1999. We do not expect to expend any significant funds to
correct Year 2000 issues. Any minor expenses will be funded through cash
provided by operations.
Based on available information, we do not believe we have any material
exposure to significant business interruptions as a result of Year 2000
compliance issues, or that the cost of remedial actions will have a material
adverse effect on our business, financial condition or results of operations.
Accordingly, we have not adopted any formal contingency plan in the event we do
not achieve Year 2000 compliance.
23
<PAGE> 26
BUSINESS
OVERVIEW
We are the leading provider of monitoring, detection and response software
that protects the security and integrity of enterprise information systems,
according to market share reports by Aberdeen Group, Gartner Group and the
Yankee Group. Our SAFEsuite family of products is designed to enforce "best
practice" information risk management automatically across distributed computing
environments. Our products use an innovative Adaptive Network Security, or ANS,
approach that entails continuous security risk monitoring, detection and
response to develop and enforce an active network security policy. In addition,
we offer professional services which enable us to deliver comprehensive network
and Internet security solutions to our customers. We pioneered the technology
for vulnerability and threat detection through a dedicated security research and
development team and we believe that we have the most comprehensive
vulnerability and threat database in existence. We have licensed our network
security solutions to over 3,000 organizations worldwide, including firms in the
Global 2000, U.S. and international government agencies, and major universities.
Twenty-one of the 25 largest commercial banks in the United States, as ranked by
Fortune, have licensed our products. We also have established strategic
relationships with industry leaders, including Check Point, GTE, IBM, MCI
WorldCom, Microsoft and Nortel, to enable worldwide distribution of our core
monitoring technology.
INDUSTRY BACKGROUND
Network computing has evolved from client/server-based local area networks
to distributed computing environments based on the integration of inter-company
wide area networks via the Internet. The proliferation and growth of corporate
intranets and the increasing importance of electronic commerce have dramatically
increased the openness of computer networks, with the Internet becoming a widely
accepted platform for many business-to-business and direct-to-customer
transactions. International Data Corporation ("IDC") estimates that the number
of Internet users will grow from 97 million in 1998 to 320 million in 2002, and
that the value of electronic commerce transactions will grow from $32 billion to
$426 billion over the same period. Additionally, IDC estimates that the number
of devices accessing the Web will increase from 120 million in 1998 to 515
million in 2002. To capitalize on these trends, organizations are increasingly
connecting their enterprise networks to the Internet to facilitate and support
strategic business objectives, including:
- - electronic data interchange (EDI);
- - supply chain systems integration;
- - Web-based access to account information and delivery schedules; and
- - secure messaging and online purchases and payments.
With the increased use of the Internet by businesses and consumers,
organizations increasingly network their key systems in order to reduce costs
and increase revenues. For example, businesses can implement supply chain
management applications through standards enabled by the Internet. To optimize
the supply chain, businesses use the Internet to provide suppliers with access
to sensitive internal information, such as engineering designs, product
development plans, raw material inventories and product schedules. Organizations
also strengthen their ties with customers through "corporate Internet portals"
that provide comprehensive information for purchasing products, checking order
status and managing customer billings. This increased level of access provided
by open systems carries with it the risk of unauthorized access to and use of
sensitive information or malicious disruptions of important information-exchange
systems.
THE NEED FOR NETWORK SECURITY
Although open computing environments have many business advantages, their
accessibility and the relative anonymity of users make these systems, and the
integrity
24
<PAGE> 27
of the information that is stored on them,
vulnerable to security threats. Open systems present inviting opportunities for
computer hackers, curious or disgruntled employees, contractors and competitors
to compromise or destroy sensitive information within the system or to otherwise
disrupt the normal operation of the system. In addition, open computing
environments are complex and typically involve a variety of hardware, operating
systems and applications supplied by a multitude of vendors, making these
networks difficult to manage, monitor and protect from unauthorized access. Each
new addition of operating system software, applications or hardware products to
the distributed computing environment may introduce a vast number of new
vulnerabilities and security risks. To adequately secure a network, information
technology, or IT, managers must have the resources to not only correctly
configure the security measures in each system, but also to understand the risks
created by any change to existing systems on the network. This situation is made
worse by the limited supply of personnel knowledgeable in information security
issues.
Executives must understand and manage the risks involved when integrating
their systems with the systems of suppliers and customers to achieve strategic
objectives. According to the annual Information Week/ PricewaterhouseCoopers LLP
1998 Global Information Security Survey of IT managers and professionals, 59% of
those surveyed who are associated with sites selling products or services on the
Web reported at least one security breach in the past year. In addition, sites
integrated with supply-chain network or enterprise resource planning
applications reported security violations 10% more often than sites without such
applications. In a separate PricewaterhouseCoopers 1998 survey of chief
executive officers, 84% cited security concerns as a barrier to deployment of IT
initiatives. Despite the convenience and the compelling economic incentives for
the use of Internet-protocol networks, they cannot reach their full potential as
a platform for global communication and commerce until organizations can
implement an effective platform to manage information risk.
Historically, organizations have responded to perceived security threats by
implementing passive point tools, such as encryption, firewall, authentication
and other technologies designed to protect individual components of their
internal networks from unauthorized use or outside attacks. These technologies
address some security concerns, but are often ineffective because:
- - encryption protects information during transmission; however, it does not
typically protect information at either the source or the destination;
- - a firewall, which controls the flow of data between an internal network and
outside networks or the Internet, is necessary for rudimentary access control,
but must be regularly reconfigured to accommodate new business applications,
users and business partners on the network. Thus, firewalls can be left
vulnerable to hackers and others seeking to compromise network integrity and
fail to protect against improper use by authorized users;
- - operating system security mechanisms, such as user authentication, passwords
and multi-level access rights, can prevent unauthorized access by internal and
external users. However, deployment issues such as easily guessed passwords or
default accounts left on newly installed devices diminish the effectiveness of
these measures.
Passive point tools do not address the fundamental issue that the inherent
utility of open systems is itself the source of their vulnerability. This
conflict between the benefits of open systems and the risks of their
unauthorized use or disruption has not been widely recognized or addressed by
passive security tools.
Many organizations have developed security policies that define the
appropriate use of network resources, establish the proper configuration of
network services, operating systems and applications and describe the actions to
be taken if there is an attack on the network. These security policies
25
<PAGE> 28
attempt to define the organization's acceptable level of risk. Organizations,
however, have not had the systems to automatically enforce and implement such
policies across their entire IT infrastructure. Without such systems, the
dynamic nature of enterprise networks causes the organization's actual security
practice to diverge from the stated security policy, potentially exposing the
organization to additional unanticipated risks.
To be effective, passive point tools need to be coordinated through
enterprise-wide systems that automatically evaluate and eliminate the
vulnerabilities and threats. Direct observation of vulnerabilities and threats
can allow an organization to define and automatically enforce an integrated,
enterprise-wide information risk management process that can be managed
centrally and implemented on a distributed basis. Any security solution must be:
- - easy to use by both management and the organization's existing IT personnel;
- - compatible with existing security technologies as well as be flexible enough
to incorporate new technologies; and
- - able to provide a comprehensive and accurate picture of security issues across
the organization's entire distributed network such that the managers of the
system trust the objectivity of the security system in monitoring, detecting
and responding to vulnerabilities and threats.
THE ISS SOLUTION
Our dynamic, process-driven Adaptive Network Security approach to
enterprise-wide information risk management relies on the principles of
monitoring, detection and response to the ever-changing vulnerabilities in and
threats to the hardware products, operating systems and applications that
comprise every network system. We designed our SAFEsuite family of products to
enable an organization to centrally define and manage an information risk policy
for its existing network system infrastructure, including all Internet
protocol-enabled devices. Our solutions provide the ability to visualize,
measure and analyze real-time security vulnerabilities and control threats
across the entire enterprise computing infrastructure, keeping the
organization's IT personnel informed of changing risk conditions and
automatically making adjustments as necessary. Through custom policies or by
using our "best practice" templates, our customers can minimize security risks
without closing off their networks to the benefits of open computing
environments and the Internet.
Our solutions reach beyond the traditional approaches to network security
in the following respects:
ADAPTIVE NETWORK SECURITY
ANS is a proactive, risk management-based approach to enterprise security
that links security practice and security policy through a continuous
improvement process. ANS achieves this objective through four critical
processes:
- - continuously monitoring network, system and user activity and configuring
devices, systems and applications on the network;
- - detecting security risks in network traffic and within systems;
- - responding to security threats to minimize risks; and
- - analyzing and reporting dynamic risk conditions and response actions and
updating security policies.
COMPREHENSIVE ENTERPRISE SECURITY SOLUTION
We combine ANS principles with our extensive knowledge of network, system
and application vulnerabilities and threats to provide scalable security
solutions. Our SAFEsuite family of products provides a comprehensive network and
system security framework. In addition, we sell our products individually as
solutions for a particular function. We also offer a broad range of professional
services to assist in the development and enforcement of an effective security
policy and to facilitate the deployment and use of our software. Our solutions
are interoperable with a broad range of platforms and complement the products of
leading security and network management vendors.
26
<PAGE> 29
They provide a single point of management and control for an enterprise-wide
security policy. In this manner, our SAFEsuite family of products serves as a
critical enhancement to traditional passive point tools, such as encryption,
firewalls and authentication. We have designed our products to be easily
installed, configured, managed and updated by a system administrator through an
intuitive graphical user interface without interrupting or affecting network
operation. The software automatically identifies systems and activities that do
not comply with a customer's policies, and provides a critical feedback
mechanism for adjusting the security levels of networked systems based upon its
findings. Our products generate easy-to-understand reports ranging from
executive-level trend analysis to detailed step-by-step instructions for
eliminating security risks.
THE X-FORCE
Because there are few IT professionals specifically trained in network and
system security issues, we have assembled a senior research and development team
composed of security experts who are dedicated to understanding new
vulnerabilities and real-time threats and attacks, and developing solutions to
address these security issues. The team is known in the industry as the "X-
Force" and represents one of our competitive advantages. Because of the
collective knowledge and experience of the members of the X-Force, we believe
that they comprise one of the largest and most sophisticated groups of IT
security experts currently researching vulnerability and threat science.
Organizations such as CERT (Computer Emergency Response Team), the FBI and
leading technology companies routinely consult the X-Force on network security
issues. Through the X-Force, we maintain a proprietary and comprehensive
knowledge base of computer exploits and attack methods, including what we
believe is the most extensive publicly-available collection of Windows NT
vulnerabilities and threats in existence. To respond to an ever-changing risk
profile, the X-Force continually updates this knowledge base with the latest
network vulnerability information, which aids in the design of new products and
product enhancements.
STRATEGY
Our objective is to be the leading provider of information risk management
systems that, through our ANS approach, proactively protect the integrity and
security of enterprise-wide information systems from vulnerabilities, misuse,
attacks and other information risks. We focus on developing innovative and
automated software solutions to provide customers with a comprehensive framework
for protecting their networks and systems by monitoring for vulnerabilities and
real-time threats. Our solutions allow customers to enforce "best practice"
network and system security policies. Key elements of our strategy include:
CONTINUE OUR LEADERSHIP POSITION IN SECURITY TECHNOLOGY
We intend to maintain and enhance our technological leadership in the
enterprise security market by hiring additional network and Internet security
experts, broadening our proprietary knowledge base, continuing to invest in
product development and product enhancements and acquiring innovative companies
and technologies that complement our solutions. By remaining independent of
other providers of system software, applications and hardware and by solidifying
our position as a best-of-breed provider of monitoring, detection and response
software, we believe that customers and potential customers will view us as the
firm of choice for establishing and maintaining effective security practices and
policies.
EXPAND DOMESTIC SALES CHANNELS
We intend to increase the distribution and visibility of our products by
expanding our regional direct sales program and increasing our market coverage
through the establishment of additional indirect channels with key managed
service providers, Internet service providers, systems integrators, resellers,
OEMs and other channel partners. We believe that a multi-channel sales approach
will build customer awareness of
27
<PAGE> 30
the need for our products and enable us to more rapidly build market share
across a wide variety of industries.
ENHANCE AND PROMOTE PROFESSIONAL SERVICES CAPABILITIES
We are establishing long-term relationships with our customers by serving
as a "trusted advisor" in addressing network security issues. To continue to
fulfill this responsibility to our customers, we are expanding our professional
services capabilities. These capabilities will allow us to provide our customers
with additional security system design, planning, installation, testing and
consulting services to assist in developing and maintaining effective
information risk management solutions. By providing professional services, we
also can heighten customer awareness about network security issues, which
creates opportunities for us to sell new products or product enhancements to our
existing customers.
EXPAND INTERNATIONAL OPERATIONS
We plan to continue to aggressively expand our international operations to
address the rapid global adoption of distributed computing environments. Many
foreign countries do not have laws recognizing network intrusion or misuse as a
crime or the resources to enforce such laws if they do exist. As a consequence,
we believe that organizations in such countries will have greater need for
effective security solutions. We currently maintain international offices in
Australia, Belgium, Brazil, Canada, England, France, Germany, Japan and Mexico
and plan to expand in those regions where businesses, governments and other
institutional users are using distributed networks and the Internet for their
mission-critical needs.
BROADEN ANS CATEGORY AWARENESS
We intend to increase and broaden awareness of the need for ANS and our
information risk management solutions. In 1998, we led the formation of the
Adaptive Network Security Alliance, or ANSA, as a means to offer Adaptive
Network Security to support a wide range of network management and security
products. In addition, by increasing our level of public relations, educational
events, seminars, advertising, direct marketing and trade show participation, we
intend to increase the public's recognition of the risks and dangers associated
with the adoption of open computing systems and electronic commerce initiatives,
as well as the ability to manage such risks through an effective ANS-based
solution.
PRODUCT ARCHITECTURE
The SAFEsuite family of products delivers our ANS approach to network
security through a flexible architecture designed to be integrated with existing
security and network system infrastructures. Our SAFEsuite products enhance the
effectiveness of passive point tools by monitoring them for threats and
vulnerabilities and responding with actions that align customers' security
practices with their security policies. SAFEsuite complements network and
security management frameworks by providing information required for informed
decisions to minimize security risks while maintaining the desired level of
network functionality. Thus, our products provide a risk management-based
approach to security with scalable deployment of best-of-breed products and
integrated enterprise-wide implementations.
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<PAGE> 31
The following depicts the SAFEsuite product architecture:
Picture headed "SAFEsuite Architecture" depicts a rectangle segmented into
15 parts: One segment spans the top of the top of the rectangle and is titled
"Information Risk Management". Immediately below that segment is another segment
spanning the center of the rectangle entitled "SAFEsuite Decisions" and includes
that product's square logo. Immediately below that segment are two segments of
half the length of the rectangle. The left segment is entitled "Vulnerability
Management" and the right segment is entitled "Threat Management". Below the
Vulnerability Management segment are three segments, entitled (from left to
right) "Internet Scanner", "Database Scanner" and "System Scanner", each with a
circular product logo. Below the "Threat Management" segment are two segments
(on a level even with the three segments below "Vulnerability Management")
entitled "RealSecure Engine" and "RealSecure Agent", both with a circular
product logo. Below these five segments is a segment spanning the center of the
rectangle entitled "Security Knowledge Base". Below that segment is another
segment spanning the center of the rectangle with a rectangular "X-Force" logo.
Along the right edge of the rectangle is a segment entitled "Professional
Services" with the words "Implementation" "Consulting" "Training" and "Advisory
Service" underneath the title. Along the left edge of the rectangle are segments
with the ANSA logo and the caption "APIs".
The SAFEsuite policy management interface lets customers choose among "best
practice" templates or policies that establish the acceptable level of risk
appropriate for their networks. Our individual products then automatically
verify compliance with the chosen policy in terms of actual system configuration
and network activity. Graphical reports describe the deviations from the
established policy, including the measures required to reduce the risk.
This product architecture allows all the SAFEsuite technologies to connect
directly into common standards, providing comprehensive security reports for the
entire enterprise. To ensure communication confidentiality between individual
SAFEsuite components and to prevent their misuse, SAFEsuite uses RSA encryption
algorithms, which have become de facto encryption standards. The SAFEsuite
Security Knowledge Base, a database containing information about the devices and
security risks on a customer's network, utilizes an open database connectivity,
or ODBC, interface and allows customers to select their preferred database such
as Informix, Microsoft SQL Server, Oracle, Sybase or any ODBC-compliant database
for data storage. The various SAFEsuite products consolidate security data,
enabling users to quickly determine their risk profiles and respond. In
addition, SAFEsuite products provide automated decision support by assessing
priorities and providing a graphical representation of important security risk
data sets. This feature allows key decision-makers to prioritize their program
strategies for effective deployment of resources to minimize security risks.
Each SAFEsuite product can be deployed as a stand-alone, best-of-breed
solution to meet the needs of the local administrator or departmental user.
Through support for remote, multi-level management consoles and the SAFEsuite
Security Knowledge Base, enterprise-level users can analyze security risk
conditions for the entire network. The SAFEsuite Security Knowledge Base allows
the customer to address both vulnerabilities
29
<PAGE> 32
and threats, thereby minimizing network security risk and associated costs.
SAFEsuite's frequent updates integrate the latest identified security
vulnerabilities and threats into the operations of an existing product
installation.
PRODUCTS
The following table lists our current offering of SAFEsuite products, and
includes a brief description of each product's functionality and current list
prices (dollar amounts are for the indicated scope of use, with prices
discounted for larger networks):
<TABLE>
<CAPTION>
INTRODUCTION
DESCRIPTION SCOPE U.S. LIST PRICE DATE
<S> <C> <C> <C> <C>
- ----------------------------------------------------------------------------------------------------------
NETWORK SECURITY VULNERABILITY DETECTION, ANALYSIS AND REPORTING
- ----------------------------------------------------------------------------------------------------------
Internet Scanner Comprehensive security 50 devices $ 3,495 October 1992
assessment for all 1000 devices 19,945
devices on an enterprise 3000 devices 39,500
network
- ----------------------------------------------------------------------------------------------------------
INTERNAL SYSTEM SECURITY VULNERABILITY DETECTION, ANALYSIS AND REPORTING
- ----------------------------------------------------------------------------------------------------------
System Scanner -- Internal security 50 computers $ 1,950 December 1998
assessment
desktop version for desktop operating 400 computers 11,950
systems 1000 computers 25,500
- ----------------------------------------------------------------------------------------------------------
System Scanner -- Internal security 5 computers $ 3,250 January 1997
assessment
server version for server operating 30 computers 17,500
systems
100 computers 50,000
- ----------------------------------------------------------------------------------------------------------
DATABASE SECURITY VULNERABILITY DETECTION, ANALYSIS AND RESPONSE
- ----------------------------------------------------------------------------------------------------------
Database Scanner Comprehensive security 5 servers $ 4,475 December 1998
assessment for SQL 10 servers 8,500
databases 50 servers 41,250
- ----------------------------------------------------------------------------------------------------------
NETWORK SECURITY THREAT AND MISUSE DETECTION, ANALYSIS AND RESPONSE
- ----------------------------------------------------------------------------------------------------------
RealSecure Engine Real-time attack 1 engine $ 8,995 December 1996
recognition,
misuse detection and 10 engines 69,900
response for network 25 engines 149,900
traffic
- ----------------------------------------------------------------------------------------------------------
INTERNAL SYSTEM SECURITY THREAT AND MISUSE DETECTION, ANALYSIS AND RESPONSE
- ----------------------------------------------------------------------------------------------------------
RealSecure Agent Real-time attack 5 computers $ 3,750 December 1998
recognition,
misuse detection and 25 computers 15,000
response for activities 100 computers 50,000
within systems
- ----------------------------------------------------------------------------------------------------------
ENTERPRISE INFORMATION RISK MANAGEMENT
- ----------------------------------------------------------------------------------------------------------
SAFEsuite Decisions Decision support system Small enterprise $ 25,000 December 1998
for information risk Medium enterprise 100,000
management Large enterprise 250,000
- ----------------------------------------------------------------------------------------------------------
</TABLE>
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<PAGE> 33
INTERNET SCANNER
Internet Scanner quickly finds and fixes security holes through automated
and comprehensive network security vulnerability detection and analysis.
Internet Scanner scans and detects vulnerabilities, prioritizes security risks
and generates an array of meaningful reports ranging from executive-level trend
analysis to detailed step-by-step instructions for eliminating security risks.
Internet Scanner initiates a scan from a workstation placed inside or outside a
corporate firewall. These scans measure the actual implementation of an
organization's security policies. Scans may be as simple as determining the
basic computing services available on the network or as comprehensive as a
thorough testing using Internet Scanner's vulnerability database -- the most
comprehensive in the industry. Internet Scanner's intranet module methodically
examines intranet servers, routers, operating systems and key applications for
potential violations in security policy. The firewall module works through the
network to find firewalls and provide an accurate assessment of their
configuration and degree of protection. Finally, the Web security module locates
intranet, extranet and Internet Web servers, checking them for possible
misconfigurations and security weaknesses. After completing their scans, the
Internet Scanner modules return lists of discovered vulnerabilities and prepare
in-depth reports to assist administrators with follow-up and review.
SYSTEM SCANNER
System Scanner serves as a security assessment system that helps manage
security risks through comprehensive detection and analysis of operating system,
application and user-controlled security weaknesses. System Scanner identifies
potential security risks by comparing security policy with actual host computer
configurations. Potential vulnerabilities include missing security patches,
dictionary-crackable passwords, inappropriate user privileges, incorrect file
system access rights, unsecure service configurations and suspicious log
activity that might indicate an intrusion. System Scanner stores scanned
operating system configurations, placing an electronic "fingerprint" on
individual hosts. Routine reviews of these records help identify damaged or
maliciously altered systems before they become a security or performance
liability. Furthermore, System Scanner helps restore suspicious or damaged Unix
systems, generating automated fix scripts for file ownerships and permissions.
System Scanner augments its automated policy compliance testing with a database
of over 600 vendor patches and other system enhancements. This powerful built-in
knowledge base quickly pinpoints high risk activity, such as password sniffing,
remote access programs or unauthorized dial-up modems and remote control
software. System Scanner returns a list of discovered vulnerabilities and
prepares in-depth reports to assist administrators with follow-up and review.
