<PAGE>
As filed with the Securities and Exchange Commission on July 12, 1999
Registration No. 333-76587
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
AMENDMENT NO. 3
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
---------------
WATCHGUARD TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C> <C>
Delaware 7372 91-1712427
(State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer
of incorporation or organization) Classification Code Number) Identification No.)
</TABLE>
316 Occidental Avenue South, Suite 200
Seattle, Washington 98104
(206) 521-8340
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
---------------
CHRISTOPHER G. SLATT
President, Chief Executive Officer and Chairman of the Board
WatchGuard Technologies, Inc.
316 Occidental Avenue South, Suite 200
Seattle, Washington 98104
(206) 521-8340
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
---------------
Copies to:
<TABLE>
<S> <C>
Stephen M. Graham Robert P. Latta
Alan C. Smith Patrick J. Schultheis
Ann L. McGuire Christian E. Montegut
Perkins Coie LLP Wilson Sonsini Goodrich & Rosati
1201 Third Avenue, 48th Floor Professional Corporation
Seattle, Washington 98101-3099 650 Page Mill Road
(206) 583-8888 Palo Alto, California 94304-1050
(650) 493-9300
</TABLE>
---------------
Approximate date of commencement of proposed sale to the public: As soon as
practicable after this registration statement becomes effective.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act of 1933, check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]_____________
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act of 1933, check the following box and list the
Securities Act registration statement number of the earlier effective
registration statement for the same offering. [_]_____________
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act of 1933, check the following box and list the
Securities Act registration statement number of the earlier effective
registration statement for the same offering. [_]_____________
If delivery of this prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
---------------
The registrant hereby amends this registration statement on such dates as
may be necessary to delay its effective date until the registrant files a
further amendment which specifically states that this registration statement
will thereafter become effective in accordance with Section 8(a) of the
Securities Act of 1933 or until this registration statement becomes effective
on such date as the Commission, acting pursuant to Section 8(a), may
determine.
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- -------------------------------------------------------------------------------
<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+The information in this prospectus is not complete and may be changed. We may +
+not sell our common stock until the registration statement filed with the +
+Securities and Exchange Commission is effective. This prospectus is offering +
+to sell our common stock, and seeking offers to buy our common stock, only in +
+states where the offer or sale is permitted. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED JULY 12, 1999
[LOGO OF WATCHGUARD TECHNOLOGIES, INC.]
3,500,000 SHARES OF COMMON STOCK
$ per share
This is the initial public offering of WatchGuard Technologies, Inc. We are
selling 3,500,000 shares of our common stock. In addition, the stockholders
listed on page 62 have granted the underwriters a 30-day option to purchase up
to an additional 525,000 shares of common stock to cover any over-allotments.
We will not receive any of the proceeds from the sale of shares by the selling
stockholders.
We expect the initial public offering price to be between $9 and $11 per
share. Our common stock has been approved for quotation on the Nasdaq National
Market under the symbol WGRD.
Investing in this stock involves significant risks. See "Risk Factors"
beginning on page 6.
-----------
<TABLE>
<CAPTION>
Total
-----------------------------
Without With
Per Share Over-Allotment Over-Allotment
--------- -------------- --------------
<S> <C> <C> <C>
Price to Public....................... $ $ $
Underwriting Discounts & Commissions..
WatchGuard's Proceeds, Before
Expenses.............................
Selling Stockholders' Proceeds, Before
Expenses.............................
</TABLE>
-----------
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if
this prospectus is truthful or complete. Any representation to the contrary is
a criminal offense.
Dain Rauscher Wessels
a division of Dain Rauscher Incorporated
Warburg Dillon Read LLC
SoundView Technology Group
Wit Capital Corporation
, 1999
<PAGE>
[INSIDE FRONT COVER]
LIVE
Security
[WATCHGUARD'S LOGO]
WatchGuard LiveSecurity--dynamic security protection, timely Internet
broadcasts and responsive security experts protecting small- to medium-sized
enterprises around the world that use the Internet for e-business and
communications.
<PAGE>
GATEFOLD ARTWORK DESCRIPTION TEXT:
The WatchGuard LiveSecurity Internet Broadcast Service
How it Works:
1. WatchGuard LiveSecurity Broadcast Service--WatchGuard's team of
security experts broadcast alerts, threat responses and security software
updates via the Internet directly to security managers at subscribing SME
customers and to ISP network operation centers (NOCs).
2. Security Policy Management--Easy-to-use monitoring and reporting tools
enable SME customers to configure their security systems, implement security
policies and monitor all of their protected offices. In the NOC, specially
designed scalable software enables ISPs to centrally track, configure, update
and individually monitor thousands of managed security customers.
3. Comprehensive Security Protection--The standard security suite
includes:
. Firewall
. User Authentication
. Remote User VPN
. IPSec Branch Office VPN
. Web Access Control
ISPs may easily extend the standard security suite by bundling their
own services like intrusion detection, 24-hour monitoring and expanded reporting
and analysis.
4. WatchGuard Firebox--Easily installed into the SME or managed
customer's existing network, the WatchGuard Firebox simply plugs in behind the
router at the Internet connection of each office. This dedicated security
appliance implements the customer's security policies and protection.
WatchGuard LiveSecurity System.
The WatchGuard LiveSecurity System is used by small- to medium-sized
enterprises (SMEs) that use the Internet for e-business and communications.
Some current customers are:
. Unimed Pharmaceuticals, Inc.
. JDA Sofware Group, Inc.
. Norm Thompson Outfitters, Inc.
. Boston Architectural Center
WatchGuard LiveSecurity for MSS
WatchGuard LiveSecurity for MSS (Managed Security Services) is used by
Internet service providers (ISPs) to deliver LiveSecurity protection to their
SME business, government and education customers around the world.
Some current ISPs:
. AT&T EasyLink Services Asia/Pacific Ltd.
. GTE Internetworking, Inc.
. PSINet, Inc.
. Verio, Inc.
================================================================================
Diagram: The WatchGuard LiveSecurity Internet Broadcast Service
================================================================================
Graphics:
Diagram showing WatchGuard LiveSecurity broadcasts going through the
Internet to:
(1) A Firebox and then to the security manager at SME headquarters. From
the security manager, the broadcast goes to Fireboxes at SME branch offices.
(2) An ISP network operations center. From the ISP security manager, the
broadcast goes to Fireboxes on the premises of the ISP's subscribing SME
customers. Behind the diagram is an outline of a world map.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary.................. 3
Risk Factors........................ 6
Forward-Looking Statements.......... 14
Use of Proceeds..................... 15
Dividend Policy..................... 15
Capitalization...................... 16
Dilution............................ 17
Selected Financial Data............. 18
Management's Discussion and Analysis
of Financial Condition and Results
of Operations...................... 19
</TABLE>
<TABLE>
<CAPTION>
Page
----
<S> <C>
Business............................ 31
Management.......................... 50
Related-Party Transactions.......... 58
Principal and Selling Stockholders.. 60
Description of Capital Stock........ 63
Shares Eligible for Future Sale..... 67
Underwriting........................ 69
Legal Matters....................... 71
Experts............................. 71
Where You Can Find More
Information........................ 71
Index to Financial Statements....... F-1
</TABLE>
<PAGE>
PROSPECTUS SUMMARY
This summary highlights information that we present more fully in the rest of
this prospectus. This summary does not contain all the information you should
consider before buying shares in this offering. You should read the entire
prospectus carefully.
WatchGuard Technologies, Inc.
WatchGuard is a leading provider of dynamic, comprehensive Internet security
solutions designed to protect small- to medium-sized enterprises, or SMEs--
those businesses, governmental entities and educational institutions with fewer
than 1,000 employees--that use the Internet for electronic commerce and
communications. Our innovative LiveSecurity solution enables SMEs to keep their
security systems current with minimal effort through our broadcast of threat
responses, software updates and information alerts over the Internet.
LiveSecurity is made possible through an updatable security appliance that
executes software sent from a remote management system that receives our
LiveSecurity broadcasts. Our solution is a fully integrated, easy-to-install
package featuring a firewall, virtual private networking, user authentication
and web surfing control.
We provide SMEs a security management choice through our two product
offerings, the LiveSecurity System and LiveSecurity for MSS, or managed
security service. Our LiveSecurity System enables SMEs to manage their own
Internet security with an easy-to-configure solution that provides point-and-
click security management and advanced real-time graphical monitoring of
network traffic. The LiveSecurity System allows SMEs to rapidly distribute
security protection from a desktop personal computer to all security appliances
on their corporate network, while retaining centralized control and
administration. Alternatively, SMEs can outsource their security management to
Internet service providers, or ISPs, that have implemented our LiveSecurity for
MSS. Through LiveSecurity for MSS, SMEs can sign up with an ISP to centrally
configure, monitor and update the SME's network security. For the ISP, our
technology greatly improves the economics of managed security services through
a scalable delivery platform that enables the ISP to remotely configure and
manage thousands of customer sites quickly, easily and economically.
We initially incorporated in Washington in 1996 and reincorporated in
Delaware in 1997. References to "we," "our," "us" and "WatchGuard" in this
prospectus refer to WatchGuard Technologies, Inc. and its predecessor. Our
executive offices are located at 316 Occidental Avenue South, Suite 200,
Seattle, Washington 98104, and our telephone number is (206) 521-8340. Our web
site is located at http://www.watchguard.com. Any information that is included
on or linked to our web site is not a part of this prospectus.
We own or have rights to various trademarks and trade names used in our
business. These include WatchGuard(R), Firebox(TM) and LiveSecurity(TM). This
prospectus also includes trademarks, service marks and trade names of other
companies, which remain the property of their owners.
3
<PAGE>
The Offering
<TABLE>
<S> <C>
Common stock offered by WatchGuard........... 3,500,000 shares
Common stock to be outstanding after this
offering.................................... 18,447,484 shares
Use of proceeds.............................. For repayment of debt, working capital and
other general corporate purposes
Proposed Nasdaq National Market symbol....... WGRD
</TABLE>
The number of shares of outstanding common stock is based on shares
outstanding on June 30, 1999, and excludes
. 1,516,244 shares available for grant under our stock option plan;
. 6,169,430 shares of common stock issuable upon exercise of options
outstanding under our stock option plan, at a weighted average exercise
price of $1.46 per share, of which options to purchase 2,211,184 shares
are currently exercisable;
. 259,500 shares of common stock issuable upon exercise of warrants
outstanding at a weighted average exercise price of $0.70 per share,
255,000 of which are currently exercisable; and
. 600,000 shares of common stock available for issuance under our employee
stock purchase plan.
----------------
Except where stated otherwise, the information we present in this prospectus
(1) assumes the conversion on a 2-for-1 basis of all outstanding shares of
convertible preferred stock into 13,425,316 shares of common stock at the
closing of this offering, (2) assumes the exercise before the closing of this
offering of warrants to purchase 42,856 shares of common stock at an exercise
price of $7.00 per share, (3) assumes no exercise by the underwriters of their
over-allotment option and (4) gives effect to a 2-for-1 split of our common
stock effected on July 8, 1999.
You should rely only on the information contained in this prospectus. We have
not authorized anyone to give you any different information or representations.
We are offering to sell, and seeking offers to buy, shares of our common stock
only in jurisdictions where offers and sales are permitted. The information in
this prospectus is accurate only as of the date of this prospectus, regardless
of the time of delivery of this prospectus or any sale of our common stock.
4
<PAGE>
Summary Financial Data
(In thousands, except per share data)
<TABLE>
<CAPTION>
Period From
February 14,
1996 Year Ended Six Months
(Inception) December 31, Ended June 30,
to December 31, ----------------- ----------------
1996 1997 1998 1998 1999
--------------- ------- -------- ------- -------
(unaudited)
<S> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Total revenues........... $ 331 $ 5,098 $ 11,379 $ 5,017 $ 8,575
Operating loss........... (462) (4,396) (9,000) (3,175) (6,314)
Net loss................. (468) (4,334) (9,119) (3,258) (6,661)
Basic and diluted net
loss per share.......... N/A $(17.17) $ (11.34) $ (4.70) $ (4.65)
Shares used in
calculation of basic and
diluted net loss per
share................... N/A 252 804 693 1,433
Pro forma basic and
diluted net loss per
share................... $ (0.68) $ (0.45)
Shares used in
calculation of pro forma
basic and diluted net
loss per share.......... 13,366 14,858
</TABLE>
<TABLE>
<CAPTION>
June 30, 1999
------------------------------
Pro Forma
Actual Pro Forma as Adjusted
------- --------- -----------
<S> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents........................ $ 2,214 $2,514 $27,264
Working capital (deficit)........................ (6,742) (6,442) 24,908
Total assets..................................... 11,123 11,423 36,173
Long-term debt, less current portion............. -- -- --
Total stockholders' equity (deficit)............. (5,061) (4,761) 26,589
</TABLE>
The preceding table summarizes
. actual balance sheet data;
. pro forma balance sheet data to give effect to the conversion of all
outstanding preferred stock into 13,425,316 shares of common stock and
the exercise of warrants to purchase 42,856 shares of common stock at an
exercise price of $7.00 per share; and
. pro forma balance sheet data as adjusted to give effect to the sale by
WatchGuard of 3,500,000 shares of common stock offered through this
prospectus at an assumed initial public offering price of $10.00 per
share, after deducting underwriting discounts and commissions and
estimated offering expenses.
See note 6 of Notes to Financial Statements for information concerning the
calculation of pro forma basic and diluted net loss per share.
5
<PAGE>
RISK FACTORS
In addition to the other information contained in this prospectus, you should
carefully read and consider the following risk factors before purchasing our
common stock. If any of these risks actually occur, our business, financial
condition or operating results could be adversely affected. In that case, the
trading price of our common stock could decline and you could lose all or part
of your investment.
We have incurred losses since inception and may never be profitable, which
could result in a decline in the value of our common stock and a loss of your
investment.
We expect our operating losses and negative cash flows to continue. Although
our revenues have increased each year since we began operations, we may be
unable to sustain any revenue growth in the future. We may never generate
profits, and if we do become profitable, we may be unable to sustain or
increase profitability on a quarterly or annual basis. As a result, the trading
price of our common stock could decline and you could lose all or part of your
investment. We have incurred net losses and experienced negative cash flows in
each quarter since we began doing business. As of June 30, 1999, we had an
accumulated deficit of approximately $20.6 million.
Our operating results fluctuate and could fall below expectations of securities
analysts and investors, resulting in a decrease in our stock price.
Our quarterly and yearly operating results have varied widely in the past and
will probably continue to fluctuate. In addition, our limited operating history
makes predicting our future performance difficult. Our operating results for a
particular quarter or year are likely to fall below the expectations of
securities analysts and investors, which could result in a decrease in our
stock price. We believe that period-to-period comparisons of our operating
results are not meaningful. Numerous factors contribute to the unpredictability
of our operating results, including
. changing demand for our products and services;
. changing product and price competition; and
. the timing of the announcement, introduction and market acceptance of
new or enhanced products and services by us or our competitors.
We base our spending levels for product development, sales and marketing, and
other operating expenses largely on our expected future revenues. Because our
expenses are largely fixed for a particular quarter or year, we may be unable
to adjust our spending in time to compensate for any unexpected quarterly or
annual shortfall in revenues.
In addition, our domestic and international sales tend to be lower in the
summer months, when businesses often defer purchasing decisions. Also, as a
result of customer buying patterns and the efforts of our sales force to meet
or exceed quarterly and year-end quotas, we generally earn a substantial
portion of a quarter's revenues during its last month and, within that month,
during the last two weeks. We expect this concentration of revenues to
continue. If expected revenues at the end of any quarter are delayed, our
revenues for that quarter could fall below the expectations of securities
analysts and investors.
6
<PAGE>
Because many potential SME customers are unaware of the need for Internet
security or may perceive it as costly and difficult to implement, our products
and services may not achieve market acceptance.
We believe that many potential customers, particularly SMEs, are not fully
aware of the need for Internet security products and services. Historically,
only enterprises having substantial resources have developed or purchased
Internet security solutions. Also, there is a perception that Internet security
is costly and difficult to implement. We will therefore not succeed unless we
can educate our market about the need for Internet security and convince SMEs
of our ability to provide this security in a cost-effective and
administratively feasible manner. Although we have spent, and will continue to
spend, considerable resources educating potential customers about the need for
Internet security and the benefits of our products and services, our efforts
may be unsuccessful.
If SMEs do not accept our innovative LiveSecurity products and services, our
business will not succeed.
We currently expect all future revenues to be generated through sales of our
LiveSecurity Internet security products and related services, particularly
subscription and license fees. Our success depends on market acceptance of our
LiveSecurity products and services and our ability and the ability of our ISP
partners to obtain and retain LiveSecurity customers. Our LiveSecurity products
and services, however, are new and unproven. The broadcast portion of our
LiveSecurity products has been available only since February 1999, and our
LiveSecurity for MSS product has been available only since September 1998. To
receive our broadcasts, enterprises will be required to pay an annual
subscription fee, either to us or, if they obtain LiveSecurity through an ISP,
to the ISP. We are not aware of any other Internet security product that allows
enterprises to keep their security solution current by receiving broadcasts of
software updates and related information over the Internet. SMEs may be
unwilling to pay a subscription fee to keep their Internet security up to date.
In addition, most businesses implementing security services have traditionally
managed their own Internet security rather than seeking the services of third-
party service providers. As a result, our products and services and the
outsourcing of Internet security to third parties may not achieve significant
market acceptance.
If our newly established and unproven relationships with ISPs are unsuccessful,
our ability to market and sell our products and services will be limited.
We expect a substantial percentage of our revenues to be derived from our
relationships with several domestic and international ISPs which have agreed to
implement our LiveSecurity for MSS solution. If these ISPs are unsuccessful in
marketing and implementing our LiveSecurity for MSS solution, our operating
results will be materially harmed. Because our relationships with the ISPs are
new, we cannot predict whether the ISPs will succeed in marketing and selling
services based on our products and services. The ISPs have not had an
opportunity to fully develop and implement service offerings incorporating
LiveSecurity and we cannot predict how long they will take to complete this
development and implementation. Until and unless this development and
implementation is achieved, our revenues from ISPs will be limited. If the ISPs
fail to provide adequate installation, deployment and support of our products
and services, end-users could decide not to subscribe, or cease subscribing,
for managed services that use our solution. The ISPs will offer our products in
combination with other products and services, some of which may be competitive
with our products and services.
7
<PAGE>
If our third-party resellers and distributors fail to perform, our ability to
sell our products and services will be limited.
We sell our products and services through value-added resellers and
distributors, and we expect our success to continue to depend in large part on
their performance. Our resellers and distributors have the ability to sell
products and services that are competitive with ours, to devote more resources
to those competitive products or to cease selling our products and services
altogether. While no single reseller or distributor currently accounts for more
than 10% of our total revenues, the loss of or reduction in sales to several
value-added resellers or a distributor, particularly to competitive products
offered by other companies, could adversely affect our revenues.
Product returns or retroactive price adjustments could exceed our allowances,
which could adversely affect our operating results.
We provide some of our distributors and resellers with product return rights
for stock rotation. We also provide some of our distributors and resellers with
price protection rights for inventories of our products held by those
distributors or resellers if we lower our prices for those products. We may
experience significant returns and price adjustments for which we may not have
adequate allowances. The short life cycles of our products and the difficulty
of predicting future sales increase the risk that new product introductions or
price reductions by us or our competitors could result in significant product
returns or price adjustments. In September 1998, when we introduced the latest
version of our security appliance, we experienced an increase in returns.
Provisions for returns and allowances for the years ended December 31, 1997 and
1998 and for the six months ended June 30, 1999 were $0, $1,655,000 and
$730,000, or 0%, 14% and 8% of total revenues before returns and allowances.
If we are unable to compete successfully in the highly competitive market for
Internet security products and services, our business will fail.
The market for Internet security products is intensely competitive and we
expect competition to intensify in the future. We may be unable to compete
successfully against our current and future competitors. An increase in
competitive pressures in our market or our failure to compete effectively may
result in pricing reductions, reduced gross margins and loss of market share.
Currently, the dominant competitor in our industry is Check Point Software
Technologies Ltd. Other current and potential competitors include hardware,
software and operating system vendors such as Axent Technologies, Inc., Cisco
Systems, Inc., Lucent Technologies, Inc., Microsoft Corporation, Network
Associates, Inc., Novell, Inc., Sun Microsystems, Inc. and a number of smaller
companies. Our competitors may develop security products or implement services
that are comparable or superior to our current or future products and services.
In addition, our competitors may bundle products competitive with ours with
other products that they may sell to our current or potential customers. These
customers may accept these bundled products rather than separately purchasing
our products.
Many of our current competitors have longer operating histories, greater name
recognition, larger customer bases and significantly greater financial,
technical, marketing and other resources than we do. As a result, they may be
able to adapt more quickly to new technologies and customer
8
<PAGE>
needs, devote greater resources to the promotion or sale of their products and
services, initiate or withstand substantial price competition, take advantage
of acquisition or other opportunities more readily or develop and expand their
product and service offerings more quickly.
Rapid changes in technology and industry standards could render our products
and services unmarketable or obsolete, and we may be unable to introduce new
products and services timely and successfully.
To succeed, we must continually change and improve our products in response
to rapid technological developments and changes in operating systems, Internet
access and communications, application and networking software, computer and
communications hardware, programming tools, computer language technology and
hacker techniques. We may be unable to successfully and timely develop these
new products and services or achieve and maintain market acceptance. The
development of new, technologically advanced products and services is a complex
and uncertain process requiring great innovation and the ability to anticipate
technological and market trends. Because Internet security technology is
complex, it can require long development and testing periods. Releasing new
products and services prematurely may result in quality problems, and releasing
them late may result in loss of customer confidence and market share. In the
past, we have on occasion experienced delays in the scheduled introduction of
new and enhanced products and services, and we may experience delays in the
future. When we do introduce new or enhanced products and services, we may be
unable to manage the transition from the older products and services to
minimize disruption in customer ordering patterns, avoid excessive inventories
of older products and deliver enough new products and services to meet customer
demand.
We may be required to defend lawsuits or pay damages in connection with the
alleged or actual failure of our products and services.
Because our products and services provide and monitor Internet security and
may protect valuable information, we may face claims for product liability,
tort or breach of warranty relating to our products and services. Anyone who
circumvents our security measures could misappropriate the confidential
information or other property of end-users using our products and services or
interrupt their operations. If that happens, affected end-users or ISPs may sue
us. In addition, we may face liability for breaches caused by faulty
installation of our products by resellers or end-users. Although we attempt to
reduce the risk of losses from claims through contractual warranty disclaimers
and liability limitations, these provisions may be unenforceable. Some courts,
for example, have found contractual limitations of liability in standard
software licenses to be unenforceable because the licensee does not sign them.
Defending a suit, regardless of its merit, could be costly and could divert
management attention. Although we currently maintain business liability
insurance, this coverage may be inadequate or may be unavailable in the future
on acceptable terms, if at all.
A breach of security could harm public perception of our products and services.
We will not succeed unless the marketplace is confident that we provide
effective Internet security protection. Even networks protected by our software
products may be vulnerable to electronic break-ins and computer viruses. If an
actual or perceived breach of Internet security occurs in an SME end-user's
systems, regardless of whether the breach is attributable to us, the market
perception of the efficacy of our products and services could be harmed. This
could cause us and our ISP partners to lose current and potential customers or
cause us to lose potential resellers, distributors and ISP partners. Because
the techniques used by computer hackers to access or sabotage networks change
frequently and generally are not recognized until launched against a target, we
may be unable to anticipate these techniques.
9
<PAGE>
If we are unable to prevent attacks on our internal network system by computer
hackers, public perception of our products and services will be harmed.
Because we provide Internet security, we have become a greater target of
attacks by computer hackers. We have experienced attacks by computer hackers in
the past and expect attacks to continue. If attacks on our internal network
system are successful, public perception of our products and services will be
harmed.
Failure to address strain on our resources caused by our rapid growth will
result in our inability to effectively manage our business.
Our current systems, management and resources will be inadequate if we
continue to grow. Our business has grown rapidly in size and complexity in the
last three years. This rapid expansion has placed significant strain on our
administrative, operational and financial resources and has resulted in ever-
increasing responsibilities for our management personnel. We will be unable to
effectively manage our business if we are unable to timely and successfully
alleviate the strain on our resources caused by our rapid growth.
We may be unable to adequately expand our operational systems to accommodate
growth, which could harm our ability to deliver our products and services.
Our operational systems have not been tested at the customer volumes that may
be required in the future. We may encounter performance difficulties when
operating with a substantially greater number of customers. In implementing our
LiveSecurity products, we have experienced periodic interruptions affecting all
or a portion of our systems, and we believe that interruptions will continue to
occur from time to time. These interruptions could harm our ability to deliver
our products and services. An inability to add software and hardware or to
develop and upgrade existing technology or operational systems to handle
increased traffic may cause unanticipated system disruptions, slower response
times and poor customer service, including problems filling customer orders.
We may be unable to adequately protect our operational systems from damage,
failure or interruption, which could harm our reputation and our ability to
attract and retain customers.
Our operations, customer service, reputation and ability to attract and
retain customers depend on the uninterrupted operation of our operational
systems. Although we have off-site backup facilities and take other precautions
to prevent damage, failure or interruption of our systems, our precautions may
be inadequate. Any damage, failure or interruption of our computer or
communications systems could lead to service interruptions, delays, loss of
data and inability to accept and fill customer orders and provide customers
with LiveSecurity updates.
We may be unable to deliver our products and services if we cannot continue to
license third-party technology that is important for the functionality of our
products.
Our success will depend in part on our continued ability to license
technology that is important for the functionality of our products. Although we
believe that we could find other sources for the technology we license, a
significant interruption in the supply of a third-party technology could delay
our development and sales until we can find, license and integrate equivalent
technology. This could damage our brand and result in loss of current and
potential customers. Additionally, alternative technologies may be unavailable
on acceptable terms, if at all. We depend on our third-
10
<PAGE>
party licensers to deliver reliable, high-quality products, develop new
products on a timely and cost-effective basis and respond to evolving
technology and changes in industry standards. We also depend on the continued
compatibility of our third-party software with future versions of our products.
We may be unable to deliver our products and services if our single-source
manufacturers fail to supply hardware with acceptable quality, quantity and
cost.
We outsource all of our hardware manufacturing and assembly to one
motherboard manufacturer and one assembly house. While these single-source
vendors have produced hardware with acceptable quality, quantity and cost in
the past, they may be unable to meet our future demands. Although we believe
that we could find another manufacturer and assembly house, our operations
could be disrupted if we have to switch to a replacement vendor or if our
hardware supply is interrupted for an extended period. This could result in
loss of customer orders and revenue.
We may have to reduce or cease operations if we are unable to obtain the
funding necessary to meet our working capital requirements.
Our future revenues may be insufficient to support the expenses of our
operations and the expansion of our business. We may therefore need additional
equity or debt capital to finance our operations. If we are unable to generate
sufficient cash flow from operations or obtain funds through additional
financing, we may have to reduce some or all of our development and sales and
marketing efforts or cease operations. We believe that the net proceeds from
this offering, together with our existing cash balances and our existing lines
of credit, should be sufficient to meet our capital requirements for at least
the next 18 months. Our capital requirements depend on several factors,
however, including the rate of market acceptance of our products and services,
our ability to expand our customer base and the growth of our sales and
marketing capabilities. If our capital requirements vary from our current
plans, we may require additional financing sooner than we anticipate. Financing
may be unavailable to us when needed or on acceptable terms.
We may be unable to adequately protect our proprietary rights, which may limit
our ability to compete effectively.
Despite our efforts to protect our proprietary rights, unauthorized parties
may misappropriate or infringe on our trade secrets, copyrights, trademarks,
service marks and similar proprietary rights. We face additional risk when
conducting business in countries that have poorly developed or inadequately
enforced intellectual property laws. While we are unable to determine the
extent to which piracy of our software products exists, we expect piracy to be
a continuing concern, particularly in international markets and as a result of
the growing use of the Internet. In any event, competitors may independently
develop similar or superior technologies or duplicate the technologies we have
developed, which could substantially limit the value of our intellectual
property.
Intellectual property claims and litigation could subject us to significant
liability for damages and invalidation of our proprietary rights.
In the future, we may have to resort to litigation to protect our
intellectual property rights, to protect our trade secrets or to determine the
validity and scope of the proprietary rights of others. Any litigation,
regardless of its success, would probably be costly and require significant
time and attention of our key management and technical personnel. Litigation
could also force us to
. stop or delay selling, incorporating or using products that incorporate
the challenged intellectual property;
11
<PAGE>
. pay damages;
. enter into licensing or royalty agreements, which may be unavailable on
acceptable terms; or
. redesign products or services that incorporate infringing technology.
Although we have not been sued for intellectual property infringement, we may
face infringement claims from third parties in the future. The software
industry has seen frequent litigation over intellectual property rights, and we
expect that participants in the Internet security industry will be increasingly
subject to infringement claims as the number of products, services and
competitors grows and functionality of products and services overlaps.
Undetected product errors or defects could result in loss of revenues, delayed
market acceptance and claims against us.
Our products and services may contain undetected errors or defects,
especially when first released. Despite extensive testing, some errors are
discovered only after a product has been installed and used by customers. Any
errors discovered after commercial release could result in loss of revenues or
claims against us.
Governmental controls over the export or import of encryption technology could
cause us to lose sales.
Any additional governmental regulation of imports or exports or failure to
obtain required export approval of our encryption technologies could adversely
affect our international and domestic sales. The United States and various
foreign governments have imposed controls, export license requirements and
restrictions on the import or export of certain technologies, especially
encryption technology. In addition, from time to time governmental agencies
have proposed additional regulation of encryption technology, such as requiring
the escrow and governmental recovery of private encryption keys. Additional
regulation of encryption technology could delay or prevent the acceptance and
use of encryption products and public networks for secure communications. This,
in turn, could result in decreased demand for our products and services.
In addition, some foreign competitors are subject to less stringent controls
on exporting their encryption technologies. As a result, they may be able to
compete more effectively than we can in the United States and international
Internet security market.
If we do not retain our key employees, our ability to execute our business
strategy will be impaired.
Our future success will depend largely on the efforts and abilities of our
senior management and our key development, technical, operations, information
systems, customer support and sales and marketing personnel and our ability to
retain them. These employees are not obligated to continue their employment
with us and may leave us at any time.
The year 2000 computer problem could disrupt our operations.
Year 2000 compliance efforts may involve significant time and expense, and
uncorrected problems could disrupt our ability to accept or fill customer
orders and provide LiveSecurity updates. Computer systems, software and
computer chips embedded in products that use only two digits to store dates in
their year code fields are incapable of distinguishing 21st century dates from
20th century dates. As a result, many computers, programs and chips are unable
to process date-related
12
<PAGE>
information beyond December 31, 1999. Unless they are upgraded to process date
information correctly, they will fail or produce erroneous results when the
century changes on January 1, 2000.
We believe that the current versions of the internally developed software
technologies incorporated in our products and services are year 2000 compliant.
We may face claims, however, for undiscovered year 2000 errors in our own
products or for year 2000 issues arising from third-party products that we
integrate into our products and services or with which our systems and products
exchange data. If our suppliers, vendors or distributors fail to timely correct
their own year 2000 software, firmware and hardware problems, or if any of them
convert to a system that is incompatible with our systems, our ability to
deliver our products and services could be disrupted. In addition, our year
2000 compliance plan may not adequately address any year 2000 issues relating
to our internal management information and other systems. We may also
experience reduced sales of our products and services as potential customers
reduce their budgets for Internet security because of their own expenditures
for year 2000 compliance. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Year 2000 Compliance."
You may be unable to resell your shares at or above the initial public offering
price, and the price of our stock is likely to be volatile.
Before this offering, there has been no public market for our common stock.
An active trading market may not develop or be sustained following this
offering. The initial public offering price of our common stock, which will be
determined through negotiations between us and the representatives of our
underwriters, may not be indicative of future market prices. See "Underwriting"
for a discussion of the factors to be considered in determining the initial
public offering price. You may be unable to resell your shares at or above the
initial public offering price due to a number of factors, including
. actual or anticipated variations in quarterly or annual operating
results;
. changes in analysts' earning projections or analysts' recommendations;
. our inability to successfully implement our business strategy;
. changes in business conditions affecting our customers, our competitors
and us; and
. changes in accounting standards that adversely affect our revenues and
earnings.
In recent years, moreover, the stock market in general and the market for
Internet-related technology companies in particular have experienced extreme
price and volume fluctuations, often unrelated to the operating performance of
the affected companies. Our common stock may experience such fluctuations in
price, regardless of our performance. Market fluctuations or volatility could
cause the market price of our common stock to decline.
Future sales of our common stock may depress our stock price.
Sales of a substantial number of shares of our common stock in the public
market following this offering could adversely affect the market price of our
common stock. After this offering, we will have outstanding 18,447,484 shares
of common stock. All the shares sold in this offering will be freely tradable.
The remaining shares of common stock outstanding after this offering will be
available for sale in the public market as follows:
<TABLE>
<CAPTION>
Number of
Date of Availability for Sale Shares
----------------------------- ----------
<S> <C>
90 days after the date of this prospectus..................... 227,776
180 days after the date of this prospectus.................... 14,676,852
At various times after 180 days, when one-year holding periods
expire....................................................... 42,856
</TABLE>
13
<PAGE>
FORWARD-LOOKING STATEMENTS
Some of our statements in this prospectus, including those under the captions
"Prospectus Summary," "Risk Factors," "Use of Proceeds," "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Business," are forward-looking statements that involve risks and
uncertainties. These forward-looking statements include statements about our
plans, objectives, expectations, intentions, future financial performance and
other statements that are not historical facts. We use words such as
anticipates, believes, expects, future and intends, and similar expressions to
identify forward-looking statements, but the absence of these words does not
mean that the statement is not forward-looking. You should not unduly rely on
these forward-looking statements, which apply only as of the date of this
prospectus. Our actual results could differ materially from those anticipated
in the forward-looking statements for many reasons, including the risks
described under "Risk Factors."
14
<PAGE>
USE OF PROCEEDS
We expect to receive approximately $31.4 million in net proceeds from the
sale of the 3,500,000 shares of common stock sold by us in this offering,
assuming an initial public offering price of $10.00 per share, and after
deducting underwriting discounts and commissions and estimated expenses to be
paid by us. We will not receive any proceeds from any shares sold by the
selling stockholders.
We will use approximately $3.0 million of the net proceeds from this offering
to repay all debt to entities affiliated with Matrix IV Management Co., L.P.,
OVMC III, L.P. and OVMC IV, LLC. As of June 30, 1999, the outstanding principal
balance on this loan was $3.0 million. This debt matures on March 9, 2000 and
bears interest at the rate of 6% per year.
In addition, we will use up to $4.25 million of the net proceeds to repay our
bridge loan facility with Silicon Valley Bank. As of June 30, 1999, the
outstanding principal balance on this loan was $3.6 million. This debt matures
on the earlier of the closing date of our initial public offering or August 26,
1999 and bears interest at prime plus 2%, which was 9.75% as of June 30, 1999.
We intend to use the remainder of the net proceeds primarily for additional
working capital and other general corporate purposes. The amounts that we
actually spend for working capital purposes will vary significantly depending
on a number of factors, including any future revenue growth, the amount of cash
we generate from operations and the progress of our product development
efforts. Although we have no present plans, agreements or proposals to do so,
we may also use a portion of the net proceeds to license or acquire new
products or technologies or to acquire or invest in businesses complementary to
our own. As a result, we will retain broad discretion in allocating the net
proceeds from this offering. Pending their use, we will invest the net proceeds
in short-term, interest-bearing, investment-grade securities.
DIVIDEND POLICY
We have never paid cash dividends on our common stock. We currently intend to
retain any future earnings to fund the development and growth of our business.
Therefore, we do not anticipate paying any cash dividends. In any event, our
line of credit agreement with Silicon Valley Bank prohibits the payment of
dividends without the bank's prior written consent.
15
<PAGE>
CAPITALIZATION
The following table shows
. our actual capitalization on June 30, 1999;
. our pro forma capitalization assuming the conversion of all outstanding
preferred stock into 13,425,316 shares of common stock and the exercise
of warrants to purchase 42,856 shares of common stock at an exercise
price of $7.00 per share;
. our pro forma capitalization as adjusted to reflect the sale by us of
3,500,000 shares of common stock at an assumed initial public offering
price of $10.00 per share, after deducting underwriting discounts and
commissions and estimated expenses we expect to pay.
You should read this table in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations," our historical
financial statements and the notes to the financial statements included in this
prospectus.
<TABLE>
<CAPTION>
June 30, 1999
---------------------------------
Pro Forma
Actual Pro Forma As Adjusted
-------- ----------- -----------
(unaudited)
(In thousands, except share
data)
<S> <C> <C> <C>
Stockholders' equity:
Preferred stock: 10,000,000 shares
authorized; 6,712,658 shares issued and
outstanding, actual; no shares issued and
outstanding, pro forma and pro forma as
adjusted.................................. $ 6 $ -- $ --
Common stock: 80,000,000 shares authorized;
1,479,312 shares issued and outstanding,
actual; 14,947,484 shares issued and
outstanding, pro forma; 18,447,484 shares
issued and outstanding, pro forma as
adjusted.................................. 1 15 18
Additional paid-in-capital................. 16,630 16,922 48,269
Deferred stock-based compensation.......... (1,116) (1,116) (1,116)
Accumulated deficit........................ (20,582) (20,582) (20,582)
-------- -------- --------
Total capitalization..................... $ (5,061) $ (4,761) $ 26,589
======== ======== ========
</TABLE>
The number of shares of common stock issued and outstanding excludes
. 1,516,244 shares available for grant under our stock option plan;
. 6,169,430 shares of common stock issuable upon exercise of options
outstanding under our stock option plan, at a weighted average exercise
price of $1.46 per share, of which options to purchase 2,211,184 shares
are currently exercisable;
. 259,500 shares of common stock issuable upon exercise of warrants
outstanding at a weighted average exercise price of $0.70 per share,
255,000 of which are currently exercisable; and
. 600,000 shares of common stock available for issuance under our employee
stock purchase plan.
16
<PAGE>
DILUTION
If you invest in our common stock, your interest will be diluted to the
extent of the difference between the initial public offering price per share
and the net tangible book value per share after this offering. We calculate net
tangible book value per share by dividing the net tangible book value, which is
total assets less intangible assets and total liabilities, by the number of
outstanding shares of common stock.
Our pro forma net tangible book value at June 30, 1999, after giving effect
to the conversion of all outstanding preferred stock into common stock and the
exercise of warrants to purchase 42,856 shares of common stock at an exercise
price of $7.00 per share, was a deficit of $4,761,000, or $0.32 per share of
common stock. After giving effect to the sale of 3,500,000 shares of common
stock by us offered through this prospectus at an assumed initial public
offering price of $10.00 per share, less underwriting discounts and commissions
and estimated expenses we expect to pay, our net tangible book value at June
30, 1999 would have been $26.6 million, or $1.44 per share. This represents an
immediate increase in the net tangible book value of $1.76 per share to
existing stockholders and an immediate dilution of $8.56 per share to new
investors, or approximately 86% of the assumed initial offering price of $10.00
per share. The following table illustrates this per-share dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share.................. $10.00
Net tangible book value per share at June 30, 1999............. $(3.42)
Increase due to the conversion of preferred stock.............. 3.10
------
Pro forma net tangible book value per share at June 30, 1999... (0.32)
Increase per share attributable to new investors............... 1.76
------
Net tangible book value per share after this offering............ 1.44
------
Dilution per share to new investors.............................. $ 8.56
======
</TABLE>
The following table shows, at June 30, 1999, the number of shares of common
stock purchased from us, after giving effect to the conversion of all
outstanding preferred stock into common stock and the exercise of warrants to
purchase 42,856 shares of common stock at an exercise price of $7.00 per share,
the total consideration paid to us and the average price paid per share by
existing stockholders and by new investors purchasing common stock in this
offering.
