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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K/A
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 1999
OR
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
Commission file number 000-26819
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WATCHGUARD TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
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Delaware 91-1712427
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
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316 Occidental Avenue South, Suite 200, Seattle, WA 98104
(Address of principal executive offices)(zip code)
(206) 521-8340
Registrant's telephone number, including area code
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Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
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Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the voting stock held by nonaffiliates of the
registrant, based upon the closing sales price of the common stock on March 31,
2000 as reported on the Nasdaq National Market, was approximately
$1,004,111,190. Shares of common stock held by each officer and director and by
each person who owns 5% or more of the outstanding common stock have been
excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes.
As of March 31, 2000, there were 22,718,643 shares outstanding of the
registrant's common stock.
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WATCHGUARD TECHNOLOGIES, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
TABLE OF CONTENTS
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PART I
ITEM 1. BUSINESS...................................................... 3
ITEM 2. PROPERTIES.................................................... 30
ITEM 3. LEGAL PROCEEDINGS............................................. 30
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........... 30
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
SHAREHOLDER MATTERS........................................... 31
ITEM 6. SELECTED FINANCIAL DATA....................................... 32
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS..................................... 33
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.... 44
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................... 45
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE...................................... 66
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............ 66
ITEM 11. EXECUTIVE COMPENSATION........................................ 67
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.................................................... 71
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................ 73
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K...................................................... 73
SIGNATURES.............................................................. 75
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PART I
ITEM 1. BUSINESS
Forward-Looking Statements
Some of our statements in this annual report on Form 10-K 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 annual report. Our actual results could
differ materially from those anticipated in the forward-looking statements for
many reasons, including the risks described under "Factors Affecting Our
Operating Results, Our Business and Our Stock Price" contained in Part I, Item
1 of this annual report.
Overview
WatchGuard is a leading provider of Internet security solutions that protect
enterprises or telecommuters using the Internet for electronic commerce and
communications. Our core market is small- to medium-sized enterprises, or SMEs,
and we have recently expanded our marketing focus to include larger enterprises
as well as small offices and home offices, or SOHOs, and telecommuters,
particularly those using broadband Internet connections. According to
The Yankee Group, SMEs represent 98% of U.S. businesses, and account for
approximately 50% of the gross national product. SMEs are increasingly
utilizing the Internet to maintain a competitive advantage and to compete
effectively against enterprises with greater resources. International Data
Corporation, or IDC, estimated that, in the United States alone, approximately
3.5 million SMEs would 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, information alerts, expert editorials, support
flashes and virus alerts over the Internet, enabling enterprises 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 for SMEs
and larger enterprises features a firewall, encryption, user authentication,
virtual private networking, web surfing control and our LiveSecurity broadcast
service. In January 2000, we announced the introduction of our security
solutions for SOHOs and telecommuters, which we began shipping in the first
quarter of 2000. Our solutions for SOHOs and telecommuters will feature a
firewall, virtual private networking, Internet protocol, or IP, sharing and our
LiveSecurity broadcast service. We make installing, configuring and monitoring
our solutions easy with point-and-click security management.
With our recent acquisition of BeadleNet, LLC, which is discussed more fully
in Part II, Item 7, and the formation of our new broadband Internet security
division, we have expanded our product line to include security solutions for
SOHOs and telecommuters, particularly those individuals or SOHOs using
broadband Internet connections. We will market this expanded product line to
both SOHOs that operate as a stand-alone business and SOHOs and telecommuters
that act as a branch office or extension of a larger organization and share
corporate resources through remote access to their company's computing systems.
According to IDC, in the United States alone, approximately 10.9 million home
offices will have broadband Internet access at the end of 2000, up from an
estimated 636,000 at the end of 1998.
Our recently introduced higher-performance security appliance for larger
enterprises enables the WatchGuard LiveSecurity System to support up to 5,000
simultaneously authenticated users and over 50 simultaneously connected virtual
private networks, or VPNs, and delivers faster VPN throughput. The
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expanded capacity represents a ten-fold increase in the number of possible
connected users and a five-fold increase in VPN throughput as compared to our
security appliance designed for SMEs. This higher-performance security
appliance, combined with our new security solution designed for SOHOs and
telecommuters and our existing SME security solution, will allow us to offer
larger enterprises integrated solutions to protect the main office, large and
small branch offices, and employees who telecommute.
Our LiveSecurity solution gives enterprises a security management choice. An
enterprise can manage its own Internet security through our LiveSecurity System
or outsource its 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 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 310 distributors and resellers
covering 54 countries. We have established relationships with a number of ISPs
to implement LiveSecurity for MSS, including AlphaNet Solutions, Inc., AT&T
Asia/Pacific Group Ltd., GTE Internetworking, Inc., Internet Initiative Japan,
Internet Security Systems, Inc., Interpath Communications, Inc., MIS Corporate
Defense Solutions, Nextcom K.K., PSINet Inc., sunrise communications AG, Verio,
Inc. and You Tools Corporation/FASTNET. As of December 31, 1999, we had shipped
over 12,000 of our security appliances.
We initially incorporated in Washington in 1996 and reincorporated in
Delaware in 1997. References to "we," "our," "us" and "WatchGuard" in this
annual report 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 annual report.
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.
IDC estimates that there were over 38 million web users in the United States
and over 86 million worldwide at the end of 1997. IDC projects the number of
web users to increase to over 177 million users in the United States and 502
million worldwide by the end of 2003. IDC also estimates that the number of
customers buying goods and services on the Internet will grow from
approximately 15 million worldwide in 1997 to 182 million in 2003, with the
value of electronic commerce transactions growing from $15 billion to over $1.3
trillion 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
enterprises. Enterprises are increasingly required to establish secure Internet
access to facilitate and support strategic business objectives. In a
marketplace that is becoming more competitive, enterprises 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
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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. With the advent of "always on" broadband Internet
connections that leave a user's computer much more vulnerable to security
breaches than a traditional dial-up connection, even SOHOs and telecommuters
face security threats similar to those faced by larger enterprises connected to
the Internet.
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.
Because enterprises 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. Enterprises
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 and SOHOs. 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, SOHOs and
individual telecommuters.
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 constantly. The Computer Emergency Response Team, a
federally funded research and development center, handled 8,268 security
incidents in 1999, an average of nearly one per hour and more than double the
3,734 security incidents handled in 1998. 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.
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The Internet security gap
The expense and complexity of traditional security solutions incorporating a
firewall puts protection out of the reach of millions of enterprises that do
not have the resources to adopt these solutions, contributing to a security
gap. Comprising 98% of U.S. businesses, SMEs exemplify this gap. Despite the
obvious and compelling reasons for Internet security, most SMEs on the Internet
do not even have a firewall.
IDC estimated that approximately 3.5 million SMEs in the United States would
be connected to the Internet by the end of 1999. IDC projected, however, that
from 1995, when IDC reports that firewalls first became widely available, until
the end of 1999, less than 450,000 firewalls would 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. SOHOs and telecommuters that adopt "always-on" broadband
Internet connections, particularly those accessing the corporate resources of a
larger enterprise, face a similar security threat but may have more limited
resources to dedicate to an Internet security solution.
Enterprises 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 enterprises
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.
The WatchGuard Solution
WatchGuard's LiveSecurity products and services offer a fundamentally new
approach to Internet security. We provide enterprises 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:
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Comprehensive, fully integrated For SMEs and larger enterprises, we offer a
security tailored to the needs of comprehensive security solution integrated
the user 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, (4) web surfing control
and (5) our LiveSecurity broadcast service.
Our recently announced solution for SOHOs
and telecommuters will offer a more
affordable, comprehensive and integrated
security solution that includes (1) a
firewall, (2) virtual private networking,
(3) IP sharing and (4) our LiveSecurity
broadcast service.
Dynamic protection Our subscription-based Internet broadcast
service is designed to keep our security
solutions up to date with (1) security
threat responses that specifically address
newly discovered security vulnerabilities or
hacker techniques, (2) software updates, (3)
information alerts concerning current news
in Internet security, (4) expert editorials
containing Internet security-related feature
articles, (5) support flashes with answers
to commonly asked questions about our
products and services
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and (6) virus alerts containing information about
the latest virus threats and access to Trend Micro's
virus protection products. Our SOHO and telecommuter
solutions will initially include only access to
security threat responses and software updates. We
expect to offer the remaining LiveSecurity broadcast
service channels as an option for SOHOs and
telecommuters in the second quarter of 2000.
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 our LiveSecurity
broadcasts.
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 enterprises can afford.
Affordability We minimize the overall ownership cost of our
security solution 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.
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Strategy
Our objective is to be the leading provider of Internet security systems and
services to enterprises worldwide. Our strategy to achieve this goal is based
on the following key elements:
Extend our SME market leadership position in comprehensive security into the
large-enterprise and SOHO/telecommuter markets.
We intend to maintain our leadership position in comprehensive security for
SMEs by expanding and enhancing our Internet security product and service
offerings. In September 1999, we introduced our security solution for larger
enterprises and, in January 2000, we announced the introduction of our new
security solutions for SOHOs and telecommuters, which we began shipping in the
first quarter of 2000. We expect to deliver new versions of our major products,
including products designed for the emerging broadband Internet connectivity
market, approximately two to three times per year. We were the first, and
remain the leader, in developing updatable security appliances that execute
software sent from a remote management system. Our architecture allows
enterprises to quickly and easily deploy new products and services from the
central management system, which utilizes a familiar Windows- or web-based
interface. Our distributed architecture also facilitates the scalability
necessary for ISPs to provide our products and services to their customers at a
price enterprises can afford. 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 enterprises to outsource their Internet
security management, we have established relationships with industry-leading
ISPs, including AlphaNet, FASTNET, GTE, Interpath, ISS, PSINet and Verio in the
United States, MIS and sunrise in Europe and AT&T Asia/Pacific Group Ltd., IIJ
and Nextcom 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
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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, information alerts, expert editorials and support
flashes 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:
. continued expansion of our rapid response team of internal security
experts;
. expansion of our LiveSecurity advisory council of industry experts,
including the addition of two outside experts by the end of 2000; and
. continued development of one to four third-party industry relationships
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.
Continue to expand WatchGuard brand awareness.
We believe that we have an opportunity to make the WatchGuard brand
synonymous with Internet security 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 enterprises with the goal of establishing www.watchguard.com as the first
location enterprises 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 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
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.
Continue to expand worldwide sales and distribution.
We intend to continue to expand our international distribution capabilities
to allow any enterprise with an Internet connection to purchase the WatchGuard
LiveSecurity solution, no matter where the enterprise 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 the continuing expansion of 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 solutions include an integrated suite of
security and management software, an Internet security appliance and a dynamic
broadcast service to keep security defenses current.
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Enterprises 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.
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.
Our LiveSecurity broadcast service enables enterprises 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.
SMEs and larger enterprises
For SMEs and larger enterprises, 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 for SMEs and larger enterprises
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 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.
. 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. Featuring logging and notification functions and real-time
monitoring and historical reporting of network, service and bandwidth
usage, our management tools 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 appliances for SMEs and larger enterprises,
the WatchGuard Firebox II, Firebox II Plus and Firebox II Plus with FastVPN,
are standalone Internet security appliances that run the security functions of
the LiveSecurity System. The security capabilities of these security appliances
come entirely from the operating system, security software and security
policies directed to them from the remote management software. They simply plug
in and reside between an enterprise's Internet router and its internal network
of servers and workstations. These Fireboxes have three independent, separately
monitored connections: one to the enterprise's network, one to the Internet and
one to the enterprise's public network for
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hosting web and email servers. The LiveSecurity System encrypts communications
between the security appliance 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.
. Expert editorials. Our team of industry-leading security advisors offer
their views and provide continuing education on the rapidly changing
field of Internet security.
. Support flashes. Interactive technical tutorials provide our customers
with answers to frequently asked questions about managing the
LiveSecurity System and information about new software updates.
. Virus alerts. Trend Micro provides information on the latest virus
threats and offers access to its virus protection products.
SOHOs and telecommuters
Our recently announced LiveSecurity System for SOHOs and telecommuters has
three key components: security and management software, our security appliance
and a subscription to our Internet-based broadcast service.
Security features. The LiveSecurity System for SOHOs and telecommuters
contains the following security features:
. Firewall. Our firewall controls incoming and outgoing traffic between
the Internet and a SOHO's or telecommuter's systems and data. The
firewall incorporates access control, detection and blocking features
and IP sharing.
. Virtual private networking. Our software enables SOHOs and telecommuters
to create virtual private networks by using encryption technology to
allow data to flow securely across the Internet between two
predetermined points.
Management features. Our web-based security management software manages and
monitors the SOHO's or telecommuter's Internet security with an intuitive,
point-and-click user interface.
. Integrated suite of system management tools. Our web-based security
management system packages, configures and deploys security software,
security policies and the operating system to a SOHO's or telecommuter's
security appliance.
. Automated installation guide. Our automated installation guide enables a
SOHO or telecommuter to install our system and define a security policy
in as quickly as 15 minutes.
Security appliance. Our security appliances for SOHOs and telecommuters, the
WatchGuard Firebox SOHO and Firebox Telecommuter, are standalone Internet
security appliances that run the security functions of the LiveSecurity System.
The security capabilities of these security appliances come entirely from the
operating system, security software and security policies directed to them from
the remote management software. They
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simply plug in and reside between the SOHO's or telecommuter's Internet router
and cable or digital service line modem and its internal network of servers and
workstations. These Fireboxes have two independent, separately monitored
connections: one to the SOHO's or telecommuter's network and one to the
Internet.
Broadcast service. We will keep our SOHO and telecommuter security solutions
current and our customers informed through a subscription-based broadcast
service that initially will transmit over the Internet to the SOHO manager's or
telecommuter's desktop computer the threat response and software update
channels of our LiveSecurity broadcast service for SMEs and larger enterprises.
We expect to offer the remaining channels of our LiveSecurity broadcast service
as an option for SOHOs and telecommuters in the second quarter of this year.
LiveSecurity for MSS for Internet service providers
To serve the needs of SMEs and larger 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. We expect to introduce a
LiveSecurity for MSS solution for SOHOs and telecommuters in the second quarter
of 2000. 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.
LiveSecurity for MSS has three main components: our network operations center
security suite software with security and management features, our security
appliances and our LiveSecurity broadcast service. In addition, we offer
optional monitoring software for the ISP's customers.
Security features. LiveSecurity for MSS includes the same comprehensive set
of security features offered with our LiveSecurity System for SMEs and larger
enterprises.
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,
information alerts, expert editorials and support flashes. 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;
. define and implement professional, customized Internet security
policies;
. automatically install software updates and threat responses;
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. 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 or access 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 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 using technologies such as
digital certificates and public key encryption or emails containing links to
the secured broadcast server.
LiveSecurity for MSS. Our scalable network operations center, or 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 December 31, 1999, we had 21 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 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 LiveSecurity 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 and editorials on the rapidly changing subject of Internet
security. The council also oversees and contributes to the
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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 email
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 SME, larger enterprise, SOHO or telecommuter purchasing our
LiveSecurity System, we include in the system price a perpetual license for the
security and management software. Each end-user also receives a renewable one-
year subscription to our LiveSecurity broadcast service, through which it
receives threat responses, software updates, information alerts, expert
editorials and support flashes.
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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<PAGE>
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 for SMEs $ 4,990
Security management system software
Firebox II security appliance
12-month LiveSecurity subscription
--------------------------------------------------------------
Live Security System for larger enterprises $ 9,990
Security management system software (Firebox II Plus)
Firebox II Plus security appliance
Firebox II with VPN accelerator security $ 12,990
appliance (Firebox II with FastVPN)
12-month LiveSecurity subscription
--------------------------------------------------------------
LiveSecurity System Live Security System for SOHOs $ 449
Web-based management and security software
Firebox SOHO security appliance (10 users)
Firebox Telecommuter security appliance
12-month LiveSecurity subscription
--------------------------------------------------------------
Firebox SOHO user-capability upgrades
25 users $ 198
50 users $ 449
Firebox SOHO VPN $ 449
--------------------------------------------------------------
LiveSecurity System for telecommuters $ 649
Web-based management and security software
Firebox
Telecommuter security appliance
12-month LiveSecurity subscription
--------------------------------------------------------------
LiveSecurity subscription renewal
Firebox II $ 995
Firebox II Plus $ 1,495
SOHO $ 95
Telecommuter $ 65
- --------------------------------------------------------------------------------
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 security appliance $ 1,300
--------------------------------------------------------------
Firebox II Plus for MSS security appliance $ 2,900
--------------------------------------------------------------
LiveSecurity for MSS Firebox II Plus for MSS with VPN accelerator $ 4,400
security appliance
--------------------------------------------------------------
MSS technical 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>
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<PAGE>
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. We currently sell our products and
services in 54 countries. International sales generated over 35% of our
revenues in 1998 and 50% of our revenues in 1999.
We sell our LiveSecurity System through distributors and value-added
resellers. We may also sell some Firebox SOHO and Firebox Telecommuter products
through retail channels. We sell our LiveSecurity for MSS products and services
directly to ISPs, which resell our products and services to end-users. Over 310
companies resell our products and services, including
. distributors, such as Eltrax Systems, Inc., Fujitsu Business Systems,
Ltd., 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 AlphaNet, AT&T Asia/Pacific Group Ltd., FASTNET, GTE, IIJ,
Interpath, ISS, MIS, Nextcom, PSINet, sunrise and Verio.
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.
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
California, Colorado, Connecticut, Georgia, Illinois, Massachusetts, New
Jersey, Texas and Washington. Internationally, we have sales personnel located
in Argentina, Australia, Germany, Japan, the Netherlands, Sweden and the United
Kingdom. 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 December 31, 1999, we had 50 employees in our
sales and marketing organization.
As an additional sales tool, we offer end-users, resellers and distributors
free interactive training on our LiveSecurity System solutions through our web
site. Our interactive training system guides customers through the
installation, setup and management of the LiveSecurity System and provides new
product information.
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, historically we have earned a substantial portion of a
quarter's revenues during its last month.
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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,
FASTNET, Funk Software, IIJ, Interpath, ISS Group, Inc., Netrex, PSINet,
Rainbow Technologies, RSA Data Security, Inc., The Learning Company, Trend
Micro, WebTrends Corporation, Verio and Virtual Media.
Customers
As of December 31, 1999, we had shipped over 12,000 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:
Internet Service Media Retail
Providers KSTW-UPN 11 Television Norm Thompson
AlphaNet Solutions, Inc. Reader's Digest Outfitters, Inc.
AT&T Asia/Pacific Group Australia Rebel Sport Limited
Ltd. The Everett Herald
GTE Internetworking, University of Toronto Manufacturing
Inc. Press Bolle Inc.
Internet Initiative Durkan Patterned Carpet,
Japan, IIJ Technology Inc.
Internet Security AlphaBlox Corporation Ferguson
Systems, Inc. Inc. Metals/Aerospace
Interpath Bentley Systems, Alloys Inc.
Communications, Inc. Incorporated Graham Steel Corporation
MIS Corporate Defense e-DOCS.net J.E. Dunn Construction
Solutions JDA Software Group, Inc. Company
Nextcom KK Pentax Technologies The Mitchell Gold
PSINet Inc. Corporation Company
sunrise communications Sheridan Software
AG Systems, Inc. Government
Verio, Inc. City of Bellingham, WA
You Tools Corporation/ Education City of Dandenong,
FASTNET Boston Architectural Australia
Center City of Garden Grove, CA
Services Canon City Schools Lenoir County, NC
Boullioun Aviation Huntsville Intermediate Mornington Peninsula
Services School District Shire
Bull Housser & Tupper Summit Board of Council, Australia
Camp, Inc. Education North Carolina State
Catholic Charities Woodridge School Ports
Digital Magic District #68 Pierce County, WA
hawthorne direct inc. Library Service
Javelin Technology Financial Services
Atlantic Mortgage & Entertainment
Medical Investment Corp. Argosy Gaming Company
Bendigo Health Care Hudson Valley Federal Black Hawk Gaming &
Group Credit Union Development Company
CoreCare Systems, Inc. KDP Investment Advisors Crave Entertainment,
Health Technologies Pty McMahan Securities Co., Inc.
Ltd LP Everton Football Club
NeoTherapeutics, Inc. Seritis Services Group,
PATH LLC Utilities and
Southeast Alabama Sunflower Bank Telecommunications
Medical Center Globecomm Systems, Inc.
Unimed Pharmaceuticals, MACtel
Inc.
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Case Studies
The following are profiles of two 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 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 our 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
solutions come in two forms: solutions for SMEs and larger enterprises and
solutions for SOHOs and telecommuters.
LiveSecurity for SMEs and larger enterprises
Our LiveSecurity solution for SMEs and larger enterprises encrypts and
authenticates communications between WatchGuard, the management system software
and the security appliance. This allows the
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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 broadcasts over the
Internet.
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.
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 in-house manager using a standard Windows-based 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
through 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, information alerts, expert
editorials, support
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flashes and virus 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.
LiveSecurity for SOHOs and telecommuters
Our LiveSecurity solutions for SOHOs and telecommuters are based on a common
hardware and software architecture.
Security Appliance. Our SOHO and telecommuter security appliances use an
industry-standard MIPS processor, which is dedicated solely to running the
security functions. The security appliances have no other function and no hard
drive memory storage. These solutions provide network address translation and
port address translation, which allows a network to use a single IP address and
allows an Internet service provider to conserve IP addresses while still
accommodating local networks.
Operating System Software. Our SOHO and telecommuter solutions utilize
WindRiver's industry-standard VxWorks Real Time operating system. These
appliances' architecture includes data encryption hardware that allows high-
speed IPSec performance.
Security Features. Our SOHO and telecommuter solutions use the same industry-
compatible IPSec protocols found in our solutions for SMEs and larger
enterprises. The firewall is based on stateful packet inspection technology,
which allows the user to access the Internet without exposing the network to
external attacks. Our telecommuter solution includes virtual private networking
to allow the home-based employee to connect to the office via an encrypted,
secure channel. While our SOHO base product does not include virtual private
networking, it may be ordered as an option or obtained as an upgrade.
Management Features. We have designed our SOHO and telecommuter solutions for
very simple installation and configuration, using a web-based interface. We
anticipate that all telecommuter sites and many SOHO sites will require end-
user installation without the availability of information technology
professional support, and we have designed these products accordingly. In
addition, our SOHO and telecommuter solutions management interfaces allow
customers to immediately download updates into the product with minimal user
intervention. This process is protected with advanced cryptography and is tied
to the serial number of the appliance for additional security. Customers may
also order new features, such as additional user capability or virtual private
networking, from our web site.
Our SOHO and telecommuter products allow local configuration. The security
appliances may be managed with an Internet browser, such as Netscape Navigator
or Internet Explorer. The systems may also be configured to allow management by
one of our security solutions for SMEs or larger enterprises or, in the near
future, by an ISP using our LiveSecurity for MSS.
Subscription Services. In addition to accessing our LiveSecurity broadcasts,
SOHOs and telecommuters will be able to subscribe to our URL tracking service.
This service allows those persons supervising the use of Internet access, such
as parents or system administrators, to track sites visited by user, time of
visit, location, frequency of visits or other parameters.
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
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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 December 31, 1999, we employed 75 people on our research and
development staff. Research and development expenses were $2.2 million in 1997,
$4.4 million in 1998 and $7.1 million in 1999. We conduct our product
development activities related to our security solutions for SMEs and larger
enterprises at our principal facility in Seattle, Washington. We conduct our
product development activities related to our security solutions for SOHOs and
telecommuters at our broadband Internet security division in Laguna Hills,
California and at our facility in Seattle.
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.
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 competitors in
our industry are Cisco Systems, Inc., Check Point Software Technologies Ltd.
and Nokia Corporation. We expect the introduction of our SOHO and telecommuter
products to increase competition with SonicWALL Inc., a developer of security
appliances for SOHOs and home users. Other competitors offering security
products include hardware and software vendors such as Axent Technologies,
Inc., Lucent Technologies, Inc. and Network Associates, Inc., operating system
vendors such as Microsoft Corporation, Novell, Inc. and Sun Microsystems, Inc.
and a number of smaller companies.
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. In addition, our current and
potential competitors may establish cooperative relationships among themselves
or with third parties that may further enhance their resources, such as the
partnership between Check Point and Nokia. 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 appliance offering. Increased
competition in any of our markets 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;
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. 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 eight 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.
. 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.
. Internet Security Systems Inc. Internet scanner. We sell an OEM version
of this software as an optional scanning module for our LiveSecurity for
MSS ISP customers.
. WebTrends Corporation Inc. WebTrends for Firewalls and VPNs. We sell an
OEM version of this software as an optional reporting module for our
LiveSecurity for MSS ISP customers.
. US Software TCP/IP stack. We use a customized version of this basic
TCP/IP stack in source code form in our SOHO and telecommuter products.
. WindRiver VxWorks Real Time operating system. We use this operating
system in our SOHO and telecommuter products.
U.S. Government Export Regulation Compliance
Our products are subject to federal regulations governing the export of
encryption commodities and software. To comply with these regulations, we have
developed two versions of our products: one for the U.S. and Canadian markets
and one for international markets. Recent federal legislation, however, has
relaxed export controls on encryption. U.S. law now allows the export of
encryption commodities and software of any strength to nongovernmental end-
users located in any country except those designated as embargoed or otherwise
restricted by the U.S. government, subject to streamlined reporting
requirements. To satisfy these encryption export reporting requirements, we use
data gathered from end-users during product registration. Encryption
commodities and software previously approved for export by the federal Bureau
of Export Administration, or BXA, under an export license or encryption
licensing arrangement are immediately eligible for export under the revised
regulations without further technical review by the BXA. These commodities and
software include our branch office and remote user VPN software and the VPN
accelerator in our Firebox II Plus with FastVPN security appliance. Our Firebox
Telecommuter and Firebox SOHO products, which also utilize this encryption in
branch office VPN software, are currently under review by the BXA for retail
export status. If we obtain retail export status, we would be eligible to
export these products to all nonembargoed and nonrestricted foreign end-users,
including government entities. We anticipate a favorable ruling by the BXA for
export of the telecommuter and SOHO products as retail encryption commodities.
21
<PAGE>
Manufacturing
We currently outsource all hardware manufacturing and assembly for our
Firebox II product lines 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. For our Firebox
SOHO and Firebox Telecommuter product lines, we currently outsource all
hardware manufacturing and assembly to Productivity Enhancement Products, Inc.
in California. We then distribute the finished products worldwide from our
Seattle distribution center. All three manufacturers test our hardware to
confirm that all components function properly. All three manufacturers are
certified as meeting the International Organization for Standardization's
quality assurance standards: Smart Modular Technologies against ISO 9001 and
9002, Streamlined Electronics Manufacturing against ISO 9002 and Productivity
Enhancement Products against ISO 9001 and 9002.
Employees
As of December 31, 1999, we had 165 employees. Of these, 50 were employed in
sales and marketing, 19 in finance and administration, 21 in customer support
and 75 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.
Factors Affecting Our Operating Results, Our Business and Our Stock Price
In addition to the other information contained in this annual report, you
should carefully read and consider the following risk factors. If any of these
risks actually occur, our business, financial condition or operating results
could be adversely affected and the trading price of our common stock could
decline.
We have incurred losses since inception and may never be profitable, which
could result in a decline in the value of our common stock.
We expect our operating losses and negative cash flows to continue. Although
our revenues have increased each year since we began operations, we do not
believe that the historical percentage growth rate of our revenues will be
sustainable as our revenue base increases. Moreover, we currently expect to
increase our operating expenses significantly in connection with
. expanding into new geographic markets;
. expanding into new product markets;
. continuing to develop our technology;
. hiring additional personnel;
. relocating or expanding our corporate facilities in the next six to
eight months;
. upgrading our information and internal control systems; and
. pursuing potential strategic acquisitions.
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. We have incurred
net losses and experienced negative cash flows in each quarter since we began
doing business. As of December 31, 1999, we had an accumulated deficit of
approximately $29.9 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. For this reason, we believe that period-
to-period comparisons of our operating results are not
22
<PAGE>
meaningful. In addition, our limited operating history makes predicting our
future performance difficult. As a result of these factors, our operating
results for a particular quarter or year may fall below the expectations of
securities analysts and investors, which could result in a decrease in our
stock price.
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. A failure to so adjust our spending in time also
could cause operating results to fall below the expectations of securities
analysts and investors, resulting in a decrease in our stock price.
Seasonality and concentration of revenues at the end of the quarter could cause
our revenues to fall below the expectations of securities analysts and
investors, resulting in a decrease in our stock price.
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, historically we have earned a substantial portion of a
quarter's revenues during its last month. 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, resulting in a decrease in
our stock price.
Because many potential 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, SOHOs and
telecommuters, 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 our potential customers 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 potential customers do not accept our 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 relatively 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. Enterprises may be
unwilling to pay a subscription fee to keep their Internet security up to date.
Because our broadcast service is relatively new, we cannot predict the rate at
which our customers will renew their annual subscriptions. 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 relationships with ISPs are unsuccessful, our ability to market and sell
our products and services will be limited.
We expect a significant percentage of our revenues to be derived from our
relationships with domestic and international ISPs that implement our
LiveSecurity for MSS solution. If these ISPs are unsuccessful in
23
<PAGE>
marketing and implementing our LiveSecurity for MSS solution, our operating
results will be materially harmed. Because our relationships with ISPs are
relatively new, we cannot predict the degree to which the ISPs will succeed in
marketing and selling services based on our products and services. Many of the
ISPs with which we have established relationships have not had an opportunity
to fully develop and implement service offerings incorporating LiveSecurity. We
cannot predict how long our current or potential ISP partners 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 and services in combination with other products and services, some
of which may be competitive with our products and services.
If our third-party resellers and distributors fail to perform, our ability to
sell our products and services will be limited.
We sell most of 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 Firebox
II security appliance, we experienced an increase in returns of previous
products and product versions. Provisions for returns and allowances for the
years ended December 31, 1997, 1998 and 1999 were $0, $1,655,000 and
$1,083,000, or 0%, 13% and 5% 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. 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 competitors in our industry are Cisco Systems, Inc., Check Point
Software Technologies Ltd. and Nokia Corporation. We expect the introduction of
our SOHO and telecommuter products to increase competition with SonicWALL Inc.,
a developer of security appliances for SOHOs and home users. Other current and
potential competitors include hardware, software and operating system vendors
such as Axent Technologies, Inc., Lucent Technologies, Inc., Microsoft
Corporation, Network Associates, Inc., Novell, Inc., Sun Microsystems Inc. and
a number of smaller companies. Many of our competitors have longer operating
histories, greater name recognition, larger customer bases and significantly
greater financial, technical, marketing and other resources than we do. In
addition, our current and potential competitors have established or may
establish cooperative relationships among themselves or with third parties that
may further enhance their resources, such as the partnership between Check
Point and Nokia. As a result, they may be able to adapt more quickly to new
24
<PAGE>
technologies and customer 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. 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.
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 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.
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.
25
<PAGE>
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. 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. Although we believe that we could find other sources for
the technology we license, alternative technologies may be unavailable on
acceptable terms, if at all. We depend on our third-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 for each of our
SME and larger-enterprise solutions and our SOHO and telecommuter solutions to
single-source motherboard manufacturers and assembly houses. While the single-
source vendors for our SME and larger-enterprise products have produced
hardware with acceptable quality, quantity and cost in the past, they may be
unable to meet our future demands. Our relationships with the single-source
vendors for our SOHO and telecommuter products are new and unproven. Although
we believe that we could find another manufacturer and assembly house for each
of our product lines, 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.
26
<PAGE>
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 existing cash and cash
equivalents balances and our existing line of credit, including the net
proceeds from our public offering in February 2000, will 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;
. 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.
27
<PAGE>
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 some 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 U.S. and international Internet
security markets.
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.
If we do not expand our international operations and successfully overcome the
risks inherent in international business activities, the growth of our business
will be limited.
Our ability to grow will depend in part on the expansion of our international
sales and operations, which are expected to continue to account for a
significant portion of our revenues. Sales to customers outside of North
America accounted for approximately 56% of our net revenues in 1997, 35% in
1998 and 50% in 1999. The failure of our resellers and distributors to sell our
products internationally would limit our ability to increase our revenues. In
addition, our international sales are subject to the risks inherent in
international business activities, including
. cost of customizing products for foreign countries;
. export and import restrictions, such as those affecting encryption
commodities and software;
. difficulties in acquiring and authenticating customer information;
. reduced protection of intellectual property rights and increased
liability exposure; and
. regional economic and political conditions.
Our international sales currently are U.S. dollar-denominated. As a result, an
increase in the value of the U.S. dollar relative to foreign currencies could
make our products less competitive in international markets.
Undiscovered year 2000-related computer problems could disrupt our operations.