DATABASE SCANNER
Database Scanner provides security risk assessment for database management
systems. Database Scanner allows a user to establish a database security policy,
audit a database and present a database's security risks and exposures in
easy-to-read reports. Most database security violations occur not because
databases have inherently weak security, but rather because systems are not set
up correctly and security policies are not established and enforced. Even in a
properly configured system, settings can be changed -- either accidentally or
maliciously -- leaving sensitive information at risk. Database Scanner develops,
implements and maintains appropriate database system security strategies,
policies and procedures. It examines database systems for adherence to accepted
operational standards for account creation, access control, account suspensions
and renewals along with software upgrades, patches and hot fixes. The security
risks in internal applications utilizing database management systems can be
measured and managed with Database Scanner. The easy to read reports provide
detailed graphical analysis with recommended fixes and promote effective
communication of security
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risks across departments and levels of management.
REALSECURE
RealSecure is an integrated network- and host-based intrusion detection and
response system. RealSecure's around-the-clock surveillance extends
unobtrusively across the enterprise, allowing administrators to automatically
monitor network traffic and host logs, detect and respond to suspicious activity
and intercept and respond to internal or external host and network abuse before
system security is compromised. RealSecure's multi-point management architecture
allows for rapid enterprise-wide deployment and operation across geographic and
organizational boundaries in both Unix and Windows NT environments. RealSecure's
innovative Manager-Engine-Agent architecture provides flexible deployments to
meet the requirements of diverse corporate networks.
REALSECURE ENGINE. The RealSecure Engine runs on dedicated workstations to
provide network intrusion detection and response. Each RealSecure Engine
monitors the packet traffic on a specific network segment for attack
signatures -- telltale evidence that an intrusion attempt is taking place.
Recognition occurs in real time and triggers user-definable alarms and responses
as soon as the attack is detected. RealSecure utilizes our Digital
FingerPrinting technology to recognize a large number of attack patterns on
high-speed networks. Additionally, our Adaptive Filtering Algorithm tunes the
packet filter rules in response to network load, allowing the engine to
effectively function during bursts in network traffic. When a RealSecure Engine
detects an attack or misuse, it transmits an alarm to the RealSecure Manager or
a third-party network management console for administrative follow-up and
review. In addition, RealSecure responds immediately by terminating the
connection, sending email or pager alerts, recording the session, reconfiguring
select firewalls or taking other user-definable actions.
REALSECURE AGENT. RealSecure Agent is a host-based complement to
RealSecure Engine. RealSecure Agent analyzes host logs to recognize attacks,
determine whether an attack was successful and provide other forensic
information not available in real time. Based on what is discovered, RealSecure
Agent reacts to prevent further incursions by terminating user processes and
suspending user accounts. It also logs events, sends, alarms and emails and
executes user-defined actions. Each RealSecure Agent installs on a workstation
or host, thoroughly examining that system's logs for telltale patterns of
network misuse and breaches of security. Like RealSecure Engine, RealSecure
Agent sends an alarm to the RealSecure Manager or third-party network management
console when it detects evidence of improper usage. Based on what it discovers,
RealSecure Agent also automatically reconfigures RealSecure Engines and select
firewalls to prevent future incursions.
SAFESUITE DECISIONS
SAFEsuite Decisions is the initial product in our new SAFEsuite Enterprise
family of enterprise security management solutions. SAFEsuite Decisions delivers
continuous security improvement across the enterprise from a single application.
SAFEsuite Decisions leverages the value of our SAFEsuite products to provide an
adaptive enterprise network security system for ongoing, active information risk
management. SAFEsuite Decisions integrates critical security data generated by
our Internet Scanner, System Scanner, RealSecure and third-party firewalls, into
a closed, automated feedback loop. This information is condensed into a
comprehensive reporting system, enabling timely, focused and informed decisions
for effective information risk management. SAFEsuite Decisions enables managers
and administrators to take immediate action to protect online resources.
SAFEsuite Decisions facilitates efficient management of enterprise security risk
and maximizes the security of large-scale networking and Internet-based
commerce.
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PROFESSIONAL SERVICES
We enhance the value of our products by offering professional consulting
services to assure customers' success in the use of our products. We have
network security professionals ready to assist customers with their particular
security policy development and enforcement needs. Our professional services can
range from providing network security resources for overburdened IT departments
to conducting investigations of serious breaches in security. Our professional
services offerings include:
- - Quick Assist -- Customer assistance for determining a client's risk condition
and development of an Adaptive Network Security business case;
- - JumpStart -- High-value, customized on-the-job training and quick-start
implementation programs;
- - Incident Response & Post-Attack Support -- Data recovery and business
resumption planning services, investigation and forensics, litigation and
expert witness support;
- - Triage -- High-impact, rapid turnaround network emergency support services
including vulnerability assessment and corrective action support;
- - Security Architecture Design & Engineering -- Adaptive Network Security
architecture and design services;
- - Enterprise Threat & Vulnerability Battle Planning -- Logical, systematic
approach for project and budget planning, acquisition and technology strategy
and security program development and implementation; and
- - Network Operations Support -- On-site and remote network monitoring and
response, coupled with standard network security operations services.
We complement our service offerings with a full range of training and
certification programs. Our Certified User courses are available at our
education center in Atlanta, Georgia, and at approved training centers around
the world. These classes address planning, installation and basic operation of
our products in a hands-on, interactive environment. For more advanced needs,
our ISS Certified Engineer training courses cover advanced topics specific to
each SAFEsuite or SAFEsuite Enterprise product. Our training goes beyond simple
"how to" exercises. Upon completion of instructor-led discussions and exercises,
students respond to actual, on-the-job scenarios. These simulations allow
students to apply their new skills to real-world situations, reinforcing both
basic and advanced skills. Our training courses encompass the complete life
cycle of our SAFEsuite products, from installation and operations to advanced
troubleshooting.
PRODUCT PRICING
We use a range of fee structures to license our products, depending on the
type of product and the intended use. We license our vulnerability detection
products, Internet Scanner, System Scanner and Database Scanner, based on the
number of devices being scanned. The pricing scheme is scalable, providing low
entry points for departmental users without limiting our revenue potential from
customers with large networks. Pricing for our threat detection products,
RealSecure Engine and RealSecure Agent, is based on the number of engines
deployed on the network. Thus, licensing fees for our products are ultimately
determined by the size of the customer's network, as size dictates the number of
devices to be scanned or the number of engines to be deployed. In addition to
license fees, customers virtually always purchase maintenance agreements in
conjunction with their initial purchase of a software license, with annual
maintenance fees typically equal to 20% of the product's license fee.
Maintenance agreements include annually renewable telephone support, product
updates, access to our X-Force Security Alerts and error corrections. Our
continuing research into new security risks and resulting product updates
provide significant ongoing value. As a result, a substantial majority of our
customers renew their maintenance agreements. Customers who use our products to
provide IT consulting services have license agreements that are
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based on a revenue sharing model. We have historically sold fully-paid perpetual
licenses with a renewable annual maintenance fee and, more recently, have
licensed our products on a subscription basis (which includes maintenance) for
one or two year periods and are exploring other alternatives for customers
desiring longer term arrangements or multi-year commitments.
PRODUCT DEVELOPMENT
We developed our SAFEsuite products to operate in heterogeneous computing
environments. Products are compatible with other vendors' products across a
broad range of platforms, including HP-UX, IBM AIX, Linux, SGI IRIX, SunOS, Sun
Solaris, Windows 95/98 and Windows NT. We have incorporated a modular design in
our products to permit plug-and-play capabilities, although customers often use
our professional services or our strategic partners to install and configure
products for use in larger or more complex network systems.
We employ a two-pronged product development strategy to achieve our goal of
providing the most comprehensive security coverage within the monitoring,
detection and response market. First, we continue to develop best-of-breed
security products to address particular network configurations. Such new
products, and our existing products like Internet Scanner, System Scanner and
RealSecure, are updated approximately every four to six months to add new
features, improve functionality and incorporate timely responses to
vulnerabilities and threats that have been added to our vulnerability and threat
database. These updates are usually provided as part of separate maintenance
agreements sold with the product license.
Second, to complement our existing products and provide more comprehensive
network security coverage, we are expanding our existing SAFEsuite products by
developing additional enterprise-level products that incorporate ANS principles.
These products will allow customers to protect their networks by continuously
measuring and analyzing the status of their network's security, and by
monitoring and controlling the security risks in real time across the enterprise
network. These SAFEsuite enterprise products are interoperable with our existing
products, allowing modular implementation.
Expenses for product development were $1.2 million, $3.4 million and $9.3
million in 1996, 1997 and 1998, respectively. All product development activities
are conducted at our principal offices in Atlanta, and at our research and
development facilities in Mountain View, California and Reading, England, where,
as of December 31, 1998, an aggregate of 108 personnel were employed in product
development teams. In addition, our personnel include members of the Computer
Security Institute, Forum for Incident Response and Security Technicians
(FIRST), Georgia Tech Industrial Partners Association, Georgia Tech Information
Security Center and the International Computer Security Association (ICSA),
enabling us to actively participate in the development of industry standards in
the emerging market for network and Internet security systems and products.
CUSTOMERS
As of December 31, 1998, we had licensed versions of our SAFEsuite family
of products to over 3,000 customers. No customer accounted for more than 10% of
our consolidated revenues in 1996, 1997 or 1998. Our target customers include
both public and private sector organizations that utilize Internet
protocol-enabled information systems to facilitate mission-critical processes in
their operations. Our customers represent a broad spectrum of organizations
within diverse sectors, including financial services, technology,
telecommunications, government and information technology services.
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The following is a list of certain of our customers that have purchased
licenses and services from us with an aggregate price of at least $15,000 and
which we believe are representative of our overall customer base:
<TABLE>
<S> <C> <C>
FINANCIAL SERVICES IT SERVICES GOVERNMENT
Charles Schwab EDS NASA
First Union KPMG Peat Marwick Salt River Project
KeyCorp Perot Systems U.S. Department of the
Merrill Lynch PricewaterhouseCoopers Air Force
PNC Bank SAIC U.S. Department of the
SITA Army
TELECOMMUNICATIONS U.S. Department of
America Online TECHNOLOGY Defense
Bell Atlantic Hewlett-Packard U.S. State Department
BellSouth IBM
GTE Internetworking Intel OTHER
NETCOM On-Line Lucent Technologies Lockheed Martin
Communications Microsoft Merck
Nippon Telephone & NCR REI
Telegraph Siemens
VeriSign
Xerox
</TABLE>
SALES AND MARKETING
SALES ORGANIZATION
Our sales organization is divided regionally among the Americas, Europe and
the Asia/Pacific region. In the Americas, we market our products primarily
through our direct sales organization augmented by our indirect channels,
including security consultants, resellers, OEMs and systems consulting and
integration firms. The direct sales organization for the Americas consists of
regionally-based sales representatives and sales engineers and a tele-sales
organization located in Atlanta. As of December 31, 1998, we maintained sales
offices in the Atlanta, Austin, Boston, Chicago, Cincinnati, Dallas, Denver, Los
Angeles, Minneapolis, Monterrey (Mexico), New York, Palo Alto, Philadelphia,
Portland, San Francisco, Sao Paulo (Brazil), Seattle, Toronto (Canada) and
Washington, D.C. metropolitan areas. A dedicated group of professionals in our
Atlanta headquarters covers Latin America. As of December 31, 1998, we employed
92 people in the Americas direct sales and professional services organization.
The regionally-based direct sales representatives focus on opportunities where
we believe we can realize more than $200,000 in revenues per year.
In Europe and the Asia/Pacific region, substantially all of our sales occur
through authorized resellers. Internationally, we have established regional
sales offices in Brussels, London, Munich, Paris, Reading (England), Stuttgart,
Sydney and Tokyo. Personnel in these offices are responsible for market
development, including managing our relationships with resellers, assisting them
in winning and supporting key customer accounts and acting as a liaison between
the end user and our marketing and product development organizations. As of
December 31, 1998, 50 employees were located in our European and Asia/Pacific
regional offices. We expect to continue to expand our field organization into
additional countries in these regions.
SECURITY PARTNERS PROGRAM
We have established a Security Partners Program to train and organize
security consulting practices, Internet service providers, systems integrators
and resellers to match our products with their own complementary products and
services. By reselling SAFEsuite products, Security Partners provide additional
value for specific market and industry segments, while maintaining our ongoing
commitment to quality software and guaranteed customer
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satisfaction. We have established three different levels of partnership
opportunities:
- - PREMIER PARTNERS. Premier Partners are value-added resellers and systems
integrators with focused security practices. Many Premier Partners are
experienced in the sales and implementation of leading firewall technology, as
well as authentication and encryption technologies. These partners leverage
their expertise with our vulnerability assessment and intrusion detection
products. Premier Partners receive direct distribution of our products, sales
training, financial incentives, access to our Web site for placing orders and
partner-only communications, including a link to the ISS Partner Web site.
- - AUTHORIZED PARTNERS. Authorized Partners generally consist of organizations
that provide security-focused consulting services, but elect not to commit to
the minimum annual purchase commitments and entry fees applicable to Premier
Partners. Authorized Partners may purchase products directly from us and may
access our Web site to place orders and receive partner-only communications.
- - REGISTERED PARTNERS. Unlike Premier Partners and Authorized Partners,
Registered Partners are not required to maintain an ISS Certified Engineer on
their staffs. Registered Partners receive partner-only communications and may
purchase products directly from us, including through our online Web order
system.
ADAPTIVE NETWORK SECURITY ALLIANCE
In 1998, we formed the Adaptive Network Security Alliance, or ANSA, as a
means to offer Adaptive Network Security to support a wide range of network
management and security products. ANSA currently has 53 members, including
leading security software vendors. ANSA delivers the flexibility of best-
of-breed products, enhanced enterprise security, accelerated implementation of
enterprise management and security solutions and additional value for existing
products and services. ANSA provides Adaptive Network Security modules for
firewalls, virtual private networks (VPNs), antivirus/malicious code software,
public key infrastructure (PKI) and enterprise systems management products.
Through ANSA, we, together with our technology partners, deliver self-correcting
security and management systems that provide maximum value for organizations
with limited IT security resources.
ANSA provides functionality in the following four key areas:
- - ACTIVE RESPONSE. Security breaches require rapid response to identify and
stop threats before they place critical online assets at risk. Through ANSA,
firewalls, routers, switches, virtual private networks and other technologies
are reconfigured automatically and in real time to break off the attack and
prevent future penetrations.
- - LOCK DOWN. Improper configurations can make any technology vulnerable to
attack and misuse. We work with ANSA partners to develop customized templates
that enable the secure configuration of network devices. With this "lock down"
functionality, customers can be assured that the ANSA partner's product will
function as designed and will be securely configured.
- - DECISION SUPPORT. Effective security decision-making and planning requires
timely analysis of enormous amounts of data across disparate systems and
network devices. ANSA enables fast and informed enterprise-wide security
decisions by collecting, integrating and analyzing data from security and
network infrastructure products of ANSA partners. Resulting high value
information is routed to network and systems management consoles for immediate
action.
- - ADAPTIVE NETWORK SECURITY MANAGEMENT. ANSA integrates Adaptive Network
Security management with enterprise system management platforms. This
integration simplifies the enforcement and implementation of security policies
across the enterprise leveraging existing IT resources.
ANSA is an open initiative and membership is offered free of charge to
vendors providing security, and enterprise and network infrastructure products
and
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services with a commitment to interoperability.
MARKETING PROGRAMS
We conduct a number of marketing programs to support the sale and
distribution of our products. These programs are designed to inform existing and
potential end-user customers, OEMs and resellers about the capabilities and
benefits of our products. Marketing activities include:
- - press relations and education;
- - publication of technical and educational articles in industry journals and our
on-line magazine, ISS Alert;
- - participation in industry tradeshows;
- - product/technology conferences and seminars;
- - competitive analysis;
- - sales training;
- - advertising and development and distribution of marketing literature; and
- - maintenance of our Web site.
A key element of our marketing strategy is to establish our products and
our ANS model as the leading approach for enterprise-wide security management.
We have implemented a multi-faceted program to leverage the use of our SAFEsuite
product family and increase its acceptance through relationships with various
channel partners:
- - STRATEGIC RESELLERS. Although we have numerous resellers, certain of these
relationships have generated significant leverage for us in targeted markets.
Our strategic resellers, which include EDS, IBM, Lucent, Siemens and Softbank,
provide broad awareness of our brand through enhanced marketing activity,
access to large sales forces, competitive control points and access to larger
strategic customer opportunities.
- - CONSULTANTS. The use of our products by security consultants not only
generates revenue from the license sold to the consultant, but also provides
us with leads to potential end users with a concern for network security.
Consultants who have generated substantial leads for our sales organization
include Andersen Consulting, Arthur Andersen, Deloitte Touche Tohmatsu
International, Ernst & Young, IBM, KPMG Peat Marwick, PricewaterhouseCoopers
and SAIC Global Integrity.
- - MANAGED SERVICE PROVIDERS AND INTERNET SERVICE PROVIDERS. We license our
products to certain managed service providers and Internet service providers
to be used as part of their value-added services for their customers. With our
products, Internet service providers can offer their users perimeter
vulnerability scanning and assessment, and intrusion detection for Web
services and applications that typically reside outside the firewalled
perimeter. We license our products to GTE, Intermedia Communications (Digex),
IRE, MCI Worldcom and PSINet and other Internet service providers for these
purposes and receive a percentage of the value-added revenue stream.
- - OEMS. A number of vendors of security products, including Check Point,
Entrust, Lucent, NCR, Nortel and ODS Networks, have signed OEM agreements with
us. These agreements enable OEMs to incorporate our products into their own
product offerings to enhance their security features and functionality. We
receive royalties from OEM vendors and increased acceptance of our products
under these arrangements, which, in turn, promotes sales of our other products
to the OEM's customers.
We typically enter into written agreements with our strategic resellers,
consultants, managed service providers, Internet service providers and OEMs.
These agreements generally do not provide for firm dollar commitments from the
strategic parties, but are intended to establish the basis upon which the
parties will work together to achieve mutually beneficial objectives.
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ADVISORY BOARD
We established an Advisory Board in February 1998 to further our sales and
recruiting efforts. Members of the Advisory Board currently consist of the
following:
SAM NUNN. Mr. Nunn has been a partner in the Atlanta law firm of King
& Spalding since January 1997. Previously, he served in the United States
Senate for four terms starting in 1972. Mr. Nunn is a director of The
Coca-Cola Company, General Electric Company, National Service Industries,
Scientific-Atlanta, Texaco and Total System Services. He also serves as
Chairman of the Board of the Center for Strategic and International Studies
(CSIS), a Washington, D.C. think tank.
JOHN P. IMLAY, JR. Mr. Imlay is Chairman of Imlay Investments, and
serves on the board of directors of the Atlanta Falcons, Gartner Group,
Metromedia International Group, and several other organizations. He was
Chairman of Dun & Bradstreet Software Services from March 1990 until
November 1996. Prior to that, Mr. Imlay served as Chairman and Chief
Executive Officer of Management Science America, a company that was
acquired by Dun & Bradstreet Software Services.
The Advisory Board members advise us on long-term strategic growth,
including strategies for selling to key industries, recruitment of board members
and other key personnel, and trends in national and international policy
influencing our products and services. We also anticipate that Advisory Board
members will provide high visibility for us at industry events and will play key
roles in leading customer user groups to support our growth and industry
prominence. Members of the Advisory Board meet individually or as a group with
our management from time to time and are compensated through issuances of common
stock or options to acquire common stock.
CUSTOMER SERVICE AND SUPPORT
We provide ongoing product support services under license agreements.
Maintenance contracts are typically sold to customers for a one-year term at the
time of the initial product license and may be renewed for additional periods.
Under our maintenance agreements with our customers, we provide, without
additional charge, telephone support, documentation and software updates and
error corrections. Customers that do not renew their maintenance agreements but
wish to obtain product updates and new version releases are generally required
to purchase such items from us at market prices. In general, major new product
releases come out annually, minor updates come out every four to six months and
new vulnerability and threat checks come out every two to four weeks. Customers
with current maintenance agreements may download product updates from our Web
site.
We believe that providing a high level of customer service and technical
support is necessary to achieve rapid product implementation which, in turn, is
essential to customer satisfaction and continued license sales and revenue
growth. Accordingly, we are committed to continued recruiting and maintenance of
a high-quality technical support team. We provide telephone support to customers
who purchase maintenance agreements along with their product license. A team of
dedicated engineers trained to answer questions on the installation and usage of
the SAFEsuite products provides telephone support from 8:00 a.m. to 6:00 p.m.,
Eastern time, Monday through Friday, from our corporate office in Atlanta. We
provide telephone support 24 hours a day, seven days a week through a call-back
procedure to certain customers who pay an additional fee for the service. In the
United States and internationally, our resellers provide telephone support to
their customers with technical assistance from us.
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COMPETITION
The market for network security monitoring, detection and response
solutions is intensely competitive, and we expect competition to increase in the
future. We believe that the principal competitive factors affecting the market
for network security products include security effectiveness, manageability,
technical features, performance, ease of use, price, scope of product offerings,
professional services capabilities, distribution relationships and customer
service and support. Although we believe that our solutions generally compete
favorably with respect to such factors, there can be no assurance that we can
maintain our competitive position against current and potential competitors,
especially those with significantly greater financial, marketing, service,
support, technical and other competitive resources. Our chief competitors
generally fall within one of four categories:
- - internal IT departments of our customers and the consulting firms that assist
them in formulating security systems;
- - relatively smaller software companies offering relatively limited applications
for network and Internet security;
- - large companies, including Axent Technologies, Cisco Systems and Network
Associates, that sell competitive products, as well as other large software
companies that have the technical capability and resources to develop
competitive products; and
- - software or hardware companies that could integrate features that are similar
to our products into their own products.
Due to a lack of appreciation of the complexity involved in the development
of automated systems to establish and maintain comprehensive and effective
security within a distributed computing environment, potential customers often
rely on their IT departments to internally formulate security systems or retain
consultants to undertake such a project. However, because experts in security
issues are in extremely short supply, such in-house solutions typically fail to
provide a comprehensive and sophisticated approach to security, are not designed
to adapt to changing security risks and are extremely expensive to develop. As
IT departments learn of our products and their relative cost, we believe that
these departments will be less inclined to independently develop systems with
functionalities similar to our products.
In addition, a number of smaller companies currently market or have under
development software applications to provide network and Internet security. We
believe that, to date, none of these companies offers products that are as
robust in features or as comprehensive in scope as the SAFEsuite family of
products. Although it is likely that the product development efforts of these
companies will eventually enable them to offer a line of products to compete
with our current product line, we intend to continue to dedicate significant
resources for product development and recruiting in order to expand our product
capabilities ahead of these competitors. Notwithstanding, we expect additional
competition from these established competitors and from other emerging
companies.