<TABLE>
<CAPTION>
Shares Purchased Total Consideration
------------------ ------------------- Average Price
Number Percent Amount Percent Per Share
---------- ------- ----------- ------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders..... 14,947,484 81.0% $13,599,000 28.0% $ 0.91
New investors............. 3,500,000 19.0 35,000,000 72.0 10.00
---------- ----- ----------- -----
Total................. 18,447,484 100.0% $48,599,000 100.0%
========== ===== =========== =====
</TABLE>
At June 30, 1999, we had outstanding options and warrants to purchase shares
of common stock as follows:
<TABLE>
<CAPTION>
Weighted
Number of Average
Shares Exercise Price
--------- --------------
<S> <C> <C>
Stock option plan................................. 6,169,430 $1.46
Warrants.......................................... 259,500 0.70
---------
6,428,930 1.43
=========
</TABLE>
Additionally, there were 1,516,244 option shares available for future grant
under our stock option plan and 600,000 shares available for issuance under our
employee stock purchase plan. There will be further dilution to new investors
to the extent that option and warrant holders exercise these outstanding
options and warrants or any options or warrants we grant in the future.
17
<PAGE>
SELECTED FINANCIAL DATA
(In thousands, except per share data)
The following selected financial data and other operating information are
derived from our financial statements, which have been audited by Ernst & Young
LLP, independent auditors. When you read this selected financial data, it is
important that you also read the historical financial statements and related
notes included in this prospectus, as well as the section of this prospectus
entitled "Management's Discussion and Analysis of Financial Condition and
Results of Operations." The historical results are not necessarily indicative
of future results.
<TABLE>
<CAPTION>
Period From Year Ended Six Months Ended
February 14, 1996 December 31, June 30,
(Inception) to ---------------- ----------------------
December 31, 1996 1997 1998 1998 1999
----------------- ------- ------- ------- -------------
(unaudited)
<S> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Revenues, net:
Product............... $ 329 $ 4,975 $10,678 $ 4,860 $ 7,218
Service............... 2 123 701 157 1,357
----- ------- ------- ------- -------
Total revenues...... 331 5,098 11,379 5,017 8,575
Cost of revenues........ 104 1,610 3,925 1,491 3,481
----- ------- ------- ------- -------
Gross margin............ 227 3,488 7,454 3,526 5,094
Operating expenses:
Sales and marketing... 224 4,369 8,666 3,821 6,271
Research and
development.......... 274 2,192 5,273 1,909 3,288
General and
administrative....... 191 1,323 2,515 971 1,849
----- ------- ------- ------- -------
Total operating
expenses........... 689 7,884 16,454 6,701 11,408
----- ------- ------- ------- -------
Operating loss.......... (462) (4,396) (9,000) (3,175) (6,314)
Interest income
(expense), net......... (6) 62 (119) (83) (347)
----- ------- ------- ------- -------
Net loss................ $(468) $(4,334) $(9,119) $(3,258) $(6,661)
===== ======= ======= ======= =======
Basic and diluted net
loss per share......... N/A $(17.17) $(11.34) $ (4.70) $ (4.65)
===== ======= ======= ======= =======
Shares used in
calculation of basic
and diluted net loss
per share.............. N/A 252 804 693 1,433
===== ======= ======= ======= =======
Pro forma basic and
diluted net loss per
share.................. $ (0.68) $ (0.45)
======= =======
Shares used in
calculation of pro
forma basic and diluted
net loss per share..... 13,366 14,858
======= =======
<CAPTION>
December 31,
-------------------------
1996 1997 1998 June 30, 1999
------- ------- ------- -------------
(unaudited)
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents................. $ 232 $ 603 $ 1,712 $ 2,214
Working capital (deficit)................. (464) 658 (274) (6,742)
Total assets.............................. 597 3,303 9,032 11,123
Long-term debt, less current portion...... -- -- -- --
Total stockholders' equity (deficit)...... (318) 1,382 881 (5,061)
</TABLE>
See note 6 of Notes to Financial Statements for information concerning the
calculation of basic and diluted net loss per share and pro forma basic and
diluted net loss per share.
18
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
WatchGuard is a leading provider of dynamic, comprehensive Internet security
solutions designed to protect small- to medium-sized enterprises, or SMEs, that
use the Internet for electronic commerce and communications. Our innovative
subscription-based LiveSecurity solution broadcasts threat responses, software
updates and information alerts over the Internet, enabling SMEs to keep their
security systems current with minimal effort. Since our inception, we have
invested heavily in the development of our products and services. In September
1996, we introduced our initial Internet security appliance and began selling
our products both domestically and internationally. In 1997, we significantly
expanded our sales force, adding 12 sales employees to recruit indirect channel
partners around the world, and expanded our distribution efforts in the
European and Asia/Pacific markets. In September 1998, we launched our managed
security service offering for ISPs. We also continued to recruit and hire
additional employees in marketing, development, technical support and finance
and invested in our operational infrastructure to support our growth.
Our revenues totaled $331,000 in 1996 and grew significantly to $5.1 million
in 1997. Our revenues totaled $11.4 million in 1998, representing a 123%
increase over 1997. Product revenues as a percentage of total revenues were 99%
in 1996, 98% in 1997 and 94% in 1998. Service revenues, although small, are
growing and are expected to be a significant component of our revenues in the
future as we expand our LiveSecurity subscription-based broadcast service. As a
result of our investments in our worldwide sales and distribution channels,
development of new products and services, brand development and our operational
infrastructure, we have incurred net losses in each fiscal quarter. As of June
30, 1999, we had an accumulated deficit of $20.6 million. We anticipate
significant growth in our operating expenses as we continue to expand our
business. In the future, however, we expect our operating expenses to begin to
decline as a percentage of total revenues.
Sources of Revenues and Revenue Recognition Policy
We generate revenues through:
. sales of products and service subscriptions through our indirect
distribution partners at a discount from list price, typically 40%;
. sales of products and service subscriptions directly to our ISP customers
at volume pricing rates; and
. from time to time, sales of service subscription renewals directly to our
enterprise customers at list price.
Product revenues include perpetual software license fees and sales of our
security appliance. Service revenues include fees for access to our
LiveSecurity broadcast service for product updates, security threat responses,
general security information and technical support. Service revenues also
include annual fees for our LiveSecurity for MSS, which allows our ISP
customers access to the LiveSecurity broadcast service and the ability to
manage and update a specific number of their customers' security appliances. To
date, service subscription renewals directly from our enterprise customers have
not been material.
We recognize revenues only when a contract or agreement has been executed,
delivery has occurred, the fee is fixed and determinable and we believe
collection is probable. We recognize
19
<PAGE>
product revenues upon shipment and service subscription revenues ratably on a
monthly basis, generally over a one-year period.
Results of Operations
The following table provides financial data for the periods indicated as a
percentage of total revenues:
<TABLE>
<CAPTION>
Six Months
Period From Year Ended Ended June
February 14, 1996 December 31, 30,
(Inception) to --------------- -------------
December 31, 1996 1997 1998 1998 1999
----------------- ------ ------ ----- -----
<S> <C> <C> <C> <C> <C>
Revenues, net:
Product............... 99.4 % 97.6 % 93.8 % 96.9 % 84.2 %
Service............... 0.6 2.4 6.2 3.1 15.8
------ ------ ------ ----- -----
Total revenues...... 100.0 100.0 100.0 100.0 100.0
Cost of revenues........ 31.4 31.6 34.5 29.7 40.6
------ ------ ------ ----- -----
Gross margin............ 68.6 68.4 65.5 70.3 59.4
Operating expenses:
Sales and marketing... 67.7 85.6 76.2 76.2 73.1
Research and
development.......... 82.8 43.0 46.3 38.1 38.3
General and
administrative....... 57.7 26.0 22.1 19.4 21.6
------ ------ ------ ----- -----
Total operating
expenses........... 208.2 154.6 144.6 133.6 133.0
------ ------ ------ ----- -----
Operating loss.......... (139.6) (86.2) (79.1) (63.3) (73.6)
Interest income
(expense), net......... (1.8) 1.2 (1.0) (1.7) (4.0)
------ ------ ------ ----- -----
Net loss................ (141.4)% (85.0)% (80.1)% (64.9)% (77.7)%
====== ====== ====== ===== =====
</TABLE>
Six Months Ended June 30, 1998 and 1999
Revenues
Total revenues, which consist of product revenues and service revenues,
increased from
$5.0 million in the six months ended June 30, 1998 to $8.6 million in the six
months ended June 30, 1999, an increase of 71%. During these periods, no one
customer accounted for 10% or more of total revenues.
Product revenues include (1) the perpetual software license fees for our
security management system and the sale of our security appliance as part of
the LiveSecurity System and (2) the sale of our NOC security suite software
license and our security appliance as part of LiveSecurity for MSS. Product
revenues increased from $4.9 million in the six months ended June 30, 1998 to
$7.2 million in the six months ended June 30, 1999, an increase of 49%. As a
percentage of total revenues, product revenues decreased from 97% in the six
months ended June 30, 1998 to 84% in the six months ended June 30, 1999.
Historically, we have generated the majority of our revenues from our product
sales, which, until the introduction of LiveSecurity for MSS in late 1998,
consisted primarily of the sale of our LiveSecurity System for the enterprise.
Product revenues from LiveSecurity for MSS are growing and are expected to be a
significant component of our revenues in the future.
Service revenues include the annual fee for our LiveSecurity broadcast
service, which is sold as a part of the LiveSecurity System and LiveSecurity
for MSS. Service revenues increased from $157,000 in the six months ended June
30, 1998 to $1.4 million in the six months ended June 30,
20
<PAGE>
1999. As a percentage of total revenues, service revenues increased from 3% in
the six months ended June 30, 1998 to 16% in the six months ended June 30,
1999. As renewals of our service subscriptions for the LiveSecurity System and
LiveSecurity for MSS increase, we expect service revenues as a percentage of
total revenues to increase significantly.
The increase in total revenues was primarily due to increases in sales volume
caused by increased distribution in the European and Asia/Pacific markets and
increased market awareness of our products in North America. Total
international revenues represented approximately 41% of total revenues in the
six months ended June 30, 1998 and 50% in the six months ended June 30, 1999.
The provision for sales returns and allowances was $550,000, or 10% of total
revenues, for the six months ended June 30, 1998 and $730,000, or 8% of total
revenues, for the six months ended June 30, 1999. The provision for returns and
allowances for the year ended December 31, 1998 was approximately 14% of total
revenues. The returns and allowances reserve, established in 1998 to address
the return rights and pricing protection rights of some of our customers,
primarily related to anticipated returns originating from the introduction of
the latest version of our security appliance, the Firebox II, during the last
half of 1998. Returns and allowances before that time were immaterial. The
provision, as a percentage of total revenues, for the six months ended June 30,
1999 as compared to the provision for all of 1998, reflects a reduction in the
expected returns remaining from the 1998 introduction of the Firebox II plus a
recurring provision for future expected returns.
We do not believe that the historical percentage growth rates of product
revenues will be sustainable as our revenue base increases.
Cost of Revenues
Cost of revenues consists of product and service costs, which include the
costs of manufacturing our security appliance, product packaging, third-party
product licensing fees and our technical support organization. Historically,
cost of revenues has increased in total dollar amount and as a percentage of
total revenues in each year. Cost of revenues increased from $1.5 million in
the six months ended June 30, 1998 to $3.5 million in the six months ended June
30, 1999. As a percentage of total revenues, cost of revenues increased from
30% in the six months ended June 30, 1998 to 41% in the six months ended June
30, 1999.
The dollar increases in cost of revenues were primarily due to increases in
sales volume. The increase in cost of revenues as a percentage of total
revenues was primarily due to an increase in the cost of manufacturing our
Firebox II security appliance and, to a lesser extent, to an increase in
personnel-related costs of our service organization.
In the third quarter of 1998, we released an enhanced version of our security
appliance, the Firebox II, which incorporated additional features required to
support our LiveSecurity for MSS product. The Firebox II is more expensive to
manufacture than the previous version of our security appliance, which
increased our cost of revenues. Over time, as volume levels increase, the unit
cost to manufacture the Firebox II should decrease.
We expect service costs to increase in total dollar amount and as a
percentage of total cost of revenues as our enterprise customer base expands
and our LiveSecurity for MSS product for ISPs is deployed. Depending on our
product and service mix, which may affect our margins, we expect our
21
<PAGE>
cost of revenues as a percentage of total revenues to remain at or slightly
above our first quarter 1999 level. As revenues from service subscriptions
increase, and become a greater percentage of total revenues, we expect our
gross margin to increase.
Operating Expenses
Sales and Marketing. Sales and marketing expenses include salaries, travel
expenses, recruiting fees, commissions, public relations costs, marketing
collateral and trade show expenses. Sales and marketing expenses increased from
$3.8 million in the six months ended June 30, 1998 to $6.3 million in the six
months ended June 30, 1999. As a percentage of total revenues, sales and
marketing expenses decreased from 76% in the six months ended June 30, 1998 to
73% in the six months ended June 30, 1999.
The dollar increase in sales and marketing expenses was due primarily to
recruiting, training and supporting our domestic and international resellers
and distributors and, to a lesser extent, to establishing brand recognition of
our products and services. Specifically, components of the increase included
. an increase in payroll and related expenses from $1.8 million to $2.9
million;
. an increase in travel expenses from $650,000 to $1.2 million;
. an increase in marketing costs from $1.0 million to $1.5 million; and
. an increase in amortization of deferred stock compensation from $7,000 to
$184,000.
The decrease in sales and marketing expenses as a percentage of total
revenues reflects both increased productivity of and efficiencies in managing
our indirect channel network and realization of our previous investments to
expand distribution, capture market share and establish brand recognition of
our products. We expect to see a gradual reduction in sales and marketing
expenses as a percentage of total revenues.
Research and Development. Research and development expenses consist of
salaries, computing equipment and software tools, nonrecurring costs associated
with our security appliance prototypes and payment of designers and
contractors. Research and development expenses increased from $1.9 million in
the six months ended June 30, 1998 to $3.3 million in the six months ended
June 30, 1999. As a percentage of total revenues, research and development
expenses remained constant at 38% for each of the six-month periods ended June
30, 1998 and 1999.
The dollar increase in research and development expenses reflects the growth
of our research and development organization to expand our enterprise product
line, development of our recently released LiveSecurity for MSS product and our
efforts to respond to new and emerging security threats through our
LiveSecurity broadcast service. Specifically, components of the increase
included
. an increase in payroll and related expenses from $1.1 million to $2.0
million and
. an increase in amortization of deferred stock compensation from $10,000
to $251,000.
We will continue to increase our research and development expenses in total
dollar amount to expand our current product offerings, develop new products and
enhance our rapid response team and advisory council, which analyze new
security vulnerabilities and threats and provide continuing education to our
employees on Internet security. We expect total research and development
expenses as a percentage of total revenues to remain relatively constant.
22
<PAGE>
General and Administrative. General and administrative expenses include costs
of executive, human resource, finance and administrative support functions,
provision for uncollectible accounts and legal and accounting professional
services. General and administrative expenses increased from $971,000 in the
six months ended June 30, 1998 to $1.8 million in the six months ended June 30,
1999. As a percentage of total revenues, general and administrative expenses
increased from 19% in the six months ended June 30, 1998 to 22% in the six
months ended June 30, 1999.
The dollar increase in general and administrative expenses reflects the
expansion of our infrastructure to manage the growth of our operations.
Specifically, components of the increase included
. an increase in payroll and related expenses from $365,000 to $650,000;
. an increase in professional fees from $156,000 to $380,000; and
. an increase of deferred stock compensation from $3,000 to $77,000.
We expect that these expenses will continue to increase in total dollar
amounts but will decrease as a percentage of total revenues.
Deferred Compensation. Deferred compensation is recorded as the difference
between the exercise price of options we granted and the deemed fair value for
financial reporting purposes of our common stock during the periods in which
the options were granted. Deferred compensation is amortized over the vesting
periods of the options. We recorded $162,000 of deferred compensation in the
six months ended June 30, 1999 and $1.9 million of deferred compensation in
1998. These deferrals resulted in the amortization of compensation expense
totaling $20,000 for the six months ended June 30, 1998 and $512,000 for the
six months ended June 30, 1999. Amortization of deferred compensation is
included in the sales and marketing, research and development and general and
administrative expense categories, as described above.
Interest Income (Expense)
Interest expense of $87,000 in the six months ended June 30, 1998 resulted
from borrowings on our bank line of credit and our equipment term loan, and was
partially offset by $4,000 of interest income generated from our investment of
proceeds from the sale of preferred stock. Interest expense of $362,000 in the
six months ended June 30, 1999 resulted from borrowings on our bank line of
credit, our equipment term loan and our convertible note agreements, and was
partially offset by $15,000 of interest income generated from our investment of
proceeds from the sale of preferred stock.
Income Taxes
We have experienced losses since inception, resulting in a net operating loss
carryforward position of approximately $16.0 million as of June 30, 1999. These
carryforwards, if not utilized, will begin to expire in 2011, and may be
subject to limitations under Section 382 of the Internal Revenue Code.
Period Ended December 31, 1996 and Years Ended December 31, 1997 and 1998
The following discussion and analysis includes revenue and cost information
for the period ended December 31, 1996 and the years ended December 31, 1997
and 1998. We have not discussed
23
<PAGE>
in detail the results of operations for the period ended December 31, 1996.
During 1996, WatchGuard was a startup operation focused on validating the
technological feasibility of its products. We introduced our initial Internet
security appliance on a preproduction basis in September 1996, and shipped our
first production model, the Firebox 10, in December 1996. Beginning in early
1997, we began to implement our business model and develop our operational
infrastructure. Due to the limited nature of our operations in the period ended
December 31, 1996, we believe that further comparisons between 1996 and 1997
would not be meaningful.
Revenues
Total revenues increased from $331,000 in 1996 to $5.1 million in 1997 and to
$11.4 million in 1998, an increase of 123% from 1997 to 1998. During these
periods, no one customer accounted for 10% or more of total revenues. Product
revenues increased from $329,000 in 1996 to $5.0 million in 1997 and to $10.7
million in 1998, an increase of 115% from 1997 to 1998. As a percentage of
total revenues, product revenues decreased from 99% in 1996 to 98% in 1997 and
to 94% in 1998. Service revenues increased from $2,000 in 1996 to $123,000 in
1997 and to $701,000 in 1998. As a percentage of total revenues, service
revenues increased from 1% in 1996 to 2% in 1997 and to 6% in 1998.
The increase in total revenues from 1996 to 1998 was primarily due to
increases in sales volume caused by increased distribution in the European and
Asia/Pacific markets and increased market awareness of our products in North
America. Total international revenues represented 56% of total revenues in 1997
and 35% in 1998.
The establishment of reserves for sales returns and allowances negatively
impacted our revenues for 1998. The provision for sales returns and allowances
in 1998 was $1.7 million, or approximately 14% of total revenues before giving
effect to the provision. The returns and allowances reserve was established in
1998 primarily to address return rights and price protection rights for some of
our customers, including anticipated returns originating from the introduction
of the Firebox II. Before 1998, we did not experience any material returns and
therefore provided no reserve.
Cost of Revenues
Cost of revenues increased from $104,000 in 1996 to $1.6 million in 1997 and
to $3.9 million in 1998. As a percentage of total revenues, cost of revenues
increased from 31% in 1996 to 32% in 1997 and to 35% in 1998. The dollar
increases in cost of revenues from 1996 to 1998 were primarily due to increases
in sales volume. The increase in cost of revenues as a percentage of total
revenues from 1997 to 1998 was primarily due to an increase in the cost of
manufacturing our security appliance. As discussed above, the Firebox II, which
we released in the third quarter of 1998, is more expensive to manufacture than
the previous version of our security appliance.
Operating Expenses
Sales and Marketing. Sales and marketing expenses increased from $224,000 in
1996 to $4.4 million in 1997 and to $8.7 million in 1998. As a percentage of
total revenues, sales and marketing expenses increased from 68% in 1996 to 86%
in 1997, and decreased to 76% in 1998.
The dollar increase in sales and marketing expenses was due primarily to
recruiting, training and supporting our domestic and international resellers
and distributors and, to a lesser extent, to establishing brand recognition of
our products and services. Specifically, components of the increase from 1997
to 1998 included
. an increase in payroll and related expenses from $2.0 million to $3.9
million;
24
<PAGE>
. an increase in travel expenses from $771,000 to $1.4 million;
. an increase in marketing costs from $1.1 million to $2.0 million;
. a $470,000 charge for a common stock warrant in 1998 issued to a
customer; and
. an increase in amortization of deferred stock compensation from $0 to
$146,000.
The decrease in 1998 sales and marketing expenses as a percentage of total
revenues reflects increased productivity of and efficiencies in managing our
indirect channel network and our utilization of our prior years' investment to
expand distribution, capture market share and establish brand recognition of
our products.
Research and Development. Research and development expenses increased from
$274,000 in 1996 to $2.2 million in 1997 and to $5.3 million in 1998. As a
percentage of total revenues, research and development expenses decreased from
83% in 1996 to 43% in 1997, and increased to 46% in 1998.
The dollar increase in research and development expenses reflects the growth
of our research and development organization to expand our enterprise product
line, development of our recently released LiveSecurity for MSS product and our
efforts to respond to new and emerging security threats through our
LiveSecurity broadcast service. Specifically, components of the increase from
1997 to 1998 included
. an increase in payroll and related expenses from $1.5 million to $2.5
million;
. a $628,000 charge for compensation expense for stock options granted to
a consultant in 1998, which was based on the fair value of the options
at the termination of the consulting agreement; and
. an increase in amortization of deferred stock compensation from $0 to
$203,000.
General and Administrative. General and administrative expenses increased
from $191,000 in 1996 to $1.3 million in 1997 and to $2.5 million in 1998. As a
percentage of total revenues, general and administrative expenses decreased
from 58% in 1996 to 26% in 1997 and to 22% in 1998.
The dollar increases in general and administrative expenses primarily reflect
the increase in personnel and related expenses and other overhead items in
connection with the expansion of our business. Specifically, components of the
increase from 1997 to 1998 included
. an increase in payroll and related expenses from $516,000 to $786,000;
. an increase in the provision for uncollectible amounts from $122,000 to
$418,000, reflecting additional exposure related to the overall growth
of our operations; and
. an increase in professional fees from $150,000 to $218,000.
The decrease in expenses as a percentage of total revenues from 1996 to 1998
reflects increased efficiencies of scale resulting from a larger revenue base.
Deferred Compensation. Amortization of deferred compensation is included in
the sales and marketing, research and development and general and
administrative expense categories and totaled $411,000 in 1998.
Interest Income (Expense)
Interest expense of $6,000 in 1996 resulted from borrowings on our bank line
of credit. Interest income of $88,000 in 1997 was generated from our investment
of proceeds from the sale of preferred
25
<PAGE>
stock, and was partially offset by $26,000 of interest expense that resulted
from borrowings. Interest expense of $203,000 in 1998 resulted from borrowings
on our bank line of credit and equipment term loan, and was partially offset by
$84,000 of interest income generated from our investment of proceeds from the
sale of preferred stock.
Quarterly Results of Operations
The following tables provide both our unaudited results of operations and our
results of operations expressed as a percentage of total revenues for each
quarter in the six-quarter period ended June 30, 1999. In our opinion, this
unaudited information has been prepared on the same basis as our audited
financial statements. This information includes all adjustments, consisting
only of normal recurring adjustments, necessary for a fair presentation of the
information for the quarters presented, when read in conjunction with our
financial statements and the notes to the financial statements. The results of
operations for any quarter are not necessarily indicative of our future
results.
<TABLE>
<CAPTION>
Three Months Ended
---------------------------------------------------------
Mar. 31, June 30, Sept. 30, Dec. 31, Mar. 31, June 30,
1998 1998 1998 1998 1999 1999
-------- -------- --------- -------- -------- --------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Revenues, net:
Product............... $ 1,993 $ 2,867 $ 2,544 $ 3,274 $ 3,387 $ 3,831
Service............... 41 116 205 339 551 806
------- ------- ------- ------- -------- -------
Total revenues....... 2,034 2,983 2,749 3,613 3,938 4,637
Cost of revenues........ 619 872 1,038 1,396 1,635 1,846
------- ------- ------- ------- -------- -------
Gross margin............ 1,415 2,111 1,711 2,217 2,303 2,791
Operating expenses:
Sales and marketing... 1,637 2,184 2,315 2,530 2,936 3,335
Research and
development.......... 805 1,104 1,465 1,899 1,548 1,740
General and
administrative....... 374 597 645 899 948 901
------- ------- ------- ------- -------- -------
Total operating
expenses............ 2,816 3,885 4,425 5,328 5,432 5,976
------- ------- ------- ------- -------- -------
Operating loss.......... (1,401) (1,774) (2,714) (3,111) (3,129) (3,185)
Interest income
(expense), net......... (23) (60) 24 (60) (84) (263)
------- ------- ------- ------- -------- -------
Net loss................ $(1,424) $(1,834) $(2,690) $(3,171) $(3,213) $(3,448)
======= ======= ======= ======= ======== =======
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended
----------------------------------------------------------
Mar. 31, June 30, Sept. 30, Dec. 31, Mar. 31, June 30,
1998 1998 1998 1998 1999 1999
-------- -------- --------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Revenues, net:
Product............... 98.0 % 96.1 % 92.5 % 90.6 % 86.0 % 82.6 %
Service............... 2.0 3.9 7.5 9.4 14.0 17.4
----- ----- ----- ----- ----- -----
Total revenues....... 100.0 100.0 100.0 100.0 100.0 100.0
Cost of revenues........ 30.4 29.2 37.8 38.6 41.5 39.8
----- ----- ----- ----- ----- -----
Gross margin............ 69.6 70.8 62.2 61.4 58.5 60.2
Operating expenses:
Sales and marketing... 80.4 73.2 84.2 70.0 74.6 72.0
Research and
development.......... 39.6 37.0 53.3 52.6 39.3 37.5
General and
administrative....... 18.4 20.0 23.5 24.9 24.0 19.4
----- ----- ----- ----- ----- -----
Total operating
expenses............ 138.4 130.2 161.0 147.5 137.9 128.9
----- ----- ----- ----- ----- -----
Operating loss.......... (68.9) (59.4) (98.8) (86.1) (79.5) (68.7)
Interest income
(expense), net......... (1.1) (2.0) 0.9 (1.7) (2.1) (5.7)
----- ----- ----- ----- ----- -----
Net loss................ (70.0)% (61.4)% (97.9)% (87.8)% (81.6)% (74.3)%
===== ===== ===== ===== ===== =====
</TABLE>
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<PAGE>
The trends discussed in the annual comparison of operating results from 1996
to 1998 and in the quarterly comparison of operating results for the six-month
periods ended June 30, 1998 and 1999 generally apply to the comparison of
results of operations for each of the quarters in the six-quarter period ended
June 30, 1999. We were 90 days late in delivering the latest version of our
security appliance, the Firebox II, in the third quarter of 1998, and the cost
to manufacture the Firebox II increased from the previous version of our
security appliance. As a result of our 90-day delay, product revenues in the
third quarter of 1998 decreased by approximately 11% over the previous quarter,
while our cost of product revenues increased by 19% over the same period. Our
quarterly operating results have fluctuated significantly in the past and will
probably continue to fluctuate.
Liquidity and Capital Resources
Since our inception, we have financed our operations primarily through
private placements of convertible preferred stock. These preferred shares will
automatically convert into common stock at the closing of this offering.
Through June 30, 1999, net proceeds from private placements of preferred stock
totaled $13.2 million. We have also financed our operations through equipment
financing, traditional financing arrangements and convertible notes.
We have a working capital revolving line of credit with a bank, secured by
our accounts receivable. The amount available under this facility is limited to
the greater of our borrowing base or $3.5 million. The amendments to our loan
and security agreement discussed below reduced our borrowing base from $4.5
million to $3.5 million until the closing of our initial public offering. For
purposes of this loan, the borrowing base means the sum of 75% of the net
amount of our eligible domestic accounts receivable and 50% of the net amount
of our eligible foreign accounts receivable. As of June 30, 1999, we had
borrowed $1.2 million on this line of credit, which expires in September 1999
and bears interest at prime plus 2% per year.
In May and June 1999, we amended our loan and security agreement with this
bank. The amendments primarily provide for a secured bridge loan facility that
immediately makes available to us an additional $4.25 million, of which $2.0
million is guaranteed by existing investors. The loan carries a commitment fee
of up to 2.0%, an interest rate of prime plus 2% and a maturity date of the
earlier of our initial public offering closing date or August 26, 1999. We have
granted our bank warrants to purchase up to 14,500 shares of common stock, of
which 10,000 shares are currently exercisable. The exercise price of these
warrants is the greater of $7.00 per share or the initial public offering
price, unless our initial public offering closes after July 31, 1999, in which
case the exercise price will be $7.00 per share. As of June 30, 1999, we had
borrowed $3.6 million under the bridge loan facility.
We also have two term-loan facilities with this bank to finance new capital
equipment purchases. The first facility closed to further advances on March 5,
1998 and is being paid in 36 equal monthly payments. The first of these
payments was made on April 5, 1998. The loan, which bears interest at prime
plus 1.5% per year, matures March 5, 2001, at which time all unpaid principal
and interest will be due and payable. The second facility closed to further
advances on December 31, 1998 and is being paid in 36 equal monthly payments.
The first of these payments was due on January 31, 1999. The loan, which bears
interest at prime plus 1% per year, matures December 31, 2002, at which time
all unpaid principal and interest will be due and payable. As of June 30, 1999,
we had a combined principal balance of $493,000 due under these term loans.
The agreements under which the line of credit, the bridge loan facility and
the term loans were established contain financial covenants, including a
provision requiring us to maintain specified
27
<PAGE>
financial ratios. At December 31, 1998, we were not in compliance with the
financial covenants, but we obtained a waiver for noncompliance at December 31,
1998. In addition, the bank has deleted these covenants through the earlier of
August 26, 1999 or the completion of our initial public offering. We have
classified the outstanding balance of long-term debt as current on the balance
sheet.
In March 1999, we entered into convertible note agreements with existing
investors for a total of $3.0 million. The notes bear interest at 6% and will
be repaid with the net proceeds of this offering. We also issued warrants to
purchase 42,856 shares of common stock at an exercise price of $7.00 per share,
which are exercisable immediately. These warrants, if not exercised before our
initial public offering, will automatically convert into common stock on a net
exercise basis at the completion of this offering.
Our operating activities resulted in net cash outflows of $131,000 in 1996,
$5.3 million in 1997, $7.6 million in 1998 and $3.8 million for the six months
ended June 30, 1999. The operating cash outflows in 1997, 1998 and the six
months ended June 30, 1999 resulted primarily from significant investments in
sales and marketing and research and development, all of which led to operating
losses.
Cash used in operating activities was net of noncash charges totaling
$207,000 for 1997, $1.7 million for 1998 and $946,000 for the six months ended
June 30, 1999. These noncash charges were primarily associated with
depreciation and amortization of capital assets, compensation charges resulting
from the issuance of stock options and warrants, and interest expense related
to stock warrants issued in connection with our bridge loans during 1998 and
the six months ended June 30, 1999. Cash used in operating activities from
working capital components impacting operating activities was $1.1 million in
1997 and $231,000 in 1998. Cash provided by operating activities from working
capital components impacting operating activities was $1.9 million in the six
months ended June 30, 1999. However, there were large fluctuations within some
major working capital components, as described below:
(a) Inventories increased to $2.2 million at December 31, 1998 and to
$2.4 million at June 30, 1999 from $218,000 at December 31, 1997. These
changes reflect (1) our decision in 1998 to change from an off-the-shelf to
a custom-made motherboard component in our Firebox products, which resulted
in our taking an inventory position on these components before their final
assembly; (2) larger initial manufacturing volumes of Firebox II in the
third and fourth quarters of 1998; and (3) our efforts to accommodate
actual and anticipated increases in sales volume.
(b) Receivables increased to $3.5 million at December 31, 1998 and to
$3.6 million at June 30, 1999, from $1.6 million at December 31, 1997.
These increases are attributable primarily to the overall increase in
revenues during these periods and, to a lesser extent, to sales mix and
timing differences arising from varying payment cycles and terms in our
customer agreements. Reserves for uncollectable accounts were $449,000 at
December 31, 1998 and $348,000 at June 30, 1999, compared to $124,000 at
December 31, 1997. The increase reflects additional exposure related to the
overall growth of our operations. Reserves for estimated product returns
were $615,000 at December 31, 1998 and $525,000 at June 30, 1999,
reflecting our estimate of returns and allowances associated with the
return rights and price protection rights of some of our customers.
(c) Accounts payable and accrued expenses increased to $3.2 million at
December 31, 1998 and to $5.1 million at June 30, 1999, from $1.1 million
in 1997. These increases reflect
28
<PAGE>
liabilities associated with growth in inventories, the increased employee
base required to sustain and build our business, expenses associated with
the overall growth of our business and liabilities incurred as a result of
our initial public offering.
(d) Deferred revenue increased to $1.8 million at December 31, 1998 and
to $2.8 million at June 30, 1999, from $313,000 at December 31, 1997. The
increases reflect service subscriptions associated with the continued
growth of product sales and, to a lesser extent, with service subscription
renewals. Service subscriptions are generally amortized ratably over a one-
year period.
Investing activities used cash of $87,000 in 1996, $461,000 in 1997, $1.0
million in 1998 and $823,000 in the six months ended June 30, 1999, primarily
for capital expenditures, including computing equipment.
Financing activities provided cash of $450,000 in 1996, $6.1 million in 1997,
$9.7 million in 1998, and $5.1 million in the six months ended June 30, 1999,
primarily from the sale of preferred stock, borrowings on our line of credit
and proceeds from the issuance of convertible notes.
As of June 30, 1999, we had $2.2 million in cash and cash equivalents
invested primarily in money market accounts. We have financed our operations to
date primarily through the issuance of equity securities and debt financing.
Further development, establishment and maintenance of our business for at least
the next 12 months will require additional equity or debt financing, which we
believe can be obtained from existing or new sources if it is not obtained from
this offering. In addition, our current investors have indicated that they will
provide sufficient financing in order for us to continue to operate through
1999. We believe, however, that existing cash balances, cash equivalents and
lines of credit, together with the net proceeds from this offering, will be
sufficient to meet our anticipated cash needs for working capital and capital
expenditures for at least the next 18 months. The underlying assumed levels of
revenues and expenses, however, may prove to be inaccurate, and we may need to
seek additional funding through public or private financings or other
arrangements before that time. Adequate funds may be unavailable when needed or
unavailable on acceptable terms. If funding is insufficient at any time in the
future, we may be unable to develop or enhance our products or services, take
advantage of business opportunities or respond to competitive pressures. If we
raise additional funds by issuing equity securities, dilution to existing
stockholders will result.
We believe that the market risk arising from holdings of our financial
instruments is not material.
Year 2000 Compliance
Like many companies, we face risks relating to year 2000 computer issues.
These issues result from computer systems, software and computer chips embedded
in products that use only two digits to store dates in their year code fields
and are therefore incapable of distinguishing 21st century dates from 20th
century dates. As a result, many computers, programs and chips are unable to
process date-related information beyond December 31, 1999. Unless they are
upgraded to process date information correctly, they will fail or produce
erroneous results when the century changes on January 1, 2000. If our internal
management and external information systems are not year 2000 compliant when
the century changes, some or all of our business operations could be disrupted.
Our products and LiveSecurity service utilize a mixture of hardware and
software technologies. The hardware technology we use in our Firebox family of
security appliance products consists of a combination of industry-standard
components configured to our specifications and driven by
29
<PAGE>
internally developed software technologies. We have tested and analyzed current
versions of these internally developed software technologies in conjunction
with our security appliances and believe them to be year 2000 compliant. These
current versions include the latest version of our software that drives the
Firebox 10 and 100 and the version that drives the Firebox II, which we are
currently shipping. While we are not aware of any year 2000 issues with
previous versions, we are recommending to our customers that they implement our
current versions. In addition to other internally developed software, our
LiveSecurity service incorporates current technologies acquired from third-
party vendors. We will have completed our year 2000 assessment of the
internally developed software incorporated in our LiveSecurity service by July
31, 1999. In addition, we are in the process of surveying the third-party
vendors to determine whether their products are year 2000 compliant and, if
not, what updates or arrangements are required to correct any year 2000
problems. We have identified several of these vendors whose products are not
year 2000 compliant and are currently determining the updates or arrangements
they require to correct these problems. We expect to complete this phase of our
year 2000 plan by September 30, 1999.
We are currently reviewing our internal management information and other
administrative systems to identify and modify any products, services or systems
that are not year 2000 compliant. Our internal information management and other
administrative systems generally are based on technologies and products
acquired from industry-leading third-party vendors. We have contacted these
vendors to determine whose products, services or systems may be impacted by
year 2000 compliance issues and whose technologies and products will require
upgrades. We have scheduled necessary upgrades with these vendors, which we
expect will be completed by October 31, 1999.
Our plan may not adequately and timely address the year 2000 issue and we may
be unable to upgrade any or all of our products, services and internal
information management and other administrative systems as we have planned. In
addition, any upgrades may not effectively address the year 2000 issue. If
required upgrades are incomplete, untimely or unsuccessful, our business may be
adversely affected. Furthermore, if our suppliers, vendors, distributors or
producers of products that we use or with which our products exchange data fail
to timely correct their own year 2000 software, firmware and hardware problems,
or if any of them convert to a system that is incompatible with our systems,
our business could be adversely affected. We may also experience reduced sales
of our products and services as potential customers reduce their budgets for
Internet security because of their own expenditures for year 2000 compliance.
We currently expect that the total cost of our efforts to assess year 2000
compliance will not be material. The most reasonably likely worst-case
scenario, however, would involve the incomplete, untimely or unsuccessful
identification or correction of year 2000 compliance issues of multiple third-
party vendors whose technology is incorporated into our LiveSecurity products
and services. If this were to occur, interruptions in our ability to deliver
our LiveSecurity service would result and our business would be adversely
affected.
Our LiveSecurity service gives us a distribution channel for the rapid
implementation of software patches if a year 2000 problem is found with our
internally developed software. In addition, we intend to establish a
contingency plan detailing actions that will be taken if we do not successfully
execute our year 2000 plan on a timely basis. Still, some problems may remain
undetected or uncorrected, and our continuing efforts to address the year 2000
issue could involve unforeseen time and expense. Any year 2000 issues that are
not identified and corrected in a timely fashion would adversely affect our
business. We expect that the cost to fix any year 2000 problems that may be
identified, however, will involve internal labor-hours and will not be
material.
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<PAGE>
BUSINESS
Overview
WatchGuard is a leading provider of dynamic, comprehensive Internet security
solutions designed to protect small- to medium-sized enterprises, or SMEs, that
use the Internet for electronic commerce and communications. According to The
Yankee Group, SMEs represent 98% of U.S. businesses, account for approximately
50% of the gross national product and spend approximately $445 billion annually
on information technology products and services. SMEs are increasingly
utilizing the Internet to maintain a competitive advantage and to compete
effectively against enterprises with greater resources. International Data
Corporation estimates that, in the United States, approximately 3.5 million
SMEs will be connected to the Internet by the end of 1999, increasing to
approximately 4.7 million by the end of 2000.
Our innovative subscription-based LiveSecurity solution broadcasts threat
responses, software updates and information alerts over the Internet, enabling
SMEs to keep their security systems current with minimal effort. The dynamic
nature of our solution is made possible through an updatable security appliance
that executes software sent from the remote management system receiving our
LiveSecurity broadcasts. Our comprehensive, fully integrated LiveSecurity
solution features a firewall, encryption, user authentication, virtual private
networking and web surfing control. We make installing, configuring and
monitoring our solution easy with point-and-click security management and
advanced real-time graphical monitoring of network traffic.
Our LiveSecurity solution gives SMEs a security management choice. SMEs can
manage their own Internet security through our LiveSecurity System or outsource
their security management to an ISP implementing our LiveSecurity for MSS.
Enterprises using the LiveSecurity System may rapidly distribute security
protection from their desktop personal computer to all security appliances on
their corporate network, while retaining centralized control and
administration. Enterprises that do not want to be directly involved with their
security management may outsource the function to an ISP. For the ISP, our
technology greatly improves the economics of managed security services through
a scalable delivery platform that enables the ISP to remotely configure and
manage thousands of sites quickly, easily and economically.
We sell our Internet security solutions directly and indirectly to ISPs and
indirectly to end-users through more than 280 distributors and resellers
covering 52 countries. We have established relationships with the following
ISPs to implement LiveSecurity for MSS: AT&T EasyLink Services Asia/Pacific
Ltd., GTE Internetworking, Inc., Internet Initiative Japan (IIJ), Interpath
Communications, Inc., Netrex Secure Solutions, Inc., PSINet Inc., sunrise
communications AG, Verio, Inc., Virtual Media Technologies, LLC and You Tools
Corporation/FASTNET. We have shipped over 8,500 WatchGuard security solutions.