We believe that the current versions of the internally developed software
technologies incorporated in our products and services, as well as our internal
management and other administrative and external information systems, are year
2000 compliant. When the century changed, we experienced no disruption to our
business operations and no product failures as a result of year 2000 compliance
issues or otherwise. Nonetheless, some year 2000 problems may not appear until
several months after January 1, 2000. As a result, we may still face claims 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. In addition, if
our suppliers, vendors or distributors encounter year 2000 software, firmware
and hardware problems, our ability to deliver our products and services could
be disrupted.
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The integration of BeadleNet, LLC and any future acquisitions may be difficult
and disruptive.
In October 1999, we acquired BeadleNet, LLC, a privately held developer of
Internet security solutions for small offices and home offices. We are
currently in the process of integrating the BeadleNet business with our
business. This integration is subject to risks commonly encountered in making
acquisitions, including
. loss of key personnel;
. difficulties in assimilating BeadleNet's technologies, products,
personnel and operations;
. disruption of our ongoing business; and
. the inability of our sales force, consultants and development staff to
adapt to the new product line.
We may not successfully overcome these or any other problems encountered in
connection with the integration of BeadleNet. As part of our business strategy,
we expect to consider acquiring other companies. We may be unable to
successfully integrate the technologies, products, personnel or operation of
companies that we may acquire in the future.
The concentrated ownership of our common stock could delay or prevent a change
of control, which could reduce the market price of our common stock.
As of December 31, 1999, our directors, executive officers and their
affiliates beneficially owned, in the aggregate, approximately 67.8% of our
outstanding common stock. After the completion of our public offering of
4,094,000 shares of our common stock in February 2000, our directors, executive
officers and their affiliates beneficially owned, in the aggregate,
approximately 54.26% of our outstanding common stock. As a result of their
concentrated ownership, these stockholders are able to exercise control over
all matters requiring stockholder approval, including the election of directors
and approval of significant corporate transactions such as acquisitions, and to
block unsolicited tender offers. This concentration of ownership therefore
could have the effect of delaying or preventing a third party from acquiring
control over us at a premium over the then-current market price of our common
stock, which could result in a decrease in our stock price.
Our stock price is volatile.
The trading price of our common stock could be subject to fluctuations for a
number of reasons, 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 has experienced, and is likely to
continue to experience, these 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 could adversely affect the market price of our common stock. As of March
31, 2000, we had outstanding 22,718,643 shares of
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common stock. Of these shares, 12,969,521 are restricted as a result of
securities laws or lock-up agreements signed by the holder and will be
available for sale in the public market as follows:
<TABLE>
<CAPTION>
Number of
Date of Availability for Sale Shares
----------------------------- ----------
<S> <C>
On the date of this annual report................................... 840,026
90 days after the date of the prospectus related to our February
2000 public offering
(May 15, 2000)..................................................... 11,720,188
At various times thereafter on the expiration of one-year holding
periods............................................................ 409,307
</TABLE>
Credit Suisse First Boston Corporation, the managing underwriter for our public
offering, may, in its sole discretion and at any time without prior notice,
release all or any portion of the common stock subject to lock-up agreements.
ITEM 2. PROPERTIES
Our principal administrative, marketing, sales, development and operations
facility is located in Seattle, Washington. We occupy approximately 30,000
square feet in our current facility, under two leases that expire in April
2001. On March 1, 2000, we signed a lease for a new, 87,000-square-foot
principal facility in Seattle, Washington. We expect to relocate our principal
offices to the new facility before the end of 2000. The lease expires in March
2010, with an option to extend. We also maintain a small office in Laguna
Hills, California for our broadband Internet security division and a 3,000-
square-foot warehouse in Seattle for product fulfillment and distribution. We
have the right to lease the Laguna Hills office on a month-to-month basis until
October 2000, but we may terminate this lease before that date. We expect to
move our broadband Internet security division to new offices before that time.
The warehouse lease expires in August 2000, but has two one-year renewal
options. We will be relocating or expanding our general office space in Laguna
Hills within the next six to eight months, and we expect adequate space to be
available on commercially reasonable terms.
ITEM 3. LEGAL PROCEEDINGS
We are currently not a party to any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our security holders during the fourth
quarter of our fiscal year ended December 31, 1999.
30
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
Market Information
Our common stock began trading on The Nasdaq National Market on July 30, 1999
under the symbol WGRD. The following table lists, for the periods indicated,
the high and low sales prices per share of our common stock as reported on The
Nasdaq National Market.
<TABLE>
<CAPTION>
Price Range
of Common
Stock
-------------
High Low
------ ------
<S> <C> <C>
Year Ended December 31, 1999
Third quarter (beginning July 30, 1999)....................... $18.38 $10.38
Fourth quarter................................................ 40.00 13.81
</TABLE>
The last reported sale price of our common stock on The Nasdaq National
Market on April 26, 2000 was $48.25 per share.
Holders
As of March 31, 2000, there were approximately 89 holders of record of our
common stock. This does not include the number of persons whose stock is in
nominee or "street name" accounts through brokers.
Dividends
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
and therefore do not anticipate paying any cash dividends in the foreseeable
future. Furthermore, our line of credit agreement prohibits the payment of
dividends without the bank's prior written consent.
Recent Sales of Unregistered Securities
On October 19, 1999, in connection with the acquisition of BeadleNet, LLC, we
issued 335,931 shares of our common stock. This transaction was exempt from
Securities Act registration under Section 4(2) of the Securities Act, on the
basis that the transaction did not involve a public offering. Also in
connection with the BeadleNet acquisition, we issued 51,948 shares of
restricted common stock to an employee in connection with an employment
agreement. This transaction was exempt from Securities Act registration under
Rule 701 under the Securities Act on the basis that these securities were
offered and sold in accordance with a written contract related to compensation.
Use of Proceeds
On July 30, 1999, our registration statement on Form S-1, file number 333-
76587, became effective. The offering date was July 30, 1999. The offering
terminated as a result of all of the shares offered being sold. The managing
underwriters were Dain Rauscher Wessels, Warburg Dillon Read LLC, SoundView
Technology Group, Inc. and Wit Capital Corporation. The offering consisted of
3,879,570 shares of our common stock, including 3,500,000 shares of common
stock offered by WatchGuard and 379,570 shares of common stock offered by our
selling stockholders pursuant to the exercise of the underwriters' over-
allotment option. The aggregate price of the shares offered and sold by us was
$45.5 million, and the aggregate price of the shares offered and sold by the
selling shareholders was $4.9 million. After accounting for approximately $3.2
million in underwriting discounts and commissions and $1.5 million in other
expenses, we received proceeds of $40.8 million.
31
<PAGE>
We are using the net proceeds raised in our initial public offering for
additional working capital, repayment of short-term indebtedness and general
corporate purposes, including increased domestic and international sales and
marketing expenditures, increased research and development expenditures and
capital expenditures made in the ordinary course of business. We also intend to
use these proceeds for possible acquisitions of businesses, products and
technologies that are complementary to ours, such as our acquisition of the
assets of BeadleNet, LLC. Although we have no current agreements or
understandings with respect to any such transactions, we do from time to time
evaluate these opportunities. Pending their use, the majority of the net
proceeds have been invested in investment-grade, interest-bearing instruments,
all of which are short-term.
We used $6.6 million of the net proceeds of the offering to repay all debt
affiliated with Matrix IV Management Co., L.P., OVMC III, L.P. and OVMC IV,
LLC, all of which are principal stockholders of WatchGuard. Andrew W. Verhalen,
a director of WatchGuard, serves as general partner of Matrix IV Management
Co., L.P. and Charles P. Waite, Jr., a director of WatchGuard, serves as a
general partner of OVMC III, L.P. and as a managing member of OVMC IV, LLC.
ITEM 6. SELECTED FINANCIAL DATA
When you read this selected financial data, it is important that you also
read the historical financial statements and related notes included in this
annual report, as well as the section of this annual report entitled
"Management's Discussion and Analysis of Financial Condition and Results of
Operations." The historical results are not necessarily indicative of future
results. See note 7 of Notes to Financial Statements for an explanation of the
method used to determine the number of shares used in computing pro forma basic
and diluted net loss per share.
<TABLE>
<CAPTION>
Period From Year Ended
February 14, 1996 December 31,
(Inception) to ----------------------------
December 31, 1996 1997 1998 1999
----------------- -------- -------- --------
(In thousands, except per share data)
<S> <C> <C> <C> <C>
Statement of Operations Data:
Revenues, net:
Product...................... $ 329 $ 4,975 $ 10,678 $ 17,329
Service...................... 2 123 701 3,290
------ -------- -------- --------
Total revenues.............. 331 5,098 11,379 20,619
Cost of revenues.............. 104 1,610 3,925 7,964
------ -------- -------- --------
Gross margin.................. 227 3,488 7,454 12,655
Operating expenses:
Sales and marketing.......... 224 4,369 8,519 13,512
Research and development..... 274 2,192 4,442 7,118
General and administrative... 191 1,323 2,454 3,646
Stock-based compensation..... -- -- 1,039 926
Acquired in-process
technology and amortization
of intangible assets
acquired.................... -- -- -- 3,626
------ -------- -------- --------
Total operating expenses.... 689 7,884 16,454 28,828
------ -------- -------- --------
Operating loss................ (462) (4,396) (9,000) (16,173)
Interest income (expense),
net.......................... (6) 62 (119) 155
------ -------- -------- --------
Net loss...................... $ (468) $ (4,334) $ (9,119) $(16,018)
====== ======== ======== ========
Basic and diluted net loss per
share........................ N/A $ (17.17) $ (11.34) $ (1.80)
====== ======== ======== ========
Shares used in calculation of
basic and diluted net loss
per share.................... N/A 252 804 8,903
====== ======== ======== ========
Pro forma basic and diluted
net loss per share
(unaudited).................. $ (0.96)
========
Shares used in calculation of
pro forma basic and diluted
net loss per share
(unaudited).................. 16,664
========
</TABLE>
32
<PAGE>
<TABLE>
<CAPTION>
December 31,
-------------------------------
1996 1997 1998 1999
------ ------ ------- -------
(In thousands)
<S> <C> <C> <C> <C>
Balance Sheet Data:
Cash, cash equivalents and marketable
securities................................... $ 232 $ 603 $ 1,712 $26,401
Working capital (deficit) .................... (464) 658 (274) 24,395
Total assets.................................. 597 3,303 9,032 41,311
Total stockholders' equity (deficit).......... (318) 1,382 881 32,245
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
WatchGuard is a leading provider of Internet security solutions designed to
protect enterprises or telecommuters using the Internet for electronic commerce
and communications. Our core market is small- to medium-sized enterprises, or
SMEs, and we have recently expanded our marketing focus to include larger
enterprises as well as small offices and home offices, or SOHOs, and
telecommuters, particularly those using broadband Internet connections. Our
innovative subscription-based LiveSecurity solution broadcasts threat
responses, software updates, information alerts, expert editorials, support
flashes and virus alerts over the Internet, enabling enterprises 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. In February 1999, we launched the
broadcast portion of our LiveSecurity products. In July 1999, we completed the
initial public offering of our common stock. In October 1999, we acquired
BeadleNet, LLC, a developer of Internet security solutions for SOHOs, and
formed our new broadband Internet security division. In January 2000, we
announced the introduction of our security solutions for SOHOs and
telecommuters, which we began shipping in the first quarter of 2000, and in the
second quarter of 2000, we expect to introduce MSS solutions for SOHOs and
telecommuters.
Our revenues were $5.1 million in 1997, our first full year of operations.
Our revenues totaled $11.4 million in 1998, representing a 123% increase over
1997, and grew to $20.6 million in 1999, representing an 81% increase over
1998. Product revenues as a percentage of total revenues were 98% in 1997, 94%
in 1998 and 84% in 1999. 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. Service revenues
as a percentage of total revenues were 2% in 1997, 6% in 1998 and 16% in 1999.
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 December 31, 1999, we had an accumulated deficit of approximately $29.9
million. We anticipate significant growth in our operating expenses as we
continue to expand our business, particularly with respect to the expected
expansion of our corporate facilities in the next six to eight months. 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, which historically
has averaged approximately 40%;
33
<PAGE>
. sales of products and service subscriptions directly and, from time to
time, indirectly through our distributors, 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 product revenues upon shipment and service
subscription revenues ratably on a monthly basis, generally over a one-year
period.
Recent Acquisition
In October 1999, we acquired substantially all of the assets of BeadleNet,
LLC for $9.6 million. The acquisition cost was comprised of
. $3.4 million cash, paid at closing;
. 335,931 unregistered shares of WatchGuard common stock with a fair value
of approximately $4.9 million, issued at closing;
. an additional $1.0 million in contingent consideration, comprised of
$400,000 in cash and 20,189 unregistered shares of WatchGuard common
stock with a fair value of $600,000, which became due on completion of
specified technology items in late December 1999 and was paid in January
2000; and
. estimated direct acquisition costs of $300,000.
The aggregate purchase price was allocated, based on estimated fair values on
the acquisition date, as follows:
<TABLE>
<S> <C>
Inventory and equipment........................................ $ 74,000
Intangibles:
Acquired workforce........................................... 204,000
Trade names.................................................. 409,000
Developed technology......................................... 503,000
Goodwill..................................................... 4,985,000
----------
Total intangibles.......................................... 6,101,000
Acquired in-process research and development................... 3,381,000
----------
Total purchase price........................................... $9,556,000
==========
</TABLE>
We determined values assigned to acquired in-process research and
development, developed technology and trade names using a discounted cash flow
analysis. The value we assigned to the workforce in place was based on
replacement cost.
To determine the value of in-process research and development, we considered,
among other factors, the state of development of each project, the time and
cost needed to complete each project, expected income and associated risks,
which included the inherent difficulties and uncertainties in completing the
project and achieving technological feasibility and risks related to the
viability of and potential changes to future target
34
<PAGE>
markets. As a result of this analysis we assigned amounts to in-process
research and development projects that had not yet reached technological
feasibility and do not have alternative future uses. We expensed the entire
$3,381,000 allocated to acquired in-process research and development on the
date of acquisition.
The in-process projects, which were to be replacement products for those
products being sold at the acquisition date and which were included in the
acquired developed technology, were designed to provide a low-cost firewall and
networking solution for personal computers using existing telephone wiring and
external connections to the Internet using a cable or digital subscribing line,
or DSL, modem. At the time of the acquisition, most of the hardware development
for the products had been completed. However, the software architecture for
virtual private network integration and the scalability of installing the
virtual private network architecture into a DSL technology had not yet been
completed.
We completed production-ready prototypes in late December 1999 and introduced
the new products in January 2000 for delivery during the first quarter of 2000.
The total costs to complete the in-process projects after the acquisition date
were approximately $635,000.
To determine the value of the developed technology, we discounted the
expected future cash flows of the existing technology product, taking into
account risks related to the characteristics and applications of each product,
existing and future markets, and assessments of the life-cycle stage of each
project. Based on this analysis, we capitalized the existing technology that
had reached technological feasibility.
We assigned to the identified intangible assets lives ranging from two to
four years and to goodwill a life of five years. Amortization expense for these
intangibles was $245,000 in the fourth quarter of 1999.
In connection with the acquisition, we entered into an employment agreement
and a stock vesting agreement with Mr. Beadle. Pursuant to the employment
agreement, we granted Mr. Beadle an option, vesting over a period of four
years, to purchase 250,000 shares of WatchGuard common stock at an exercise
price of $14.44 per share, the fair value of the stock on the date the option
was granted. In consideration of some of Mr. Beadle's obligations in the
employment agreement, including his agreement not to compete with WatchGuard
for a period of three years after his employment terminates, we also issued to
Mr. Beadle 51,948 unregistered shares of WatchGuard common stock, valued at
$750,000 on the closing date of the acquisition. We have recorded the value of
this stock as deferred stock compensation expense and are amortizing the value
of the deferred stock compensation on a straight-line basis over the two-year
employment agreement period. Amortization of this deferred stock compensation
was $73,000 in the fourth quarter of 1999. Under the stock vesting agreement,
34,632 of these shares will be subject to forfeiture if Mr. Beadle's employment
is terminated for cause or if he resigns. One half of these shares will no
longer be subject to forfeiture on October 19, 2000 and the remainder will no
longer be subject to forfeiture on October 19, 2001.
35
<PAGE>
Results of Operations
The following table provides financial data for the periods indicated as a
percentage of total revenues:
<TABLE>
<CAPTION>
Year Ended
December 31,
---------------------
1997 1998 1999
----- ----- -----
<S> <C> <C> <C>
Revenues:
Product............................................... 97.6 % 93.8 % 84.0 %
Service............................................... 2.4 6.2 16.0
----- ----- -----
Total revenues...................................... 100.0 100.0 100.0
Cost of revenues....................................... 31.6 34.5 38.6
----- ----- -----
Gross margin........................................... 68.4 65.5 61.4
Operating expenses:
Sales and marketing................................... 85.6 74.9 65.5
Research and development.............................. 43.0 39.0 34.5
General and administrative............................ 26.0 21.6 17.7
Stock-based compensation.............................. -- 9.1 4.5
Acquired in-process technology and amortization of
intangible assets acquired........................... -- -- 17.6
----- ----- -----
Total operating expenses............................ 154.6 144.6 139.8
----- ----- -----
Operating loss......................................... (86.2) (79.1) (78.4)
Interest income (expense), net......................... 1.2 (1.0) 0.7
----- ----- -----
Net loss............................................... (85.0)% (80.1)% (77.7)%
===== ===== =====
</TABLE>
Years Ended December 31, 1998 and 1999
Total Revenues
Total revenues, which consist of product revenues and service revenues,
increased from $11.4 million in 1998 to $20.6 million in 1999, an increase of
81%. During these periods, no one customer accounted for 10% or more of total
revenues. The increase in total revenues was primarily due to increases in
sales volume caused by increased distribution in the European, Asia/Pacific and
North American markets. Total international revenues represented approximately
35% of total revenues in 1998 and 50% in 1999.
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, or network operations
center, security suite software license and our security appliance as part of
LiveSecurity for MSS. Product revenues increased from $10.7 million in 1998 to
$17.3 million in 1999, an increase of 62%. As a percentage of total revenues,
product revenues decreased from 94% in 1998 to 84% in 1999. We do not believe
that the historical percentage growth rates of product revenues will be
sustainable as our revenue base increases. 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 more 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 $701,000 in 1998 to $3.3 million in
1999, an increase of 369%. As a percentage of total revenues, service revenues
increased from 6% in 1998 to 16% in 1999.
Revenues from our LiveSecurity for MSS have been increasing in amount during
each quarter since we introduced the product. Total revenues for the
LiveSecurity System increased from $10.4 million in 1998 to
36
<PAGE>
$17.7 million in 1999, while total revenues from LiveSecurity for MSS increased
from $1.0 million in 1998 to $2.9 million in 1999. As a percentage of total
revenues, LiveSecurity for MSS revenues increased from 9% in 1998 to 14% in
1999. During the fourth quarter of 1999, LiveSecurity for MSS revenues reached
16% of total revenues. The increase in LiveSecurity for MSS revenues, both in
dollars and as a percentage of total revenues, is attributable to the growing
number of enterprises seeking security protection through their ISPs and an
increase in the number of ISPs with which we contract to offer the LiveSecurity
for MSS service.
We established a returns and allowances reserve 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 a new
version of our security appliance, the Firebox II, during the last half of
1998. The provision for sales returns and allowances was $1.7 million, or 13%
of total revenues before returns and allowances, in 1998 and $1.1 million, or
5% of total revenues before returns and allowances, in 1999. Returns and
allowances before that time were immaterial. The provision in 1999 as compared
to 1998, as a percentage of total revenues, reflects a reduction in the
expected returns and pricing protection allowances based on actual results over
the last several quarters and no recent introduction of replacement products.
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, including costs
associated with our LiveSecurity broadcast service. 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 $3.9 million in 1998 to
$8.0 million in 1999. As a percentage of total revenues, cost of revenues
increased from 35% in 1998 to 39% in 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 reflects an increase in the cost of manufacturing our Firebox II
security appliance and an increase in personnel-related costs of our service
organization, but is offset by the increased leverage of our service costs
relative to an increasing rate of service revenues. 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, we expect the unit cost to
manufacture the Firebox II to decrease. However, we cannot predict if or when
this reduction will occur.
We expect service costs to increase in total dollar amount 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 gross margin to remain at or slightly below our fourth
quarter 1999 level for the short term. For the longer term, 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,
commissions and related expenses and some variable marketing expenses,
including public relations costs, marketing collateral and trade show expenses.
Overall sales and marketing expenses increased from $8.5 million in 1998 to
$13.5 million in 1999, an increase of 59%. As a percentage of total revenues,
sales and marketing expenses decreased from 75% in 1998 to 66% in 1999. The
dollar increase in sales and marketing expenses was primarily due 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, major components of the increase
included
. an increase in payroll and related expenses from $3.9 million to $6.6
million;
37
<PAGE>
. an increase in travel expenses from $1.4 million to $2.5 million; and
. an increase in marketing costs from $2.0 million to $3.4 million.
The sales and marketing expense in 1998 included a one-time charge of $470,000
for a common stock warrant issued to a customer.
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 $4.4 million in
1998 to $7.1 million in 1999, an increase of 60%. As a percentage of total
revenues, research and development expenses decreased from 39% in 1998 to 35%
in 1999. The dollar increase in research and development expenses reflects the
growth of our research and development organization to expand and enhance our
enterprise product line, development and enhancement of our LiveSecurity for
MSS product and our efforts in researching and evaluating new and emerging
security threats through our LiveSecurity broadcast service. Specifically,
major components of the increase included
. an increase in payroll and related expenses from $2.5 million to $4.9
million;
. an increase in contract labor and consulting services from $445,000 to
$555,000; and
. an aggregate of $562,000 in costs incurred by our broadband Internet
security division in connection with completion of our SOHO and
telecommuter products originating from the acquisition of BeadleNet.
We will continue to increase our research and development expenses in total
dollar amounts to enhance and 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 that research and
development expenses will continue to increase in total dollar amounts but will
decrease as a percentage of total revenues.
General and Administrative. General and administrative expenses include costs
of executive, human resource, finance and administrative support functions,
provision for uncollectable accounts and legal and accounting professional
services. General and administrative expenses increased from $2.5 million in
1998 to $3.6 million in 1999, an increase of 49%. As a percentage of total
revenues, general and administrative expenses decreased from 22% in 1998 to 18%
in 1999. The dollar increase in general and administrative expenses reflects
the expansion of our infrastructure to manage the growth of our operations.
Specifically, major components of the increase included
. an increase in payroll and related expenses from $786,000 to $1.4
million; and
. an increase in professional fees from $218,000 to $672,000, related to
legal and accounting costs incurred primarily in conjunction with the
revision and implementation of our employee benefit plans and the
expansion of our international operations.
We expect that these expenses will continue to increase in total dollar
amounts but will decrease as a percentage of total revenues.
Stock-Based Compensation. Deferred compensation is recorded for 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 and for the value of common stock issued in
connection
38
<PAGE>
with an employment agreement associated with the acquisition of BeadleNet. We
recorded $912,000 of deferred compensation in 1999, which included $750,000
related to the same employment agreement, and $2.5 million of deferred
compensation in 1998, which included $628,000 in stock-based compensation
related to options exchanged for services from a former employee. Deferred
compensation is amortized over the vesting periods of the options. Amortization
of deferred compensation, or stock-based compensation, expenses were
$1.0 million in 1998 and $926,000 in 1999. The allocation of the stock-based
compensation expense associated with the functional operating expense
categories of sales and marketing, research and development and general and
administrative was $148,000, $829,000 and $62,000, respectively, for 1998 and
$307,000, $491,000 and $128,000, respectively, for 1999.
Interest Income (Expense)
Interest expense of $203,000 in 1998 resulted from borrowings on our bank
line of credit and our equipment term loan, and was offset by $84,000 of
interest income generated from our investment of proceeds from the sale of
preferred stock. Interest expense of $485,000 in 1999 resulted from borrowings
on our bank line of credit, our equipment term loan and our convertible note
agreements, and was offset by $640,000 of interest income generated from our
investment of proceeds from the sale of preferred stock in private transactions
and the sale of common stock in our initial public offering.
Income Taxes
We have experienced losses since inception, resulting in a net operating loss
carryforward position of approximately $24.0 million as of December 31, 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.
Years Ended December 31, 1997 and 1998
Total Revenues
Total revenues increased from $5.1 million in 1997 to $11.4 million in 1998,
an increase of 123%. During these periods, no one customer accounted for 10% or
more of total revenues. Product revenues increased from $5.0 million in 1997 to
$10.7 million in 1998, an increase of 115%. As a percentage of total revenues,
product revenues decreased from 98% in 1997 to 94% in 1998. Service revenues
increased from $123,000 in 1997 to $701,000 in 1998. As a percentage of total
revenues, service revenues increased from 2% in 1997 to 6% in 1998.
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 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 13% 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 $1.6 million in 1997 to $3.9 million in 1998.
As a percentage of total revenues, cost of revenues increased from 32% in 1997
to 35% in 1998. 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 security appliance. As
39
<PAGE>
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 $4.4 million
in 1997 to $8.5 million in 1998. As a percentage of total revenues, sales and
marketing expenses decreased from 86% in 1997 to 75% in 1998.
The dollar increase in sales and marketing expenses was primarily due 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;
. 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; and
. a $470,000 charge for a common stock warrant in 1998 issued to a
customer.
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
$2.2 million in 1997 to $4.4 million in 1998. As a percentage of total
revenues, research and development expenses decreased from 43% in 1997 to 39%
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 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.
General and Administrative. General and administrative expenses increased
from $1.3 million in 1997 to $2.5 million in 1998. As a percentage of total
revenues, general and administrative expenses decreased from 26% in 1997 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 uncollectable 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.
Stock-Based Compensation. Amortization of deferred compensation totaled $1.0
million for 1998. The allocation of the stock-based compensation expense
associated with the functional operating expense categories of sales and
marketing, research and development and general and administrative was
$148,000, $829,000 and $62,000, respectively.
40
<PAGE>
Interest Income (Expense)
Interest income of $88,000 in 1997 was generated from our investment of
proceeds from the sale of preferred 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 our unaudited results of operations both in
dollar amounts and expressed as a percentage of total revenues for each quarter
in the six-quarter period ended December 31, 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
----------------------------------------------------------
Sept. Dec. 31, Mar. 31, June 30, Sept. Dec. 31,
30, 1998 1998 1999 1999 30, 1999 1999
-------- -------- -------- -------- -------- --------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Revenues, net:
Product............... $ 2,544 $ 3,274 $ 3,387 $ 3,831 $ 4,614 $ 5,497
Service............... 205 339 551 806 907 1,026
-------- -------- -------- -------- -------- -------
Total revenues...... 2,749 3,613 3,938 4,637 5,521 6,523
Cost of revenues........ 1,038 1,396 1,635 1,846 2,085 2,398
-------- -------- -------- -------- -------- -------
Gross margin............ 1,711 2,217 2,303 2,791 3,436 4,125
Operating expenses:
Sales and marketing... 2,258 2,447 2,841 3,242 3,612 3,817
Research and
development.......... 1,233 1,430 1,426 1,614 1,700 2,378
General and
administrative....... 622 864 912 862 842 1,030
Stock-based
compensation......... 312 587 253 258 186 229
Acquired in-process
technology and
amortization of
intangible assets
acquired............. -- -- -- -- -- 3,626
-------- -------- -------- -------- -------- -------
Total operating
expenses........... 4,425 5,328 5,432 5,976 6,340 11,080
-------- -------- -------- -------- -------- -------
Operating loss.......... (2,714) (3,111) (3,129) (3,185) (2,904) (6,955)
Interest income
(expense), net......... 24 (60) (84) (263) 118 384
-------- -------- -------- -------- -------- -------
Net loss................ $ (2,690) $ (3,171) $ (3,213) $ (3,448) $ (2,786) $(6,571)
======== ======== ======== ======== ======== =======
</TABLE>
41
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended
----------------------------------------------------------
Sept. 30, Dec. 31, Mar. 31, June 30, Sept. 30, Dec. 31,
1998 1998 1999 1999 1999 1999
--------- -------- -------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Revenues, net:
Product............... 92.5 % 90.6 % 86.0 % 82.6 % 83.6 % 84.3 %
Service............... 7.5 9.4 14.0 17.4 16.4 15.7
----- ----- ----- ----- ----- ------
Total revenues...... 100.0 100.0 100.0 100.0 100.0 100.0
Cost of revenues........ 37.8 38.6 41.5 39.8 37.8 36.8
----- ----- ----- ----- ----- ------
Gross margin............ 62.2 61.4 58.5 60.2 62.2 63.2
Operating expenses:
Sales and marketing... 82.1 67.7 72.1 69.9 65.4 58.5
Research and
development.......... 44.9 39.6 36.2 34.8 30.8 36.4
General and
administrative....... 22.6 23.9 23.1 18.6 15.3 15.8
Stock-based
compensation......... 11.3 16.2 6.4 5.5 3.4 3.5
Acquired in-process
technology and
amortization of
intangible assets
acquired............. -- -- -- -- -- 55.6
----- ----- ----- ----- ----- ------
Total operating
expenses........... 161.0 147.5 137.9 128.9 114.8 169.8
----- ----- ----- ----- ----- ------
Operating loss.......... (98.8) (86.1) (79.5) (68.7) (52.6) (106.6)
Interest income
(expense), net......... 0.9 (1.7) (2.1) (5.7) 2.1 5.9
----- ----- ----- ----- ----- ------
Net loss................ (97.9)% (87.8)% (81.6)% (74.3)% (50.5)% (100.7)%
===== ===== ===== ===== ===== ======
</TABLE>
Liquidity and Capital Resources
Since our inception, we have financed our operations primarily through
private placements of convertible preferred stock, and most recently through
the sale of common stock in our initial public offering in July 1999 and our
public offering in February 2000. To date, net proceeds from private placements
of preferred stock and our two public offerings have totaled approximately
$144.0 million. We have also financed our operations through equipment
financing, traditional accounts receivable financing arrangements, bridge
financing arrangements and convertible notes.
We have a working capital revolving line of credit with a bank, secured by
our accounts receivable. The line of credit was renegotiated in March 2000 and
provides for borrowings not greater than $5.0 million or the amount of the
borrowing base. For purposes of the loan, the borrowing base means the sum of
80% of the net amount of our eligible domestic accounts receivable and 50% of
the net amount of our eligible foreign accounts receivable. As of December 31,
1999, we had no borrowings on this line of credit, which expires in
February 2001 and bears interest at prime plus 0.5% per year. At December 31,
1999, our borrowing base was $2.1 million. Our two term-loan facilities with
the same bank, which had a combined balance of $383,000 as of December 31,
1999, were paid off with the proceeds from our public offering in February
2000.
As of December 31, 1999, we had $26.4 million in cash, cash equivalents and
short-term investments, invested primarily in high-quality money market
accounts and marketable securities. We believe that the market risk arising
from our holdings of these financial instruments is not material. Our working
capital as of December 31, 1999 was $24.4 million.
Operating Activities
Our operating activities resulted in net cash outflows of $7.6 million in
1998 and $7.9 million in 1999. The operating cash outflows in 1998 and 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
42
<PAGE>
was net of noncash charges totaling $3.9 million in 1998 and $6.6 million in
1999. These noncash charges were primarily associated with depreciation and
amortization of capital assets, provisions for bad debts and sales returns and
allowances, compensation charges resulting from the issuance of stock options
and warrants and a one-time charge for in-process research and development
associated with the acquisition of BeadleNet. Cash used in operating activities
from working capital components impacting operating activities was $2.4 million
in 1998, and cash provided from working capital components for operating
activities was $1.5 in 1999. In 1999, there were large fluctuations within some
major working capital components, as described below.
Receivables. Our receivables increased from $3.5 million at December 31, 1998
to $3.8 million at December 31, 1999, while revenues increased from $3.6
million in the three months ended December 31, 1998 to $6.5 million in the
three months ended December 31, 1999. We implemented enhanced credit and
collection processes during 1999 that contributed to improved collection
periods. Days sales outstanding, or DSO, were 86 days for the quarter ended
December 31, 1998 compared to 52 days for the quarter ended December 31, 1999.
Based upon sales mix, timing differences arising from varying payment cycles
and terms in our customer agreements, we expect our DSO to generally range from
50 days to 70 days. Reserves for uncollectable accounts were $449,000 at
December 31, 1998 and $177,000 at December 31, 1999. The decrease reflects
reduced exposure attributed to our improved credit and collection processes
referred to above. Our returns and allowance reserve was $615,000 at December
31, 1998 and $550,000 at December 31, 1999, and reflects our estimate of
returns and allowances associated with the return rights and price protection
rights of some of our customers. The reserve may fluctuate from time to time
depending upon the timing of product introductions and pricing program changes.
Deferred revenue. Deferred revenue increased from $1.8 million at December
31, 1998 to $4.2 million at December 31, 1999, an increase of 130%. The
increase reflects service subscriptions and annual client licenses associated
with the continued growth of product sales and, to a lesser extent, with
service subscription renewals. Deferred revenue from service subscriptions and
annual client licenses is generally amortized ratably over a one-year period.