Mergers or consolidations among our competitors, or acquisitions of small
competitors by larger companies, would make such combined entities more
formidable competitors to us. In the last 18 months, both Cisco Systems and
Network Associates have acquired privately-held companies with products
competitive to ours. Although we believe that Cisco Systems and Network
Associates will continue to integrate these security products with their other
product offerings, we believe that our products will compete favorably based on
our product and platform functionality and Adaptive Network Security approach.
Notwithstanding, large companies may have advantages over us because of their
longer operating histories, greater name recognition, larger customer bases or
greater financial, technical and marketing resources. We believe that the entry
of larger, more established companies into our market will require them to
undertake operations that are currently not within their core areas of
expertise, thus exposing them to significant uncertainties in the product
development process. In addition, if larger
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companies were to enter our market, they could have a greater ability to adapt
more quickly to new or emerging technologies and changes in customer
requirements. They also could devote greater resources to the promotion and sale
of their products than we can. In addition, these companies have reduced, and
could continue to reduce, the price of their security monitoring, detection and
response products, which increases pricing pressures within our market. In
addition, large companies with broad product offerings, such as Network
Associates, have bundled their security products with their other products, and
we expect them to continue to do so in the future, which makes it more difficult
for us to compete with them. These companies may develop security monitoring,
detection and response products that are better than our current or future
products and this may render our products obsolete.
Several companies currently sell software products (such as encryption,
firewall, operating system security and virus detection software) that our
customers and potential customers have broadly adopted. Some of these companies
sell products which perform the same functions as some of our products. In
addition, vendors of operating system software or networking hardware may
enhance their products to include the same kinds of functions that our products
currently provide. The widespread inclusion in operating system software or
networking hardware of features comparable to our software could render our
products obsolete, particularly if such features are of a high quality. Even if
security functions integrated into operating system software or networking
hardware are more limited than those of our software, a significant number of
customers may accept more limited functionality to avoid purchasing additional
software.
For the above reasons, we may not be able to compete successfully against
our current and future competitors. Increased competition may result in price
reductions, reduced gross margins and loss of market share, any one of which
could materially and adversely affect our business, operating results and
financial condition.
PROPRIETARY RIGHTS AND TRADEMARK ISSUES
We rely primarily on a combination of copyright and trademark laws, trade
secrets, confidentiality procedures and contractual provisions to protect our
proprietary rights. Furthermore, we believe that factors such as the
technological and creative skills of our personnel, new product developments,
frequent product enhancements, name recognition and reliable product maintenance
are essential to establishing and maintaining a technology leadership position.
We seek to protect our software, documentation and other written materials under
the trade secret and copyright laws, which afford only limited protection. We
also have submitted two United States patent applications. There can be no
assurance that any patents will issue from these applications or, if issued,
that any such patent would provide meaningful competitive advantages to us. We
generally license our SAFEsuite products to end users in object code
(machine-readable) format. Certain customers have required us to maintain a
source-code escrow account with a third-party software escrow agent, and a
failure by us to perform our obligations under any of the related license and
maintenance agreements, or our insolvency, could conceivably cause the release
of our product source code to such customers. The standard form agreement allows
the end user to use our SAFEsuite products solely on the end user's computer
equipment for the end user's internal purposes, and the end user is generally
prohibited from sublicensing or transferring the products.
Despite our efforts to protect our proprietary rights, unauthorized parties
may attempt to copy aspects of our products or to obtain and use information
that we regard as proprietary. Policing unauthorized use of our products is
difficult, and while we are unable to determine the extent to which piracy of
our software products exists, software piracy can be expected to be a persistent
problem. In addition, the laws of some foreign countries do not protect our
proprietary rights to as great an extent as do the laws of the United States.
There can be no assurance that our competitors will not independently develop
similar technologies.
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We are not aware that any of our products infringes the proprietary rights
of others, but it is possible that our current or future products may infringe
proprietary rights of others. In fact, in July 1998, Network Associates, which
is one of our competitors, filed a lawsuit against us alleging that our
RealSecure product violates a patent claim for intrusion detection technology
held by Network Associates. Although we believe that the lawsuit is without
merit and are vigorously defending against Network Associates' claims, should
Network Associates prevail in the suit, it could result in us having to pay
significant damages and cease the licensing of our RealSecure product. Such a
result would materially and adversely affect our business, operating results and
financial condition. See "-- Legal Proceedings".
It is conceivable that other third parties, in addition to Network
Associates, could claim infringement by us with respect to our current or future
products. We expect that software product developers will increasingly be
subject to infringement claims as the number of products and competitors in our
industry segment grows and the functionality of products in different industry
segments overlaps. Any such claims, with or without merit, could be time
consuming, result in costly litigation, cause product shipment delays or require
us to enter into royalty or licensing agreements. Such royalty or licensing
agreements, if required, may not be available on terms acceptable to us or at
all, which could have a material adverse effect upon our business, operating
results and financial condition.
The name "Internet Security Systems" is not currently subject to trademark
registration in the United States, and may not be a name for which a trademark
is registrable due to its general use in a variety of security-related
applications. Although we have in the past asserted and intend to continue to
assert our rights with respect to the name "Internet Security Systems" and we
have taken and will take action against any use of such name in a manner that
may create confusion with our products in relevant markets, there can be no
assurance that we will be successful in such efforts, which could have a
material adverse effect upon our business, operating results and financial
condition.
EMPLOYEES
As of December 31, 1998, we had 328 employees, of whom 108 were engaged in
product research and development, 103 were engaged in sales, 16 were engaged in
customer service and support, 46 were engaged in professional services, 35 were
engaged in marketing and business development and 20 were engaged in
administrative functions. We believe that we have good relations with our
employees.
FACILITIES
Our Atlanta headquarters and research and development facilities consist of
approximately 72,000 square feet of office space occupied pursuant to a lease
and a sublease expiring in June 2002, which provide for minimum annual lease
obligations of approximately $1,240,000. We also lease office space in Mountain
View, California, New York City, Washington, D.C., Brussels, London, Paris,
Reading (England), Stuttgart and Tokyo, as well as small executive suites in
several United States cities. We believe that our existing facilities are
adequate for our current needs and that additional space will be available as
needed.
LEGAL PROCEEDINGS
On June 25, 1998, Network Associates filed a lawsuit against us in the U.
S. District Court for the Northern District of California (the "Court") which
alleges that our RealSecure product infringes a patent claim for intrusion
detection technology held by Network Associates. Network Associates claims that
this alleged infringement is deliberate and willful and is seeking treble
damages in an unspecified amount and attorneys' fees, in addition to an
injunction prohibiting the alleged infringement. The Court conditionally
dismissed the original complaint based on the parties' representation to the
Court that they would attempt to reach a settlement. However, on January 13,
1999, Network Associates notified the Court that no settlement had been
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<PAGE> 44
reached and requested that the Court place the case on the Court's calendar. On
January 25, 1999, we filed our answer to the complaint with the Court. In our
answer, we asserted several affirmative defenses and made counterclaims against
Network Associates for unfair competition and antitrust violations under federal
and state laws. We believe that Network Associates' lawsuit is without merit and
we will continue to vigorously defend against it. However, should Network
Associates prevail in the suit, it could materially and adversely affect our
business, operating results and financial condition.
Except as noted above, we are not a party to any material legal
proceedings.
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<PAGE> 45
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
Set forth below is certain information concerning our directors and
executive officers.
<TABLE>
<CAPTION>
NAME AGE POSITION(S)
- --------------------------------------------------- ------- -----------------------------------------------------------
<S> <C> <C>
Thomas E. Noonan................................... 38 President, Chief Executive Officer and Chairman of
the Board of Directors
Christopher W. Klaus............................... 25 Chief Technology Officer, Secretary and Director
Richard Macchia.................................... 47 Vice President and Chief Financial Officer
H. Keith Cooley.................................... 45 Vice President (Engineering)
M. Thomas McNeight................................. 54 Vice President (Americas Sales)
Alex Bogaerts...................................... 49 Vice President (Europe)
Lin Ja Hong........................................ 40 Vice President (Asia/Pacific)
Richard S. Bodman.................................. 60 Director
Robert E. Davoli................................... 50 Director
Kevin J. O'Connor.................................. 37 Director
David N. Strohm.................................... 50 Director
</TABLE>
MR. NOONAN has served as our President and as a director since August 1995,
and as our Chief Executive Officer and Chairman of the Board of Directors since
November 1996. Prior to joining our company, Mr. Noonan served as Vice
President, Sales and Business Development with TSI International, an electronic
commerce company then owned by Warburg Pincus and Dun & Bradstreet, from October
1994 until August 1995. From November 1989 until October 1994, Mr. Noonan held
high-level sales and marketing positions at Dun & Bradstreet Software, a
developer of enterprise business software. Prior to 1989, Mr. Noonan co-founded
Actuation Electronics, a motion control company for precision applications, and
founded Leapfrog Technologies, an object-oriented software development tools
company for networked applications. Mr. Noonan holds a B.S. in mechanical
engineering from the Georgia Institute of Technology and a C.S.S. in business
administration and management from Harvard University.
MR. KLAUS founded ISS in April 1994 and served as our President until
August 1995 and as our Chief Executive Officer until November 1996. Mr. Klaus
continues to serve as our Chief Technology Officer and as a director. Prior to
founding our company, Mr. Klaus developed a shareware version of Internet
Scanner while attending the Georgia Institute of Technology.
MR. MACCHIA has been our Vice President and Chief Financial Officer since
December 1997. From December 1989 until December 1997, Mr. Macchia was employed
by First Financial Management Corporation as its Executive Vice President
(Finance), and by First Data Corporation as its Senior Vice President (Finance)
following its merger with First Financial Management Corporation. Mr. Macchia
received a B.B.A. in accounting from the University of Notre Dame.
MR. COOLEY has served as our Vice President (Engineering) since January
1996. Mr. Cooley has over 20 years of executive-level experience in software
development and customer support, most recently as a founding partner for Value
Sourcing Group, an Atlanta-based management consultancy specializing in
information technology, from 1995 to 1996. Prior to that, Mr. Cooley was
employed by Dun & Bradstreet Software for over 16 years where he held various
management and executive-level positions in marketing, development and support,
and ended his tenure as Chief Information Officer. Mr. Cooley holds a B.S. in
industrial engineering from the Georgia Institute of Technology.
MR. MCNEIGHT has served as our Vice President (Americas Sales) since August
1996. Prior to joining our company, Mr. McNeight was employed for more than 20
years in various sales, sales management and
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<PAGE> 46
executive management positions with technology and service companies, having
most recently been a principal in The Complex Sale, a strategic sales consulting
and training firm, from December 1995 to August 1996. In 1995, Mr. McNeight was
Senior Vice President, Americas Operations, for TSW International, Inc., a
supplier of plant performance and maintenance management software. Additionally,
Mr. McNeight was Chief Executive Officer of Aurum Software Inc., a provider of
sales, marketing and customer service software that was subsequently acquired by
Baan Company, from 1993 to 1994 and, prior to that, spent 13 years at Dun &
Bradstreet, ending his tenure there as Executive Vice President for the
Americas. Mr. McNeight serves on the board of directors of Firstwave
Technologies, Inc. Mr. McNeight has a B.S. in chemistry from Oklahoma State
University and an M.S. in management information sciences from Texas Christian
University.
MR. BOGAERTS joined us as our Vice President (Europe) in February 1996.
Before joining us, Mr. Bogaerts was an independent technology consultant from
September 1995 to February 1996, and prior to that held sales, marketing and
strategic marketing, and general management positions with Dun & Bradstreet
Software from 1992 to September 1995, and with Ethica N.V., an enterprise IT
management and consulting firm, from 1989 to 1992. Mr. Bogaerts received a
degree in applied economics and management sciences from the University of
Leuven, Belgium, and an M.B.A. through a joint program of the University of
Leuven, the University of Chicago and Cornell University Business Schools.
MR. LIN has served as our Vice President (Asia/Pacific) since January 1997
and manages the Company's Asia/Pacific operations from the Company's office in
Tokyo. Mr. Lin has over 20 years of sales and marketing experience in the
Asia/Pacific software market. From 1984 to December 1996, he held a number of
sales, marketing and development positions with Dun & Bradstreet Technology Asia
(formerly known as Ashisuto KK), most recently as its Vice President and General
Manager of Sales and Operations. Mr. Lin holds a B.A. in business administration
from Aoyama Gakuin University in Tokyo.
MR. BODMAN joined our Board in July 1997. Since May 1996, Mr. Bodman has
served as the Managing General Partner of AT&T Ventures, LLC, which manages
numerous venture capital investments. Before joining AT&T Ventures, LLC, Mr.
Bodman served AT&T Corporation in various senior management positions. Mr.
Bodman serves on the board of directors of several public companies, including
Tyco International, Inc., LIN Television, Inc., NHP, Inc., Reed Elsevier plc.
and Young & Rubicam, and several private companies. Mr. Bodman holds a B.S. in
engineering from Princeton University and an M.S. in industrial management from
the Massachusetts Institute of Technology.
MR. DAVOLI has been a director since February 1996. Mr. Davoli has been a
general partner of or an advisor to Sigma Partners, a venture capital firm,
since January 1995. Mr. Davoli was President and Chief Executive Officer of
Epoch Systems, Inc., a client/server storage management provider, from February
1993 to September 1994. From May 1986 through June 1992, Mr. Davoli was the
President and Chief Executive Officer of SQL Solutions, a relational database
management systems consulting and tools company that he founded and sold to
Sybase, Inc. in January 1990. Mr. Davoli serves as a director of several
privately held companies. Mr. Davoli received a B.A. in history from Ricker
College.
MR. O'CONNOR has served as a director since October 1995. Mr. O'Connor has
been the Chief Executive Officer and Chairman of DoubleClick Inc., a provider of
Internet advertising services, since January 1996. From September 1994 to
December 1995, Mr. O'Connor served as Director of Research for Digital
Communications Associates, a data communications company (now Attachmate
Corporation), and from April 1992 to September 1994, as its Chief Technical
Officer and Vice President, Research. From its inception in May 1983 until its
sale in April 1992, Mr. O'Connor served as Vice President, Research of
Intercomputer Communications
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<PAGE> 47
Corp., a software development company. Mr. O'Connor received his B.S. in
electrical engineering from the University of Michigan.
MR. STROHM has served as a director since January 1996. Since 1980, Mr.
Strohm has been an employee of Greylock Management Corporation, a venture
capital group, and has been a general partner of several venture capital funds
affiliated with Greylock. Mr. Strohm currently serves as a director of
DoubleClick, Banyan Systems, Inc., an enterprise networking software company,
and Legato Systems, Inc., a data storage management software company. Mr. Strohm
received his B.A. from Dartmouth College and his M.B.A. from Harvard Business
School.
CLASSES OF DIRECTORS
Our charter and bylaws provide that the size of the board shall be
determined by resolution of the board. The board is currently composed of six
members. Each director holds office until their next election at an annual
meeting of stockholders or until his or her successor is duly elected and
qualified. Our charter and bylaws also provide that, beginning with our 1999
annual meeting of stockholders, the board will be divided into three classes
serving staggered three-year terms as follows:
<TABLE>
<CAPTION>
CLASS CURRENT DIRECTORS NEXT ELECTION
- ----- ----------------- -------------
<C> <S> <C>
I Messrs. Bodman 1999 Annual
and O'Connor Meeting
II Messrs. Noonan 2000 Annual
and Strohm Meeting
III Messrs. Davoli 2001 Annual
and Klaus Meeting
</TABLE>
BOARD COMMITTEES
The board established an audit committee in January 1998. The current
members of the audit committee are Messrs. Bodman, Davoli and Noonan. The audit
committee reviews, acts on and reports to the board with respect to various
auditing and accounting matters, including the selection of the auditors, the
scope of the annual audits, fees to be paid to the auditors, the performance of
the independent auditors and our accounting practices.
The board established a compensation committee in February 1996 and
re-authorized it in January 1998. The current members of the compensation
committee are Messrs. Davoli, O'Connor and Strohm. The compensation committee
determines the salaries and incentive compensation of our officers and provides
recommendations for the salaries and incentive compensation of our other
employees. The compensation committee also administers our various incentive
compensation, stock and benefit plans.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The board established a compensation committee in February 1996. During
1997, Messrs. Davoli, O'Connor and Strohm served as members of the compensation
committee. None of these individuals has served at any time as one of our
officers or employees. Prior to the establishment of the compensation committee,
all decisions relating to executive compensation were made by the board. For a
description of the transactions between us and members of the compensation
committee and entities affiliated with such members, see "Certain Transactions".
None of our executive officers serve as a member of the board of directors or
compensation committee of any entity which has one or more executive officers
serving as a member of the board or compensation committee.
COMPENSATION OF DIRECTORS
Except for grants of stock options, directors generally do not receive
compensation for services rendered as a director. We also do not pay
compensation for committee participation or special assignments of the board. We
reimburse each director for all out-of-pocket expenses incurred in attending
meetings of the board and committees thereof. Non-employee board members receive
option grants at periodic intervals under the automatic option grant program of
our stock option plan and also are eligible to receive discretionary option
grants under the discretionary option grant program
45
<PAGE> 48
of such plan. See "-- Our Stock Option Plan".
On December 8, 1997, we granted to each of Messrs. Bodman, Davoli, O'Connor
and Strohm an option to purchase 20,000 shares of common stock at an exercise
price of $7.00 per share. These options are immediately exercisable for all of
the option shares. However, the shares purchasable upon exercise of the options
are unvested, and subject to repurchase at the option exercise price paid per
share, upon an early termination of the optionee's board service. The shares
subject to each option grant will vest as to 25% of the option shares upon the
optionee's completion of each year of board service after the grant date. These
options expire 10 years from the grant date, subject to earlier termination
following the cessation of the optionee's board service. These options will
immediately vest in the event of either certain changes in the ownership or
control of our company (except upon assumption of such options by the
successor), or the death or disability of the optionee while serving as a board
member.
INDEMNIFICATION
The bylaws provide for indemnification of directors and officers to the
fullest extent permitted by Delaware law, except if limited by contract. We have
indemnification agreements with all of our directors and have purchased
directors' and officers' liability insurance. In addition, our charter limits
the personal liability of board members to our company or our stockholders for
breaches of the directors' fiduciary duties to the fullest extent permitted by
Delaware law. See "Description of Securities -- Certain Anti-Takeover, Limited
Liability and Indemnification Provisions".
EMPLOYMENT CONTRACTS AND CHANGE IN CONTROL ARRANGEMENTS
Our officers serve at the discretion of the board. We do not presently
have an employment contract in effect with any of our executive officers. The
compensation committee, as plan administrator of our stock option plan, has the
authority to accelerate vesting of the shares of common stock subject to
outstanding options held by the chief executive officer and our other executive
officers or any unvested shares actually held by those individuals under our
stock option plan, in the event that we are acquired by merger, consolidation or
asset sale or there is a change in control effected by a successful tender or
exchange offer for more than 50% of our outstanding voting securities or a
change in the majority of the board as a result of one or more contested
elections for board membership. Alternatively, the compensation committee may
condition such accelerated vesting upon the individual's position with us being
replaced with a lesser position or the termination of the individual's service
within a designated period following the acquisition or takeover. In addition,
we have agreements with certain management members regarding acceleration of
option vesting in the event of the consummation of a transaction that results in
a change of control.
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<PAGE> 49
EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE. The following table provides certain summary
information concerning the compensation earned by our chief executive officer
and certain other executive officers (collectively,
the "Named Officers") whose salary and bonus exceeded $100,000 for services
rendered in all capacities to us and our subsidiaries during 1997 and 1998.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
ANNUAL COMPENSATION ---------------------
-------------------- SECURITIES UNDERLYING
NAME AND PRINCIPAL POSITION(S) YEAR SALARY BONUS OPTIONS
- -------------------------------------------------- ---- -------- ------- ---------------------
<S> <C> <C> <C> <C>
Thomas E. Noonan.................................. 1998 $185,486 $95,000 120,000
President, Chief Executive Officer and Chairman 1997 130,000 60,000 --
of the Board
Alex Bogaerts..................................... 1998 100,000 104,401 --
Vice President (Europe) 1997 89,000(1) 76,000(1) 25,000
Lin Ja Hong....................................... 1998 110,000 62,642 15,000
Vice President (Asia/Pacific) 1997 110,000 43,890 27,500
Richard Macchia................................... 1998 135,000 35,320 --
Vice President and Chief Financial Officer 1997 1,688(2) -- --
M. Thomas McNeight................................ 1998 125,000 240,874 --
Vice President (Americas Sales) 1997 125,000 91,300 --
</TABLE>
- ---------------
(1) Mr. Bogaerts' compensation, other than options, was paid to a consulting
company owned by Mr. Bogaerts.
(2) Mr. Macchia joined our company in December 1997.
OPTION GRANTS IN LAST YEAR. The following table provides certain
information concerning stock options granted to each of the Named Officers
during 1998. No stock appreciation rights were granted to these individuals
during 1998.
OPTION GRANTS IN 1998
<TABLE>
<CAPTION>
% OF TOTAL POTENTIAL REALIZABLE VALUE AT
NUMBER OF OPTIONS ASSUMED ANNUAL RATES OF
SECURITIES GRANTED EXERCISE MARKET STOCK PRICE APPRECIATION FOR
UNDERLYING TO PRICE PRICE OPTION TERM(1)
OPTIONS EMPLOYEES PER PER EXPIRATION -----------------------------
NAME GRANTED IN 1998 SHARE SHARE DATE 5% 10%
- --------------------------- ----------- ---------- -------- ------ ---------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Thomas E. Noonan........... 20,000(2) 2.1% $22.00 $20.00 3/13/2003 $ 121,564 $ 268,624
100,000(3) 10.4 20.00 20.00 3/13/2008 1,257,789 3,187,485
Alex Bogaerts.............. -- -- -- -- -- -- --
Lin Ja Hong................ 15,000(4) 1.6 20.00 20.00 3/13/2008 188,668 478,123
Richard Macchia............ -- -- -- -- -- -- --
M. Thomas McNeight......... -- -- -- -- -- -- --
</TABLE>
- ---------------
(1) Future value assumes appreciation in the market value of the common stock of
5% and 10% per year over the ten-year option period as mandated by the rules
and regulations of the Securities and Exchange Commission and does not
represent our estimate or projection of the future value of our common
stock. The actual value realized may be greater than or less than the
potential realizable values set forth in the table.
(2) The option is immediately exercisable with respect to 5,000 shares and
becomes exercisable for an additional 5,000 shares on January 1 of each of
1999, 2000 and 2001. The option shares are initially unvested and subject to
repurchase by us. Our repurchase right shall lapse with respect to, and Mr.