Industry Background
The growth of the Internet
The Internet has experienced rapid growth and has developed into a
significant tool for global communications, commerce and media, enabling
millions of people to share information and transact business electronically.
International Data Corporation estimates that there were over 38 million web
users in the United States and over 68 million worldwide at the end of 1997.
IDC projects the number of web users to increase to over 135 million users in
the United States and 319 million worldwide by the end of 2002. IDC also
estimates that the number of customers buying goods and
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services on the Internet will grow from approximately 18 million worldwide in
1997 to 128 million in 2002, with the value of electronic commerce transactions
growing from $12 billion to over $400 billion in the same period.
The growth in the Internet provides enterprises, regardless of size, with new
revenue opportunities through global distribution of products and services and
with significant reductions of sales and marketing costs through automation and
instantaneous access. Because of its affordability, global reach and
versatility, the Internet is a particularly powerful and necessary tool for
SMEs. SMEs are increasingly required to establish secure Internet access to
facilitate and support strategic business objectives. In a marketplace that is
becoming more and more competitive, SMEs are increasingly utilizing new
business tools and initiatives such as remote access, e-commerce, online
customer service and supply chain management to gain competitive advantage.
The need for Internet security
The increased importance of electronic commerce and the proliferation and
growth of corporate intranets have dramatically increased the openness of
computer networks, with the Internet becoming a widely accepted platform for
many business-to-business and direct-to-consumer transactions. The
accessibility and the relative anonymity of users in open computing
environments, however, make systems and the integrity of information stored on
them increasingly 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 disrupt operations and Internet access. In addition,
open computing environments are complex and typically involve a variety of
hardware, operating systems and applications supplied by a variety of vendors,
making these networks difficult to manage, monitor and protect from
unauthorized access.
The annual Computer Security Institute survey conducted in early 1999
highlights the potential risks faced by organizations connected to the
Internet. The CSI poll of 521 computer security specialists at U.S.
corporations, government agencies, financial institutions and universities
revealed that 62% of respondents had experienced security breaches within the
past 12 months. The damage caused by a security breach is often difficult to
quantify and may include the loss of irreplaceable proprietary information or
data, damage to business reputation or undetected theft or alteration of
information. The 163 organizations in the CSI poll that were able to quantify
losses reported an average total loss of over $650,000 per organization.
Breached computer security has become such an extensive problem that the U.S.
Federal Bureau of Investigation has recently established the National
Infrastructure Protection Center to prevent and respond to cyber attacks on the
nation's infrastructure.
The Internet security challenge
Internet security begins with a firewall, a security component of varying
complexity designed to provide a barrier and control the flow of information
between a company's internal network and the Internet. Firewalls, however, are
often difficult to install, must be configured by skilled personnel and, to
maximize effectiveness, must be continually monitored and updated. A
comprehensive security solution also typically integrates several other
sophisticated security components, such as virtual private networking, which
secures encrypted communications between two points on the Internet, and access
control mechanisms. These components use a complex mixture of technologies,
including user authentication, passwords, packet filters, proxies and
encryption.
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Because SMEs increasingly depend on the Internet for external and internal
communications and for facilitating and conducting business, they need
comprehensive Internet security solutions. Traditional Internet security
solutions, however, are generally difficult to install and expensive to
maintain. Additionally, the technological complexity of traditional solutions
introduces a new set of risks -- their many interacting components can easily
be misconfigured. The CSI poll revealed that more than 75% of the reported
successful break-ins took place despite the presence of a firewall. SMEs
therefore face increasing pressure to hire trained security personnel to ensure
that traditional security solutions are installed and maintained properly. The
scarcity of skilled network and Internet security personnel, however, makes the
cost of hiring in-house personnel prohibitive for many enterprises,
particularly SMEs. Because of the financial and technical resources necessary
to implement, maintain and update these complex security solutions, they tend
to be better suited for larger enterprises than for SMEs.
Traditional security solutions are also expensive to maintain because they
must be updated continually to maximize effectiveness. These security solutions
tend to be static, while the dangers against which they must protect are
dynamic, with new types of intrusion schemes and other security threats and
vulnerabilities emerging on a monthly or weekly basis. In 1998, the Computer
Emergency Response Team, a federally funded research and development center,
published 42 responses to security threats or vulnerabilities, an average of
one every 9 days. Even if updates are available to allow an enterprise's
security systems to respond to the changing security landscape, the enterprise
needs dedicated security experts to proactively identify, obtain and manually
implement these updates quickly and correctly.
The Internet security gap
Despite the obvious and compelling reasons for Internet security, most SMEs
on the Internet do not even have a firewall. The expense and complexity of
traditional security solutions incorporating a firewall puts protection out of
the reach of millions of SMEs that do not have the resources to adopt these
solutions, contributing to a security gap.
IDC estimates that approximately 3.5 million SMEs in the United States will
be connected to the Internet by the end of 1999. According to IDC projections,
however, from 1995, when IDC reports that firewalls first became widely
available, until the end of 1999, less than 450,000 firewalls will be shipped,
leaving more than 3 million SMEs without a firewall. This security gap is
increasing, with IDC projecting that in the United States more than 1.1 million
new SMEs will connect to the Internet in the year 2000, but less than 260,000
firewalls will be shipped during the same period. We believe that the security
gap for SMEs results from the cost and complexity of traditional comprehensive
solutions, combined with the ineffectiveness of lower-end firewall solutions,
which lead many SMEs to choose not to adopt any Internet security solution.
Moreover, many enterprises that have installed security systems continue to
experience significant security breaches because their systems are either
configured improperly or are not timely or properly updated in response to the
latest security threats.
SMEs require an easy-to-use, highly effective, fully integrated Internet
security solution with low installation and maintenance costs that can be
installed quickly and kept up to date easily. In addition, many SMEs would
rather outsource the management of any Internet security system to vendors such
as ISPs. ISPs, however, face challenges in economically delivering affordable
security services that can be rapidly deployed to thousands of customer sites
and easily managed from a central location.
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The WatchGuard Solution
WatchGuard's LiveSecurity products and services offer a fundamentally new
approach to Internet security. We provide SMEs with a comprehensive, easy-to-
use and cost-effective Internet security solution that we keep up to date
through our innovative Internet-based broadcast service. Our solution has the
following key benefits:
<TABLE>
<C> <S>
Comprehensive, fully integrated We offer a comprehensive security solution
security integrated into a single package that
includes (1) a firewall, (2) virtual private
networking for secure, encrypted
communication between remote offices, mobile
employees and trading partners,
(3) authentication functions that identify
network users and define user-group security
policies and (4) web surfing control.
Dynamic protection Our subscription-based Internet broadcast
service keeps SMEs and their systems up to
date with (1) security threat responses that
specifically address newly discovered
security vulnerabilities or hacker
techniques, (2) software updates and
(3) information alerts concerning current
news in Internet security.
Easy installation and use We offer (1) a security appliance with plug-
in installation, (2) management and security
software with an automated installation guide
and (3) point-and-click centralized
management. These features make it easy for
the non-security professional to install,
configure and monitor our security system and
to receive and implement the threat
responses, software updates and information
alerts we broadcast over the Internet.
Viable ISP outsourcing Through its centralized configuration and
management capabilities, LiveSecurity for MSS
enables ISPs to provide outsourced Internet
security services to thousands of customers
quickly, easily and at a price SMEs can
afford.
Affordability We minimize SMEs' overall ownership cost with
easy deployment and management that reduces
the requirements for information technology
personnel. Our broadcast updating enables
users of LiveSecurity to address their
security needs by leveraging our team of
security experts.
</TABLE>
Strategy
Our objective is to be the leading provider of Internet security systems and
services to SMEs worldwide. Our strategy to achieve this goal is based on the
following key elements:
Maintain our market leadership position in comprehensive security for
SMEs. We intend to maintain our leadership position in comprehensive security
for SMEs by expanding and enhancing our Internet security product and service
offerings. We expect to deliver new versions of our major products
approximately two to three times per year. We were the first, and remain the
leader, in
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developing updatable security appliances that execute software sent from a
remote management system. Our architecture allows SMEs to quickly and easily
deploy new products and services from the central management system, which
utilizes a familiar Windows-based interface. Our distributed architecture also
facilitates the scalability necessary for ISPs to provide our products and
services to their customers at a price SMEs can afford. Because our security
appliances are placed at each end-user's site, updates and future offerings
can be delivered to thousands of customers directly from the ISP's network
operations center. We intend to continue to enhance our technology and
architecture, hire additional network and Internet security experts and
continue to invest in product development and product and service
enhancements.
Expand our strategic relationships with leading Internet service
providers. To capitalize on the desire of many SMEs to outsource their
Internet security management, we have established relationships with industry-
leading ISPs, including FASTNET, GTE, IIJ, Interpath, Netrex, PSINet, sunrise,
Verio and Virtual Media in the United States and AT&T EasyLink Services
Asia/Pacific Ltd. in the Asia/Pacific region. We intend to continue to
establish similar relationships with ISPs and expect that these relationships
will facilitate the widespread adoption of our LiveSecurity solution by
enabling us to capitalize on the brand recognition and customer bases of the
ISPs. In addition, these strategic relationships should enhance WatchGuard
brand awareness and provide a powerful endorsement of our security technology
and services. For example, GTE and PSINet use LiveSecurity for MSS to provide
managed security services to their customer bases, and their marketing of
these services prominently features the WatchGuard brand.
Expand and enhance our innovative LiveSecurity broadcast service. We have
created an innovative LiveSecurity solution that broadcasts threat responses,
software updates and information alerts over the Internet directly to our
subscribers and ISP partners. We plan to expand and enhance our LiveSecurity
broadcast content, and therefore the value of our subscription service,
through additional investment in three areas:
. expansion of our rapid response team of dedicated internal security
experts, including the addition of two to four employees by the end of
1999;
. expansion of our LiveSecurity advisory council of industry experts,
including the addition of one to three outside experts by the end of
1999; and
. development of third-party industry relationships, including the addition
of one to four new relationships by the end of 1999, that will allow us
to broadcast third-party software and content to our subscribers.
As we expand and enhance our broadcast content, we plan to ensure that it
remains easy to implement and use by enterprises and ISPs.
Expand WatchGuard brand awareness in the SME market. Currently, there
appears to be little or no brand awareness in the SME market for any Internet
security product. We therefore believe that we have a unique opportunity to
make the WatchGuard brand synonymous with Internet security for SMEs
worldwide. We intend to increase our telemarketing and direct mail programs to
companies that fit our target subscriber profile. We also plan to develop our
web site as a security portal for SMEs with the goal of establishing
www.watchguard.com as the first location SMEs will visit with questions about
Internet security. Our web site currently features links to the web sites of
PSINet and GTE. We plan to add additional links in 1999 and the early part of
2000 and to further integrate our web sites with the web sites of our ISP
partners. In addition, we intend to continue to invest in
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marketing programs jointly executed with our distribution partners around the
world. These programs include WatchGuard web site content and links placed on
many of our reseller sites, regionally targeted public relations activities and
events worldwide, and use of the WatchGuard brand name when ISP partners market
their managed security services.
Expand worldwide sales and distribution. We intend to expand our
international distribution capabilities to allow any SME with an Internet
connection to purchase the WatchGuard LiveSecurity solution, no matter where
the SME is located. Our goal is to make our security solutions the easiest to
purchase and deploy, whether by the enterprise or by the ISP. We plan to expand
our base of resellers, distributors and ISP partners and make our solution
available for purchase through our resellers' web sites. We will continue to
invest in web-based training programs that educate our worldwide resellers and
subscribers about our product and service features and benefits and that assist
our customers in deploying our products and services.
We have not determined a schedule for expanding our international
distribution capabilities or for implementing other components of our strategy.
The timing for executing these strategies will depend on market conditions, the
availability of strategic opportunities and the availability of management
resources.
Products and Services
Our comprehensive LiveSecurity solution includes an integrated suite of
monitoring and management software, an Internet security appliance and a
dynamic broadcast service to keep security defenses current. SMEs may use our
LiveSecurity System to internally manage their Internet security or elect to
outsource security management to an ISP implementing our LiveSecurity for MSS.
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The LiveSecurity System for enterprise-managed security
We designed our LiveSecurity System for use by enterprises that want to
manage their own Internet security. With the LiveSecurity System, an enterprise
can quickly and affordably deploy comprehensive security protection to all
sites on its network, while retaining centralized control and administration.
[Diagram depicting the LiveSecurity System of enterprise-managed security:
WatchGuard sends LiveSecurity broadcast over the Internet to the Firebox and
the security manager at SME headquarters; the SME security manager manages the
Fireboxes at SME branch offices from SME headquarters.]
The LiveSecurity System has three key components: our security management
system software with security and management features, our security appliance
and a subscription to our Internet-based broadcast service.
Security features. The LiveSecurity System contains the following security
features:
. Firewall. Our firewall controls incoming and outgoing traffic between the
Internet and an enterprise's systems and data. The firewall incorporates
access control, logging and notification, and detection and blocking
features.
. Authentication. Our authentication features identify network users and
define user and user-group security policies.
. Virtual private networking. Our software enables enterprises to create
virtual private networks by using encryption technology to allow data to
flow securely across the Internet between two predetermined points. Our
remote user VPN secures communications with telecommuters and traveling
employees, while our branch office VPN secures communications with branch
offices and trading partners. Our virtual private networking solutions
implement industry standard protocols.
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. Web surfing control. Our web-blocking feature enables enterprises to
restrict site access privileges by user, group, time of day, site type or
particular site.
Management features. Our Windows-based software manages and monitors an
enterprise's Internet security with an intuitive, point-and-click user
interface.
. Integrated suite of system management tools. Our security management
system packages, configures and deploys security software, security
policies and the operating system to an enterprise's security appliances.
Our management tools feature real-time monitoring and historical
reporting of network, service and bandwidth usage and allow management of
multiple security appliances from a single location.
. Automated installation guide. Our automated installation guide enables
enterprises to install our system and define user and user-group security
policies in as quickly as 30 minutes.
Security appliance. Our security appliance, the WatchGuard Firebox, is a
standalone Internet security appliance that runs the security functions of the
LiveSecurity System. The Firebox's security capabilities come entirely from the
operating system, security software and security policies directed to it from
the remote management software. It simply plugs in and resides between an
enterprise's Internet router and its internal network of servers and
workstations. The Firebox has three independent, separately monitored
connections: one to the enterprise's network, one to the Internet and one to
the enterprise's public network for hosting web and email servers. The
LiveSecurity System encrypts communications between the Firebox and the
management software on the in-house manager's desktop.
Broadcast service. We keep our security solution current and our customers
informed through a subscription-based broadcast service that securely transmits
new security content over the Internet directly to the in-house manager's
desktop computer. Our broadcasts include:
. Threat responses. When our rapid response team discovers and neutralizes
a security vulnerability or new hacker technique, we broadcast software
that specifically addresses that security threat.
. Software updates. We broadcast software updates that enhance the function
of the LiveSecurity System as a whole.
. Information alerts. We notify our customers of breaking Internet security
news and upcoming enhancements. In addition, our team of industry-leading
security advisors provides continuing education on the rapidly changing
field of Internet security.
Our LiveSecurity broadcast service enables SMEs to augment their information
technology staff with our security experts, which we believe substantially
reduces personnel costs. Every new LiveSecurity System includes a one-year
subscription to our broadcast service.
LiveSecurity for MSS for Internet service providers
To serve the needs of enterprises that want to outsource their Internet
security and the needs of ISPs that want to provide this service, we have
created LiveSecurity for MSS. LiveSecurity for MSS allows an ISP to centrally
configure, monitor and update the Internet security of thousands of managed
customers. The ISP can economically deliver a full range of security services
while their subscribing customers enjoy the benefit of our up-to-date
protection at an affordable price.
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[Diagram depicting LiveSecurity for MSS for Internet service providers:
WatchGuard sends LiveSecurity broadcast to the ISP security manager at the ISP
network operations center; ISP security manager manages and monitors Fireboxes
at the time premises of the ISP's subscribing customers.]
LiveSecurity for MSS has four components: our network operations center, or
NOC, security suite software with security and management features, our
security appliances, our LiveSecurity broadcast service and optional monitoring
software for the ISP's customers.
Security features. LiveSecurity for MSS includes the same comprehensive set
of security features offered with the LiveSecurity System.
Management features. Centrally located at the ISP's network operations
center, our global policy manager software provides security intelligence and
configuration for all customer sites under management. Our software allows the
ISP to create and store various security policy configurations for different
customer groups or service plans. Our scalable WatchGuard event processor
software provides monitoring and reporting for customer sites.
Security appliances. One or more of our security appliances resides on the
ISP customer's premises. The appliances receive and implement the operating
system, security software and security policies that the ISP sends.
Broadcast service. Through our LiveSecurity broadcast service, the ISP's
network operations center receives threat responses, system updates and
information alerts. The ISP then updates the security policy of its customers
and transmits these policy updates over its network to those customers.
Monitoring software for the ISP's customers. The optional Firebox monitor
software allows the ISP's customer to view its network activity on-site while
otherwise leaving the management of its Internet security to the ISP.
Receiving the benefits of our security solution through an ISP gives an
enterprise a number of added advantages. ISPs
. monitor and manage customers' security 24 hours a day, 7 days a week;
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. define and implement professional, customized Internet security
policies;
. automatically install software updates and threat responses;
. regularly review customers' security and provide detailed reporting and
analysis; and
. mitigate the up-front cost of security system purchase and setup.
Implementation
The WatchGuard LiveSecurity System. Once an enterprise registers on one of
our LiveSecurity web sites, its registration information is automatically
transferred to our LiveSecurity database. Upon verification, the enterprise can
download and install our security management system software and begin
receiving our LiveSecurity broadcasts. The security management system software
configures the LiveSecurity System, implements security protection and manages
the installed security features with a point-and-click user interface. Our
LiveSecurity broadcasts go directly to the Windows desktop of the person
responsible for Internet security, who follows our easy installation
instructions to send the updated security software, security policy or
operating system to all of the enterprise's security appliances for automatic
implementation. We send our LiveSecurity broadcasts from a redundant, secured
broadcast server, using digital certificates and public key encryption.
Communications between the management software and the security appliances are
also encrypted.
LiveSecurity for MSS. Our scalable NOC security suite software enables an ISP
to economically and efficiently configure, monitor and update the Internet
security of thousands of managed customers from its network operations center.
The ISP uses our global policy manager's security policy templates to
streamline initialization and configuration of security policies to match the
ISP's specific service offerings and customer needs. The global policy manager
then sends the desired operating system, security software or policy
configuration to subscribing customers' security appliances. The security
appliances implement the new security policies and forward activity logs to
WatchGuard event processor software, which monitors network activity and
reports back to the global policy manager. Communications between the network
operations center, the event processors and the security appliances are
encrypted, and we have implemented automatic failover features to protect
valuable log information against being lost due to hardware or network failure.
ISP personnel at the network operations center use our suite of real-time
monitoring tools to track each security appliance on the ISP's network and
transmit LiveSecurity broadcast content to all ISP subscribers. In addition,
the ISP can offer its customers Firebox monitor software, a Windows-based
monitoring tool that allows subscribers to view their network activity and
defenses in real time while leaving management of the system to the ISP.
Customer service. We make customer service a priority. Our staff of support
representatives serves our end-users and ISP partners by phone and email from
6:00 a.m. to 5:00 p.m. Pacific standard time, Monday through Friday, excluding
national holidays. As of June 30, 1999, we had 16 customer support
representatives. We also offer 24-hour-a-day, 7-day-a-week web support tools.
Our computerized customer center manages all support requests and allows
customers to check resolution status on-line. We provide on-line answers to
frequently asked questions about our products, descriptions of how to configure
WatchGuard products to work with other products and other technical
information.
The WatchGuard team of experts
Rapid response team. Our rapid response team identifies, analyzes and
generates responses to new Internet security threats. To identify new threats,
the team continually monitors a wide variety of
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Internet sources related to network security, including news groups, vendor web
sites and hacker bulletin boards. When the rapid response team identifies a new
security threat, we send an advisory to our subscribers while software or
configuration changes to neutralize the threat are developed and tested. We
then broadcast the software updates or configuration recommendations to our
subscribers. The team sends other information of interest as information
alerts, which include cautionary notices, general usage guidelines and other
important announcements.
LiveSecurity advisory council. Our LiveSecurity advisory council provides
continuing education on the rapidly changing subject of Internet security. The
council also oversees and contributes to the efforts of our rapid response
team. We intend to expand the council as opportunities arise. Currently, the
council is composed of Messrs. Frederick Avolio and Rik Farrow.
Frederick Avolio. Mr. Avolio has been involved in Internet computing and
communication since the early 1980s and has worked with Internet security
systems for over 10 years. He assisted in the creation of the first
commercial Internet firewall offering and helped create the commercial
security products division of Trusted Information Systems. His areas of
expertise include firewalls, intrusion detection, cryptography, security
management and electronic mail systems. Mr. Avolio is the co-author, with
Paul Vixie, of Sendmail Theory and Practice, published by Digital Press. He
holds a B.S. in computer science from the University of Dayton and an M.S.
in computer science from Indiana University.
Rik Farrow. Mr. Farrow provides UNIX and Internet security consulting and
training. He has been working with UNIX system security since 1984 and with
TCP/IP networks since 1988. He has taught in a number of countries and for
a variety of organizations. He also consults with firms in designing and
implementing security applications. Mr. Farrow is the author of UNIX System
Security, published by Addison-Wesley, and is the co-author, with Rebecca
Thomas, of UNIX Administrator's Guide to System V, published by Prentice
Hall. He writes a column for ;login:, the magazine of the USENIX
Association, and a network security column for Network magazine.
Licensing and pricing
For an enterprise purchasing our LiveSecurity System, we include in the
system price a perpetual license for the security and management software. The
enterprise also receives a renewable one-year subscription to our LiveSecurity
broadcast service, through which it receives threat responses, software updates
and information alerts.
For LiveSecurity for MSS, an ISP buys a license to use our NOC security suite
management and security software and makes an annual license payment for each
customer security appliance it manages. The licenses, the cost of which varies
depending on the ISP's volume commitment, allow the ISP to manage its
subscribers' security appliances from its network operations center. Each
annual license includes a subscription to our LiveSecurity broadcast service.
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The following table lists our current end-user product prices. We offer
reseller discounts, educational discounts and occasional promotional pricing.
<TABLE>
<CAPTION>
Product Components List Price
- -----------------------------------------------------------
<C> <S> <C>
LiveSecurity System $ 4,990
Security management
LiveSecurity System system software
Firebox II security
appliance
12-month LiveSecurity
subscription
----------------------------------
LiveSecurity
subscription renewal $ 995
- -----------------------------------------------------------
LiveSecurity for MSS
platform pack $ 64,475
NOC Security Suite
Firebox II for MSS: 5
appliances
MSS client licenses: 5
licenses
MSS technical
certification class: 1
attendee
LiveSecurity broadcast
service
----------------------------------
NOC security suite
software $ 50,000
----------------------------------
Firebox II for MSS $ 1,300
----------------------------------
MSS technical
LiveSecurity For MSS certification class $ 2,500
----------------------------------
Firebox monitor software $ 195
----------------------------------
MSS annual client
license
Block of 25: $1,695 per
license $ 42,375
Block of 50: $1,495 per
license 74,750
Block of 100: $1,395 per
license 139,500
Block of 250:$1,295 per
license 323,750
Block of 500: $1,095 per
license 547,500
Block of 1,000: $945 per
license 945,000
</TABLE>
Sales, Marketing and Distribution
We employ a global marketing strategy. Because the need for Internet security
crosses geographic and economic boundaries, our business opportunity extends
worldwide to all business segments. Since our inception, we have invested
heavily in worldwide sales and marketing. International sales generated over
35% of our revenues in 1998 and approximately 50% of our revenues in the six
months ended June 30, 1999.
We sell our products and services through indirect channels covering 52
countries. Over 280 companies resell our products and services, including
. distributors, such as Eltrax Systems, Inc., Ingram Micro, Otsuka Shokai
Co., Ltd., Tech Data and Wick Hill Group, Plc;
. value-added resellers, such as CDW Computer Centers, Inc., Integrated
Network Technologies, Kent DataComm, Network Computing Architects, Inc.
and Solunet; and
. ISPs, such as AT&T EasyLink Services Asia/Pacific Ltd., FASTNET, GTE,
IIJ, Interpath, Netrex, PSINet, sunrise, Verio and Virtual Media.
Our agreements with our resellers are nonexclusive and provide for discounts
based on the reseller's minimum purchase commitment or the volume that the
reseller purchases or resells.
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We divide our sales organization regionally among North America, Latin
America, Europe and Asia/Pacific, and also between the enterprise and managed
security market segments. In North America, we have sales personnel located in
Atlanta, Boston, Chicago, Dallas, Denver, Los Angeles, New York, Philadelphia,
San Francisco, Seattle and Toronto. Internationally, we have sales personnel
located in Amsterdam, Melbourne, Munich, Surrey and Tokyo, and in Buenos Aires
and Miami to cover Latin America. Assisting our reseller network within a
specific region is a central responsibility of our regional sales
representatives. Regional sales representatives manage our relationships with
our network of distributors, resellers and ISPs, help our reseller network sell
and support key customer accounts, and act as liaison between our reseller
network and our marketing and product development organizations. We expect to
continue to expand our field sales organization in support of both the managed
security and enterprise market segments.
We conduct a number of marketing programs to support the sale and
distribution of our products. These programs inform existing and potential
resellers, distributors, ISPs and end-user customers about the capabilities and
benefits of our products. Marketing activities include advertising, publishing
technical and educational articles in industry journals, participating in
industry tradeshows and product technology conferences, sales training and
marketing on our web site. As of June 30, 1999, we had 45 employees in our
sales and marketing organization.
Preferred service provider program. For our partner ISPs, we instituted a
preferred service provider program in 1999. The goal of the program is to
partner with managed security service providers to jointly promote LiveSecurity
protection to SMEs worldwide. Joining the program gives ISPs access to several
marketing and promotional opportunities, including special placement on the
WatchGuard web site, prominence in WatchGuard marketing materials and joint
participation in tradeshows and events. For example, PSINet and GTE are
featured on the WatchGuard web site. The WatchGuard site has active links to
PSINet's and GTE's sites, which contain instructions on how to sign up for
WatchGuard-based managed security services. The program also includes several
options for joint promotions, which leverage the marketing and sales abilities
of both WatchGuard and the ISP.
WatchGuard LiveSecurity alliance. In September 1998, we launched a
LiveSecurity alliance, a technology and marketing program designed to support
the LiveSecurity concept and WatchGuard products and services. The purpose of
the alliance program is to enhance the interoperability of our LiveSecurity
products and services with alliance partner products and services and to engage
in cooperative marketing. Vendors in the alliance include BackWeb Technologies,
Clarent Corporation, CRYPTOCard, eSafe Technologies, Inc., FASTNET, Finjan,
Inc., Funk Software, IIJ, Interpath, ISS Group, Inc., Netrex, PSINet, Rainbow
Technologies, RSA Data Security, Inc., The Learning Company, WebTrends
Corporation, Worldtalk Corporation, Verio and Virtual Media.
43
<PAGE>
Customers
As of June 30, 1999, we had shipped over 8,500 of our security appliances to
our reseller network, which resold our products and services to end-users
spanning a wide variety of countries and industries. The following is a
representative list of our ISP and end-user customers:
<TABLE>
<S> <C> <C>
Internet Service Providers Media Manufacturing
- -------------------------- ----- -------------
AT&T EasyLink Services KSTW-UPN 11 Television Bolle Inc.
Asia/Pacific Ltd. Reader's Digest Australia Durkan Patterned Carpet, Inc.
GTE Internetworking, Inc. The Herald Ferguson Metals/Aerospace
Internet Initiative Japan (IIJ) University of Toronto Press Alloys Inc.
Interpath Communications, Inc. Graham Steel Corporation
Netrex Secure Solutions, Inc. Technology J.E. Dunn Construction Company
PSINet Inc. ---------- The Mitchell Gold Company
sunrise communications AG AlphaBlox Corporation Inc.
Verio, Inc. Bentley Systems, Incorporated Government
Virtual Media Technologies, LLC e-DOCS.net ----------
You Tools Corporation/FASTNET JDA Software Group, Inc. City of Bellingham, WA
Pentax Technologies Corporation City of Dandenong, Australia
Services Sheridan Software Systems, Inc. City of Garden Grove, CA
- -------- Lenoir County, NC MIS
Boullioun Aviation Services Education Mornington Peninsula
Bull Housser & Tupper --------- Shire Council, Australia
Camp, Inc. Boston Architectural Center North Carolina State Ports
Catholic Charities Canon City Schools Pierce County, WA Library Service
Digital Magic Huntsville Intermediate
hawthorne direct inc. School District Entertainment
Javelin Technology Summit Board of Education -------------
Woodridge School District #68 Argosy Gaming Company
Medical Black Hawk Gaming &
- ------- Financial Services Development Company
Bendigo Health Care Group ------------------ Crave Entertainment, Inc.
CoreCare Systems, Inc. Atlantic Mortgage & Everton Football Club
Health Technologies Pty Ltd Investment Corp.
NeoTherapeutics, Inc. Hudson Valley Federal Utilities and Telecommunications
PATH Credit Union --------------------------------
Southeast Alabama Medical Center KDP Investment Advisors Globecomm Systems, Inc.
Unimed Pharmaceuticals, Inc. McMahan Securities Co., LP MACtel
Seritis Services Group, LLC
Sunflower Bank
Retail
------
Norm Thompson Outfitters, Inc.
Rebel Sport Limited
</TABLE>
Case Studies
The following are profiles of WatchGuard customers that have successfully
implemented our products and services:
GTE Internetworking, Inc. -- An ISP providing managed Internet security
services
GTE Internetworking, Inc., part of one of the largest publicly held
telecommunications companies in the world, has been providing managed Internet
access and related services worldwide
44
<PAGE>
for more than 20 years. In April 1999, GTE introduced a new LiveSecurity for
MSS-based security service, GTE Security Advantage(TM), which enables GTE to
offer a cost-effective managed Internet security service to SMEs and branch
offices of large corporations.
GTE has integrated LiveSecurity for MSS into its sophisticated $6 million,
5,000-square-foot network operations center in Burlington, Massachusetts, and
offers GTE Security Advantage to both current and new customers. In the past,
GTE focused its managed security services on Fortune 500 corporations. By
partnering with WatchGuard, however, GTE can expand its range of services by
offering SMEs the same level of security it could only offer in the past to
large enterprises, due to the cost and complexity of its previous service
offerings.
GTE is a member of our preferred service provider program, which enables GTE
and WatchGuard to combine their marketing expertise and resources in joint
marketing activities that promote GTE Security Advantage through various media.
GTE will also promote the GTE Security Advantage service through its network of
independent local exchange carriers, which deliver telephone service and
Internet connectivity to SMEs.
Bentley Systems, Incorporated -- An enterprise using the WatchGuard
LiveSecurity System
Bentley Systems, Incorporated is a worldwide leader in quality engineering
software products and user services, serving over 300,000 professionals in
building engineering, geoengineering and mechanical engineering. Its
MicroStation(TM) and ModelServer products, used by over 70% of the largest
engineering firms in the United States, are used to design buildings, airports,
hospitals, facilities, highways, bridges and industrial plants throughout the
world.
Bentley uses the WatchGuard LiveSecurity System, deploying 11 WatchGuard
Fireboxes. The company has implemented WatchGuard's branch office VPN software
to secure communications between its headquarters in Exton, Pennsylvania and
its branch offices in Huntsville, Alabama and Littleton, Massachusetts, and
uses WatchGuard's remote user VPN software to encrypt communications between
its offices and approximately 55 traveling salespeople. Now that Bentley has
established interconnectivity between offices with its network of WatchGuard
security appliances, it is in the process of moving from a private-frame wide
area network to a virtual private network of Internet sites, which will reduce
its remote access costs by over 60%.
Technology and Architecture
Our LiveSecurity solution utilizes an innovative distributed architecture
through which a basic processor in a security appliance receives and executes
software directed to it from a remote management system. Because the security
intelligence resides in the software and not in the hardware, we can keep our
customers' Internet security up to date with periodic broadcasts of new
security software and operating system configurations. Our LiveSecurity
solution encrypts and authenticates communications between WatchGuard, the
management system software and the security appliance. This allows the
management system and the appliance to be separated within an enterprise's
local or wide area network or between an ISP and its subscriber. Typically, to
install software on a computer using a general-purpose operating system such as
Windows, a person must be physically present at the computer. Our distributed
architecture, however, allows our customers to remotely install our software on
the security appliances and receive updated software broadcast over the
Internet.
45
<PAGE>
The diagram below depicts the core technologies we use to deliver our
products and services. Our approach gives us flexibility, reliability and
scalability.
[Diagram depicting the components of WatchGuard's security applicance,
operating system software, security software, management software and Internet
distribution.]
Security appliance. Our security appliance uses a standard Intel Pentium
processor, which is dedicated solely to running security functions. The
security appliance has no other function and no hard drive memory storage.
Operating system software. Our security appliance's operating system is a
custom-configured Linux kernel. Using Linux under an open source license, we
have been able to review the source code and generate a flexible, robust and
secure operating system. We use specially designed application programming
interfaces to facilitate secure loading of new operating system and security
software that our management software sends to the appliance.
Security features. The LiveSecurity solution implements our security features
in a number of software modules. Each module provides the specific function
that the management system defines in security rules and transmits to the
appliance. For example, the firewall features that control network traffic are
based around an extensible set of network service protocols, such as HTTP and
SMTP. The appliance applies the security policies defined by the management
system to all incoming or outgoing traffic. Those network services that require
special security, such as mail and file transfers, are directed to specific
modules. Additional modules implement other security features, such as
authentication and web surfing control, which also are defined in the security
policies that the management system transmits to the appliance. If web surfing
control is activated, for example, the web surfing control software module will
automatically check the details of all outgoing web traffic to make sure it
complies with the defined policies.
We use an open architectural structure to allow integration with common
standards for network security. For example, our virtual private networking
component currently supports IPSec and PPTP standards, and our authentication
module supports a variety of standard authentication methods. We intend to
adopt additional standards as they mature in the market.
46
<PAGE>
Management features. Because enterprise and ISP environments are very
different, we designed a separate management system for each. Our LiveSecurity
System management software allows for quick installation and management by a
typical SME in-house manager using a standard Windows system. We designed the
LiveSecurity for MSS management software, on the other hand, for a trained
operator using a dedicated management console to configure and manage the
security of a large subscriber base. Both management systems have the ability
to remotely deploy new security software to the appliances or update their
security engines from the management console. Our ISP customers can choose to
separately and remotely deploy certain security features, such as virtual
private networking and web blocking. This gives ISPs the ability to
incrementally add for-fee services to their basic service offering, without the
expense of sending personnel to their customers' sites.
To enable ISPs to configure, monitor and manage the Internet security of
thousands of customers, LiveSecurity for MSS includes scalable logging and
monitoring software called WatchGuard event processors. The event processors
run on UNIX-based workstations and can be located in the network operations
center or distributed at the ISP's point of presence. Each event processor
manages the logging and notification features of up to 500 security appliances
via commands issued from the global policy manager at the network operations
center.
LiveSecurity broadcast. Our scalable LiveSecurity broadcast system is a
collection of secured servers that registers subscribers, facilitates
downloading our software to the desktop computers of registered subscribers and
broadcasts threat responses, software updates and information alerts to
subscribers. To facilitate a high level of security and authenticity, we
protect our servers with our own security system and strongly encrypt data
communication between servers. We also encrypt and digitally sign broadcasts to
ensure that subscribers receive only authentic LiveSecurity broadcast content.
We can replicate and distribute our LiveSecurity servers throughout the world,
which should enable us to meet growth in demand for our LiveSecurity service.
We have initially deployed one primary server and two replicated servers to
reach North America, Asia and Europe.
Research and Development
To maintain our product and service leadership position, we focus our
research and development efforts on enhancing our existing products, developing
new products based on our innovative distributed appliance architecture and
developing services that capitalize on our LiveSecurity broadcast
infrastructure. We utilize a modular design, which allows us to develop new
applications that plug into our existing product line. As a result, our
products can be deployed in stages, whether directly by an enterprise or by an
ISP if the enterprise has outsourced its security management. As we develop new
products, our LiveSecurity end-users and ISP partners can incorporate the new
products into their systems with minimal system interruption.
As of June 30, 1999, we employed 47 people on our research and development
staff. Research and development expenses were approximately $274,000 in 1996,
$2.2 million in 1997, $5.3 million in 1998 and $3.3 million in the six months
ended June 30, 1999. All of our product development activities are conducted at
our principal facility in Seattle, Washington.
Competition
We compete in a market that is new, intensely competitive, highly fragmented
and rapidly changing. We face competition in sales both of products and
services designed for enterprises and of those designed for ISPs. We have
experienced and will continue to experience increased competition from current
and emerging competitors, many of which have significantly greater financial,
technical, marketing and other resources.
47
<PAGE>
In the market for Internet security solutions, we compete on the basis of
technological expertise and functionality, breadth of service and product
features, ease of installation and management, updatability, scalability, brand
recognition, price and customer support. Currently, the dominant competitor in
our industry is Check Point Software Technologies Ltd. Other competitors
offering security products include hardware and software vendors such as Axent
Technologies, Inc., Cisco Systems, Inc., Lucent Technologies, Inc., Network
Associates, Inc. and a number of smaller companies, and operating system
vendors such as Microsoft Corporation, Novell, Inc. and Sun Microsystems, Inc.
Our competitors may be able to respond more quickly to new or emerging
technologies and changes in customer requirements than we can. In addition, our
current and future competitors may bundle their products with other software or
hardware, including operating systems and browsers, in a manner that may
discourage users from purchasing the products and services we offer. Many of
our current and potential competitors have greater name recognition, larger
customer bases to leverage and access to proprietary technology, and could
therefore gain market share to our detriment. We expect additional competition
as other established and emerging companies enter the Internet security market
and new products and technologies are introduced.
While most of our competitors have generally targeted large-enterprise
security needs, using complex products that run on general purpose hosts such
as UNIX or Windows NT and require full training and support programs, these
vendors could adapt their existing products to make them more attractive to
SMEs. If our competitors were to focus their greater financial, technical and
marketing resources on the SME market, our business could be adversely
affected. While none of our competitors currently offer a technology similar to
our LiveSecurity solution architecture to address changing security threats,
they could develop such technology as part of any SME appliance offering.
Increased competition in the SME market could result in price reductions, fewer
customer orders, reduced gross margins and loss of market share.
Proprietary Rights
To protect our proprietary rights, we rely primarily on
. copyright, trademark, service mark and trade secret laws;
. license agreements with third parties, including a standard software
license included with our products;
. confidentiality agreements with our employees and third parties;
. invention assignment agreements with our employees and contractors;
. protective contractual provisions in our agreements with some of our
consultants, resellers and customers; and
. limited access to our software, documentation and other proprietary
information.
WatchGuard(R) is a registered trademark in the United States, Norway, New
Zealand and Japan. Applications to register the WatchGuard trademark are
pending in other foreign jurisdictions. Firebox(TM) and LiveSecurity(TM) are
trademarks in use in the United States, and applications are pending in the
United States for registration of these trademarks. We have no patents, but we
have five patents pending.
We currently license and use the following technologies in our products and
services:
. BSAFE encryption toolkit from RSA Data Security, Inc. This industry-
standard product provides us with encryption functions that we use in our
remote office VPN product. We pay a fee for this perpetual license, which
we may terminate for any reason with 90 days' notice.
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<PAGE>
. Cyber Patrol database from The Learning Company. This database provides
blocking of particular web addresses as part of our web-blocking module.
. Linux kernel. We use a customized version of the Linux operating system
for our security appliance platform. This license is a no-cost, open-
source license.
. BackWeb Technologies client software and server. We use this technology
to facilitate the distribution of our LiveSecurity content.
U.S. Government Export Regulation Compliance
Our products are subject to federal export restrictions on encryption
strength. To comply with these restrictions, we have developed two versions of
our products: one for the U.S. and Canadian market and one for international
markets. Recent federal legislation, however, has increased exportable
encryption strength and allows the export of any-strength encryption to
designated business sectors overseas, including U.S. subsidiaries, banks,
financial institutions, insurance companies and health and medical end-users.