Investing Activities
Cash used in investing activities totaled $1.0 million in 1998 and $30.1
million in 1999, and reflects capital expenditures for computing equipment and
furniture, payments made in connection with the acquisition of BeadleNet and
investment in marketable securities of the net proceeds from our initial public
offering.
Financing Activities
Cash provided by financing activities totaled $9.7 million in 1998 and $38.2
million in 1999. These activities primarily reflect proceeds from the sale of
preferred stock in 1998, borrowings on our line of credit during 1998 and 1999
and proceeds from our initial public offering in 1999, offset to some extent by
borrowing and repayments under our bank line of credit and various bridge
financing arrangements.
We believe that existing cash and cash equivalents balances and our existing
lines of credit, including the net proceeds from our public offering in
February 2000, 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 may prove to be inaccurate,
however, and we may need to seek additional funding through public or private
financings or other arrangements before that time.
Year 2000 Compliance
We believe that we have successfully rendered our products, internal
management and other administrative systems and external information systems
year 2000 compliant. In addition, we have surveyed the vendors of the third-
party technologies we incorporate into our products and services and applied
updates or arrangements to correct potential year 2000 compliance problems.
Since January 1, 2000, we have experienced no disruptions
43
<PAGE>
in our business operations as a result of year 2000 compliance problems or
otherwise, and we have received no reports of any year 2000 compliance problems
with our products and services. We are continuing to monitor third-party
vendors of incorporated technologies for additional recommended year 2000
upgrades, which we will apply as soon as they become available. To date, the
total cost of our efforts to address year 2000 compliance has not been
material.
Nonetheless, some problems related to year 2000 risks may not appear until
several months after January 1, 2000. Year 2000 issues could include problems
with our own products and services or with third-party products or technology
that we use or with which our products exchange data. Any problems that are not
identified and corrected successfully and completely could 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.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk. We do not hold derivative financial instruments or
derivative equity securities in our investment portfolio. Our cash equivalents
consist of high-quality securities, as specified in our investment policy
guidelines. Our policy limits the amount of credit exposure to any one issue or
issuer to a maximum of 20% of the total portfolio or $5 million per issuer,
with the exception of treasury securities and money market funds, which are
exempt from this size limitation. Our policy limits all investments to those
that mature in two years or less, with the average maturity of our investments
equal to one year or less. The securities are subject to interest-rate risk and
will decrease in value if interest rates increase. Due to the short-term nature
of our investments and our investment policies and procedures, however, we
believe that the risk associated with interest-rate fluctuations related to
these securities does not pose a material risk to WatchGuard.
Foreign Currency Risk. All of our sales and the majority of our expenses are
currently denominated in U.S. dollars. As a result, we have not experienced
significant foreign exchange gains and losses. While we conducted some
transactions in foreign currencies during 1999 and expect to continue to do so
in the future, we do not anticipate that foreign exchange gains or losses will
be material to WatchGuard. Although we have not engaged in foreign currency
hedging to date, we may do so in the future.
44
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Board of Directors and Stockholders
WatchGuard Technologies, Inc.
We have audited the accompanying balance sheets of WatchGuard Technologies,
Inc. as of December 31, 1998 and 1999 and the related statements of operations,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1999. Our audits also included the financial statement
schedule listed in the Index at Item 14(a). These financial statements and
schedule are the responsibility of WatchGuard's management. Our responsibility
is to express an opinion on these financial statements and schedule based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of WatchGuard Technologies, Inc.
at December 31, 1998 and 1999, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1999, in
conformity with accounting principles generally accepted in the United States.
Also, in our opinion, the related financial statement schedule, 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
February 4, 2000
45
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
BALANCE SHEETS
(In thousands, except share data)
<TABLE>
<CAPTION>
December 31,
-----------------
1998 1999
-------- -------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 1,712 $ 1,903
Securities available for sale............................. -- 24,498
Trade accounts receivable, net............................ 3,458 3,772
Inventories............................................... 2,156 2,013
Prepaid expenses and other receivables.................... 483 1,275
-------- -------
Total current assets........................................ 7,809 33,461
Equipment and furniture, net................................ 1,140 1,927
Goodwill.................................................... -- 4,830
Other intangibles and other assets.......................... 83 1,093
-------- -------
Total assets................................................ $ 9,032 $41,311
======== =======
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
<S> <C> <C>
Current liabilities:
Line of credit............................................ $ 2,500 $ --
Accounts payable.......................................... 2,185 2,088
Accrued expenses.......................................... 1,016 2,362
Deferred revenue.......................................... 1,841 4,233
Equipment term loan....................................... 609 383
-------- -------
Total current liabilities................................... 8,151 9,066
Commitments
Stockholders' equity:
Preferred stock, $0.001 par value:
Authorized shares: 10,000,000
Shares issued and outstanding: 6,712,658 at December 31,
1998 and 0 at December 31, 1999........................ 6 --
Common stock, $0.001 par value:
Authorized shares: 80,000,000
Shares issued and outstanding: 1,362,744 at December 31,
1998 and 19,511,752 at December 31, 1999............... 1 19
Additional paid-in capital................................ 16,261 63,694
Stock-based compensation.................................. (1,466) (1,452)
Accumulated other comprehensive loss...................... -- (77)
Accumulated deficit....................................... (13,921) (29,939)
-------- -------
Total stockholders' equity.............................. 881 32,245
-------- -------
Total liabilities and stockholders' equity.............. $ 9,032 $41,311
======== =======
</TABLE>
See accompanying notes.
46
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
STATEMENTS OF OPERATIONS
(In thousands, except per share data)
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------
1997 1998 1999
-------- -------- --------
<S> <C> <C> <C>
Revenues:
Product........................................ $ 4,975 $ 10,678 $ 17,329
Service........................................ 123 701 3,290
-------- -------- --------
Total revenues............................... 5,098 11,379 20,619
Cost of revenues................................. 1,610 3,925 7,964
-------- -------- --------
Gross margin..................................... 3,488 7,454 12,655
Operating expenses:
Sales and marketing............................ 4,369 8,519 13,512
Research and development....................... 2,192 4,442 7,118
General and administrative..................... 1,323 2,454 3,646
Stock-based compensation....................... -- 1,039 926
Acquired in-process technology and amortization
of intangible assets acquired................. -- -- 3,626
-------- -------- --------
Total operating expenses..................... 7,884 16,454 28,828
-------- -------- --------
Operating loss................................... (4,396) (9,000) (16,173)
Interest income.................................. 88 84 640
Interest expense................................. (26) (203) (485)
-------- -------- --------
Net loss......................................... $ (4,334) $ (9,119) $(16,018)
======== ======== ========
Basic and diluted net loss per share............. $ (17.17) $ (11.34) $ (1.80)
======== ======== ========
Shares used in calculation of basic and diluted
net loss per share.............................. 252 804 8,903
======== ======== ========
</TABLE>
See accompanying notes.
47
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except share data)
<TABLE>
<CAPTION>
Accumulated
Preferred Stock Common Stock Additional Other Total
------------------ ----------------- Paid-in Stock-Based Comprehensive Accumulated Stockholders'
Shares Amount Shares Amount Capital Compensation Loss Deficit Equity
---------- ------ ---------- ------ ---------- ------------ ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, January 1,
1997.............. 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
Issuance of stock
warrant to a
customer......... -- -- -- -- 470 -- -- -- 470
Stock-based
compensation..... -- -- -- -- 2,505 (2,505) -- -- --
Amortization of
stock-based
compensation..... -- -- -- -- -- 1,039 -- -- 1,039
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
Proceeds from
issuance of
common stock
from initial
public offering,
net of offering
costs............ -- -- 3,500,000 3 40,666 -- -- -- 40,669
Conversion of
preferred stock
into common
stock............ (6,712,658) (6) 13,425,316 13 (7) -- -- -- --
Stock-based
compensation..... -- -- -- -- 162 (162) -- -- --
Issuance of
common stock to
an employee...... -- -- 51,948 -- 750 (750) -- -- --
Amortization of
stock-based
compensation..... -- -- -- -- -- 926 -- -- 926
Issuance of
common stock in
connection with
acquisition...... -- -- 335,931 -- 5,450 -- -- -- 5,450
Issuance of stock
warrants......... -- -- -- -- 195 -- -- -- 195
Exercise of
common stock
options and
warrants......... -- -- 835,813 2 217 -- -- -- 219
Comprehensive
loss:
Net unrealized
loss on
securities
available for
sale........... -- -- -- -- -- -- (77) -- (77)
Net loss........ -- -- -- -- -- -- -- (16,018) (16,018)
--------
Comprehensive
loss........... (16,095)
---------- ----- ---------- ----- -------- -------- ----- --------- --------
Balance, December
31, 1999 ......... -- $ -- 19,511,752 $ 19 $ 63,694 $ (1,452) $ (77) $ (29,939) $ 32,245
========== ===== ========== ===== ======== ======== ===== ========= ========
</TABLE>
See accompanying notes.
48
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------
1997 1998 1999
-------- -------- --------
<S> <C> <C> <C>
Operating activities:
Net loss........................................ $ (4,334) $ (9,119) $(16,018)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation.................................. 207 235 602
Amortization of intangible assets............. 52 86 259
Amortization of stock-based compensation...... -- 1,039 926
Loss on disposal of equipment................. -- -- 57
Warrant issued in exchange for services....... -- 470 --
Acquired in-process research and development.. -- -- 3,381
Provision for sales returns and allowances.... -- 1,655 1,083
Provision for bad debt expense................ 122 418 129
Noncash interest expense...................... -- -- 195
Changes in operating assets and liabilities:
(Increase) in accounts receivable............ (1,551) (3,968) (1,526)
(Increase) decrease in inventories........... (214) (1,938) 148
(Increase) in prepaid expenses and other..... (113) (288) (792)
(Increase) decrease in other assets.......... (325) 183 12
Increase in accounts payable and accrued
expenses.................................... 868 2,093 1,249
Increase (decrease) in deferred revenue...... (22) 1,528 2,392
-------- -------- --------
Net cash used in operating activities........... (5,310) (7,606) (7,903)
Investing activities:
Purchases of equipment and furniture............ (391) (1,003) (1,387)
Purchase of intangible assets................... (70) -- --
Proceeds from sale of marketable securities..... -- -- 1,000
Purchases of marketable securities.............. -- -- (25,575)
Net cash paid in connection with BeadleNet
acquisition.................................... -- -- (4,106)
-------- -------- --------
Net cash used in investing activities........... (461) (1,003) (30,068)
Financing activities:
Borrowings on line of credit, long-term debt and
notes payable.................................. 700 2,663 7,280
Issuance of warrants............................ -- -- 195
Principal repayments on line of credit, long-
term debt and notes payable.................... (540) (54) (10,201)
Proceeds from sale of preferred stock........... 5,979 7,075 --
Proceeds from sale of common stock, net of
expenses....................................... -- -- 40,669
Proceeds from exercise of common stock options
and warrants................................... 3 34 219
-------- -------- --------
Net cash provided by financing activities....... 6,142 9,718 38,162
-------- -------- --------
Net increase in cash and cash equivalents....... 371 1,109 191
Cash and cash equivalents at beginning of period
............................................... 232 603 1,712
-------- -------- --------
Cash and cash equivalents at end of period...... $ 603 $ 1,712 1,903
======== ======== ========
Supplemental disclosure of cash flow
information:
Cash paid for interest.......................... $ 21 $ 179 $ 508
======== ======== ========
</TABLE>
See accompanying notes.
49
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS
1. Accounting Policies
Description of Business
WatchGuard Technologies, Inc. is a provider of Internet security solutions
designed to protect enterprises or telecommuters using the Internet for
electronic commerce and communications.
Revenue Recognition
Statement of Position (SOP) 97-2, "Software Revenue Recognition," was issued
in October 1997 by the American Institute of Certified Public Accountants
(AICPA) and was amended by 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.
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 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 are 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, 1999, WatchGuard had the following financial instruments:
cash and cash equivalents, accounts receivable, accounts payable, accrued
liabilities and equipment loans. 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 debt
approximates fair value based on the market interest rates available to
WatchGuard for debt of similar risk and maturities.
50
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
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.
Securities Available for Sale
WatchGuard's investments are classified as available for sale, and are stated
at fair value on the balance sheet with the unrealized gains and losses
included as a component of stockholders' equity. Interest earned on securities
is included in interest income. The amortized cost of investments is adjusted
for amortization of premiums and accretion of discounts to maturity. These
amortization and accretions are included in interest income. The cost of
securities sold is calculated using the specific identification method.
WatchGuard's investment guidelines state that the maximum life of any one
security shall be two years, with the maximum weighted average life of the
investment portfolio being one year.
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.
Goodwill and Other Intangibles
Goodwill and other intangibles represent the excess of the purchase price
over the fair value of net tangible assets acquired. Goodwill and other
intangibles are being amortized on a straight-line basis over lives ranging
from two to five years.
Long-Lived Assets
In accordance with Financial Accounting Standards Board (FASB) Statement of
Financial Accounting Standard (SFAS) No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed of," the carrying
value of intangible assets and other long-lived assets is reviewed on a regular
basis for the existence of facts or circumstances, both internal and external,
that may suggest impairment. To date, no such impairment has been indicated.
Should there be an impairment in the future, WatchGuard will measure the amount
of the impairment based on undiscounted expected future cash flows from the
impaired assets. The cash flow estimates that will be used will contain
management's best estimates, using assumptions and projections appropriate and
customary at the time.
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
51
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
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.
Advertising Costs
WatchGuard expenses advertising costs as incurred. Total expenses were
$199,500, $60,000 and $234,000 in 1997, 1998 and 1999, respectively.
Concentration of Credit Risk
WatchGuard is subject to concentrations of credit risk primarily from cash
investments and accounts receivable. WatchGuard's credit risk is managed by
investing its excess cash in high-quality money market instruments and
securities available for sale. 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 $2.8 million, $4.0
million and $10.3 million, or 56%, 35% and 50% of total revenues for 1997, 1998
and 1999, respectively. No single customer or foreign country accounted for
more than 10% of revenues in the periods presented, except that in 1997
revenues from one customer in Japan accounted for 17% of total revenues.
Foreign geographic regions accounting for 10% or more of revenues were Europe,
with 22%, 18% and 26% of total revenues, and Asia, with 24%, 10% and 16% of
total revenues, for 1997, 1998 and 1999, respectively.
Stock Compensation
WatchGuard has elected to apply the disclosure-only provisions of SFAS No.
123, "Accounting for Stock-Based Compensation." 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.
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.
Comprehensive Loss
As of January 1, 1998, WatchGuard adopted SFAS No. 130, "Reporting
Comprehensive Income," which establishes standards for the reporting and
display of comprehensive income and its components (revenues, expenses, gains
and losses) in a full set of general-purpose financial statements. WatchGuard's
comprehensive loss includes all items that comprise net loss and the effect of
unrealized gains or losses on securities available for sale. Comprehensive loss
is shown on the statement of stockholders' equity.
52
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
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.
Reclassifications
Certain prior-year items have been reclassified to conform to the current-
year presentation.
New Accounting Pronouncements
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.
2. Balance Sheet Account Detail
Trade Accounts Receivable, Net
Trade accounts receivable, net consisted of the following:
<TABLE>
<CAPTION>
December 31,
----------------
1998 1999
------- -------
(In thousands)
<S> <C> <C>
Trade accounts receivable................................ $ 4,522 $4,499
Reserve for returns...................................... (615) (550)
Allowance for uncollectable accounts..................... (449) (177)
------- -------
$3,458 $3,772
======= =======
Inventories
Inventories consisted of the following:
<CAPTION>
December 31,
----------------
1998 1999
------- -------
(In thousands)
<S> <C> <C>
Finished goods........................................... $ 1,203 $ 1,093
Components............................................... 953 920
------- -------
$ 2,156 $ 2,013
======= =======
</TABLE>
53
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Equipment and Furniture
Equipment and furniture consisted of the following:
<TABLE>
<CAPTION>
December 31,
---------------
1998 1999
------- -------
(In thousands)
<S> <C> <C>
Computer equipment........................................ $ 831 $ 1,615
Furniture and fixtures.................................... 337 576
Software.................................................. 302 638
------- -------
1,470 2,829
Less accumulated depreciation............................. 330 902
------- -------
$ 1,140 $ 1,927
======= =======
</TABLE>
Accrued Expenses
Accrued expenses consisted of the following:
<TABLE>
<CAPTION>
December 31,
---------------
1998 1999
------- -------
(In thousands)
<S> <C> <C>
Accrued payroll-related expenses........................... $ 526 $ 1,323
Acquisition-related liabilities............................ -- 531
Other...................................................... 490 508
------- -------
$ 1,016 $ 2,362
======= =======
</TABLE>
Of the liabilities related to WatchGuard's acquisition of BeadleNet, LLC,
$400,000 relates to contingent consideration earned before December 31, 1999.
The remaining acquisition-related liabilities relate to estimated acquisition
costs. See Note 12.
3. Securities Available for Sale
Securities available for sale consist of the following:
<TABLE>
<CAPTION>
Gross Gross
Market Unrealized Unrealized Amortized
Value Gains Losses Cost
-------- ---------- ---------- ---------
(In thousands)
<S> <C> <C> <C> <C>
December 31, 1999:
Corporate debt securities........... $ 23,485 $ -- $ (75) $ 23,560
U.S. Government and agency
obligations........................ 1,013 -- (2) 1,014
-------- ----- ----- --------
$ 24,498 $ -- $ (77) $ 24,574
======== ===== ===== ========
</TABLE>
54
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
WatchGuard's gross realized gains or losses in 1999 on sales of available-
for-sale securities were immaterial. The contractual maturities of WatchGuard's
available-for-sale securities are shown below:
<TABLE>
<CAPTION>
Estimated Fair Amortized
Market Value Cost
-------------- ---------
(In thousands)
<S> <C> <C>
December 31, 1999:
Due in one year or less.............................. $14,449 $14,472
Due in one year through two years.................... 10,049 10,103
------- -------
$24,498 $24,575
======= =======
</TABLE>
4. Acquisition of Intangibles
In March 1996, WatchGuard acquired certain technology (source code for its
software products) from Mazama Software Labs, Inc. for $50,000. Additionally,
WatchGuard was required to make royalty payments for a three-year period 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
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. As of December 31, 1999, this amount was fully
amortized.
5. Borrowing Agreements
Line of Credit and Term Loans
At December 31, 1999, WatchGuard had borrowings outstanding under (a) a $4.5
million working capital revolving line of credit; (b) a $95,000 equipment term
loan; and (c) a $288,000 equipment term loan. All three facilities are from a
commercial bank.
The revolving line of credit is for operating needs and expires in November
2000. 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% (9.5% at
December 31, 1999). 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. The line of credit is
collateralized by substantially all of WatchGuard's assets. There was no
balance outstanding on this line at December 31, 1999 and $2.1 million was
available for borrowing. The weighted average interest rate on WatchGuard's
short-term borrowings for 1999 was 8.7%.
The $95,000 term loan bears interest at the bank's prime interest rate plus
1.5% (10.0% at December 31, 1999) and matures in March 2001. The $288,000 term
loan bears interest at the bank's prime interest rate plus 1% (9.5% at December
31, 1999) and matures in December 2001. The term loans require monthly
principal and interest payments, with the principal payments fixed at $6,327
and $11,995, respectively, and are collateralized by equipment.
At December 31, 1999, WatchGuard was not in compliance with one of its
covenants related to the line of credit and term loans, but obtained a waiver
for noncompliance.
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. In connection with these
note agreements, WatchGuard issued warrants to purchase
55
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
42,856 shares of common stock at an exercise price of $7.00 per share, all of
which were exercisable immediately. WatchGuard assigned the warrants 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 dividend yield rate of 0%, volatility of 0.6 and an expected life of one
year. WatchGuard amortized the resulting discount on the notes over the
expected term of the notes. Upon completion of WatchGuard's initial public
offering, the notes were repaid and the warrants were exercised.
Bridge Loan
In May and June 1999, WatchGuard amended its loan and security agreement with
its bank. The amendments primarily provided for a secured bridge loan facility
that immediately made available to WatchGuard an additional $4.25 million, of
which $2.0 million was guaranteed by existing investors. WatchGuard granted the
bank warrants to purchase up to 14,500 shares of common stock, at an exercise
price of $13.00 per share. The loan was repaid with proceeds from the initial
public offering.
6. Stockholders' 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.
Stock Split
On May 26, 1999, the board of directors authorized a two-for-one 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 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 restated to reflect the
stock split.
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 had preferential rights to
dividends when and if declared by the board of directors. Series A, B and C
preferred stockholders had 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, had 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 had preferential rights to liquidation payments of $0.05, $2.59, and
$5.16 per share, respectively, plus any declared, but unpaid,
56
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
dividends. Series A, B, and C preferred stock was 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 were not less than
$15 million and a price per share is paid by the public of at least $10.31.
Each share of Series A, B, and C preferred stock converted into two shares of
common stock at the closing of WatchGuard's initial public offering.
The following is a summary of terms and conditions for each series of
preferred stock before their conversion:
<TABLE>
<CAPTION>
Approximate Annual
Aggregate Dividend
Shares Shares Stated Liquidation Rate--
Designated Outstanding Value Value Non-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>
Initial Public Offering
On July 30, 1999, WatchGuard issued 3,500,000 shares of its common stock at
an initial public offering price of $13.00 per share. The proceeds to
WatchGuard from the offering were approximately $40.7 million, net of $4.8
million in offering expenses, underwriting discounts and commissions. At the
closing of the offering, all 6,712,658 shares of preferred stock automatically
converted into 13,425,316 shares of common stock.
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. In May 1999, the board of directors and stockholders approved
amendments to the Plan that provide for a 900,000-share increase in the
authorized number of shares to be granted under the Plan, plus an automatic
increase to be added on the first day of each fiscal year, the first of which
occurred on January 1, 2000, equal to the least 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, and (c) a lesser amount determined by the board of
directors.
As of December 31, 1999, WatchGuard had authorized 8,634,986 shares of common
stock for possible grant under the Plan. Options under the Plan generally are
granted at fair market value on the date of grant. The shares of common stock
covered by the options generally vest at the rate of 25% on the first
anniversary, 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.
57
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
The following table summarizes WatchGuard's stock option activity during
1997, 1998 and 1999:
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1998 December 31, 1999
------------------- ------------------- -------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
--------- -------- --------- -------- --------- --------
<S> <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................. 4,970,526 0.08 1,212,500 0.44 2,248,314 13.26
Exercised............... (12,916) 0.03 (819,828) 0.04 (774,563) 0.09
Canceled................ (887,024) 0.04 (474,984) 0.09 (116,339) 5.67
--------- --------- ---------
Balance at end of
period................. 5,227,580 0.08 5,145,268 0.16 6,502,680 4.60
========= ========= =========
Exercisable at end of
period................. 428,300 1,618,038 2,359,707
Shares of common stock
available for grant
under the plan......... 524,999
Weighted average fair
value of options
granted during period
Granted at fair
value................ 4,970,526 0.02 308,000 0.01 2,086,314 13.75
Granted at below fair
value................ -- -- 904,500 2.08 162,000 7.00
</TABLE>
The weighted average remaining contractual life and weighted average exercise
price of options outstanding and options exercisable at December 31, 1999 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>
$ 0.03-1.13....... 4,269,491 7.38 $ 0.16 2,265,924 $ 0.13
$ 2.25-13.00...... 1,609,767 9.37 12.26 83,471 10.74
$ 14.30-15.94...... 597,922 9.21 14.50 10,312 14.30
$ 32.13-32.13...... 25,500 9.95 32.13 -- --
--------- ---------
6,502,680 8.05 $ 4.60 2,359,707 $ 0.57
========= =========
</TABLE>
WatchGuard uses the intrinsic value-based method to account for all of 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 1998 and 1999. WatchGuard
recorded deferred stock compensation expense of $2.5 million relating to
options granted during the year ended December 31, 1998, which includes
$628,000 related to the 48,000 option shares described below. An additional
expense of $162,000 was recorded in 1999. These amounts represent the
difference between the exercise price and the deemed fair value for financial
reporting purposes of WatchGuard's common stock on the date the options were
granted. Amounts recorded as deferred stock compensation expense are generally
being amortized over a four-year vesting period using a graded vesting
approach. Under this approach, 52% of the deferred stock compensation is
amortized in the first year after grant, 27% in the second year, 15% in the
third year and the remaining 6% in the fourth year. Amortization of deferred
stock compensation originating from stock option grants of $1.0 million and
$853,000 were recognized for the years ended December 31, 1998 and 1999,
respectively. Amortization of deferred stock compensation originating from
stock option grants will be $461,000 in 2000, $237,000 in 2001 and $78,000 in
2002. See Note 12.
58
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
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
through the date of WatchGuard's initial public offering in July 1999 and using
the Black-Scholes pricing model thereafter. The following weighted average
assumptions were used in the pricing model: risk-free interest rates ranging
from 6.0% to 4.9% from 1997 through 1999; a dividend yield rate of 0% for all
periods; volatility of 0.85 since the initial public offering date; and an
expected life ranging from two to 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,
----------------------------------------
1997 1998 1999
------------ ------------ ------------
(In thousands, except per share data)
<S> <C> <C> <C>
Net loss--as reported.......... $ (4,334) $ (9,119) $ (16,018)
Net loss--pro forma............ (4,363) (9,166) (19,837)
Net loss per share--as
reported...................... (17.17) (11.34) (1.80)
Net loss per share--pro forma.. (17.30) (11.42) (2.23)
</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, 1998 and 1999, 100,000, 10,000 and 20,000 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.
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. These warrants were exercised in 1999.
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 0.6 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
59
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
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 during the last six months of 1998, the period in which WatchGuard
derived its promotional value from its customer. The warrant is not tied to any
performance commitments under the license and sales agreement.
Warrants were also granted in connection with the bridge loan and convertible
notes discussed in Note 5. At December 31, 1999 WatchGuard had 225,000 warrants
outstanding.
1999 Employee Stock Purchase Plan
In May 1999, the board of directors and stockholders approved the 1999
Employee Stock Purchase Plan (ESPP). WatchGuard implemented the ESPP upon the
effectiveness of its initial public offering. Subject to certain limitations,
the ESPP 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 each
fiscal year, the first of which occurred on January 1, 2000, equal to the least
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, and (c) a lesser amount
determined by the board of directors.
Common Stock Grant
In connection with the employment and stock vesting agreement granted to an
employee in connection with the BeadleNet acquisition, WatchGuard issued 51,948
unregistered shares of its common stock, valued at $750,000, on the closing
date of the acquisition. See Note 12.
Common Shares Reserved
At December 31, 1999, common stock reserved for future issuance was as
follows:
<TABLE>
<S> <C>
Exercise of common stock options................................. 7,027,679
Exercise of common stock warrants................................ 225,000
---------
7,252,679
=========
</TABLE>
60
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
7. 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
preferred stock outstanding as if such shares were converted to common stock at
the time of issuance.
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------
1997 1998 1999
-------- -------- --------
(In thousands, except per
share data)
<S> <C> <C> <C>
Net loss........................................ $ (4,334) $ (9,119) $(16,018)
======== ======== ========
Basic and diluted net loss per common share..... $ (17.17) $ (11.34) $ (1.80)
======== ======== ========
Weighted average number of common shares used
for basic and diluted per share amounts........ 252 804 8,903
======== ========
Weighted average common shares issuable upon
pro forma conversion of preferred stock........ 7,761
--------
Weighted average number of shares used for pro
forma per share amounts........................ 16,664
========
Pro forma basic and diluted net loss per share.. $ (0.96)
========
</TABLE>
For the years ended December 31, 1997, 1998 and 1999, options to purchase
5,227,580, 5,145,268 and 6,502,680 shares of common stock, respectively, and
warrants to purchase 245,000, 45,000 and 225,000 shares of common stock,
respectively, were excluded from the computation of actual and pro forma
diluted net loss per common share, as their effect is antidilutive.
8. Income Taxes
At December 31, 1999, WatchGuard had a net operating loss carryforward for
federal tax purposes of approximately $24 million. 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
generating future taxable income necessary 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 1999
------- ------- --------
(In thousands)
<S> <C> <C> <C>
Deferred tax assets:
Net operating loss carryforwards............. $ 1,423 $ 3,358 $ 8,216
Acquisition intangibles...................... -- -- 1,179
Research and development tax credit.......... 92 218 313
Returns reserve.............................. -- 215 253
Allowance for bad debts...................... 42 153 60
Accrued expenses............................. 43 102 214
------- ------- --------
Total deferred tax assets...................... 1,600 4,046 10,235
Valuation allowance............................ (1,600) (4,046) (10,235)
------- ------- --------
Net deferred taxes............................. $ -- $ -- $ --
======= ======= ========
</TABLE>
61
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
WatchGuard's valuation allowance increased by $1,441,000, $2,446,000 and
$6,189,000 in 1997, 1998 and 1999, respectively.
9. 401(k) Retirement 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.
10. Commitments
WatchGuard leases office space and equipment under noncancelable operating
leases. Future minimum payments at December 31, 1999 under these leases are as
follows (in thousands):
<TABLE>
<S> <C>
2000.................................................................. $468
2001.................................................................. 182
2002.................................................................. 24
2003.................................................................. 14
----
$688
====
</TABLE>
Two of the officers of WatchGuard are guarantors of part of the office lease.
Rent expense for 1997, 1998 and 1999 was $134,000, $273,000 and $512,000,
respectively.
11. 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>
Year Ended December 31,
------------------------
1997 1998 1999
------- -------- -------
(In thousands)
<S> <C> <C> <C>
United States.................................... $ 2,262 $ 7,401 $10,303
Rest of World
Europe......................................... 1,140 2,049 5,340
Asia........................................... 1,209 1,106 3,275
Other.......................................... 487 823 1,701
------- -------- -------
2,836 3,978 10,316
------- -------- -------
Total........................................ $ 5,098 $ 11,379 $20,619
======= ======== =======
</TABLE>
12. Acquisition of BeadleNet, LLC
On October 19, 1999, WatchGuard acquired the assets of BeadleNet, LLC, a
California limited liability company, pursuant to an Asset Purchase Agreement
dated as of October 19, 1999, among BeadleNet,
62
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Productivity Enhancement Products, Inc. (PEP), a member of BeadleNet, Danny M.
Beadle, the founder and a member of BeadleNet and the principal shareholder of
PEP, and WatchGuard. WatchGuard accounted for the acquisition using the
purchase method of accounting. The results of operations of BeadleNet and the
fair value of the assets acquired have been included in the financials
statements beginning on the acquisition date.
The total BeadleNet acquisition cost of $9,556,000 is comprised of: (1)
$3,406,000 in cash paid at closing, including $1,000,000 paid to PEP in
satisfaction of BeadleNet's outstanding liabilities to PEP; (2) 335,931
unregistered shares of WatchGuard common stock issued at closing with a fair
value of $4,850,000; (3) an additional $1 million in contingent consideration,
comprised of $400,000 in cash and 20,189 unregistered shares of WatchGuard
common stock with a fair value of $600,000, which became due upon completion of
certain technology items in late December 1999 and was paid in January 2000;
and (4) estimated direct acquisition costs of $300,000.
The aggregate purchase price was allocated, based on estimated fair values on
the acquisition date, as follows:
<TABLE>
<S> <C>
Inventories...................................................... $ 5,000
Equipment........................................................ 69,000
Intangibles:
Acquired workforce............................................. 204,000
Tradenames..................................................... 409,000
Developed technology........................................... 503,000
Goodwill....................................................... 4,985,000
----------
Total intangibles............................................ 6,101,000
Acquired in-process research and development..................... 3,381,000
----------
Total purchase price............................................. $9,556,000
==========
</TABLE>
Values assigned to the acquired in-process research and development,
developed technology and tradenames were determined using a discounted cash
flow analysis. The value assigned to the workforce in place was based on
replacement cost.
To determine the value of the in-process research and development, WatchGuard
considered, among other factors, the state of development of each project, the
time and cost needed to complete each project, expected income, and associated
risks, which included the inherent difficulties and uncertainties in completing
the project and achieving technological feasibility and risks related to the
viability of and potential changes in future target markets. This analysis
resulted in amounts assigned to in-process research and development projects
that had not yet reached technological feasibility and do not have alternative
future uses. The entire $3,381,000 allocated to acquired in-process research
and development was expensed on the date of acquisition.
To determine the value of the developed technology, WatchGuard discounted the
expected future cash flows of the existing technology product, taking into
account risks related to the characteristics and applications of each product,
existing and future markets and assessments of the life cycle stage of each
project. Based on this analysis, WatchGuard capitalized the existing technology
that had reached technological feasibility.
The lives assigned to the identified intangible assets ranged from two to
four years and the life assigned to goodwill was five years. Amortization
expense for these intangibles was $245,000 in the fourth quarter of 1999, and
was recorded based on the straight-line method.