Noonan shall vest in all of the option shares on March 12, 2003, provided
that Mr. Noonan remains in our service through such date. In addition, our
repurchase right lapses on an accelerated basis based upon achievement of
prescribed revenue levels. Based upon 1998 revenues, 5,000 additional shares
vested on December 31, 1998.
(3) The option is exercisable in its entirety on March 12, 2004, subject to
acceleration based upon achievement of prescribed revenue levels. Based upon
our 1998 revenues, 25,000 shares became exercisable on December 31, 1998.
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<PAGE> 50
(4) The shares underlying these options vest 25% per year over a four-year
period and are subject to repurchase by us at the exercise price should Mr.
Lin cease his employment with us prior to full vesting. If we are acquired
by merger, consolidation or asset sale, the option shares will accelerate in
full unless the successor assumes these options. In the event that the
successor assumes these options, if within 12 months following the
acquisition, Mr. Lin's position is reduced to a lesser position or Mr. Lin's
employment is involuntarily terminated, the option shares will accelerate in
part so that the next annual installment of option shares scheduled to vest
will immediately vest in full and, to the extent Mr. Lin continues in our
service, each installment of option shares scheduled to vest thereafter will
vest on each subsequent anniversary of the acceleration date. Each option
expires on the earlier of ten years from the date of grant or termination of
Mr. Lin's employment with us. All options were granted at fair market value
as determined by the board on the date of grant.
AGGREGATE OPTION EXERCISES IN 1998 AND YEAR-END OPTION VALUES. The
following table provides certain information concerning option exercises and
option holdings for the fiscal year ended December 31, 1998 with respect to each
of the Named Officers.
AGGREGATE 1998 OPTION EXERCISES AND YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
SHARES UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
ACQUIRED OPTIONS AT DECEMBER 31, 1998 AT DECEMBER 31, 1998(1)
ON VALUE ---------------------------- ---------------------------
NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- --------------------- -------- --------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Thomas E. Noonan..... -- $ -- 35,000(2) 85,000(2) $1,205,000 $2,955,000
Alex Bogaerts........ 16,250 519,969 28,750(3) -- 1,568,500 --
Lin Ja Hong.......... -- -- 27,500(3) 15,000 1,448,000 525,000
Richard Macchia...... -- -- 125,000(3) -- 6,000,000 --
M. Thomas McNeight... 100,000 2,742,356 135,000(3) -- 7,404,750 --
</TABLE>
- ---------------
(1) Value determined by subtracting the exercise price from the closing price
per share of the common stock on the Nasdaq National Market on December 31,
1998 ($55.00 per share).
(2) Mr. Noonan's options vest as described in footnotes (2) and (3) to the table
captioned "Option Grants in 1998".
(3) The shares purchasable upon exercise of these options are subject to
repurchase by us at the exercise price upon the optionee's termination of
employment prior to vesting in the shares. Our repurchase right lapses with
respect to, and the optionee vests in, 25% of the option shares upon the
optionee's completion of each year of service. As of December 31, 1998, the
number of exercisable vested option shares for each named officer was as
follows: Mr. Bogaerts -- no shares; Mr. Lin -- 6,875 shares; Mr.
Macchia -- 31,250 shares; Mr. McNeight -- 17,500 shares.
OUR STOCK OPTION PLAN
The board of directors of Internet Security Systems, Inc. first adopted the
Restated 1995 Stock Incentive Plan on September 6, 1995, and its stockholders
approved this stock option plan on January 31, 1996. On December 8, 1997, we
assumed this stock option plan and all outstanding options thereunder and
converted such options on a share-for-share basis into options to purchase
shares of our common stock. As of December 31, 1998, we had reserved 3,000,000
shares of common stock for issuance under our stock option plan. We will
automatically increase this share reserve on the first trading day of each
calendar year beginning with 1999 by an amount equal to three percent of the
number of shares of common stock outstanding on the last trading day of the
immediately preceding calendar year. Accordingly, on January 4, 1999, 518,762
additional shares of common stock were reserved for issuance under our stock
option plan. No single participant in our stock option plan may receive option
grants or direct stock issuances for more than 300,000 shares per calendar year.
Our stock option plan has three separate components:
- - the discretionary option grant program, which allows the plan administrator to
grant options to purchase shares of common stock to eligible individuals at an
exercise price equal to, greater than or less than their fair market value on
the grant date;
- - the stock issuance program, which allows the plan administrator to issue
shares of
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<PAGE> 51
common stock directly to eligible individuals for a price equal to, greater
than or less than their fair market value at the time of issuance, or as a
bonus for services rendered; and
- - the automatic option grant program, which automatically grants options to
purchase shares of common stock at an exercise price equal to 100% of the fair
market value of such shares on the grant date at periodic intervals to
eligible non-employee board members.
The compensation committee of the board administers the discretionary
option grant program and the stock issuance program. The compensation committee,
as current plan administrator, has complete discretion to determine:
- - which eligible individuals are to receive option grants or stock issuances;
- - the time or times when such option grants or stock issuances are to be made;
- - the number of shares subject to each such grant or issuance;
- - the status of any granted option as either an incentive stock option or a
non-statutory stock option under the federal tax laws;
- - the vesting schedule to be in effect for the option grant or stock issuance;
and
- - the maximum term for which any granted option is to remain outstanding.
The administration of the automatic option grant program is self-executing
in accordance with its express provisions.
The exercise price for the shares of common stock subject to option grants
made under our stock option plan may be paid in cash or in shares of common
stock (held for the requisite period necessary to avoid a charge to our earnings
for financial reporting purposes) valued at fair market value on the exercise
date. The option may also be exercised through a same-day sale program without
any cash outlay by the optionee. In addition, the plan administrator may provide
financial assistance to optionees in the exercise of outstanding options by
allowing optionees to deliver a full-recourse, interest-bearing promissory note
in payment of the exercise price and any associated withholding taxes incurred
in connection with such exercise. During the 90-day period following the date of
this prospectus, optionees exercising options under our stock option plan will
be required to enter into lock-up agreements with the representatives of the
underwriters.
If our company is acquired by merger, consolidation or asset sale, each
outstanding option under the discretionary option grant program which is not to
be assumed by our successor will automatically become fully exercisable, and all
unvested shares under the stock issuance program will immediately vest, except
to the extent our repurchase rights with respect to those shares are to be
assigned to our successor. In the event an outstanding option is assumed and our
repurchase rights are assigned to our successor, and within 12 months following
the merger, consolidation or asset sale, either the optionee is offered a lesser
position compared to the position held by the optionee prior to the acquisition
or the optionee's service is terminated, either involuntarily or through
resignation as a result of being offered a lesser position, then the option will
accelerate in part so that it will become immediately exercisable with respect
to the next annual installment of option shares scheduled to vest. The plan
administrator also has the authority under the discretionary option grant and
stock issuance programs to grant options and to structure repurchase rights so
that the shares subject to those options or repurchase rights will automatically
vest in the event the individual is offered a lesser position or the
individual's service is terminated, whether involuntarily or through a
resignation as a result of being offered a lesser position, within a specified
period (not to exceed 12 months) following a change in control effected by a
successful tender offer for more than 50% of the outstanding voting stock or by
proxy contest for the election of directors. The plan administrator also has the
discretion to provide for the automatic acceleration of outstanding options and
the lapse of any outstanding repurchase rights
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<PAGE> 52
upon certain changes in the ownership or control of our company.
In February 1998, we entered into an Amended and Restated Agreement
Regarding Acceleration of Vesting of Future Optionees with Greylock Equity
Limited Partnership ("Greylock"), Sigma Associates III, L.P., Sigma Investors
III, L.P. and Sigma Partners III, L.P. (collectively, the "Sigma Entities"),
AT&T Venture Fund II, L.P. and Venture Fund I, L.P. (collectively, the "AT&T
Entities") and Kleiner, Perkins, Caufield & Byers VIII, KPCB Information
Sciences Zaibatsu Fund II and KPCB Java Fund (collectively, the "KPCB Entities")
which provides that, in all option grants made after the date of the agreement,
we will provide that no more than the greater of (i) 50% of the unvested shares
issued pursuant to such grant or (ii) the options which would be vested in such
optionee's next vesting installment may become immediately vested in the event
that (x) we sell, convey or otherwise dispose of all or substantially all of our
property or business, or merge into or effect a reorganization with any
corporation (other than a wholly-owned subsidiary corporation) in which our
stockholders immediately prior to the transaction possess less than 50% of the
voting power of the surviving entity (or its parent), and (y) the optionee is
not offered a position with the surviving entity which (I) offers compensation
equivalent to or greater than that provided to the optionee by us immediately
prior to the change in control, and (II) offers duties and responsibilities
comparable to those associated with the position held by the optionee with us
immediately prior to the change in control such that the duties and
responsibilities of the optionee with the surviving entity are not materially
diminished from those of the optionee at our company.
The discretionary option grant program authorizes the issuance of stock
appreciation rights, which provide their holders with the election, subject to
the plan administrator's approval, to surrender their outstanding options for an
appreciation distribution from us equal to the excess of the fair market value
of the vested shares of common stock subject to the surrendered option over the
aggregate exercise price payable for such shares. In addition, the plan
administrator has the authority to grant to certain officers and directors
limited stock appreciation rights which, upon a hostile takeover (as defined in
our stock option plan), generally provide the holders with the automatic right
to surrender his or her outstanding options for an appreciation distribution
from us equal to the excess of the tender price paid in the hostile takeover for
the vested shares subject to the surrendered options over the aggregate exercise
price payable for such shares. Such appreciation distribution may be made in
cash or in shares of common stock.
The plan administrator also has the authority to effect the cancellation of
outstanding options under the discretionary option grant program with the
consent of the affected option holders in return for the grant of new options
for the same or different number of option shares with an exercise price per
share based upon the fair market value of the common stock on the new grant
date.
Under the automatic option grant program, each individual who first joins
the board as a non-employee director will receive an option to purchase 20,000
shares of common stock on the date he or she is first elected or appointed to
the board, provided he or she has not otherwise been in our prior employ. In
addition, at each annual stockholders meeting each individual who is to continue
to serve as a non-employee board member after the meeting will receive an
additional option to purchase 2,500 shares of common stock.
Each automatic grant will have a term of 10 years, subject to earlier
termination following the optionee's cessation of board service. Each automatic
option will be immediately exercisable; however, any shares purchased upon
exercise of the option will be subject to repurchase by us should the optionee's
service as a non-employee board member cease prior to vesting in the shares. An
initial 20,000-share grant will vest in four equal successive annual
installments over an optionee's period of board service. However, the shares
subject to each initial automatic
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grant will immediately vest upon certain changes in the ownership or control of
our company or upon the death or disability of the optionee while serving as a
board member. Each additional 2,500-share grant will vest immediately.
The board may amend or modify our stock option plan at any time. Our stock
option plan will terminate on the earliest of September 6, 2005, the date on
which all available shares have been issued as vested shares or the termination
of all outstanding options in connection with certain changes in the ownership
or control of our company.
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CERTAIN TRANSACTIONS
SALE OF SERIES A PREFERRED STOCK
In February 1996, we sold an aggregate of 3,650,000 shares of our Series A
preferred stock for $1.00 per share in a private placement exempt from
registration under Section 4(2) of the Securities Act of 1933. The purchasers of
the Series A preferred stock included, among others, Greylock and the Sigma
Entities. The Series A preferred stock automatically converted into common stock
on a one-for-one basis upon the completion of our initial public offering.
Concurrently with the closing of the financing, David N. Strohm, an employee of
Greylock and the general partner of several venture capital funds associated
with Greylock, and Robert E. Davoli, a general partner of the Sigma Entities,
joined the board.
In connection with the sale of the Series A preferred stock, we entered
into an agreement with Greylock and Sigma Partners concerning certain of the
shares of the common stock sold by the underwriters of the initial public
offering of the common stock to persons designated by us ("Directed Shares").
This agreement required us to use our best efforts to cause Greylock and the
Sigma Entities to receive up to 100,000 Directed Shares at the initial public
offering price. Pursuant to this right, Greylock and the Sigma Entities
purchased 36,488 and 27,674 Directed Shares, respectively, in our initial public
offering. Also in connection with the 1996 Series A preferred stock financing,
we:
- - entered into an Agreement Regarding Acceleration of Vesting of Future
Optionees with Greylock and the Sigma Entities, which was later amended and
restated to make certain technical clarifications;
- - entered into a Rights Agreement, which was amended and restated in connection
with the sale of our Series B preferred stock; and
- - repurchased 100,000 shares of common stock from Christopher W. Klaus, a
founder, officer and director of the Company, for $15,000.
SALE OF SERIES B PREFERRED STOCK
In February 1997, we sold an aggregate of 2,086,957 shares of our Series B
preferred stock for $2.53 per share in a private placement exempt from
registration under Section 4(2) of the Securities Act of 1933. The purchasers of
the Series B preferred stock included, among others, Greylock, the Sigma
Entities, the AT&T Entities and the KPCB Entities. The Series B preferred stock
automatically converted into common stock on a one-for-one basis upon the
closing of our initial public offering. Richard S. Bodman, the managing general
partner of the AT&T Entities, joined our board in July 1997.
In connection with the sale of the Series B preferred stock, we entered
into an agreement with the AT&T Entities and Kleiner, Perkins, Caufield & Byers
("KPCB") concerning Directed Shares. This agreement required us to use our best
efforts to cause the AT&T Entities and KPCB to receive up to 100,000 Directed
Shares at the initial public offering price. Pursuant to this right, the AT&T
Entities and KPCB purchased 15,141 and 19,789 Directed Shares, respectively, in
our initial public offering.
In connection with the sale of the Series B preferred stock, we also
entered into an Agreement Regarding Acceleration of Vesting of Future Optionees
with the AT&T Entities and the KPCB Entities, which was later amended and
restated to make certain technical clarifications. We also entered into an
Amended and Restated Rights Agreement. Pursuant to this agreement, purchasers of
the Series A preferred stock and Series B preferred stock have the right,
subject to certain conditions and limitations, to require us to file a
registration statement, including, if requested, a shelf registration statement,
under the Securities Act of 1933 in order to register all or part of their
shares of common stock. In certain circumstances, we may defer such
registrations, and the underwriters have the right, subject to certain
limitations, to limit the number of shares included in such registrations. In
the event that we propose to register any of our securities under the
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Securities Act of 1933, either for our account or for the account of other
security holders, the purchasers of the Series A preferred stock and Series B
preferred stock and certain holders of the common stock, including Christopher
W. Klaus, Thomas E. Noonan and Kevin J. O'Connor, are entitled to include their
shares of common stock in such registration, subject to marketing and other
limitations. Generally, we are required to bear all expenses associated with
such registrations.
AMENDED AND RESTATED AGREEMENT REGARDING ACCELERATION OF FUTURE OPTIONEES
In February 1998, we entered into an Amended and Restated Agreement
Regarding Acceleration of Vesting of Future Optionees with Greylock, the Sigma
Entities, the AT&T Entities and the KPCB Entities which restricts the
acceleration of vesting of shares subject to options in certain situations. For
a more detailed description of this agreement, see "Management -- Our Stock
Option Plan".
FUTURE TRANSACTIONS
All future transactions, including loans, between us and our officers,
directors, principal stockholders and their affiliates, will be approved by a
majority of the board, including a majority of the independent and disinterested
outside directors on the board, and will continue to be on terms no less
favorable to us than could be obtained from unaffiliated third parties.
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PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information regarding beneficial
ownership of the common stock as of January 28, 1999 adjusted to reflect the
sale of shares offered hereby for
- - each person who is known by us to own beneficially more than five percent of
the common stock;
- - each Named Officer;
- - each director;
- - each selling stockholder; and
- - all current executive officers and directors as a group.
Unless otherwise indicated, the address for the following stockholders is
c/o ISS Group, Inc., 6600 Peachtree-Dunwoody Road, 300 Embassy Row, Suite 500,
Atlanta, Georgia 30328.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED BEFORE THE OWNED AFTER THE
OFFERING NUMBER OFFERING(1)(2)
------------------------ OF SHARES -----------------------
BENEFICIAL OWNER NUMBER PERCENTAGE OFFERED NUMBER PERCENTAGE
- ----------------------------------- ----------- ---------- --------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Christopher W. Klaus............... 3,915,276 22.6% 800,000 3,115,276 16.8%
Ark Asset Management Co., Inc.(3).. 2,740,000 15.8 -- 2,740,000 14.8
Thomas E. Noonan(4)................ 1,621,070 9.3 140,000 1,481,070 8.0
Greylock Equity Limited
Partnership(5)................... 885,991 5.1 -- 885,991 4.8
Alex Bogaerts(6)................... 42,600 * 3,000 39,600 *
Lin Ja Hong(7)..................... 31,250 * 2,500 28,750 *
Richard Macchia(8)................. 125,600 * 12,500 113,100 *
M. Thomas McNeight(9).............. 135,000 * 17,000 118,000 *
Richard S. Bodman(10).............. 281,638 1.6 -- 281,638 1.5
Robert E. Davoli(11)............... 841,762 4.9 -- 841,762 4.5
Kevin J. O'Connor(12).............. 473,980 2.7 70,000 403,980 2.2
David N. Strohm(5)................. 885,991 5.1 -- 885,991 4.8
Nancy Blair(13).................... 157,500 * 20,000 137,500 *
H. Keith Cooley(14)................ 130,000 * 30,000 100,000 *
Glenn M. McGonnigle(15)............ 166,590 * 60,000 106,590 *
Charles Meyers(16)................. 90,000 * 20,000 70,000
Patrick J.D. Taylor(17)............ 59,500 * 25,000 34,500 *
All directors and officers as a
group (11 persons)(18)........... 8,484,167 47.5 1,075,000 7,409,167 38.9
</TABLE>
- ---------------
* Indicates less than 1%.
(1) Assumes no exercise of the underwriters' over-allotment option.
(2) Beneficial ownership is calculated in accordance with the rules of the
Securities and Exchange Commission. In computing the number of shares
beneficially owned by a person and the percentage ownership of that person,
shares of common stock subject to options held by that person that are
currently exercisable or become exercisable within 60 days following
January 28, 1999, are deemed outstanding. However, such shares are not
deemed outstanding for the purpose of computing the percentage ownership of
any other person. Unless otherwise indicated in the footnotes to this
table, the persons and entities named in the table have sole voting and
sole investment power with respect to all shares beneficially owned,
subject to community property laws where applicable.
(3) Based solely on information provided by Ark Asset Management Co., Inc. on
its Schedule 13G filed December 9, 1998 with the Securities and Exchange
Commission. The address for Ark Asset Management Co., Inc. is 125 Broad
Street, New York, New York 10004.
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(4) Includes 168,822 shares held in family trusts and options immediately
exercisable for 35,000 shares of common stock.
(5) Includes 83,760 shares of common stock held by Mr. Strohm and 802,231
shares held by Greylock Equity Limited Partnership. The general partner of
Greylock Equity Limited Partnership is Greylock Equity GP Limited
Partnership. Mr. Strohm, a director of our company, is a general partner of
Greylock Equity GP Limited Partnership. Mr. Strohm disclaims beneficial
ownership of the shares held by Greylock Equity Limited Partnership except
to the extent of his pecuniary interest therein arising from his general
partnership interest in Greylock Equity GP Limited Partnership. The address
of Greylock Equity Limited Partnership and Mr. Strohm is c/o Greylock
Equity Limited Partnership, 755 Page Mill Road, Building A, Palo Alto,
California 94304.
(6) Includes options immediately exercisable for 28,750 shares of common stock.
(7) Includes options immediately exercisable for 31,250 shares of common stock.
(8) Includes option immediately exercisable for 125,000 shares of common stock.
(9) Includes options immediately exercisable for 135,000 shares of common
stock.
(10) Includes 66 shares of common stock and options immediately exercisable for
20,000 shares of common stock held by Mr. Bodman and 261,572 shares held by
AT&T Venture Fund II, L.P. The general partner of AT&T Venture Fund II,
L.P. is Venture Management LLC. Mr. Bodman is a managing member of Venture
Management LLC. Mr. Bodman disclaims beneficial ownership of the shares
held by AT&T Venture Fund II, L.P. except to the extent of his pecuniary
interest therein arising from his management interest in Venture Management
LLC. Mr. Bodman's address is c/o AT&T Ventures, L.L.C., Two Wisconsin
Circle, Chevy Chase, Maryland 20815.
(11) Includes 49,340 shares of common stock and options immediately exercisable
for 20,000 shares of common stock held by Mr. Davoli, 125,472 shares held
by Sigma Associates III, L.P., 10,175 shares held by Sigma Investors III,
L.P. and 636,775 shares held by Sigma Partners III, L.P. Mr. Davoli, a
director of our company, is also a general partner of Sigma Management III,
L.P., which is the general partner of Sigma Associates III, L.P., Sigma
Investors III, L.P. and Sigma Partners III, L.P. Mr. Davoli disclaims
beneficial ownership of the shares held by Sigma Associates III, L.P.,
Sigma Investors III, L.P. and Sigma Partners III, L.P. except to the extent
of his pecuniary interest therein arising from his general partnership
interest in Sigma Management III, L.P. The address of Mr. Davoli and the
Sigma Entities is 20 Custom House Street, Suite 830, Boston, Massachusetts
02110.
(12) Includes options immediately exercisable for 20,000 shares of common stock.
In addition to the number of shares shown as offered for sale in the table,
Mr. O'Connor has granted the underwriters the right to purchase up to an
additional 20,000 shares pursuant to the underwriters' over-allotment
option. Mr. O'Connor's address is c/o DoubleClick Inc., 41 Madison Avenue,
New York, New York 10010.
(13) Includes options immediately exercisable for 157,500 shares of common
stock.
(14) Includes options immediately exercisable for 130,000 shares of common
stock.
(15) Includes options immediately exercisable for 85,500 shares of common stock.
In addition to the number of shares shown as offered for sale in the table,
Mr. McGonnigle has granted the underwriters the right to purchase up to an
additional 10,000 shares pursuant to the underwriters' over-allotment
option.
(16) Includes options immediately exercisable for 90,000 shares common stock.
(17) Includes options immediately exercisable for 14,500 shares of common stock.
(18) Includes options immediately exercisable for 545,000 shares of common
stock.
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DESCRIPTION OF SECURITIES
AUTHORIZED AND OUTSTANDING CAPITAL STOCK
Our authorized capital stock consists of 50,000,000 shares of common stock,
par value $0.001 per share, and 20,000,000 shares of preferred stock, par value
$0.001 per share. Upon consummation of this offering, no shares of preferred
stock and 18,557,487 shares of common stock (18,887,487 shares if the
underwriters' over-allotment option is exercised in full) will be outstanding.