In addition, we have obtained a federal export license that allows us to export
encryption of any strength to commercial entities in 45 approved countries.
With these expanded export rights, we may export strong encryption to a wide
range of foreign end-users, subject to limitations and record-keeping
requirements. To comply with these constraints, we obtain from our distributors
and resellers detailed information about each foreign end-user customer that
will obtain strong encryption.
Manufacturing
We currently outsource all hardware manufacturing and assembly to two
companies in California: Smart Modular Technologies, Inc., our motherboard
manufacturer, and Streamlined Electronics Manufacturing, our final assembly
house. The motherboard manufacturer designed and manufactures the motherboard
to our specifications. The manufacturer may terminate the agreement for breach
or insolvency of WatchGuard. We then distribute the finished products worldwide
from our Seattle distribution center. Both the motherboard manufacturer and
final assembly house test our hardware to confirm that all components function
properly. Both companies are certified as meeting the International
Organization for Standardization's quality assurance standards: Smart Modular
Technologies against ISO 9001 and 9002, and Streamlined Electronics
Manufacturing against ISO 9002.
Employees
As of June 30, 1999, we had 134 employees. Of these, 45 were employed in
sales and marketing, 15 in finance and administration, 16 in customer support
and 58 in development and operations. We are not parties to any collective
bargaining agreements with our employees and we have not experienced any work
stoppages. We believe we have good relations with our employees.
Facilities
Our principal administrative, marketing, sales, development and operations
facility is located in Seattle, Washington. We occupy approximately 20,200
square feet in this facility, under two leases that expire in April 2001. We
will be expanding our general office space within the next 12 months, and we
expect adequate space to be available on commercially reasonable terms. We also
maintain a 3,000-square-foot warehouse for product fulfillment and
distribution. The warehouse lease expires in August 2000, but has two one-year
renewal options.
Legal Proceedings
We currently are not a party to any material legal proceeding.
49
<PAGE>
MANAGEMENT
Executive Officers, Directors and Key Employees
The following table lists the executive officers, directors and key employees
of WatchGuard as of June 30, 1999.
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<C> <C> <S>
Executive Officers and Directors
Christopher G. Slatt............ 41 President, Chief Executive Officer and
Chairman of the Board
Steven N. Moore................. 41 Executive Vice President of Finance,
Chief Financial Officer, Secretary,
Treasurer and Director
R. Michael Peronto.............. 42 Vice President and Chief Operating
Officer
Stuart J. Ellman................ 32 Director
Andrew W. Verhalen.............. 43 Director
Charles P. Waite, Jr............ 44 Director
Key Employees
David W. Bonn................... 36 Chief Technology Officer
Randall C. Boroughs............. 42 Vice President of LiveSecurity
Dennis R. Cloutier.............. 48 Executive Vice President of Sales
Todd A. Hooper.................. 33 Vice President of Business Development
Michael V. Martucci............. 40 Vice President of Marketing
</TABLE>
We have no employment agreements with our executive officers.
Christopher G. Slatt cofounded WatchGuard in February 1996. Mr. Slatt has
served WatchGuard as president, chief executive officer and director since its
inception, and as chairman of the board since April 1999. From September 1993
to October 1995, he served as a vice president and a general manager of Legent
Corporation, a computer software company. Legent Corporation was acquired by
Computer Associates International, Inc., a computer software company, in August
1995. He is also a director of a privately held company. Mr. Slatt holds a
B.S.E.E. from the University of Notre Dame.
Steven N. Moore cofounded WatchGuard in February 1996. Mr. Moore has served
WatchGuard as executive vice president of finance, chief financial officer,
secretary, treasurer and director since its inception, and as its vice
president of finance and operations from its inception until March 1999. From
September 1993 to September 1995, he served as a director of finance of Legent
Corporation. Mr. Moore holds a B.S. in finance from Central Washington
University.
R. Michael Peronto joined WatchGuard as vice president and chief operating
officer in March 1999. From February 1997 to November 1998, Mr. Peronto served
as president and chief executive Officer of Endura Software Corporation, a
management software supply company. From September 1994 to February 1997, he
served as vice president of publishing products and site manager of Adobe
Systems Incorporated, a desktop publishing and graphics software company. From
July 1992 to September 1994, he served as general manager of graphic products
of Aldus Corporation, a desktop publishing and graphics software company that
was acquired by Adobe Systems Incorporated. Mr. Peronto holds a B.A. in
economics from UCLA and an M.B.A. from the University of Washington.
50
<PAGE>
Stuart J. Ellman has served as a director of WatchGuard since April 1998. In
August 1994, Mr. Ellman cofounded RRE Investors, LLC and RRE Investors II, LLC,
both of which are venture capital firms. He serves as managing director of RRE
Investors, LLC and as a member of RRE Investors II, LLC. He is also a director
of several privately held companies. Mr. Ellman holds a B.A. in economics from
Wesleyan University and an M.B.A. from Harvard University.
Andrew W. Verhalen has served as a director of WatchGuard since May 1997.
Since April 1992, Mr. Verhalen has been a partner of Matrix Partners, a venture
capital firm. He currently is a director of Copper Mountain Networks, a
communications equipment company, and Unwired Planet, a wireless communications
software company. He also serves on the board of several private technology
companies. Before Matrix, Mr. Verhalen held senior management positions at 3Com
Corporation and Intel Corporation. He holds a B.S.E.E., an M.E. and an M.B.A.
from Cornell University.
Charles P. Waite, Jr. has served as a director of WatchGuard since May 1997.
Since December 1987, Mr. Waite has served as a general partner of Olympic
Venture Partners. He is also a director of Cardima, Inc., CellPro Incorporated,
Verity, Inc. and several privately held companies. Mr. Waite holds an A.B. in
history from Kenyon College and an M.B.A. from Harvard University.
David W. Bonn joined WatchGuard in March 1996 and has served WatchGuard as
chief technology officer since March 1999. From May 1997 to March 1999, Mr.
Bonn served as WatchGuard's vice president of engineering. From February 1997
to May 1997, he served as WatchGuard's chief technology officer. From March
1996 to February 1997, he served as WatchGuard's vice president of security
products. He cofounded Mazama Software Labs, Inc., a computer software company,
in 1995, and served as its president until the acquisition of Mazama's
technology by WatchGuard in March 1996. From November 1993 to January 1995, he
served as senior software engineer of Legent Corporation. Mr. Bonn holds a B.S.
in computer science from the University of Washington.
Randall C. Boroughs joined WatchGuard in October 1997 and has served
WatchGuard as vice president of LiveSecurity since December 1998. From October
1997 to December 1998, Mr. Boroughs served as WatchGuard's vice president of
product management. From August to October 1997, he served as a consultant with
MarkeTech Consulting. From January 1996 to August 1997, he served as director
of marketing of GTE Corporation's network management organization. From August
1995 to January 1996, he served as a director of product management of Computer
Associates International, Inc. From September 1993 to August 1995, he served as
a director of product management of Legent Corporation. Mr. Boroughs holds a
B.S. in aeronautical engineering from the University of Washington.
Dennis R. Cloutier joined WatchGuard in March 1997 as executive vice
president of sales. From March 1994 to September 1996, Mr. Cloutier served as
vice president of sales of Sierra On-Line, an education and entertainment
computer software publisher. Mr. Cloutier holds a B.S. in marketing from
Central Connecticut University.
Todd A. Hooper joined WatchGuard in June 1998 and has served WatchGuard as
vice president of business development since February 1999. From June 1998 to
February 1999, Mr. Hooper served as WatchGuard's director of market
development. From March 1996 to May 1998, he served as manager of Internet and
open systems of AlphaWest Pty. Ltd., a provider of information technology-based
services. From January 1994 to March 1996, he served as chief executive officer
and managing director of Momentum Pty. Ltd., a management consulting company.
Mr. Hooper holds a Bachelor of Business in information processing from Curtin
University.
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<PAGE>
Michael V. Martucci joined WatchGuard in May 1997 as vice president of
marketing. From February 1996 to May 1997, Mr. Martucci served as director of
sales and marketing worldwide of Corbis Corporation, an Internet delivery and
sales company. From August 1994 to February 1996, he served as director of
sales and marketing worldwide of Knight-Ridder's Presslink, Inc., an Internet
delivery and sales company. From August 1993 to August 1994, he served as vice
president of marketing of Telepad Corporation, a wireless and hand-held
computer company. Mr. Martucci holds a B.C.E. in civil engineering and an
M.S.I.M. in marketing and financial management from Georgia Institute of
Technology.
Committees of the Board of Directors
The compensation committee of our board of directors consists of Messrs.
Ellman, Verhalen and Waite. The compensation committee
. reviews and approves the compensation and benefits for our executive
officers and grants stock options under our stock option plan and
. makes recommendations to the board of directors regarding these matters.
The audit committee consists of Messrs. Ellman, Verhalen and Waite. The audit
committee
. makes recommendations to the board of directors regarding the selection
of independent auditors;
. reviews the results and scope of the audit and other services provided by
our independent auditors; and
. reviews and evaluates our audit and control functions.
We established these committees in February 1999.
Director Compensation
We do not pay cash compensation to our directors for their services as
directors or members of committees of the board of directors, but we do
reimburse them for reasonable expenses they incur in attending meetings of the
board of directors. Directors of WatchGuard are eligible to participate in our
stock option plan.
Director and Officer Indemnification and Liability
Our certificate of incorporation limits the liability of directors to the
full extent permitted by Delaware law. Delaware law provides that a
corporation's certificate of incorporation may eliminate or limit the personal
liability of directors for monetary damages for breach of their fiduciary
duties as directors, except for liability for
. any breach of their duty of loyalty to the corporation or its
stockholders;
. acts or omissions not in good faith or that involve intentional
misconduct or a knowing violation of law;
. unlawful payments of dividends or unlawful stock repurchases or
redemptions; or
. any transaction from which the director derived an improper benefit.
Our bylaws provide that we shall indemnify our directors and officers and may
indemnify our employees and agents to the fullest extent permitted by law. In
addition, we intend to obtain and
52
<PAGE>
maintain directors' and officers' liability insurance, under which our
directors and officers may be indemnified against liability they incur for
serving in their capacities as directors and officers of WatchGuard.
The Securities and Exchange Commission has advised us that, in its opinion,
any indemnification of our directors and officers for liabilities arising under
the Securities Act of 1933 is against public policy as expressed in the
Securities Act and is therefore unenforceable.
We believe that the limitation of liability provision in our certificate of
incorporation, the indemnification provisions in our bylaws and the liability
insurance will facilitate our ability to continue to attract and retain
qualified individuals to serve as directors and officers of WatchGuard.
Compensation Committee Interlocks and Insider Participation
Our board of directors' compensation committee currently consists of Messrs.
Ellman, Verhalen and Waite. None of these individuals has at any time been an
employee or officer of WatchGuard. Until the compensation committee was formed
in February 1999, the full board of directors made all decisions regarding
executive compensation. No member of our board of directors or of its
compensation committee serves as a member of the board of directors or
compensation committee of any entity that has one or more executive officers
serving as members of its board of directors or its compensation committee.
Mr. Ellman is a member of RRE Investors II, LLC, the managing member of RRE
Investors, L.P., which purchased 500,241 shares of our Series C preferred
stock. RRE Investors II, LLC is also the indirect manager of RRE Investors Fund
L.P., which purchased 275,403 shares of our Series C preferred stock. Mr.
Verhalen is the general partner of Matrix IV Management Co., L.P., the general
partner of Matrix Partners IV, L.P., which purchased 1,100,416 shares of our
Series B preferred stock and 276,324 shares of our Series C preferred stock.
Matrix IV Management Co., L.P. is also the general partner of Matrix IV
Entrepreneurs Fund, L.P., which purchased 57,917 shares of our Series B
preferred stock and 14,543 shares of our Series C preferred stock. Mr. Waite is
the general partner of OVMC III, L.P., the general partner of Olympic Venture
Partners III, L.P., which purchased 489,685 shares of our Series B preferred
stock and 122,964 shares of our Series C preferred stock. OVMC III, L.P. is
also the general partner of OVP III Entrepreneurs Fund, L.P., which purchased
25,773 shares of our Series B preferred stock and 6,472 shares of our Series C
preferred stock. Mr. Waite is also the managing member of OVMC IV, LLC, the
general partner of Olympic Venture Partners IV, L.P., which purchased 610,731
shares of our Series B preferred stock and 153,360 shares of our Series C
preferred stock. OVMC IV, LLC is also the general partner of OVP IV
Entrepreneurs Fund, L.P., which purchased 32,144 shares of our Series B
preferred stock and 8,071 shares of our Series C preferred stock.
We sold the Series B preferred stock on May 9, 1997 at $2.59 per share. We
sold the Series C preferred stock on April 24, 1998 at $5.16 per share.
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<PAGE>
Executive Compensation
The following table provides information concerning the compensation received
for services rendered to WatchGuard in all capacities during the year ended
December 31, 1998, by our chief executive officer and the other executive
officer of WatchGuard whose compensation exceeded $100,000 in fiscal 1998.
Summary Compensation Table
<TABLE>
<CAPTION>
Long-Term
Compensation
Awards
------------
Annual Compensation
---------------------- Securities
Name and Principal Underlying Other Annual All Other
Position Salary($) Bonus($) Options(#) Compensation($) Compensation($)
- ------------------ ----------- --------- ------------ --------------- ---------------
<S> <C> <C> <C> <C> <C>
Christopher G. Slatt,
Chief Executive Officer
and President.......... $ 155,000 $ -- 70,000 $ -- $ --
Steven N. Moore,
Executive Vice
President of Finance,
Chief Financial
Officer, Secretary and
Treasurer.............. 155,000 -- 70,000 -- --
</TABLE>
The following table provides information regarding stock options we granted
in fiscal 1998 to our chief executive officer and the other executive officer
whose compensation exceeded $100,000 in fiscal 1998. The table includes the
potential realizable value over the five-year term of the options, based on
assumed rates of stock appreciation of 5% and 10%, compounded annually. The
assumed rates of appreciation are prescribed by the Securities and Exchange
Commission for illustrative purposes only and are not intended to forecast or
predict future stock prices. Any actual gains on option exercises will depend
on the future performance of our stock.
Option Grants in Last Fiscal Year
<TABLE>
<CAPTION>
Individual Grants Potential Realizable
------------------------ Value at Assumed
Number of Percent of Annual Rates of Stock
Securities Total Options Price Appreciation
Underlying Granted to for Option Term
Options Employees in Exercise Expiration ----------------------
Name Granted(#) Fiscal Year Price ($/Sh) Date 5%($) 10%($)
- ---- ---------- ------------- ------------ ---------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Christopher G. Slatt.... 70,000 5.77% $0.14 01/28/03 $ 2,700 $ 6,000
Steven N. Moore......... 70,000 5.77 0.14 01/28/03 2,700 6,000
</TABLE>
Approximately 2% of Mr. Slatt's and Mr. Moore's options vest and become
exercisable each month, commencing February 28, 1998. In 1998, we granted
options to purchase up to an aggregate of 1,212,500 shares to employees,
directors and consultants. We granted all options under our stock option plan
at exercise prices at the fair market value of our common stock on the date of
grant, as determined in good faith by our board of directors.
The following table provides information regarding unexercised options held
as of December 31, 1998 by our chief executive officer and the other executive
officer whose compensation exceeded
54
<PAGE>
$100,000 in fiscal 1998. The value of unexercised options is calculated on the
basis of an assumed initial public offering price of $10.00 per share. These
individuals did not exercise any options in fiscal 1998.
FY-End Option Values
<TABLE>
<CAPTION>
Number of
Securities Underlying Value of Unexercised
Unexercised Options at In-the-Money Options at
Fiscal Year End(#) Fiscal Year-End($)
------------------------- -------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
- ---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Christopher G. Slatt........ 16,040 53,960 $158,106 $531,884
Steven N. Moore............. 16,040 53,960 158,106 531,884
</TABLE>
Change-of-Control Arrangements
On April 12, 1999, R. Michael Peronto, our chief operating officer, was
granted an option to purchase 439,564 shares of our common stock. If a change
of control of WatchGuard occurs, half of the unvested shares subject to this
option will vest and become exercisable.
Employee Benefit Plans
1996 Stock Incentive Compensation Plan
In March 1996, our board of directors and stockholders adopted our 1996 stock
incentive compensation plan. The purpose of the stock option plan is to enhance
long-term stockholder value by offering opportunities to selected persons to
participate in our growth and success, and to encourage them to remain in our
service or in the service of our subsidiaries and to acquire and maintain
ownership in WatchGuard. The stock option plan provides for awards, which may
include incentive stock options, nonqualified stock options and stock awards.
The board has reserved a total of 8,634,986 shares of common stock under the
plan, of which 1,516,244 remain available for grant as of June 30, 1999. In
addition, the plan provides for an automatic annual increase, to be added on
the first day of each fiscal year beginning on January 1, 2000, equal to the
least of
. 750,000 shares;
. 3% of the average number of outstanding common shares used to calculate
fully diluted earnings per share as reported in our annual financial
statements for the preceding year; and
. a lesser amount determined by our board of directors.
As of June 30, 1999, 949,312 shares had been issued upon the exercise of stock
options granted under the stock option plan and 6,169,430 shares were subject
to outstanding options.
The compensation committee of our board of directors serves as the plan
administrator of the stock option plan. Unless the plan administrator permits
otherwise, no awards granted under the stock option plan may be assigned or
transferred by the holder other than by will or the applicable laws of descent
and distribution. During the holder's lifetime, awards generally may be
exercised only by the holder. The board may suspend or terminate the stock
option plan at any time. Unless sooner terminated by the board, the plan will
terminate on May 26, 2009.
Stock Option Grants. The plan administrator has the authority to select
individuals to receive options under the stock option plan and to specify the
terms and conditions of each option granted, the exercise price, the vesting
provisions and the option term. For incentive stock options, the exercise price
must be equal to at least the fair market value of the common stock on the
grant date
55
<PAGE>
and, for nonqualified stock options, must be not less than 85% of the fair
market value of the common stock on the grant date. Unless otherwise provided
by the plan administrator, options granted under the stock option plan will
expire 10 years from the grant date.
Stock Awards. The stock option plan authorizes the plan administrator to
award shares of common stock subject to terms, conditions and restrictions
established by the plan administrator in its sole discretion. The terms,
conditions and restrictions that the plan administrator has the power to
determine include the manner in which shares subject to stock awards are held
during the periods they are subject to restrictions and the circumstances under
which forfeiture of restricted stock will occur because of termination of the
holder's services. Holders of restricted stock are stockholders of WatchGuard
and generally have all the rights of stockholders with respect to those shares.
Corporate Transactions. Unless individual letter agreements provide
otherwise, if certain corporate transactions, such as a merger or sale of
WatchGuard, occur, each outstanding option will automatically accelerate and
become 100% vested and exercisable immediately before the corporate
transaction, unless the option is assumed, continued or replaced with a
comparable award by the successor corporation or the parent of the successor
corporation. If option vesting is accelerated, any forfeiture provisions
applicable to the stock awards will lapse. Any option or stock award that is
assumed, continued or replaced with a comparable award in the corporate
transaction will accelerate if the holder's employment or services are
terminated by the successor corporation without cause or by the holder
voluntarily and with good reason within two years.
1999 Employee Stock Purchase Plan
In May 1999, our board of directors and stockholders approved our 1999
employee stock purchase plan. We will implement our stock purchase plan upon
the effectiveness of this offering to encourage employees to remain in our
employ or the employ of our subsidiaries. We intend for the plan to qualify
under Section 423 of the Internal Revenue Code.
Our stock purchase plan permits our eligible employees and eligible employees
of our subsidiaries to purchase common stock through payroll deductions of up
to 15% of their salary or wage compensation. Under our stock purchase plan, no
employee may purchase common stock with a fair market value of more than
$25,000 in any calendar year, or purchase more than 1,000 shares of common
stock in any single purchase period.
We will implement the stock purchase plan with two-year offering periods.
Each two-year offering period has four consecutive six-month purchase periods.
The first offering period will commence on the effectiveness of this offering
and end on August 31, 2001. The first purchase period under the first offering
period will commence on the effectiveness of this offering and end on February
29, 2000. Subsequent purchase periods will begin on each March 1 and September
1 and end on the next August 31 and February 28, or February 29 in the case of
leap years. The plan administrator generally may establish a different term and
different commencing and ending dates for future offerings.
The price of the common stock purchased under the stock purchase plan will be
the lesser of 85% of the fair market value on the first day of the applicable
offering period and 85% of the fair market value on the last day of the
applicable purchase period. The purchase price for the first offering period,
however, will be equal to the lesser of 100% of the initial public offering
price of the common stock and 85% of the fair market value on the last day of
the applicable purchase period. The stock purchase plan terminates 10 years
after the date of adoption by our board of directors, but
56
<PAGE>
the board may terminate it at any earlier time. We have not yet issued any
shares of common stock under the stock purchase plan.
Employees generally will be eligible to participate in the stock purchase
plan if they are customarily employed by WatchGuard for 20 hours or more per
week and are not, as of the beginning of a purchase period, holders of 5% or
more of our common stock or the common stock of our subsidiaries. Options
granted under the stock purchase plan generally are not transferable and are
exercisable only during the optionee's lifetime.
We authorized the issuance under the stock purchase plan of a total of
600,000 shares of common stock. In addition, the plan provides for automatic
annual increases, to be added on the first day of our fiscal year beginning on
January 1, 2000, equal to the least of
. 400,000 shares;
. 1.5% of the average outstanding common shares used to calculate fully
diluted earnings per share as reported in our annual financial statements
for the preceding year; and
. a lesser amount determined by our board of directors.
If a merger or consolidation resulting in a change of control or acquisition
by another corporation of all or substantially all our assets occurs, each
outstanding option to purchase shares under the stock purchase plan will be
assumed or an equivalent option substituted by the successor corporation. If
the successor corporation refuses to assume or substitute for the option, the
offering period during which a participant may purchase stock will be shortened
to a specified date before the proposed transaction. Similarly, if a
liquidation or dissolution of WatchGuard is proposed, the offering period
during which a participant may purchase stock will be shortened to a specified
date before the date of the proposed liquidation or dissolution.
401(k) Plan
We maintain a 401(k) plan that covers all our employees who satisfy the
plan's eligibility requirements relating to minimum age, length of service and
hours worked. We may make an annual contribution for the benefit of eligible
employees in an amount determined by our board of directors. We have not made
any contribution to date and have no current plans to do so. Eligible employees
may make pretax elective contributions of up to 15% of their compensation,
subject to maximum limits on contributions prescribed by law.
57
<PAGE>
RELATED-PARTY TRANSACTIONS
Since our inception in February 1996, we have issued shares of preferred
stock in private placement transactions as the following table summarizes:
<TABLE>
<CAPTION>
Number of Shares of
Preferred Stock
Issuance Price per ----------------------------
Purchaser Date Share Series A Series B Series C
--------- ---------- --------- --------- --------- --------
<S> <C> <C> <C> <C> <C>
Christopher G. Slatt...................................... March and $0.05 1,500,002
July 1996
Steven N. Moore........................................... March and 0.05 1,500,002
July 1996
Entities affiliated with Matrix IV Management Co., L.P. .. May 1997 2.59 1,158,333
April 1998 5.16 290,867
Olympic Venture Partners III, L.P. and OVP III
Entrepreneurs Fund....................................... May 1997 2.59 515,458
April 1998 5.16 129,436
Olympic Venture Partners IV, L.P. and OVP IV Entrepreneurs
Fund, L.P. .............................................. May 1997 2.59 642,875
April 1998 5.16 161,431
MLS-I, L.C. .............................................. March 1998 2.59 38,610
Entities affiliated with RRE Investors II, LLC ........... April 1998 5.16 775,644
</TABLE>
Christopher G. Slatt and Steven N. Moore are executive officers and directors
of WatchGuard. Stuart J. Ellman, a director of WatchGuard, is a member of RRE
Investors II, LLC, which is the managing member of RRE Investors, L.P. and the
indirect managing member of RRE Investors Fund, L.P. Andrew W. Verhalen, a
director of WatchGuard, is the general partner of Matrix IV Management Co.,
L.P., which is the general partner of Matrix Partners IV, L.P. and of Matrix IV
Entrepreneurs Fund, L.P. Charles P. Waite, Jr., a director of WatchGuard, is a
general partner of OVMC III, L.P., which is the general partner of Olympic
Venture Partners III, L.P. and of OVP III Entrepreneurs Fund, L.P. Mr. Waite is
also a managing member of OVMC IV, LLC, which is the general partner of Olympic
Venture Partners IV, L.P. and of OVP IV Entrepreneurs Fund, L.P. The holders of
the preferred stock are entitled to registration rights with respect to the
common stock to be issued when the preferred stock is converted. All
outstanding shares of preferred stock will convert into an aggregate of
13,425,316 shares of common stock upon the closing of this offering.
Mr. Slatt and Mr. Moore are guarantors of the lease agreement between COM
Realty, Inc. and WatchGuard Technologies Inc., dated as of March 16, 1996. Mr.
Slatt and Mr. Moore were guarantors of our loan with Commerce Bank of
Washington, which we have repaid. Mr. Slatt was a guarantor of the cell phone
service contract between WatchGuard and AT&T Wireless, but is no longer a
guarantor.
On March 9, 1999, we borrowed an aggregate of $1,500,000 from entities
affiliated with Olympic Venture Partners and an aggregate of $1,500,000 from
entities affiliated with Matrix IV Management Co., L.P. We issued each entity a
promissory note, which bears interest at 6% per year and matures on March 9,
2000, and a warrant to purchase our common stock at an exercise price of $7.00
per share. The table below states the amount of each loan and the number of
shares for which
58
<PAGE>
each warrant is exercisable. If not exercised before the closing of this
offering, all of these warrants will automatically convert into common stock on
a net exercise basis at the closing of this offering.
<TABLE>
<CAPTION>
Number of Shares
Amount of for Which Warrant
Name of Investor Loan Is Exercisable
- ---------------- ---------- -----------------
<S> <C> <C>
Olympic Venture Partners III, L.P. ................ $ 647,500 9,244
OVP III Entrepreneurs Fund, L.P.................... 20,000 296
Olympic Venture Partners IV, L.P. ................. 774,225 11,060
OVP IV Entrepreneurs Fund, L.P..................... 58,275 828
Matrix Partners IV, L.P............................ 1,425,000 20,356
Matrix IV Entrepreneurs Fund, L.P. ................ 75,000 1,072
</TABLE>
On June 29, 1999, we amended our loan and security agreement with our bank to
make available to us additional funds under our secured bridge loan facility.
Each of Matrix Partners IV, L.P., Matrix IV Entrepreneurs Fund L.P., Olympic
Venture Partners III, L.P., Olympic Venture Partners IV, L.P. and RRE
Investors, L.P. jointly and severally guaranteed a portion of the loan, in the
amounts shown below.
<TABLE>
<CAPTION>
Maximum Amount
Name of Guarantor of Guaranty
- ----------------- --------------
<S> <C>
Matrix Partners IV, L.P. ........................................ $633,334
Matrix IV Entrepreneurs Fund, L.P. .............................. 33,334
Olympic Venture Partners III, L.P. .............................. 333,334
Olympic Venture Partners IV, L.P. ............................... 333,334
RRE Investors, L.P. ............................................. 666,667
</TABLE>
We believe that we made all of the transactions described above on terms no
less favorable to us than we could have obtained from unaffiliated third
parties. Any future transactions between us and our officers, directors and
principal stockholders will be approved by a majority of our board of
directors, including a majority of the independent and disinterested directors,
and will be on terms no less favorable to us that we could obtain from
unaffiliated third parties.
Dain Rauscher Incorporated, the parent company of our underwriter Dain
Rauscher Wessels, is a limited partner in Olympic Venture Partners III, L.P., a
shareholder of WatchGuard.
59
<PAGE>
PRINCIPAL AND SELLING STOCKHOLDERS
Principal Stockholders
The following table provides information regarding the actual beneficial
ownership of our outstanding common stock as of June 30, 1999, and as adjusted
to reflect the sale of common stock offered by this prospectus, for
. each person or group that we know beneficially owns more than 5% of our
common stock;
. each of our directors;
. our chief executive officer;
. the other executive officer whose compensation exceeded $100,000 in
fiscal 1998; and
. all of our directors and executive officers as a group.
Under the rules of the Securities and Exchange Commission, beneficial
ownership includes shares over which the indicated beneficial owner exercises
voting and/or investment power. Shares of common stock subject to options that
are currently exercisable or will become exercisable within 60 days are deemed
outstanding for computing the percentage ownership of the person holding the
option, but are not deemed outstanding for purposes of computing the percentage
ownership of any other person. Unless otherwise indicated in the footnotes
below, we believe that the persons and entities named in the table have sole
voting and investment power with respect to all shares beneficially owned,
subject to applicable community property laws. Unless otherwise indicated, the
following beneficial owners can be reached at our principal offices.
<TABLE>
<CAPTION>
Percentage of
Shares of Common
Stock Outstanding
Number of Shares -----------------
of Common Stock Before After
Name and Address Beneficially Owned Offering Offering
- ---------------- ------------------ -------- --------
<S> <C> <C> <C>
Entities affiliated with Matrix IV
Management Co., L.P.(1)................. 2,919,828 19.53% 15.83%
2500 Sand Hill Road
Menlo Park, CA 94025
Entities affiliated with Olympic Venture
Partners(2)............................. 2,919,828 19.53 15.83
2420 Carillon Point
Kirkland, WA 98033
Entities affiliated with RRE
Investors II, LLC(3).................... 1,551,288 10.38 8.41
156 East 56th St., 22nd Floor
New York, NY 10022
Stuart J. Ellman(4)...................... 1,551,288 10.38 8.41
Andrew W. Verhalen(5).................... 2,919,828 19.53 15.83
Charles P. Waite, Jr.(6)................. 2,919,828 19.53 15.83
Christopher G. Slatt(7).................. 3,029,378 20.23 16.40
Steven N. Moore(7)....................... 3,029,378 20.23 16.40
Directors and executive officers as a
group (6 persons)(8).................... 13,449,700 89.63 72.68
</TABLE>
60
<PAGE>
- --------
(1) Represents 2,898,400 shares issuable upon conversion of the preferred stock
and 21,428 shares subject to warrants exercisable within 60 days of June
30, 1999, held by entities affiliated with Matrix IV Management Co., L.P.
Matrix IV Management Co., L.P. is the general partner of Matrix Partners
IV, L.P. and of Matrix IV Entrepreneurs Fund, L.P., and thus is deemed to
beneficially own these shares. Andrew W. Verhalen, a director of
WatchGuard, is a general partner of Matrix IV Management Co., L.P.
(2) Includes 1,289,788 shares issuable upon conversion of the preferred stock
and 9,540 shares subject to warrants exercisable within 60 days of June 30,
1999, held by Olympic Venture Partners III, L.P. and OVP III Entrepreneurs
Fund, L.P. OVMC III, L.P. is the general partner of Olympic Venture
Partners III, L.P. and of OVP III Entrepreneurs Fund, L.P., and thus is
deemed to beneficially own these shares. Also includes 1,608,612 shares
issuable upon conversion of the preferred stock and 11,888 shares subject
to warrants exercisable within 60 days of June 30, 1999, held by Olympic
Venture Partners IV, L.P. and OVP IV Entrepreneurs Fund, L.P. OVMC IV, LLC
is the general partner of Olympic Venture Partners IV, L.P. and of OVP IV
Entrepreneurs Fund, L.P., and thus is deemed to beneficially own these
shares. OVMC III, L.P. and OVMC IV, LLC disclaim beneficial ownership of
these shares except to the extent of their pecuniary interests in these
shares. Charles P. Waite, Jr., a director of WatchGuard, is a general
partner of OVMC III, L.P. and a managing member of OVMC IV, LLC.
(3) Represents 1,551,288 shares issuable upon conversion of the preferred stock
held by entities affiliated with RRE Investors II, LLC. RRE Investors II,
LLC is the managing member of RRE Investors, L.P. and the indirect managing
member of RRE Investors Fund, L.P., and thus is deemed to beneficially own
these shares. Stuart J. Ellman, a director of WatchGuard, is a member of
RRE Investors II, LLC.
(4) Represents 1,551,288 shares issuable upon conversion of the preferred stock
held by entities affiliated with RRE Investors II, LLC. Mr. Ellman is a
member of RRE Investors II, LLC, which is the direct or indirect managing
member of each of the entities affiliated with it. Mr. Ellman disclaims
beneficial ownership of the shares held by the entities affiliated with
RRE Investors II, LLC, except to the extent of his pecuniary interest
arising from his interest in RRE Investors II, LLC.
(5) Represents 2,898,400 shares issuable upon conversion of the preferred stock
and 21,428 shares subject to warrants exercisable within 60 days of June
30, 1999, held by entities affiliated with Matrix IV Management Co., L.P.
Mr. Verhalen is a general partner of Matrix IV Management Co., L.P., which
is the general partner of each of the entities affiliated with it. Mr.
Verhalen disclaims beneficial ownership of the shares held by the entities
affiliated with Matrix IV Management Co., L.P., except to the extent of his
pecuniary interest arising from his interest in Matrix IV Management Co.,
L.P.
(6) Represents 2,898,400 shares issuable upon conversion of the preferred stock
and 21,428 shares subject to warrants exercisable within 60 days of June
30, 1999, held by affiliates of OVMC III, L.P. and OVMC IV, LLC. Mr. Waite
is a general partner of OVMC III, L.P., which is the general partner of
Olympic Venture Partners III, L.P. and of OVP III Entrepreneurs Fund. Mr.
Waite is also a managing member of OVMC IV, LLC, which is the general
partner of Olympic Venture Partners IV, L.P. and of OVP IV Entrepreneurs
Fund, L.P. Mr. Waite disclaims beneficial ownership of the shares held by
Olympic Venture Partners III, L.P., OVP III Entrepreneurs Fund, L.P.,
Olympic Venture Partners IV, L.P. and OVP IV Entrepreneurs Fund, L.P.,
except to the extent of his pecuniary interest arising from his interest in
these entities.
(7) Represents 3,000,004 shares issuable upon conversion of the preferred
stock and 29,374 shares subject to an option exercisable within 60 days of
June 30, 1999. If the underwriters exercise their over-allotment option in
full, each of Mr. Slatt and Mr. Moore will sell 125,000 shares of
61
<PAGE>
common stock, after which they will each beneficially own 2,904,378 shares,
representing 15.66% of the common stock outstanding after this offering.
(8) Includes 58,748 shares subject to options exercisable within 60 days of
June 30, 1999 and 42,856 shares subject to warrants exercisable within 60
days of June 30, 1999. If the underwriters exercise their over-allotment
option in full, the directors and officers as a group will beneficially own
13,199,700 shares, representing 71.04% of the common stock outstanding
after this offering.
Selling Stockholders
If the underwriters exercise their over-allotment option in full, the
following directors, officers and stockholders will sell the number of shares
indicated below:
<TABLE>
<CAPTION>
Percentage
of Shares
Beneficial Beneficial of Common
Ownership Ownership Stock
Prior to After Outstanding
Over- Number of Over- After Over-
allotment Shares allotment allotment
Name Exercise Being Offered Exercise Exercise
- ---- ---------- ------------- ---------- -----------
<S> <C> <C> <C> <C>
Randall C. Boroughs(1).. 80,998 1,000 79,998 *
Dennis R. Cloutier(2)... 553,192 100,000 453,192 2.43%
Michael V. Martucci(3).. 355,740 74,000 281,740 1.49
Mazama Software Labs,
Inc.(4)................ 400,000 100,000 300,000 1.62
Steven N. Moore......... 3,029,378 125,000 2,904,378 15.66
Christopher G. Slatt.... 3,029,378 125,000 2,904,378 15.66
</TABLE>
- --------
* Less than 1%.
(1) Includes 78,998 shares subject to options exercisable within 60 days of
June 30, 1999.
(2) Includes 164,976 shares subject to options exercisable within 60 days of
June 30, 1999.
(3) Represents 355,740 shares subject to options exercisable within 60 days of
June 30, 1999.
(4) Shareholders and officers of Mazama Software Labs, Inc. include David W.
Bonn and Kangho Lee, employees of WatchGuard.
62
<PAGE>
DESCRIPTION OF CAPITAL STOCK
We are authorized to issue up to 80,000,000 shares of common stock and
10,000,000 shares of preferred stock. You should carefully read our certificate
of incorporation, which is included as an exhibit to the registration statement
of which this prospectus is a part.
Common Stock
As of June 30, 1999, assuming conversion of all outstanding shares of
preferred stock and the exercise before the closing of this offering of
warrants to purchase 42,856 shares of common stock at an exercise price of
$7.00 per share, there were 14,947,484 shares of common stock outstanding, held
of record by 42 stockholders. Following this offering, there will be 18,447,484
shares of common stock outstanding, assuming no exercise of the underwriters'
over-allotment option and no exercise of outstanding options or warrants. The
holders of common stock are entitled to one vote for each share held of record
on all matters submitted to a vote of stockholders. Subject to preferences of
any outstanding shares of preferred stock, the holders of common stock are
entitled to receive ratably any dividends the board of directors declares out
of funds legally available for paying dividends. If WatchGuard is liquidated,
dissolved or wound up, the holders of common stock are entitled to share
ratably in all assets remaining after paying liabilities and liquidation
preferences of any outstanding shares of preferred stock. Holders of common
stock have no preemptive rights or rights to convert their common stock into
any other securities. 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
At the closing of this offering, all outstanding shares of preferred stock
will be converted into 13,425,316 shares of common stock. Under our certificate
of incorporation, the board of directors will then have the authority, without
further action by the stockholders, to issue up to 10,000,000 shares of
preferred stock in one or more series and to fix the price, rights, privileges,
preferences and restrictions of that preferred stock, any or all of which may
be greater than the rights of the common stock. The board of directors, without
stockholder approval, can issue preferred stock with voting, conversion or
other rights that could adversely affect the voting power and other rights of
the holders of common stock. Preferred stock could thus be issued quickly with
terms that could delay or prevent a change of control of WatchGuard or make
removal of management more difficult. Additionally, the issuance of preferred
stock may decrease the market price of the common stock and may adversely
affect the voting and other rights of the holders of common stock. We have no
current plans to issue any preferred stock.
Warrants
As of June 30, 1999, there were outstanding warrants to purchase 259,500
shares of common stock, excluding the warrants to purchase 42,856 shares of
common stock discussed above. The warrants expire and are exercisable as
follows:
.15,000 shares at an exercise price of $0.03 per share, expiring on July
24, 2001;
.20,000 shares at an exercise price of $0.03 per share, expiring on
September 24, 2001;
.10,000 shares at an exercise price of $0.13 per share, expiring on March
23, 2003;
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<PAGE>
. 200,000 shares at an exercise price of $0.39 per share, expiring on June
17, 2003; and
. 14,500 shares at an exercise price of $7.00 per share, expiring on May
26, 2004, unless our initial public offering closes after July 31, 1999,
in which case the exercise price of this warrant will be $7.00 per
share.
Antitakeover Effects of Provisions of Our Certificate of Incorporation, Our
Bylaws, Delaware Law and Washington Law
Preferred Stock. Our board of directors, without stockholder approval, has
the authority under our certificate of incorporation to issue preferred stock
with rights superior to the rights of the holders of common stock. As a result,
preferred stock could be issued quickly and easily, could adversely affect the
rights of holders of common stock and could be issued with terms calculated to
delay or prevent a change of control of WatchGuard or make removal of
management more difficult.
Election and Removal of Directors. Effective with the first annual meeting of
stockholders following this offering, our bylaws provide for the division of
our board of directors into three classes, as nearly equal in number as
possible. The directors in the first class will serve an initial term of one
year, the directors in the second class an initial term of two years, and the
directors in the third class an initial term of three years. After the initial
term, all classes of directors will serve for a three-year term, and one class
will be elected each year by our stockholders. Directors may be removed only
for cause. Because this system of electing and removing directors generally
makes it more difficult for stockholders to replace a majority of directors, it
may tend to discourage a third party from making a takeover bid or attempting
to gain control of WatchGuard and may maintain the incumbency of our board of
directors.
Approval for Certain Business Combinations. Our certificate of incorporation
requires that certain business combinations, including a merger, share exchange
and the disposition or encumbrance of a substantial part of our assets other
than in the usual course of business, be approved by the holders of at least
two-thirds of the outstanding shares. If the business combination has been
approved by a majority of the board of directors, however, the affirmative vote
required is a majority of the outstanding shares.