63
<PAGE>
WATCHGUARD TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
The unaudited pro forma combined historical results presented as if BeadleNet
had been acquired at the beginning of each period presented and excluding the
nonrecurring one-time charge for in-process research and development are as
follows:
<TABLE>
<CAPTION>
Year Ended
December 31,
------------------
1998 1999
-------- --------
(unaudited)
<S> <C> <C>
Total revenues, net........................................ $ 11,379 $ 20,619
Net loss................................................... $(10,396) $(15,707)
Pro forma net loss per share............................... $ (10.21) $ (1.69)
</TABLE>
In connection with the acquisition, WatchGuard entered into an employment
agreement and a stock vesting agreement with Mr. Beadle. Pursuant to the
employment agreement, WatchGuard granted Mr. Beadle an option, vesting over a
period of four years, to purchase 250,000 shares of WatchGuard common stock at
an exercise price of $14.44 per share, the fair value of the stock on the date
the option was granted. In consideration of certain of Mr. Beadle's obligations
in the employment agreement, including his agreement not to compete with
WatchGuard for a period of three years after his employment terminates,
WatchGuard also issued to Mr. Beadle 51,948 unregistered shares of WatchGuard
common stock, valued at $750,000 on the closing date of the acquisition. The
value of this stock has been recorded as deferred stock compensation expense
and is being amortized on a straight-line basis over the two-year employment
agreement period. Amortization of this deferred stock compensation was $73,000
in the fourth quarter of 1999. Under the stock vesting agreement, 34,632 of
these shares will be subject to forfeiture if Mr. Beadle's employment is
terminated for cause or if he resigns. One half of these shares will no longer
be subject to forfeiture on October 19, 2000 and the remainder will no longer
be subject to forfeiture on October 19, 2001.
13. Related-Party Transactions
The vice president and general manager of WatchGuard's broadband Internet
security division is also the founder and principal shareholder of PEP, the
former parent of BeadleNet. Since the acquisition date, PEP has provided, and
continues to provide, various products and services to WatchGuard. Primarily,
PEP supplies products for sale (including purchasing, producing and assembling
products), provides office space and facilities services and provides
engineering and consulting services during the development of some of
WatchGuard's new broadband product offerings. Total expenditures for PEP
products and services during 1999 were $448,000 and total amounts due PEP at
December 31, 1999 were $361,000. WatchGuard expects that PEP will continue to
provide products and services during the first half of 2000 until WatchGuard
relocates to a new facility, contracts with new manufacturing sources and fills
its open staffing positions, all of which are believed to be reasonably
attainable during that time frame.
64
<PAGE>
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>
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
Year ended December 31,
1999
Allowance for
uncollectible
accounts............. $ 449 $ 129 $ -- $ 401 (A) $ 177
Sales return reserve.. $ 615 $ 1,083 $ -- $ 1,148 (B) $ 550
</TABLE>
- --------
(A) Deductions consist of write-offs of uncollectible accounts, net of
recoveries.
(B) Deductions consist of product returns.
65
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Executive Officers and Directors
The following table lists the executive officers, directors and key employees
of WatchGuard as of March 31, 2000.
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<C> <C> <S>
Executive Officers
Christopher G. Slatt.... 41 President, Chief Executive Officer and Chairman
of the Board
Steven N. Moore......... 42 Executive Vice President of Finance, Chief
Financial Officer, Secretary, Treasurer and
Director
R. Michael Peronto...... 43 Vice President and Chief Operating Officer
Directors
Stuart J. Ellman........ 33 Director
Andrew W. Verhalen...... 43 Director
Charles P. Waite, Jr. .. 44 Director
</TABLE>
Christopher G. Slatt cofounded WatchGuard in February 1996. Mr. Slatt has
served as president, chief executive officer and a director of WatchGuard 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 private 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
as executive vice president of finance of WatchGuard since March 1999, as chief
financial officer, secretary, treasurer and a director since inception, and as
vice president of finance and operations from inception until March 1999. From
September 1993 to September 1995, he served as director of finance of Legent
Corporation. Mr. Moore holds a B.S. in finance from Central Washington
University.
R. Michael Peronto has served as vice president and chief operating officer
of WatchGuard since 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.
Stuart J. Ellman has served as a director of WatchGuard since April 1998. Mr.
Ellman cofounded RRE Ventures LLC, a venture capital firm, and since August
1994 has served as general partner of RRE Ventures LLC and its affiliates and
predecessors. He also serves as managing director of RRE Investors, LLC and as
a member of RRE Investors II, LLC. He is also a director of several private
companies. Mr. Ellman holds a B.A. in economics from Wesleyan University and an
M.B.A. from Harvard University.
66
<PAGE>
Andrew W. Verhalen has served as a director of WatchGuard since May 1997.
Since April 1992, Mr. Verhalen has served as a partner of Matrix Partners, a
venture capital firm. Before 1992, Mr. Verhalen held senior management
positions at 3Com Corporation and Intel Corporation. He is also a director of
Copper Mountain Networks, Unwired Planet, Alteon WebSystems Inc., Turnstone
Systems and several private technology companies. 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, a venture capital firm. He is also a director of Loudeye,
Inc., Verity, Inc. and several private companies. Mr. Waite holds an A.B. in
history from Kenyon College and an M.B.A. from Harvard University.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires
our executive officers, directors and holders of 10% or more of a registered
class of our equity securities to file reports of ownership and changes in
ownership with the Securities and Exchange Commission. Commission regulations
require executive officers, directors and 10%-or-greater stockholders to give
us copies of all Section 16(a) forms they file with the Commission.
Based solely on our review of the copies of these forms we received, or
written representations from reporting persons that no such forms were required
for those persons, we believe that during 1999 our executive officers,
directors and 10%-or-greater stockholders complied with all applicable filing
requirements.
ITEM 11. EXECUTIVE COMPENSATION
Compensation Summary
The following table lists all compensation earned during 1999 by our chief
executive officer and our other executive officers whose compensation exceeded
$100,000 in 1999.
Summary Compensation Table
<TABLE>
<CAPTION>
Long-Term
Compensation
Awards
Annual ------------
Compensation Securities
------------------ Underlying
Name and Principal Position Year Salary($) Bonus($) Options(#)
--------------------------- ---- --------- -------- ------------
<S> <C> <C> <C> <C>
Christopher G. Slatt..................... 1999 $190,000 $67,203 40,000
Chief Executive Officer and President 1998 155,000 -- 70,000
Steven N. Moore.......................... 1999 171,250 67,203 40,000
Executive Vice President of Finance,
Chief Financial Officer, 1998 155,000 -- 70,000
Secretary and Treasurer
R. Michael Peronto....................... 1999 142,019 49,538 440,564
Vice President and Chief Operating
Officer(1)
</TABLE>
- --------
(1) Mr. Peronto joined WatchGuard in March 1999. His annual salary is
$175,000.
Option Grants in 1999
The following table provides information regarding options granted during
1999 to our chief executive officer and our other executive officers whose
compensation exceeded $100,000 in 1999. The table includes the potential
realizable value over the 10-year term of the options, based on assumed rates
of stock appreciation of 5% and 10%, compounded annually. The assumed rates of
appreciation are prescribed by the Securities and
67
<PAGE>
Exchange Commission for illustrative purposes only and are not intended to
forecast or predict future stock prices. Any actual gains on option exercises
will depend on the future performance of our stock.
Option Grants in Last Fiscal Year
<TABLE>
<CAPTION>
Individual Grants Potential Realizable
------------------------------------------------ Value at Assumed Annual
Number of Percent of Total Rates of Stock Price
Securities Options Granted Appreciation for Option
Underlying to Employees in Exercise Term
Options Last Fiscal Price Expiration ------------------------
Name Granted(#) Year ($/Share) Date 5%($) 10%($)
- ---- ---------- ---------------- --------- ---------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
Christopher G. Slatt.... 40,000 1.78% $14.30 6/17/04 $ 158,000 $ 349,000
Steven N. Moore......... 40,000 1.78 14.30 6/17/04 158,000 349,000
R. Michael Peronto...... 439,564 19.55 13.00 4/12/09 3,594,000 9,107,000
1,000 * 13.00 7/30/09 8,000 21,000
</TABLE>
- --------
* Less than 1%
Approximately 2% of Mr. Slatt's and Mr. Moore's options vest and become
exercisable each month, commencing on July 17, 1999. Of the options we granted
to Mr. Peronto on April 12, 1999, 25% vested and became exercisable on April
12, 2000 and approximately 2% of the remaining options vest and become
exercisable each month after that date. Of the options we granted to Mr.
Peronto on July 30, 1999, approximately 2% vest and become exercisable each
month, commencing on August 30, 1999. In 1999, we granted options to purchase
an aggregate of 2,248,314 shares to employees. We granted all options under our
stock option plan at exercise prices that equal the fair market value of our
common stock on the date of grant.
Unexercised Options Held as of December 31, 1999
The following table provides information regarding unexercised options held
as of December 31, 1999 by our chief executive officer and our other executive
officers whose compensation exceeded $100,000 in 1999. The value of unexercised
options is calculated on the basis of the closing sales price of our common
stock on the Nasdaq National Market on December 31, 1999, which was $30.25 per
share. The individuals listed below did not exercise any options during 1999.
Fiscal Year-End Option Values
<TABLE>
<CAPTION>
Number of Securities
Underlying Value of Unexercised
Unexercised Options at In-the-Money Options at
Fiscal Year-End(#) Fiscal Year-End($)
------------------------- -------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
- ---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Christopher G. Slatt........ 38,541 71,459 $1,089,569 $1,655,921
Steven N. Moore............. 38,541 71,459 1,089,569 1,655,921
R. Michael Peronto.......... 104 440,460 1,794 7,597,935
</TABLE>
68
<PAGE>
Compensation Committee Report on Executive Compensation
The compensation committee of the board of directors has furnished the
following report on compensation. The compensation committee, which is
comprised of three nonemployee directors, reviews and approves the compensation
and benefits for our executive officers, grants stock options to officers and
nonemployees under our stock option plan and makes recommendations to the board
of directors regarding these matters. The compensation committee applies a
similar compensation policy to executives and employees and considers internal
and external information in determining compensation.
Compensation Philosophy
Our compensation policies are based on the belief that the interests of
employees should be closely aligned with those of our stockholders. The
compensation policies are designed to achieve the following objectives:
. Offer compensation opportunities that attract highly qualified employees,
reward outstanding initiative and achievement, and retain the leadership and
skills necessary to build long-term stockholder value.
. Maintain a market competitive compensation structure in line with corporate
business objectives. The focus is weighted on incentive programs and based
on results as measured by both the quarterly and long-term financial
performance of Watchguard.
. Further our short- and long-term strategic goals and values by aligning
compensation with business objectives and individual performance.
Compensation Program
Our compensation program has three major integrated components: base salary,
quarterly bonus awards, and long-term incentives. We emphasize the award of
stock options as long-term incentives to executive officers.
Base Salary. Base salary levels are determined annually by reviewing the
skills, performance level, and contribution to the business of individual
employees.
Quarterly Bonus Awards. Quarterly bonus awards are based on individual
employee goals and the attainments of quarterly corporate objectives, which are
set on a quarterly basis.
Long-Term Incentives. The compensation committee views stock options as an
important part of its long-term, performance-based compensation program. The
committee believes that stock ownership is an excellent vehicle for
compensating its officers and employees. We provide long-term incentives
through our Amended and Restated 1996 Stock Incentive Compensation Plan and our
1999 Employee Stock Purchase Plan, the purpose of which is to create a direct
link between executive compensation and increases in stockholder value. Stock
options are granted at fair market value and vest in installments generally
over four years. Thus, the value of the stockholders' investment must
appreciate before the optionee receives any financial benefit. Additionally,
the employee must remain in our employ for the period required for the stock
option to be exercisable, thus providing an incentive to remain in our employ.
When determining option awards for an executive officer, the committee
considers the executive's current contribution to Watchguard's performance, the
anticipated contribution to meeting our long-term strategic performance goals,
and industry practices and norms. Long-term incentives granted in prior years
and existing levels of stock ownership are also taken into consideration.
Because the receipt of value by an executive officer under a stock option
depends on an increase in the price of our common stock, this portion of the
executive's compensation is directly aligned with an increase in stockholder
value. The committee believes that such stock plans align the interests of the
employees with the long-term interests of the stockholders.
Chief Executive Officer Compensation
Mr. Slatt's annual salary for 1999 was $200,000. During fiscal 1999, Mr.
Slatt was granted a stock option to purchase 40,000 shares of common stock at
an exercise price of $14.30 per share, 10% above the fair market
69
<PAGE>
value of our common stock on the date of the grant. The stock option will vest
in accordance with our customary vesting schedule for performance-based grants
as set forth in footnote to the table titled "Options Grants in Last Fiscal
Year." Mr. Slatt's base salary, annual incentive award and long-term
compensation for 1999 was determined based upon the same factors employed by
the committee for executive officers generally.
Section 162(m) of the Internal Revenue Code limits the tax deductibility by a
corporation of compensation in excess of $1 million paid to its chief executive
officer and any other of its four most highly compensated executive officers.
Compensation that qualifies as "performance-based," however, is excluded from
the $1 million limit. The Committee does not presently expect total cash
compensation payable for salaries to exceed the $1 million limit for any
individual executive. In addition, our stock option plan is designed to qualify
as performance-based compensation that is fully deductible by us for income tax
purposes. The Committee will continue to monitor the compensation levels
potentially payable under our other compensation programs, but intends to
retain the flexibility necessary to provide total compensation in line with
competitive practice, our compensation philosophy and the best interests of
WatchGuard.
Compensation Committee
Stuart J. Ellman
Andrew W. Verhalen
Charles P. Waite, Jr.
70
<PAGE>
Performance Graph
The following graph shows a comparison of cumulative total stockholder return
for WatchGuard, the Nasdaq Stock Market Index and the Nasdaq Computer and Data
Processing Index. The graph shows the value as of December 31, 1999 of $100
invested on July 30, 1999, the date of our initial public offering, in
WatchGuard common stock, the Nasdaq Stock Market Index (U.S. companies) and the
Nasdaq Computer and Data Processing Index.
Comparison of Cumulative Total Return Among WatchGuard Technologies, Inc., the
Nasdaq Stock Market Index and the Nasdaq Computer and Data Processing Index
[PERFORMANCE CHART GRAPHIC]
<TABLE>
<CAPTION>
July Dec.
30, 31,
1999 1999
------- -------
<S> <C> <C>
WatchGuard.................................................. $100.00 $226.70
Nasdaq Stock Market Index (U.S. companies).................. 100.00 149.80
Nasdaq Computer and Data Processing Index................... 100.00 178.50
</TABLE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Principal Stockholders
The following table provides information regarding the actual beneficial
ownership of our outstanding common stock as of March 31, 2000 by
. each person or group that we know beneficially owns 5% or more of our
common stock;
. each of our directors;
. our chief executive officer and the other executive officers whose
compensation exceeded $100,000 in 1999; and
. all of our directors and executive officers as a group.
The percentage ownership data is based on 22,718,643 shares of WatchGuard
common stock outstanding as of March 31, 2000. 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 of
71
<PAGE>
March 31, 2000 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
Number of Shares Common Stock
Name and Address Beneficially Owned Outstanding
---------------- ------------------ -------------
<S> <C> <C>
Entities affiliated with Matrix IV Management
Co., L.P.(1)................................ 2,908,291 12.80%
2500 Sand Hill Road
Menlo Park, CA 94025
Entities affiliated with Olympic Venture
Partners(2)................................. 2,670,628 11.76
2420 Carillon Point
Kirkland, WA 98033
Entities affiliated with RRE Investors II,
LLC(3)...................................... 1,017,288 4.48
156 East 56th St., 22nd Floor
New York, NY 10022
Stuart J. Ellman(4).......................... 1,017,288 4.48
Andrew W. Verhalen(5)........................ 2,908,291 12.80
Charles P. Waite, Jr.(6)..................... 2,670,628 11.76
Christopher G. Slatt(7)...................... 2,532,429 11.12
Steven N. Moore(8)........................... 2,532,429 11.12
R. Michael Peronto(9)........................ 120,019 *
Directors and executive officers as a group
(6 persons)(10)............................. 11,781,084 51.36
</TABLE>
- --------
* Less than 1%
(1) Matrix IV Management Co., L.P. is the general partner of each of Matrix
Partners IV, L.P. and Matrix Entrepreneurs Fund, L.P., and thus is deemed
to beneficially own the shares held by these entities. Andrew W.
Verhalen, a director of WatchGuard, is a general partner of Matrix IV
Management Co., L.P.
(2) Includes 1,189,680 shares 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 the shares held by these
entities. Also includes 1,480,948 shares 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 the shares held by
these entities. OVMC III, L.P. and OVMC IV, LLC disclaim beneficial
ownership of these shares except to the extent of their pecuniary
interest 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) 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 the shares held by these entities. Stuart J.
Ellman, a director of WatchGuard, is a member of RRE Investors II, LLC.
(4) 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.
72
<PAGE>
(5) Represents 2,908,291 shares 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 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 2,670,628 shares held by entities affiliated with 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, 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. 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) Includes 300,000 shares held by Venus Capital LLC and 49,999 shares
subject to options exercisable within 60 days of March 31, 1999.
(8) Includes 300,000 shares held by Baja Investment Co. LLC and 49,999 shares
subject to options exercisable within 60 days of March 31, 1999.
(9) Includes 119,234 shares subject to options exercisable within 60 days of
March 31, 1999.
(10) Includes 219,232 shares subject to options exercisable within 60 days of
March 31, 1999.
Change-of-Control Arrangements
Under Mr. Peronto's stock option letter agreement, if a change of control of
WatchGuard occurs, half of the unvested shares subject to the option for
439,564 shares granted on April 12, 1999 will vest and become exercisable.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Financial Statements and Financial Statement Schedules
(1) INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Ernst & Young LLP, Independent Auditors........................ 45
Balance Sheets........................................................... 46
Statements of Operations................................................. 47
Statements of Stockholders' Equity....................................... 48
Statements of Cash Flows................................................. 49
Notes to Financial Statements............................................ 50
</TABLE>
(2) INDEX TO FINANCIAL STATEMENT SCHEDULES
Schedule II--Valuation and Qualifying Accounts for each of the three years
ended December 31, 1999, 1998 and 1997
73
<PAGE>
Schedules not listed above have been omitted because they are not applicable
or are not required or the information required to be set forth in the
schedules is included in the financial statements or related notes.
(3) EXHIBITS
<TABLE>
<CAPTION>
Number Description
------ -----------
<C> <S>
3.1* Restated Certificate of Incorporation of the registrant.
3.2* Restated Bylaws of the registrant.
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(Omega) Asset Purchase Agreement, dated as of October 19, 1999, by and among
BeadleNet, LLC, Productivity Enhancement Products, Inc., Danny M.
Beadle and WatchGuard Technologies, Inc.
10.11(Omega) Employment Agreement, dated as of October 19, 1999, by and between
Danny M. Beadle and WatchGuard Technologies, Inc.
10.12(Omega) Stock Vesting Agreement, dated as of October 19, 1999, by and between
Danny M. Beadle and WatchGuard Technologies, Inc.
10.13 Lease Agreement, dated as of March 1, 2000, between 505 Union Station
Ltd. and the registrant.
10.14 Loan Modification Agreement, dated as of March 21, 2000, between
Silicon Valley Bank and the registrant.
23.1 Consent of Ernst & Young LLP, independent auditors.
27.1(Beta) Financial Data Schedule
</TABLE>
- --------
+ Portions of these exhibits have been omitted based on a grant of
confidential treatment by the Securities and Exchange Commission. The
omitted portions of the exhibits have been filed separately with the
SEC.
* Incorporated by reference to the Registration Statement on Form S-1
(No. 333-76587) filed by WatchGuard on April 20, 1999, as amended.
(Omega) Incorporated by reference to the Current Report on Form 8-K (File No.
000-26819) filed by the registrant on November 2, 1999, as amended.
(Beta) Incorporated by reference to the Annual Report on Form 10-K for the
year ended December 31, 1999 (File No. 000-26819) filed by the
registrant on February 11, 2000.
(b) Reports on Form 8-K
On November 2, 1999, we filed with the Securities and Exchange Commission a
Current Report on Form 8-K, as amended by Form 8-K/A filed on January 3, 2000,
reporting our acquisition of BeadleNet, LLC.
74
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of
1934, as amended, the registrant has duly caused this amendment to this report
to be signed on its behalf by the undersigned, thereunto duly authorized.
WatchGuard Technologies, Inc.
/s/ Christopher G. Slatt
_____________________________________
Name: Christopher G. Slatt
Title: President and Chief Executive
Officer
Date: April 28, 2000
Pursuant to the requirements of the Securities Act of 1934, as amended, this
amendment to this report has been signed by the following persons, on behalf of
the registrant, in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Christopher G. Slatt President, Chief Executive April 28, 2000
______________________________________ Officer and Chairman of
Christopher G. Slatt the Board (Principal
Executive Officer)
/s/ Steven N. Moore Executive Vice President April 28, 2000
______________________________________ of Finance, Chief
Steven N. Moore Financial Officer,
Secretary, Treasurer and
Director (Principal
Financial and Accounting
Officer)
Director
______________________________________
Stuart J. Ellman
/s/ Andrew W. Verhalen Director April 28, 2000
______________________________________
Andrew W. Verhalen
/s/ Charles P. Waite, Jr. Director April 28, 2000
______________________________________
Charles P. Waite, Jr.
</TABLE>
75
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Number Description
------ -----------
<C> <S>
3.1* Restated Certificate of Incorporation of the registrant.
3.2* Restated Bylaws of the registrant.
Lease Agreement, dated as of March 15, 1996, between COM Realty, Inc.
10.1* and the registrant.
Lease Agreement, dated as of October 10, 1997, between Burke-State
10.2* Bldg. LLC and the registrant.
Lease Agreement, dated as of August 17, 1998, between Cederstrand
10.3* 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(Omega) Asset Purchase Agreement, dated as of October 19, 1999, by and among
BeadleNet, LLC, Productivity Enhancement Products, Inc., Danny M.
Beadle and WatchGuard Technologies, Inc.
10.11(Omega) Employment Agreement, dated as of October 19, 1999, by and between
Danny M. Beadle and WatchGuard Technologies, Inc.
10.12(Omega) Stock Vesting Agreement, dated as of October 19, 1999, by and between
Danny M. Beadle and WatchGuard Technologies, Inc.
10.13 Lease Agreement, dated as of March 1, 2000, between 505 Union Station
Ltd. and the registrant.
10.14 Loan Modification Agreement, dated as of March 21, 2000, between
Silicon Valley Bank and the registrant.
23.1 Consent of Ernst & Young LLP, independent auditors.
27.1(Beta) Financial Data Schedule
</TABLE>
- --------
+ Portions of these exhibits have been omitted based on a grant of
confidential treatment by the Securities and Exchange Commission. The
omitted portions of the exhibits have been filed separately with the
SEC.
* Incorporated by reference to the Registration Statement on Form S-1
(No. 333-76587) filed by the registrant on April 20, 1999, as
amended.
(Omega) Incorporated by reference to the Current Report on Form 8-K (File No.
000-26819) filed by the registrant on November 2, 1999, as amended.
(Beta) Incorporated by reference to the Annual Report on Form 10-K for the
year ended December 31, 1999 (File No. 000-26819) filed by the
registrant on February 11, 2000.
<PAGE>
EXHIBIT 10.13
LEASE
Between
WATCHGUARD TECHNOLOGIES, INC.
a Delaware corporation
(Tenant)
and
505 UNION STATION LTD.,
a Washington corporation
(Landlord)
<PAGE>
LEASE
THIS LEASE (the "Lease") is made as of March 1, 2000, between 505 UNION
-----
STATION LTD., a Washington corporation (the "Landlord"), and the Tenant named in
--------
the Schedule below. The term "Project" means the building (the "Building")
------- --------
known as "505 Union Station" and the land (the "Land") located at 505 Fifth
----
Avenue South in Seattle, King County, Washington. "Premises" means that part of
--------
the Project leased to Tenant described in the Schedule and outlined on
Appendix A.
- -------- -
The following schedule (the "Schedule") is an integral part of this Lease.
--------
Terms defined in this Schedule shall have the same meaning throughout the Lease.
SCHEDULE
A. Tenant: Watchguard Technologies, Inc.
B. Premises: Floors 3, 4 & 5 in the Building
C. Rentable Square Feet of the Premises: 87,439 RSF, per BOMA standards
(ANSI Z 65.1.1996) ("BOMA")
D. Tenant's Proportionate Share: 29.96% (based upon a total of 291,860
rentable square feet in the Building, per BOMA)
E. Security Deposit: See Section 4 of the Addendum to Lease.
F. Tenant's Real Estate Broker for this Lease: Eric Olmstead, NAI Leibsohn
& Co.
G. Landlord's Real Estate Broker for this Lease: Colliers International
H. Tenant Improvements, if any: See the Tenant Improvement Agreement
attached hereto as Appendix D.
----------
I. Commencement Date: Subject to extension pursuant to the terms of
Appendix D, the date that is the earlier to occur of (i) the date
-------
Tenant occupies any substantial portion of the Premises for its
business purposes; or (ii) ninety-seven (97) days after the date on
which Landlord delivers possession of the entire Premises to Tenant
with Landlord's Shell and Core Improvements (as defined in Appendix C)
completed to the point that Tenant and its contractors shall be able to
commence and continue Tenant's proposed improvements to the Premises
without substantial interference or delay caused by Landlord's work not
being fully completed (hereinafter, "Premises Delivery"). The foregoing
notwithstanding, Tenant shall not be required to accept Premises
Delivery at any time prior to May 15, 2000 or on less than fourteen
(14) days' prior written notice of the Premises Delivery Date. Although
Tenant shall not be required to accept Premises Delivery at any time
prior to May 15, 2000, or on less than fourteen (14) days' prior
written notice of the Premises Delivery Date, if Landlord tenders and
Tenant accepts Premises Delivery prior to May 15, 2000 or on less than
fourteen (14) days' prior written notice, then the 97-day period
referenced above shall nevertheless not begin to run until May 15, 2000
or the date that is fourteen (14) days after the notice of the Premises
Delivery date, whichever is later. It is anticipated that the
Commencement Date will be August 22, 2000. Landlord and Tenant shall
execute a Commencement Date Confirmation substantially in the form of
Appendix F promptly following the Commencement Date.
----------
-1-
<PAGE>
J. Termination Date/Term: The term shall be ten (10) years and the
Termination Date shall be midnight on the day immediately preceding the
tenth (10) anniversary of the Commencement Date (anticipated to be
August 22, 2010 (subject to the Option to Extend set forth in the
Addendum to Lease attached hereto).
K. Credit Enhancement: See the Addendum to Lease attached hereto.
L. Base Rent:
<TABLE>
<CAPTION>
Annual Monthly
Period Rental Rate Base Rent
------ ----------- ---------
<S> <C> <C>
Lease Months 1-12 $24.00/RSF (NNN) $174,878.00
Lease Months 13-24 $25.00/RSF (NNN) $182,164.58
Lease Months 25-36 $26.00/RSF (NNN) $189,451.16
Lease Months 37-48 $27.00/RSF (NNN) $196,737.75
Lease Months 49-60 $28.00/RSF (NNN) $204,024.33
Lease Months 61-72 $29.00/RSF (NNN) $211,310.91
Lease Months 73-84 $30.00/RSF (NNN) $218,597.50
Lease Months 85-96 $31.00/RSF (NNN) $225,884.08
Lease Months 97-108 $32.00/RSF (NNN) $233,170.66
Lease Months 109-120 $33.00/RSF (NNN) $240,457.25
</TABLE>
1. LEASE AGREEMENT. On the terms stated in this Lease, Landlord leases
---------------
the Premises to Tenant, and Tenant leases the Premises from Landlord, for the
Term beginning on the Commencement Date and ending on the Termination Date
unless extended or sooner terminated pursuant to this Lease.
2. RENT.
----
(a) Types of Rent. Tenant shall pay the following Rent, without
-------------
notice demand, deduction or offset (except as specifically set forth herein) in
the form of a check to Landlord at the following address:
505 Union Station Ltd.
505 Fifth Ave. S., Suite 800
Seattle, WA 98104
or in such other manner as Landlord may notify Tenant.
-2-
<PAGE>
(i) Base Rent in monthly installments in advance, the first
---------
monthly installment payable on the Commencement Date and thereafter on or before
the first day of each month of the Term in the amount set forth in Section 12 of
the above Schedule. If the Commencement Date or the Termination Date occurs
other than on the first day of a month, Base Rent for such month shall be
prorated on the basis of the number of days in such month that fall within the
term.
(ii) Operating Cost Share Rent in an amount equal to the Tenant's
-------------------------
Proportionate Share of the Operating Costs for the applicable fiscal year of the
Lease, paid monthly in advance in an estimated amount. Definitions of Operating
Costs and Tenant's Proportionate Share, and the method for billing and payment
of Operating Cost Share Rent are set forth in Sections 2(b), 2(c) and 2(d).
Tenant acknowledges that this Lease is, in all respects, considered to be a net
Lease and it is the intent of the parties that Tenant shall pay Tenant's
Proportionate Share of the Operating Costs relating to the Building, the Land
the Project, and the common areas of the Building.
(iii) Tax Share Rent in an amount equal to the Tenant's
--------------
Proportionate Share of the Taxes for the applicable fiscal year of this Lease,
paid monthly in advance in an estimated amount. A definition of Taxes and the
method for billing and payment of Tax Share Rent are set forth in Sections 2(b),
2(c) and 2(d).
(iv) Additional Rent in the amount of all costs, expenses,
---------------
liabilities, and amounts which Tenant is required to pay under this Lease,
excluding Base Rent, Operating Cost Share Rent, and Tax Share Rent, but
including any interest for late payment of any item of Rent.
(v) Rent as used in this Lease means Base Rent, Operating Cost
----
Share Rent, Tax Share Rent and Additional Rent. Tenant's agreement to pay Rent
is an independent covenant, with no right of setoff, deduction or counterclaim
of any kind.
(b) Payment of Operating Cost Share Rent and Tax Share Rent.
-------------------------------------------------------
(i) Payment of Estimated Operating Cost Share Rent and Tax Share
------------------------------------------------------------
Rent. Landlord shall estimate the Operating Costs and Taxes of the Project by
- ----
April 1 of each fiscal year, or as soon as reasonably possible thereafter.
Landlord may revise these estimates whenever it obtains more accurate
information, such as the final real estate tax assessment or tax rate for the
Project. Within twenty (20) days after receiving the original or revised
estimate from Landlord, Tenant shall pay Landlord one-twelfth (1/12th) of
Tenant's Proportionate Share of this estimate, multiplied by the number of
months that have elapsed in the applicable fiscal year to the date of such
payment including the current month, minus payments previously made by Tenant
for the months elapsed. On the first day of each month thereafter, Tenant shall
pay Landlord one-twelfth (1/12th) of Tenant's Proportionate Share of this
estimate, until a new estimate becomes applicable.
(ii) Correction of Operating Cost Share Rent. Landlord shall
---------------------------------------
deliver to Tenant a report for the previous fiscal year (the "Operating Cost
--------------
Report") by April 15 of each year, or as soon as reasonably possible thereafter,
- ------
setting forth (a) the actual Operating Costs incurred, (b) the amount of
Operating Cost Share Rent due from Tenant, and (c) the amount of
-3-
<PAGE>
Operating Cost Share Rent paid by Tenant. Within twenty (20) days after such
delivery, Tenant shall pay to Landlord the amount due minus the amount paid. If
the amount paid exceeds the amount due, Landlord shall apply the excess to
Tenant's payments of Operating Cost Share Rent next coming due or, if the Term
has then expired, Landlord shall pay the excess to Tenant at the time Landlord
delivers the Operating Cost Report to Tenant.
(iii) Correction of Tax Share Rent. Landlord shall deliver to
----------------------------
Tenant a report for the previous fiscal year (the "Tax Report") by April 15 of
----------
each year, or as soon as reasonably possible thereafter, setting forth (a) the
actual Taxes, together with copies of all supporting tax bills, (b) the amount
of Tax Share Rent due from Tenant, and (c) the amount of Tax Share Rent paid by
Tenant. Within twenty (20) days after such delivery, Tenant shall pay to
Landlord the amount due from Tenant minus the amount paid by Tenant. If the
amount paid exceeds the amount due, Landlord shall apply the excess to Tenant's
payments of Tax Share Rent next coming due, or, of the Term has then expired,
Landlord shall pay the excess to Tenant at the time Landlord delivers the Tax
Report to Tenant.
(c) Definitions.