The following summary is qualified in its entirety by reference to our charter
and bylaws, copies of which are filed as exhibits to the registration statement
of which this prospectus is a part.
COMMON STOCK
As of December 31, 1998, there were 17,292,087 shares of common stock
outstanding that were held by 201 stockholders of record. The holders of common
stock are entitled to one vote per share on all matters to be voted upon by the
stockholders. Subject to preferences that may be applicable to any outstanding
preferred stock, the holders of common stock are entitled to receive ratably
such dividends, if any, as may be declared from time to time by the board out of
funds legally available therefor. In the event of liquidation, dissolution or
winding up, the holders of common stock are entitled to share ratably in all
assets remaining after payment of liabilities, subject to prior distribution
rights of preferred stock, if any, then outstanding. The common stock has no
preemptive or conversion rights or other subscription rights. There are no
redemption or sinking fund provisions applicable to the common stock. All
outstanding shares of common stock are fully paid and nonassessable, and the
shares of common stock to be issued upon completion of this offering will be
fully paid and nonassessable.
PREFERRED STOCK
The board has the authority to issue the preferred stock in one or more
series and to fix the rights, preferences, privileges and restrictions thereof,
including dividend rights, dividend rates, conversion rights, voting rights,
terms of redemption, redemption prices, liquidation preferences and the number
of shares constituting any series or the designation of such series, without
further vote or action by the stockholders. The issuance of preferred stock may
have the effect of delaying, deferring or preventing a change in control of our
company without further action by the stockholders and may adversely affect the
voting and other rights of the holders of common stock. The issuance of
preferred stock with voting and conversion rights may adversely affect the
voting power of the holders of common stock, including the loss of voting
control to others. At present, we have no plans to issue any shares of preferred
stock.
STOCK OPTIONS
As of December 31, 1998, options to purchase a total of 2,379,670 shares of
common stock were outstanding. The total number of shares of common stock that
may be subject to the granting of options under our stock option plan shall be
equal to 3,000,000 shares plus the number of shares with respect to options
previously granted under our stock option plan that terminate without being
exercised, expire, are forfeited or canceled, and the number of shares of common
stock that are surrendered in payment of any options or any tax withholding
requirements. In addition, on the first trading date of each year, the share
reserve will be increased by an amount equal to three percent of the total
number of shares of common stock outstanding on the last trading day of the
immediately preceding calendar year. Pursuant to this automatic increase
provision, on January 4, 1999 an additional 518,762 shares of common stock were
reserved for issuance under our stock option plan. See "Management -- Our Stock
Option Plan" and "Shares Eligible for Future Sale".
On May 21, 1998, we filed a registration statement with the Securities and
Exchange Commission pursuant to which we registered
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<PAGE> 59
the 3,000,000 shares of common stock issued or issuable at that time upon the
exercise of options granted under our stock option plan. Such registration
statement became immediately effective upon filing. We have outstanding a large
number of stock options to purchase common stock with exercise prices
significantly below the current market price of the common stock. The possible
sale of a significant number of such shares by the holders thereof may have an
adverse effect on the price of the common stock.
CERTAIN ANTI-TAKEOVER, LIMITED LIABILITY AND INDEMNIFICATION PROVISIONS
SECTION 203 OF THE DELAWARE GENERAL CORPORATION LAW
We are subject to the provisions of Section 203 of the Delaware General
Corporation Law, as amended from time to time. Subject to certain exceptions,
Section 203 prohibits a publicly-held Delaware corporation from engaging in a
"business combination" with an "interested stockholder" for a period of three
years after the date of the transaction in which the person became an interested
stockholder, unless the interested stockholder attained such status with the
approval of the board of directors or unless the business combination is
approved in a prescribed manner. A "business combination" includes mergers,
assets sales and other transactions resulting in a financial benefit to the
interested stockholder. Subject to certain exceptions, an "interested
stockholder" is a person who, together with affiliates and associates, owns, or
within three years did own, 15% or more of the corporation's voting stock. The
statute could prohibit or delay the accomplishment of mergers or other takeover
or change in control attempts with respect to us and, accordingly, may
discourage attempts to acquire our company.
CHARTER AND BYLAW PROVISIONS
Our charter and bylaws include provisions that may have the effect of
discouraging, delaying or preventing a change in control or an unsolicited
acquisition proposal that a stockholder might consider favorable, including a
proposal that might result in the payment of a premium over the market price for
the shares held by stockholders. These provisions are summarized in the
following paragraphs.
CLASSIFIED BOARD OF DIRECTORS. Our charter and bylaws provide for the
board to be divided into three classes of directors serving staggered,
three-year terms. The classification of the board has the effect of requiring at
least two annual stockholder meetings, instead of one, to replace a majority of
board members.
SUPERMAJORITY VOTING. Our charter requires that holders of at least
66 2/3% of our company's combined voting power approve certain amendments to the
charter unless such amendments are approved by a majority of the directors not
affiliated or associated with any person holding (or which has announced an
intention to acquire) 26% or more of the voting power of our outstanding capital
stock. Either a majority of the board or holders of a majority of voting stock
may amend the bylaws, but certain amendments approved by stockholders require
the approval of at least 66 2/3% of our combined voting power unless such
amendments are approved by a majority of the directors not affiliated or
associated with any person holding (or which has announced an intention to
acquire) 26% or more of the voting power of our outstanding capital stock.
AUTHORIZED BUT UNISSUED OR UNDESIGNATED CAPITAL STOCK. Our charter
authorizes 50,000,000 shares of common stock and 20,000,000 shares of preferred
stock. No preferred stock will be designated upon consummation of this offering.
After this offering, 18,512,462 shares of common stock will be outstanding
(18,842,462 shares if the underwriters' over-allotment option is exercised in
full). The authorized but unissued (and in the case of preferred stock,
undesignated) stock may be issued by the board in one or more transactions. In
this regard, our charter grants the board broad power to establish the rights
and preferences of authorized and unissued preferred stock. The issuance of
shares of preferred stock pursuant to the board's authority described
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above could decrease the amount of earnings and assets available for
distribution to holders of common stock and adversely affect the rights and
powers, including voting rights, of such holders and may have the effect of
delaying, deferring or preventing a change in control. The board does not
currently intend to seek stockholder approval prior to any issuance of preferred
stock, unless otherwise required by law.
SPECIAL MEETINGS OF STOCKHOLDERS. Our bylaws provide that special meetings
of our stockholders may be called only by our board, chairman or President.
NO STOCKHOLDER ACTION BY WRITTEN CONSENT. Our charter and bylaws provide
that an action required or permitted to be taken at any annual or special
meeting of the stockholders may only be taken at a duly called annual or special
meeting of stockholders. This provision prevents stockholders from initiating or
effecting any action by written consent, and thereby taking actions opposed by
the board.
NOTICE PROCEDURES. Our bylaws establish advance notice procedures with
regard to all stockholder proposals to be brought before meetings of our
stockholders, including proposals relating to the nomination of candidates for
election as directors, the removal of directors and amendments to our charter or
bylaws. These procedures require notice of such stockholder proposals to be
given timely and in writing to our corporate secretary prior to the meeting.
Generally, to be timely, notice must be received by our corporate secretary not
less than 120 days prior to the meeting. The notice must contain certain
information specified in our bylaws.
OTHER ANTI-TAKEOVER PROVISIONS. See "Management -- Our Stock Option Plan"
for a discussion of certain provisions of our stock option plan which may have
the effect of discouraging, delaying or preventing a change in control or
unsolicited acquisition proposals.
LIMITATION OF DIRECTOR LIABILITY. Our charter limits the liability of
directors (in their capacity as directors but not in their capacity as officers)
to our company and our stockholders to the fullest extent permitted by Delaware
law. Specifically, directors will not be personally liable for monetary damages
for breach of a director's fiduciary duty as a director, except for liability:
- - for any breach of the director's duty of loyalty to our company or our
stockholders;
- - for acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
- - under Section 174 of the Delaware General Corporation Law, which relates to
unlawful payments of dividends or unlawful stock repurchases or redemptions;
or
- - for any transaction from which the director derived an improper personal
benefit.
INDEMNIFICATION ARRANGEMENTS. Our bylaws provide that our directors and
officers shall be indemnified and provide for the advancement to them of
expenses in connection with actual or threatened proceedings and claims arising
out of their status as such to the fullest extent permitted by the Delaware
General Corporation Law. We have entered into indemnification agreements with
each of our directors and executive officers that will provide them with rights
to indemnification and expense advancement to the fullest extent permitted under
the Delaware General Corporation Law.
REGISTRATION RIGHTS
Pursuant to the terms of the Amended and Restated Rights Agreement between
our company and certain existing stockholders, the holders of 2,222,761 shares
of common stock have the right, subject to certain conditions and limitations,
to require us to file a registration statement, including, if requested, a shelf
registration statement, under the Securities Act of 1933 in order to register
all or part of such stockholders' shares of common stock. We may in certain
circumstances defer such registrations, and the underwriters have the right,
subject to certain limitations, to limit the number of
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shares included in such registrations. In the event that we propose to register
any of our securities under the Securities Act of 1933, either for our own
account or for the account of other security holders, certain stockholders
holding 7,189,177 shares of common stock are entitled to include their shares of
common stock in such registration, subject to marketing and other limitations.
Generally, we are required to bear the expense of all such registrations.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the common stock is SunTrust Bank,
Atlanta, located in Atlanta, Georgia.
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SHARES ELIGIBLE FOR FUTURE SALE
Upon the closing of the offering, we will have an aggregate of 18,576,587
shares of common stock outstanding, assuming no exercise of the underwriters'
over-allotment option and no exercise of outstanding options to purchase common
stock after December 31, 1998.
Of these shares, the 3,450,000 shares sold in our IPO in March 1998, the
2,400,000 shares being offered hereby and 5,229,997 shares that have been sold
in accordance with Rule 144 are freely tradeable.
Of the remaining outstanding shares of common stock, (i) approximately
6,982,398 shares are subject to 90-day lock-up agreements, approximately
6,851,580 of which are also "restricted securities" as that term is defined
under Rule 144, and (ii) approximately 514,192 shares are "restricted
securities", as that term is defined under Rule 144, and not subject to lock-up
agreements. The 6,982,398 shares that are subject to 90-day lock-up agreements
will be eligible for immediate sale in the public market without restriction on
their expiration except that the 6,941,308 shares which are also held by our
"affiliates" may only be sold in compliance with the volume and other
limitations of Rule 144.
In general, under Rule 144, a person (or persons whose shares are
aggregated), including an affiliate, who has beneficially owned shares for at
least one year is entitled to sell, within any three-month period commencing 90
days after the date of this prospectus, a number of shares that does not exceed
the greater of 1% of the then outstanding shares of common stock (approximately
185,766 shares immediately after the offering) or the average weekly trading
volume in the common stock during the four calendar weeks preceding the date on
which notice of such sale is filed, subject to certain restrictions. In
addition, a person who is not deemed to have been an affiliate of us at any time
during the 90 days preceding a sale and who has beneficially owned the shares
proposed to be sold for at least two years would be entitled to sell such shares
under Rule 144(k) without regard to the share volume limitations described
above. To the extent that shares were acquired from one of our affiliates, the
acquiring stockholders' holding period for the purpose of effecting a sale under
Rule 144 commences on the date of transfer from the affiliate.
On May 21, 1998, we filed a registration statement with the Commission
pursuant to which it registered the 3,000,000 shares of common stock issued or
issuable upon the exercise of options granted or that may be granted in the
future under our stock option plan, as well as 100,000 shares of common stock
that were subject to options granted pursuant to written compensation agreements
separate from our stock option plan. Such registration statement became
immediately effective upon filing. At December 31, 1998, options to purchase
2,379,670 shares were issued and outstanding under our stock option plan and
options to purchase 60,000 shares were issued and outstanding outside of our
stock option plan, all of which shares will be eligible for sale in the public
market from time to time, subject to vesting and, in the case of certain of such
options, the expiration of lock-up agreements. These stock options generally
have exercise prices significantly below the current market price of the common
stock. The possible sale of a significant number of such shares by the holders
thereof may have an adverse affect on the price of the common stock.
The market price of the common stock after the offering may be
significantly affected by the risks detailed in this prospectus, including, but
not limited to, those set forth under the caption "Risk Factors". In particular,
the stock prices for many high technology companies, especially those that base
their respective businesses on the Internet, recently have experienced wide
fluctuations and extreme volatility which have often been unrelated to the
operating performance of such companies. Such fluctuations have adversely
affected and may in the future adversely affect the market price of the common
stock. Furthermore, following periods of volatility in the market price of a
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company's securities, securities class action claims frequently are brought
against the subject company. To the extent that the market price of the common
stock falls dramatically in any period of time, there is a high likelihood that
claims, with or without merit, will be brought against us. Such litigation would
be very expensive to defend and would divert management attention and resources
regardless of outcome.
61
<PAGE> 64
VALIDITY OF COMMON STOCK
The validity of the common stock offered hereby will be passed upon for ISS
by Brobeck, Phleger & Harrison LLP, Austin, Texas, U.S. counsel to ISS. Certain
legal matters in connection with the offering will be passed upon for the
underwriters by Ropes & Gray, Boston, Massachusetts, U.S. counsel for the
underwriters.
EXPERTS
ISS GROUP, INC.
Ernst & Young LLP, independent auditors, have audited our consolidated
financial statements (and schedule) as of December 31, 1997 and 1998, and for
each of the three years in the period ended December 31, 1998, included herein,
as set forth in their reports, which are also included herein. Our consolidated
financial statements and schedule have been included in reliance on their
reports given on their authority as experts in accounting and auditing.
MARCH INFORMATION SYSTEMS LIMITED
Ernst & Young has audited the consolidated balance sheets of March
Information Systems Limited as of March 31, 1997 and 1998 and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the two years in the period ended March 31, 1998, included herein as set
forth in their report, which is also included herein. These financial statements
have been included in reliance on their report given on their authority as
experts in accounting and auditing.
ADDITIONAL INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement on Form S-1 (including the exhibits and schedules thereto) under the
Securities Act of 1933 with respect to the shares to be sold in the offering.
This prospectus does not contain all of the information set forth in the
registration statement. For further information with respect to us and the
shares to be sold in the offering, reference is made to the registration
statement. Statements contained in this prospectus as to the contents of any
contract, agreement or other document referred to are not necessarily complete,
and in each instance reference is made to the copy of such contract, agreement
or other document filed as an exhibit to the registration statement, each such
statement being qualified in all respects by such reference. In addition, we
file annual, quarterly and current reports, proxy statements and other
information with the Securities and Exchange Commission.
You may read and copy all or any portion of the registration statement or
any reports, statements or other information we file at the Securities and
Exchange Commission's public reference room at 450 Fifth Street, N.W.,
Washington, D.C. 20549. You can request copies of these documents, upon payment
of a duplicating fee, by writing to the Securities and Exchange Commission.
Please call the Securities and Exchange Commission at 1-800-SEC-0330 for further
information on the operation of the public reference rooms. Our filings with the
Securities and Exchange Commission, including the registration statement of
which this prospectus is a part, are also available to you on the Securities and
Exchange Commission's Internet site (http://www.sec.gov). In addition, reports,
proxy statements and other information concerning our company may be inspected
at the National Association of Securities Dealers, Inc. at 1735 K Street, N.W.,
Washington, D.C. 20006.
62
<PAGE> 65
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
ISS GROUP, INC.
Report of Independent Auditors.............................. F-2
Consolidated Balance Sheets as of December 31, 1997 and
1998...................................................... F-3
Consolidated Statements of Operations for the Years Ended
December 31, 1996, 1997 and 1998.......................... F-4
Consolidated Statements of Stockholders' Equity (Deficit)
for the Years Ended December 31, 1996, 1997 and 1998...... F-5
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1996, 1997 and 1998.......................... F-6
Notes to Consolidated Financial Statements.................. F-7
MARCH INFORMATION SYSTEMS LIMITED
Report of Independent Auditors.............................. F-18
Consolidated Balance Sheets as of March 31, 1997 and 1998
and September 30, 1998 (unaudited)........................ F-19
Consolidated Statements of Operations for the Years Ended
March 31, 1997 and 1998 and the Six Months Ended September
30, 1997 and 1998 (unaudited)............................. F-20
Consolidated Statements of Shareholders' Equity for the
Years Ended March 31, 1997 and 1998 and the Six Months
Ended September 30, 1998 (unaudited)...................... F-21
Consolidated Statements of Cash Flows for the Years Ended
March 31, 1997 and 1998 and the Six Months Ended September
30, 1997 and 1998 (unaudited)............................. F-22
Notes to Consolidated Financial Statements.................. F-23
Unaudited Pro Forma Consolidated Statement of Operations.... F-31
</TABLE>
F-1
<PAGE> 66
REPORT OF INDEPENDENT AUDITORS
Board of Directors
ISS Group, Inc.
We have audited the accompanying consolidated balance sheets of ISS Group,
Inc. as of December 31, 1997 and 1998, and the related consolidated statements
of operations, stockholders' equity (deficit), and cash flows for each of the
three years in the period ended December 31, 1998. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of ISS Group, Inc.
at December 31, 1997 and 1998, and the consolidated results of its operations
and its cash flows for each of the three years in the period ended December 31,
1998, in conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
Atlanta, Georgia
January 15, 1999
F-2
<PAGE> 67
ISS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1997 1998
---------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $3,929,000 $52,632,000
Accounts receivable, less allowance for doubtful accounts
of $255,000 and $287,000, respectively................. 4,038,000 12,586,000
Prepaid expenses and other current assets................. 281,000 743,000
---------- -----------
Total current assets.............................. 8,248,000 65,961,000
Property and equipment:
Computer equipment........................................ 1,688,000 4,370,000
Office furniture and equipment............................ 268,000 1,027,000
Leasehold improvements.................................... 15,000 275,000
---------- -----------
1,971,000 5,672,000
Less accumulated depreciation............................. 402,000 1,655,000
---------- -----------
1,569,000 4,017,000
Goodwill, less accumulated amortization of $77,000.......... -- 3,094,000
Other intangible assets, less accumulated amortization of
$154,000.................................................. -- 4,692,000
Other assets................................................ 49,000 257,000
---------- -----------
Total assets......................................... $9,866,000 $78,021,000
========== ===========
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
<S> <C> <C>
Current liabilities:
Accounts payable.......................................... $2,002,000 $ 692,000
Accrued expenses.......................................... 1,798,000 4,202,000
Deferred revenues......................................... 2,106,000 6,678,000
Current portion of long-term debt......................... 70,000 --
---------- -----------
Total current liabilities............................ 5,976,000 11,572,000
Long-term debt.............................................. 70,000 --
Other liabilities........................................... -- 134,000
Commitments and contingencies
Redeemable, Convertible Preferred Stock (5,737,000 shares
authorized):
Series A; $.001 par value; 3,650,000 and 0 shares issued
and outstanding, respectively (liquidation preference
$1 per share).......................................... 3,621,000 --
Series B; $.001 par value; 2,087,000 and 0 shares issued
and outstanding, respectively (liquidation preference
$2.53 per share)....................................... 5,257,000 --
Stockholders' equity (deficit):
Preferred stock; $.001 par value; 20,000,000 shares
authorized, none issued or outstanding
Common stock, $.001 par value, 50,000,000 shares
authorized, 7,921,000 and 17,292,000 shares issued and
outstanding, respectively.............................. 8,000 17,000
Additional paid-in capital................................ 695,000 76,110,000
Deferred compensation..................................... (571,000) (662,000)
Cumulative adjustment for currency revaluation............ -- 142,000
Accumulated deficit....................................... (5,190,000) (9,292,000)
---------- -----------
Total stockholders' equity (deficit)................. (5,058,000) 66,315,000
---------- -----------
Total liabilities and stockholders' equity
(deficit)........................................... $9,866,000 $78,021,000
========== ===========
</TABLE>
See accompanying notes.
F-3
<PAGE> 68
ISS GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Revenues:
Perpetual licenses................................ $ 4,233,000 $10,936,000 $25,936,000
Subscriptions..................................... 219,000 2,465,000 7,406,000
Professional services............................. 10,000 66,000 2,587,000
----------- ----------- -----------
4,462,000 13,467,000 35,929,000
Costs and expenses:
Cost of revenues.................................. 18,000 676,000 4,831,000
Research and development.......................... 1,225,000 3,434,000 9,321,000
Charge for in-process research and development.... -- -- 802,000
Sales and marketing............................... 3,768,000 11,731,000 22,762,000
General and administrative........................ 656,000 1,773,000 4,389,000
Amortization...................................... -- -- 230,000
----------- ----------- -----------
5,667,000 17,614,000 42,335,000
----------- ----------- -----------
Operating loss...................................... (1,205,000) (4,147,000) (6,406,000)
Interest income..................................... 77,000 245,000 2,382,000
Interest expense.................................... (3,000) (17,000) (16,000)
----------- ----------- -----------
Loss before income taxes............................ (1,131,000) (3,919,000) (4,040,000)
Provision for income taxes.......................... -- -- 62,000
=========== =========== ===========
Net loss............................................ $(1,131,000) $(3,919,000) $(4,102,000)
=========== =========== ===========
Basic and diluted net loss per share of Common
Stock............................................. $ (0.14) $ (0.50) $ (0.28)
=========== =========== ===========
Weighted average number of shares used in
calculating basic and diluted net loss per share
of Common Stock................................... 7,916,000 7,907,000 14,883,000
=========== =========== ===========
Unaudited pro forma net loss per share of Common
Stock............................................. $ (0.29) $ (0.25)
=========== ===========
Unaudited weighted average number of shares used in
calculating unaudited pro forma net loss per share
of Common Stock................................... 13,644,000 16,189,000
=========== ===========
</TABLE>
See accompanying notes.