Stockholder Meetings. Under our certificate of incorporation and bylaws, our
stockholders may call a special meeting only upon the request of holders of at
least 25% of the outstanding shares. Additionally, the board of directors, the
chairman of the board and the president may call special meetings of
stockholders.
Requirements for Advance Notification of Stockholder Nominations and
Proposals. Our bylaws establish advance notice procedures for stockholder
proposals and the nomination of candidates for election as directors, other
than nominations made by or at the direction of the board of directors or a
committee of the board of directors.
Washington Law. The laws of Washington, where our principal executive offices
are located, impose restrictions on transactions between foreign corporations
and significant stockholders. Chapter 23B.19 of the Washington Business
Corporation Act generally prohibits a target corporation from engaging in
significant business transactions with an acquiring person. An acquiring person
is defined as a person or group of persons that beneficially owns 10% or more
of the voting securities of the target corporation, for a period of five years
after the acquisition, unless a majority of the members of
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<PAGE>
the target corporation's board of directors approves the transaction before the
acquisition. Prohibited transactions include
. a merger or consolidation with, disposition of assets to, or issuance or
redemption of stock to or from, the acquiring person;
. termination of 5% or more of the employees of the target corporation as a
result of the acquiring person's acquisition of 10% or more of the
shares; and
. allowing the acquiring person to receive any disproportionate benefit as
a stockholder.
After the five-year period, a significant business transaction may take place
so long as it complies with the fair price provisions of the statute or is
approved at an annual or special meeting of stockholders. A target corporation
includes a foreign corporation if
. the corporation has a class of voting stock registered under Section 12
or 15 of the Securities Exchange Act of 1934;
. the corporation's principal executive office is located in Washington;
. any of (a) more than 10% of the corporation's stockholders of record are
Washington residents, (b) more than 10% of its shares of record are owned
by Washington residents or (c) 1,000 or more of its stockholders of
record are Washington residents;
. a majority of the corporation's employees are Washington residents or
more than 1,000 Washington residents are employees of the corporation;
and
. a majority of the corporation's tangible assets are located in Washington
or the corporation has more than $50 million of tangible assets located
in Washington.
A corporation may not opt out of this statute. If WatchGuard meets the
definition of a target corporation, Chapter 23B.19 of the Washington Business
Corporation Act may have the effect of delaying, deferring or preventing a
change of control of WatchGuard.
Delaware Law. WatchGuard is subject to Section 203 of the Delaware General
Corporation Law, which 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
. before that date, the board of directors of the corporation approves
either the business combination or the transaction that resulted in the
stockholder's becoming an interested stockholder;
. upon consummation of the transaction that resulted in the stockholder's
becoming an interested stockholder, the interested stockholder owns at
least 85% of the outstanding voting stock, excluding shares held by
directors, officers and certain employee stock plans; or
. on or after the consummation date, the business combination is approved
by the board of directors and by the affirmative vote at an annual or
special meeting of stockholders of at least 66 2/3% of the outstanding
voting stock that is not owned by the interested stockholder.
For purposes of Section 203, a business combination includes a merger, asset
sale or other transaction resulting in a financial benefit to the interested
stockholder. An interested stockholder is generally a person who, together with
affiliates and associates of that person, (a) owns 15% or more
65
<PAGE>
of the corporation's voting stock or (b) is an affiliate or associate of the
corporation and was the owner of 15% or more of the outstanding voting stock of
the corporation at any time within the prior three years.
These charter provisions and provisions of Washington and Delaware law may
have the effect of delaying, deterring or preventing a change of control of
WatchGuard.
Registration Rights
After this offering, the holders of 13,425,316 shares of common stock will
have rights with respect to the registration of those shares under the
Securities Act, under a registration rights agreement among the holders and
WatchGuard, dated as of April 24, 1998. Under the terms of the registration
rights agreement, if we propose to register any of our securities under the
Securities Act, either for our own account or for the account of other security
holders exercising registration rights, the holders are entitled to notice of
the registration and to include shares of common stock in the registration at
our expense. Additionally, the holders are entitled to demand registration
rights under which they may require us to file a registration statement under
the Securities Act at our expense for their shares of common stock. Further,
the holders may require us to file additional registration statements on Form
S-3 at our expense. All of these registration rights are subject to conditions
and limitations, including the right of the underwriters of an offering to
limit the number of shares included in the registration and our right to
decline to effect such a registration before the earlier of January 1, 2000 and
six months after the closing of the initial public offering.
Transfer Agent and Registrar
The transfer agent and registrar for the common stock is ChaseMellon
Shareholder Services, LLC.
Nasdaq National Market Listing
Our common stock has been approved for quotation on the Nasdaq National
Market under the symbol WGRD.
66
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Before this offering, there has been no public market for our common stock. A
significant public market for our common stock may not develop or be sustained
after this offering. Future sales of substantial amounts of our common stock in
the public market, or the possibility of these sales occurring, could adversely
affect prevailing market prices for our common stock or our future ability to
raise capital through an offering of equity securities.
After this offering, we will have outstanding 18,447,484 shares of common
stock, or 18,521,484 shares if the underwriters exercise their over-allotment
option in full. Of these shares, the 3,500,000 shares that we expect to sell in
this offering, or 4,025,000 shares if the underwriters exercise their over-
allotment option in full, will be freely tradable in the public market without
restriction under the Securities Act, unless the shares are held by affiliates
of WatchGuard, as that term is defined in Rule 144 under the Securities Act. In
general, affiliates include directors, officers and 10% stockholders.
The remaining 14,947,484 shares of common stock that will be outstanding
after this offering will be restricted shares. We issued and sold the
restricted shares in private transactions in reliance on exemptions from
registration under the Securities Act. Restricted shares may be sold in the
public market only if they are registered or if they qualify for an exemption
from registration under Rule 144 or 701 under the Securities Act, which are
summarized below.
The executive officers, directors and most stockholders and employees of
WatchGuard, who collectively hold an aggregate of 14,719,708 restricted shares,
have agreed not to offer, sell, contract to sell, grant any option to purchase
or dispose of their shares by any other means for a period of 180 days from the
date of this prospectus. This 180-day period is known as the lock-up period. We
also have entered into an agreement with the underwriters that we will not
offer, sell or otherwise dispose of common stock during the lock-up period.
Ninety days after the date of this prospectus, 227,776 shares that are not
subject to lock-up agreements will be eligible for sale in the public market
under Rules 144 and 701. On the date the lock-up agreements expire, an
additional 14,676,852 restricted shares will be eligible for immediate sale, of
which 13,425,316 shares will be subject to the volume, manner of sale and other
limitations of Rule 144. The remaining 42,856 restricted shares will be
eligible for sale under Rule 144 when one-year holding periods expire.
After the lock-up periods expire, some of the shares issued upon exercise of
options we granted before the date of this prospectus will also be available
for sale in the public market under Rule 701 under the Securities Act. Rule 701
permits resales of those shares in reliance on Rule 144 but without compliance
with some of the restrictions imposed by Rule 144, including the holding period
requirement. Under Rule 144, beginning 90 days after the date of this
prospectus, a person who has beneficially owned restricted shares for at least
one year would be entitled to sell within any three-month period up to the
greater of
. 1% of the then-outstanding shares of common stock, which will be
approximately 184,475 shares immediately after this offering, and
. the average weekly trading volume of the common stock during the four
calendar weeks preceding the filing of a Form 144 with respect to such
sale.
Sales under Rule 144 are also subject to manner of sale and notice
requirements and to the availability of current public information about
WatchGuard. Under Rule 144(k), a person who is not
67
<PAGE>
deemed to have been an affiliate of WatchGuard during the 90 days preceding a
sale and who has beneficially owned the restricted shares for at least two
years may sell them without complying with the manner of sale, public
information, volume limitation or notice provisions of Rule 144.
After the effective date of this offering, we intend to file a registration
statement on Form S-8 to register up to approximately 10,610,796 shares of
common stock reserved for issuance under our stock option plan and our employee
stock purchase plan. That registration statement will become effective
automatically upon filing. After the filing of a registration statement on Form
S-8, shares issued under our stock option plan and our employee stock purchase
plan may be sold in the open market. Some holders, however, will be subject to
the Rule 144 limitations applicable to affiliates, the lock-up agreements and
vesting restrictions imposed by us.
In addition, following this offering, the holders of an aggregate of
13,425,316 shares of outstanding common stock will have rights to require us to
register their shares for future sale.
68
<PAGE>
UNDERWRITING
Each of the underwriters named below, acting through its representatives,
Dain Rauscher Wessels, a division of Dain Rauscher Incorporated, Warburg Dillon
Read LLC, a subsidiary of UBS AG, SoundView Technology Group, Inc. and Wit
Capital Corporation, has agreed, subject to the terms and conditions of the
underwriting agreement, to purchase from us the number of shares of common
stock listed opposite its name below. The underwriters have committed to
purchase and pay for all of the shares if any are purchased, subject to the
conditions stated in the underwriting agreement.
<TABLE>
<CAPTION>
Number of
Name of Underwriter Shares
- ------------------- ---------
<S> <C>
Dain Rauscher Wessels ................................................
Warburg Dillon Read LLC, a subsidiary of UBS AG.......................
SoundView Technology Group, Inc. .....................................
Wit Capital Corporation...............................................
---------
Total............................................................... 3,500,000
=========
</TABLE>
The representatives have advised us that the underwriters propose to offer
the shares of common stock to the public at the initial public offering price
stated on the cover page of this prospectus and to dealers at that price less a
concession of no more than $ per share, of which $ may be reallowed
to other dealers. After the public offering, the representatives may reduce the
public offering price, concession and reallowance to dealers. The
representatives may not change the offering price and other selling terms until
after the completion of this offering, and no reduction in the offering price
may change the amount of proceeds to be received by WatchGuard stated on the
cover page of this prospectus.
A prospectus in electronic format is being made available on an Internet web
site maintained by Wit Capital. In addition, all dealers purchasing shares from
Wit Capital in this offering have agreed to make a prospectus in electronic
format available on web sites maintained by each of these dealers. Wit Capital,
a member of the National Association of Securities Dealers, Inc., will
participate in this offering as one of the underwriters. The National
Association of Securities Dealers, Inc. approved the membership of Wit Capital
on September 4, 1997.
The underwriting agreement contains covenants of indemnity among the
underwriters, WatchGuard and the selling stockholders against civil
liabilities, including liabilities under the Securities Act and liabilities
arising from breaches of representations and warranties contained in the
underwriting agreement.
The selling stockholders listed on page 62 have granted the underwriters an
option to purchase up to 525,000 additional shares of common stock, which may
be exercised at any time up to 30 days after the date of this prospectus. The
option entitles the underwriters to purchase the additional shares of common
stock at the same price per share as the 3,500,000 shares being sold in this
offering. If the underwriters exercise the option, each of the underwriters
must purchase approximately the same percentage of additional shares from the
selling stockholders that they purchased from WatchGuard. If purchased, the
additional shares will be sold by the underwriters on the same terms as those
on which the 3,500,000 shares are being sold.
69
<PAGE>
The price of the shares of common stock purchased by the underwriters will be
the public offering price stated on the cover page of this prospectus less the
following underwriting discounts and commissions to be paid by us:
<TABLE>
<CAPTION>
Total Without Total With
Per Share Over-allotment Over-allotment
--------- -------------- --------------
<S> <C> <C> <C>
By WatchGuard........................... $ $ $
By the selling stockholders.............
</TABLE>
We will also pay offering expenses estimated to total $1,200,000.
Most of our stockholders and option holders have agreed, for the 180-day
lock-up period after the date of this prospectus, not to sell, transfer, grant
any third party the right to purchase or dispose of by any other means any
shares of common stock or other securities that they own or acquire, without
the written consent of the underwriters. This agreement does not apply to any
shares sold by the selling stockholders in this offering. The representatives
may, without notice and in their sole discretion, allow any stockholder or
option holder to dispose of common stock or other securities before the
expiration of the lock-up period. There are, however, no agreements between the
underwriters and any of our stockholders or option holders that would allow
them to do so.
In addition, we have agreed that we will not issue, sell, offer to sell or
dispose of by any other means any shares of our common stock or other
securities during the lock-up period without the written consent of the
underwriters. This agreement does not include shares of common stock or other
securities issued under our stock option plan or employee stock purchase plan
or common stock or other securities issued for options or other securities
outstanding on the date of this prospectus.
The underwriters have reserved for sale, at the initial public offering
price, 175,000 shares of common stock for persons selected by WatchGuard who
have expressed an interest in purchasing shares of common stock in this
offering. The number of shares available for sale to the general public in this
offering will be reduced to the extent these persons purchase the reserved
shares. Any reserved shares not purchased will be offered by the underwriters
on the same basis as the other shares included in this offering.
The underwriters have advised us that in connection with this offering, some
persons participating in this offering may engage in transactions that may have
the effect of stabilizing or maintaining the market price of the common stock
at a level above that which might otherwise prevail in the open market. These
transactions may include stabilizing bids, syndicate covering transactions and
the imposition of penalty bids. A stabilizing bid is a bid for or the purchase
of common stock on behalf of the underwriters for the purpose of preventing or
retarding a decline in the market price of the common stock. A syndicate
covering transaction is the bid for or the purchase of the common stock on
behalf of the underwriters to reduce a short position incurred by the
underwriters in connection with this offering. A penalty bid is an arrangement
permitting the representatives to reclaim the selling concession otherwise
accruing to an underwriter or syndicate member, if the common stock originally
sold by the underwriter or syndicate member is purchased by the representatives
in a syndicate covering transaction and has therefore not been effectively
placed by the underwriter or syndicate member. The representatives have advised
us that these transactions may be effected on the Nasdaq National Market or
other market and, if commenced, may be discontinued at any time.
Before this offering, there was no public market for our common stock. The
initial public offering price for the common stock will be determined by
negotiation between us and the representatives of the underwriters. Factors to
be considered in determining the initial public offering price include
70
<PAGE>
. prevailing market and economic conditions;
. our revenues and earnings;
. the state of our business operation;
. an assessment of our management; and
. market valuation of companies in related businesses.
The prices at which the common stock will sell in the public market after this
offering, however, may not be equal to or greater than the initial public
offering price.
LEGAL MATTERS
WatchGuard's legal counsel is Perkins Coie LLP of Seattle, Washington. The
underwriters' legal counsel is Wilson Sonsini Goodrich & Rosati, Professional
Corporation, of Palo Alto, California and Kirkland, Washington.
EXPERTS
Ernst & Young LLP, independent auditors, have audited our financial
statements and schedule at December 31, 1997 and 1998, and for the period from
our inception on February 14, 1996 to December 31, 1996 and for the years ended
December 31, 1997 and 1998, as described in their reports. We have included our
financial statements and schedule in this prospectus and elsewhere in the
registration statement in reliance on Ernst & Young LLP's reports, given on
their authority as experts in accounting and auditing.
WHERE YOU CAN FIND MORE INFORMATION
We have filed a registration statement on Form S-1 with the Securities and
Exchange Commission. This prospectus, which is part of the registration
statement, does not contain all the information included in the registration
statement. Because some information is omitted, you should refer to the
registration statement and its exhibits. For copies of actual contracts or
documents referred to in this prospectus, you should refer to the exhibits
attached to the registration statement. You may review a copy of the
registration statement, including the attached exhibits and schedule, at the
SEC's public reference facilities in Room 1024, Judiciary Plaza, 450 Fifth
Street, N.W., Washington, D.C. 20549, and at the regional offices of the SEC at
7 World Trade Center, Suite 1300, New York, New York 10048, and Citicorp
Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. You may
also obtain copies of these materials from the Public Reference Room of the
SEC, Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C.
20549, at prescribed rates. You may obtain information on the operation of the
Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains a
web site at http://www.sec.gov that contains reports, proxy and information
statements and other information regarding registrants, such as WatchGuard,
that file electronically with the SEC.
71
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Ernst & Young LLP, Independent Auditors.......................... F-2
Balance Sheets............................................................. F-3
Statements of Operations................................................... F-4
Statements of Stockholders' Equity......................................... F-5
Statements of Cash Flows................................................... F-6
Notes to Financial Statements.............................................. F-7
</TABLE>
F-1
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Board of Directors and Shareholders
WatchGuard Technologies, Inc.
We have audited the accompanying balance sheets of WatchGuard Technologies,
Inc. as of December 31, 1997 and 1998 and the related statements of operations,
stockholders' equity, and cash flows for the period from February 14, 1996
(date of inception) to December 31, 1996 and for the years ended December 31,
1997 and 1998. These financial statements are the responsibility of
WatchGuard'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 financial position of WatchGuard Technologies, Inc.
at December 31, 1997 and 1998, and the results of its operations and its cash
flows for the period from February 14, 1996 (date of inception) to December 31,
1996 and for the years ended December 31, 1997 and 1998, in conformity with
generally accepted accounting principles.
ERNST & YOUNG LLP
Seattle, Washington
March 26, 1999, except as to Note 11,
as to which the date is July 8, 1999.
F-2
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
BALANCE SHEETS
(In thousands, except share data)
ASSETS
<TABLE>
<CAPTION>
Pro Forma
Stockholders'
December 31, Equity
----------------- June 30, June 30,
1997 1998 1999 1999
------- -------- ----------- -------------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents....... $ 603 $ 1,712 $ 2,214
Trade accounts receivable, net.. 1,596 3,491 3,621
Inventories..................... 218 2,156 2,353
Prepaid expenses and other...... 162 450 1,186
------- -------- --------
Total current assets........ 2,579 7,809 9,374
Equipment and furniture, net...... 372 1,140 1,697
Deposits, intangibles, and other
assets........................... 352 83 52
------- -------- --------
Total assets................ $ 3,303 $ 9,032 $ 11,123
======= ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Line of credit.................. $ 500 $ 2,500 $ 1,150
Equipment term loan............. -- 609 493
Notes payable................... -- -- 6,600
Accounts payable................ 682 2,185 3,925
Accrued expenses................ 426 1,016 1,172
Deferred revenue................ 313 1,773 2,776
------- -------- --------
Total current liabilities... 1,921 8,083 16,116
Deferred revenue.................. -- 68 68
Commitments.......................
Stockholders' equity:
Preferred stock, $0.001 par
value:
Authorized shares --
10,000,000
Shares issued and
outstanding -- 5,316,670,
6,712,658 and 6,712,658 at
December 31, 1997 and 1998
and June 30, 1999
respectively (none pro
forma).......................
Liquidation preference --
$13,250..................... 5 6 6 $ --
Common stock, $0.001 par value:
Authorized shares --
80,000,000
Shares issued and
outstanding -- 532,916,
1,362,744 and 1,479,312 at
December 31, 1997 and 1998
and June 30, 1999,
respectively (14,947,484
pro forma)................... -- 1 1 15
Additional paid-in capital.... 6,179 16,261 16,630 16,922
Deferred stock-based
compensation................... -- (1,466) (1,116) (1,116)
Accumulated deficit............. (4,802) (13,921) (20,582) (20,582)
------- -------- -------- --------
Total stockholders' equity
(deficit).................. 1,382 881 (5,061) $ (4,761)
------- -------- -------- ========
Total liabilities and
stockholders' equity ...... $ 3,303 $ 9,032 $11,123
======= ======== ========
</TABLE>
See accompanying notes.
F-3
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
STATEMENTS OF OPERATIONS
(In thousands, except per share data)
<TABLE>
<CAPTION>
Period from Year Ended Six Months Ended
February 14, 1996 December 31, June 30,
(Inception) to ---------------- ------------------
December 31, 1996 1997 1998 1998 1999
----------------- ------- ------- -------- --------
(unaudited)
<S> <C> <C> <C> <C> <C>
Revenues, net:
Product............... $ 329 $ 4,975 $10,678 $ 4,860 $ 7,218
Service............... 2 123 701 157 1,357
----- ------- ------- -------- --------
Total revenues...... 331 5,098 11,379 5,017 8,575
Cost of revenues........ 104 1,610 3,925 1,491 3,481
----- ------- ------- -------- --------
Gross margin............ 227 3,488 7,454 3,526 5,094
Operating expenses:
Sales and marketing... 224 4,369 8,666 3,821 6,271
Research and
development.......... 274 2,192 5,273 1,909 3,288
General and
administrative....... 191 1,323 2,515 971 1,849
----- ------- ------- -------- --------
Total operating
expenses........... 689 7,884 16,454 6,701 11,408
----- ------- ------- -------- --------
Operating loss.......... (462) (4,396) (9,000) (3,175) (6,314)
Interest income......... -- 88 84 4 15
Interest expense........ (6) (26) (203) (87) (362)
----- ------- ------- -------- --------
Net loss................ $(468) $(4,334) $(9,119) $ (3,258) $ (6,661)
===== ======= ======= ======== ========
Basic and diluted net
loss per share......... N/A $(17.17) $(11.34) $ (4.70) $ (4.65)
===== ======= ======= ======== ========
Shares used in
calculation of basic
and diluted net loss
per share.............. N/A 252 804 693 1,433
===== ======= ======= ======== ========
Pro forma basic and
diluted net loss per
share (unaudited)...... $ (0.68) $ (0.45)
======= ========
Shares used in
calculation of pro
forma basic and diluted
net loss per share
(unaudited)............ 13,366 14,858
======= ========
</TABLE>
See accompanying notes.
F-4
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except share data)
<TABLE>
<CAPTION>
Preferred Stock Common Stock Additional Deferred
---------------- ---------------- Paid-in Stock-Based Accumulated
Shares Amount Shares Amount Capital Compensation Deficit Total
--------- ------ --------- ------ ---------- ------------ ----------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Sale of Series A
Preferred Stock........ 3,000,004 $ 3 -- $-- $ 147 $ -- $ -- $ 150
Net loss................ -- -- -- -- -- -- (468) (468)
--------- --- --------- --- ------- ------- -------- -------
Balance, December 31,
1996................... 3,000,004 3 -- -- 147 -- (468) (318)
Sale of Series B
preferred stock, net
of issuance costs of
$21.................. 2,316,666 2 -- -- 5,977 -- -- 5,979
Issuance of common
stock in settlement
of royalty payments.. -- -- 400,000 52 -- -- 52
Exercise of common
stock options and
warrants............. -- -- 132,916 3 -- -- 3
Net loss.............. -- -- -- -- -- -- (4,334) (4,334)
--------- --- --------- --- ------- ------- -------- -------
Balance, December 31,
1997................... 5,316,670 5 532,916 6,179 -- (4,802) 1,382
Sales of Series B
preferred stock...... 38,610 -- -- -- 100 -- -- 100
Sales of Series C
preferred stock, net
of issuance costs of
$25.................. 1,357,378 1 -- -- 6,974 -- -- 6,975
Stock options
exchanged for
services............. -- -- -- 628 -- -- 628
Issuance of stock
warrant to a
customer............. -- -- -- 470 -- -- 470
Deferred stock
compensation......... -- -- -- -- 1,877 (1,877) -- --
Amortization of
deferred stock-based
compensation......... -- -- -- -- 411 -- 411
Exercise of common
stock options and
warrants............. -- -- 829,828 1 33 -- -- 34
Net loss.............. -- -- -- -- -- -- (9,119) (9,119)
--------- --- --------- --- ------- ------- -------- -------
Balance, December 31,
1998................... 6,712,658 6 1,362,744 1 16,261 (1,466) (13,921) 881
Deferred stock
compensation
(unaudited).......... -- -- -- -- 162 (162) -- --
Amortization of
deferred stock-based
compensation
(unaudited).......... -- -- -- -- -- 512 -- 512
Issuance of stock
warrants
(unaudited).......... -- -- -- -- 195 -- -- 195
Exercise of common
stock options and
warrants
(unaudited).......... -- -- 116,568 -- 12 -- -- 12
Net loss (unaudited).. -- -- -- -- -- -- (6,661) (6,661)
--------- --- --------- --- ------- ------- -------- -------
Balance, June 30, 1999
(unaudited)............ 6,712,658 $ 6 1,479,312 $ 1 $16,630 $(1,116) $(20,582) $(5,061)
========= === ========= === ======= ======= ======== =======
</TABLE>
See accompanying notes.
F-5
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Period from
February 14, 1996 Year Ended Six Months
(date of inception) December 31, Ended June 30,
to December 31, ---------------- ----------------
1996 1997 1998 1998 1999
------------------- ------- ------- ------- -------
(unaudited)
<S> <C> <C> <C> <C> <C>
Operating activities
Net loss................ $(468) $(4,334) $(9,119) $(3,259) $(6,661)
Adjustments to reconcile
net loss to net cash
used in operating
activities:
Depreciation and
amortization......... 23 207 235 94 266
Stock and warrant
issued in exchange
for services......... -- -- 1,098 595 --
Amortization of
deferred stock-based
compensation......... -- -- 411 20 512
Non-cash interest
expense.............. -- -- -- -- 168
Changes in operating
assets and
liabilities:
(Increase) in trade
accounts
receivable......... (167) (1,429) (1,895) (1,541) (130)
(Increase) in
inventories........ -- (214) (1,938) (47) (197)
(Increase) decrease
in prepaid expenses
and other.......... (52) (113) (288) (586) (708)
(Increase) decrease
in deposits,
intangibles and
other assets....... (41) (273) 269 (55) 31
Increase in accounts
payable and accrued
expenses........... 240 868 2,093 1,113 1,896
Increase (decrease)
in deferred
revenue............ 334 (22) 1,528 550 1,003
----- ------- ------- ------- -------
Net cash used in
operating activities... (131) (5,310) (7,606) (3,116) (3,820)
Investing activities
Purchase of equipment
and furniture.......... (77) (391) (1,003) (534) (823)
Purchase of intangible
assets................. (10) (70) -- -- --
----- ------- ------- ------- -------
Net cash used in
investing activities... (87) (461) (1,003) (534) (823)
Financing activities
Borrowings on line of
credit and long-term
debt................... 300 700 2,663 1,481 6,405
Issuance of warrants.... -- -- -- -- 195
Principal repayments on
line of credit......... -- (500) (54) (15) (1,467)
Repayment of note
payable................ -- (40) -- -- --
Proceeds from sale of
preferred stock........ 150 5,979 7,075 7,100 --
Proceeds from exercise
of common stock options
and warrants........... -- 3 34 8 12
----- ------- ------- ------- -------
Net cash provided by
financing activities... 450 6,142 9,718 8,574 5,145
----- ------- ------- ------- -------
Net increase (decrease)
in cash and cash
equivalents............ 232 371 1,109 4,924 502
Cash and cash
equivalents at
beginning of period.... -- 232 603 603 1,712
----- ------- ------- ------- -------
Cash and cash
equivalents at end of
period................. $ 232 $ 603 $ 1,712 $ 5,527 $ 2,214
===== ======= ======= ======= =======
Supplementary disclosure
of cash flow
information:
Cash paid for
interest............. $ 6 $ 21 $ 179 $ -- $ 301
===== ======= ======= ======= =======
Supplemental schedule of
noncash investing and
financing activities:
Issuance of note
payable for purchase
of intangible
assets............... $ 40 $ -- $ -- $ -- $ --
===== ======= ======= ======= =======
Issuance of common
stock for purchase of
intangible assets.... $ -- $ 52 $ -- $ -- $ --
===== ======= ======= ======= =======
</TABLE>
See accompanying notes.
F-6
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS
1. Accounting Policies
Description of Business
WatchGuard Technologies, Inc. is in the business of developing and marketing
Internet security solutions which incorporate a security appliance, security
and management software and an Internet-based broadcast service designed to
keep its products current. WatchGuard was incorporated in the state of
Washington on February 14, 1996 and maintains its headquarters in Seattle,
Washington. In May 1997, WatchGuard reincorporated in the state of Delaware. In
conjunction with the reincorporation, WatchGuard changed its name from Seattle
Software Labs, Inc. to WatchGuard Technologies, Inc. in August 1997.
Basis of Presentation and Liquidity
The accompanying financial statements have been prepared on a going-concern
basis. This basis of accounting contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business operations.
WatchGuard recorded losses of $9.1 million and used $7.6 million to fund
operations during the year ended December 31, 1998. At December 31, 1998,
WatchGuard had cash and cash equivalents of $1.7 million, a working capital
deficit of $274,000 and an accumulated deficit of $13.9 million.
WatchGuard has financed its operations to date through the issuance of equity
securities and debt financing. Further development and establishment of
WatchGuard's business will require additional equity or debt financing.
WatchGuard believes that equity or debt financing can be obtained from existing
or new sources. WatchGuard's current investors have indicated that they will
provide sufficient financing in order for WatchGuard to continue to operate
through 1999.
Revenue Recognition
Statement of Position 97-2, "Software Revenue Recognition" (SOP 97-2), was
issued in October 1997 by the American Institute of Certified Public
Accountants (AICPA) and was amended by Statement of Position 98-4 (SOP 98-4).
In December 1998, the AICPA issued SOP 98-9, which amends SOP 97-2 and 98-4 and
is effective for transactions entered into after March 15, 1999. WatchGuard
adopted SOP 97-2, as amended by SOP 98-9, effective January 1, 1998. Based upon
its interpretation of SOP 97-2 and SOP 98-9, WatchGuard believes its current
revenue recognition policies and practices are consistent with the SOPs.
However, full implementation guidelines for this standard have not yet been
issued. Once available, implementation guidance could lead to unanticipated
changes in current revenue accounting practices, and these changes could
materially adversely affect the timing of WatchGuard's future revenues and
earnings.
WatchGuard generates revenues through sales of its Firebox products,
including related software licenses, and subscriptions for its LiveSecurity
broadcast service, which includes threat responses, information alerts,
software updates and maintenance. Software license revenues are generated from
licensing the rights to use WatchGuard's products directly to end-users, from
sublicense fees from resellers, distributors and, beginning in late 1998, from
sales of its products to Internet service providers (ISPs), which utilize the
product to provide managed security services to the ISPs' customers. Revenues
from LiveSecurity subscriptions are recognized ratably over the term of the
contract, typically one year.
Revenues from software license agreements are generally recognized upon
delivery of software if persuasive evidence of an arrangement exists,
collection is probable and the fee is fixed or
F-7
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
determinable, and vender-specific objective evidence exists to allocate the
total fee to elements of the arrangement. Payment terms do not extend beyond a
year. A limited number of WatchGuard's distributors have the right to delay
payment until the product is sold to the end-user. Revenues from these
arrangements is not recognized until sale to the end-user occurs. WatchGuard
provides unspecified upgrades on a when and if available basis. These upgrades
are considered post-contract customer support (PCS) and are recognized as
revenues ratably over the terms of the PCS arrangement. Vendor-specific
objective evidence is typically based on the price charged when an element is
sold separately or, in the case of an element not sold separately, on the price
established by authorized management, if it is probable that the price, once
established, will not change before market introduction. WatchGuard uses the
residual method, as defined in SOP 98-9, to allocate revenue to delivered
elements once it has established vendor-specific objective evidence for all
undelivered elements. Under the residual method, any discount in the
arrangement is allocated to the delivered element. WatchGuard provides for
return rights and pricing protection rights for some of its customers. The
return rights included in these customer agreements are generally limited to a
percentage of purchases by these customers for the previous quarter. The
pricing protection rights in these agreements are generally limited to 60 to 90
days after notification of a price change. Revenues are reduced by the
provision for estimated returns and allowance at the time the sale is made. The
reserves are reviewed and revised as needed.
Fair Values of Financial Instruments
At December 31, 1998, WatchGuard had the following financial instruments:
cash and cash equivalents, accounts receivable, accounts payable, accrued
liabilities, capital lease obligations and long-term debt. The carrying value
of cash and cash equivalents, accounts receivable, accounts payable and accrued
liabilities approximates their fair value based on the liquidity of these
financial instruments or based on their short-term nature. The carrying value
of long-term debt approximates fair value based on the market interest rates
available to WatchGuard for debt of similar risk and maturities.
Cash Equivalents
WatchGuard considers all highly liquid investments purchased with an initial
maturity of three months or less to be cash equivalents. Cash equivalents are
carried at fair market value.
Deferred Public Offering Costs
Included in prepaid expenses at June 30, 1999 are costs capitalized in
connection with the planned initial public offering. Upon closing, these costs
will be offset against the proceeds of this offering.
Inventories
Inventories are stated at the lower of cost (first-in, first-out basis) or
market. WatchGuard outsources all of its hardware manufacturing and assembly to
one manufacturer and one assembler. The inability of the manufacturer and
assembler to supply product in a timely manner and on terms acceptable to
WatchGuard could severely affect WatchGuard's ability to meet customers'
demands.
Equipment and Furniture
Equipment and furniture is stated at cost, less accumulated depreciation.
Equipment and furniture is depreciated using the straight-line method over
estimated useful lives ranging from three to five years.
F-8
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
Research and Development
Research and development costs are expensed as incurred and consist primarily
of software development costs. Financial accounting standards require the
capitalization of certain software development costs after technological
feasibility of the software is established. In the development of WatchGuard's
new products and enhancements to existing products, the technological
feasibility of the software is not established until substantially all product
development is complete, including the development of a working model. Internal
software development costs that were eligible for capitalization were
insignificant and were charged to research and development expense in the
accompanying statements of operations.
Net Loss per Share
Basic and diluted net loss per share is calculated using the average number
of shares of common stock outstanding. Other common stock equivalents,
including preferred stock, stock options and warrants, are excluded from the
computation as their effect is antidilutive. See Note 6.
Upon the completion of WatchGuard's proposed initial public offering, all
convertible preferred stock will automatically convert into common stock.
Accordingly, pro forma net loss per share is computed using the weighted
average number of shares of common stock outstanding and the weighted average
convertible preferred stock outstanding as if these shares were converted to
common stock at the time of issuance.
Advertising Costs
WatchGuard expenses advertising costs as incurred. Total expenses were $900,
$199,500, and $60,000 in 1996, 1997, and 1998, respectively.
Concentration of Credit Risk
WatchGuard is subject to concentrations of credit risk primarily from cash
investments. WatchGuard's credit risk is managed by investing its excess cash
in high-quality money market instruments. In addition, substantially all of
WatchGuard's accounts receivable are due from WatchGuard's resellers,
distributors and ISPs located throughout the world. International sales were
$46,000, $2.8 million and $4.0 million for 1996, 1997 and 1998, respectively.
No single customer, foreign country, or geographic area accounted for more than
10% of revenues in the periods presented. WatchGuard does not believe there are
any significant concentrations of credit risk as of December 31, 1998.
Stock Compensation
WatchGuard has elected to apply the disclosure-only provisions of Statement
of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (SFAS 123). Accordingly, WatchGuard accounts for stock-based
compensation using the intrinsic value method prescribed in Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees,"
and related interpretations. Compensation cost for stock options is measured as
the excess, if any, of the fair value of WatchGuard's common stock at the date
of grant over the stock option exercise price.
F-9
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
Income Taxes
WatchGuard recognizes deferred tax assets and liabilities based on
differences between the financial reporting and tax bases of assets and
liabilities using the enacted tax rates and laws that are expected to be in
effect when the differences are expected to be recovered. WatchGuard provides a
valuation allowance for deferred tax assets that cannot be currently recognized
due to WatchGuard's losses and the uncertainty of future profitability.
Reclassifications
Certain prior-year items have been reclassified to conform to the current-
year presentation.
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 reported in the financial statements and accompanying
notes. Actual results could differ from those estimates.
Unaudited Interim Financial Information
The financial information as of June 30, 1999 and for the six months ended
June 30, 1998 and 1999 is unaudited, but includes all adjustments, consisting
only of normal recurring adjustments, that WatchGuard considers necessary for a
fair presentation of the financial position at those dates and of the
operations and cash flows for the periods then ended. Operating results for the
six months ended June 30, 1999 are not necessarily indicative of results that
may be expected for the entire year.
New Accounting Pronouncements
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income,"
which establishes standards for reporting and display of comprehensive income
and its components (revenues, expenses, gains and losses) in a full set of
general-purpose financial statements. This statement requires that all items
that are required to be recognized under accounting standards as components of
comprehensive income be reported in a financial statement that is displayed
with the same prominence as other financial statements. This statement, adopted
by WatchGuard on January 1, 1998, does not affect results of operations or
financial position, as WatchGuard had no items that would have been classified
as other comprehensive income.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivatives and
Hedging Activities," which establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts (collectively referred to as derivatives), and for hedging
activities. Because WatchGuard has never used nor currently intends to use
derivatives, management does not anticipate that the adoption of this new
standard will have a significant effect on earnings or the financial position
of WatchGuard.
F-10
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
2. Balance Sheet Account Detail
Trade Accounts Receivable
Trade accounts receivable consisted of the following:
<TABLE>
<CAPTION>
December 31,
-------------- June 30,
1997 1998 1999
------ ------ -----------
(unaudited)
(In thousands)
<S> <C> <C> <C>
Trade accounts receivable........................ $1,720 $4,555 $4,494
Reserve for returns.............................. -- (615) (525)
Allowance for uncollectible accounts............. (124) (449) (348)
------ ------ ------
$1,596 $3,491 $3,621
====== ====== ======
Inventories
Inventories consisted of the following:
<CAPTION>
December 31,
-------------- June 30,
1997 1998 1999
------ ------ -----------
(unaudited)
(In thousands)
<S> <C> <C> <C>
Finished goods................................... $ 218 $1,203 $1,204
Components....................................... -- 953 1,149
------ ------ ------
$ 218 $2,156 $2,353
====== ====== ======
Prepaid Expenses and Other
Prepaid expenses and other consisted of the following:
<CAPTION>
December 31,
-------------- June 30,
1997 1998 1999
------ ------ -----------
(unaudited)
(In thousands)
<S> <C> <C> <C>
Prepaid expenses................................. $ 162 $ 450 $ 388
Deferred public offering costs................... -- -- 798
------ ------ ------
$ 162 $ 450 $1,186
====== ====== ======
Equipment and Furniture
Equipment and furniture consisted of the following:
<CAPTION>
December 31,
-------------- June 30,
1997 1998 1999
------ ------ -----------
(unaudited)
(In thousands)
<S> <C> <C> <C>
Computer equipment............................... $ 361 $ 831 $1,311
Furniture and fixtures........................... 57 337 485
Software......................................... 50 302 497
------ ------ ------
468 1,470 2,293
Less accumulated depreciation.................... 96 330 (596)
------ ------ ------
$ 372 $1,140 $1,697
====== ====== ======
</TABLE>
3. Acquisition of Intangibles
In March 1996, WatchGuard acquired certain technology (source code for its
software products) from Mazama Software Labs, Inc. (Mazama) for $50,000.
Additionally, WatchGuard was required for a three-year period to make royalty
payments on the sale of products that utilized the Mazama technology, with the
total royalty payments not to exceed $4 million. In June 1997, WatchGuard and
Mazama agreed to a buy-out of the royalty payments due Mazama, with WatchGuard
paying $70,000
F-11
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
in cash and issuing 400,000 shares of its common stock valued at $52,000, the
deemed fair value at that date, which was based on the board of directors' best
estimate of fair value. This amount is included in other assets, net of
accumulated amortization of $157,600 at December 31, 1998, and is being
amortized over its useful life of three years.
4. Debt
At December 31, 1998, WatchGuard had borrowings outstanding under a) a $2.5
million working capital revolving line of credit (increased to $4.5 million
available on January 7, 1999); b) a $177,000 equipment term loan; and c) a
$432,000 equipment term loan. All three facilities are from a commercial bank.
The revolving line of credit is for operating needs and expires on September
30, 1999. Principal and interest are due at maturity. Borrowings under the line
of credit bear interest at the bank's prime interest rate plus 1.0% (8.75% at
December 31, 1998). The borrowing base for the line is to be monitored on a
monthly basis and is to consist of the sum of up to 75% of eligible domestic
and 50% of eligible foreign accounts receivable. There was $2.5 million
outstanding on this line at December 31, 1998 and no additional amount
available.
The $177,000 term loan bears interest at the bank's prime interest rate plus
1.5% (9.25% at December 31, 1998) and matures in March 2001. The $432,000 term
loan bears interest at the bank's prime interest rate plus 1% (8.75% at
December 31, 1998) and matures in December 2001. The term loans require monthly
principal and interest payments of $6,327 and $11,995, respectively, and are
collateralized by equipment.