-----------
(i) Included Operating Costs. "Operating Costs" means, subject to
------------------------ ---------------
the exclusions and limitations set forth below, any expenses, costs and
disbursements of any kind other than Taxes, paid or incurred by Landlord in
connection with the management, maintenance, operation, insurance, repair and
other related activities in connection with any part of the Project and of the
personal property, fixtures, machinery, equipment, systems and apparatus used by
Landlord in connection therewith, including the cost of providing those services
required to be furnished by Landlord under this Lease. Operating Costs shall
also include the costs of any capital improvements which are intended to reduce
Operating Costs or improve safety, and those made to keep the Project in
compliance with governmental requirements enacted or reinterpreted after the
Commencement Date applicable from time to time (collectively, "Included Capital
----------------
Items"). A capital improvement shall be any alteration, repair, replacement or
- -----
improvement of or to the Project, the cost of which would be capitalized and not
included in current expenses under generally accepted accounting principles. The
cost of an Included Capital Item shall be amortized over the lesser of seven (7)
------
years or useful life of the Included Capital Item at a commercially reasonable
interest rate and only the annual amortization shall be included in Operating
Costs.
If the Project is not fully occupied during any portion of any fiscal year,
Landlord may adjust (an "Equitable Adjustment") Operating Costs to equal what
--------------------
would have been incurred by Landlord had the Project been fully occupied. This
Equitable Adjustment shall apply only to Operating Costs which are variable and
therefore increase as occupancy of the Project increases. Landlord may
incorporate the Equitable Adjustment in its estimates of Operating Costs.
If Landlord does not furnish any particular service whose cost would have
constituted an Operating Cost to a tenant other than Tenant who has undertaken
to perform such service itself, Operating Costs shall be increased by the amount
which Landlord would have incurred if it had furnished the service to such
tenant.
(ii) Excluded Operating Costs. Operating Costs shall not include:
------------------------
-4-
<PAGE>
(1) costs of alterations, renovations, improvements, painting
or redecorating of tenant premises;
(2) costs of capital improvements other than Included Capital
Items;
(3) interest and principal payments on mortgages or any other
debt costs, or rental payments on any ground lease of the Project;
(4) promotional, marketing and advertising costs, real estate
brokers' leasing commissions, all other costs and expenses of letting or
reletting space in the Project, costs incurred in connection with disputes with
tenants or in preparing, negotiating, or enforcing leases or related agreements,
such as guarantees, estoppel certificates, nondisturbance agreements,
termination agreements, amendments, subleases, assignments and the like, costs
arising from the violation by Landlord or any occupant of the Project of the
terms and conditions of any lease or other agreement, and the costs of any
rental concessions or buyouts or tenant relocations;
(5) legal fees and space planner fees;
(6) any cost or expenditure for which Landlord is reimbursed,
by insurance proceeds, warranties, claims or otherwise, except by Operating Cost
Share Rent, and costs occasioned by the gross negligence, intentional
misconduct, or violating of law by Landlord, or its agents, employees or
contractors;
(7) the cost of any service furnished to any office tenant of
the Project which Landlord does not make available to Tenant;
(8) depreciation, reserves, and bad debt or rent loss;
(9) franchise or income taxes imposed upon Landlord, except
to the extent imposed in lieu of all or any part of Taxes;
(10) costs incurred in connection with the initial development
and construction of the shell and core of the Building and costs of correcting
defects in construction of the Building (as opposed to the cost of normal
repair, maintenance and replacement expected with the construction materials and
equipment installed in the Building); and
(11) the wages, salaries, compensation, benefits, and labor
burden of any employee for services not related directly to the management,
maintenance, operation and repair of the Project.
(12) management fees substantially in excess of the then-
market rate fees or charges for similar services to similar buildings in the
vicinity;
-5-
<PAGE>
(13) increases in the cost of insurance directly caused by the
activities of any other occupant of the Project; costs incurred to remove or
remediate any hazardous material from the Building or Land and any judgements,
fines, penalties or other costs incurred in connection with any hazardous
material exposure or release; except to the extent caused by Tenant or its
agents, employees, contractors, customers or invitees;
(14) political and charitable contributions;
(15) costs to acquire sculpture, paintings and other art
objects;
(16) damages incurred by Landlord for any default or breach,
hereunder or any claim, judgment or settlement related thereto; and
(17) costs related in any way to the financing, refinancing,
or sale of the Project or any interest therein.
(iii) Taxes. "Taxes" means any and all taxes, assessments and
----- -----
charges of any kind, general or special, ordinary or extraordinary, levied
against the Project, which Landlord shall pay or become obligated to pay in
connection with the ownership, leasing, renting, management, use, occupancy,
control or operation of the Project or of the personal property, fixtures,
machinery, equipment, systems and apparatus used in connection therewith. Taxes
shall include real estate taxes, personal property taxes, sewer rents, water
rents, special or general assessments, transit taxes, ad valorem taxes, and any
tax levied on the rents hereunder or the interest of Landlord under this Lease
(the "Rent Tax"). Taxes shall also include all fees and other costs and expenses
--------
paid by Landlord in reviewing any tax and in seeking a refund or reduction of
any Taxes, whether or not the Landlord is ultimately successful.
For any year, the amount to be included in Taxes (a) from taxes or
assessments payable in installments, shall be the amount of the installments
(with any interest) due and payable during such year, and (b) from all other
Taxes, shall be the amount due and payable in such year. Any refund or other
adjustment to any Taxes by the taxing authority, shall apply to the year for
which the adjustment is made. If and to the extent a refund is applicable to a
year during the Term or extended Term, Landlord shall pay to Tenant Tenant's
Proportionate Share of such refund and this obligation shall survive the
expiration or termination of this Lease.
Taxes shall not include any net income (except Rent Tax), capital, stock,
succession, transfer, franchise, gift, estate or inheritance tax, except to the
extent that such tax shall be imposed in lieu of any portion of Taxes nor shall
include interest or penalties imposed for late payment of Taxes unless such late
payment was caused by Tenant.
(iv) Lease Year. "Lease Year" means each consecutive twelve-month
---------- ----------
period beginning with the Commencement Date, except that if the Commencement
Date is not the first day of a calendar month, then the first Lease Year shall
be the period from the Commencement Date through the final day of the twelve
months after the first day of the following month, and each subsequent Lease
Year shall be the twelve months following the prior Lease Year.
-6-
<PAGE>
(v) Fiscal Year. "Fiscal Year" means the calendar year, except
----------- -----------
that the first fiscal year and the last fiscal year of the Term may be a partial
calendar year.
(d) Computation of Base Rent and Rent Adjustments.
---------------------------------------------
(i) Prorations. If this Lease begins on a day other than the
-----------
first day of a month, the Base Rent, Operating Cost Share Rent and Tax Share
Rent shall be prorated for such partial month based on the actual number of days
in such month. If this Lease begins on a day other than the first day, or ends
on a day other than the last day, of the fiscal year, Operating Cost Share Rent
and Tax Share Rent shall be prorated for the applicable fiscal year.
(ii) Default Interest. Any sum due from Tenant to Landlord not
-----------------
paid when due shall bear interest from the date due until paid at the higher of
(a) the prime or similar rate published by The Wall Street Journal plus five
-----------------------
percent (5%), or (b) fifteen percent (15%) per annum, but not in excess of the
highest lawful rate permitted under applicable laws, calculated from the
original due date thereof to the date of payment in full.
(iii) Rent Adjustments. The square footage of the Premises and
-----------------
the Building set forth in the Schedule shall be confirmed by Landlord's and
Tenant's architects upon completion of final plans for the construction of the
Premises pursuant to Appendix D and thereafter shall be conclusively deemed to
be the actual square footage thereof, without regard to any subsequent re-
measurement of the Premises or the Building during the initial Term. If
Landlord's and Tenant's architects are unable to confirm the square footage of
the Building and Premises within thirty (30) days of the completion of the final
plans for construction of the Premises, then the two architects shall, within
forty-five (45) days of the completion of the final plans for the Premises,
select a third architect that has not been employed by either Landlord or Tenant
and such third architect shall promptly determine the square footage of the
Building and the Premises. All determinations shall be made in accordance with
BOMA. Landlord and Tenant shall each bear the costs of its architect and shall
share equally the cost of the third architect. If, for any reason, the square
footages of the Building and Premises have not been determined as herein
provided by the Commencement Date, all obligations of Tenant hereunder that are
based upon the square footages of either or both of the Building and the
Premises, including Tenant's obligation to pay Base Rent, Operating Cost Share
Rent and Tax Share Rent, shall be determined using the square footages set forth
in the Schedule. When the square footages of the Building and Premises have been
finally determined as provided herein, all obligations of Tenant hereunder that
are based upon the square footages of either or both of the Building and the
Premises, including Tenant's obligation to pay Base Rent, Operating Cost Share
Rent and Tax Share Rent, shall be adjusted to reflect such determination and, if
the Commencement Date has already occurred, any overpayment by Tenant shall be
refunded by Landlord and any underpayment by Tenant shall be paid within thirty
(30) days of such determination. If any Operating Cost paid in one fiscal year
relates to more than one fiscal year, Landlord may proportionately allocate such
Operating Cost among the related fiscal years.
(iv) Books and Records. Landlord shall maintain books and records
------------------
reflecting the Operating Costs and Taxes in accordance with sound accounting and
management practices. Tenant and its certified public accountant shall have the
right to
-7-
<PAGE>
inspect Landlord's records at Landlord's office upon at least seventy-two (72)
hours' prior notice during Normal Business Hours during the ninety (90) days
following the respective delivery of the Operating Cost Report or the Tax
Report. The results of any such inspection shall be kept strictly confidential
by Tenant and its agents, and Tenant and its certified public accountant must
agree, in their contract for such services, to such confidentiality restrictions
and shall specifically agree that the results shall not be made available to any
other tenant of the Building. Unless Tenant sends to Landlord any written
exception to either such report within said ninety (90) day period, such report
shall be deemed final and accepted by Tenant. Tenant shall pay the amount shown
on both reports in the manner prescribed in this Lease, whether or not Tenant
takes any such written exception, without any prejudice to such exception. If
Tenant makes a timely exception, Landlord shall cause its independent certified
public accountant to issue a determination of Tenant's exception. If Tenant and
Landlord cannot, within thirty (30) days after such determination, agree upon a
resolution of the matters in dispute, then Landlord and Tenant shall select an
independent certified public accountant that has not been previously engaged by
either to make a final, conclusive determination of such matters, which
determination shall be binding upon both Landlord and Tenant. Tenant shall pay
the cost of such certification unless Landlord's original determination of
annual Operating Costs or Taxes overstated the amounts thereof by more than
seven and one-half percent (7 1/2%), in which case Landlord shall pay the cost
of such certification.
(v) Miscellaneous. So long as Tenant is in default of any
--------------
obligation under this Lease beyond the applicable notice and cure period, Tenant
shall not be entitled to any refund of any amount from Landlord until such
default is cured. If this Lease is terminated for any reason prior to the annual
determination of Operating Cost Share Rent or Tax Share Rent, either party shall
pay the full amount due to the other within twenty (20) days after Landlord's
notice to Tenant of the amount when it is determined. Landlord may commingle any
payments made with respect to Operating Cost Share Rent or Tax Share Rent,
without payment of interest.
3. PREPARATION AND CONDITION OF PREMISES; POSSESSION AND SURRENDER OF
------------------------------------------------------------------
PREMISES.
- --------
(a) Condition of Premises. Except to the extent of the Tenant
---------------------
Improvements item on the Schedule, and Landlord's obligation to construct
Landlord's Shell and Core Improvements as hereinafter provided, Landlord is
leasing the Premises to Tenant "as is", without any obligation to alter,
remodel, improve, repair or decorate any part of the Premises. Subject to delays
described below, Landlord (i) shall complete construction of Landlord's Shell
and Core Improvements to the extent necessary to achieve Premises Delivery, and
(ii) shall thereafter substantially complete the same (excepting minor "punch
list" items that can be completed without substantial interference to Tenant's
use and enjoyment of the Premises) on or before the Commencement Date. Landlord
shall complete Landlord's Shell and Core Improvements in a good and workmanlike
fashion and in compliance with all laws, rules, codes, regulations and
ordinances applicable thereto.
(b) Delivery Schedule. In the event Landlord has not achieved
-----------------
Premises Delivery by September 30, 2000 (the "Outside Delivery Date," which
shall be extended by one (1) day for each one (1) day of delay caused by Tenant
Delays (defined below) and up to ninety (90) days for delays caused by Force
Majeure (defined in Section 21 hereinbelow,
-8-
<PAGE>
provided that delays caused by demolition of the Kingdome shall not be
considered Force Majeure for purposes of this paragraph)), and thereafter
continue construction without substantial interference or delay, then, from and
after the Commencement Date, one (1) day of Base Rent shall abate for each one
(1) day after the Outside Delivery Date (subject to extension as set forth
above) on which delivery actually occurs. If Premises Delivery has not occurred
by December 31, 2000 for any reason other than Tenant Delays, then Tenant shall
thereafter have the right to (i) terminate this Lease and, except as otherwise
expressly provided herein, neither party shall have any further obligations to
the other hereunder; or (ii) elect not to terminate this Lease, in which event
one (1) day of Base Rent shall abate from and after the Commencement Date for
each one (1) day after the Outside Delivery Date (subject to extension as set
forth above) on which delivery actually occurs.
(i) Tenant Delay. As used herein, "Tenant Delay" shall mean, as
------------
to any delay experienced by Landlord in connection with its Shell and Core Work,
(a) any interference or delay caused by occurrences within the reasonable
control of Tenant not otherwise permitted under this Lease (i.e. permitted
Tenant approval and construction processes applied within scheduled time periods
shall not be deemed Tenant Delay); (b) any delay caused by Tenant's failure or
---
refusal to furnish plans, or approve or disapprove plans for the Tenant
Improvements in excess of the periods set out in Appendix D; (c) any delay
attributable to changes in or additions to Landlord's plans requested by Tenant
beyond or after the approval process set forth in Appendix D; or (d) any other
delay in acts of Tenant required under Appendix D; provided that the foregoing
clauses (a) through (d) shall apply only to the extent that such delay,
----
notwithstanding Landlord's reasonable best efforts to mitigate the delay,
actually delays the date of Premises Delivery. Landlord shall notify Tenant as
soon as reasonably possible when Landlord becomes aware of an event that it
believes constitutes a Tenant Delay. Such notice shall include a description of
the matter constituting the Tenant Delay and Landlord's good faith estimate of
the length of the Tenant Delay. Landlord also agrees to meet and cooperate with
Tenant to seek opportunities to minimize Tenant Delay.
(c) Tenant's Possession. Tenant's taking possession of the Premises
--------------------
upon delivery thereof by Landlord shall be conclusive evidence that the Premises
was in good order, repair and condition, except for latent defects and except
for items which are brought to Landlord's attention on or before the
Commencement Date.
(d) Maintenance. Throughout the Term and Extended Term, Tenant shall
------------
maintain the Premises in good condition and repair from and after the
Commencement Date, loss or damage caused by the elements, ordinary wear, and
fire and other casualty excepted, and at the termination of this Lease, or
Tenant's right to possession, Tenant shall return the Premises to Landlord in
broom-clean condition. To the extent Tenant fails to perform either obligation,
Landlord may, but need not, restore the Premises to such condition and Tenant
shall pay the reasonable cost thereof. Throughout the Term and Extended Term,
Landlord shall maintain the common areas of the Project, the plumbing,
mechanical, electrical, HVAC, and other systems of the Building, the roof,
exterior walls, windows, foundation and other structural elements of the
Building, and all components of Landlord's Shell and Core Improvements in good
condition and repair consistent with Class-A office buildings located in the
vicinity of the Project.
-9-
<PAGE>
4. PROJECT SERVICES. Landlord shall furnish services as follows:
----------------
(a) Heating and Air Conditioning. During the normal business hours of
----------------------------
7:00 a.m. to 6:00 p.m., Monday through Friday, and 8:00 a.m. to 1:00 p.m. on
Saturday ("Normal Business Hours"), Landlord shall furnish heating and air
---------------------
conditioning to provide a comfortable temperature for normal business
operations. If Tenant installs equipment which adversely affects the temperature
maintained by the air conditioning system, Landlord may, after notice to Tenant
and a reasonable opportunity for Tenant to mitigate such adverse effects,
install supplementary air conditioning units in the Premises, and Tenant shall
pay to Landlord within thirty (30) days after demand as Additional Rent the
actual reasonable cost of installation, operation and maintenance thereof.
Landlord shall furnish heating and air conditioning after business hours if
Tenant provides Landlord reasonable prior notice, and pays Landlord the then-
current charges being charged to other Building occupants for such additional
heating or air conditioning.
(b) Elevators. Landlord shall provide non-attended passenger elevator
---------
service during Normal Business Hours to Tenant in common with Landlord and all
other tenants. Landlord shall provide passenger service with at least one (1)
elevator via access card at all other times, twenty-four hours per day, seven
days per week, except in case of an emergency. The elevators shall be able to be
programmed so that, if Tenant so requests, access to floors designated by Tenant
will be accessible only by use of an access card.
(c) Electricity. Landlord shall provide sufficient electricity to
-----------
operate HVAC equipment, normal office lighting and office equipment. Tenant
shall not install or operate in the Premises any electrically operated equipment
or other machinery, other than business machines and equipment normally employed
for general office use in a normal density which do not require high electricity
consumption for operation, without obtaining the prior written consent of
Landlord. Electricity may be submetered by Landlord at Tenant's expense, and
Tenant shall reimburse Landlord as Additional Rent for the cost of its
submetered consumption based upon Landlord's average cost of electricity. Such
Additional Rent shall be in addition to Tenant's obligations pursuant to Section
2A(2) to pay its Proportionate Share of Operating Costs.
(d) Water. Landlord shall furnish hot and cold tap water for drinking
-----
and toilet purposes. Tenant shall pay Landlord for water furnished for any other
purpose as Additional Rent at rates fixed by Landlord.
(e) Janitorial Service. Landlord shall furnish janitorial service
------------------
similar to that furnished in comparable Class-A general office space within the
general area. Any and all additional janitorial service desired by Tenant shall
be contracted for by Tenant directly with Landlord's janitorial agent, and the
cost and payment thereof shall be Tenant's responsibility.
(f) Security. The Building shall initially have a PC-based card
--------
access system to control access to all building entrances. All card readers for
the Building shall initially be proximity type. Each entrance to the Building
shall be monitored by closed-circuit television or other security protections
commonly utilized in comparable Class-A office buildings in downtown Seattle,
Washington.
-10-
<PAGE>
(g) Interruption of Services. If any of the Building equipment or
------------------------
machinery ceases to function properly for any cause whatsoever, Landlord shall
use reasonable diligence to repair the same promptly. Landlord's inability to
furnish, to any extent, the Project services set forth in this Section 4, or any
cessation thereof resulting from any causes, including any entry for repairs
pursuant to this Lease, and any renovation, redecoration or rehabilitation of
any area of the Building shall not, except in the event of the gross negligence,
willful misconduct or breach of an express obligation under this Lease by
Landlord or Landlord's contractors, agents or employees, render Landlord liable
for damages to either person or property or for interruption or loss to Tenant's
business, nor be construed as an eviction of Tenant, nor except as otherwise
provided herein, work an abatement of any portion of Rent, nor relieve Tenant
from fulfillment of any covenant or agreement hereof. The foregoing
notwithstanding, if (i) there occurs an interruption or failure of service or
facilities provided by Landlord that is caused by the gross negligence, willful
misconduct or breach of this Lease by Landlord or Landlord's agents, employees
or contractors, or (ii) if there occurs an interruption or failure of service or
facilities provided by Landlord from any other cause within Landlord's
reasonable control and Landlord does not begin to cure such failure to the
extent within its reasonable control within five (5) days and thereafter
diligently continue such cure to completion, then, in either case, from the
fifth (5th) day of the existence of the interruption until the service is fully
restored, Base Rent payable by Tenant hereunder shall be abated for the portion
of the Premises for which normal and customary utilization by Tenant is
impractical.
5. ALTERATIONS AND REPAIRS.
------------------------
(a) Landlord's Consent and Conditions. Tenant shall not make any
---------------------------------
improvements or alterations to the Premises (the "Work", which term shall not
----
apply to the initial Tenant Improvements) without in each instance submitting
plans and specifications for the Work to Landlord and obtaining Landlord's prior
written consent which shall not be unreasonably withheld. Pursuant to Section
5(a)(vi) below, Tenant shall pay Landlord's standard charge for review of the
plans and all other items submitted by Tenant. Landlord may withhold its consent
in its sole discretion for any Work which (a) impacts the base structural
components or systems of the Building, (b) impacts any other tenant's premises,
or (c) is visible from outside the Premises. Further, as a condition to its
consent Landlord may require Tenant to remove such Work or changes to the
Premises upon the expiration or earlier termination of the Term and to restore
the Premises to the condition they were in prior to such Work or changes,
including restoring any damage resulting from such removal, all at Tenant's
expense.
Tenant shall reimburse Landlord for actual costs incurred for review of the
plans and all other items submitted by Tenant as provided in Section 5(a)(vi)
below. Tenant shall pay for the cost of all Work. All Work shall become the
property of Landlord upon its installation, except for Tenant's trade fixtures
and for items which Landlord requires Tenant to remove at Tenant's cost at the
termination of the Lease pursuant to Section 5(e). In no event shall Tenant be
required to remove any of the initial Tenant Improvements unless at the time of
Landlord's approval thereof, Landlord, indicated that removal would be required
at the end of the Term.
The following requirements shall apply to all Work:
-11-
<PAGE>
(i) Prior to commencement, Tenant shall furnish to Landlord
building permits, certificates of insurance satisfactory to Landlord.
(ii) Tenant shall perform all Work so as to maintain peace and
harmony among other contractors serving the Project and shall avoid interference
with other work to be performed or services to be rendered in the Project.
Tenant's selection of contractors shall be subject to the Landlord's prior
approval, not to be unreasonably withheld. If any Work contemplates substantive
or material changes to major Building systems, to structural components of the
Building, or involves more than 10,000 RSF of the Premises, Landlord may require
Tenant to use Landlord's mechanical, electrical, and structural engineers and
contractors.
(iii) The Work shall be performed in a good and workmanlike manner,
meeting the standard for construction and quality of materials in the Building,
and shall comply with all insurance requirements and all applicable governmental
laws, ordinances and regulations ("Governmental Requirements").
-------------------------
(iv) Tenant shall perform all Work so as to minimize or prevent
disruption to other tenants (provided that the foregoing shall not necessarily
---
require all of such Work to be performed after normal business hours or on
weekends), and Tenant shall comply with all reasonable requests of Landlord in
response to complaints from other tenants.
(v) Tenant shall perform all Work in compliance with Landlord's
tenant improvement manual, "505 Union Station Project Manual - Tenant
Improvement Manual" in effect at the time the Work is performed.
(vi) Tenant, or Tenant's project manager, or, at Tenant's
election, the Landlord, shall at Tenant's expense manage such Work in accordance
with the process set forth herein and in the Tenant Improvement Manual. If
Tenant elects to have Landlord or Landlord's employees or agents provide such
management services, Landlord shall be paid a management fee in the amount of
three percent (3%) of labor, materials and all other hard and soft costs of the
Work. In addition, and regardless of whether Landlord, Tenant, or a third party,
manages the design and construction process, Landlord's time and expenses in
connection with review and approval of the Work shall be reimbursed to Landlord
by Tenant in the amount of $100.00 per hour. Furthermore, if Landlord or its
employees or contractors performs any Work at Tenant's request, Landlord may
charge a supervisory fee not to exceed fifteen percent (15%) of labor, material,
and all other costs of the Work actually performed by Landlord or its employees
or contractors.
(vii) Upon completion, unless Landlord's employees or contractors
perform the Work, Tenant shall furnish Landlord with contractor's affidavits and
full and final statutory waivers of liens, as-built plans and specifications,
and receipted bills covering all labor and materials, and all other close-out
documentation required in Landlord's tenant improvement manual, "505 Union
Station - Tenant Improvement Manual."
(b) Damage to Systems. If any part of the mechanical, electrical or
------------------
other systems in the Premises shall be damaged, Tenant shall promptly notify
Landlord, and Landlord shall repair such damage. Landlord may also at any
reasonable time make any repairs or
-12-
<PAGE>
alterations which Landlord deems necessary for the safety or protection of the
Project, or which Landlord is required to make by any court or pursuant to any
Governmental Requirement. Tenant shall at its expense (except to the extent such
repairs are made necessary by the gross negligence or intentional misconduct of
Landlord or Landlord's employees, contractors or agents) make all other repairs
necessary to keep the Premises, and Tenant's fixtures and personal property, in
good order, condition and repair; to the extent Tenant fails to do so, Landlord
may, after notice to Tenant, make such repairs itself. The cost of any repairs
made by Landlord on account of Tenant's default, or on account of the mis-use or
neglect by Tenant or its invitees, contractors or agents anywhere in the
Project, shall become Additional Rent payable by Tenant within thirty (30) days
after demand.
(c) No Liens. Tenant has no authority to cause or permit any lien or
---------
encumbrance of any kind to affect Landlord's interest in the Project; any such
lien or encumbrance shall attach to Tenant's interest only. If any mechanic's
lien shall be filed or claim of lien made for work or materials furnished to
Tenant, then Tenant shall at its expense within twenty (20) days thereafter
receiving notice thereof either discharge (by providing a bond or in any other
manner sufficient to release the Project from the lien) or contest the lien or
claim. If Tenant contests the lien or claim without discharging the same, then
Tenant shall (i) within such twenty (20) day period, provide Landlord adequate
security for the lien or claim, (ii) contest the lien or claim in good faith by
appropriate proceedings that operate to stay its enforcement, and (iii) pay
promptly any final adverse judgment entered in any such proceeding. If Tenant
does not comply with these requirements, Landlord may discharge the lien or
claim after notice to Tenant, and the amount paid, as well as attorney's fees
and other expenses incurred by Landlord, shall become Additional Rent payable by
Tenant on demand.
(d) Ownership of Improvements. All Work as defined in this Section 5,
--------------------------
partitions, hardware, equipment, machinery and all other improvements and all
fixtures except trade fixtures, constructed in the Premises by either Landlord
or Tenant, (i) shall become Landlord's property upon installation without
compensation to Tenant, unless Landlord consents otherwise in writing, and (ii)
shall at Landlord's option either (a) be surrendered to Landlord with the
Premises at the termination of the Lease or of Tenant's right to possession, or
(b) be removed in accordance with Subsection 5(e) below (if Landlord at the time
it gives its consent to the performance of such construction expressly requires
such removal).
(e) Removal at Termination. Upon the termination of this Lease or
-----------------------
Tenant's right of possession Tenant shall remove from the Project its trade
fixtures, furniture, moveable equipment and other personal property, any
improvements which Landlord has elected in connection with Landlord's approval
thereof shall be removed by Tenant pursuant to Section 5(d), and any
improvements to any portion of the Project other than the Premises. Tenant shall
repair all damage caused by the installation or removal of any of the foregoing
items. If Tenant does not timely remove such property, then Tenant shall be
conclusively presumed to have, at Landlord's election (i) conveyed such property
to Landlord without compensation or (ii) abandoned such property, and Landlord
may dispose of or store any part thereof in any manner at Tenant's sole cost,
without waiving Landlord's right to claim from Tenant all expenses arising out
of Tenant's failure to remove the property, and without liability to Tenant or
any other person. Landlord shall have no duty to be a bailee of any such
personal property. If Landlord elects abandonment, Tenant shall pay to Landlord,
upon demand, any expenses incurred for disposition.
-13-
<PAGE>
6. USE OF PREMISES. Tenant shall use the Premises only for general office
---------------
purposes in connection with software development and associated hardware
development, testing, and analysis, and otherwise consistent with a Class A
office building in downtown Seattle, Washington. Landlord makes no
representation or warranty that any of the foregoing uses are permitted under
applicable land use and zoning laws, codes and ordinances. Tenant shall not
allow any use of the Premises which will negatively affect the cost of coverage
of Landlord's insurance on the Project, unless Tenant agrees to pay any increase
in the cost of Landlord's insurance that is the direct result of such use.
Tenant shall not allow any inflammable or explosive liquids or materials to be
kept on the Premises (other than as permitted under Section 28 below). Tenant
shall not allow any use of the Premises which would cause the value or utility
of any part of the Premises to materially diminish or would interfere with any
other Tenant or with the operation of the Project by Landlord. Tenant shall not
permit any nuisance or waste upon the Premises, or allow any offensive noise or
odor in or around the Premises. Subject to events beyond Landlord's control,
Tenant and its employees shall have access to the Premises 24 hours per day, 7
days a week.
If any governmental authority shall deem the Premises to be a "place of
public accommodation" under the Americans with Disabilities Act or any other
comparable law as a result of Tenant's use, Tenant shall either modify its use
to cause such authority to rescind its designation or be responsible for any
alterations, structural or otherwise, required to be made to the Building or the
Premises under such laws.
7. GOVERNMENTAL REQUIREMENTS AND BUILDING RULES. Tenant shall comply with
--------------------------------------------
all Governmental Requirements applying to its use of the Premises. Tenant shall
also comply with all reasonable rules established for the Project from time to
time by Landlord. The present rules and regulations are contained in Appendix B.
-------- -
Failure by another tenant to comply with the rules or failure by Landlord to
enforce them shall not relieve Tenant of its obligation to comply with the rules
or make Landlord responsible to Tenant in any way. Landlord shall use reasonable
efforts to apply the rules and regulations uniformly with respect to Tenant and
tenants in the Building under leases containing rules and regulations similar to
this Lease. In the event of alterations and repairs performed by Tenant, Tenant
shall comply with the provisions set forth in Landlord's tenant improvement
manual, "505 Union Station - Tenant Improvement Manual" in effect at the time
the Work is performed.
8. WAIVER OF CLAIMS; INDEMNIFICATION; INSURANCE.
--------------------------------------------
(a) Indemnification. Tenant shall indemnify, defend and hold harmless
----------------
Landlord and its officers, directors, employees and agents against any claim by
any third party for injury to any person or damage to or loss of any property
occurring in the Project and arising from the use of the Premises or from any
other act or omission or negligence of Tenant or any of Tenant's employees or
agents. Tenant's obligations under this section shall survive the termination of
this Lease.
Landlord shall indemnify, defend and hold harmless Tenant and its officers,
directors, employees and agents against any claim by any third party for injury
or damage to person or the Premises or from any other act or omission or
negligence of Landlord or any of Landlord's
-14-
<PAGE>
employees or agents. Landlord's obligations under this section shall survive the
termination of this Lease.
EACH OF LANDLORD AND TENANT HEREBY WAIVES ITS IMMUNITY WITH RESPECT TO THE
OTHER PARTY UNDER THE INDUSTRIAL INSURANCE ACT (RCW TITLE 51) AND/OR THE
LONGSHOREMAN'S AND HARBORWORKER'S ACT AND/OR ANY EQUIVALENT ACTS AND EACH PARTY
EXPRESSLY AGREES TO ASSUME POTENTIAL LIABILITY FOR ACTIONS BROUGHT AGAINST THE
OTHER PARTY BY THE WAIVING PARTY'S EMPLOYEES. THIS WAIVER HAS BEEN SPECIFICALLY
NEGOTIATED BY THE PARTIES TO THIS LEASE AND EACH PARTY HAS HAD THE OPPORTUNITY
TO, AND HAS BEEN ENCOURAGED, TO CONSULT WITH INDEPENDENT COUNSEL REGARDING THIS
WAIVER.
(b) Tenant's Insurance. Tenant shall maintain insurance as follows,
-------------------
with such other terms and coverages as Landlord shall reasonably require from
time to time:
(i) Commercial General Liability Insurance, with (a) Contractual
Liability including the indemnification provisions contained in this Lease, (b)
a severability of interest endorsement, (c) limits of not less than Two Million
Dollars ($2,000,000) per occurrence and not less than Two Million Dollars
($2,000,000) in the aggregate for bodily injury and property damage. Landlord
shall be named as an additional insured on this policy.
(ii) Umbrella liability coverage in an amount of not less than
Five Million Dollars ($5,000,000) providing excess liability over the Commercial
General Liability Insurance.
(iii) Property Insurance against "All Risks" of physical loss
covering the replacement cost of all of Tenant's improvements, fixtures and
personal property.
(iv) Workers' compensation or similar insurance in form and
amounts required by law, and Employer's Liability with not less than the
following limits:
<TABLE>
<CAPTION>
<S> <C>
Each Accident $500,000
Disease--Policy Limit $500,000
Disease--Each Employee $500,000
</TABLE>
Tenant's insurance shall be primary and not contributory to that carried by
Landlord, its agents, or mortgagee. Landlord, and if any, Landlord's building
manager or agent and ground lessor shall be named as additional insureds as
respects to insurance required of the Tenant in Section 8(b)(i). The company or
companies writing any insurance which Tenant is required to maintain under this
Lease shall be licensed to do business in the state in which the Building is
located. Such insurance companies shall have a A.M. Best rating of A VI or
better.
(c) Tenant Contractor's Insurance. Tenant shall cause any contractor
-----------------------------
of Tenant performing work on the Premises to maintain insurance as follows, with
such other terms, coverages and insurers, as Landlord shall reasonably require
from time to time:
(i) Commercial General Liability Insurance, including contractor's
liability coverage, contractual liability coverage, completed operations
coverage, broad form
-15-
<PAGE>
property damage endorsement, and contractor's protective liability coverage, to
afford protection with limits, for each occurrence, of not less than One Million
Dollars ($1,000,000) with respect to personal injury, death or property damage.