F-4
<PAGE> 69
ISS GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
ACCUMULATED RETAINED
COMMON STOCK ADDITIONAL OTHER EARNINGS
-------------------- PAID-IN DEFERRED COMPREHENSIVE (ACCUMULATED
SHARES AMOUNT CAPITAL COMPENSATION INCOME DEFICIT)
---------- ------- ----------- ------------ -------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995............... 8,002,000 $8,000 $ 125,000 $ -- $ -- $ (140,000)
Comprehensive income (loss)
Net loss............................... -- -- -- -- -- (1,131,000)
Repurchase of Common Stock from
founder................................ (100,000) -- (15,000) -- -- --
Accretion related to Redeemable,
Convertible Preferred Stock............ -- -- (7,000) -- -- --
---------- ------- ----------- --------- -------- -----------
Balance at December 31, 1996............... 7,902,000 8,000 103,000 -- -- --
Comprehensive income (loss)
Net loss............................... -- -- -- -- -- (3,919,000)
Accretion related to Redeemable,
Convertible Preferred Stock............ -- -- (11,000) -- -- --
Deferred compensation related to stock
options................................ -- -- 571,000 (571,000) -- --
Issuance of Common Stock................. 19,000 -- 32,000 -- -- --
---------- ------- ----------- --------- -------- -----------
Balance at December 31, 1997............... 7,921,000 8,000 695,000 (571,000) -- (5,190,000)
Comprehensive income (loss)
Net loss............................... -- -- -- -- -- (4,102,000)
Translation adjustment................. -- -- -- -- 142,000 --
-- -- -- -- -- --
Issuance of Common Stock:
Initial public offering................ 3,070,000 3,000 61,528,000 -- -- --
Conversion of Redeemable, Convertible
Preferred Stock in connection with
the initial public offering.......... 5,737,000 6,000 8,872,000 -- -- --
Acquisitions........................... 158,000 -- 3,901,000 -- -- --
Exercise of stock options.............. 405,000 -- 292,000 -- -- --
Issuance to consultant................. 1,000 -- 11,000 -- -- --
Deferred compensation related to stock
options................................ -- -- 811,000 (811,000) -- --
Amortization of deferred compensation in
connection with stock options.......... -- -- -- 720,000 -- --
---------- ------- ----------- --------- -------- -----------
Balance at December 31, 1998............... 17,292,000 $17,000 $76,110,000 $(662,000) $142,000 $(9,292,000)
========== ======= =========== ========= ======== ===========
<CAPTION>
TOTAL
STOCKHOLDERS'
COMPREHENSIVE EQUITY
INCOME (DEFICIT)
------------- --------------
<S> <C> <C>
Balance at December 31, 1995............... -- $ (7,000)
Comprehensive income (loss)
Net loss............................... $(1,131,000) (1,131,000)
===========
Repurchase of Common Stock from
founder................................ -- (15,000)
Accretion related to Redeemable,
Convertible Preferred Stock............ -- (7,000)
-----------
Balance at December 31, 1996............... (1,160,000)
Comprehensive income (loss)
Net loss............................... $(3,919,000) (3,919,000)
===========
Accretion related to Redeemable,
Convertible Preferred Stock............ -- (11,000)
Deferred compensation related to stock
options................................ -- --
Issuance of Common Stock................. -- 32,000
-----------
Balance at December 31, 1997............... -- (5,058,000)
Comprehensive income (loss)
Net loss............................... $(4,102,000) (4,102,000)
Translation adjustment................. 142,000 142,000
-----------
$(3,960,000) --
===========
Issuance of Common Stock:
Initial public offering................ -- 61,531,000
Conversion of Redeemable, Convertible
Preferred Stock in connection with
the initial public offering.......... -- 8,878,000
Acquisitions........................... -- 3,901,000
Exercise of stock options.............. -- 292,000
Issuance to consultant................. -- 11,000
Deferred compensation related to stock
options................................ -- --
Amortization of deferred compensation in
connection with stock options.......... 720,000
-----------
Balance at December 31, 1998............... $66,315,000
===========
</TABLE>
See accompanying notes.
F-5
<PAGE> 70
ISS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss............................................ $(1,131,000) $(3,919,000) $(4,102,000)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation................................... 66,000 334,000 1,253,000
Amortization of goodwill and intangibles....... -- -- 231,000
Charge for in-process research and
development.................................. -- -- 802,000
Amortization of deferred compensation.......... -- -- 720,000
Other non-cash expense......................... -- 31,000 118,000
Changes in assets and liabilities, excluding
the effects of acquisitions:
Accounts receivable....................... (1,802,000) (2,089,000) (8,107,000)
Prepaid expenses and other assets......... (146,000) (179,000) (501,000)
Accounts payable and accrued expenses..... 955,000 2,728,000 776,000
Deferred revenues......................... 607,000 1,462,000 4,461,000
----------- ----------- -----------
Net cash used in operating activities..... (1,451,000) (1,632,000) (4,349,000)
----------- ----------- -----------
INVESTING ACTIVITIES
Acquisitions, net of cash acquired.................. -- -- (5,206,000)
Purchases of property and equipment................. (320,000) (1,630,000) (3,567,000)
----------- ----------- -----------
Net cash used in investing activities............... (320,000) (1,630,000) (8,773,000)
----------- ----------- -----------
FINANCING ACTIVITIES
Proceeds from (payments on) long-term debt.......... 210,000 (70,000) (140,000)
Net proceeds from Redeemable, Convertible Preferred
Stock issuances................................... 3,607,000 5,253,000 --
Payments on notes payable to shareholder............ (30,000) -- --
Net proceeds from initial public offering........... -- -- 61,531,000
Other Common Stock activities....................... (15,000) 1,000 292,000
----------- ----------- -----------
Net cash provided by financing activities........... 3,772,000 5,184,000 61,683,000
----------- ----------- -----------
Foreign currency impact on cash..................... -- -- 142,000
Net increase in cash and cash equivalents........... 2,001,000 1,922,000 48,703,000
Cash and cash equivalents at beginning of year...... 6,000 2,007,000 3,929,000
----------- ----------- -----------
Cash and cash equivalents at end of year............ $ 2,007,000 $ 3,929,000 $52,632,000
=========== =========== ===========
SUPPLEMENTAL CASH FLOW DISCLOSURE
Interest paid....................................... $ 1,000 $ 17,000 $ 16,000
=========== =========== ===========
</TABLE>
See accompanying notes.
F-6
<PAGE> 71
ISS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. SIGNIFICANT ACCOUNTING POLICIES
CONSOLIDATION AND DESCRIPTION OF BUSINESS
The consolidated financial statements include the accounts of ISS Group,
Inc. and its subsidiaries ("ISS"). All significant intercompany investment
accounts and transactions have been eliminated in consolidation.
On March 27, 1998, ISS completed an initial public offering ("IPO") of its
Common Stock. A total of 3,450,000 shares were sold at $22 per share, including
450,000 shares sold pursuant to the underwriters over-allotment option and
380,000 sold by certain selling stockholders. ISS did not receive any of the
proceeds from the sale of shares by the selling stockholders. The net proceeds
to ISS were approximately $61,531,000 and certain of such proceeds have been
used for general corporate purposes. ISS's shares are traded on the Nasdaq
National Market under the ticker symbol "ISSX".
ISS Group, Inc. was incorporated in the State of Delaware on December 8,
1997 to be a holding company for Internet Security Systems, Inc., a Georgia
company incorporated on April 19, 1994, to design, market, and sell computer
network security assessment software. In addition, ISS has various other
subsidiaries in Europe and the Asia/Pacific region with primary marketing and
sales responsibilities for ISS's products and services in their respective
markets.
The financial statements of foreign subsidiaries have been translated into
United States dollars in accordance with Financial Accounting Standards Board
("FASB") Statement of Financial Accounting Standards ("SFAS") No. 52 Foreign
Currency Translation. Revenues from international customers, except in Japan,
were denominated in U.S. dollars. Revenues from Japanese customers and
international expenditures were denominated in the respective local currencies
and translated using the average exchange rates for the year. The effect on the
statements of operations related to transaction gains and losses is
insignificant for all years presented. All balance sheet accounts have been
translated using the exchange rates in effect at the balance sheet date.
ISS's business is focused on maintaining the latest security threat and
vulnerability checks within existing products and creating new products and
services that are consistent with ISS's goal of providing an adaptive solution
approach to enterprise network security. This approach entails continuous
security risk monitoring and response to develop an active and informed network
security policy.
REVENUE RECOGNITION
ISS recognizes its perpetual license revenues upon (i) delivery of software
or, if the customer has evaluation software, delivery of the software key, and
(ii) issuance of the related license, assuming no significant vendor obligations
or customer acceptance rights exist. For perpetual license agreements when
payment terms extend over periods greater than 12 months, revenue is recognized
as such amounts are billable. In October 1997, the AICPA issued Statement of
Position ("SOP") No. 97-2, Software Revenue Recognition, which ISS adopted,
effective January 1, 1997. Such adoption had no effect on ISS's methods of
recognizing revenue from license and maintenance activities. Prior to 1997,
ISS's revenue recognition policy was in accordance with the preceding
authoritative guidance provided by SOP No. 91-1, Software Revenue Recognition.
F-7
<PAGE> 72
ISS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Subscriptions revenues include maintenance and term licenses. Annual
renewable maintenance is a separate component of perpetual license agreements
with revenue recognized ratably over the maintenance contract term. Term
licenses allow customer use of the product and maintenance for a specified
period, generally 12 months, for which revenues are also recognized ratably over
the contract term. Professional services revenues are recognized as such
services are performed.
COST OF REVENUES
Cost of revenues include amounts related to ISS's technical support group
who provide assistance to customers with maintenance agreements and the costs
related to ISS's professional services.
CASH AND CASH EQUIVALENTS
Cash equivalents include all highly liquid investments with a maturity of
three months or less when purchased. Such amounts are stated at cost, which
approximates market value.
CONCENTRATIONS OF CREDIT RISK
Financial instruments that potentially subject ISS to significant
concentrations of credit risk consist principally of cash and cash equivalents
and accounts receivable. ISS maintains cash and cash equivalents in short-term
money market accounts with two financial institutions and short-term, investment
grade commercial paper. ISS's sales are primarily to companies located in the
United States, Europe and the Asia/Pacific region. ISS performs periodic credit
evaluations of its customers' financial condition and does not require
collateral. Accounts receivable are due principally from large U.S. companies
under stated contract terms. ISS provides for estimated credit losses, which
have not been significant to date, as required.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost less accumulated depreciation.
Depreciation is computed using the straight-line method for financial reporting
purposes over the estimated useful lives of the assets (primarily three years).
F-8
<PAGE> 73
ISS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
GOODWILL AND INTANGIBLES
The major classes of intangible assets, including goodwill (excess of cost
over acquired net assets), at December 31, 1998 are as follows:
<TABLE>
<CAPTION>
LIFE
----
<S> <C> <C>
Goodwill.................................................... 10 $3,171,000
less accumulated amortization............................... (77,000)
----------
$3,094,000
==========
Core technology............................................. 8 $3,853,000
Developed technology........................................ 5 778,000
Work force.................................................. 6 215,000
----------
4,846,000
less accumulated amortization............................... (154,000)
----------
$4,692,000
==========
</TABLE>
Goodwill and other intangible assets are amortized using the straight-line
method for the period indicated. They are reviewed for impairment whenever
events indicate that their carrying amounts may not be recoverable. In such
reviews, undiscounted cash flows associated with these assets are compared with
their carrying values to determine if a write-down to fair value is required.
RESEARCH AND DEVELOPMENT COSTS
Research and development costs are charged to expense as incurred. ISS has
not capitalized any such development costs under SFAS No. 86, Accounting for the
Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed, because
the cost incurred between the attainment of technological feasibility for the
various software products through the date when such products are made available
for general release to customers has been insignificant.
INCOME TAXES
ISS uses the liability method of accounting for income taxes. Under this
method, deferred income tax assets and liabilities are determined based on
differences between the financial reporting and tax bases of assets and
liabilities and are measured using the enacted tax rates and laws that will be
in effect when the differences are expected to reverse.
ADVERTISING COSTS
ISS incurred $485,000, $572,000 and $486,000 of advertising costs for the
years ended December 31, 1996, 1997 and 1998, respectively, which are expensed
as incurred and are included in sales and marketing expense in the statements of
operations.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts
F-9
<PAGE> 74
ISS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
reported in the financial statements and accompanying notes. Actual results may
differ from those estimates, and such differences may be material to the
consolidated financial statements.
STOCK-BASED COMPENSATION
ISS generally grants stock options for a fixed number of shares to certain
employees with an exercise price equal to the fair value of the shares at the
date of grant. ISS accounts for stock option grants in accordance with
Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued
to Employees, and, accordingly, recognizes compensation expense only if the fair
value of the underlying Common Stock exceeds the exercise price of the stock
option on the date of grant. In October 1995, the FASB issued SFAS No. 123,
Accounting for Stock-Based Compensation, which provides an alternative to APB
Opinion No. 25 in accounting for stock-based compensation issued to employees.
As permitted by SFAS No. 123, ISS continues to account for stock-based
compensation in accordance with APB Opinion No. 25 and has elected the pro forma
disclosure alternative of SFAS No. 123 (see Note 5).
LOSS PER SHARE
Basic and diluted historical net loss per share (see Note 9) was computed
by dividing net loss plus accretion of the Series A and Series B Redeemable,
Convertible Preferred Stock by the weighted average number of shares of Common
Stock. Common Stock equivalents were antidilutive and therefore were not
included in the computation of weighted average shares used in computing diluted
loss per share. Also, ISS has no Common Stock equivalents due to "cheap stock"
as defined in Securities and Exchange Commission ("SEC") Staff Accounting
Bulletin No. 98.
Unaudited pro forma net loss per share was computed by dividing net loss by
the unaudited weighted average number of shares of Common Stock outstanding plus
the assumed conversion of the Redeemable, Convertible Preferred Stock into
5,737,000 shares of Common Stock as of the later of (i) January 1, 1997 or (ii)
the date of issuance of such preferred stock, instead of March 27, 1998 when
such shares of preferred stock automatically converted into Common Stock.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of
an Enterprise and Related Information. SFAS No. 131 establishes standards for
the way that public business enterprises report information about operating
segments in annual financial statements for periods beginning after December 15,
1997. The Statement requires that business segment financial information be
reported in the financial statements utilizing the management approach. The
management approach is defined as the manner in which management organizes the
segments within the enterprise for making operating decisions and assessing
performance. Since ISS is organized as, and operates in, a single business
segment that provides products, technical support and consulting and training
services as components of its enterprise solution for network security, this
Statement did not have an impact on financial reporting for the year ended
December 31, 1998.
ISS adopted SFAS No. 130, Reporting Comprehensive Income, on January 1,
1998. ISS reported comprehensive income in its statement of changes in
stockholders' equity (deficit). The
F-10
<PAGE> 75
ISS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
adoption of SFAS No. 130 resulted in revised and additional disclosures but had
no effect on the financial position, results of operations, or liquidity of ISS.
RECLASSIFICATIONS
Certain reclassifications were made to the prior years' financial
statements to conform with the 1998 presentation.
2. FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts reported in the balance sheets for cash and cash
equivalents, accounts receivable and accounts payable approximate their fair
values. The carrying amounts reported in the balance sheet at December 31, 1997
for long-term debt approximated its fair values as the interest rate related to
such debt was variable and commensurate with the credit worthiness of ISS.
3. BUSINESS COMBINATION AND ASSET ACQUISITION
In October 1998, ISS acquired March Information Systems Limited ("March"),
a United Kingdom-based developer of Windows NT and Unix-based security
assessment technologies. Also in October 1998, ISS acquired the technology
assets of DbSecure, Inc., a developer of database security risk assessment
software. ISS issued 158,000 shares of ISS Common Stock and paid $5,206,000 in
cash, net of cash acquired, and direct transaction costs for these acquisitions.
Both of these acquisitions have been accounted for as purchases and their
results have been included in the results of ISS's operations from the effective
dates of acquisition. Substantially all of the aggregate consideration of
$9,144,000 was allocated to identified intangibles, including core and developed
technologies, in-process research and development, work force and goodwill (see
Note 1).
The valuations of core and developed technologies and in-process research
and development were based on the present value of estimated future cash flows
over the lesser of: (i) five years or (ii) the period in which the product is
expected to be integrated into an existing ISS product. The resulting values
were reviewed for reasonableness based on the time and cost spent on the effort,
the complexity of the development effort and, in the case of in-process
development projects, the stage to which it had progressed. For in-process
research and development, the valuation was reduced for the core technology
component of such product and the percentage of product development remaining at
the acquisition date. The resulting in-process research and development amount
of $802,000 is reflected as a charge in the 1998 statement of operations.
F-11
<PAGE> 76
ISS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. BUSINESS COMBINATION AND ASSET ACQUISITION (CONTINUED)
The following table summarizes pro forma unaudited results of operations as
if the acquisition of March was concluded on January 1, 1997. The effect of the
DbSecure acquisition is not included as its impact was immaterial. The
adjustments to the historical data reflect the reduction of interest income in
connection with the cash portion of the purchase price and amortization of
goodwill and intangibles. This unaudited pro forma financial information is not
necessarily indicative of what the combined operations would have been if ISS
had control of such combined businesses for the periods presented.
<TABLE>
<CAPTION>
1997 1998
----------- -----------
<S> <C> <C>
Revenues.................................................... $15,513,000 $37,735,000
Operating loss.............................................. (4,901,000) (6,838,000)
Net loss.................................................... (4,946,000) (4,828,000)
Per share:
Basic and diluted net loss................................ $ (0.62) $ (0.32)
Pro forma net loss........................................ $ (0.36) $ (0.30)
</TABLE>
4. REDEEMABLE, CONVERTIBLE PREFERRED STOCK
Redeemable, Convertible Preferred Stock consisted of the following:
<TABLE>
<CAPTION>
GROSS NET
SERIES DATE OF ISSUANCE PROCEEDS PROCEEDS SHARES ISSUED
- ------ ----------------- ---------- ---------- --------------
<S> <C> <C> <C> <C>
A February 2, 1996 $3,650,000 $3,607,000 3,650,000
B February 14, 1997 5,280,000 5,253,000 2,087,000
---------- ---------- ---------
$8,930,000 $8,860,000 5,737,000
========== ========== =========
</TABLE>
Accretion related to the Series A and Series B Redeemable, Convertible
Preferred Stock was recorded over the respective redemption period by charges
against additional paid-in capital with corresponding increases to the carrying
value of the Series A and Series B Redeemable, Convertible Preferred Stock. Such
increases aggregated $7,000 and $11,000 for the years ended December 31, 1996
and 1997, respectively, and were immaterial in 1998.
All of the outstanding shares of Redeemable, Convertible Preferred Stock
were automatically converted into an aggregate of 5,737,000 shares of Common
Stock on March 27, 1998 in connection with the IPO.
5. STOCK OPTION PLANS
ISS's Incentive Stock Plan (the "Plan") provides for the granting of
qualified or nonqualified options to purchase shares of ISS's Common Stock.
Under the Plan, there are 3,000,000 shares reserved for future issuances, which
increases automatically on the first trading day of each year, beginning with
1999, by an amount equal to 3% of the number of shares of Common Stock
outstanding on the last trading day of the immediately preceding year.
Certain options granted under the Plan prior to the IPO are immediately
exercisable, subject to a right of repurchase by ISS at the original exercise
price for all unvested shares. Options granted subsequent to the IPO are
generally exercisable as vesting occurs. Vesting is generally in equal annual
installments over four years, measured from the date of the grant.
F-12
<PAGE> 77
ISS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. STOCK OPTION PLANS (CONTINUED)
During the quarters ended December 31, 1997 and March 31, 1998, deferred
compensation of $571,000 and $811,000, respectively, was recorded for options
granted with an exercise price less than the fair value of the Common Stock on
the date of grant. The deferred compensation was determined by comparing the
exercise price of stock options issued in December 1997 to the estimated price
range for the IPO as set forth in the initial filing on January 20, 1998 of
ISS's Registration Statement on Form S-1. The fair value of ISS's Common Stock
in January and February 1998 was based on the final estimated price range
contained in ISS's pre-effective amendment to its Registration Statement filed
in March 1998. The amounts are being charged to operations proportionately over
the four-year vesting period of the related stock options. Amortization of
deferred compensation for the year ended December 31, 1998 was $720,000. All
other options were issued at fair market value on the date of grant.
On December 8, 1997, the Board of Directors granted to each of the four
non-employee directors a nonstatutory option to purchase up to 20,000 shares of
Common Stock outside the Plan, on the same terms as if those options had been
granted under the 1995 Plan. ISS reserved 80,000 shares of Common Stock for
issuance under these options.
A summary of ISS's stock option activity is as follows:
<TABLE>
<CAPTION>
1997 1998
--------------------- ---------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
NUMBER EXERCISE NUMBER EXERCISE
OF SHARES PRICE OF SHARES PRICE
---------- -------- ---------- --------
<S> <C> <C> <C> <C>
Outstanding at beginning of year................. 810,000 $0.16 1,888,000 $ 2.71
Granted........................................ 1,103,000 4.54 961,000 22.78
Exercised...................................... (7,000) 0.15 (405,000) 0.72
Canceled....................................... (18,000) 0.50 (65,000) 9.32
---------- ----------
Outstanding at end of year....................... 1,888,000 2.71 2,379,000 10.98
========== ==========
Exercisable at end of year....................... 1,888,000 2.71 1,585,000 3.85
========== ==========
Weighted average fair value of options granted
during the year................................ $ 2.34 $ 12.77
========== ==========
</TABLE>
The following table summarizes information about stock options outstanding
at December 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS FULLY
---------------------------- VESTED AND EXERCISABLE
NUMBER OF WEIGHTED --------------------------
OPTIONS AVERAGE NUMBER WEIGHTED
OUTSTANDING AT REMAINING EXERCISABLE AVERAGE
RANGE OF DECEMBER 31, CONTRACTUAL AT DECEMBER 31, EXERCISE
EXERCISE PRICES 1998 LIFE 1998 PRICE
- --------------- -------------- ----------- --------------- --------
<S> <C> <C> <C> <C>
$0.15-0.60................................. 695,000 7.7 years 289,000 $0.26
$1.00-7.00................................. 741,000 8.9 years 185,000 5.99
$8.00-20.00................................ 612,000 9.2 years -- --
$21.00-30.00............................... 181,000 9.8 years -- --
$31.00-50.00............................... 150,000 9.7 years -- --
</TABLE>
ISS has reserved 2,379,000 shares of ISS common stock for the future
exercise of stock options at December 31, 1998.