At December 31, 1998, WatchGuard was not in compliance with certain covenants
related to the line of credit and term loans, but has obtained a waiver for
noncompliance at December 31, 1998. In addition, the bank has deleted these
covenants through the earlier of July 31, 1999, as amended (see Note 11) or the
completion of an initial public offering of WatchGuard's stock. WatchGuard has
classified the outstanding balance of long-term debt as current on the
accompanying balance sheets.
The contractual maturities of the term loans are as follows:
<TABLE>
<S> <C>
1999................................................................ $216
2000................................................................ 220
2001................................................................ 173
----
$609
====
</TABLE>
Convertible Note Financing and Warrants
In March 1999, WatchGuard entered into convertible note agreements with its
existing investors for an aggregate of $3,000,000. The notes bear interest at
6% and are due on demand after March 2000. The notes will automatically be due
upon an initial public offering or converted into Series D preferred stock (new
series) if a subsequent private equity financing is completed before the
initial public offering, on the same terms and conditions offered to the other
investors in the private financing. WatchGuard also issued warrants to purchase
42,856 shares of common stock (21,428 to each group of funds), at an exercise
price of $7.00 per share, which are exercisable immediately. These warrants, if
not exercised before the closing of an initial public offering, will
automatically convert into common stock on a net exercise basis upon completion
of the initial public offering. The warrants were assigned a fair value of
$155,139 based upon the Black Scholes pricing model, based upon a fair value of
the underlying stock of $8.00 per share, a risk-free interest rate of 6%, a
F-12
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
dividend yield rate of 0%, volatility of .6 and an expected life of one year.
WatchGuard is amortizing the resulting discount on the notes over the expected
term of the notes.
5. Shareholders' Equity
Reincorporation
WatchGuard was incorporated as Seattle Software Labs, Inc. in the state of
Washington in February 1996. In March 1996, WatchGuard sold 1,000,000 shares of
Series A preferred stock to its two cofounders for $0.05 per share, resulting
in aggregate proceeds of $50,000. In July 1996, WatchGuard sold 350,878 shares
of what was originally characterized as Series B preferred stock to the
cofounders for $0.29 per share, resulting in aggregate proceeds of $100,000. In
connection with the restatement of its Articles of Incorporation in March 1997,
WatchGuard reclassified the preferred shares originally characterized as Series
B preferred stock into 2,000,004 Series A preferred shares. The financial
statements have been restated to reflect this recapitalization.
Preferred Stock
In May 1997, WatchGuard completed a Series B preferred stock offering by
selling 2,316,666 shares at $2.59 per share, aggregating gross proceeds of $6.0
million. In March 1998, WatchGuard issued an additional 38,610 shares of Series
B preferred stock at $2.59 per share, aggregating gross proceeds of $100,000.
In April 1998, WatchGuard completed a Series C preferred stock offering by
selling 1,357,378 shares at $5.16 per share, aggregating gross proceeds of
approximately $7.0 million.
Holders of Series A, B, and C preferred stock have preferential rights to
dividends when and if declared by the board of directors. Series A, B and C
preferred stockholders have the right to one vote for each share of common
stock into which these Series A, B, and C preferred stock could then be
converted and, with respect to that vote, have full voting rights and powers
equal to those of the holders of common stock.
In the event of liquidation, the holders of Series A, B, and C preferred
stock have preferential rights to liquidation payments of $0.05, $2.59, and
$5.16 per share, respectively, plus any declared, but unpaid, dividends. Series
A, B, and C preferred stock is convertible into common stock at a price per
share of $0.05, $2.59, and $5.16, respectively, at the option of the holder, or
automatically upon the vote or written consent of a majority of the preferred
stockholders in the case of Series A or Series B, or 75% in the case of Series
C, or upon the closing of an initial public offering of WatchGuard's common
stock from which the aggregate proceeds are not less than $15 million and a
price per share is paid by the public of at least $10.31. Currently, each share
of Series A, B, and C preferred stock will convert into two shares of common
stock.
The following is a summary of terms and conditions for each series of
preferred stock as of December 31, 1998:
<TABLE>
<CAPTION>
Annual
Approximate Dividend
Aggregate Rate --
Shares Shares Stated Liquidation Non-
Designated Outstanding Value Value Cumulative
---------- ----------- ------ ----------- ----------
<S> <C> <C> <C> <C> <C>
Series A................ 3,000,004 3,000,004 $0.05 $ 150,000 $0.01
Series B................ 2,374,581 2,355,276 2.59 6,100,000 0.16
Series C................ 1,357,378 1,357,378 5.16 7,000,000 0.31
</TABLE>
F-13
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
Stock Options
In 1996, WatchGuard adopted the 1996 Stock Incentive Compensation Plan (the
Plan), which provides for the granting of incentive and nonqualified stock
options to employees, officers, directors, agents, consultants and independent
contractors. As of December 31, 1998, WatchGuard had authorized 7,734,986
shares of common stock for possible grants under the Plan. Options under the
Plan generally are granted at fair market value on the date of grant. Of the
shares of common stock covered by the options, 25% become vested on the first
anniversary of the date of grant, with the remaining shares covered by the
option vesting at 2.08% every month thereafter, and with all shares becoming
fully vested on the fourth anniversary date of the date of grant. Stock options
under the Plan have a term of ten years unless modified by the plan
administrator.
The following table summarizes WatchGuard's stock option activity:
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1997 December 31, 1998 June 30, 1999
------------------ ------------------- ------------------- -------------------
Weighted Weighted Weighted Weighted
Average Average Average Average
Exercise Exercise Exercise Exercise
Options Price Options Price Options Price Options Price
--------- -------- --------- -------- --------- -------- --------- --------
(unaudited)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at beginning of
period................. -- $ -- 1,156,994 $0.03 5,227,580 $0.08 5,145,268 $0.16
Granted................. 1,156,994 0.03 4,970,526 0.08 1,212,500 0.44 1,189,064 7.00
Exercised............... -- -- (12,916) 0.03 (819,828) 0.04 (116,568) 0.10
Canceled................ -- -- (887,024) 0.04 (474,984) 0.09 (48,334) 2.38
--------- --------- --------- ---------
Balance at end of
period................. 1,156,994 0.03 5,227,580 0.08 5,145,268 0.16 6,169,430 1.46
========= ========= ========= =========
Exercisable at end of
period................. -- 428,300 1,618,038 2,211,184
Weighted average fair
value of options
granted during period
Granted at fair
value................ 1,156,994 0.01 4,970,526 0.02 308,000 0.01 1,027,064 7.00
Granted at below fair
value................ -- -- -- -- 904,500 2.08 162,000 7.00
</TABLE>
At December 31, 1998, 1,756,974 shares of common stock were available for
future grant under the Plan.
Included in the options for 1,189,064 shares granted during the six months
ended June 30, 1999 are options for 1,027,064 shares with an exercise price
equal to the greater of $7.00 per share or the initial public offering price.
If the initial public offering occurs after September 30, 1999, the exercise
price of these options will be $7.00 per share.
The weighted average remaining contractual life and weighted average exercise
price of options outstanding and options exercisable at December 31, 1998 for
selected exercise price ranges is as follows:
<TABLE>
<CAPTION>
Options
Options Outstanding Exercisable
---------------------------------- ------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Contractual Exercise Exercise
Exercise Prices Shares Life (in years) Price Shares Price
- --------------- --------- --------------- -------- --------- --------
<S> <C> <C> <C> <C> <C>
$0.03-0.14................ 4,501,392 8.08 $0.09 1,582,370 $0.08
$0.39-0.55................ 516,876 9.54 0.54 33,481 0.55
$1.13-2.25................ 127,000 9.74 1.29 2,187 1.13
--------- ---------
5,145,268 8.27 $0.16 1,618,038 $0.09
========= =========
</TABLE>
F-14
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
WatchGuard uses the intrinsic value-based method to account for all its
employee stock-based compensation arrangements. Accordingly, no compensation
cost has been recognized for its stock options in the accompanying financial
statements because the fair value of the underlying common stock equals or
exceeds the exercise price of the stock options at the date of grant, except
with respect to certain options granted during the year ended December 31,
1998. WatchGuard has recorded deferred stock compensation expense of
$1.9 million relating to options granted during the year ended December 31,
1998. This amount represents the difference between the exercise price and the
deemed fair value for financial reporting purposes of WatchGuard's common stock
during the periods in which the options were granted. Amortization of deferred
stock compensation of $411,000 was recognized during the year ended December
31, 1998.
The following pro forma information regarding stock-based compensation has
been determined as if WatchGuard had accounted for its employee stock options
under the fair market value method of SFAS 123. The fair value of these options
was estimated at the date of grant using a minimum value option pricing model
with the following weighted average assumptions: risk-free interest rates range
from 6.0% to 5.0% in 1996, 1997, and 1998; a dividend yield rate of 0% for all
periods; and an expected life of five years.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting periods. WatchGuard's
pro forma information is as follows:
<TABLE>
<CAPTION>
Year Ended December
31,
-----------------------
1996 1997 1998
----- ------- -------
(In thousands)
<S> <C> <C> <C>
Net loss -- as reported............................ $(468) $(4,334) $(9,119)
Net loss -- pro forma.............................. (470) (4,368) (9,182)
Net loss per share -- as reported.................. N/A (17.17) (11.34)
Net loss per share -- pro forma.................... N/A (17.30) (11.42)
</TABLE>
Under SFAS 123, compensation expense representing the fair value of the
option grant is recognized over the vesting period. The initial impact on pro
forma net loss may not be representative of compensation expense in future
years, when the effect of amortization of multiple awards would be reflected in
pro forma earnings.
In December 1997 WatchGuard granted approximately 48,000 options with
exercise prices ranging from $0.05 to $0.26 to a consultant in connection with
a one-year consulting agreement. The options vested at the December 1998
termination date of the consulting agreement. WatchGuard has recorded
compensation expense of approximately $628,000 based on the fair value of the
options at the termination of the consulting agreement.
Common Stock Warrants
During 1996, WatchGuard issued warrants for 145,000 shares of common stock at
an exercise price of $0.03 per share to various consultants and vendors for
technical and marketing services, including public relations and technical
writing. The warrants expire five years from date of issuance, beginning in
July 2001. During 1997 and 1998, 100,000 and 10,000 shares, respectively, of
these warrants were exercised.
In January 1997, WatchGuard granted warrants for 20,000 shares at an exercise
price at $0.03 per share to an individual for recruiting services. In July
1997, the warrant was exercised for all 20,000 shares.
F-15
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
In March 1998, WatchGuard granted a warrant to purchase 10,000 shares of
common stock at an exercise price of $0.13 per share to a bank in connection
with a debt financing.
WatchGuard performed an analysis to value all warrants using the Black
Scholes pricing model based upon the exercise prices described above, a risk-
free interest rate of 6%, a dividend yield rate of 0%, volatility of .6 and an
expected life of one year. The fair value associated with these warrants was
immaterial.
In June 1998, WatchGuard entered into a two-year license and sales agreement
with a customer, under which the customer has committed to minimum purchase
quantities. This agreement may be terminated by either party for
nonperformance. The only recourse for nonperformance is the return of all
product and promotional material. Because of the promotional value of this
customer, WatchGuard granted it a warrant to purchase 200,000 shares of common
stock at an exercise price of $0.39 per share. The warrant is fully vested,
nonforfeitable and fully exercisable at the date of grant. The fair value of
the warrant, approximately $470,000, was recorded as sales and marketing
expense.
Common Shares Reserved
At December 31, 1998 common stock reserved for future issuance was as
follows:
<TABLE>
<S> <C>
Conversion of preferred stock................................. 13,425,316
Exercise of common stock options.............................. 6,902,242
Exercise of common stock warrants............................. 245,000
----------
20,572,558
==========
</TABLE>
6. Net Loss per Share
Basic and diluted net loss per common share is calculated by dividing net
loss by the weighted average number of common shares outstanding. Pro forma net
loss per share is computed using the weighted average number of shares used for
basic and diluted per share amounts and the weighted average convertible
redeemable preferred stock outstanding as if such shares were converted to
common stock at the time of issuance.
<TABLE>
<CAPTION>
Period from Years Ended Six Months Ended
February 14, 1996 December 31, June 30,
(date of inception) ---------------- ------------------
to December 31, 1996 1997 1998 1998 1999
-------------------- ------- ------- -------- --------
(unaudited)
(In thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Net loss................ $(468) $(4,334) $(9,119) $ (3,258) $ (6,661)
===== ======= ======= ======== ========
Basic and diluted net
loss per common share.. N/A $(17.17) $(11.34) $ (4.70) $ (4.65)
===== ======= ======= ======== ========
Weighted average number
of common shares used
for basic and diluted
per share amounts...... N/A 252 804 693 1,433
===== ======= ======= ======== ========
Weighted average common
shares issuable upon
pro forma conversion of
preferred stock........ 12,570 13,425
------- --------
Weighted average number
of shares used for pro
forma per share amounts
(unaudited)............ 13,366 14,858
======= ========
Pro forma basic and
diluted net loss per
share (unaudited)...... $ (0.68) $ (0.45)
======= ========
</TABLE>
F-16
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
Options to purchase 5,145,268 shares of common stock and warrants to purchase
245,000 shares of common stock were excluded from the computation of actual and
pro forma diluted net loss per common share, as their effect is antidilutive.
7. Income Taxes
At December 31, 1998, WatchGuard had a net operating loss carryforward for
federal tax purposes of approximately $9,875,000. The carryforwards begin to
expire in 2011. Utilization of net operating loss carryforwards may be subject
to certain limitations under Section 382 of the Internal Revenue Code. A
valuation allowance has been established to reflect the uncertainty of future
taxable income to utilize available tax loss carryforwards.
Deferred income taxes reflect the net tax effect 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 WatchGuard's deferred tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
December 31,
----------------
1997 1998
------- -------
(In thousands)
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards......................... $ 1,423 $ 3,358
Research and development tax credit...................... 92 218
Returns reserve.......................................... -- 215
Allowance for bad debts.................................. 42 153
Accrued expenses......................................... 43 102
------- -------
Total deferred tax assets.................................. 1,600 4,046
Valuation allowance........................................ (1,600) (4,046)
------- -------
Net deferred taxes......................................... $ -- $ --
======= =======
</TABLE>
WatchGuard's valuation allowance increased $159,000, $1,441,000, and
$2,446,000 for 1996, 1997, and 1998, respectively.
8. Retirement 401(k) Plan
WatchGuard sponsors a 401(k) plan that is available to all employees who
satisfy certain eligibility requirements relating to minimum age, length of
service and hours worked. Eligible employees may elect to contribute up to 15%
of their pre-tax gross earnings, subject to statutory limitations regarding
maximum contributions. WatchGuard may also make a discretionary contribution to
the plan. No such contributions have been made by WatchGuard.
F-17
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
9. Commitments
WatchGuard leases office space and equipment under noncancelable operating
leases. Future minimum payments at December 31, 1998 under these leases are as
follows (in thousands):
<TABLE>
<S> <C>
1999.............................................................. $ 489
2000.............................................................. 441
2001.............................................................. 155
2002.............................................................. 23
2003 and thereafter............................................... 14
------
$1,122
======
</TABLE>
Two of the officers of WatchGuard are guarantors of part of the office lease.
Rent expense for 1996, 1997 and 1998 was $67,000, $134,000 and $273,000,
respectively.
10. International Revenues
WatchGuard licenses and markets its Internet security products and services
throughout the world, and operates in a single industry segment. While certain
expenses for sales and marketing activities are incurred in various
geographical regions, substantially all of WatchGuard's assets are located, and
the majority of its operating expenses are incurred, at its corporate
headquarters. Revenue information by geographic region is the only segment
information presented as follows:
<TABLE>
<CAPTION>
Six Months
Year Ended December Ended June
31, 30,
------------------- -------------
1996 1997 1998 1998 1999
---- ------ ------- ------ ------
(unaudited)
(In thousands)
<S> <C> <C> <C> <C> <C>
United States.............................. $285 $2,262 $ 7,401 $2,945 $4,304
Rest of World
Europe................................... 42 1,140 2,049 856 2,153
Asia..................................... 2 1,209 1,106 698 1,449
Other.................................... 2 487 823 518 669
---- ------ ------- ------ ------
46 2,836 3,978 2,072 4,271
---- ------ ------- ------ ------
Total...................................... $331 $5,098 $11,379 $5,017 $8,575
==== ====== ======= ====== ======
</TABLE>
11. Subsequent Events
Initial Public Offering
On April 12, 1999, the board of directors authorized management to file a
registration statement with the Securities and Exchange Commission to permit
WatchGuard to offer its common stock to the public. If the offering is
consummated under terms presently anticipated, each outstanding share of
convertible preferred stock will convert into two shares of common stock.
Unaudited pro forma stockholders' equity reflects the assumed conversion of the
convertible preferred stock outstanding at June 30, 1999.
Stock Split
On May 26, 1999, the board of directors authorized a 2-for-1 stock split of
WatchGuard's common stock and approved an amendment to the certificate of
incorporation to increase the number of authorized common and preferred shares
to 80,000,000 and 10,000,000 shares, respectively. The
F-18
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
stock split was effected on July 8, 1999. The related common share, preferred
share and per share data in the accompanying financial statements have been
retroactively restated to reflect the stock split, including preferred share
data on an assumed converted to common stock basis.
Bridge Loan
In May and June 1999, WatchGuard amended its loan and security agreement with
its bank. The amendments primarily provide for a secured bridge loan facility
that immediately makes available to WatchGuard an additional $4.25 million, of
which $2.0 million is guaranteed by existing investors. The loan carries a
commitment fee of up to 2%, an interest rate of prime plus 2% and a maturity
date of the earlier of WatchGuard's initial public offering closing date or
August 26, 1999. WatchGuard granted the bank warrants to purchase up to
14,500 shares of common stock, of which 10,000 shares are currently
exercisable. The exercise price of these warrants is the greater of $7.00 per
share or the initial public offering price, unless the public offering closes
after July 31, 1999, in which case the exercise price will be $7.00,
In connection with the amendments, the bank has extended the waiver and
deletion of certain debt covenants, as described in Note 4 above, through the
earlier of August 26, 1999 or the closing of an initial public offering. Also,
in connection with the amendment, the $4.5 million line of credit, as discussed
in Note 4 above, was reduced to $3.5 million. The amount will be increased to
$4.5 million after the completion of an initial public offering.
Stock Option Grants
On April 12, 1999, R. Michael Peronto, WatchGuard's chief operating officer,
was granted an option to purchase 439,564 shares of common stock. If a change
of control of WatchGuard occurs, half of the unvested shares subject to this
option will vest and become exercisable. In addition, WatchGuard granted other
employees options to purchase 587,500 shares of common stock. If the initial
public offering occurs on or before September 30, 1999, the exercise price of
the option will be equal to the greater of $7.00 per share and the initial
public offering price. If the initial public offering occurs after September
30, 1999, the exercise price of the option will be $7.00 per share.
1999 Employee Stock Purchase Plan
In May 1999, the board of directors and stockholders approved the 1999
Employee Stock Purchase Plan (the ESPP). WatchGuard will implement the ESPP
upon the effectiveness of the initial public offering. The ESPP, subject to
certain limitations, permits eligible employees of WatchGuard to purchase
common stock through payroll deductions of up to 15% of their compensation.
WatchGuard authorized the issuance under the ESPP of a total of 600,000 shares
of common stock, plus an automatic annual increase, to be added on the first
day of the fiscal year beginning in 2000, equal to the lesser of (a) 400,000
shares, (b) 1.5% of the average common shares outstanding as used to calculate
fully diluted earnings per share as reported in WatchGuard's annual financial
statements for the preceding year, or (c) a lesser amount determined by the
board of directors.
Amended 1996 Stock Incentive Compensation Plan
In May 1999, the board of directors and stockholders approved amendments to
the Stock Incentive Compensation Plan (SICP). The amendment provides for the
expansion of the SICP by
F-19
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
900,000 shares, plus an automatic increase, to be added on the first day of the
fiscal year beginning in 2000, equal to the lesser of (a) 750,000 shares, (b)
3.0% of the average common shares outstanding as used to calculate fully
diluted earnings per share as reported in WatchGuard's annual financial
statements for the preceding year, or (c) a lesser amount determined by the
board of directors.
F-20
<PAGE>
[INSIDE BACK COVER ARTWORK DESCRIPTION]
Text: WatchGuard LiveSecurity
The Security Manager's View
Point-and-click management tools enable security managers to view
their security policies at a glance.
WATCHGUARD LIVESECURITY THREAT RESPONSE
After a newly discovered threat is identified, WatchGuard's security
experts transmit a software update to specifically addresses the new
threat.
WATCHGUARD LIVESECURITY SOFTWARE UPDATE
Ongoing functional enhancements that are systematically broadcast to
security managers enable them to keep their defenses current with
minimal effort.
WATCHGUARD LIVESECURITY INFORMATION ALERT
Timely notifications of breaking news and current issues in Internet
security keep security managers around the world informed about the
fast-changing Internet security landscape.
Watchguard LiveSecurity--dynamic security protection, timely Internet
broadcasts, and responsive security experts protecting small- to
medium-sized enterprises around the world that use the Internet for
e-business and communications.
Graphics: Screen shot showing WatchGuard and other software program icons on a
Windows desktop.
[WatchGuard logo]
<PAGE>
[OUTSIDE BACK COVER]
[WATCHGUARD'S LOGO]
Until , 1999, 25 days after the date of this prospectus, all dealers
that buy, sell or trade our common stock, whether or not participating in this
offering, may be required to deliver a prospectus. This requirement is in
addition to the dealers' obligation to deliver a prospectus when acting as
underwriters and with respect to their unsold allotments or subscriptions.
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution
The following table states the costs and expenses, other than the
underwriting discounts and commissions, payable by the registrant in connection
with the sale of the common stock being registered by this registration
statement. All amounts shown are estimates, except the Securities and Exchange
Commission registration fee, the NASD filing fee and the Nasdaq National Market
listing fee.
<TABLE>
<S> <C>
Securities and Exchange Commission registration fee............ $ 12,788
NASD filing fee................................................ 5,100
Nasdaq National Market listing fee............................. 95,000
Blue Sky fees and expenses..................................... 10,000
Printing and engraving expenses................................ 200,000
Legal fees and expenses........................................ 500,000
Accounting fees and expenses................................... 350,000
Transfer Agent and Registrar fees.............................. 10,000
Miscellaneous expenses......................................... 17,112
----------
Total...................................................... $1,200,000
==========
</TABLE>
Item 14. Indemnification of Directors and Officers
Section 145 of the Delaware General Corporation Law (the "DGCL") provides
that a corporation may indemnify directors and officers, as well as other
employees and individuals, against expenses (including attorneys' fees),
judgments, fines and amounts paid in settlement in connection with specified
actions, suits or proceedings, whether civil, criminal, administrative or
investigative (other than an action by or in the right of the corporation -- a
"derivative action"), if they acted in good faith and in a manner they
reasonably believed to be in or not opposed to the best interests of the
corporation, and, with respect to any criminal action or proceeding, had no
reasonable cause to believe their conduct was unlawful. A similar standard
applies in the case of derivative actions, except that indemnification extends
only to expenses (including attorneys' fees) incurred in connection with the
defense or settlement of those actions, and the statute requires court approval
before there can be any indemnification where the person seeking
indemnification has been found liable to the corporation. The statute provides
that other indemnification may also be granted by a corporation's charter,
bylaws, disinterested director vote, stockholder vote, agreement or otherwise.
Section 10 of the registrant's restated bylaws (Exhibit 3.2) requires
indemnification to the full extent permitted under Delaware law. Subject to any
restrictions imposed by Delaware law, the registrant's bylaws provide an
unconditional right to indemnification for all expense, liability and loss
(including attorneys' fees, judgment, fines, ERISA excise taxes or penalties
and amounts paid in settlement) actually and reasonably incurred or suffered by
any person in connection with any actual or threatened action, suit or
proceeding, whether civil, criminal, administrative or investigative
(including, to the extent permitted by law, any derivative action) by reason of
the fact that the person is or was serving as a director or officer of the
registrant or that, being or having been a director or officer of the
registrant, the person is or was serving at the registrant's request as a
director, officer, employee or agent of another corporation, partnership, joint
venture, trust or other enterprise, including service with respect to an
employee benefit plan. The bylaws also provide that the
II-1
<PAGE>
registrant may, by action of the registrant's board of directors, provide
indemnification to its employees and agents with the same scope and effect as
the above indemnification of directors and officers.
Section 102(b)(7) of the DGCL permits a corporation to provide in its
certificate of incorporation that a director of the corporation shall not be
personally liable to the corporation or its stockholders for monetary damages
for breach of fiduciary duty as a director, except for liability for (i) any
breach of the director's duty of loyalty to the corporation or its
stockholders, (ii) acts or omissions not in good faith or which involve
intentional misconduct or a knowing violation of law, (iii) payments of
unlawful dividends or unlawful stock repurchases or redemptions, or (iv) any
transaction from which the director derived an improper personal benefit.
Article 10 of the registrant's Restated Certificate of Incorporation (Exhibit
3.1) provides that to the full extent that the DGCL permits the limitation or
elimination of the liability of directors, the registrant's directors shall not
be liable to the registrant or its stockholders for monetary damages for breach
of fiduciary duty as a director. Any amendment to or repeal of Article 10 shall
not adversely affect any right or protection of the registrant's directors for
or with respect to any acts or omissions of the directors occurring before the
amendment or repeal.
The registrant intends to obtain and maintain directors' and officers'
liability insurance, under which the registrant's directors and officers may be
indemnified against liability they may incur for serving in their capacities as
directors and officers of the registrant.
Item 15. Recent Sales of Unregistered Securities
Since the registrant's inception in February 1996, the registrant has issued
and sold unregistered securities as follows. The numbers below reflect the 2-
for-1 split of the registrant's common stock reflected by this registration
statement.
1. On March 11, 1996, the registrant issued 1,000,000 shares of Series A
preferred stock to the registrant's two cofounders for a consideration of $0.05
per share, or an aggregate of $50,000. On July 18, 1996, the registrant issued
an additional 2,000,004 shares of Series A preferred stock to the registrant's
two cofounders, for a consideration of $0.05 per share, or an aggregate of
$100,000. In the aggregate, these 3,000,004 shares of Series A preferred stock
are convertible into 6,000,008 shares of common stock.
2. On May 9, 1997, May 29, 1997 and March 12, 1998, the registrant issued
2,355,276 shares of Series B preferred stock, which are convertible into
4,710,552 shares of common stock, to seven investors for a consideration of
$2.59 per share, or an aggregate of $6,100,165.
3. On June 11, 1997, under an Asset Purchase Agreement among the registrant,
Mazama Software Labs, Inc. and the shareholders of Mazama, the registrant
issued 400,000 shares of common stock, valued at $0.13 per share, or an
aggregate of $52,000, to Mazama as partial consideration for the registrant's
purchase of certain of Mazama's technology.
4. On July 24, 1996, September 24, 1996, September 25, 1996 and January 28,
1997, the registrant issued warrants for the purchase of an aggregate of
165,000 shares of common stock, with an exercise price of $0.025 per share, to
five consultants in exchange for services.
5. On March 23, 1998, the registrant issued a warrant for the purchase of
10,000 shares of common stock, with an exercise price of $0.13 per share, to a
bank in connection with a debt financing.
II-2
<PAGE>
6. On April 24, 1998, the registrant issued 1,357,378 shares of Series C
preferred stock, which are convertible into 2,714,756 shares of common stock,
to eight investors for a consideration of $5.157 per share, or an aggregate of
$6,999,998.
7. On June 17, 1998, the registrant issued a warrant for the purchase of
200,000 shares of common stock, with an exercise price of $0.39 per share, to a
customer because of that customer's promotional value.
8. From March 1, 1996 through June 30, 1999, the registrant granted stock
options to purchase 8,529,084 shares of common stock, with exercise prices
ranging from $0.03 to $7.00 per share, to employees under the registrant's 1996
Stock Option Plan. Of these options, options for 1,410,342 shares have been
canceled without being exercised, options for 949,312 shares have been
exercised and options for 6,169,430 shares remain outstanding.
9. On March 9, 1999, the registrant issued warrants for the purchase of an
aggregate of 42,856 shares of common stock, with an exercise price of $7.00 per
share, to two groups of affiliated investors in connection with a debt
financing.
10. On May 26, 1999, the registrant issued warrants for the purchase of up to
14,500 shares of common stock, with an exercise price per share of the greater
of $7.00 or the initial public offering price, to a bank in connection with a
debt financing. If the initial public offering closes after July 31, 1999, the
exercise price will be $7.00 per share.
The sales and issuances of securities described in paragraphs 1, 2, 3, 5, 6,
7 and 9 above were exempt from Securities Act registration under Section 4(2)
of the Securities Act, on the basis that the transactions did not involve a
public offering.
The sales and issuances of securities described in paragraphs 4 and 8 above
were exempt from Securities Act registration under Rule 701 under the
Securities Act, on the basis that these options were offered and sold either in
accordance with a written compensatory benefit plan or in accordance with
written contracts relating to compensation.
No underwriters were used in connection with these sales and issuances.
Item 16. Exhibits and Financial Statement Schedules
(a) Exhibits
<TABLE>
<CAPTION>
Number Description
------ -----------
<C> <S>
1.1* Form of Underwriting Agreement.
3.1 Restated Certificate of Incorporation of the registrant.
3.2+ Restated Bylaws of the registrant.
5.1 Opinion of Perkins Coie LLP as to the legality of the shares.
10.1+ Lease Agreement, dated as of March 15, 1996, between COM Realty, Inc.
and the registrant.
10.2+ Lease Agreement, dated as of October 10, 1997, between Burke-State
Bldg. LLC and the registrant.
10.3+ Lease Agreement, dated as of August 17, 1998, between Cederstrand
Rentals and the registrant.
10.4+ Amended and Restated Loan and Security Agreement, dated as of March 20,
1998, between Silicon Valley Bank and the registrant.
10.5+ Loan Modification Agreement, dated as of September 18, 1998, between
Silicon Valley Bank and the registrant.
</TABLE>
II-3
<PAGE>
<TABLE>
<CAPTION>
Number Description
------ -----------
<C> <S>
10.6+ 1996 Stock Incentive Compensation Plan.
10.7+ Standardized Adoption Agreement Prototype Cash or Deferred Profit-
Sharing Plan and Trust (401(k) plan), effective as of September 1,
1998.
10.8+++ Development and Supply Agreement, dated as of March 25, 1998, between
SMART Modular Technologies, Inc. and the registrant.
10.9+++ OEM Master License Agreement, dated as of August 14, 1997, between RSA
Data Security, Inc. and the registrant.
10.10+ 1999 Employee Stock Purchase Plan.
10.11+ Loan Modification Agreement, dated May 26, 1999, between Silicon
Valley Bank and the registrant.
10.12 Loan Modification Agreement, dated June 29, 1999, between Silicon
Valley Bank and the registrant.
23.1 Consent of Ernst & Young LLP, Independent Auditors.
23.2 Consent of Perkins Coie LLP (contained in the opinion filed as Exhibit
5.1).
24.1+ Power of Attorney (contained on signature page).
27.1+ Financial Data Schedule.
27.2+ Financial Data Schedule.
27.3 Financial Data Schedule.
99.1 Report of Ernst & Young LLP, Independent Auditors Report on Financial
Statement Schedule.
</TABLE>
- --------
* To be filed by amendment.
++Confidential treatment has been requested for portions of this exhibit. The
omitted material has been separately filed with the Securities and Exchange
Commission.
+ Previously filed.
(b)Financial Statement Schedules
Schedule II--Valuation and Qualifying Accounts
All financial statement schedules not listed are omitted because they are
inapplicable or the requested information is shown in the financial statements
of the registrant or in the related notes to the financial statements.
Item 17. Undertakings
Insofar as indemnification for liabilities arising under the Securities Act
of 1993 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act, and is
therefore unenforceable. If a claim for indemnification against such
liabilities (other than the payment by the registrant of expenses incurred or
paid by a director, officer or controlling person of the registrant in the
successful defense of any action, suit or proceeding) is asserted against such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the
matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question of whether such indemnification by it is
against public policy as expressed in the Securities Act, and will be governed
by the final adjudication of such issue.
The undersigned registrant hereby undertakes to provide to the underwriters
at the closing specified in the Underwriting Agreement, certificates in such
denominations and registered in such names as required by the underwriters to
permit prompt delivery to each purchaser.
II-4
<PAGE>
The undersigned registrant hereby undertakes that
(1) for purposes of determining any liability under the Securities Act of
1933, the information omitted from the form of prospectus filed as part
of this registration statement in reliance upon Rule 430A and contained
in a form of prospectus filed by the registrant pursuant to Rule
424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to
be part of this registration statement as of the time it was declared
effective; and
(2) for the purpose of determining any liability under the Securities Act
of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating
to the securities offered therein, and the offering of such securities
at that time shall be deemed to be the initial bona fide offering
thereof.
II-5
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
registrant has duly caused this Amendment No. 3 to Registration Statement to be
signed on its behalf by the undersigned, thereunto duly authorized, in the City
of Seattle, State of Washington, on the 9th day of July, 1999.
WATCHGUARD TECHNOLOGIES, INC.
/s/ Christopher G. Slatt
By: _________________________________
Christopher G. Slatt, President
and Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, as amended, this
Amendment No. 3 to Registration Statement has been signed by the following
persons in the capacities indicated below on the 9th day of July, 1999.
<TABLE>
<C> <S>
/s/ Christopher G. Slatt President, Chief Executive Officer and
________________________________________ Chairman of the Board (Principal Executive
Christopher G. Slatt Officer)
/s/ Steven N. Moore Executive Vice President of Finance and
________________________________________ Operations, Chief Financial Officer,
Steven N. Moore Secretary and Treasurer (Principal
Financial and Accounting Officer)
* Stuart J. Ellman Director
________________________________________
Stuart J. Ellman
* Andrew W. Verhalen Director
________________________________________
Andrew W. Verhalen
* Charles P. Waite, Jr. Director
________________________________________
Charles P. Waite, Jr.
</TABLE>
/s/ Steven N. Moore
*By: ______________________________
Steven N. Moore
Attorney-in-Fact
II-6
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
<TABLE>
<CAPTION>
Column A Column B Column C Column D Column E
- ------------------------ ------------ --------------------- ------------ ----------
Additions
---------------------
Charged to Charged to
Balance at Revenue, Other Balance at
Beginning of Costs or Accounts-- Deductions-- End of
Description Period Expenses Describe Describe Period
- ------------------------ ------------ ---------- ---------- ------------ ----------
<S> <C> <C> <C> <C> <C>
Period from February 14,
1996 (inception) to
December 31, 1996
Allowance for
uncollectible
accounts............. $-- $ 8 $-- $ -- $ 8
Sales return reserve.. $-- $ -- $-- $ -- $--
Year ended December 31,
1997
Allowance for
uncollectible
accounts............. $ 8 $ 122 $-- $ 6 $124
Sales return reserve.. $-- $ -- $-- $ -- $--
Year ended December 31,
1998
Allowance for
uncollectible
accounts............. $124 $ 418 $-- $ 93(A) $449
Sales return reserve.. $-- $1,655 $-- $1,040(B) $615
</TABLE>
- --------
(A) Deductions consist of write-offs of uncollectible accounts, net of
recoveries.
(B) Deductions consist of product returns.
S-1
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Number Description
------ -----------
<C> <S>
1.1* Form of Underwriting Agreement.
3.1 Restated Certificate of Incorporation of the registrant.
3.2+ Restated Bylaws of the registrant.
5.1 Opinion of Perkins Coie LLP as to the legality of the shares.
10.1+ Lease Agreement, dated as of March 15, 1996, between COM Realty, Inc.
and the registrant.
10.2+ Lease Agreement, dated as of October 10, 1997, between Burke-State
Bldg. LLC and the registrant.
10.3+ Lease Agreement, dated as of August 17, 1998, between Cederstrand
Rentals and the registrant.
10.4+ Amended and Restated Loan and Security Agreement, dated as of March
20, 1998, between Silicon Valley Bank and the registrant.
10.5+ Loan Modification Agreement, dated as of September 18, 1998, between
Silicon Valley Bank and the registrant.
10.6+ 1996 Stock Incentive Compensation Plan.
10.7+ Standardized Adoption Agreement Prototype Cash or Deferred Profit-
Sharing Plan and Trust (401(k) plan), effective as of September 1,
1998.
10.8+++ Development and Supply Agreement, dated as of March 25, 1998, between
SMART Modular Technologies, Inc. and the registrant.
10.9+++ OEM Master License Agreement, dated as of August 14, 1997, between
RSA Data Security, Inc. and the registrant.
10.10+ 1999 Employee Stock Purchase Plan.
10.11+ Loan Modification Agreement, dated May 26, 1999, between Silicon
Valley Bank and the registrant.
10.12 Loan Modification Agreement, dated June 29, 1999, between Silicon
Valley Bank and the registrant.
23.1 Consent of Ernst & Young LLP, Independent Auditors.
23.2 Consent of Perkins Coie LLP (contained in the opinion filed as Exhibit
5.1).
24.1+ Power of Attorney (contained on signature page).
27.1+ Financial Data Schedule.
27.2+ Financial Data Schedule.
27.3 Financial Data Schedule.
99.1 Report of Ernst & Young LLP, Independent Auditors Report on Financial
Statement Schedule.
</TABLE>
- --------
* To be filed by amendment.
++ Confidential treatment has been requested for portions of this exhibit. The
omitted material has been separately filed with the Securities and Exchange
Commission.
+ Previously filed.
<PAGE>
EXHIBIT 3.1
WATCHGUARD TECHNOLOGIES, INC.
Restated Certificate of Incorporation
WatchGuard Technologies, Inc., a corporation organized and existing
under the General Corporation Law of the State of Delaware, does hereby certify:
1. This corporation's original name was Seattle Software Labs, Inc.
2. The original Certificate of Incorporation was filed with the
Secretary of State on May 7, 1997.
3. The following Restated Certificate of Incorporation was duly
proposed by this corporation's Board of Directors pursuant to the applicable
provisions of Sections 242 and 245 of the General Corporation Law of the State
of Delaware. In lieu of a meeting of the stockholders, written consent has been
given for the adoption of said Restated Certificate of Incorporation and the
amendments to be made thereby pursuant to the applicable provisions of Sections
228, 242 and 245 of the General Corporation Law of the State of Delaware, and
written notice of the taking of such corporate action has been given as provided
in said Section 228.
ARTICLE 1. NAME
The name of this corporation is WatchGuard Technologies, Inc.
ARTICLE 2. REGISTERED OFFICE AND AGENT
The address of the initial registered office of this corporation is
Corporation Trust Center, 1209 Orange Street, Wilmington, County of New Castle,
State of Delaware 19801, and the name of its initial registered agent at such
address is The Corporation Trust Company.
ARTICLE 3. PURPOSE
The purpose of this corporation is to engage in any lawful act or
activity for which corporations may be organized under the General Corporation
Law of the State of Delaware (the "DGCL").
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ARTICLE 4. SHARES
The total authorized stock of this corporation shall consist of
80,000,000 shares of common stock, having a par value of $.001 per share (the
"Common Stock"), and 10,000,000 shares of preferred stock, having a par value of
$.001 per share (the "Preferred Stock"). Authority is hereby expressly granted
to the Board of Directors to fix by resolution or resolutions any of the
designations and the powers, preferences and rights, and the qualifications,
limitations or restrictions that are permitted by the DGCL in respect of any
class or classes of stock or any series of any class of stock of this
corporation. The Preferred Stock shall be divided into series, and 3,000,004
shares of Preferred Stock are designated Series A Convertible Preferred Stock
(the "Series A Stock"), 2,374,581 shares of Preferred Stock are designated
Series B Convertible Preferred Stock (the "Series B Stock"), and 1, 357,378
shares of Preferred Stock are designated Series C Convertible Preferred Stock
(the "Series C Stock").
This corporation shall from time to time in accordance with the laws of
the State of Delaware increase the authorized amount of the Common Stock if at
any time the number of shares of Common Stock remaining unissued and available
for issuance shall not be sufficient to permit conversion of the Preferred
Stock.
Authority is hereby expressly granted to the Board of Directors,
subject to the provisions of this Article 4 and to the limitations prescribed by
law, to authorize the issue of one or more additional series of Preferred Stock,
and, with respect to each such series, to fix by resolution or resolutions
providing for the issue of each series the number of shares of such series and
the relative rights, limitations and preferences of the shares of any such
series so established with respect to any matter allowable under the DGCL.