(ii) Workers' compensation or similar insurance in form and amounts
required by law, and Employer's Liability with not less than the following
limits:
<TABLE>
<CAPTION>
<S> <C>
Each Accident $500,000
Disease--Policy Limit $500,000
Disease--Each Employee $500,000
</TABLE>
Tenant's contractor's insurance shall be primary and not contributory
to that carried by Tenant, Landlord, their agents or mortgagees. Tenant and
Landlord, and if any, Landlord's building manager or agent, mortgagee or ground
lessor shall be named as additional insured on Tenant's contractor's insurance
policies.
(d) Insurance Certificates. Tenant shall deliver to Landlord
----------------------
certificates evidencing all required insurance no later than five (5) days prior
to Tenant's occupancy of the Premises, and prior to each renewal of this Lease
(if any). Each certificate will provide for thirty (30) days prior written
notice of cancellation to Landlord and Tenant.
(e) Landlord's Insurance. Landlord shall maintain "All-Risk" property
---------------------
insurance at replacement cost on the Building, and Commercial General Liability
insurance policies covering the common areas of the Building, with limits of no
less than $10,000,000 per occurrence. With respect to property insurance,
Landlord and Tenant mutually waive all rights of subrogation, and the respective
"All-Risk" coverage property insurance policies carried by Landlord and Tenant
shall contain waiver of subrogation endorsements.
(f) Waiver of Subrogation and Release. With respect to property
---------------------------------
insurance Landlord and Tenant mutually waive all rights of subrogation, and the
respective "All-Risk" coverage property insurance policies carried by Landlord
and Tenant shall contain waiver of subrogation endorsements. Notwithstanding any
other provision of this Lease to the contrary, whether a loss or damage is due
to the negligence of either Landlord or Tenant or their employees or agents, or
any other cause, Landlord and Tenant hereby waive and release each other and
their respective employees and agents from all claims for recovery for any loss
or damage to the real or personal property of either or loss resulting from
business interruption at the Premises or loss of rental income from the
Building, arising in any instance out of or incident to the occurrence of any of
the perils which are covered by their respective insurance policies or required
to be insured against hereunder.
9 . FIRE AND OTHER CASUALTY.
-----------------------
(a) Termination. If a fire or other casualty causes substantial
------------
damage to the Building or the Premises, Landlord shall engage a registered
architect to certify within one (1) month of the casualty to both Landlord and
Tenant the amount of time needed to restore the Building and the Premises to
tenantability (using standard working methods). If the time needed to restore
the Building and the Premises to tenantability (using standard working methods)
exceeds twelve (12) months from the beginning of the restoration, or if the
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restoration would begin during the last twelve (12) months of the Term, then in
the case of the Premises, either Landlord or Tenant may terminate this Lease by
giving the other party such notice of termination within ten (10) days after the
notifying party's receipt of the architect's certificate, and in the case of the
Building, Landlord may terminate this Lease, by notice to the other party within
ten (10) days after the notifying party's receipt of the architect's
certificate. The termination shall be effective thirty (30) days from the date
of the notice, whereupon neither party, except to the extent otherwise provided
herein, shall have any further obligations or liabilities to the other
hereunder, and Rent shall be paid by Tenant to that date, with an abatement for
any portion of the Premises which has been untenantable after the casualty.
(b) Restoration. If a casualty causes damage to the Building or the
------------
Premises but this Lease is not terminated for any reason, then subject to the
rights of any mortgagees or ground lessors, Landlord shall obtain the applicable
insurance proceeds and diligently restore the Building and the Premises subject
to current Governmental Requirements. Tenant shall replace its damaged
improvements, personal property and fixtures. Rent shall be abated on a per diem
basis during the restoration for any portion of the Premises which is
untenantable, except to the extent that Tenant's negligence caused the casualty.
10. EMINENT DOMAIN. If a part of the Project is taken by eminent domain
--------------
or deed in lieu thereof which is so substantial that the Premises cannot
reasonably be used by Tenant for the operation of its business, then either
party may terminate this Lease effective as of the date of the taking. If any
substantial portion of the Project is taken without affecting the Premises, then
Landlord may terminate this Lease as of the date of such taking. Rent shall
abate from the date of the taking in proportion to any part of the Premises
taken. The entire award for a taking of any kind shall be paid to Landlord, and
Tenant shall have no right to share in the award, but Tenant shall have the
right to pursue a separate award for improvements to the extent paid for by
Tenant, Tenant's trade fixtures and personal property, moving expenses and any
other damages recoverable by Tenant, to the extent same may be separately
awarded and do not diminish Landlord's award. All obligations accrued to the
date of the taking shall be performed by the party liable to perform said
obligations, as set forth herein.
11. RIGHTS RESERVED TO LANDLORD. Landlord may exercise at any time any of
---------------------------
the following rights respecting the operation of the Project without liability
to the Tenant of any kind:
(a) Name. To change the name or street address of the Building.
----
(b) Signs. To install and maintain any signs on the exterior and in
-----
the interior of the Building, and to approve at its sole discretion, prior to
installation, any of Tenant's signs in the Premises visible from the common
areas or the exterior of the Building.
(c) Window Treatments. To approve, at its discretion exercised
-----------------
consistently for all tenants, prior to installation, any shades, blinds,
ventilators or window treatments of any kind, as well as any lighting within the
Premises that may be visible from the exterior of the Building or any interior
common area.
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<PAGE>
(d) Keys. To retain and use at any time passkeys to enter the
----
Premises or any door within the Premises. Tenant shall not alter or add any lock
or bolt unless a passkey thereto is provided to Landlord.
(e) Access. To have access to inspect the Premises, and to perform
------
its obligations, or make repairs, alterations, additions or improvements, as
permitted by this Lease. Except in the case of an emergency where such notice is
not practicable, Landlord shall give Tenant not less than four (4) hours' notice
of Landlord's desire to have access to the Premises and of the portion or
portions of the Premises to which Landlord desires to have access.
(f) Preparation for Reoccupancy. To decorate, remodel, repair, alter
---------------------------
or otherwise prepare the Premises for reoccupancy at any time after Tenant
abandons the Premises, without relieving Tenant of any obligation to pay Rent.
(g) Heavy Articles. To approve the weight, size, placement and time
--------------
and manner of movement within the Building of any safe, central filing system or
other heavy article of Tenant's property. Tenant shall move its property
entirely at its own risk.
(h) Show Premises. Upon not less than twenty-four (24) hours prior
-------------
notice, to show the Premises to prospective purchasers, brokers, lenders,
investors, rating agencies or others at any reasonable time and to prospective
tenants during the last six (6) months of the Term, provided that Landlord gives
prior notice to Tenant and does not materially interfere with Tenant's use of
the Premises.
(i) Use of Lockbox. To designate a lockbox collection agent for
---------------
collections of amounts due Landlord. In that case, the date of payment of Rent
or other sums shall be the date of the agent's receipt of such payment or the
date of actual collection if payment is made in the form of a negotiable
instrument thereafter dishonored upon presentment. However, if Tenant is in
default hereunder, Landlord may reject any payment for all purposes as of the
date of receipt or actual collection by mailing to Tenant within ten (10)
business days after such receipt or collection a check equal to the amount sent
by Tenant. Notices to Landlord delivered to the lockbox, shall not, under any
circumstance, be deemed to have been received by Landlord; it being understood
that notices to Landlord must be delivered in the manner set forth in Section 23
hereof.
(j) Repairs and Alterations. To make repairs or alterations to the
------------------------
Project and in doing so transport any required material through the Premises, to
close entrances, doors, corridors, elevators and other facilities in the
Project, to open any ceiling in the Premises, or to temporarily suspend services
or use of common areas in the Building. Landlord may perform any such repairs or
alterations during ordinary business hours, except that Tenant may require any
Work in the Premises to be done after business hours if Tenant pays Landlord for
overtime and any other expenses incurred. Landlord may do or permit any work on
any nearby building, land, street, alley or way. In exercising its rights under
this Section 11(j), Landlord shall use commercially reasonable efforts to
minimize disruption of and inconvenience to Tenant.
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(k) Landlord's Agents. If Tenant is in default under this Lease,
------------------
possession of Tenant's funds or negotiation of Tenant's negotiable instrument by
any of Landlord's agents shall not waive any breach by Tenant or any remedies of
Landlord under this Lease.
(l) Building Services. To install, use and maintain through the
------------------
Premises, pipes, conduits, wires and ducts serving the Building, provided that
such installation, use and maintenance does not unreasonably interfere with
Tenant's use or the appearance of the Premises.
(m) Other Actions. To take any other commercially reasonable action
--------------
which Landlord deems reasonably necessary in connection with the operation,
maintenance or preservation of the Building.
12. TENANT'S DEFAULT. Each of the following shall constitute a default by
----------------
Tenant as such term if used in this Lease.
(a) Rent Default. Tenant fails to pay any Rent within five (5) days
-------------
after the date due.
(b) Assignment/Sublease or Hazardous Materials Default. Tenant
---------------------------------------------------
defaults in its obligations under Section 17 Assignment and Sublease or Section
28 Hazardous Materials;
(c) Other Performance Default. Tenant fails to perform any other
--------------------------
obligation to Landlord under this Lease, and this failure continues for ten (10)
days after written notice from Landlord, except that if Tenant begins to cure
its failure within the ten (10) day period but cannot reasonably complete its
cure within such period, then, so long as Tenant continues to diligently attempt
to cure its failure, the ten (10) day period shall be extended to such greater
period as is reasonably necessary to complete the cure;
(d) Credit Default. One of the following credit defaults occurs:
---------------
(i) Tenant commences any proceeding under any law relating to
bankruptcy, insolvency, reorganization or relief of debts, or seeks appointment
of a receiver, trustee, custodian or other similar official for the Tenant or
for any substantial part of its property, or any such proceeding is commenced
against Tenant and either remains undismissed for a period of thirty days or
results in the entry of an order for relief against Tenant which is not fully
stayed within seven days after entry;
(ii) Tenant becomes insolvent or bankrupt, does not generally pay
its debts as they become due, or admits in writing its inability to pay its
debts, or makes a general assignment for the benefit of creditors;
(iii) Any third party other than a permitted assignee obtains a
levy or attachment under process of law against Tenant's leasehold interest.
(e) Abandonment Default. Tenant abandons the Premises.
--------------------
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13. LANDLORD REMEDIES.
-----------------
(a) Termination of Lease or Possession. If Tenant defaults as defined
-----------------------------------
in Section 12 above, Landlord may elect by notice to Tenant either to terminate
this Lease or to terminate Tenant's possession of the Premises without
terminating this Lease. In either case, Tenant shall immediately vacate the
Premises and deliver possession to Landlord, and Landlord may repossess the
Premises and may, at Tenant's sole cost, remove any of Tenant's signs and any of
its other property, without relinquishing its right to receive Rent or any other
right against Tenant.
(b) Lease Termination Damages. If Landlord terminates the Lease,
--------------------------
Tenant shall pay to Landlord all Rent due on or before the date of termination,
plus Landlord's reasonable estimate of the aggregate Rent that would have been
payable from the date of termination through the Termination Date, reduced by
the rental value of the Premises calculated as of the date of termination for
the same period, taking into account anticipated vacancy prior to reletting,
reletting expenses and market concessions, both discounted to present value at
the rate of five percent (5%) per annum. If Landlord shall relet any part of the
Premises for any part of such period before such present value amount shall have
been paid by Tenant or finally determined by a court, then the amount of Rent
payable pursuant to such reletting (taking into account vacancy prior to
reletting and any reletting expenses or concessions) shall be deemed to be the
reasonable rental value for that portion of the Premises relet during the period
of the reletting.
(c) Possession Termination Damages. If Landlord terminates Tenant's
-------------------------------
right to possession without terminating the Lease and Landlord takes possession
of the Premises itself, Landlord may relet any part of the Premises for such
Rent, for such time, and upon such terms as Landlord in its sole discretion
shall determine, without any obligation to do so prior to renting other vacant
areas in the Building. Any proceeds from reletting the Premises shall first be
applied to the expenses of reletting, including redecoration, repair,
alteration, advertising, brokerage, legal, and other reasonably necessary
expenses. If the reletting proceeds after payment of expenses are insufficient
to pay the full amount of Rent under this Lease, Tenant shall pay such
deficiency to Landlord monthly upon demand as it becomes due. Any excess
proceeds shall be retained by Landlord.
(d) Landlord's Remedies Cumulative. All of Landlord's remedies under
-------------------------------
this Lease shall be in addition to all other remedies Landlord may have at law
or in equity. Waiver by Landlord of any breach of any obligation by Tenant shall
be effective only if it is in writing, and shall not be deemed a waiver of any
other breach, or any subsequent breach of the same obligation. Landlord's
acceptance of payment by Tenant shall not constitute a waiver of any breach by
Tenant, and if the acceptance occurs after Landlord's notice to Tenant, or
termination of the Lease or of Tenant's right to possession, the acceptance
shall not affect such notice or termination. Acceptance of payment by Landlord
after commencement of a legal proceeding or final judgment shall not affect such
proceeding or judgment. Landlord may advance such monies and take such other
actions for Tenant's account as reasonably may be required to cure or mitigate
any default by Tenant. Tenant shall immediately reimburse Landlord for any such
advance, and such sums shall bear interest at the default interest rate until
paid.
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<PAGE>
(e) Mitigation of Damages. Landlord shall in all circumstances
---------------------
mitigate Landlord's damages arising from and after a default by Tenant to the
extent required by applicable law.
(f) WAIVER OF TRIAL BY JURY. EACH PARTY WAIVES TRIAL BY JURY IN THE
------------------------
EVENT OF ANY LEGAL PROCEEDING BROUGHT BY THE OTHER IN CONNECTION WITH THIS
LEASE. EACH PARTY SHALL BRING ANY ACTION AGAINST THE OTHER IN CONNECTION WITH
THIS LEASE IN A FEDERAL OR STATE COURT LOCATED IN WASHINGTON, CONSENTS TO THE
JURISDICTION OF SUCH COURTS, AND WAIVES ANY RIGHT TO HAVE ANY PROCEEDING
TRANSFERRED FROM SUCH COURTS ON THE GROUND OF IMPROPER VENUE OR INCONVENIENT
FORUM.
(g) Litigation Costs. In the event of a dispute between Landlord and
-----------------
Tenant arising under this Lease, the losing party shall pay the prevailing
party's reasonable attorneys' fees and other costs in enforcing this Lease,
whether or not suit is filed.
14. SURRENDER. Upon termination of this Lease or Tenant's right to
---------
possession, Tenant shall return the Premises to Landlord in good order and
condition, ordinary wear and casualty damage excepted. If, in accordance with
Section 5(e) above, Landlord requires Tenant to remove any alterations, then
Tenant shall remove the alterations in a good and workmanlike manner and restore
the Premises to its condition prior to their installation.
15. HOLDOVER. Tenant shall have no right to holdover possession of the
--------
Premises after the expiration or termination of this Lease without Landlord's
prior written consent, which consent may be withheld in Landlord's sole and
absolute discretion. If Tenant retains possession of any part of the Premises
after the Term, Tenant shall become a month-to-month tenant for the entire
Premises upon all of the terms of this Lease as might be applicable to such
month-to-month tenancy, except that Tenant shall pay Base Rent, at one-hundred
fifty percent (150%) of the rate in effect immediately prior to such holdover,
computed on a monthly basis for each full or partial month Tenant remains in
possession plus Tenant's then-applicable Operating Cost Share Rent and all of
Tax Share Rent. Tenant shall also pay Landlord all of Landlord's damages if
Tenant holds over without Landlord's consent. No acceptance of Rent or other
payments by Landlord under these holdover provisions shall operate as a waiver
of Landlord's right to regain possession or any other of Landlord's remedies.
16. SUBORDINATION TO GROUND LEASES AND MORTGAGES.
--------------------------------------------
(a) Subordination. This Lease shall be subordinate to any present or
--------------
future ground lease or mortgage respecting the Project, and any amendments to
such ground lease or mortgage, at the election of the ground lessor or mortgagee
as the case may be, effected by notice to Tenant in the manner provided in this
Lease. The subordination shall be effective upon such notice, but at the request
of Landlord or ground lessor or mortgagee, Tenant shall within ten (10) days of
the request, execute and deliver to the requesting party any reasonable
documents provided to evidence the subordination. Any mortgagee has the right,
at its option, to subordinate its mortgage to the terms of this Lease, without
notice to, nor the consent of, Tenant. Notwithstanding the foregoing, Tenant's
obligation to subordinate this Lease or execute agreements effecting
subordination to future encumbrances is conditioned on such agreement(s)
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<PAGE>
containing commercially reasonable nondisturbance language in the ground
lessor's, mortgagee's and/or trust deed beneficiary's standard form.
(b) Termination of Ground Lease or Foreclosure of Mortgage. If any
-------------------------------------------------------
ground lease is terminated or mortgage foreclosed or deed in lieu of foreclosure
given and the ground lessor, mortgagee, or purchaser at a foreclosure sale shall
thereby become the owner of the Project, Tenant shall attorn to such ground
lessor or mortgagee or purchaser without any deduction or setoff by Tenant, and
this Lease shall continue in effect as a direct lease between Tenant and such
ground lessor, mortgagee or purchaser. The ground lessor or mortgagee or
purchaser shall be liable as Landlord only with respect to matters arising
during the time such ground lessor or mortgagee or purchaser is the owner of the
Project. At the request of Landlord, ground lessor or mortgagee, Tenant shall
execute and deliver within ten (10) days of the request any document furnished
by the requesting party to evidence Tenant's agreement to attorn.
(c) Security Deposit. Any ground lessor or mortgagee shall be
-----------------
responsible for the return of any security deposit by Tenant only to the extent
the security deposit is received by such ground lessor or mortgagee.
(d) Notice and Right to Cure. If the Project is subject to any ground
------------------------
lease or mortgage identified with the name and address of the ground lessor or
mortgage in Appendix E hereto (as the same may be amended from time to time by
----------
written notice to Tenant), Tenant agrees to send by registered or certified mail
to any ground lessor or mortgagee identified either in such Appendix or in any
later notice from Landlord to Tenant, a copy of any notice of default sent by
Tenant to Landlord. If Landlord fails to cure such default within the required
time period under this Lease, but the ground lessor or mortgagee begins to cure
within ten (10) days after such period and proceeds diligently to complete such
cure, then the ground lessor or mortgagee shall have such additional time as is
necessary to complete such cure, including any time necessary to obtain
possession if possession is necessary to cure, and Tenant shall not begin to
enforce its remedies so long as the cure is being diligently pursued.
(e) Definitions. As used in this Section 16, "mortgage" shall include
------------
"deed of trust" and/or "trust deed" and "mortgagee" shall include "beneficiary"
and/or "trustee", "mortgagee" shall include the mortgagee of any ground lessee,
and "ground lessor", "mortgagee", and "purchaser at a foreclosure sale" shall
include, in each case, all of its successors and assigns, however remote.
17. ASSIGNMENT AND SUBLEASE.
-----------------------
(a) In General. Tenant shall not, without the prior consent of
----------
Landlord in each case, (i) make or allow any assignment or transfer, by
operation of law or otherwise, of any part of Tenant's interest in this Lease,
(ii) grant or allow any lien or encumbrance, by operation of law or otherwise,
upon any part of Tenant's interest in this Lease, (iii) sublet any part of the
Premises, or (iv) permit anyone other than Tenant and its employees to occupy
any part of the Premises. Tenant shall remain primarily liable for all of its
obligations under this Lease, notwithstanding any assignment or transfer. No
consent granted by Landlord shall be deemed to be a consent to any subsequent
assignment or transfer, lien or encumbrance, sublease or occupancy. Tenant shall
pay all of Landlord's reasonable attorneys' fees and other
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<PAGE>
expenses incurred in connection with any consent requested by Tenant or in
reviewing any proposed assignment or subletting, not to exceed one thousand five
hundred ($1,500.00) Any assignment or transfer, grant of lien or encumbrance, or
sublease or occupancy without Landlord's prior written consent shall be void. If
Tenant shall assign this Lease or sublet the Premises in its entirety other than
as permitted under Section 17(d) below, any rights of Tenant to renew this
Lease, extend the Term or to lease additional space in the Project shall be
extinguished thereby and will not be transferred to the assignee or subtenant
(other than a permitted assignee or subtenant under Section 17(d)), all such
rights being personal to the Tenant named herein.
(b) Landlord's Consent. Landlord will not unreasonably withhold its
-------------------
consent to any proposed assignment or subletting. It shall be reasonable for
Landlord to withhold its consent to any assignment or sublease if (i) Tenant is
in a continuing default under this Lease and the applicable notice and cure
period, if any, has expired, (ii) the proposed assignee or sublessee is a tenant
in the Project or an affiliate of such a tenant or a party that Landlord, prior
to Tenant's request for consent, has identified, in correspondence with such
party or such party's brokers, as a prospective tenant in the Project, (iii) the
nature of business and character of the proposed assignee or subtenant are not
all reasonably satisfactory to Landlord, (iv) the proposed assignee or subtenant
is a government entity, or (v) the proposed assignment is for less than the
entire Premises or for less than the remaining Term of the Lease (but this
clause (v) shall not apply to a subletting). The foregoing shall not exclude any
other reasonable basis for Landlord to withhold its consent; provided that
Landlord agrees that it will not withhold consent to a proposed subletting
merely because the proposed subtenant lacks financial strength or otherwise
fails to satisfy Landlord's creditworthiness standards.
(c) Procedure. Tenant shall notify Landlord of any proposed
----------
assignment or sublease at least thirty (30) days prior to its proposed effective
date. The notice shall include the name and address of the proposed assignee or
subtenant, its partners in a case of a partnership, an execution copy of the
proposed assignment or sublease, and sufficient information to permit Landlord
to determine the financial responsibility and character of the proposed assignee
or subtenant. As a condition to any effective assignment of this Lease, the
assignee shall execute and deliver in form satisfactory to Landlord at least
fifteen (15) days prior to the effective date of the assignment, an assumption
of all of the obligations of Tenant under this Lease from and after the date of
the assignment. As a condition to any effective sublease, subtenant shall
execute and deliver in form satisfactory to Landlord at least fifteen (15) days
prior to the effective date of the sublease, an agreement to comply with all of
Tenant's obligations under this Lease, and at Landlord's option, an agreement
(except for the economic obligations which subtenant will undertake directly to
Tenant) to attorn to Landlord under the terms of the sublease in the event this
Lease terminates before the sublease expires.
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<PAGE>
(d) Change of Management or Ownership; Certain Excluded Transactions.
----------------------------------------------------------------
Any direct or indirect change in more than fifty percent (50%) of the ownership
interest in Tenant shall constitute an assignment of this Lease. The foregoing
notwithstanding, the transfer of outstanding capital stock or other listed
equity interests by persons or parties other than "insiders" within the meaning
of the Security Exchange Act of 1934, as amended, through the "over-the-counter"
market or any recognized national or international securities exchange shall not
be included in determining whether a transfer of control or ownership has
occurred. Anything to the contrary in this Lease notwithstanding, the assignment
of this Lease or a subletting of all or a portion of the Premises to an
affiliate of Tenant, a public or private offering of equity interests in Tenant,
a merger or acquisition of Tenant with or by a third party, or the acquisition
of substantially all of the assets of Tenant (including Tenant's interest in
this Lease) by a third party, shall not require the Landlord's consent, but
shall require prior or contemporaneous notice to Landlord.
(e) Excess Payments. If Tenant shall assign this Lease or sublet any
----------------
part of the Premises for consideration in excess of the pro-rata portion of Rent
applicable to the space subject to the assignment or sublet, then Tenant shall,
after first recovering market brokerage commissions, and other reasonable,
documented advertising-related costs and expenses incurred by Tenant in
connection with such assignment or subletting, pay to Landlord as Additional
Rent fifty percent (50%) of any such excess immediately upon receipt.
(f) Recapture. Notwithstanding anything to the contrary herein,
----------
Landlord may, by giving written notice to Tenant within thirty (30) days after
receipt of Tenant's notice of assignment or subletting, terminate this Lease
with respect to the space described in Tenant's notice, as of the effective date
of the proposed assignment or sublease and all obligations under this Lease as
to such space shall expire except as to any obligations that expressly survive
any termination of this Lease. However, Tenant may designate in writing to
Landlord a full-floor portion of the Premises (the "Designated Floor") which
shall be exempt from Landlord's recapture rights set forth in this paragraph, so
that for the remainder of the Term (and any extensions or renewals thereof),
Landlord shall not be entitled to recapture space on the Designated Floor should
---
Tenant ever request consent to any subletting or assignment thereon.
18. CONVEYANCE BY LANDLORD. If Landlord shall at any time transfer its
----------------------
interest in the Project or this Lease and the transferee shall be deemed to have
expressly assumed and agreed to perform all obligations of Landlord arising
hereunder after the date of such transfer, Landlord shall be released of any
obligations occurring after such transfer, except the obligation to return to
Tenant any security deposit not delivered to its transferee, and Tenant shall
look solely to Landlord's successors for performance of such obligations. This
Lease shall not be affected by any such transfer.
19. ESTOPPEL CERTIFICATE. Each party shall, within ten (10) days of
--------------------
receiving a request from the other party, execute, acknowledge in recordable
form, and deliver to the other party or its designee a certificate stating,
subject to a specific statement of any applicable exceptions, that the Lease as
amended to date is in full force and effect, that the Tenant is paying Rent and
other charges on a current basis, and that to the actual knowledge of the
certifying party, the other party has committed no uncured defaults and has no
offsets or claims. The certifying party may also be required to state the date
of commencement of
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payment of Rent, the Commencement Date, the Termination Date, the Base Rent, the
current Operating Cost Share Rent and Tax Share Rent estimates, the status of
any improvements required to be completed by Landlord, the amount of any
security deposit, and such other matters as may be reasonably requested. Failure
to deliver such statement within the time required shall be conclusive evidence
against the non-certifying party that, except to the extent that the party or
parties to whose benefit the certificate is to run have actual knowledge to the
contrary, this Lease, with any amendments identified by the requesting party, is
in full force and effect, that there are no uncured defaults by the requesting
party, that not more than one month's Rent has been paid in advance, that the
non-certifying party has not paid any security deposit, and that the non-
certifying party has no claims or offsets against the requesting party.
20. SECURITY DEPOSIT. There is no initial Security Deposit being required
----------------
of Tenant in connection with the execution and delivery of this Lease. However,
any proceeds from the Letter of Credit (defined in that certain Addendum
attached hereto and by this reference incorporated herewith) that are not
applied toward amounts then owed by Tenant to Landlord shall continue to be held
as a Security Deposit under the terms and conditions hereof. If Tenant defaults
under this Lease, Landlord may use any part of the Security Deposit to make any
defaulted payment, to pay for Landlord's cure of any defaulted obligation, or to
compensate Landlord for any loss or damage resulting from any default. If
Landlord has drawn on the Letter of Credit pursuant to the terms and conditions
therein and retains cash portions thereof that have not been applied toward
defaults of Tenant hereunder, then Landlord shall not keep any cash portion in
its general funds and instead shall hold same in a separate, interest-bearing
account at a federally-insured, national bank doing business in Seattle,
Washington, segregated from all other funds of Landlord and clearly designated
as part of Tenant's Security Deposit, and Tenant shall be entitled to all
interest earned thereon, net of the actual charges of the depository for
maintaining the separate account. So long as there exists no default by Tenant
that continues beyond any applicable notice and cure period, Tenant shall have
the right to direct the investment of the Security Deposit by the depository
institution in commercially reasonable investments. If, after Landlord draws the
Letter of Credit, Tenant provides Landlord with a replacement letter of credit
satisfying the requirements of Section 4 of the Addendum, Landlord shall cause
the remaining, unapplied cash portion thereof to be returned or released to
Tenant, together with all interest earned thereon. If Tenant shall perform all
of its obligations under this Lease and return the Premises to Landlord at the
end of the Term, Landlord shall return all of the remaining Security Deposit and
all interest earned thereon to Tenant and/or release any remaining Letter of
Credit within thirty (30) days after the end of the Term. The Security Deposit
shall not serve as an advance payment of Rent or a measure of Landlord's damages
for any default under this Lease.
If Landlord transfers its interest in the Project or this Lease, Landlord
may transfer the Security Deposit to its transferee. Upon such transfer,
Landlord shall have no further obligation to return the Security Deposit to
Tenant, and Tenant's right to the return of the Security Deposit shall apply
solely against Landlord's transferee.
21. FORCE MAJEURE. Neither Landlord nor Tenant shall be in default of any
-------------
of its nonmonetary obligations under this Lease to the extent such party is
unable to perform any of its nonmonetary obligations on account of any strike or
labor problem, energy shortage, governmental pre-emption or prescription,
national emergency, or any other cause of any kind
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<PAGE>
beyond the reasonable control of such party ("Force Majeure"). Force Majeure
-------------
shall not include lack of funds, regardless of the cause.
22. NOTICES. All notices, consents, approvals and other communications to
-------
be given by one party to the other under this Lease, shall be given in writing,
mailed (by United States mail or overnight courier) or personally delivered as
follows:
To Landlord as follows: 505 Union Station Ltd.
505 Fifth Ave. S., Suite 800
Seattle, WA 98104
with a copy to: Foster Pepper & Shefelman PLLC
1111 Third Avenue, Suite 3400
Seattle, Washington 98101
Attention: Bruce Coffey
or to such other person at such other address as Landlord may designate by
notice to Tenant.
To Tenant as follows: WatchGuard Technologies, Inc.
316 Occidental Avenue South, Suite 200
Seattle, Washington 98104
Attention: Michael C. Piraino, General Counsel
With a copy to: Perkins Coie LLP
1201 Third Avenue
Seattle, Washington 98101
Attention: Michael A. Barrett
or to such other person at such other address as Tenant may designate by notice
to Landlord.
Mailed notices shall be sent by United States certified or registered mail,
or by a reputable national overnight courier service, postage prepaid. Notices
sent by personal delivery shall be deemed to have been given upon actual
delivery. Mailed notices shall be deemed to have been given on the earlier of
actual delivery or three (3) business days after posting in the United States
mail in the case of registered or certified mail, and one business day in the
case of overnight courier.
23. QUIET POSSESSION. So long as Tenant is not in default hereunder
----------------
(beyond applicable notice and cure periods), Tenant shall enjoy peaceful and
quiet possession of the Premises against any party claiming through the
Landlord; subject to the terms and conditions of this Lease.
24. REAL ESTATE BROKER. Tenant represents to Landlord that Tenant has not
------------------
dealt with any real estate broker with respect to this Lease except for the
broker(s) listed in the Schedule, and no other broker is in any way entitled to
any broker's fee or other payment in connection with this Lease by reason of
having dealt with Tenant. Tenant shall indemnify and defend Landlord against
any breach of the foregoing representation. Landlord represents to Tenant that
Landlord has not dealt with any real estate broker with respect to this Lease
except
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<PAGE>
for the brokers listed in the Schedule, and no other broker is in any way
entitled to any broker's fee or other payment in connection with this Lease by
reason of having dealt with Landlord. Landlord shall indemnify and defend Tenant
against any breach of the foregoing representation. Landlord shall pay all fees
and commissions owing to the brokers listed in the Schedule in connection with
this Lease. Landlord and Tenant acknowledge that Eric Olmstead of NAI Leibsohn &
Company represents the interests of Tenant and Geoff Boguch and Leigh Callaghan
of Colliers International represent the interest of Landlord. If Landlord and
Tenant execute this Lease, Landlord shall pay NAI Leibsohn & Company a brokerage
commission equal to Five Dollars ($5.00) per square foot of the Rentable Square
Footage of the Premises, one half of which shall be paid by Landlord within
twenty (20) days after Landlord's and Tenant's mutual execution of this Lease
and one half of which shall be paid upon Tenant's taking occupancy of the
Premises.
25. MISCELLANEOUS.
-------------
(a) Successors and Assigns. Subject to the limits on Tenant's
-----------------------
assignment contained in Section 17, the provisions of this Lease shall be
binding upon and inure to the benefit of all successors and assigns of Landlord
and Tenant.
(b) Date Payments Are Due. Except for payments to be made by Tenant
----------------------
under this Lease which are due upon demand or are due in advance (such as Base
Rent), Tenant shall pay to Landlord any amount for which Landlord renders a
statement of account within twenty (20) days of Tenant's receipt of Landlord's
statement.
(c) Meaning of "Landlord", "Re-Entry, "including" and "Affiliate".
--------------------------------------------------------------
The term "Landlord" means only the owner of the Project and the lessor's
interest in this Lease from time to time. The words "re-entry" and "re-enter"
are not restricted to their technical legal meaning. The words "including" and
similar words shall mean "without limitation." The word "affiliate" shall mean a
person or entity controlling, controlled by or under common control with the
applicable entity. "Control" shall mean the power directly or indirectly, by
contract or otherwise, to direct the management and policies of the applicable
entity.