F-13
<PAGE> 78
ISS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. STOCK OPTION PLANS (CONTINUED)
Pro forma information regarding net income and net income per share is
required by SFAS No. 123, which also requires that the information be determined
as if ISS had accounted for its employee stock options granted subsequent to
December 31, 1994 under the fair value method prescribed by that Statement. The
fair value for options granted was estimated at the date of grant using the
Black-Scholes option pricing model. The following weighted average assumptions
were used for 1997 and 1998, respectively: risk-free interest rates of 6.28% and
5.27%; no dividend yield; a .60 volatility factor; and an expected life of the
options of 4 and 5 years, respectively.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because employee stock options have characteristics different from
those of traded options, and because the changes in the subjective input
assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the
option is amortized to expense over the options' vesting period. The following
pro forma information adjusts net loss for the years ended December 31, 1997 and
1998 for the impact of SFAS No. 123:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
-------------------------
1997 1998
----------- -----------
<S> <C> <C>
Pro forma net loss....................................... $(3,975,000) $(6,126,000)
=========== ===========
Pro forma net loss per share............................. $ (0.29) $ (0.38)
=========== ===========
</TABLE>
6. COMMITMENTS AND CONTINGENT LIABILITIES
ISS has noncancellable operating leases for facilities that expire at
various dates through July 2002. Future minimum payments under noncancellable
operating leases with initial terms of one year or more consisted of the
following at December 31, 1998:
<TABLE>
<CAPTION>
OPERATING
LEASES
----------
<S> <C>
1999........................................................ $1,855,000
2000........................................................ 1,693,000
2001........................................................ 1,513,000
2002........................................................ 683,000
----------
Total minimum lease payments...................... $5,744,000
==========
</TABLE>
Rent expense was approximately $105,000, $401,000 and $1,200,000 for the
years ended December 31, 1996, 1997, and 1998, respectively.
In July 1998, Network Associates, Inc. ("Network Associates"), a competitor
of ISS, filed a patent infringement suit against ISS in the Federal District
Court for the Northern District of California. The suit alleges that ISS's
product, RealSecure, violates certain patent claims issued for Network
Associates' intrusion detection technology. ISS believes the lawsuit is without
merit
F-14
<PAGE> 79
ISS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
6. COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED)
and intends to defend against it vigorously. However, there can be no assurance
that the lawsuit will not have or result in a material adverse effect on ISS's
business, operating results or financial condition.
7. INCOME TAXES
A reconciliation of the provision for income taxes to the statutory federal
income tax rate is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1996 1997 1998
--------- ----------- -----------
<S> <C> <C> <C>
Statutory rate at 34%, applied to pretax loss......... $(384,000) $(1,332,000) $(1,440,000)
State income taxes, net of federal income tax
benefit............................................. (45,000) (157,000) (160,000)
Intangibles........................................... -- -- 345,000
Research and development tax credit................... (28,000) (159,000) (384,000)
Foreign operations.................................... 100,000 -- 62,000
Other................................................. 46,000 (26,000) 42,000
Change in valuation allowance......................... 311,000 1,674,000 1,597,000
--------- ----------- -----------
$ -- $ -- $ 62,000
========= =========== ===========
</TABLE>
The provision for income taxes for the year ended December 31, 1998
consisted of $62,000 of current income taxes related to some of ISS's foreign
operations.
Deferred income taxes reflect the net income tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Significant
components of ISS's net deferred income tax assets are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1997 1998
----------- ------------
<S> <C> <C>
Deferred income tax liabilities:
Core technology............................................. $ -- $ (494,000)
----------- ------------
Total deferred income tax liabilities....................... -- (494,000)
----------- ------------
Deferred income tax assets:
Depreciation.............................................. 69,000 72,000
Accrued liabilities....................................... 143,000 410,000
Allowance for doubtful accounts........................... 97,000 109,000
Deferred compensation..................................... -- 274,000
Net operating loss carryforwards.......................... 1,573,000 5,178,000
Research and development tax credit carryforwards......... 187,000 571,000
----------- ------------
Total deferred income tax assets.................. 2,069,000 6,120,000
Less deferred income tax asset valuation allowance.......... (2,069,000) (6,120,000)
----------- ------------
Net deferred income tax assets.............................. $ -- $ --
=========== ============
</TABLE>
For financial reporting purposes, a valuation allowance has been recognized
to reduce the net deferred income tax assets to zero. ISS has not recognized the
benefit from the future use of such loss carryforwards because management's
evaluation of all the available evidence in
F-15
<PAGE> 80
ISS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. INCOME TAXES (CONTINUED)
assessing the realizability of the tax benefits of such loss carryforwards and
other deferred income tax benefits indicates that the underlying assumptions of
future profitable operations contain risks that do not provide sufficient
assurance to recognize such tax benefits currently.
ISS has approximately $13,600,000 of net operating loss carryforwards for
federal income tax purposes that expire in varying amounts between 2011 and
2018. These carryforwards include approximately $7,700,000 related to exercises
of stock options in 1998 for which the income tax benefit, if realized, would
increase additional paid-in capital. ISS also has approximately $800,000 of net
operating loss carryforwards related to its foreign operations which expire
between 2002 and 2003. Additionally, ISS has approximately $571,000 of research
and development tax credit carryforwards which expire between 2011 and 2014.
8. EMPLOYEE BENEFIT PLANS
ISS sponsors a 401(k) plan that covers substantially all employees over 21
years of age. ISS may make contributions to the plan at its discretion, but has
made no contributions to the plan through December 31, 1998.
9. LOSS PER SHARE
The following table sets forth the computation of basic, diluted and pro
forma (unaudited) net loss per share:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Numerator:
Net loss.......................................... $(1,131,000) $(3,919,000) $(4,102,000)
Accretion of Series A and Series B Redeemable,
Convertible Preferred Stock.................... (7,000) (11,000) --
----------- ----------- -----------
$(1,138,000) $(3,930,000) $(4,102,000)
=========== =========== ===========
Denominator:
Denominator for basic and diluted net loss per
share -- weighted average shares............... 7,916,000 7,907,000 14,883,000
Redeemable, Convertible Preferred Stock........... -- 5,737,000 1,306,000
----------- ----------- -----------
Weighted average shares for pro forma net loss per
share.......................................... 7,916,000 13,644,000 16,189,000
=========== =========== ===========
Basic net loss per share............................ $ (0.14) $ (0.50) $ (0.28)
=========== =========== ===========
Diluted net loss per share.......................... $ (0.14) $ (0.50) $ (0.28)
=========== =========== ===========
Pro forma net loss per share (unaudited)............ $ (0.29) $ (0.25)
=========== ===========
</TABLE>
Stock options aggregating 1,888,000 and 2,379,000 at December 31, 1997 and
1998, respectively, are not included in the above calculations as they are
antidilutive.
10. EXPORT SALES
Export sales from the United States to the Europe and Asia/Pacific region
represented approximately 10% and 3%, respectively, of total revenues for the
year ended December 31, 1997
F-16
<PAGE> 81
ISS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. EXPORT SALES (CONTINUED)
and 12% and 0%, respectively, of total revenues for the year ended December 31,
1998. Export sales were not significant for the year ended December 31, 1996.
Revenues generated from ISS's foreign operations located in the Europe and
Asia/Pacific region totaled approximately 0% and 8%, respectively, and 2% and
5%, respectively, of total revenues for the years ended December 31, 1997 and
1998, respectively. ISS had no revenue generating foreign operations prior to
1997.
11. QUARTERLY FINANCIAL RESULTS (UNAUDITED)
Summarized quarterly results for the two years ended December 31, 1997 and
1998 are as follows (in thousands, except per share data):
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
------- ------- ------- -------
<S> <C> <C> <C> <C>
1997 by quarter:
Revenues..................................... $ 2,225 $ 2,671 $ 3,473 $ 5,098
Operating loss............................... (429) (678) (1,092) (1,948)
Net loss..................................... (394) (610) (1,026) (1,889)
Loss per share(1):
Basic and diluted............................ (0.05) (0.08) (0.13) (0.24)
Pro forma (unaudited)........................ (0.03) (0.05) (0.08) (0.14)
1998 by quarter:
Revenues..................................... 6,073 7,331 9,430 13,095
Operating loss............................... (1,705) (1,924) (1,348) (1,429)
Net loss..................................... (1,639) (1,083) (583) (797)
Loss per share(1):
Basic and diluted............................ (0.19) (0.06) (0.03) (0.05)
Pro forma (unaudited)........................ (0.12) -- -- --
</TABLE>
- ---------------
(1) Because of the method used in calculating per share data, the quarterly per
share data will not add to the per share data as computed for the year.
F-17
<PAGE> 82
REPORT OF ERNST & YOUNG, INDEPENDENT AUDITORS
To the Board of Directors and Shareholders
March Information Systems Limited
We have audited the accompanying consolidated balance sheets of March
Information Systems Limited as of March 31, 1997 and 1998 and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the two years in the period ended March 31, 1998, which have been
prepared in accordance with accounting principles generally accepted in the
United States and are expressed in U.S. Dollars. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with UK auditing standards, which do
not differ materially from auditing standards generally accepted in the United
States. Those standards 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of March
Information Systems Limited at March 31, 1997 and 1998 and the results of its
operations and its cash flows for the each of the two years in the period ended
March 31, 1998, in conformity with accounting principles generally accepted in
the United States.
/s/ Ernst & Young
Reading, England
October 16, 1998
F-18
<PAGE> 83
MARCH INFORMATION SYSTEMS LIMITED
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31,
------------------- SEPTEMBER 30,
1997 1998 1998
-------- -------- -------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current Assets
Cash and cash equivalents.............................. $ 4,494 $ 16,900 $ 38,683
Accounts receivable.................................... 533,080 538,851 441,074
Other receivables...................................... 32,433 25,724 81,089
Prepaid expenses....................................... 26,545 20,800 49,765
Other current assets................................... 15,434 15,742 26,105
-------- -------- --------
Total current assets......................... 611,986 618,017 636,716
Investments (Note 2)................................... 821 837 --
Equipment and fixtures:
Computer equipment................................ 176,594 220,985 243,701
Office furniture and equipment.................... 36,244 38,469 39,039
Motor vehicles.................................... 312,857 230,541 243,216
-------- -------- --------
525,695 489,995 525,956
Less accumulated depreciation..................... 327,295 356,635 391,792
-------- -------- --------
198,400 133,360 134,164
Deferred income taxes (Note 4)......................... 12,256 12,704 12,704
-------- -------- --------
Total Assets................................. $823,463 $764,918 $783,584
======== ======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable....................................... $ 1,478 $ 42,763 $ 44,084
Accrued expenses and other liabilities................. 68,457 51,747 91,516
Deferred revenue....................................... 92,227 84,301 111,370
Taxes and social security payable...................... 180,387 98,011 103,193
Notes payable to Directors............................. 52,544 90,428 --
Current portion of capital lease obligations........... 63,378 25,713 20,802
-------- -------- --------
Total current liabilities.................... 458,471 392,963 370,965
Capital lease obligation (Note 3)...................... 31,191 6,097 12,710
Minority interest...................................... 161 -- --
Commitments (Note 7)
Shareholders' Equity
Ordinary shares: $1 par value, 50,000 shares
authorized; 9,600 issued and outstanding at March 31,
1997, 9,700 shares at March 31,1998 and 9,800 shares
at September 30, 1998................................ 14,654 14,821 14,988
Retained earnings...................................... 292,128 317,305 345,180
Cumulative translation adjustment...................... 26,858 33,732 39,741
-------- -------- --------
Total shareholders' equity................... 333,640 365,858 399,909
-------- -------- --------
Total Liabilities and Shareholders' Equity... $823,463 $764,918 $783,584
======== ======== ========
</TABLE>
F-19
<PAGE> 84
MARCH INFORMATION SYSTEMS LIMITED
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED
MARCH 31, SEPTEMBER 30,
----------------------- ---------------------
1997 1998 1997 1998
---------- ---------- -------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C>
Revenues:
Consulting............................... $1,294,573 $1,224,339 $566,991 $ 663,205
Licenses................................. 267,568 690,764 275,582 461,247
Maintenance and other.................... 73,909 131,265 65,231 74,323
---------- ---------- -------- ----------
1,636,050 2,046,368 907,804 1,198,775
Research and development................... 460,027 697,808 367,380 405,083
Marketing, general and administrative...... 1,176,375 1,193,958 519,050 695,334
Depreciation and amortization.............. 110,216 99,304 55,029 39,293
---------- ---------- -------- ----------
1,746,618 1,991,070 941,459 1,139,710
Operating (loss) profit.................... (110,568) 55,298 (33,655) 59,065
Equity share of losses of affiliated
company.................................. 3,263 -- -- --
Interest expense........................... (29,253) (12,861) (6,518) (6,921)
Interest income............................ 1,680 3,103 1,995 714
Other income............................... -- 330 8,402 727
---------- ---------- -------- ----------
Income (loss) before taxation and minority
interests................................ (134,878) 45,870 (29,776) 53,585
Minority interest.......................... 692 -- -- --
Income tax benefit (expense)............... 26,677 (20,693) -- (25,710)
---------- ---------- -------- ----------
Net (loss) income.......................... $ (107,509) $ 25,177 $(29,776) $ 27,875
========== ========== ======== ==========
</TABLE>
See accompanying Notes to the Consolidated Financial Statements.
F-20
<PAGE> 85
MARCH INFORMATION SYSTEMS LIMITED
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
CUMULATIVE
COMMON RETAINED TRANSLATION
STOCK EARNINGS ADJUSTMENT TOTAL
------- -------- ----------- --------
<S> <C> <C> <C> <C>
Balance at March 31, 1996 (unaudited)........... $14,654 $399,637 $20,267 $434,558
Net loss........................................ -- (107,509) -- (107,509)
Cumulative translation adjustment............... -- -- 6,591 6,591
------- -------- ------- --------
Balance at March 31, 1997....................... 14,654 292,128 26,858 333,640
Net income...................................... -- 25,177 -- 25,177
Cumulative translation adjustment............... -- -- 6,874 6,874
Issuance of ordinary stock for bonuses to
employees..................................... 167 -- -- 167
------- -------- ------- --------
Balance at March 31, 1998....................... 14,821 317,305 33,732 365,858
Net income (unaudited).......................... -- 27,875 -- 28,042
Cumulative translation adjustment (unaudited)... -- -- 6,009 6,009
Issuance of ordinary stock for bonuses to
employees (unaudited)......................... 167 -- -- 167
------- -------- ------- --------
Balance at September 30, 1998 (unaudited)....... $14,988 $345,180 $39,741 $399,909
======= ======== ======= ========
</TABLE>
See accompanying Notes to the Consolidated Financial Statements
F-21
<PAGE> 86
MARCH INFORMATION SYSTEMS LIMITED
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED
MARCH SEPTEMBER 30,
------------------- --------------------------
1997 1998 1997 1998
--------- ------- ----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net (loss) income......................... $(107,509) $25,177 $ (29,776) $ 27,875
Adjustments to reconcile net (loss) income
to net cash provided by operating
activities:
Depreciation............................ 110,216 99,304 55,029 39,293
Minority interest....................... 692 -- -- --
Loss on disposal of assets.............. 6,107 12,354 7,926 7,953
Changes in operating assets and
liabilities:
Accounts receivable.................. (59,188) 4,719 160,112 102,894
Other receivable..................... (23,401) 7,210 6,915 (53,496)
Prepaid expenses..................... (13,036) 6,149 (8,360) (27,881)
Other current assets................. 714 -- -- (9,856)
Accounts payable..................... (159) 40,450 39,022 670
Accrued expenses and other
liabilities........................ 70,140 18,406 27,189 (51,336)
Deferred revenue..................... 30,478 (9,567) (19,845) 25,122
Taxes and social security payable.... 28,839 (84,279) (147,501) 3,629
Deferred income taxes................ (5,259) (448) -- --
--------- ------- --------- --------
Net cash provided by operating
activities.............................. 38,634 119,475 90,711 64,867
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of equipment and fixtures....... (87,164) (44,026) (5,003) (18,917)
Loss from Joint Venture................... -- -- -- 827
--------- ------- --------- --------
Net cash used in investing activities..... (87,164) (44,026) (5,003) (18,090)
CASH FLOWS FROM FINANCING ACTIVITIES
Payments on capital lease obligations..... (35,355) (63,374) (36,852) (25,993)
Minority interest......................... (1,537) (161) (160) --
Dividends paid............................ (41,050) -- -- --
Issuance of ordinary stock for bonus...... -- 167 167 167
--------- ------- --------- --------
Net cash used in financing activities..... (77,942) (63,368) (36,845) (25,826)
--------- ------- --------- --------
Net (decrease) increase in cash and cash
equivalents............................. (126,472) 12,081 48,863 20,951
Cash and cash equivalents at the beginning
of the year............................. 124,544 4,494 4,494 16,900
Translation adjustment.................... 6,422 325 (596) 832
--------- ------- --------- --------
Cash and cash equivalents at the end of
the year................................ $ 4,494 $16,900 $ 52,761 $ 38,683
========= ======= ========= ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION
Interest paid............................. $ 13,850 $12,368 $ 5,866 $ 8,182
========= ======= ========= ========
Income taxes paid......................... $ 56,455 $ -- $ 20,047 $ --
========= ======= ========= ========
SUPPLEMENTAL SCHEDULE OF NON-CASH
INVESTING AND FINANCING ACTIVITIES
Equipment and fixtures acquired under
capital leases.......................... $ -- $ -- $ -- $ 27,190
========= ======= ========= ========
</TABLE>
See accompanying Notes to the Consolidated Financial Statements
F-22
<PAGE> 87
MARCH INFORMATION SYSTEMS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
March Information Systems ("March" or the "Company") was incorporated in
England in 1990 with the name March Systems Consultancy Limited with the
objective of providing computer consultancy services in systems administration,
application development and systems integration. The Company's name was changed
in February 1997 to March Information Systems reflecting the refocus of the
company as a supplier of specialist security software rather than as a
consultancy company. The company was acquired in October 1998 by ISS Group, Inc.
as further explained in Note 7.
The Company provides security software and services to customers using
computers running Unix and Windows NT operating systems with the objective of
helping those customers improve the security of and reduce the threats to
critical corporate data held on these computers.
BASIS OF PRESENTATION
These financial statements do not comprise the statutory accounts of the
Company within the meaning of Section 240 of the Companies Act 1985, as amended
(the "Companies Act"). The Company's statutory accounts, which are its primary
financial statements, are prepared in accordance with the Companies Act and are
presented in British pounds. Statutory accounts for the year ended March 31,
1997 and March 31, 1998 have been prepared and the auditors have given
unqualified audit reports thereon. The consolidated financial statements have
been prepared in accordance with accounting principles generally accepted in the
United States and have been prepared in U.S. dollars. These consolidated
financial statements have been translated from the functional currency (British
pounds) to U.S. dollars in accordance with Statement of Financial Accounting
Standards No. 52 -"Foreign Currency Translation". Under this Statement assets
and liabilities are translated at year end rates and income and expenses are
translated at average rates.
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries. All significant intercompany balances and
transactions have been eliminated. Investments in 50% or less owned companies
and joint ventures over which the Company has the ability to exercise
significant influence are accounted for using the equity method.
REVENUE RECOGNITION
The Company recognizes its license revenue upon (i) delivery of software
or, if the customer has evaluation software, delivery of the software key, and
(ii) issuance of the related license, assuming no significant vendor obligations
or customer acceptance rights exist. In October 1997, the AICPA issued Statement
of Position ("SOP") No. 97-2, Software Revenue Recognition, which the Company
adopted, effective April 1, 1997. Such adoption had no effect on the Company's
revenue recognition policies related to its licensee and maintenance activities.
Prior to 1997, the Company's revenue recognition policy was in accordance with
the preceding authoritative guidance provided by SOP No. 91-1, Software Revenue
Recognition.
Annual renewable maintenance is a separate component of each contract, and
is recognized ratably over the contract term. Professional services revenues are
recognized as such services are performed.
F-23
<PAGE> 88
MARCH INFORMATION SYSTEMS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
EQUIPMENT AND FIXTURES
Depreciation is provided so as to write down the cost of property and
equipment to their estimated residual value over their expected useful lives
which is typically 3-4 years. The principal annual depreciation rates and
methods of calculation are as follows:
<TABLE>
<S> <C>
Computer and telecom equipment.............................. 3 years straight line
Furniture and fittings...................................... 3 years straight line
Motor vehicles.............................................. 4 years straight line
</TABLE>
INCOME TAXES
Income taxes are accounted for in accordance with Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes." Under the asset and
liability method of Statement No. 109, deferred income tax assets and
liabilities are recognized for the future tax consequences attributable to
carryforward losses and differences between the financial statement carrying
amounts of existing assets and liabilities, and their respective tax bases.
Deferred income tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. Deferred income tax assets
are recorded at their likely realizable amount.
FOREIGN CURRENCY TRANSLATION
Although the Company's functional currency is the British pound, some
transactions are made in different currencies. Foreign currency transactions are
converted into local currency at the rate of exchange prevailing at the date of
the transaction. Exchange gains or losses arising from transactions denominated
in a currency other than the functional currency of the entity involved are
included in other expenses.
USE OF ESTIMATES
The preparation of financial statements requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Certain estimates used by management are particularly susceptible to
significant changes, such as the recoverability and amortization periods of
intangible assets. Management believes that as of March 31, 1997 and 1998 and
September 30, 1998, the estimates used are adequate based on the information
currently available.
INTERIM FINANCIAL INFORMATION
The financial information at September 30, 1998 and for the six months
ended September 30, 1997 and 1998 is unaudited but included all adjustments
(consisting of normal recurring adjustments) which the Company considers
necessary for a fair presentation of the financial position at such date and the
operating results and cash flows for those periods. Results of the September 30,
1998 period are not necessarily indicative of the results for the entire year.
F-24
<PAGE> 89
MARCH INFORMATION SYSTEMS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts for the Company's financial instruments, including
cash, accounts receivable, accounts payable, accrued expenses and long-term debt
approximate fair values.
However, considerable judgment is required in interpreting market data to
develop estimates of fair value. Therefore, the estimates are not necessarily
indicative of the amounts which could be realized or would be paid in a current
market exchange. The effect of using different market assumptions and/or
estimation methodologies may be material to the estimated fair value amount.
CASH AND CASH EQUIVALENTS
The Company considers investments in highly liquid instruments purchased
with an original maturity of 90 days or less to be cash equivalents. Such
amounts are stated at cost which approximates market value.
CONCENTRATION OF CREDIT RISK
The Company performs ongoing credit evaluations of its customers' financial
condition and, generally, does not require collateral on accounts receivable.
When required, the Company maintains allowances for credit losses and such
losses have been within management's expectations. The Company's services are
provided to customers mainly throughout Europe and United States. There was no
allowance for doubtful accounts established for the periods presented and
write-offs of accounts receivable have not been significant.