The relative powers, preferences, special rights, qualifications,
limitations and restrictions granted to or imposed on the respective classes of
the shares of capital stock or the holders thereof are as follows:
4.1 Dividends
The holders of Series A Stock, Series B Stock and Series C Stock shall,
in preference to the holders of other stock of this corporation, including,
without limitation, the Common Stock, be entitled to receive, out of funds
legally available therefor, when and if declared by the Board of Directors,
dividends at the rate per annum of $.01 per share (the "Series A Dividends"),
$.155 per share (the "Series B Dividends") and $.311 per share (the "Series C
Dividends"), respectively (as adjusted for any stock dividends, combinations or
splits with respect to such shares). Together, the Series A Dividends, Series B
Dividends and Series C Dividends are referred to
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herein as the "Preferred Stock Dividends". The Preferred Stock Dividends shall
not be cumulative. No right shall accrue to holders of Common Stock or Preferred
Stock by reason of the fact that dividends on said shares are not declared in
any prior period. In addition to their respective Preferred Stock Dividends,
holders of Series A Stock, Series B Stock and Series C Stock shall be entitled
to dividends at the same rate as dividends (other than dividends paid in
additional shares of Common Stock) are paid with respect to the Common Stock
(treating each share of Preferred Stock as being equal to the number of shares
of Common Stock (including fractions of a share) into which such share is then
convertible).
4.2 Liquidation Preference
4.2.1 Preferred Stock Preference
Upon the voluntary or involuntary dissolution, liquidation or
winding up of this corporation, the assets of this corporation available for
distribution to its stockholders shall be distributed in the following order and
amounts:
(i) First, the holders of Series C Stock shall be entitled to
receive $5.157 for each outstanding share of Series C Stock
held by them plus any declared but unpaid dividend per
share on such outstanding shares of Series C Stock (as
adjusted for any stock dividends, combinations, splits,
recapitalizations and the like with respect to such shares)
(the "Series C Liquidation Amount"). If, upon the
occurrence of such event, the assets of this corporation
shall be insufficient to permit the payment of the Series C
Liquidation Amount payable to the holders of Series C
Stock, then the assets of this corporation available for
distribution shall be distributed ratably among the holders
of the Series C Stock in the same proportions as the full
Series C Liquidation Amount each such holder would
otherwise be entitled to receive bears to the total Series
C Liquidation Amount that would otherwise be payable to all
holder of Series C Stock.
(ii) If, upon completion of the distribution required by
subsection (i), assets remain in this corporation, the
holders of Series A Stock shall be entitled to receive $.05
for each outstanding share of Series A Stock held by them
plus any declared but unpaid dividend per share on such
outstanding shares of Series A Stock (as adjusted for any
stock dividends, combinations, splits, recapitalizations
and the like with respect to such shares) (the "Series A
Liquidation Amount"), the holders of Series B Stock shall
be entitled to receive $2.59 for each outstanding share of
Series B Stock held by them plus any declared but unpaid
dividend per share on such outstanding shares of Series B
Stock (as adjusted for any stock dividends, combinations,
splits, recapitalizations and the like with respect to such
shares) (the
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"Series B Liquidation Amount"), and any other outstanding
shares of preferred stock of this corporation having a
preferential right to liquidation payments ranking equal to
the rights of the holders of Series A Stock and Series B
Stock (together, the "Parity Shares") shall be entitled to
receive the liquidation payment specified for such shares
held by them (the "Parity Liquidation Amount"). If, upon
the occurrence of such event, the assets of this
corporation shall be insufficient to permit the payment of
the Liquidation Amounts payable to the holders of each
series, then the assets of this corporation available for
distribution shall be distributed ratably among the holders
of the Series A Stock, Series B Stock and the Parity Shares
in the same proportions as the aggregate of the Series A
Liquidation Amount, the Series B Liquidation Amount and the
Parity Liquidation Amount each such holder would otherwise
be entitled to receive bears to the total Series A
Liquidation Amount, Series B Liquidation Amount and Parity
Liquidation Amount that would otherwise be payable to all
such holders.
(iii) If, upon completion of the distribution required by
subsection (ii), assets remain in this corporation, the
holders of Series A Stock, Series B Stock, Series C Stock
and any Parity Shares entitled to participate in
distributions hereunder, in addition to their respective
Liquidation Amounts, and the holders of Common Stock shall
be entitled to receive liquidation payments on a pro rata
basis (assuming the conversion of all shares of Preferred
Stock to Common Stock at the then applicable conversion
rates for each series of the Preferred Stock) until, (A)
with respect to the holders of Series A Stock, they shall
have received an aggregate liquidation payment pursuant to
subsections (ii) and (iii) equal to one and one half times
the Series A Liquidation Amount distributed to the holders
of Series A Stock pursuant to subsection (ii), (B) with
respect to the holders of Series B Stock, they shall have
received an aggregate liquidation payment pursuant to
subsections (ii) and (iii) equal to one and one half
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time the Series B Liquidation Amount distributed to the
holders of Series B Stock pursuant to subsection (ii), (C)
with respect to holders of Series C Stock, they shall have
received an aggregate liquidation payment pursuant to
subsection (i) and (iii) equal to one and one half times the
Series C Liquidation Amount distributed to the Series C
holders pursuant to subsection (i) and, (D) with respect to
holders, if any, of Parity Shares, they shall have received
an aggregate liquidation payment pursuant to subsections
(ii) and (iii) equal to any applicable limit thereon but not
in excess of one and one half times the amount distributed
to such holders of Parity Shares pursuant to subsection
(ii).
(iii) If, upon completion of the distributions required by
subsections (i), (ii) and (iii), assets remain in this
corporation, the holders of Common Stock shall be entitled
to receive such assets on a pro rata basis based on the
number of shares of Common Stock held by each such holder.
4.2.2 Merger or Consolidation
The acquisition of this corporation by another entity or entities by
means of any transaction or series of related transactions (including, without
limitation, any consolidation or merger which results in the exchange of
outstanding shares of this corporation for securities or other consideration
issued or paid or caused to be issued or paid by any such entity or affiliate
thereof, but excluding (a) a merger to reincorporate this corporation in a
different jurisdiction and (b) a merger in which this corporation's stockholders
own or control 50% or more of the surviving entity's voting shares), and the
sale or other disposition by this corporation of all or substantially all its
assets, shall be deemed to be a liquidation, dissolution or winding up of this
corporation within the meaning of the provisions of this Section 4.2; provided,
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however, that each holder of convertible Preferred Stock of this corporation
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shall have the opportunity to convert Preferred Stock into Common Stock pursuant
to Section 4.4 in lieu of receiving payment in liquidation, dissolution or
winding up of this corporation pursuant to this Section 4.2.
4.2.3 Noncash Distributions
If any of the assets of this corporation are to be distributed other than
in cash under this Section 4.2 or for any purpose, then the Board of Directors
shall determine in good faith the fair value of the assets to be distributed to
the holders of Preferred
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Stock or Common Stock. This corporation shall give prompt written notice to each
holder of shares of Preferred Stock or Common Stock of the fair value so
determined.
4.3 Voting Rights
4.3.1 Preferred Stock
Except as otherwise provided herein or as required by law, the holder
of each share of Preferred Stock shall be entitled to vote together with all
other classes and series of stock of this corporation as a single class on all
actions to be taken by the stockholders of this corporation, including, but not
limited to, actions amending the Certificate of Incorporation of this
corporation to increase the number of authorized shares of Common Stock or
Preferred Stock. If, as provided herein or as required by law, the Preferred
Stock is entitled to vote as a separate class from the Common Stock, then except
as otherwise provided herein, all series of Preferred Stock shall vote together
as a single class and not as a separate series. Each share of Preferred Stock
shall entitle the holder thereof to such number of votes per share on each such
action as shall equal the number of shares of Common Stock (including fractions
of a share) into which such share of Preferred Stock is then convertible
pursuant to Section 4.4 at the record date for the determination of the
stockholders entitled to vote on such matters or, if no such record date is
established, at the date such vote is taken. Except as otherwise provided herein
or as required by law, the Preferred Stock shall have voting rights and powers
equal to the voting rights and powers of the Common Stock.
4.3.2 Common Stock
Each holder of shares of Common Stock shall be entitled to one vote for
each share thereof held.
4.3.3 Board Size
This corporation shall not, without the written consent or affirmative
vote of the holders of a majority of the then outstanding shares of each series
of Preferred Stock, given in writing or by vote at a meeting, consenting or
voting (as the case may be) separately as a class, increase the number of
directors constituting the Board of Directors to a number greater than seven.
4.3.4 Board Seats
The holders of the Series A Stock, voting as a separate class, shall be
entitled to elect two directors of this corporation. The holders of the Series B
Stock, voting as a
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separate class, shall be entitled to elect two directors of this corporation.
The holders of the Series C Stock, voting as a separate class, shall be entitled
to elect one director of this corporation. The holders of the Common Stock and
Preferred Stock, voting together as a single class (with the Preferred Stock
voting on an as-converted basis), shall be entitled to elect up to two directors
of this corporation. At any meeting (or in a written consent in lieu thereof)
held for the purpose of electing directors, the presence in person or by proxy
(or the written consent) of (a) the holders of a majority of the shares of a
series of Preferred Stock then outstanding shall constitute a quorum of the
Preferred Stock of that series for the election of the directors to be elected
solely by the holders of the series and (b) the holders of a majority of the
shares of Preferred Stock and Common Stock then outstanding voting in accordance
with Section 4.3.1 shall constitute a quorum for the election of the directors
to be elected jointly by the holders of Preferred Stock and Common Stock. A
vacancy in any directorship or removal of any director elected by the holders of
a series of Preferred Stock shall be filled or accomplished only by vote or
written consent of the holders of that series and a vacancy in any directorship
or removal of any director to be elected jointly by the Preferred Stock and the
Common Stock shall be filled or accomplished only by vote or written consent of
the holders of Preferred Stock and Common Stock as provided herein.
4.4 Conversion
The holders of Preferred Stock shall have conversion rights as follows
(the "Conversion Rights"):
4.4.1 Optional Conversion
Subject to the terms and conditions of this Section 4.4, each share of
Preferred Stock shall be convertible, at the option of the holder thereof, at
any time after the date of issuance of such share at the office of this
corporation or any transfer agent for such Preferred Stock, except that upon any
liquidation of this corporation the right of conversion shall terminate at the
close of business on the business day fixed for payment of the amount
distributable on the Preferred Stock. Each share of Preferred Stock shall be
convertible into the number of fully paid and nonassessable shares of Common
Stock that results from dividing the "Conversion Price" per share in effect for
such series of Preferred Stock at the time of conversion (the "Series A
Conversion Price", "Series B Conversion Price" or "Series C Conversion Price,"
as the case may be) into the "Conversion Value" per share of such series of
Preferred Stock. The number of shares of Common Stock into which each series of
Preferred Stock is convertible is hereinafter collectively referred to as the
"Conversion Rate" for such series. Initially, the Conversion Price per share of
the Series A Stock shall be $.05, of
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the Series B Stock shall be $2.59 and of the Series C Stock shall be $5.157 and
the Conversion Value per share of the Series A Stock shall be $.05, of the
Series B Stock shall be $2.59 and of the Series C Stock shall be $5.157, so that
each share of Series A Stock, Series B Stock and Series C Stock shall be
initially convertible into one share of Common Stock. The Conversion Price of
each series of Preferred Stock shall be subject to adjustment as hereinafter
provided.
4.4.2 Automatic Conversion
Each share of Series A Stock and Series B Stock shall automatically be
converted into shares of Common Stock at its then effective Conversion Rate upon
the earlier to occur of (i) the closing of a firm commitment underwritten public
offering of Common Stock pursuant to an effective registration statement under
the Securities Act of 1933, as amended (the "1933 Act"), with aggregate gross
proceeds, at the public offering price, of at least $10,000,000 and a price per
share paid by the public of at least $7.77 (appropriately adjusted to reflect
the occurrence of any event described in Section 4.4.6) , and (ii) the vote or
written consent of the holders of a majority of the outstanding shares of Series
A Stock or the holders of a majority of the outstanding shares of Series B
Stock, as the case may be.
Each share of Series C Stock shall automatically be converted into
shares of Common Stock at its then effective Conversion Rate upon the earlier to
occur of (i) the closing of a firm commitment underwritten public offering of
Common Stock pursuant to an effective registration statement under the
Securities Act of 1933, as amended the 1933 Act, with aggregate gross proceeds,
at the public offering price, of at least $15,000,000 and a price per share paid
by the public of at least $10.314 (appropriately adjusted to reflect the
occurrence of any event described in Section 4.4.6) , and (ii) the vote or
written consent of the holders of seventy-five percent (75%) of the outstanding
shares of Series C Stock.
4.4.3 Mechanics of Conversion
Before any holder of Preferred Stock shall be entitled to convert the
same into shares of Common Stock, such holder shall surrender the certificate or
certificates therefor, duly endorsed, at the office of this corporation or of
any transfer agent for such Preferred Stock and shall give written notice to
this corporation at such office that such holder elects to convert a stated
number of the shares of Preferred Stock into Common Stock.
This corporation shall, as soon as practicable thereafter, issue and
deliver to such holder of Preferred Stock a certificate or certificates for the
number of shares of Common Stock to which such holder shall be entitled as
aforesaid, and shall pay in
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cash any declared and unpaid dividends on the shares of Preferred Stock being
converted. To the extent permitted by law, such conversion shall be deemed to
have been effected and the Conversion Price shall be determined immediately
prior to the close of business (a) on the date such written notice is given
(provided that such holder's certificate or certificates are delivered to this
corporation within two business days after such notice is given) or (b) in any
other case, on the date of such surrender of the shares of Preferred Stock to be
converted, and the person or persons entitled to receive the shares of Common
Stock issuable upon such conversion shall be treated for all purposes as the
record holder or holders of such shares of Common Stock on such date.
Notwithstanding the foregoing, no written notice of election to convert or
surrender of certificates shall be required in the event of an automatic
conversion pursuant to Section 4.4.2.
4.4.4 Conversion Price Adjustments of Preferred Stock for Certain
Dilutive Issuances.
The Series C Conversion Price shall be subject to adjustment
from time to time as follows:
(i) (A) If this corporation shall issue, after the
date on which shares of Series C Stock are first issued (the "Series C Issuance
Date"), any Additional Stock (as defined below) without consideration or for a
consideration per share less than the Series C Conversion Price in effect
immediately prior to the issuance of such Additional Stock, the Series C
Conversion Price in effect immediately prior to each such issuance shall
forthwith (except as otherwise provided in this clause (i)) be adjusted to a
price determined by multiplying such Conversion Price by a fraction, the
numerator of which shall be the total number of Common Stock Equivalents (as
defined below) outstanding immediately prior to such issuance plus the number of
shares of Common Stock that the aggregate consideration received by this
corporation for such issuance would purchase at such Conversion Price, and the
denominator of which shall be the total number of Common Stock Equivalents
outstanding immediately prior to such issuance plus the number of shares of such
Additional Stock. The term "Common Stock Equivalents" shall mean all shares of
Common Stock actually outstanding, plus all shares of Common Stock issuable upon
conversion or exchange of all convertible or exchangeable securities then
outstanding.
(B) In the case of the issuance of Additional
Stock for cash, the consideration shall be deemed to be the gross amount of cash
paid therefor before deducting any discounts, commissions or other expenses
allowed, paid or incurred by this corporation for any underwriting or otherwise
in connection with the issuance and sale thereof.
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(C) In the case of the issuance of Additional
Stock for consideration in whole or in part other than cash, the consideration
other than cash shall be deemed to be the fair value thereof, as determined by
at least two-thirds of the Board of Directors irrespective of any accounting
treatment.
(D) In the case of the issuance of options to
purchase or rights to subscribe for Additional Stock, securities by their terms
convertible into or exchangeable for Additional Stock or options to purchase or
rights to subscribe for such convertible or exchangeable securities, the
following provisions shall apply for all purposes of this subsection 4.4.4(i)
and 4.4.4(ii):
(1) The aggregate maximum number of shares of
Common Stock deliverable upon exercise (assuming the satisfaction of any
conditions to exercisability, including without limitation, the passage of time,
but without taking into account potential antidilution adjustments) of such
options to purchase or rights to subscribe for Additional Stock shall be deemed
to have been issued at the time such options or rights were issued and for a
consideration equal to the consideration (determined in the manner provided in
subsections 4.4.4(i)(B) and 4.4.4(i)(C)), if any, received by this corporation
upon the issuance of such options or rights plus the minimum exercise price
provided in such options or rights (without taking into account potential
antidilution adjustments) for the Common Stock covered thereby.
(2) The aggregate maximum number of shares of
Common Stock deliverable upon conversion of or in exchange (assuming the
satisfaction of any conditions to convertibility or exchangeability, including,
without limitation, the passage of time, but without taking into account
potential antidilution adjustments) for any such convertible or exchangeable
securities or upon the exercise of options to purchase or rights to subscribe
for such convertible or exchangeable securities and subsequent conversion or
exchange thereof shall be deemed to have been issued at the time such securities
were issued or such options or rights were issued and for a consideration equal
to the consideration, if any, received by this corporation for any such
securities and related options or rights (excluding any cash received on account
of accrued interest or accrued dividends), plus the minimum additional
consideration, if any, to be received by this corporation (without taking into
account potential antidilution adjustments) upon the conversion or exchange of
such securities or the exercise of any related options or rights (the
consideration in each case to be determined in the manner provided in
subsections 4.4.4(i)(B) and 4.4.4(i)(C)).
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(3) In the event of any change in the number of shares
of Common Stock deliverable or in the consideration payable to this corporation
upon exercise of such options or rights or upon conversion of or in exchange for
such convertible or exchangeable securities, including, without limitation, a
change resulting from the antidilution provisions thereof, the Series C
Conversion Price to the extent in any way affected by or computed using such
options, rights or securities, shall be recomputed to reflect such change, but
no further adjustment shall be made for the actual issuance of Common Stock or
any payment of such consideration upon the exercise of any such options or
rights or the conversion or exchange of such securities.
(4) Upon the expiration of any such options or rights,
the termination of any such rights to convert or exchange or the expiration of
any options or rights related to such convertible or exchangeable securities,
the Series C Conversion Price to the extent in any way affected by or computed
using such options, rights or securities or options or rights related to such
securities, shall be recomputed to reflect the issuance of only the number of
shares of Common Stock (and convertible or exchangeable securities which remain
in effect) actually issued upon the exercise of such options or rights, upon the
conversion or exchange of such securities or upon the exercise of the options or
rights related to such securities.
(5) The number of shares of Common Stock deemed issued
and the consideration deemed paid therefor pursuant to subsections
4.4.4(i)(D)(l) and (2) shall be appropriately adjusted to reflect any change,
termination or expiration of the type described in either subsection
4.4.4(i)(D)(3) or (4).
(ii) "Additional Stock" shall mean any shares of Common Stock
issued (or deemed to have been issued pursuant to subsection 4(i)(D)) by this
corporation after the Series C Issuance Date, other than the following:
(A) shares of Common Stock issued pursuant to a
transaction described in subsection 4.4.6;
(B) shares of Common Stock issued or issuable pursuant to
options, warrants or convertible Preferred Stock outstanding on or issued as of
the Series C Issuance Date, or pursuant to conversion of any convertible
securities issuable upon exercise of options or warrants outstanding on or
issued as of the Series C Issuance Date;
(C) options for the purchase of up to 3,661,035 shares of
Common Stock (plus any additional shares approved by a majority of this
corporation's Board of Directors granted or available for grant to employees,
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consultants, directors, independent contractors and similar parties pursuant to
one or more stock option plans or restricted stock plans approved by this
corporation's Board of Directors, and the shares of Common Stock issuable upon
exercise of such options.
4.4.5 Fractional Shares; Dividends; Partial Conversion
No fractional shares of Common Stock shall be issued upon conversion of
the Preferred Stock and no payment or adjustment shall be made upon any
conversion on account of any cash dividends on the Common Stock issued upon such
conversion. In lieu of any fractional shares to which the holder would otherwise
be entitled, this corporation shall pay cash equal to such fraction multiplied
by the applicable Conversion Price. At the time of each conversion, this
corporation shall pay in cash an amount equal to all dividends, declared and
unpaid on the shares of Preferred Stock surrendered for conversion to the date
upon which such conversion is deemed to take place as provided in Section 4.4.3.
In case the number of shares of Preferred Stock represented by the certificate
or certificates surrendered for conversion exceeds the number of shares
converted, this corporation shall, upon such conversion, execute and deliver to
the holder, at the expense of this corporation, a new certificate or
certificates for the number of shares of Preferred Stock represented by the
certificate or certificates surrendered which are not to be converted.
4.4.6 Subdivision or Combination of Common Stock; Other Dividends and
Distributions
(i) In case this corporation shall at any time subdivide (by any
stock split, stock dividend or otherwise) its outstanding shares of Common Stock
into a greater number of shares, the Conversion Prices in effect immediately
prior to such subdivision shall be proportionately reduced, and, conversely, in
case the outstanding shares of Common Stock shall be combined into a smaller
number of shares, the Conversion Prices in effect immediately prior to such
combination shall be proportionately increased. Any adjustment under this
Subsection (i) shall become effective at the close of business on the date the
subdivision or combination becomes effective.
(ii) If this corporation issues a dividend or makes a distribution
payable in securities of this corporation other than shares of Common Stock,
provision shall be made so that the holders of Preferred Stock shall receive
upon conversion thereof, in addition to the number of shares of Common Stock
receivable thereupon, the amount of other securities of this corporation which
they would have received had their Preferred Stock been converted into Common
Stock on the date of such event and had they thereafter, during the period from
the date of such event to and including the
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conversion date, retained such securities receivable by them as aforesaid during
such period, subject to all other adjustments called for during such period
under this Section 4.4 with respect to the rights of the holders of the
Preferred Stock or with respect to such other securities by their terms.
4.4.7 Reorganization or Reclassification
If any capital reorganization or reclassification of the capital stock
of this corporation shall be effected in such a way that holders of Common Stock
shall be entitled to receive stock, securities or assets with respect to or in
exchange for Common Stock, then, as a condition of such reorganization or
reclassification, lawful and adequate provisions shall be made whereby each
holder of a share or shares of Preferred Stock shall thereupon have the right to
receive, upon the basis and upon the terms and conditions specified herein and
in lieu of the shares of Common Stock immediately theretofore receivable upon
the conversion of such share or shares of Preferred Stock, such shares of stock,
securities or assets as may be issued or payable with respect to or in exchange
for a number of outstanding shares of such Common Stock equal to the number of
shares of such Common Stock immediately theretofore receivable upon such
conversion had such reorganization or reclassification not taken place, and in
any such case appropriate provisions shall be made with respect to the rights
and interests of such holder to the end that the provisions hereof (including,
without limitation, provisions for adjustments of the applicable Conversion
Price) shall thereafter be applicable, as nearly as may be, in relation to any
shares of stock, securities or assets thereafter deliverable upon the exercise
of such conversion rights.
4.4.8 Notice of Adjustment
Upon any adjustment or readjustment of the Conversion Price applicable
to a series of Preferred Stock, then and in each such case this corporation
shall give written notice thereof, by delivery in person, certified or
registered mail, return receipt requested, telecopier or telex, addressed to
each holder of shares of such series of Preferred Stock at the address of such
holder as shown on the books of this corporation, which notice shall state the
Conversion Price for such series of Preferred Stock resulting from such
adjustment or readjustment, setting forth in reasonable detail the method upon
which such calculation is based. In the case of any adjustment or readjustment
of the Series C Conversion Price pursuant Section 4.4.4, the written notice
required by this Section 4.4.8 shall include a statement of (a) the
consideration received or deemed to be received by this corporation for any
Additional Stock issued or sold or deemed to have been issued or sold, (b) the
Series C Conversion Price at the time in effect, (c) the number of shares of
Additional Stock and (d) the type and
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amount, if any, of other property which at the time would be received upon
conversion of the Preferred Stock.
4.4.9 Minimal Adjustments
All calculations under this Section 4.4 shall be made to the nearest
cent. No adjustment in a Conversion Price need be made if such adjustment would
result in a change in a Conversion Price of less than $0.01. Any adjustment of
less than $0.01 that is not made shall be carried forward and shall be made at
the time of and together with any subsequent adjustment that, on a cumulative
basis, amounts to an adjustment of $0.01 or more in a Conversion Price.
4.4.10 No Impairment
This corporation shall not, through any reorganization, transfer of
assets, consolidation, merger, dissolution, issue or sale of securities, or any
other voluntary action, avoid or seek to avoid the observance or performance of
any of the terms to be observed or performed hereunder by this corporation, but
shall at all times in good faith assist in the carrying out of all the
provisions of this Section 4.4 and in the taking of all such action as may be
necessary or appropriate in order to protect the Conversion Rights of the
holders of Preferred Stock against impairment. This provision shall not restrict
this corporation from amending its Certificate of Incorporation in accordance
with the DGCL.
4.4.11 Other Notices
In case at any time:
(a) This corporation shall declare any dividend upon the
Common Stock payable in cash or stock or make any other distribution to the
holders of the Common Stock;
(b) This corporation shall offer for subscription pro
rata to the holders of the Common Stock any additional shares of stock of any
class or other rights;
(c) There shall be any capital reorganization or
reclassification of the capital stock of this corporation, or a consolidation or
merger of this corporation with or into another entity or entities, or a sale,
lease, abandonment, transfer or other disposition of all or substantially all
its assets; or
(d) There shall be a voluntary or involuntary
dissolution, liquidation or winding up of this corporation;
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then, in any one or more of said cases, this corporation shall give, by delivery
in person, certified or registered mail, return receipt requested, telecopier or
telex, addressed to each holder of any shares of Preferred Stock at the address
of such holder as shown on the books of this corporation, (a) at least 20 days'
prior written notice of the date on which the books of this corporation shall
close or a record shall be taken for such dividend, distribution or subscription
rights or for determining rights to vote in respect of any such reorganization,
reclassification, consolidation, merger, disposition, dissolution, liquidation
or winding up and (b) in the case of any such reorganization, reclassification,
consolidation, merger, disposition, dissolution, liquidation or winding up, at
least 20 days' prior written notice of the date when the same shall take place.
Such notice in accordance with the foregoing clause (a) shall also specify, in
the case of any such dividend, distribution or subscription rights, the date on
which holders of Common Stock shall be entitled thereto and such notice in
accordance with the foregoing clause (b) shall also specify the date on which
the holders of Common Stock shall be entitled to exchange their Common Stock for
securities or other property deliverable upon such reorganization,
reclassification, consolidation, merger, disposition, dissolution, liquidation
or winding up, as the case may be.
4.4.12 Stock to Be Reserved
This corporation shall at all times reserve and keep available
out of its authorized Common Stock, solely for the purpose of issuance upon the
conversion of Preferred Stock as herein provided, such number of shares of
Common Stock as shall then be issuable upon the conversion of all outstanding
shares of Preferred Stock. This corporation covenants that all shares of Common
Stock which shall be so issued shall be duly and validly issued and fully paid
and nonassessable and free from all taxes, liens and charges with respect to the
issue thereof, and without limiting the generality of the foregoing, this
corporation covenants that it shall from time to time take all such action as
may be requisite to ensure that the par value per share of the Common Stock is
at all times equal to or less than the Conversion Price applicable to any
outstanding series of Preferred Stock in effect at the time. This corporation
shall take all such action as may be reasonably necessary to ensure that all
such shares of Common Stock may be so issued without violation of any applicable
law or regulation, or of any requirement of any national securities exchange
upon which the Common Stock may be listed. This corporation shall not take any
action which results in any adjustment of the Conversion Price applicable to a
series of Preferred Stock if the total number of shares of Common Stock issued
and issuable after such action upon conversion of all the outstanding shares of
Preferred Stock would exceed the total number of shares of Common Stock then
authorized by this corporation's Certificate of Incorporation.
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4.4.13 No Reissuance of Preferred Stock
Shares of Preferred Stock that are converted into shares of
Common Stock as provided herein shall not be reissued.
4.4.14 Issue Tax
The issuance of certificates for shares of Common Stock upon
conversion of Preferred Stock shall be made without charge to the holders
thereof for any issuance tax or other governmental charges in respect thereof,
provided that this corporation shall not be required to pay any tax that may be
payable in respect of any transfer involved in the issuance and delivery of any
certificate in a name other than that of the holder of the Preferred Stock that
is being converted.
4.4.15 Closing of Books
This corporation shall at no time close its transfer books
against the transfer of any Preferred Stock or of any shares of Common Stock
issued or issuable upon the conversion of any shares of Preferred Stock in any
manner that interferes with the timely conversion of such Preferred Stock,
except as may otherwise be required to comply with applicable securities laws.
4.4.16 Definition of Common Stock
As used in this Section 4.4, the term "Common Stock" shall mean
and include this corporation's authorized Common Stock $.001 par value per
share, as constituted on April 24, 1998, and shall also include any capital
stock of any class of this corporation thereafter authorized that shall not be
limited to a fixed sum or percentage in respect of the rights of the holders
thereof to participate in dividends or in the distribution of assets upon the
voluntary or involuntary liquidation, dissolution or winding up of this
corporation; provided that the shares of Common Stock receivable upon conversion
of shares of Preferred Stock shall include only shares designated as Common
Stock of this corporation on April 24, 1998, or in case of any reorganization or
reclassification of the outstanding shares thereof, the stock, securities or
assets provided for in Section 4.4.9.
4.4.17 Notices
Any notice required by the provisions of this Section 4.4 to be given
to the holder of shares of Preferred Stock shall be deemed given if deposited in
the United States mail, postage prepaid, and addressed to each such holder of
record at such holder's address appearing on the books of this corporation.
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4.5 Protective Provisions
4.5.1 Approval of Series A Stock, Series B Stock and Series C Stock
At any time when shares of Series A Stock, Series B Stock or Series C
Stock are outstanding, except where the vote or written consent of the holders
of a greater number of shares of this corporation is required by law or by the
Certificate of Incorporation, and in addition to any other vote required by law
or the Certificate of Incorporation, without the approval of the holders of a
majority of the then outstanding shares of Series A Stock, Series B Stock and
Series C Stock given in writing or by vote at a meeting, with each series
consenting or voting (as the case may be) together as a single class, this
corporation shall not:
(a) Merger or Sale
Sell, convey or otherwise dispose of all or substantially all of its
property, business or assets the disposition of which would have a material
effect upon the business or financial condition of this corporation; or
recapitalize, reorganize or merge into or consolidate with any other corporation
(a "Corporate Transaction"), unless this corporation's stockholders of record as
constituted immediately prior to such Corporate Transaction will, immediately
after such Corporate Transaction, hold at least 50% of the voting power of the
surviving or acquiring entity.
(b) Redeem Other Capital Stock
Redeem or purchase, or set aside any sum for the redemption or other
purchase of, or pay any dividend or make any distribution on, any shares of
stock other than shares of Preferred Stock, except for dividends or other
distributions payable on the Common Stock solely in the form of additional
shares of Common Stock and except for the purchase of shares of Common Stock
from former employees of this corporation who acquired such shares directly from
this corporation, if each such purchase is made pursuant to contractual rights
held by this corporation relating to the termination of employment of such
former employee and the purchase price does not exceed the original issue price
paid by such former employee to this corporation for such shares.
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4.5.2 Approval of Series A Stock
At any time when shares of Series A Stock are outstanding, in addition to any
other vote required by law or the Certificate of Incorporation, without the
approval of the holders of a majority of the then outstanding shares of Series A
Stock given in writing or by vote at a meeting, consenting or voting (as the
case may be) separately as a series, this corporation shall not:
(a) Amend Certificate of Incorporation or Bylaws
Amend, alter or repeal its Certificate of Incorporation or Bylaws in a
manner adversely affecting the Series A Stock; or
(b) Increase the Authorized Shares of Series A Stock
Increase the authorized number of shares of the Series A Stock.
4.5.3 Approval of Series B Stock
At any time when shares of Series B Stock are outstanding, in addition
to any other vote required by law or the Certificate of Incorporation, without
the approval of the holders of a majority of the then outstanding shares of
Series B Stock given in writing or by vote at a meeting, consenting or voting
(as the case may be) separately as a series, this corporation shall not:
(a) Amend Certificate of Incorporation or Bylaws
Amend, alter or repeal its Certificate of Incorporation or Bylaws in a
manner adversely affecting the Series B Stock;
(b) Increase the Authorized Shares of Series B Stock
Increase the authorized number of shares of the Series A Stock or Series B
Stock.
4.5.4 Approval of Series C Stock
At any time when shares of Series C Stock are outstanding, in addition
to any other vote required by law or the Certificate of Incorporation, without
the approval of the holders of a majority of the then outstanding shares of
Series C Stock given in writing or by vote at a meeting, consenting or voting
(as the case may be) separately as a series, this corporation shall not:
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(a) Authorize Senior Capital Stock
Authorize or create a series or class of equity security
(including any equity security convertible into or exercisable for any other
equity security) with a preference over the Series C Stock as to voting,
dividends or upon liquidation;
(b) Increase or Decrease the authorized shares of Series C Stock
Increase or decrease the authorized number of shares of Series C
Stock.
(c) Amend Certificate of Incorporation or Bylaws
Amend, alter or repeal any provision of, or add any provision to,
its Certificate of Incorporation or Bylaws in a manner changing the rights of
the Series C Stock; or
(d) Redeem Shares of Series C Stock
Redeem, purchase or otherwise acquire any share or shares of
Series C Stock.
19
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4.6 Amendments Upon Conversion of Outstanding Shares
When, as a result of the conversion of the shares of Series A, Series B
and Series C Preferred Stock to shares of Common Stock, no such shares of
Preferred Stock remain outstanding (a "Full Conversion Event"), the Board of
Directors may, at its discretion and without a vote of the stockholders of this
corporation, cause the modification of Article 2 hereof to (i) cause the
elimination of the provisions of this Restated Certificate of Incorporation that
are no longer operative and in effect by reason of such Full Conversion Event,
including Sections 4.1 through 4.5, (ii) delete this Section 4.6, by providing
for the filing of the applicable amendment or restatement to this Restated
Certificate of Incorporation, and (iii) make such clerical amendments as are
appropriate to effectuate any amendments to the provisions of this Restated
Certificate of Incorporation that become effective upon a Full Conversion Event.
ARTICLE 5. BYLAWS
Subject to Sections 4.3 and 4.4, the Board of Directors shall have the
power to adopt, amend or repeal the Bylaws for this corporation, subject to the
power of the stockholders to amend or repeal such Bylaws. Subject to Sections
4.3 and 4.4, the stockholders shall also have the power to adopt, amend or
repeal the Bylaws for this corporation.
ARTICLE 6. DIRECTORS
Following a Full Conversion Event, the number of Directors of this
corporation shall be determined, and the Directors of this corporation shall be
elected and removed from office, as provided in this Section 6.1.
The number of Directors of this corporation shall be determined in the
manner provided by the Bylaws and may be increased or decreased from time to
time in the manner provided therein. Prior to the first annual election of
Directors following such a Full Conversion Event, unless a Director earlier
dies, resigns or is removed, his or her term of office shall expire at the next
annual meeting of stockholders. At the first annual election of Directors
following such a Full Conversion Event, the Board shall be divided into three
classes, with said classes to be as equal in number as may be possible, with any
Director or Directors in excess of the number divisible by three being assigned
to Class 3 and Class 2, as the case may be. At the first election of Directors
to such classified Board, each Class 1 Director shall be elected to serve until
the next ensuing annual meeting of stockholders, each Class 2 Director shall be
elected to serve until the second ensuing annual meeting of stockholders and
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each Class 3 Director shall be elected to serve until the third ensuing annual
meeting of stockholders. At each annual meeting of stockholders following the
meeting at which the Board is initially classified, the number of Directors
equal to the number of Directors in the class whose term expires at the time of
such meeting shall be elected to serve until the third ensuing annual meeting of
stockholders. Notwithstanding any of the foregoing provisions of this Article,
Directors shall serve until their successors are elected and qualified or until
their earlier death, resignation or removal from office, or until there is a
decrease in the number of Directors.
The Directors of this corporation may be removed only for cause; such
removal shall be in the manner provided by the Bylaws.
ARTICLE 7. PREEMPTIVE RIGHTS
Preemptive rights shall not exist with respect to shares of stock or
securities convertible into shares of stock of this corporation.
ARTICLE 8. CUMULATIVE VOTING
The right to cumulate votes in the election of directors shall not exist
with respect to shares of stock of this corporation.
ARTICLE 9. AMENDMENTS TO CERTIFICATE OF INCORPORATION
This corporation reserves the right to amend or repeal any of the
provisions contained in this Restated Certificate of Incorporation in any manner
now or hereafter permitted by law, and the rights of the stockholders of this
corporation are granted subject to this reservation. Following a Full Conversion
Event, the provisions contained in this Restated Certificate of Incorporation
shall only be amended as follows:
9.1. Supermajority Voting
Except as provided in Section 9.2 or Section 9.3, the following Sections
and subsections may be amended or repealed only upon the affirmative vote of the
holders of at least two-thirds of the outstanding shares and, to the extent, if
any, provided by resolution adopted by the Board of Directors authorizing the
issuance of a class or series of Common Stock or Preferred Stock, by the
affirmative vote of the holders of at least two-thirds of the outstanding shares
of such class or series, voting as a separate voting group:
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Article 6 ("Directors")
Article 9 ("Amendments to Certificate of Incorporation").
Article 11 ("Special Voting Requirements")
Article 12 ("Special Meetings of Stockholders")
9.2. Majority Voting
Notwithstanding the provisions of Section 9.1, and except as provided in
Section 9.3, an amendment or repeal of a Section identified in Section 9.1 that
is approved by a majority of the Continuing Directors (as defined in Section
11.1), voting separately and as a subclass of Directors, shall require the
affirmative vote of the holders of at least a majority of the outstanding shares
entitled to vote thereon and, to the extent, if any, provided by resolution
adopted by the Board authorizing the issuance of a class or series of Common
Stock or Preferred Stock, by the affirmative vote of the holders of at least a
majority of the outstanding shares of such class or series, voting as a separate
voting group.
9.3. No Stockholder Vote
Notwithstanding the provisions of Section 9.1 or 9.2, if the amendment or
repeal of any Section not identified in Section 9.1 shall have been approved by
a majority of the Continuing Directors, voting separately and as a subclass of
Directors, and if such amendment or repeal is not otherwise required to be
approved by this corporation's stockholders pursuant to the provisions of the
DGCL or of this Restated Certificate of Incorporation other than this Article 9,
then no vote of the stockholders of this corporation shall be required for
approval of such amendment or repeal.
This corporation reserves the right to amend or repeal any of the
provisions contained in this Restated Certificate of Incorporation in any manner
now or hereafter permitted by law, and the rights of the stockholders of this
corporation are granted subject to this reservation.
ARTICLE 10. LIMITATION OF DIRECTOR LIABILITY
To the full extent that the DGCL, as it exists on the date hereof or may
hereafter be amended, permits the limitation or elimination of the liability of
directors, a director of this corporation shall not be liable to this
corporation or its stockholders for monetary damages for breach of fiduciary
duty as a director. Any amendment to
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or repeal of this Article 10 shall not adversely affect any right or protection
of a director of this corporation for or with respect to any acts or omissions
of such director occurring prior to such amendment or repeal.
ARTICLE 11. SPECIAL VOTING REQUIREMENTS
Following a Full Conversion Event, in addition to any affirmative vote
required by law, by this Restated Certificate of Incorporation or otherwise, any
"Business Combination" (as hereinafter defined) involving this corporation shall
be subject to approval in the manner set forth in this Article 11.
11.1. Definitions
For the purposes of this Article 11:
(a) "Business Combination" means (i) a merger, share exchange or
consolidation of this corporation or any of its Subsidiaries with any other
corporation or entity; (ii) the sale, lease, exchange, mortgage, pledge,
transfer or other disposition or encumbrance, whether in one transaction or a
series of transactions, by this corporation or any of its Subsidiaries of all or
a substantial part of this corporation's assets otherwise than in the usual and
regular course of business; or (iii) any agreement, contract or other
arrangement providing for any of the foregoing transactions.
(b) "Continuing Director" means any member of the Board who was a
member of the Board on May 1, 1999 or who is elected to the Board after May 1,
1999 upon the recommendation of a majority of the Continuing Directors voting
separately and as a subclass of Directors on such recommendation.