(d) Time of the Essence. Time is of the essence of each provision of
--------------------
this Lease.
(e) No Option. This document shall not be effective for any purpose
----------
until it has been executed and delivered by both parties; execution and delivery
by one party shall not create any option or other right in the other party.
(f) Severability. The unenforceability of any provision of this Lease
-------------
shall not affect any other provision.
(g) Governing Law. This Lease shall be governed in all respects by
--------------
the laws of the state in which the Project is located, without regard to the
principles of conflicts of laws.
(h) Lease Modification. Tenant agrees to modify this Lease in any way
-------------------
reasonably requested by a mortgagee which does not cause increased expense to
Tenant or otherwise adversely affect Tenant's interests or rights under this
Lease.
-27-
<PAGE>
(i) No Oral Modification. No modification of this Lease shall be
---------------------
effective unless it is a written modification signed by both parties.
(j) Landlord's Right to Cure. If Landlord breaches any of its
-------------------------
obligations under this Lease, Tenant shall notify Landlord in writing and shall
take no action respecting such breach so long as Landlord promptly begins to
cure the breach and diligently pursues such cure to its completion. Landlord may
cure any default by Tenant; any reasonable expenses incurred shall become
Additional Rent due from Tenant on demand by Landlord.
(k) Captions. The captions used in this Lease shall have no effect on
---------
the construction of this Lease.
(l) Authority. Landlord and Tenant each represents to the other that
----------
it has full power and authority to execute and perform this Lease.
(m) Landlord's Enforcement of Remedies. Landlord may enforce any of
-----------------------------------
its remedies under this Lease either in its own name or through an agent.
(n) Entire Agreement. This Lease, together with all Appendices and
-----------------
the Addendum, constitutes the entire agreement between the parties. No
representations or agreements of any kind have been made by either party which
are not contained in this Lease.
(o) Landlord's Title. Landlord's title shall always be paramount to
-----------------
the interest of the Tenant, and nothing in this Lease shall empower Tenant to do
anything which might in any way impair Landlord's title.
(p) Light and Air Rights. Landlord does not grant in this Lease any
---------------------
rights to light and air in connection with Project. Landlord reserves to itself,
the Land, the Building below the improved floor of each floor of the Premises,
the Building above the ceiling of each floor of the Premises, the exterior of
the Premises and the areas on the same floor outside the Premises, along with
the areas within the Premises required for the installation and repair of
utility lines and other items required to serve other tenants of the Building.
(q) Singular and Plural. Wherever appropriate in this Lease, a
--------------------
singular term shall be construed to mean the plural where necessary, and a
plural term the singular. For example, if at any time two parties shall
constitute Landlord or Tenant, then the relevant term shall refer to both
parties together.
(r) No Recording by Tenant. Tenant shall not record in any public
-----------------------
records any memorandum or any portion of this Lease.
(s) Exclusivity. Landlord does not grant to Tenant in this Lease any
------------
exclusive right except the right to occupy its Premises.
(t) No Construction Against Drafting Party. The rule of construction
---------------------------------------
that ambiguities are resolved against the drafting party shall not apply to this
Lease.
-28-
<PAGE>
(u) Survival. All obligations of Landlord and Tenant under this Lease
---------
shall survive the termination of this Lease.
(v) Rent Not Based on Income. No rent or other payment in respect of
-------------------------
the Premises shall be based in any way upon net income or profits from the
Premises. Tenant may not enter into or permit any sublease or license or other
agreement in connection with the Premises which provides for a rental or other
payment based on net income or profit.
(w) Building Manager and Service Providers. Landlord may perform any
---------------------------------------
of its obligations under this Lease through its employees or third parties hired
by the Landlord.
(x) Late Charge and Interest on Late Payments. Without limiting the
------------------------------------------
provisions of Section 13(a), if Tenant fails to pay any installment of Rent or
other charge to be paid by Tenant pursuant to this Lease within five (5)
business days after the same becomes due and payable, then for the first such
default in any calendar year, Tenant shall pay a late charge equal to Two
Thousand Five Hundred Dollars ($2500) and, for any subsequent default during
such calendar year, Tenant shall pay a late charge equal to the greater of five
percent (5%) of the amount of such payment or $250. In addition, interest shall
be paid by Tenant to Landlord on any late payments of Rent from the date due
until paid at the rate provided in Section 2(d)(ii). Such late charge and
interest shall constitute Additional Rent due and payable by Tenant to Landlord
upon the date of payment of the delinquent payment referenced above.
(y) Tenant's Financial Statements. Within ten (10) days after
------------------------------
Landlord's written request therefor, Tenant shall deliver to Landlord (if Tenant
is then publicly-traded); a copy of the most recent publicly available financial
statement; otherwise, Tenant shall provide the current audited annual and
quarterly financial statements of Tenant, and annual audited financial
statements of the two (2) years prior to the current year's financial
statements, each with an option of a certified public accountant and including a
balance sheet and profit and loss statement, all prepared in accordance with
generally accepted accounting principles consistently applied.
(z) Parking. Tenant shall have the right to use one (1) parking stall
--------
per 1,000 RSF of the Premises. A maximum of fifteen percent (15%) of such stalls
shall be Executive Parking Stalls, and the balance of which shall be Regular
Parking Stalls. Tenant shall pay fair market rates for such stalls (currently
$225 per month per stall for Executive Parking Stalls and $175 per month per
stall for Regular Parking Stalls). Subject to availability, Tenant may rent
additional parking stalls during the lease-up phase of the project on a
month-to-month basis. Executive Parking Stalls are available 24 hours a day, 7
days a week; Regular Parking Stalls are available 24 hours a day, 7 days a week
except for days when a Posted Event is scheduled to occur. On days of Posted
Events, Regular Parking Stalls shall be available only during Parking Hours,
which shall mean 7 a.m. to 6 p.m. Monday-Friday; and 7 a.m. to 12 noon on
Saturdays. Tenant may rent Regular Parking Stalls outside of Parking Hours at
the rate then being charged for Posted Events. A schedule of Posted Events for
each calendar month shall be posted at the entrances to the garage, in the lobby
of the Building and delivered to the reception desks of all tenants of the
Building not later than the 15th day of the calendar month preceding the
calendar month for which the schedule was prepared. Tenant may park in parking
area upon the terms and conditions as may from time to time be established by
the operator of such parking area.
-29-
<PAGE>
26. UNRELATED BUSINESS INCOME. If Landlord is advised by its counsel at
-------------------------
any time that any part of the payments by Tenant to Landlord under this Lease
may be characterized as unrelated business income under the United States
Internal Revenue Code and its regulations, then Tenant shall enter into any
amendment proposed by Landlord to avoid such income, so long as the amendment
does not require Tenant to make more payments or accept fewer services from
Landlord, than this Lease provides.
27. HAZARDOUS MATERIALS.
-------------------
(a) "Hazardous Material" means any substance, waste or material which
is deemed hazardous, toxic, a pollutant or a contaminate, under any federal,
state, or local statute, law, ordinance, rule regulation, or judicial or
administrative order or decision, now or hereafter in effect.
(b) Tenant shall not cause or permit any Hazardous Material to be
brought upon, kept or used in or about the Premises, the Building and/or the
Land by Tenant, its agents, employees, contractors, or invitees without the
prior written consent of Landlord. In order to obtain Landlord's consent, Tenant
must demonstrate to Landlord's reasonable satisfaction that such Hazardous
Material is necessary or useful to Tenant's business and will be used, kept, and
stored in a manner that complies with all laws regulating any such Hazardous
Material so brought upon or used or kept in or about the Premises.
Notwithstanding the foregoing, Tenant shall not be in violation of this
provision by its use and storage of standard office products meeting the
definition of Hazardous Material, if such products are used by Tenant with due
care and in accordance with the instructions of the product manufacturer, in the
reasonable and prudent conduct of Tenant's business in the Premises.
(c) Tenant shall be liable to Landlord for any and all clean-up costs
and any and all other charges, fees, and penalties imposed by any governmental
authority with respect to Tenant's use, disposal, release, transportation,
generation and/or sale of Hazardous Materials or other waste materials in or
about the Project. Tenant shall indemnify, defend and save Landlord harmless
from any and all costs, fees, penalties and charges assessed against or imposed
upon Landlord as a result of Tenant's use, disposal, release, transportation,
generation and/or sale of Hazardous Materials or other waste materials in or
about the Project.
(d) Landlord shall be liable to Tenant for any and all clean-up costs
and any and all other charges, fees, and penalties imposed by any governmental
authority with respect to Landlord's incorporation into the construction of the
Building or use, disposal, release, transportation, generation and/or sale of
Hazardous Materials or other waste materials in or about the Project. Landlord
shall indemnify, defend and save Tenant harmless from any and all costs, fees,
penalties and charges assessed against or imposed upon Tenant as a result of
Landlord's incorporation into the construction of the Building or use, disposal,
release, transportation, generation and/or sale of Hazardous Materials or other
waste materials in or about the Project
-30-
<PAGE>
28. TELECOMMUNICATION LINES AND EQUIPMENT.
-------------------------------------
(a) Location of Tenant's Equipment and Landlord.
-------------------------------------------
(i) Except for the installation of Lines as contemplated by the
final plans and specifications for the initial Tenant Improvements, Tenant may
install, maintain, replace, remove and use communications or computer wires,
cables and related devices (collectively, the Lines) at the Building in or
serving the Premises, only with Landlord's prior written consent, which consent
may be withheld in Landlord's sole and absolute discretion. Tenant shall locate
all electronic telecommunications equipment serving the Lines within the
Premises and shall relocate all Tenants equipment which is located within the
Building telephone closets or riser spaces, at Tenants cost, to the Tenants
Premises. Any request for consent shall contain detailed plans, drawings and
specifications identifying all work to be performed, the estimated time schedule
for completion of the work, the identity of the entity that will provide service
to the Lines and the identity of the entity that will perform the proposed work
(which entity shall be subject to Landlord's reasonable approval). Landlord
shall have a reasonable time in which to evaluate the request after it is
submitted by Tenant.
(ii) Without in any way limiting Landlord's right to withhold its
consent, Landlord may consider the following factors, among others, in making
its determination: (A) the experience, qualifications and prior work practice of
the proposed contractor and its ability to provide sufficient insurance coverage
for its work at the Building; (B) whether or not the proposed work will
interfere with the use of any then existing Lines at the Building; (C) whether
or not an acceptable number of spare Lines and space for additional Lines shall
be maintained for existing and future occupants of the Building; (D) a
requirement that Tenant remove existing abandoned Lines located in or servicing
the Premises, as a condition to permitting the installation of new lines; (E)
whether or not a default by Tenant is continuing and the applicable notice and
cure period has expired under this Lease; (F) whether the proposed work or
resulting Lines will impose material, as determined by Landlord in its
reasonable discretion, new obligations on Landlord, expose Landlord to liability
of any nature or description, increase Landlord's insurance premiums for the
Building, create material, as determined by Landlord in its reasonable
discretion, liabilities for which Landlord is unable to obtain insurance
protection or imperil Landlord's insurance coverage; (G) whether Tenant's
proposed service provider is willing to pay reasonable monetary compensation for
the use and occupation of the Building; and (H) whether the work or resulting
Lines would adversely affect the Land, Building or any space in the Building in
any manner.
(iii) Landlord's approval of, or requirements concerning, the
Lines or any equipment related thereto, the plans, specifications or designs
related thereto, the contractor or subcontractor, or the work performed
hereunder, shall not be deemed a warranty as to the adequacy thereof, and
Landlord hereby disclaims any responsibility or liability for the same. Landlord
disclaims all responsibility for the condition or utility of the intra-building
network cabling ("INC") and makes no representation regarding the suitability of
---
the INC for Tenants intended use.
-31-
<PAGE>
(iv) If Landlord consents to Tenant's proposal, Tenant shall (A)
pay all costs in connection therewith (including all costs related to new
Lines); (B) comply with all requirements and conditions of this Section; (C)
use, maintain and operate the Lines and related equipment in accordance with and
subject to all laws governing the Lines and equipment. Tenant shall further
insure that (I) Tenant's contractor complies with the provisions of this Section
and Landlord's reasonable requirements governing any work performed; (II)
Tenant's contractor provides all insurance required by Landlord; (III) any work
performed shall comply with all laws; and (IV) as soon as the work in completed,
Tenant shall submit as-built drawings to Landlord.
(v) Landlord reserves the right to require that Tenant remove
any Lines located in or serving the Premises which are installed in
violation of these provisions, or which are at any time in violation of any
laws or present a dangerous or potentially dangerous condition (whether
such Lines were installed by Tenant or any other party on behalf of Tenant
other than Landlord or Landlord's employees, agents or contractors, within
ten (10) business days after written notice.
(b) Landlord's Rights. Landlord may (but shall not have the
-----------------
obligation to):
(i) install new lines at the Building;
(ii) create additional space for Lines at the Building; and
(iii) direct, monitor and/or supervise the installation,
maintenance, replacement and removal of, the allocation and periodic re-
allocation of available space (if any) for, and the allocation of excess
capacity (if any) on, any Lines now or hereafter installed at the Building by
Landlord, Tenant or any other party (but Landlord shall have no right to
allocate excess capacity on Lines installed by or for Tenant or to monitor or
control the information transmitted through any such Lines, whether installed by
Tenant or any other party).
(c) Indemnification. In addition to any other indemnification
---------------
obligations under this Lease but subject to Section 8 above, Tenant shall
indemnify and hold harmless Landlord and its employees, agents, officers, and
contractors from and against any and all claims, demands, penalties, fines,
liabilities, settlements, damages, costs or expenses (including reasonable
attorneys fees) arising out of the acts and omissions of Tenant, Tenants
officers, directors, employees, agents, contractors, subcontractors, subtenants,
and invitees with respect to: (i) any Lines or equipment related thereto serving
Tenant in the Building; (ii) any personal injury (including wrongful death) or
property damage arising out of or related to any Lines or equipment related
thereto serving Tenant in the Building; (iii) any lawsuit brought or threatened,
settlement reached, or governmental order, fine or penalty relating to such
Lines or equipment related thereto; and (iv) any violations or laws or demands
of governmental authorities, or any reasonable policies or requirement of
Landlord, which are based upon or in any way related to such Lines or equipment.
This indemnification and hold harmless agreement shall survive the termination
of this Lease.
(d) Limitation of Liability. Except to the extent arising from the
------------------------
gross negligence, breach of this Lease or willful misconduct of Landlord or
Landlord's contractors, agents or employees, Landlord shall have no liability
for damages arising from, and Landlord
-32-
<PAGE>
does not warrant that the Tenant's use of any Lines will be free from the
following (collectively called Line Problems): (i) any shortages, failures,
variations, interruptions, disconnections, loss or damage caused by the
installation, maintenance, or replacement, use or removal of Lines by or for
other tenants or occupants at the Building, by any failure of the environmental
conditions or the power supply for the Building to conform to any requirement of
the Lines or any associated equipment, or any other problems associated with any
Lines by any other cause; (ii) Any failure of any Lines to satisfy Tenants
requirements; or (iii) any eavesdropping or wire-tapping by unauthorized
parties. Landlord in no event shall be liable for damages by reason of loss of
profits, business interruption or other consequential damage arising from any
Line Problems. Under no circumstances shall any Line Problems be deemed an
actual or constructive eviction of Tenant, render Landlord liable to Tenant for
abatement of Rent, or relieve Tenant from performance of Tenants obligations
under this Lease. The foregoing notwithstanding, (x) if there occurs a Line
Problem that is caused by the gross negligence, willful misconduct or breach of
this Lease of Landlord or Landlord's employees, agents or contractors, or (y) if
there occurs a Line Problem from any other cause within Landlord's reasonable
control and Landlord does not begin to cure such Line Problem to the extent
within its reasonable control within five (5) days and thereafter diligently
continue such cure to completion, then, in either case, from the fifth (5th) day
of the existence of the Line Problem until the service is fully restored, Base
Rent payable by Tenant hereunder shall be abated for the portion of the Premises
for which normal and customary utilization by Tenant is impractical by reason of
the Line Problem.
(e) Electromagnetic Fields. If Tenant at any time uses any equipment
----------------------
that may create an electromagnetic field exceeding the normal insulation ratings
of ordinary twisted pair riser cable or cause radiation higher than normal
background radiation, Landlord reserves the right to require Tenant to
appropriately insulate the Lines therefore (including riser cables) to prevent
such excessive electromagnetic fields or radiation.
29. LIMITATION ON LANDLORD LIABILITY. In consideration of the benefits
--------------------------------
accruing hereunder, Tenant and all successors and assigns covenant and agree
that, in the event of any actual or alleged failure, breach or default hereunder
by Landlord:
(a) The sole and exclusive remedy shall be against Landlord's interest
in the Project, including without limitation, all rents and other revenues and
income of the Project, insurance proceeds, condemnation proceeds, financing
proceeds and sales proceeds (collectively, "Proceeds");
(b) No general or limited partner of any partnerships who have any
interest in the property, or member or manager or shareholder or Landlord shall
be sued or named as a party in any suit or action (except as may be necessary to
secure jurisdiction of the partnership or limited liability company);
(c) No service of process shall be made against any general or limited
partner of any partnerships who have any interest in the property, or member or
manager or shareholder of Landlord (except as may be necessary to secure
jurisdiction of the partnership or limited liability company);
-33-
<PAGE>
(d) No limited partner of any partnerships who have any interest in
the property, or member or manager or shareholder of Landlord shall be required
to answer or otherwise plead to any service or process;
(e) No judgment will be taken against any limited partner of any
partnerships who have any interest in the property, or member or manager or
shareholder of Landlord;
(f) Any judgment taken against any limited partner of any partnerships
who have any interest in the property, or member or manager or shareholder of
Landlord may be vacated and set aside at any time nunc pro tunc;
(g) No writ of execution will ever be levied against the asset of any
limited partner of any partnerships who have any interest in the property, or
member or manager or shareholder of Landlord; and
(h) These covenants and agreements are enforceable both by Landlord
and also by any partner of any partnerships who have any interest in the
property, or member or manager or shareholder of Landlord.
30. ADDITIONAL LEASE TERMS. Additional terms, provisions, covenants, and
----------------------
agreements of this Lease (if any) are included in the Addendum attached hereto
and made a part hereof by this reference.
IN WITNESS WHEREOF, the parties hereto have executed this Lease.
LANDLORD: 505 UNION STATION LTD., a Washington
corporation
By: /s/ Larry C. Martin
-----------------------------------
Name: Larry C. Martin
---------------------------------
Title: Vice President
--------------------------------
TENANT: WATCHGUARD TECHNOLOGIES, INC. a
Delaware corporation
By: /s/ Steven N. Moore
-----------------------------------
Name: Steven N. Moore
---------------------------------
Title: CFO
--------------------------------
-34-
<PAGE>
STATE OF WASHINGTON |
| ss.
COUNTY OF KING |
I certify that I know or have satisfactory evidence that Larry C. Martin is
the person who appeared before me, and said person acknowledged that said person
signed this instrument, on oath stated that said person was authorized to
execute the instrument and acknowledged it as the Vice President of 505 UNION
STATION LTD., a corporation, to be the free and voluntary act of such
corporation for the uses and purposes mentioned in the instrument.
Dated this 22nd day of March, 2000.
/s/ Leslee A. Bush
----------------------------------------
(Signature of Notary)
/s/ Leslee A. Bush
----------------------------------------
[NOTARY SEAL] (Legibly Print or Stamp Name of Notary)
Notary public in and for the state of
Washington, residing at Bellevue
My appointment expires Feb. 07, 2003
-35-
<PAGE>
STATE OF WASHINGTON |
| ss.
COUNTY OF KING |
I certify that I know or have satisfactory evidence that Steven N. Moore is
the person who appeared before me, and said person acknowledged that said person
signed this instrument, on oath stated that said person was authorized to
execute the instrument and acknowledged it as the Chief Financial Officer of
WATCHGUARD TECHNOLOGIES, INC., a corporation, to be the free and voluntary act
of such corporation for the uses and purposes mentioned in the instrument.
Dated this 16th day of March, 2000.
/s/ Tricia Lynn Haber
--------------------------------------------------
(Signature of Notary)
Tricia Lynn Haber
--------------------------------------------------
(Legibly Print or Stamp Name of Notary)
Notary public in and for the state of Washington,
residing at Seattle
My appointment expires October 22, 2003
-36-
<PAGE>
APPENDIX A
----------
TO LEASE
WatchGuard Technologies
Plan Of The Premises
--------------------
[FLOOR PLAN DIAGRAM]
APPENDIX A
<PAGE>
APPENDIX B
----------
TO LEASE
WatchGuard Technologies
RULES AND REGULATIONS
---------------------
1. Tenant shall not place anything, or allow anything to be placed near
the glass of any window, door, partition or wall which may, in Landlord's
judgment, appear unsightly from outside of the Project.
2. The Project directory shall be available to Tenant solely to display
names and their location in the Project, which display shall be as directed by
Landlord.
3. The sidewalks, halls, passages, exits, entrances, elevators and
stairways shall not be obstructed by Tenant or used by Tenant for any purposes
other than for ingress to and egress from the Premises. During the construction
of the Tenant Improvements, Tenant shall comply with the requirements of the
"505 Union Station - Tenant Improvement Manual" as in effect on the date of the
Lease and Appendix D to the Lease with respect to keeping such areas free from
obstruction and in a clean and sightly condition and moving supplies, furniture
and equipment into the Premises and waste out of the Premises. Thereafter,
Tenant shall lend its full cooperation to keep such areas free from all
obstruction and in a clean and sightly condition and shall move all supplies,
furniture and equipment as soon as received directly to the Premises and move
all such items and waste being taken from the Premises (other than waste
customarily removed by employees of the Building) directly to the shipping
platform at or about the time arranged for removal therefrom. The halls,
passages, exits, entrances, elevators, stairways, balconies and roof are not for
the use of the general public and Landlord shall, in all cases, retain the right
to control and prevent access thereto by all persons whose presence in the
judgment of Landlord, reasonably exercised, shall be prejudicial to the safety,
character, reputation and interests of the Project. Neither Tenant nor any
employee or invitee of Tenant shall go upon the roof of the Project.
4. The toilet rooms, urinals, wash bowls and other apparatuses shall not
be used for any purposes other than that for which they were constructed, and no
foreign substance of any kind whatsoever shall be thrown therein, and to the
extent caused by Tenant or its employees or invitees, the expense of any
breakage, stoppage or damage resulting from the violation of this rule shall be
borne by Tenant to the extent not reimbursed by Landlord's insurance.
5. Tenant shall not cause any unnecessary janitorial labor or services by
reason of Tenant's carelessness or indifference in the preservation of good
order and cleanliness.
6. Tenant shall not install or operate any refrigerating (other than
standard refrigerators for the incidental storage of employee food and
beverages), heating or air conditioning apparatus, or carry on any mechanical
business (other than that within the scope of Tenant's permitted use) without
the prior written consent of Landlord; use the Premises for housing or lodging
purposes; or permit preparation or warming of food in the Premises
APPENDIX B
PAGE B-1
<PAGE>
(warming of coffee and individual meals with employees and guests excepted).
Tenant shall not occupy or use the Premises or permit the Premises to be
occupied or used for any purpose, act or thing which is in violation of any
Governmental Requirement or which may be dangerous to persons or property.
7. Except as permitted under Section 27 of the Lease or, during
construction of the Tenant Improvements, the "505 Union Station - Tenant
Improvement Manual" as in effect on the date of the Lease, Tenant shall not
bring upon, use or keep in the Premises or the Project any kerosene, gasoline or
inflammable or combustible fluid or material, or any other articles deemed
hazardous to persons or property, or use any method of heating or air
conditioning other than that supplied by Landlord.
8. After the completion of the initial Tenant Improvements, Landlord shall
have sole power to direct electricians as to where and how telephone and other
wires are to be introduced. After the completion of the initial Tenant
Improvements, no boring or cutting for wires is to be allowed without the
consent of Landlord, not to be unreasonably withheld. Except for items
contemplated by the final plans for the Tenant Improvements, the location of
telephones, call boxes and other office equipment affixed to the Premises shall
be subject to the approval of Landlord.
9. No additional locks shall be placed upon any doors, windows or transoms
in or to the Premises unless Landlord is provided with a passkey thereto. Tenant
shall not change existing locks or the mechanism thereof without Landlord's
prior approval, not to be unreasonably withheld, and in any event Landlord shall
be provided a passkey thereto. Upon termination of the lease, Tenant shall
deliver to Landlord all keys and passes for offices, rooms, parking lot and
toilet rooms which shall have been furnished Tenant.
In the event of the loss of keys so furnished, Tenant shall pay Landlord
therefor. Tenant shall not make, or cause to be made, any such keys and shall
order all such keys solely from Landlord and shall pay Landlord for any keys in
addition to the two sets of keys originally furnished by Landlord for each lock.
10. Tenant shall not install linoleum, tile, carpet or other floor
covering so that the same shall be affixed to the floor of the Premises in any
manner except as approved by Landlord.
11. No furniture, packages, supplies, equipment or merchandise will be
received in the Project or carried up or down in the freight elevator, except
between such hours and in such freight elevator as shall be designated by
Landlord uniformly for all tenants of the Building. Tenant shall not take or
permit to be taken in or out of other entrances of the Building, or take or
permit on other elevators, any item normally taken in or out through the
trucking concourse or service doors or in or on freight elevators.
12. Without the prior written consent of Landlord, not to be unreasonably
withheld, Tenant shall not use the name of the Project or any picture of the
Project in connection with, or in promoting or advertising the business of,
Tenant, except Tenant may use the name and address of the Project as the address
of its business.
APPENDIX B
PAGE B-2
<PAGE>
13. Tenant shall cooperate fully with Landlord to assure the most
effective operation of the Premises' or the Project's heating and air
conditioning, and shall refrain from attempting to adjust any controls, other
than room thermostats installed for Tenant's use. Tenant shall keep corridor
doors closed.
14. Tenant assumes full responsibility for protecting the Premises from
theft, robbery and pilferage, which may arise from a cause other than Landlord's
negligence, which includes keeping doors locked and other means of entry to the
Premises closed and secured.
15. Peddlers, solicitors and beggars shall be reported to the office of
the Project or as Landlord otherwise requests.
16. Tenant shall not advertise the business, profession or activities of
Tenant conducted in the Project in any manner which violates the letter or
spirit of any code of ethics adopted by any recognized association or
organization pertaining to such business, profession or activities.
17. No bicycle or other vehicle and no animals or pets shall be allowed in
the Premises, halls, freight docks, or any other parts of the Building except
that blind persons may be accompanied by "seeing eye" dogs. Tenant shall not
make or permit any noise, vibration or odor to emanate from the Premises, or do
anything therein tending to create, or maintain, a nuisance, or do any act
tending to injure the reputation of the Building.
18. Tenant acknowledges that Building security problems may occur which
may require the employment of extreme security measures in the day-to-day
operation of the Project. Accordingly:
(a) Landlord may, at any time, or from time to time, or for regularly
scheduled time periods, as deemed advisable by Landlord and/or its agents, in
their reasonable discretion, require that persons entering or leaving the
Project or the Property identify themselves to watchmen or other employees
designated by Landlord, by registration, identification or otherwise.
(b) Tenant agrees that it and its employees will cooperate fully with
Project employees in the implementation of any and all security procedures.
(c) Such security measures shall be the sole responsibility of
Landlord, and Tenant shall have no liability for any action taken by Landlord in
connection therewith, it being understood that, except as otherwise provided in
the Lease, Landlord is not required to provide any security procedures and shall
have no liability for such security procedures or the lack thereof.
19. Tenant shall not disturb the quiet enjoyment of any other tenant.
20. Tenant shall not provide any janitorial services or cleaning without
Landlord's written consent and then only subject to supervision of Landlord and
at Tenant's sole
APPENDIX B
PAGE B-3
<PAGE>
responsibility and by janitor or cleaning contractor or employees at all times
satisfactory to Landlord.
21. No equipment, mechanical ventilators, awnings, special shades or other
forms of window covering shall be permitted either inside or outside the windows
of the Premises without the prior written consent of Landlord, and then only at
the expense and risk of Tenant, and they shall be of such shape, color,
material, quality, design and make as may be approved by Landlord.
22. Tenant shall not during the term of this Lease canvas or solicit other
tenants of the Building for any purpose.
23. Except for ordinary personal entertainment devices and ordinary
business equipment, such as, without limitation, compact disc players, personal
stereos, radios, and televisions, and personal computers with sound capacity,
Tenant shall not install or operate any phonograph, musical or sound- producing
instrument or device, radio receiver or transmitter, TV receiver or transmitter,
or similar device in the Building, nor install or operate any antenna, aerial,
wires or other equipment inside or outside the Building, nor operate any
electrical device from which may emanate electrical waves which may interfere
with or impair radio or television broadcasting or reception from or in the
Building or elsewhere, without in each instance the prior written approval of
Landlord. The use thereof, if permitted, shall be subject to control by Landlord
to the end that others shall not be disturbed.
24. Tenant shall not exhibit, sell or offer for sale, Rent or exchange in
the Premises or at the Project any article, thing or service, except those
ordinarily embraced within the use of the Premises specified in Section 6 of
this Lease, without the prior written consent of Landlord.
25. Tenant shall list desks, credenzas, sofas, and other large or heavy
pieces of all furniture, equipment and similar articles Tenant desires to remove
from the Premises or the Building and deliver a copy of such list to Landlord.
Tenant shall either procure a removal permit from the Office of the Building
authorizing Building employees to permit such articles to be removed or provide
the persons removing such articles with written authorization to remove such
articles.
26. Tenant shall not overload any floors in the Premises or any public
corridors or elevators in the Building.
27. Tenant shall not do any painting in the Premises, or mark, paint, cut
or drill into, drive nails or screws into, or in any way deface any part of the
Premises or the Building, outside or inside, without the prior written consent
of Landlord, not to be unreasonably withheld. Notwithstanding the foregoing,
Tenant shall have the right, without Landlord's prior consent, to perform minor
surface work and minor surface painting and to hang pictures, etc., weighing not
more than 15 lbs. on walls in the Premises; provided that none of the foregoing
involves modifications to Building systems.
APPENDIX B
PAGE B-4
<PAGE>
28. Whenever Landlord's consent, approval or satisfaction is required
under these Rules, then unless otherwise stated, any such consent, approval or
satisfaction must be obtained in advance, such consent or approval may be
granted or withheld in Landlord's sole discretion, and Landlord's satisfaction
shall be determined in its sole judgment.
29. Tenant and its employees shall cooperate in all fire drills conducted
by Landlord in the Building.
APPENDIX B
PAGE B-5
<PAGE>
APPENDIX C
----------
TO LEASE
WatchGuard Technologies
LANDLORD'S SHELL AND CORE IMPROVEMENTS
--------------------------------------
This section is an outline of materials and finishes provided by Landlord during
the construction of the Building.
CORE AREAS
- ----------
1. Elevator Lobbies:
----------------
a. Core walls sheet rocked, taped, mudded, and ready to receive
paint.
b. Elevator, restroom, and service room doors and frames installed.
c. Concrete floors ready for finishes.
d. Life safety systems installed per code and operational.
2. Restrooms:
---------
a. Painted gypsum wallboard and ceramic tile walls
b. Ceramic tile floors
c. Gypsum wall board ceiling and light fixtures
d. Solid surface lavatory countertops
e. Plumbing fixtures, including drinking fountains
f. Life safety systems installed per code and operational.
3. Life Safety:
------------
a. Fire sprinkler riser, code minimum tenant distribution.
b. Central life safety system with conduit and wire to floor.
OFFICE AREAS
- ------------
APPENDIX C
PAGE C-1
<PAGE>
1. Perimeter columns and stub walls (below windows) insulated and metal
studs installed.
2. Concrete floors ready for carpet finish per carpet industry standards;
depressions between high spots shall not exceed 1/8" using a 10-foot
straight edge.
3. Ceiling height is designed at 9'-0" to top of window head. Ceiling
grid and tile will be installed during tenant improvement as a Tenant
expense.
4. The building's structure is designed for a live loading capacity for
the building of 80 pounds per square foot (psf) 15 feet from the core
and 50 psf elsewhere. The static load for a typical floor is 83 psf,
of which 25 psf is superimposed (i.e., partitions, flooring,
sprinklers) and 58 psf is structure itself.
EXIT STAIRS
- -----------
1. Exit stairs sheet rocked, mudded, taped and painted. Metal stair will
have only a primer finish.
BLINDS AND ACCENT LIGHTING
- --------------------------
1. Blinds installed on the south, east and west facing exterior windows.
2. Accent lighting along the windows at the north curtain wall. This
accent lighting will provide tenant lighting along the north wall.
MECHANICAL
- ----------
1. Plumbing: Tenant Floors provided with vent and waste stub-outs at
four locations and a water stub-out at one location.