The Company had one customer that accounted for approximately 49% of total
revenues for the year ended March 31, 1997 and 45% for the six months ended
September 30, 1997 and two customers that accounted for approximately 33% and
41% of total revenues for the year ended March 31, 1998 and 29% and 42% of total
revenues for the six months ended September 30, 1998, respectively.
PENSION PLAN
The Company sponsors a defined contribution pension plan. The pension
charge represents the amounts payable by the Company to the fund. Employees are
eligible to join the plan after three months of employment. The Company matches
the employees contribution up to a maximum 5% of the employees salary. If an
employee belongs to a pension fund outside of the company and does not elect to
join the pension fund maintained by March, then the Company will contribute to
the outside fund at a rate of 5% or match what the employee contributes,
whichever is lower. Contributions for the year ended March 31, 1997 and 1998 and
the six months ending September 30, 1997 and 1998 were $45,030, $47,247, $23,733
and $22,588, respectively.
RESEARCH AND DEVELOPMENT
Research and development costs are charged to expense as incurred. The
Company has not capitalized any such development costs under SFAS No. 86,
Accounting for the Costs of Computer Software to be sold, leased, or otherwise
marketed, because the costs incurred by the company between the attainment of
technological feasibility for the related software product through the date when
the product is available for general release to customers is insignificant.
F-25
<PAGE> 90
MARCH INFORMATION SYSTEMS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ADVERTISING
Costs related to advertising are expensed as incurred. Advertising expense
was $4,879, $4,031 $1,051 and $7,589 for the years ended March 31, 1997 and 1998
and the six months ended September 30, 1997 and 1998, respectively.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income". This Statement requires that changes in comprehensive income be shown
in a financial statement that is displayed with the same prominence as other
financial statements. The Statement will be effective for annual periods
beginning after December 15, 1997 and the Company will adopt its provisions in
fiscal 1998. Reclassification for earlier periods is required for comparative
purposes. The Company is currently evaluating the impact this Statement will
have on its financial statements, however, because the Statement requires only
additional disclosure, the Company does not expect the statement to have a
material impact on its financial position or results of operations.
In June 1997, the FASB issued SFAS No 131, "Disclosure about Segments of an
Enterprise and Related Information," which changes the way public companies
report information about operating segments. SFAS No. 131, which is based on the
management approach to segment reporting, establishes requirements to report
selected segment information quarterly and to report entity-wide disclosures
about products and services, major customers, and the material countries in
which the entity holds assets and reports revenue. The Statement will be
effective for annual periods beginning after December 15, 1997 and the Company
will adopt its provisions in fiscal 1998. The Company does not expect the
Statement to have a material impact on its financial position or results of
operations.
YEAR 2000 (UNAUDITED)
The Company has determined that its current computer systems are Year 2000
compliant and would function properly with respect to dates in the Year 2000 and
beyond. The Company has not noted any Year 2000 issues with its products;
however, the Company has not performed a significant amount of testing with
respect to its products. The Company has yet to initiate discussions with all of
its third-party relationships to ensure that those parties have appropriate
plans in place to correct all of their year 2000 issues.
While the Company believes its planning efforts are adequate to address its
Year 2000 concerns, there can be no assurance that the systems and products of
other companies on which the Company's operations rely will be converted on a
timely basis and will not have a material adverse effect on the Company's
results of operations. The cost of the Year 2000 initiatives is not expected to
be material to the Company's consolidated results of operations or financial
position.
2. BUSINESS COMBINATIONS
The Company incorporated a wholly-owned subsidiary in Belgium, March
Systems Consultancy BVBA, in January 1993 to exploit the market for temporary
computer specialists in Belgium and Western Europe. March Systems Consultancy
BVBA was dissolved in December 1997 as the UK company continued to focus on
software development.
F-26
<PAGE> 91
MARCH INFORMATION SYSTEMS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. BUSINESS COMBINATIONS (CONTINUED)
Also in 1993, the Company acquired a 50% interest in another company,
Westmount UK Limited, supplying Unix based I-CASE software and professional
services. Westmount UK ceased trading in December 1997.
3. COMMITMENTS
OPERATING LEASES
The Company leases two separate office spaces under non-cancelable
operating leases. One lease is month to month and the other expires on September
30, 1999. The Company also leases cars and computer equipment under a
non-cancelable lease arrangements.
Required future minimum lease payments under both operating and capital
leases as of March 31, 1998 are as follows:
<TABLE>
<CAPTION>
OPERATING CAPITAL
LEASES LEASES
--------- --------
<S> <C> <C>
Years ending December 31:
1999...................................................... $31,817 $ 32,226
2000...................................................... 15,908 3,190
------- --------
Total minimum payments required................... $47,725 35,416
=======
Present value of future lease payments.................... 31,810
Less current portion...................................... (25,713)
--------
Noncurrent portion........................................ $ 6,097
========
</TABLE>
Rent expense was $42,152, $43,629, $16,424 and $22,744 for the fiscal years
ending March 31, 1997 and March 31, 1998, and the six months ending September
30, 1997 and September 30, 1998, respectively.
Equipment and fixtures financed under a capital lease were $277,639,
$158,365 and $85,592 at March 31, 1997, March 31, 1998 and September 30, 1998,
respectively. Accumulated amortization related to the leased assets were
$139,910, $98,466 and $37,528 at March 31, 1997, March 31, 1998 and September
30, 1998, respectively. Amortization related to capital leases are included in
depreciation expense.
4. INCOME TAX
The deferred tax asset reflects the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes.
Significant components of the Company's deferred tax assets are as follows:
<TABLE>
<CAPTION>
YEAR ENDED
MARCH 31,
-----------------
1997 1998
------- -------
<S> <C> <C>
Book over tax depreciation.................................. $11,468 $10,945
Other....................................................... 788 1,759
======= =======
Total deferred tax asset.......................... $12,256 $12,704
======= =======
</TABLE>
F-27
<PAGE> 92
MARCH INFORMATION SYSTEMS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
4. INCOME TAX (CONTINUED)
Significant components of the benefit (provision) for income taxes
attributable to operations are as follows:
<TABLE>
<CAPTION>
YEAR ENDED
MARCH 31,
------------------
1997 1998
------- --------
<S> <C> <C>
Current..................................................... $21,418 $(20,811)
Deferred.................................................... 5,259 118
======= ========
$26,677 $(20,693)
======= ========
</TABLE>
A reconciliation of the statutory income tax rate to the Company's
effective income tax rate is as follows:
<TABLE>
<CAPTION>
YEAR ENDED
MARCH 31,
------------------
1997 1998
------- --------
<S> <C> <C>
Income tax at statutory rates............................... $32,370 $ (9,564)
Income not taxable.......................................... -- 3,276
Non deductible expenses..................................... (6,239) (12,210)
Other....................................................... 809 (152)
Change in rate for deferred accounts........................ (263) (2,043)
======= ========
$26,677 $(20,693)
======= ========
19.8% 45.4%
======= ========
</TABLE>
5. RELATED PARTIES
The directors of the Company have made short term loans to assist in the
funding of the Company during temporary cash flow shortages. At March 31, 1997
and March 31, 1998 the total of the loans were approximately $52,544 and
$90,428, respectively. There were no balances outstanding at September 30, 1998.
There were no specific payment terms attached to the notes. The balances are
included in accrued expenses and other liabilities on the balance sheet.
Subsequent to year end, the balance of the notes were paid.
6. SEGMENT REPORTING
Revenue by geographic area is as follows:
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED
MARCH 31, SEPTEMBER 30,
----------------------- -------------------------
1997 1998 1997 1998
---------- ---------- ----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
United Kingdom customers............... $1,553,784 $1,473,022 $691,533 $ 691,287
Continental Europe customers........... 62,754 118,691 57,866 240,123
United States of America............... -- 358,461 147,386 41,610
Rest of the world...................... 19,512 96,194 11,019 225,755
========== ========== ======== ==========
Total revenue................ $1,636,050 $2,046,368 $907,804 $1,198,775
========== ========== ======== ==========
</TABLE>
F-28
<PAGE> 93
MARCH INFORMATION SYSTEMS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. SUBSEQUENT EVENTS
On October 6, 1998, the Company was purchased by ISS Group, Inc. for $4.75
million plus 120,000 shares of ISS Group, Inc.'s common stock. The acquisition
will be accounted for as a purchase. ISS Group is a US based company currently
being traded on the Nasdaq National Market. Upon acquisition, the Company's name
was changed to ISS Group Ltd.
F-29
<PAGE> 94
ISS GROUP, INC. ACQUISITION OF MARCH INFORMATION SYSTEMS
UNAUDITED PRO FORMA FINANCIAL DATA
On October 6, 1998, ISS acquired privately held March Information Systems
Limited ("March Systems"), a United Kingdom-based developer of Windows NT and
Unix-based security assessment technologies. Under the terms of the agreement,
ISS Group, Inc. ("ISS" or "Company") acquired all of the outstanding stock of
March Systems in exchange for $4.75 million in cash and 120,000 shares of ISS
Group common stock. The ISS shares were valued at the closing price of ISS
common stock on October 6, 1998 of $24 per share, as quoted on the Nasdaq
National Market. In addition, there were transaction costs of approximately
$265,000, principally for legal and accounting professional services and stock
transfer taxes. The transaction has been accounted for using the purchase method
of accounting and the results of March Systems will be included in future
results of ISS from October 6, 1998, the closing date of the transaction.
The Unaudited Pro Forma Consolidated Statement of Operations set forth
below for the year ended December 31, 1998 gives effect to the acquisition as if
it occurred on January 1, 1998. It has been derived from the ISS historical
consolidated statement of operations for the year ended December 31, 1998 and
from the March Systems unaudited consolidated statement of operations for the
nine-month period ended September 30, 1998.
The Pro Forma Consolidated Financial Statements do not purport to be
indicative of the results of operations or financial position which would have
actually been reported if the acquisition had been consummated on the date
indicated, or which may be reported in the future.
F-30
<PAGE> 95
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998
<TABLE>
<CAPTION>
MARCH
INFORMATION PRO FORMA
SYSTEMS ACQUISITION ISS GROUP
ISS GROUP LIMITED ADJUSTMENTS PRO FORMA
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenues:
Perpetual licenses................. $25,936,000 $1,029,000 $ -- $26,965,000
Subscriptions...................... 7,406,000 109,000 7,515,000
Professional services.............. 2,587,000 668,000 3,255,000
----------- ---------- --------- -----------
35,929,000 1,806,000 37,735,000
----------- ---------- --------- -----------
Costs and expenses:.................. --
Cost of revenues................... 4,831,000 584,000 5,415,000
Research and development........... 9,321,000 387,000 9,708,000
Charge for in-process research and
development..................... 802,000 802,000
Sales and marketing................ 22,762,000 585,000 23,347,000
Amortization....................... 230,000 -- 607,000(1) 837,000
General and administrative......... 4,389,000 75,000 4,464,000
----------- ---------- --------- -----------
42,335,000 1,631,000 607,000 44,573,000
----------- ---------- ---------
Operating income (loss).............. (6,406,000) 175,000 (607,000) (6,838,000)
Interest income (expense), net....... 2,366,000 (31,000) (196,000)(2) 2,139,000
----------- ---------- --------- -----------
Income (loss) before income taxes.... (4,040,000) 144,000 (803,000) (4,699,000)
Provision for income taxes........... 62,000 67,000 129,000
----------- ---------- --------- -----------
Net income (loss).................... $(4,102,000) $ 77,000 $(803,000) (4,828,000)
=========== ========== ========= ===========
Basic and diluted net loss per share
of Common Stock.................... $ (0.28) $ (0.32)
=========== ===========
Weighted average number of shares
used in calculating basic and
diluted net loss per share of
Common Stock....................... 14,883,000 120,000 15,003,000
=========== ========= ===========
Unaudited pro forma net loss per
share of Common Stock (see note
3)................................. $ (0.25) $ (0.30)
=========== ===========
Unaudited weighted average number of
shares used in calculating pro
forma net loss per share of Common
Stock (see note 3)................. 16,189,000 120,000 16,309,000
=========== ========= ===========
</TABLE>
See accompanying notes to unaudited pro forma consolidated financial statements
for explanation of pro forma acquisition adjustments.
F-31
<PAGE> 96
ISS GROUP, INC. ACQUISITION OF MARCH INFORMATION SYSTEMS
NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION
(1) ALLOCATION OF PURCHASE PRICE AND RELATED AMORTIZATION
The purchase price was allocated first to tangible net assets, then to
identified intangible assets with any remaining unallocated purchase price
attributed to goodwill. The fair value of tangible assets approximated their
historical book values at September 30, 1998. The identified intangible assets,
along with their estimated lives for amortization, are as follows:
<TABLE>
<CAPTION>
LIFE
----
<S> <C> <C>
Professional work force..................................... $ 215,000 6
Core technology software.................................... 3,099,000 8
Developed software.......................................... 380,000 5
In process research and development software................ 705,000
Goodwill.................................................... 3,096,000 10
</TABLE>
The value assigned to in-process research and development software, in
accordance with generally accepted accounting principles, was written off at the
time of the acquisition and is reflected in the ISS consolidated financial
results for the year ended December 31, 1998.
(2) INTEREST INCOME
In connection with the payment of $5,015,000 in cash in conjunction with
the acquisition, including transaction costs, interest income was reduced for
the nine months ended September 30, 1998 using the 5.2% interest rate earned on
such funds.
(3) PRO FORMA LOSS PER SHARE
The Pro Forma basic and diluted historical net loss per share use the
historical amounts for ISS Group, Inc adjusted by the impact of the March
Systems acquisition. This impact includes March Systems historical net income
for the periods, the impact of purchase accounting adjustments and the shares of
Common Stock issued in connection with the acquisition.
Additionally, these pro forma consolidated statements of operation reflect
adjustments to the pro forma net loss per share amounts reflected in the ISS
historical consolidated statements of operations. The per share amounts were
computed for the historical ISS statements by dividing its net losses by the
number of shares of common Stock outstanding plus the conversion of the
3,650,000 shares of Series A and 2,087,000 shares of Series B Redeemable,
Convertible Preferred Stock into 5,737,000 share of Common Stock which occurred
upon consummation of ISS's initial public offering in March 1998. These pro
forma financial statements adjust such net loss and weighted average share
amounts for March Systems historical net income for the period, the impact of
purchase accounting adjustments and the shares of Common Stock issued in
connection with the acquisition.
F-32
<PAGE> 97
UNDERWRITING
ISS, the selling stockholders and the underwriters for the U.S. offering
(the "U.S. Underwriters") named below have entered into an underwriting
agreement with respect to the shares being offered in the United States. Subject
to certain conditions, each U.S. Underwriter has severally agreed to purchase
the number of shares indicated in the following table. Goldman, Sachs & Co.,
Dain Rauscher Wessels, a division of Dain Rauscher Incorporated, Warburg Dillon
Read LLC, a subsidiary of UBS AG, and BancBoston Robertson Stephens Inc. are the
representatives of the U.S. Underwriters.
<TABLE>
<CAPTION>
Number of
Underwriters Shares
------------ ---------
<S> <C>
Goldman, Sachs & Co......................................... 888,000
Dain Rauscher Wessels, a division of Dain Rauscher
Incorporated.............................................. 355,200
Warburg Dillon Read LLC, a subsidiary of UBS AG............. 355,200
BancBoston Robertson Stephens Inc........................... 177,600
Hambrecht & Quist LLC....................................... 48,000
Nationsbanc Montgomery Securities LLC....................... 48,000
Prudential Securities Incorporated.......................... 48,000
---------
Total............................................. 1,920,000
=========
</TABLE>
----------------------
If the U.S. Underwriters sell more shares than the total number set forth
in the table above, the U.S. Underwriters have an option to buy up to an
additional 264,000 shares from ISS and an option to buy an additional 24,000
shares from the selling stockholders to cover such sales. They may exercise that
option for 30 days. If any shares are purchased pursuant to this option, the
U.S. Underwriters will severally purchase shares in approximately the same
proportion as set forth in the table above.
The following tables show the per share and total underwriting discounts
and commissions to be paid to the U.S. Underwriters by ISS and the selling
stockholders. Such amounts are shown assuming both no exercise and full exercise
of the U.S. Underwriters' option to purchase additional shares.
<TABLE>
<CAPTION>
Paid by the Company
-------------------------------
No Full
Exercise Exercise
----------- -------------
<S> <C> <C>
Per Share............ $ 2.80 $ 2.80
Total................ $2,688,000 $3,427,200
</TABLE>
<TABLE>
<CAPTION>
Paid by the Selling
Stockholders
-------------------------------
No Full
Exercise Exercise
----------- -------------
<S> <C> <C>
Per Share............ $ 2.80 $ 2.80
Total................ $2,688,000 $2,755,200
</TABLE>
Shares sold by the Underwriters to the public will initially be offered at
the initial public offering price set forth on the cover of this Prospectus. Any
shares sold by the Underwriters to securities dealers may be sold at a discount
of up to $1.60 per share from the initial public offering price. Any such
securities dealers may resell any shares purchased from the U.S. Underwriters to
certain other brokers or dealers at a discount of up to $0.10 per share from the
initial public offering price. If all the shares are not sold at the initial
offering price, the representatives may change the offering price and the other
selling terms.
ISS and the selling stockholders have entered into underwriting agreements
with the Underwriters for the sale of shares outside of the United States. The
terms and conditions of both offerings are the same and the sale of shares in
both Offerings are conditioned on each other. Goldman Sachs International, Dain
Rauscher Wessels, a division of Dain Rauscher Incorporated, UBS AG, acting
through its division, Warburg Dillon Read, and BancBoston Robertson Stephens
Inc. are representatives of the Underwriters for the international offering
outside of the United States (the "International Underwriters"). ISS and the
selling stockholders have granted the International Underwriters similar options
to
U-1
<PAGE> 98
purchase up to an aggregate of an additional 72,000 shares.
The Underwriters for both of the Offerings have entered into an agreement
in which they agree to restrictions on where and to whom they and any dealer
purchasing from them may offer shares as a part of the distribution of the
shares. The Underwriters also have agreed that they may sell shares among each
of the underwriting groups.
ISS and the selling stockholders have agreed with the Underwriters not to
dispose of or hedge any of their common stock or securities convertible into or
exchangeable for shares of common stock during the period from the date of this
prospectus continuing through the date 90 days after the date of this
prospectus, except with the prior written consent of the representatives. This
agreement does not apply to any existing employee benefit plans. See "Shares
Available for Future Sale" for a discussion of certain transfer restrictions.
The common stock will be quoted on the Nasdaq National Market under the
symbol "ISSX".
In connection with the Offerings, the Underwriters may purchase and sell
shares of common stock in the open market. These transactions may include short
sales, stabilizing transactions and purchases to cover positions created by
short sales. Short sales involve the sale by the Underwriters of a greater
number of shares than they are required to purchase in the Offerings.
Stabilizing transactions consist of certain bids or purchases made for the
purpose of preventing or retarding a decline in the market price of the common
stock while the Offerings are in progress.
The Underwriters also may impose a penalty bid. This occurs when a
particular Underwriter repays to the Underwriters a portion of the underwriting
discount received by it because the representatives have repurchased shares sold
by or for the account of such Underwriter in stabilizing or short covering
transactions.
These activities by the Underwriters may stabilize, maintain or otherwise
affect the market price of the common stock. As a result, the price of the
common stock may be higher than the price that otherwise might exist in the open
market. If these activities are commenced, they may be discontinued by the
Underwriters at any time. These transactions may be effected on the Nasdaq
National Market, in the over-the-counter market or otherwise.
ISS estimates that the total expenses of the Offerings, excluding
underwriting discounts and commissions, will be approximately $600,000.
ISS and the selling stockholders have agreed to indemnify the several
Underwriters against certain liabilities, including liabilities under the
Securities Act of 1933.
This prospectus may be used by the Underwriters and other dealers in
connection with offers and sales of the shares, including sales of shares
initially sold by the Underwriters in the Offerings being made outside of the
United States, to persons located in the United States.
U-2
<PAGE> 99
Picture headed "SAFEsuite Architecture" depicts a rectangle segmented into
15 parts: One segment spans the top of the top of the rectangle and is titled
"Information Risk Management". Immediately below that segment is another segment
spanning the center of the rectangle entitled "SAFEsuite Decisions" and includes
that product's square logo. Immediately below that segment are two segments of
half the length of the rectangle. The left segment is entitled "Vulnerability
Management" and the right segment is entitled "Threat Management". Below the
Vulnerability Management segment are three segments, entitled (from left to
right) "Internet Scanner", "Database Scanner" and "System Scanner", each with a
circular product logo. Below the "Threat Management" segment are two segments
(on a level even with the three segments below "Vulnerability Management")
entitled "RealSecure Engine" and "RealSecure Agent", both with a circular
product logo. Below these five segments is a segment spanning the center of the
rectangle entitled "Security Knowledge Base". Below that segment is another
segment spanning the center of the rectangle with a rectangular "X-Force" logo.
Along the right edge of the rectangle is a segment entitled "Professional
Services" with the words "Implementation" "Consulting" "Training" and "Advisory
Service" underneath the title. Along the left edge of the rectangle are segments
with the ANSA logo and the caption "APIs".
<PAGE> 100
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No dealer, salesperson or other person is authorized to give you any
information or to represent anything not contained in this prospectus. You must
not rely on any unauthorized information or representations. This prospectus is
an offer to sell or to buy only the shares offered hereby, but only under
circumstances and in jurisdictions where it is lawful to do so. The information
contained in this prospectus is current only as of its date.
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
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<S> <C>
Prospectus Summary...................... 1
Risk Factors............................ 3
Use of Proceeds......................... 12
Price Range of Common Stock............. 12
Dividend Policy......................... 12
Capitalization.......................... 13
Dilution................................ 14
Selected Consolidated Financial Data.... 15
Management's Discussion and Analysis of
Financial Condition and Results of
Operations............................ 16
Business................................ 24
Management.............................. 43
Certain Transactions.................... 52
Principal and Selling Stockholders...... 54
Description of Securities............... 56
Shares Eligible for Future Sale......... 60
Validity of Common Stock................ 62
Experts................................. 62
Additional Information.................. 62
Index to Consolidated Financial
Statements............................ F-1
Underwriting............................ U-1
</TABLE>
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2,400,000 Shares
ISS GROUP, INC.
Common Stock
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(ISS LOGO)
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GOLDMAN, SACHS & CO.
DAIN RAUSCHER WESSELS
A DIVISION OF DAIN RAUSCHER INCORPORATED
WARBURG DILLON READ LLC
BANCBOSTON
ROBERTSON STEPHENS
Representatives of the Underwriters
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