(c) "Subsidiary" means a domestic or foreign corporation, a majority
of the outstanding voting shares of which are owned, directly or indirectly, by
this corporation.
11.2. Vote Required for Business Combinations
11.2.1. Supermajority Vote
Except as provided in subsections 11.2.2 and 11.2.3, the affirmative
vote of the holders of not less than two-thirds of the outstanding shares
entitled to vote thereon and, to the extent, if any, provided by resolution
adopted by the Board authorizing the issuance of a class or series of Common
Stock or Preferred Stock, the affirmative vote of the holders of not less than
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two-thirds of the outstanding shares of such class or series, voting as a
separate voting group, shall be required for the adoption or authorization of a
Business Combination.
11.2.2. Majority Vote
Notwithstanding subsection 11.2.1, if a Business Combination shall
have been approved by a majority of the Continuing Directors, voting separately
and as a subclass of Directors, and if such Business Combination is otherwise
required to be approved by this corporation's stockholders pursuant to the
provisions of the DGCL or of this Restated Certificate of Incorporation other
than this Article 11, then the affirmative vote of the holders of not less than
a majority of the outstanding shares entitled to vote thereon and, to the
extent, if any, provided by resolution adopted by the Board authorizing the
issuance of a class or series of Common Stock or Preferred Stock, the
affirmative vote of the holders of not less than a majority of the outstanding
shares of such class or series, voting as a separate voting group, shall be
required for the adoption or authorization of such Business Combination.
11.2.3. No Stockholder Vote
Notwithstanding subsection 11.2.1 or 11.2.2, if a Business
Combination shall have been approved by a majority of the Continuing Directors,
voting separately and as a subclass of Directors, and if such Business
Combination is not otherwise required to be approved by this corporation's
stockholders pursuant to the provisions of the DGCL or of this Restated
Certificate of Incorporation other than this Article 11, then no vote of the
stockholders of this corporation shall be required for approval of such Business
Combination.
ARTICLE 12. SPECIAL MEETINGS OF STOCKHOLDERS
Following a Full Conversion Event, special meetings of the stockholders
shall be called in the manner set forth in this Article 12.
The Chairman of the Board, the President or the Board may call special
meetings of the stockholders for any purpose. Further, a special meeting of the
stockholders shall be held if the holders of not less than twenty-five percent
(25%) of all the votes entitled to be cast on any issue proposed to be
considered at such special meeting have dated, signed and delivered to the
Secretary of this corporation no later than 20 days prior to the date of such
meeting one or more
24
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written demands for such meeting, describing the purpose or purposes for which
it is to be held.
ARTICLE 13. ACTION BY STOCKHOLDERS WITHOUT A MEETING
Any action that could be taken at any annual or special meeting of the
stockholders may be taken without a meeting, without prior notice and without a
vote if a written consent setting forth the action so taken is signed by the
holders of a majority of the outstanding shares of stock entitled to be voted
with respect to the subject matter thereof. Upon this corporation's becoming a
Public Company (as defined below), actions of the stockholders may be taken only
at a meeting thereof and may not be taken by written consent. This corporation
shall be a "Public Company" upon the earliest of (a) a vote by the Board of
Directors referencing this Article 11 and designating this corporation a Public
Company, (b) when a registration statement filed by this corporation under the
1933 Act, in connection with an offering of this corporation's securities to the
general public, first becomes effective, and (c) upon the effective date of the
registration of this corporation's securities pursuant to Section 12 of the
Securities Exchange Act of 1934, as amended. Upon this corporation's becoming a
Public Company, the Board of Directors may, at its discretion and without a vote
of the stockholders of this corporation, cause the modification of this Article
13 to cause the elimination of the provisions of this Article 13 that are no
longer operative and in effect by reason of this corporation's becoming a Public
Company and make such clerical amendments to this Article 13 that become
effective upon this corporation's becoming a Public Company.
ARTICLE 14. ANTITAKEOVER PROVISIONS
This corporation's Board of Directors shall have the broadest possible
authority and discretion in adopting and maintaining resistance to, and defenses
against, takeover bids that it deems not to be in the best interests of this
corporation, including, without limitation, adopting and maintaining any form of
stockholder rights plan or "poison pill" comprised of such terms and features as
the Board deems to be in the best interests of this corporation. Without
limiting the foregoing, the Board shall have the authority and discretion to
adopt and maintain a stockholder rights plan or other defensive mechanism that
may be deactivated or redeemed only (a) by vote of continuing directors (i.e.,
the directors who put such stockholder rights plan or other defensive mechanism
in place or the designated successors of such directors) to the exclusion of
newly elected directors nominated or supported by a takeover bidder or bidders,
(b) after a prescribed delay period following election of directors making up a
majority of the Board if such new directors are nominated or supported by a
takeover
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bidder or bidders, or (c) before election of directors making up a majority of
the Board if such new directors are nominated or supported by a takeover bidder
or bidders.
No bylaw shall limit in any way the authority of this corporation's board
of Directors to adopt or maintain any stockholder rights plan or otherwise to
resist or defend against any takeover bid that the Board finds not to be in the
best interests of this corporation.
[THIS SPACE INTENTIONALLY LEFT BLANK]
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IN WITNESS WHEREOF, the undersigned has executed this document and affirms,
under penalties of perjury, that the statements herein are true and that this
instrument is the act and deed of WatchGuard Technologies, Inc. as of this 7th
day of July, 1999.
WATCHGUARD TECHNOLOGIES, INC.
By /s/ CHRISTOPHER G. SLATT
-------------------------
Christopher G. Slatt, President and CEO
ATTEST:
/s/ STEVEN N. MOORE
- --------------------
Steven N. Moore, Secretary
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EXHIBIT 5.1
[PERKINS COIE LLP LETTERHEAD]
July 8, 1999
WatchGuard Technologies, Inc.
316 Occidental Avenue South, Suite 200
Seattle, WA 98104
Ladies and Gentlemen:
We have acted as counsel to you in connection with the proceedings for the
authorization and issuance by WatchGuard Technologies, Inc. (the "Company") of
up to 3,500,000 shares (the "Firm Shares") of the Company's Common Stock, $.001
par value per share (the "Common Stock"), together with up to an additional
525,000 shares of Common Stock if and to the extent the underwriters exercise an
over-allotment option granted by certain of the Company's stockholders (the
"Selling Stockholders") (the "Option Shares" and, together with the Firm Shares,
the "Shares"), and with the preparation and filing of a registration statement
on Form S-1 (the "Registration Statement") under the Securities Act of 1933, as
amended (the "Securities Act"), which you are filing with the Securities and
Exchange Commission with respect to the Firm Shares and the Option Shares.
We have examined the Registration Statement and such documents and records
of the Company and other documents as we have deemed necessary for the purpose
of this opinion. Based upon the foregoing, we are of the opinion that upon the
happening of the following events:
(a) the effectiveness of the Registration Statement and any amendments
thereto,
(b) due execution by the Company and registration by its registrar of the
Firm Shares and, to the extent the underwriters exercise their over-
allotment option, the Option Shares,
(c) due action by the Selling Stockholders authorizing the sale of the
Option Shares,
<PAGE>
(d) the offering and sale of the Firm Shares and, to the extent the
underwriters exercise the over-allotment option, the Option Shares, as
contemplated by the Registration Statement and the Underwriting
Agreement and in accordance with the resolutions of the Board of
Directors of the Company authorizing the sale and issuance of the Firm
Shares and the aforesaid Stockholder authorizations, and
(e) receipt by the Company of the consideration required for the Firm
Shares to be sold by the Company as contemplated by the Registration
Statement and the Underwriting Agreement, and to the extent the
underwriters exercise their over-allotment option, receipt by the
Selling Stockholders of the consideration required for the Option
Shares to be sold by the Selling Stockholders as contemplated by the
Registration Statement and the Underwriting Agreement,
the Firm Shares and, to the extent the underwriters exercise their over-
allotment option, the Option Shares, will be duly authorized, validly issued,
fully paid and nonassessable.
We hereby consent to the filing of this opinion as an exhibit to the
Registration Statement and any amendment thereto, including any and all post-
effective amendments and any registration statement relating to the same
offering that is to be effective upon filing pursuant to Rule 462(b) under the
Securities Act, and to the reference to our firm in the Prospectus of the
Registration Statement under the heading "Legal Matters". In giving such
consent, we do not thereby admit that we are in the category of persons whose
consent is required under Section 7 of the Securities Act.
Very truly yours,
/s/ PERKINS COIE
-2-
<PAGE>
EXHIBIT 10.12
LOAN MODIFICATION AGREEMENT
BETWEEN: WatchGuard Technologies, Inc., a Delaware corporation ("Borrower"),
whose address is 316 Occidental Avenue South, Suite 300, Seattle, WA
98104;
AND: Silicon Valley Bank ("Silicon"), whose address is 3003 Tasman Drive,
Santa Clara, California 95054;
DATE: June 29, 1999
This Loan Modification Agreement is entered into on the above date by
Borrower and Silicon.
1. Background. Borrower entered into a Loan and Security Agreement with
----------
Silicon in August, 1997, an Amended and Restated Loan and Security Agreement
dated as of March 20, 1998, a Loan Modification Agreement dated as of September,
1998, and a Loan Modification Agreement dated as of May, 1999 (as amended from
time to time, the "Loan Agreement"). Capitalized terms used in this Loan
Modification Agreement shall, unless otherwise defined in this Agreement, have
the meaning given to such terms in the Loan Agreement.
Silicon and Borrower are entering into this Agreement to state the terms
and conditions of certain modifications to the Loan Agreement and the Schedule,
as amended prior to the date of this Agreement.
2. Modifications to Loan Agreement and Schedule.
--------------------------------------------
2.1. The Schedule to the Loan Agreement is hereby deleted and
replaced by the Amended and Restated Schedule to Loan and Security
Agreement attached to this Agreement.
3. Conditions Precedent. This Loan Modification Agreement shall not take
--------------------
effect until Borrower delivers to Silicon (i) a Certified Resolution of
Borrower, (ii) such other documents as Silicon shall reasonably require to give
effect to the terms of this Loan Modification Agreement, and (iii) payment for
all fees and expenses associated with the modifications, including, but not
limited to, all outstanding legal fees.
4. No Other Modifications. Except as expressly modified by this Loan
----------------------
Modification Agreement, the terms of the Loan Agreement, as amended prior to the
date of this Loan Modification Agreement, shall remain unchanged and in full
force and effect. Silicon's agreement to modify the Loan Agreement pursuant to
this Loan Modification Agreement shall not obligate Silicon to make any future
modifications to the Loan Agreement or any other loan document. Nothing in this
Loan Modification Agreement shall constitute a satisfaction of any indebtedness
of any Borrower to Silicon. It is the intention of Silicon and Borrower to
retain as liable parties all makers and endorsers of the Loan Agreement or any
other loan document. Except as provided in the Amended and Restated Schedule to
Loan and Security Agreement attached to this Agreement, no maker, endorser, or
guarantor shall be released by virtue of this Loan Modification Agreement. The
terms of this paragraph shall apply not only to this Loan Modification
Agreement, but also to all subsequent loan modification agreements.
5. Representations and Warranties.
------------------------------
5.1. The Borrower represents and warrants to Silicon that the
execution, delivery and
Page 1 - LOAN MODIFICATION AGREEMENT
<PAGE>
performance of this Agreement are within the Borrower's corporate powers, and
have been duly authorized and are not in contravention of law or the terms of
the Borrower's articles of incorporation, bylaws or of any undertaking to which
the Borrower is a party or by which it is bound.
5.2. The Borrower understands and agrees that in entering into this
Agreement, Silicon is relying upon the Borrower's representations, warranties
and agreements as set forth in the Loan Agreement and other loan documents.
Borrower hereby reaffirms all representations and warranties in the Loan
Agreement, all of which are true as of the date of this Agreement.
Borrower:
WATCHGUARD TECHNOLOGIES, INC.
By: /s/ Steven Moore
---------------------------
Title: Chief Financial Officer
------------------------
Silicon:
SILICON VALLEY BANK
By: /s/ Carolyn Grant
---------------------------
Title: Vice President
------------------------
Page 2 - LOAN MODIFICATION AGREEMENT
<PAGE>
AMENDED AND RESTATED SCHEDULE TO LOAN AND SECURITY AGREEMENT
Borrower: WatchGuard Technologies, Inc.
Date: June 29, 1999
SECURED BRIDGE LOAN FACILITY
Credit Limit: This Bridge Loan shall be available in three tranches:
1. "Tranche One" in the amount of $1,000,000 was previously
made available to Borrower;
2. "Tranche Two" in the amount of $1,250,000 shall be
available upon receipt of comments from the Securities and
Exchange Commission regarding Borrower's registration
statement, provided that such comments are deemed
satisfactory to Silicon, in its sole discretion; and
3. "Tranche Three" in the amount of $2,000,000 shall be
available immediately upon closing of this Loan
Modification, and receipt by Silicon of the guarantees of
certain investors in Borrower.
This is a revolving credit facility and Borrower may borrow,
repay and re-borrow under this facility so long as the amount
outstanding does not exceed the credit limit, the Borrower is
not in default, and the facility has not matured.
Interest Rate: The interest rate applicable to this Loan shall be a rate equal
to the "Prime Rate" in effect from time to time, plus 2.00%.
Interest calculations shall be made on the basis of a 360-day
year and the actual number of days elapsed. "Prime Rate" means
the rate announced from time to time by Silicon as its "prime
rate"; it is a base rate upon which other rates charged by
Silicon are based, and it is not necessarily the best rate
available at Silicon. The interest rate applicable to the
Obligations shall change on each date there is a change in the
Prime Rate.
Commitment Fee: 1.5% of Tranche One and Tranche Two ($33,750 in the aggregate),
with such amounts to be due and payable in full upon the
initial advance under each tranche. For Tranche Three, $40,000,
due and payable in full upon execution of this Loan
Modification Agreement, plus an additional $30,000 if this
Bridge Loan is not repaid in full on or before the Maturity
Date. (This pricing Arrangement shall not constitute a
commitment to extend the Maturity Date beyond August 26, 1999.)
Maturity Date: The earlier of (i) two (2) business days after the date of
closing and funding of Borrower's initial public offering
("IPO"), or (ii) August 26, 1999.
Warrants: A warrant to purchase common shares in the following amounts:
(i) 2,250 shares to be granted, contemporaneous with "Tranche
One" at either the IPO price, or, if the IPO is not closed by
July 31, 1999, the current option price; and (ii) 2,750 shares
to be granted, contemporaneous with "Tranche Two: at either the
IPO
Page 1 - AMENDED AND RESTATED SCHEDULE TO LOAN AND SECURITY AGREEMENT
<PAGE>
price, or, if the IPO is not closed by July 31, 1999, the
current option price. If this Secured Bridge Loan Facility is
not paid in full by the Maturity Date, in addition to any other
remedies Silicon may have, Silicon shall receive an additional
warrant to purchase 1,000 shares for the "Tranche One" loan, if
"Tranche Two" is utilized, an additional 1,250 shares, with all
post-maturity warrants priced at either the IPO price per
share, or, if the IPO does not close by July 31, 1999, the
current option price per share. Borrower shall exercise and
deliver such warrant to Silicon upon execution of the Loan
Modification Agreement, and it shall be returned to Borrower
unexercised if the Secured Bridge Loan Facility is paid in full
by the Maturity Date.
SECURED ACCOUNTS RECEIVABLE LINE OF CREDIT
Credit Limit: An amount not to exceed the lesser of: (i) $3,500,000 at any
one time outstanding; or (ii) the amount of the "Borrowing
Base," as defined below. The maximum amount as provided in (i)
above shall be increased to $4,500,000 upon closing of
Borrower's initial public offering ("IPO"). ("Closing," for
purposes of this Agreement, shall mean the date upon which the
proceeds of Borrower's IPO are disbursed to Borrower.) For
purposes of this Schedule, the "Borrowing Base" shall mean (i)
75% of the Net Amount of Borrower's eligible domestic accounts
receivable, and (ii) 50% of the Net Amount of Borrower's
eligible foreign accounts receivable. With respect to
Borrower's accounts, "Net Amount" means the gross amount of the
account, minus all applicable sales, use, excise and other
similar taxes and minus all discounts, credits and allowances
of any nature granted or claimed.
Without limiting the fact that the determination of which
accounts are eligible for borrowing is a matter of Silicon's
discretion, the following shall not be deemed eligible for
borrowing: accounts in which Silicon does not have a first
priority, perfected security interest; accounts outstanding for
more than 90 days from the invoice date, accounts subject to
any contingencies, accounts owing from an account debtor
outside the United States, accounts owing from governmental
agencies, accounts owing from one account debtor to the extent
they exceed 25% of the total eligible accounts outstanding,
accounts owing from an affiliate of the Borrower, and accounts
owing from an account debtor to whom the Borrower is or may be
liable for goods purchased from such account debtor or
otherwise. Accounts owing from About Communications, Data
Construction, Wick Hill (operations in France, Germany, and
Great Britain), Otsuka Shokai, Unitech, Etek, GG Data, GEC
Alstom, Linn, Magenta, Metro Link, Oriel, Performance
Networking, Quaternaire, and Softnet shall be eligible as
foreign accounts receivable for Borrowing Base purposes,
subject to an advance rate of 50%. In addition, if more than
50% of the accounts owing from an account debtor are
outstanding more than 90 days from the invoice date or are
otherwise not eligible accounts, then all accounts owing from
that account debtor shall be deemed ineligible for borrowing.
Interest Rate: The interest rate applicable to this Loan shall be a rate equal
to the "Prime Rate" in effect from time to time, plus 0.50% per
annum.
Page 2 - AMENDED AND RESTATED SCHEDULE TO LOAN AND SECURITY AGREEMENT
<PAGE>
Interest calculations shall be made on the basis of a 360-day
year and the actual number of days elapsed. "Prime Rate" means
the rate announced from time to time by Silicon as its "prime
rate"; it is a base rate upon which other rates charged by
Silicon are based, and it is not necessarily the best rate
available at Silicon. The interest rate applicable to the
Obligations shall change on each date there is a change in the
Prime Rate.
Commitment Fee: No new fee.
Maturity Date: September 30, 1999, at which time all unpaid principal and
accrued but unpaid interest shall be due and payable.
SECURED EQUIPMENT TERM LOAN
Credit Limit: An initial amount not to exceed the lesser of (i) $250,000 at
any one time outstanding; or (ii) the amount of the "Equipment
Borrowing Base", as defined below. For purposes of this
Schedule, the "Equipment Borrowing Base" meant 80% of the
invoice value of equipment purchased by Borrower. Silicon had
no obligation to advance against taxes, freight charges,
installation charges or other similar amounts relating to
Borrower's equipment, whether or not such amounts were
identified on the invoices submitted to Silicon. Equipment
included in the Equipment Borrowing Base was required to be new
equipment, at the time of purchase by Borrower, owned by
Borrower, in good working order, was required to be subject to
any liens in favor of any person or entity other than Silicon,
and was required to be subject to a first priority, perfected
security interest in favor of Silicon. Silicon had no
obligation to make advances against non-standard equipment,
such as tooling, software and custom equipment. Silicon had no
obligation to make advances on this Secured Equipment Term Loan
after March 5, 1998. The Borrower's indebtedness to Silicon
with respect to this Secured Equipment Term Loan shall be
evidenced by this Schedule and the Loan Agreement, not by a
separate promissory note unless required by Silicon. There was
approximately $132,900 in principal outstanding under this
facility as of June 23, 1999.
Borrower shall not have the right to reborrow any amount on
this Secured Equipment Term Loan that has been repaid by
Borrower. The unpaid principal balance owing on this Secured
Equipment Term Loan at any time may be evidenced by Silicon's
internal records, including daily computer print-outs (which
Silicon shall provide to Borrower periodically).
Purpose: Borrowers used the proceeds of this Secured Equipment Term Loan
to finance the purchase of new equipment.
Interest Rate: The interest rate applicable to the Secured Equipment Term Loan
shall be a rate equal to the "Prime Rate" (as defined above) in
effect from time to time, plus 1.5% per annum. Interest
calculations shall be made on the basis of a 360-day year and
the actual number of days elapsed. The interest rate applicable
to the Obligations shall change on each date there is a change
in the Prime Rate.
Page 3 - AMENDED AND RESTATED SCHEDULE TO LOAN AND SECURITY AGREEMENT
<PAGE>
Amortization: Borrower shall pay Silicon monthly payments of interest only on
the last day each month. In addition, Borrower shall pay
Silicon on the last day of each month, commencing with April 5,
1998, the amount necessary to repay fully the amount of the
Secured Equipment Term Loan in 36 equal monthly payments.
Maturity Date: March 5, 2001, at which time all unpaid principal and accrued
but unpaid interest, fees and other charges shall be due and
payable.
Commitment
Fee: No new fee.
SECURED EQUIPMENT TERM LOAN NO. 2
Credit Limit: An initial amount not to exceed the lesser of (i) $500,000 at
any one time outstanding; or (ii) the amount of the "Equipment
Borrowing Base", as defined below. For purposes of this
Schedule, the "Equipment Borrowing Base" meant 90% of the
invoice value of equipment purchased by Borrower. Silicon had
no obligation to advance against taxes, freight charges,
installation charges or other similar amounts relating to
Borrower's equipment, whether or not such amounts were
identified on the invoices submitted to Silicon. However, in
the case of the $140,000 ONYX System purchase, the Equipment
Borrowing Base included software, installation and costs.
Equipment included in the Equipment Borrowing Base was required
to be new equipment at the time of purchase by Borrower, owned
by Borrower, in good working order, not subject to any liens in
favor of any person or entity other than Silicon, and subject
to a first priority, perfected security interest in favor of
Silicon. Silicon had no obligation to make advances against
non-standard equipment, such as tooling, software and custom
equipment. Silicon had no obligation to make advances on this
Secured Equipment Term Loan No. 2 after December _____, 1998.
The Borrower's indebtedness to Silicon with respect to this
Secured Equipment Term Loan No. 2 shall be evidenced by this
Schedule and the Loan Agreement, not by a separate promissory
note unless required by Silicon. There was approximately
$371,800 in principal outstanding under this facility as of
June 23, 1999.
Borrower shall not have the right to reborrow any amount on
this Secured Equipment Term Loan No. 2 that has been repaid by
Borrower. The unpaid principal balance owing on this Secured
Equipment Term Loan No. 2 at any time may be evidenced by
Silicon's internal records, including daily computer print-outs
(which Silicon shall provide to Borrower periodically).
Purpose: Borrowers used the proceeds of this Secured Equipment Term Loan
No. 2 to finance the purchase of new equipment.
Interest Rate: The interest rate applicable to the Secured Equipment Term Loan
No. 2 shall be a rate equal to the "Prime Rate" (as defined
above) in effect from time to time, plus 1.00% per annum.
Interest calculations shall be made on the basis of a 360-day
year and the actual number of days elapsed. The interest rate
applicable to the Obligations shall change on each date there
is a change in the Prime Rate.
Page 4 - AMENDED AND RESTATED SCHEDULE TO LOAN AND SECURITY AGREEMENT
<PAGE>
Amortization: Borrower shall pay Silicon monthly payments of interest only on
the last day each month. In addition, Borrower shall pay
Silicon on the last day of each month, commencing with January
31, 1999, the amount necessary to repay fully the amount of the
Secured Equipment Term Loan No. 2 in 36 equal monthly payments.
Maturity Date: December 31, 2001, at which time all unpaid principal and
accrued but unpaid interest, fees and other charges shall be
due and payable.
Commitment
Fee: No new fee.
Prior Names of
Borrower: See attached Exhibit B
Trade Names of
Borrower: See attached Exhibit B
Trademarks of
Borrower: See attached Exhibit B
Other Locations
and Addresses: See attached Exhibit B
Material Adverse
Litigation: See attached Exhibit B
Financial
Covenants: The Borrower shall at all times, beginning upon the earlier of
(i) August 26, 1999, or (ii) the Closing of Borrower's IPO,
comply with all of the following covenants, all of which shall
be determined and measured on a monthly basis in accordance
with generally accepted accounting principles, on a
consolidated basis with any subsidiary of Borrower, except as
otherwise stated below:
Tangible Net
Worth: Borrower shall at all times maintain a Tangible Net Worth of
not less than $4,000,000.
Profitability: Borrower shall not incur a loss (as defined below) in excess of
$1,500,000 for each month. For purposes of this paragraph,
"loss" means net income after taxes of less than $0.00, as
reported on Borrower's financial statements.
Quick Ratio: Borrower shall maintain a ratio of Quick Assets (defined below)
to current liabilities less deferred revenue of not less than
1.50:1.0.
Liquidity: Borrower shall at all times maintain a minimum Term Liquidity
Coverage of at least 1.75:1.0.
Definitions: "Quick Assets" means cash on hand or on deposit in banks,
readily marketable securities issued by the United States,
readily marketable commercial paper rated
Page 5 - AMENDED AND RESTATED SCHEDULE TO LOAN AND SECURITY AGREEMENT
<PAGE>
"A-I" by Standard & Poor's Corporation (or a similar rating by
a similar rating organization), certificates of deposit and
banker's acceptances, and accounts receivable (net of allowance
for doubtful accounts).
"Tangible Net Worth" means stockholders' equity plus debt, if
any, that has been subordinated to the Loans in a written
subordination agreement on terms satisfactory to Silicon, and
accrued interest thereon, less goodwill, patents, capitalized
software costs, deferred organizational costs, tradenames,
trademarks, and all other assets which would be classified as
intangible assets under generally accepted accounting
principles.
"Term Liquidity coverage" means (a) cash + cash equivalents
(readily marketable securities issued by the United States,
readily marketable commercial paper rated "A-I" by Standard &
Poors Corporation or a similar rating by a similar rating
organization, certificates of deposit and banker's acceptances)
+ availability under the Secured Accounts Receivable Line of
Credit divided by (b) the outstanding Secured Equipment Term
Loan and Secured Equipment Term Loan No. 2 balances.
Other Covenants: Borrower shall at all times comply with all of the following
additional covenants:
Banking Relationship. Borrower and its subsidiaries shall at
all times maintain their primary banking relationship with
Silicon. Neither Borrower nor its subsidiaries shall establish
any deposit accounts of any type with any bank or other
financial institution other than Silicon without Silicon's
prior written consent.
Financial Statements and Reports. The Borrower shall provide
Silicon: (a) within 30 days after the end of each month, a
monthly financial statement (consisting of a income statement
and a balance sheet) prepared by the Borrower in accordance
with generally accepted accounting principles; (b) within five
business days after the end of each month, an accounts
receivable aging report, an accounts payable aging report, and
an inventory schedule in such form as Silicon shall reasonably
specify; (c) within five business days after the end of each
month, a Borrowing Base Certificate in the form attached to
this Agreement as Exhibit A, as Silicon may reasonably modify
such Certificate from time to time, signed by the Chief
Financial Officer of the Borrower; (d) within 30 days after the
end of each month, a Compliance Certificate in such form as
Silicon shall reasonably specify, signed by the Chief Financial
Officer of the Borrower, setting forth calculations showing
compliance (at the end of each such calendar month) with the
financial covenants set forth on the Schedule, and certifying
that throughout such month the Borrower was in full compliance
with all other terms and conditions of this Agreement and the
Schedule, and providing such other information as Silicon shall
reasonably request; and (e) within 90 days following the end of
the Borrower's fiscal year, complete annual CPA-audited
financial statements, such audit being conducted by independent
certified public accountants reasonably acceptable to Silicon,
together with an unqualified opinion of such accountants. The
financial statements and reports described in sections (b) and
(c) above shall be due within five days of month-end until the
Secured Bridge Loan facility is paid in full, after which time
they shall be due within 30 days of month-end.
Page 6 - AMENDED AND RESTATED SCHEDULE TO LOAN AND SECURITY AGREEMENT
<PAGE>
Conditions to
Closing: Without in any way limiting the discretionary nature of
advances under this Agreement, before requesting any such
advance, the Borrower shall satisfy each of the following
conditions:
1. Loan
Documents:
Silicon shall have received this Agreement, the Schedule,
Warrants in a form satisfactory to Silicon, executed by the
Borrower, the guarantees of certain investors in Borrower, and
such other loan documents as Silicon shall require, each duly
executed and delivered by the parties thereto.
2. Documents
Relating to
Authority, Etc.:
Silicon shall have received each of the following in form and
substance satisfactory to it:
(a) Certified Copies of the Articles of Incorporation and
Bylaws of the Borrower;
(b) A Certificate of Good Standing issued by the Secretary of
State of the Borrower's state of incorporation and such other
states as Silicon may reasonably request with respect to the
Borrower;
(c) A certified copy of a Resolution adopted by the Board of
Directors of the Borrower authorizing the execution, delivery
and performance of this Agreement, and any other documents or
certificates to be executed by the Borrower in connection with
this transaction; and
(d) Incumbency Certificates describing the office and
identifying the specimen signatures of the individuals signing
all such loan documents on behalf of the Borrower.
3. Perfection
and Priority of
Security:
Silicon shall have received evidence satisfactory to it that
its security interest in the Collateral has been duly perfected
and that such security interest is prior to all other liens,
charges, security interests, encumbrances and adverse claims in
or to the Collateral other than Permitted Liens, which evidence
shall include, without limitation, a certificate from the
appropriate state agencies showing the due filing and first
priority of the UCC Financing Statements to be signed by the
Borrower covering the Collateral.
4. Insurance: Silicon shall have received evidence satisfactory to it that
all insurance required by this Agreement is in full force and
effect, with loss payee designations and additional insured
designations as required by this Agreement.
5. Other Information:
Page 7 - AMENDED AND RESTATED SCHEDULE TO LOAN AND SECURITY AGREEMENT
<PAGE>
Silicon shall have received such other statements, opinions,
certificates, documents and information with respect to matters
contemplated by this Agreement as it may reasonably request,
all of which must be acceptable to Silicon.
Silicon shall have conducted an examination of the Borrower's
books, records, ledgers, journals, and registers, as Silicon
may deem necessary, and shall be satisfied with the results of
such examination in its sole discretion.
Silicon and the Borrower agree that the terms of this Schedule supplement
the Loan and Security Agreement between Silicon and the Borrower and agree to be
bound by the terms of this Schedule.
Borrower:
WATCHGUARD TECHNOLOGIES, INC.
By: /s/ Steven Moore
--------------------------------
Title: Chief Financial Officer
-----------------------------
Silicon:
SILICON VALLEY BANK
By: /s/ Carolyn Grant
--------------------------------
Title: Vice President
-----------------------------
Page 8 - AMENDED AND RESTATED SCHEDULE TO LOAN AND SECURITY AGREEMENT
<PAGE>
EXHIBIT A
BORROWING BASE CERTIFICATE
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------
Borrower: WatchGuard Technologies, Inc. Lender: Silicon Valley Bank
316 Occidental Avenue South, Suite 300 3003 Tasman Drive
Seattle, WA 98104 Santa Clara, CA 95054
Commitment Amount:
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ACCOUNTS RECEIVABLE
1. Accounts Receivable Book Value as of _______ $__________
2. Additions (please explain on reverse) $__________
3. TOTAL ACCOUNTS RECEIVABLE $__________
ACCOUNTS RECEIVABLE DEDUCTIONS (without duplication)
4. Amounts over 90 days due $__________
5. Balance of 50% over 90 day accounts $__________
6. Credit balances $__________
7. Concentration Limits $__________
8. Foreign Accounts $__________
9. Governmental Accounts $__________
10. Contra Accounts $__________
11. Promotion or Demo Accounts $__________
12. Intercompany/Employee Accounts $__________
13. Other (please explain on reverse) $__________
14. TOTAL ACCOUNTS RECEIVABLE DEDUCTIONS $__________
15. Eligible Accounts (#3 minus #14) $__________
16. LOAN VALUE OF ACCOUNTS (75% of #15) $__________
BALANCES
17. Maximum Loan Amount $__________
18. Total Funds Available [Lesser of #17 or #16] $__________
19. Present balance owing on Line of Credit $__________
20. RESERVE POSITION (#18 minus #19) $__________
</TABLE>
The undersigned represents and warrants that this is true, complete and correct,
and that the information in this Borrowing Base Certificate complies with the
representations and warranties in the Loan and Security Agreement between the
undersigned and Silicon Valley Bank.
COMMENTS:
WATCHGUARD TECHNOLOGIES, INC.
By:__________________________
Name:________________________
Title:_______________________
Page 9 - AMENDED AND RESTATED SCHEDULE TO LOAN AND SECURITY AGREEMENT
<PAGE>
Exhibit B
---------
Tradenames
- ----------
WatchGuard Technologies (registered, waiting for final notification)
WatchGuard Firebox (accepted and reviewed, waiting for final notification)
Prior Names
- -----------
Seattle Software Labs
Trademarks
- ----------
[WatchGuard Logo]
Other Locations and Addresses
- -----------------------------
None
Material Adverse Litigation
- ---------------------------
None
<PAGE>
CONTINUING GUARANTY
Borrower: WatchGuard Technologies, Inc.
Guarantor: [Name of Guarantor]
Date: June 29, 1999
1. For valuable consideration, the undersigned ("Guarantor")
unconditionally guarantees and promises to pay to Silicon Valley Bank
("Silicon"), which has extended or may hereafter extend credit to the borrower
identified above (the "Borrower"), in lawful money of the United States, any and
all Indebtedness of Borrower to Silicon resulting from any drawdown by Borrower
on Tranche 3 on the Secured Bridge Loan facility of the Amended and Restated
Schedule to the Loan and Security Agreement, dated June 29, 1999, up to a
maximum amount of $_______. The word "Indebtedness" is used herein in its most
comprehensive sense and includes any and all advances, debts, obligations and
liabilities of Borrower or any one or more of them, heretofore, now, or
hereafter made, incurred or created, whether voluntary or involuntary and
however arising, whether direct or acquired by Silicon by assignment or
succession, whether due or not due, absolute or contingent, liquidated or
unliquidated, determined or undetermined, and whether Borrower may be liable
individually or jointly with others, or whether recovery upon such Indebtedness
may be or hereafter become barred by any statute of limitations, or whether such
Indebtedness may be or hereafter become otherwise unenforceable. "Indebtedness"
includes any amount Silicon receives from or on behalf of Borrower that Silicon
is required to repay at any time as a result of the insolvency, bankruptcy or
reorganization of Borrower. If more than one Guarantor executes this Continuing
Guaranty or another guaranty of Indebtedness, the liability of such Guarantors
shall be joint and several.
2. This is a guaranty of payment, not a guaranty of collection. It is not
necessary for Silicon to take any action to collect from Borrower or any other
person or entity prior to making demand on Guarantor.
3. This is a Continuing Guaranty relating to any Indebtedness described
above in section 1, including that arising under successive transactions which
shall either continue the Indebtedness or from time to time renew it after it
has been satisfied.
4. Guarantor waives the benefit of any statute of limitations affecting
its liability hereunder.
5. Guarantor authorizes Silicon, without notice or demand and without
affecting its liability hereunder, from time to time, either before or after
revocation hereof, to (a) renew, compromise, extend, accelerate or otherwise
change the time for payment of, or otherwise change the terms of the
Indebtedness or any part thereof, including increase or decrease of the rate of
interest thereon; (b) receive and hold security for the payment of this Guaranty
or the Indebtedness guaranteed, and exchange, enforce, waive, release, fail to
perfect, sell, or otherwise dispose of any such security; (c) apply such
security and direct the order or manner of sale thereof as Silicon in its
discretion may determine; and (d) release or substitute any one or more of the
endorsers or guarantors.
6. Guarantor waives any defense arising by reason of any disability or
other defense of Borrower, or any claim that Guarantor's obligations exceed or
are more burdensome than those of Borrower. Guarantor waives any and all
defenses, claims and damages arising from errors or omissions in Silicon's
administration of the Indebtedness guaranteed hereunder. Guarantor waives all
presentments, demands for performance, notices of nonperformance, protests,
notices of protest, notices of dishonor and notices of acceptance of this
Guaranty and of the existence, creation, or incurring of new or additional
Indebtedness.
Page 1 - CONTINUING GUARANTY
<PAGE>
7. Guarantor acknowledges and agrees that it shall have the sole
responsibility for obtaining from Borrower such information concerning
Borrower's financial condition or business operations as Guarantor may require,
and that Silicon has no duty at any time to disclose to Guarantor any
information relating to the business operations or financial condition of
Borrower.
8. It is not necessary for Silicon to inquire into the powers of Borrower
or of the officers, directors, partners or agents acting or purporting to act on
its behalf, and any Indebtedness made or created in reliance upon the professed
exercise of such powers shall be guaranteed hereunder.
9. Any and all rights of Guarantor under any and all debts, liabilities
and obligations owing from Borrower to Guarantor, including any security for and
guaranties of any such obligations, whether now existing or hereafter arising,
are hereby subordinated in right of payment to the prior payment in full of all
of the Indebtedness and to all liens and security interests of Silicon that
secure the Indebtedness. No payment in respect of any such subordinated
obligations shall at any time be made to or accepted by Guarantor if at the time
of such payment any Indebtedness is outstanding. If any Event of Default has
occurred, Borrower and any assignee, trustee in bankruptcy, receiver, or any
other person having custody or control over any or all of Borrower's property
are hereby authorized and directed to pay to Silicon the entire unpaid balance
of the Indebtedness before making any payments whatsoever to Guarantor, whether
as a creditor, shareholder, or otherwise; and insofar as may be necessary for
that purpose, Guarantor hereby assigns and transfers to Silicon all rights to
any and all debts, liabilities and obligations owing from Borrower to Guarantor,
including any security for and guaranties of any such obligations, whether now
existing or hereafter arising, including without limitation any payments,
dividends or distributions out of the business or assets of Borrower. Any
amounts received by Guarantor in violation of the foregoing provisions shall be
received and held as trustee for the benefit of Silicon and shall immediately be
paid over to Silicon to be applied to the Indebtedness in such order and
sequence as Silicon shall in its sole discretion determine, without limiting or
affecting any other right or remedy which Silicon may have hereunder or
otherwise and without otherwise affecting the liability of Guarantor hereunder.
Guarantor hereby expressly waives any right to set-off or assert any
counterclaim against Borrower.
10. Silicon may, without notice to Guarantor and without affecting
Guarantor's obligations hereunder, assign the Indebtedness and this Guaranty, in
whole or in part. Guarantor agrees that Silicon may disclose to any prospective
purchaser and any purchaser of all or part of the Indebtedness any and all
information in Silicon's possession concerning Guarantor, this Guaranty and any
security for this Guaranty.
11. Guarantor agrees to pay all attorneys' fees, the allocated costs of
Silicon's in-house counsel, and all other costs and expenses which may be
incurred by Silicon in the enforcement of this Guaranty, including without
limitation all costs and necessary disbursements in any legal action (at trial,
on appeal or on review) or arbitration proceeding.
12. This Guaranty shall be governed by and construed according to the laws
of the State of Washington.
Executed as of this 29th day of June 1999.
[NAME OF GUARANTOR]
By:_______________________
Its:______________________
Page 2 - CONTINUING GUARANTY
<PAGE>
Address for notices to Silicon:
SILICON VALLEY BANK
3003 Tasman Drive
Santa Clara, CA 95054
Address for notices to Guarantor:
Page 3 - CONTINUING GUARANTY
<PAGE>
Exhibit 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the reference to our firm under the captions "Selected
Financial Data" and "Experts" and to the use of our reports dated March 26,
1999 except as to Note 11, as to which the date is July 8, 1999, in the
Registration Statement (Form S-1 No. 333-76587) and related Prospectus of
WatchGuard Technologies, Inc. for the registration of 4,025,000 shares of its
common stock.
ERNST & YOUNG LLP
Seattle, Washington
July 9, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
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0
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<PAGE>
Exhibit 99.1
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
ON FINANCIAL STATEMENT SCHEDULE
We have audited the financial statements of WatchGuard Technologies, Inc. as
of December 31, 1997 and 1998, and the related statements of operations,
stockholders' equity, and cash flows for the period from February 14, 1996
(date of inception) to December 31, 1996 and for the years ended December 31,
1997 and 1998, and have issued our report thereon dated March 26, 1999, except
as to Note 11, as to which the date is July 8, 1999 (included elsewhere in this
Registration Statement). Our audits also included the financial statement
schedule listed in Item 16(b) of this Registration Statement. This schedule is
the responsibility of the Company's management. Our responsibility is to
express an opinion based on our audits.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
ERNST & YOUNG LLP
Seattle, Washington
March 26, 1999