2. HVAC: The building's main cooling system will operate between 7:00 AM
and 6:00 PM Monday through Friday and 8:00 AM and 1:00 PM on Saturday,
and will not operate on Sundays and holidays.
a. The Landlord will provide floor-by-floor custom VAV chilled water air
handling unit.
b. The floor-by-floor relief is provided by shell and core relief fans
discharging through exterior louvers.
c. Shell and core medium velocity supply ductwork is provided from the
chilled water air handling units to each quadrant of the floor.
APPENDIX C
PAGE C-2
<PAGE>
d. Supplemental chilled water connections are located on each floor in
the mechanical room.
e. The Landlord's building automation system is manufactured and
installed by Siemens Building Controls.
The shell and core mechanical system was designed using the
following Code as well as other applicable codes:
1997 Seattle Mechanical Code
1997 Seattle Building Code
1997 Washington State Energy Code with Seattle Amendments
1997 Washington State Ventilation and Indoor Air Quality Code
<TABLE>
<CAPTION>
Design Conditions Outdoor Indoor
<S> <C> <C>
Winter: 24 F DB 70 F DB Occupied
60 F DB Unoccupied
Summer: 83 F DB 74 F DB
67 F DB
Supply air temperature delivered to VAV boxes: 49 F DB
Chilled water supply temperature: 42 F
Chilled water supply temperature: 49 F (for supplemental cooling)
</TABLE>
The foregoing design conditions shall be satisfied on the basis of 143 usable
square feet per person.
ELECTRICAL
- ----------
Each floor has a high voltage board (480 V 3 phase/280 V 1 phase) and a low
voltage board (208 V 3 phase/ 120 V 1 phase) in each electrical room. Total
breakers per floor to be allocated prorata are as follows:
High Voltage Board
14 20A single-phase breakers designated for tenant lighting,
10 40A three-phase breakers for tenant HVAC
84 Single-phase spaces
16 Single-phase spaces for additional breakers
Low Voltage Boards
114 20A single-phase breakers for tenant receptacles
130 Single-phase spaces for additional breakers
APPENDIX C
PAGE C-3
<PAGE>
Power distributed to the panels provides 1.2 watts per square foot for lighting,
5.5 watts connected load per square foot for tenant receptacles and other uses,
and sufficient wattage for mechanical and HVAC at 143 usable square feet per
person.
ELEVATORS
- ---------
At least the freight elevator shall be installed and operational at the time
Landlord delivers the Premises to Tenant; on or before the actual Commencement
Date of this Lease, all planned Building elevators shall be installed and
operational.
MISCELLANEOUS
- -------------
1. Each typical office floor will be provided with two fire
extinguisher/valve cabinets in the core area.
2. Exit signs will be installed at exit stair entrances as part of shell
and core construction.
3. Quick response brass pendant sprinkler heads are provided throughout
Tenant's space, spaced at approximately one per 144 square feet. The
sprinklers are installed directly in the sprinkler piping facing down
for future relocation to the tenant ceiling. Tenant shall use
concealed sprinkler heads per the Tenant Improvements Manual.
APPENDIX C
PAGE C-4
<PAGE>
APPENDIX D
----------
TO LEASE
WatchGuard Technologies
TENANT IMPROVEMENT AGREEMENT
----------------------------
1. DELIVERY OF PREMISES BY LANDLORD
--------------------------------
1.1 Except as may be otherwise specifically set forth in this Lease, all
Tenant Improvements to be performed at the Premises shall be performed by Tenant
at Tenant's expense.
1.2 Landlord does not warrant any information Landlord may have furnished
or will furnish Tenant regarding the Premises. It shall be Tenant's
responsibility to verify existing field conditions and measurements of the
Premises. Tenant's failure to verify the existing conditions and measurements
of the Premises shall not relieve Tenant of any expenses or responsibilities
resulting from such failure, nor shall Landlord have any liability or
obligations to Tenant arising from such failure.
2. TENANT IMPROVEMENTS -- GENERAL CRITERIA
---------------------------------------
2.1 Tenant shall construct Tenant's initial improvements to the Premises
("Tenant Improvements") as provided herein. In the event of a conflict between
the lease and the more specific provisions of this Appendix D, this Appendix D
shall control.
2.2 Tenant or Tenant's project manager shall perform Tenant Improvements
in accordance with all laws including, without limitation, the building codes of
the jurisdiction in which the Building is located and all requirements of the
Americans with Disabilities Act.
2.3 Tenant shall prepare its plans and specifications for Tenant
Improvements in accordance with this Appendix and Landlord's tenant improvement
manual, "505 Union Station -- Tenant Improvement Manual" hereinafter the "Tenant
Improvement Manual", as in effect as of the date of this Lease. The Tenant
Improvement Manual contains specific criteria for the design and performance of
the Tenant Improvements, including the mechanical and electrical Tenant
Improvements. The Tenant Improvement Manual contains "Standard Project Details"
as issued from time to time with which Tenant shall comply.
2.4 Tenant Improvements shall be subject to the advance written approval
by Landlord as and to the extent required in this Appendix D. Landlord
acknowledges review and preliminary approval of the Schematic Plans attached as
Appendix D-1. Due to the general nature of the Schematic Plans, Landlord cannot
represent that the Building structure or Building systems are adequate to
accommodate Tenant's requirements. Landlord may require Tenant to remove the
following portions of the Tenant Improvements reflected in the Schematic Plans
at expiration or earlier termination of this Lease and to restore any damage
resulting from such removal, all at Tenant's expense: all cabling and telephone
equipment; local area network
APPENDIX D
PAGE D-1
<PAGE>
("LAN") and laboratory spaces and equipment (not including normal demising
walls); any commercial quality kitchen(s); and all non-building standard office
doorways and doors (except the sliding door shown on the Schematic Plans as
"Door/Relite, Option B"), which shall be removed and replaced with building-
standard doorways and doors, unless Landlord, upon its review and approval of
the Drawings (defined below) advises Tenant that any or all Tenant's
contemplated doorways and doors shall not be so removed or replaced. Further, as
a condition to its approval of the Final Drawings (defined below), if the Final
Drawings materially differ from the Schematic Plans, Landlord may require Tenant
to remove additional portions of such Tenant Improvements at expiration or
earlier termination of this Lease and to restore any damage resulting from such
removal, all at Tenant's expense, if Landlord expressly so notes at the time it
approves the Final Drawings.
2.5 Tenant shall, prior to commencement of Tenant Improvements, obtain all
required building and other permits at Tenant's expense and post said permits at
the Premises as required.
2.6 Tenant shall use only new materials for the Tenant Improvements,
including improvements, equipment, trade fixtures and all other fixtures.
Notwithstanding the foregoing, Tenant may reuse portions of existing
improvements subject to Landlord's prior written approval, provided that said
approval shall in no manner relieve Tenant from the requirement that all Tenant
Improvements comply with this Lease, the Tenant Improvement Manual and all laws.
Reuse of existing improvements shall be clearly indicated on Tenant's Drawings
(as defined below). Landlord makes no warranty or representation as to the
condition or suitability of existing improvements reused by Tenant.
2.7 Tenant shall make no marks or penetrations into the roof, upper floor
decks, exterior walls, or floors, unless approved by Landlord in advance.
2.8 If any Tenant Improvements being performed by Tenant to connect to
Landlord's utilities requires access through the Premises of any other tenant or
otherwise will affect any other tenant and Landlord has approved such Tenant
Improvements, Tenant shall be responsible for coordinating such Tenant
Improvements with the work being performed by such other tenant, including
restoring said tenant's premises to its original condition following the Tenant
Improvements, and compensating said other tenant for any costs incurred by it on
account of such Tenant Improvements.
2.9 If any Tenant Improvements necessitates any special work, such as, but
not limited to, structural modification, increasing the size of electric conduit
or telephone service, Landlord, at Landlord's election, may perform such work,
and Tenant shall reimburse Landlord the cost thereof plus fifteen percent (15%)
thereof for administration, or require Tenant perform the work at Tenant's cost.
If Landlord does any Tenant Improvements on behalf of Tenant, Tenant shall pay
twenty-five percent (25%) of the anticipated cost to Landlord prior to
commencement of the Tenant Improvements and the balance upon completion thereof.
Notwithstanding anything to the contrary contained in the Lease or this Appendix
D, Tenant is responsible for Tenant's telephone service.
APPENDIX D
PAGE D-2
<PAGE>
2.10 Tenant shall retain Landlord's identification signs or, at Tenant's
cost, provide new signs, using Landlord's standards, for Landlord's utilities,
valves, and other such devices in the Premises.
2.11 Landlord may at its election require any aspect of Tenant
Improvements to be tested consistent with normal construction practices, and
Tenant shall cooperate with any such testing procedure.
2.12 No approval from Landlord with respect to any aspect of Tenant
Improvements shall be valid unless in writing.
2.13 Tenant, or Tenant's project manager, or, at Tenant's election, the
Landlord, shall at Tenant's expense manage the tenant improvement design and
construction process in accordance with the process set forth herein and in the
Tenant Improvement Manual. If Tenant elects to have Landlord or Landlord's
employees or agents provide such management services, Landlord shall be paid a
management fee in the amount of three percent (3%) of labor, materials and all
other hard and soft costs of the Tenant Improvements which shall be charged
against the Allowance. In addition, and regardless of whether Landlord, Tenant,
or a third party, manages the design and construction process, Landlord's time
and expenses in connection with review and approval of Tenant Improvements shall
be reimbursed to Landlord by Tenant in the amount of $100.00 per hour.
Furthermore, if Landlord or its employees or contractors performs any Work,
Landlord may charge a supervisory fee not to exceed fifteen percent (15%) of
labor, material, and all other costs of the Work actually performed by Landlord
or its employees or contractors.
3. PROCEDURES AND SCHEDULES FOR THE COMPLETION OF PLANS AND SPECIFICATIONS
-----------------------------------------------------------------------
3.1 All prints, drawing information, and other materials to be furnished
by Tenant as required hereinafter, shall be delivered to Landlord. Tenant's
preliminary drawings and specifications are herein referred to as the "Design
Development Drawings." Tenant's final drawings and specifications are herein
referred to as the "Final Contract Drawings". The Design Development Drawings
and Final Contract Drawings are sometimes referred to herein as the "Drawings."
3.2 Tenant shall, at its sole expense, utilize the services of an
architect and engineer approved by Landlord, which approval shall not be
unreasonably withheld, to prepare all Drawings. Said architect and engineer
shall be registered in the state in which the Building is located. All Drawings
shall be submitted to Landlord for approval in the form of one (1) set of
reproducible sepia prints and three (3) sets of blueline prints. All Final
Contract Drawings shall be computer generated on a diskette submitted to the
Landlord.
3.3 Simultaneously with the execution of this Lease, Landlord will furnish
Tenant a drawing that shows the dimensions and square footage of the Premises
(the "Layout Drawing"). The Layout Drawing shall also show the location of
certain existing improvements in the Premises. Landlord has heretofore
furnished Tenant with the Tenant Improvement Manual. If, pursuant to the
foregoing, Tenant is supposed to receive the Layout Drawing and/or the Tenant
APPENDIX D
PAGE D-3
<PAGE>
Improvement Manual, and has not received the same by the date this Lease is
fully executed, Tenant shall promptly notify Landlord and Landlord shall furnish
said item(s) to Tenant as soon as reasonably possible. Landlord does not
warrant the information or measurements shown on the Layout Drawing, or on any
other drawings it furnishes to Tenant with respect to the Premises. It shall be
the Tenant's responsibility to field measure and field verify all existing
conditions at the Building.
3.4 Tenant shall submit the Design Development Drawings promptly, and in
no event later than sixty (60) days after mutual execution hereof. The Design
Development Drawings shall include dimensioned interior floor plans, interior
elevations, reflected ceiling plan(s), signage design, size and location,
furniture layout, and any other work Tenant intends to perform. The Design
Development Drawings shall clearly identify and locate equipment requiring
plumbing or other specific mechanical systems, areas subject to above-normal
floor loads, special floor slab openings, special electrical requirements, and
any other major or special features including an outline of specification of
special finishes. With the Design Development Drawings Tenant shall submit a
color and material board showing quality and location of all finishes. Landlord
shall notify Tenant that it approves or disapproves the Design Development
Drawings within ten (10) business days after receipt thereof. If Landlord
disapproves, Landlord shall specify the reasons for the disapproval. If
Landlord disapproves, Tenant shall within ten (10) business days after receipt
of Landlord's disapproval, send Landlord revised Design Development Drawings
addressing Landlord's comments. This procedure shall be repeated until Landlord
has approved the Design Development Drawings. Landlord may give approval "as
noted" in which event the changes noted by Landlord shall be deemed incorporated
into the Design Development Drawings; provided, if Tenant notifies Landlord
within five (5) days thereafter that it does not accept said changes, then the
Design Development Drawings shall be deemed disapproved on account of the
changes Landlord has requested.
3.5 Within thirty (30) days after Landlord approves the Design Development
Drawings, Tenant shall submit the Final Contract Drawings. The Final Contract
Drawings shall include detailed final Drawings for architectural, electrical,
mechanical, structural, sprinkler and plumbing and all other Tenant Improvements
to be performed by Tenant and shall be prepared consistent with the approved
Design Development Drawings. Landlord shall notify Tenant that it approves or
disapproves of the Final Contract Drawings within ten (10) business days after
receipt thereof. If Landlord disapproves, Landlord shall specify the reasons
for the disapproval. If Landlord disapproves, Tenant shall within ten (10)
business days after receipt of Landlord's disapproval, send Landlord revised
Final Contract Drawings addressing Landlord's comments. This procedure shall be
repeated until Landlord has approved the Final Contract Drawings. Landlord may
give approval "as noted" in which event the changes noted by Landlord shall be
deemed incorporated into the Final Contract Drawings; provided, if Tenant
notifies Landlord within five (5) days thereafter that it does not accept said
changes, the Final Contract Drawings shall be deemed disapproved on account of
the absence of the changes Landlord had requested.
3.6 Design Development Drawings and Final Contract Drawings shall include,
but not be limited to, the items described in Section 1, Final Contract
Documents, and Section 2, Drawing Standards, of the Tenant Improvement Manual.
APPENDIX D
PAGE D-4
<PAGE>
3.7 The approval by Landlord or Landlord's agent of any Drawings or of
Tenant Improvements shall not constitute an implication, representation or
certification by Landlord or Landlord's agent that either said Drawings or
Tenant Improvements is accurate, sufficient, efficient or in compliance with
insurance and indemnity requirements, or any laws, including but not limited to,
code and the Americans with Disabilities Act, the responsibility for which
belongs solely to Tenant.
3.8 In those instances where multiple standards and requirements apply
with respect to Tenant Improvements, the strictest of such standards and/or
requirements shall control unless prohibited by applicable law.
4. CONSTRUCTION
------------
4.1 Tenant may not commence any Tenant Improvements until this Lease has
been fully executed, Landlord has approved the Final Contract Drawings, a copy
of which has been executed by Tenant and delivered to Landlord, all required
insurance certificates have been furnished Landlord, all building permits have
been obtained, and Tenant has complied with all other requirements herein and
elsewhere in this Lease.
4.2 A representative of Tenant shall meet with Landlord prior to start of
construction to discuss construction-related items. Tenant's representative
shall contact the Landlord in advance to schedule said meeting at a mutually
satisfactory time.
4.3 Without limitation to any provision of this Lease, prior to
commencement of any Tenant Improvements at the Premises Tenant shall furnish
Landlord the following:
(a) The names, addresses, representatives and telephone numbers of the
general contractor and all subcontractors ("Tenant's Contractors").
(b) Amounts of the general contract and each subcontract.
(c) Certificates of Insurance evidencing the insurance required of
Tenant and Tenant's Contractors as provided in this Lease, including this
Appendix.
(d) A copy of the building permit(s).
(e) A detailed construction schedule.
(f) Prior to commencement of Tenant Improvements, Tenant shall furnish
to Landlord, subject to Landlord's reasonable approval, the following:
(i) A copy of the executed contract between Tenant and Tenant's
general contractor covering all of Tenant's obligations under this Appendix D;
and
(ii) Such contract shall be in form reasonably satisfactory to
Landlord.
APPENDIX D
PAGE D-5
<PAGE>
(g) Tenant's general contractor's acknowledgment of receipt of the
Tenant Improvement Manual.
(h) Proof that Tenant's general contractor is licensed to construct
Tenant Improvements in the State of Washington.
(i) A specific job-site safety program, as required by the State of
Washington.
4.4 All Tenant's Contractors shall be union, bondable, licensed
contractors, having good labor relations, capable of working in harmony with
Landlord's general contractor and other contractors in the Building. Tenant
shall coordinate Tenant Improvements with other construction work at the
Building, if any. Landlord specifically reserves the right to approve Tenant's
Contractors, such approval not to be unreasonably withheld.
4.5 Intentionally Omitted.
4.6 Tenant Improvements shall be subject to the inspection of Landlord's
representative from time to time during the period in which the Tenant
Improvements is being performed.
4.7 Tenant's general contractor shall maintain at the Premises during
construction approved Final Contract Drawings, including all elements then
incorporated therein and approved by Landlord, bearing Landlord's approval
stamp.
4.8 Prior to the commencement of construction, Landlord shall have the
right to post, in a conspicuous location, on Tenant's Premises, as well as
record with the City of Seattle, a Notice of Nonresponsibility.
4.9 Temporary facilities.
(a) Landlord shall provide at its cost temporary ventilation for the
Premises during construction of the Tenant Improvements.
(b) Tenant shall make the necessary temporary electrical connections
at a source designated by Landlord prior to beginning its Tenant Improvements at
the Premises so that it shall have electricity during its construction period.
The costs of such electricity shall not be charged to Tenant unless and only to
---
the extent Tenant's usage exceeds $0.04 per square foot of the Premises per
month during construction of the Tenant Improvements.
(c) If Tenant requires water service during construction and Landlord
is able to provide it, Landlord shall do so at a designated location at or near
the job site at no cost to Tenant.
(d) Tenant shall place all trash in trash containers at a pick-up area
or areas designated by Landlord. Tenant shall be responsible for breaking down
boxes. Tenant shall furnish its own trash containers at its cost unless
Landlord elects to furnish the containers.
APPENDIX D
PAGE D-6
<PAGE>
Tenant shall provide trash removal service at Tenant's own cost from the pick-up
areas unless Landlord elects to provide the trash removal service. Tenant shall
not permit trash to accumulate within the Premises or in the corridor or common
areas adjacent to the Premises. Should Landlord elect to remove Tenant's trash
from the designated pick-up areas for any reason the charge to Tenant for
Landlord's provided services shall be reimbursed to Landlord. Tenant shall be
solely responsible for removal from Premises and legal disposal of any
containers considered as hazardous waste by the local sanitation authority and
Tenant shall take all precautions to assure that such containers are not placed
in Landlord's disposal containers.
(e) Landlord may utilize a recycle bin refuse program and, if made
available to Tenant, Tenant shall take necessary precautions to sort refuse and
to prevent cross contamination of recycle containers.
(f) Landlord shall provide temporary sanitary facilities at the job
site for Tenant's use and charge Tenant a reasonable amount for such service.
(g) Tenant shall take all necessary precautions to contain
construction "wash-up" liquids (such as grout wash, paint wash, etc.) and
prevent entry of such liquids into Landlord's sanitary or storm waste system.
All construction wash-up shall be conducted at a location designated by Landlord
at the job site.
(h) In the event the Tenant Improvements are being performed
concurrent with the construction of the Building shell and core or other tenant
spaces, Tenant shall schedule usage of the freight or other Building elevator
for conveyance of Tenant's materials with Landlord's general contractor.
Landlord shall cause Landlord's General Contractor to make the freight elevator
available to Tenant and Tenant's contractor on a regular, equitable basis during
Normal Business Hours. If performance of the Tenant Improvements occurs before
completion of the initial construction of the Building, use of the freight
elevator will be provided by Landlord on a regular basis during Normal Business
Hours. Tenant shall coordinate use of the freight or other Building elevator
through Landlord's designated representative for such purpose. Except as
hereinafter provided for overtime usage, no charges shall be payable to Landlord
for such usage. Tenant shall make prior written request to Landlord's
designated representative for any overtime scheduling for use of the freight or
other Building elevator. Provided that same is available, and unless Tenant is
using Landlord's general contractor, Tenant shall pay for all operator overtime
incurred during such special period(s). If Tenant requests overtime scheduling
for use of the freight or other Building elevator because either Landlord or
Landlord's General Contractor has failed to make the freight elevator available
on a regular, equitable basis during Normal Business Hours, Tenant shall not be
obligated to pay for the costs of such usage, which shall be borne by Landlord.
4.10 The cost of any Tenant Improvements permitted or required to be
performed by Landlord on behalf of Tenant under this Appendix shall become due
and payable in full within thirty (30) days after Tenant has been invoiced for
same by Landlord and said charges shall be deemed Rent under the Lease.
APPENDIX D
PAGE D-7
<PAGE>
4.11 Upon completion of Tenant Improvements, Tenant shall notify the
Landlord. Upon said notification, Landlord's designated representative shall
inspect the Premises and, if the Premises are constructed substantially in
accordance with the approved Drawings, said representative shall issue a Letter
of Acceptance for the Premises. If Landlord believes the Premises have not been
constructed in accordance with the approved Drawings, Landlord shall so notify
Tenant and Tenant shall promptly correct any such defective construction.
Tenant shall furnish Landlord a copy of a certificate of occupancy for the
Premises, either temporary or permanent provided, that the permanent Certificate
of Occupancy shall be delivered to Landlord as soon as available from the City.
4.12 All Tenant Improvements performed by Tenant during its construction
period, or otherwise during the Term, shall be performed so as to minimize to
the extent reasonably possible any interference with other tenants and the
operation of the Building (provided that the foregoing shall not be interpreted
to necessarily require that all Tenant Improvements must be performed after
normal business hours), and Landlord shall have the right to impose reasonable
requirements with respect to timing and performance of the Tenant Improvements
in order to minimize such interference. Tenant Improvements causing substantial
noise, odor or vibration outside the Premises shall be performed only outside of
normal business hours if other tenants or occupants are occupying affected
portions of the building for business purposes. Tenant shall take commercially
reasonable and customary precautionary steps to protect its facilities and the
facilities of others affected by the Tenant Improvements (including Landlord
flooring in the vicinity of the Premises) and shall police same properly.
Construction equipment and materials are to be located in confined areas and
truck traffic is to be routed to and from the site as reasonably and equitably
directed by Landlord so as not to burden the construction or operation of the
Building. All Tenant Improvements shall be confined to the Premises. Tenant's
Contractor shall coordinate with Landlord's on-site representative for the
delivery and removal of its equipment and materials. Landlord shall have the
right to order Tenant or any Tenant's Contractors who willfully violates the
above requirements to cease Tenant Improvements and to remove its equipment and
employees from the Building. Tenant and/or Tenant's Contractors shall take
commercially reasonable and customary precautions to protect adjacent tenants
and tenants on common air distribution systems from airborne dust, dirt and
contaminants, VOC's (volatile organic compounds such as paint thinner or varnish
vapor) including, if necessary, isolating or otherwise protecting Landlord's
central air distribution and return air systems (including return air plenum)
from entry of these potential contaminants.
4.13 It is understood and agreed that Tenant's Contractors and Landlord's
contractors shall perform their respective work in a manner and at times that do
not impede or delay the other in the performance of the other's work. Tenant
and its contractor shall not in the performance of the Tenant Improvements do
anything that tends to jeopardize the labor relations of others in the Building.
Furthermore, and notwithstanding the generality of the foregoing, if Tenant does
not use Landlord's general contractor for completion of the Tenant Improvements,
Tenant acknowledges that the Tenant Improvements may take longer to complete
than might be the case had Tenant selected Landlord's general contractor, and
that any such delays (except to the extent caused by the failure of Landlord or
its contractors to reasonably cooperate with Tenant and its contractors after
Premises Delivery) shall not be deemed a "Landlord Delay" described below and
---
shall not extend Tenant's build-out period or
---
APPENDIX D
PAGE D-8
<PAGE>
otherwise delay the Commencement Date. Furthermore, Tenant shall be responsible
and shall indemnify, defend, and hold Landlord harmless from and against any and
all claims, liability, damages, delays and losses incurred by Landlord due to
interference with or delay in completion of the remainder of the Building, the
Building shell and core work, and work in other tenant spaces, to the extent
caused by Tenant's general contractor's failure, after notice to Tenant and
expiration of a commercially reasonable period (under the circumstances) to
permit Tenant to cause its contractor to cure such failure, to reasonably
cooperate with Landlord's contractors and the contractors of other tenants of
occupants in the Building; provided that the foregoing shall specifically
exclude (x) any such claims, liability, damages, delays and losses caused by the
failure of Landlord or its contractors or the contractors of such other tenants
or occupants to reasonably cooperate with Tenant and its contractors, and (y)
consequential damages. Any delays in the completion of the Tenant Improvements
or the commencement of the Lease term and any damage to any Tenant Improvements
caused by Tenant's Contractors shall be at the cost and expense of Tenant. The
Commencement Date shall be extended by one (1) day for each day of Landlord
Delay, which shall mean, as to any delay experienced by Tenant in connection
with its Tenant's Improvements (a) any interference or delay caused by
occurrences within the reasonable control of Landlord after Premises Delivery
not otherwise permitted under this Lease (i.e. permitted Landlord approval and
construction processes applied within scheduled time periods shall not be deemed
Landlord Delay); (b) any delay caused by Landlord's failure or refusal to
approve or disapprove plans for the Tenant Improvements in excess of the periods
set out in this Appendix D; (c) any delay attributable to changes in or
additions to Tenant's plans requested by Landlord beyond or after the approval
process set forth in this Appendix D; or (d) any other delay in acts or
approvals of Landlord required under this Appendix D which are subject to
express time periods or deadlines elsewhere in this Lease; provided that the
foregoing clauses (a) through (d) shall apply only to the extent that such
delay, notwithstanding Tenant's reasonable best efforts to mitigate the delay,
actually delays the completion of the Tenant Improvements. Tenant shall notify
Landlord as soon as reasonably possible when Tenant becomes aware of an event
that it believes constitutes a Landlord Delay. Such notice shall include a
description of the matter constituting the Landlord Delay and Tenant's good
faith estimate of the length of the Landlord Delay. Tenant also agrees to meet
and cooperate with Landlord to seek opportunities to minimize Landlord Delay.
4.14 Tenant shall cause Tenant's Contractors to maintain during the
construction period the following insurance: (i) commercial general liability
insurance, with limits of not less than $2 million per occurrence (the portion
of such coverage over $1 million may be provided under an umbrella or excess
liability policy), for personal injury, bodily injury or death or property
damage or destruction, arising out of or relating to the contractor's Tenant
Improvements at or in connection with the Premises and completed operations for
one (1) year following job completion and shall provide for a waiver of
subrogation by the insurance company; (ii) worker's compensation insurance with
respect to each contractor's workers at the site or involved in the Tenant
Improvements, in the amount required by statute; (iii) employer's liability
insurance in the amount of at least $1,000,000.00 per accident and at least
$1,000,00.00 for disease, each employee; (iv) comprehensive automobile liability
insurance covering all owned, hired or non-owned vehicles, including the loading
and unloading thereof, with limits of not less than $2 million per occurrence
(the portion of such coverage over $1 million may be provided under an umbrella
or excess liability policy); and (v) builder's risk property insurance upon the
entire Tenant Improvements to the full replacement cost value
APPENDIX D
PAGE D-9
<PAGE>
thereof. Landlord, Landlord's managing agent, and such other parties as
designated by Landlord, shall be additional insured under (i), naming
owner/Landlord, Tenant, general contractor, and all subcontractors. All
insurance required hereunder shall be provided by responsible insurers rated at
least A and X in the then current edition of Best's Key Rating Insurance Guide
and shall be licensed in the State in which the Building is located. Tenant
shall provide, or cause its contractors to provide, such certificates prior to
any Tenant Improvements being performed at the Premises. Such certificates shall
state that the coverage may not be changed or cancelled without at least thirty
(30) days' prior written notice to Landlord.
4.15 During the construction of the Tenant Improvements, Landlord will
make available at reasonable times and upon reasonable prior notice from Tenant
Landlord's chief engineer for the Building or another similarly qualified
employee of Landlord to consult with Tenant and Tenant's Contractor with respect
to matters involving tie-ins and connections with and coordination between
Landlord's Shell and Core Improvements and the Tenant Improvements. In the
event Tenant requests that Landlord's chief engineer or other similarly
qualified employee be present in the Building or Premises after such person's
normal working hours or to provide assistance or services in excess of such
person's normal duties, Tenant shall reimburse Landlord for all overtime or
extra compensation paid by Landlord to such person as a result of Tenant's
request.
4.16 Tenant shall utilize Landlord's mechanical and structural engineers in
connection with the design of the Tenant Improvements on terms mutually
agreeable to Tenant and such engineers, all at Tenant's sole cost and expense.
Furthermore, Landlord may require Tenant to use Landlord's mechanical,
electrical, and structural contractors in connection with the construction of
the Tenant Improvements on terms mutually agreeable to Tenant and such
contractors, all at Tenant's sole cost and expense. Landlord shall also use
commercially reasonable efforts at Tenant's request to make such contractors
available for use by Tenant (at no expense to Landlord); provided that the
foregoing shall not be interpreted to require Landlord to permit, agree to or
---
require any delay in construction and completion of Landlord's Shell and Core
Improvements or in the construction and completion of tenant improvements for
any other tenant or occupant of the Building.
5. CONSTRUCTION ALLOWANCE AND PAYMENT
----------------------------------
5.1 Subject to the provisions of this Rider, Landlord shall pay to Tenant
a construction allowance (the "Allowance") in an amount up to $30.00 per usable
square foot of the Premises, provided that in no event shall the Allowance
exceed the actual cost of the Tenant Improvements performed by Tenant (including
space planning, construction drawings, and WSST, provided that a maximum of
$2.00 per usable square foot of such $30.00 may be applied toward costs for
initial space planning, programming, preparation of construction documents and
interior design services). The Allowance may be paid directly to Tenant (or, at
Tenant's request and upon submittal of invoices for payment, directly to
Tenant's contractor(s)) within thirty (30) days after the request of Tenant,
provided that Tenant is not then in default under this Lease, and provided
further that payments of the Allowance shall be further subject to the
following:
APPENDIX D
PAGE D-10
<PAGE>
(a) With respect to all requests for payment prior to completion of
---------------------------------------------------------------
the Tenant Improvements:
- ------------------------
(i) Tenant has furnished Landlord with a certificate from
Tenant's architect stating that Tenant has theretofore performed all the Tenant
Improvements for which that portion of the Allowance is being requested in
accordance with the approved plans and specifications and in accordance with all
other applicable provisions of this lease;
(ii) Tenant has either (x) fully paid for all of the Tenant
Improvements theretofore performed (or such amounts have been paid by Landlord,
or will be paid by Landlord, directly to Tenant's contractor with the requested
installment) and has furnished to Landlord a certificate from an officer of
Tenant stating that all the Tenant Improvements theretofore performed has been
paid for and setting forth the total amount that was spent on the Tenant
Improvements, or (y) included with its installment request invoices from its
contractor(s) showing the claimed amount of the work theretofore performed for
which payment is being sought;
(iii) Tenant has furnished Landlord a copy of the original, valid,
partial mechanic's lien releases from the general and all other contractors and
suppliers who performed Tenant Improvements or furnished supplies for or in
connection with Tenant's Tenant Improvements at the Premises with respect to
contracts in excess of $2,000.00 covering all of the Tenant Improvements
theretofore performed and such other evidence, including, without limitation,
the general contractor's sworn statement, as Landlord may reasonably request to
evidence that no liens can arise from the Tenant Improvements theretofore
performed;
(iv) Tenant has furnished Landlord (a) an affidavit from Tenant
listing all contractors and suppliers whom Tenant has contracted with in
connection with the Tenant Improvements, together with the cost of each
contract, and (b) an affidavit from Tenant's general contractor listing all
subcontractors and suppliers whom the general contractor has contracted with in
connection with the Tenant Improvements, together with the cost of each
contract; and
(v) Tenant shall not be in default under the Lease beyond any
applicable cure period.
(b) With respect to the final request for payment:
---------------------------------------------
(i) Tenant has furnished to Landlord a certificate from Tenant's
architect, stating that Tenant has theretofore performed all the Tenant
Improvements in accordance with the approved plans and specifications and in
accordance with all other applicable provisions of this Lease, including, but
not limited to, the completion of all punchlist items;
(ii) Tenant has furnished Landlord (a) an affidavit from Tenant
listing all contractors and suppliers whom Tenant has contracted with in
connection with the Tenant Improvements, together with the cost of each
contract, and (b) an affidavit from Tenant's
APPENDIX D
PAGE D-11
<PAGE>
general contractor listing all subcontractors and suppliers whom the general
contractor has contracted with in connection with the Tenant Improvements,
together with the cost of each contract;
(iii) Tenant has obtained a certificate of occupancy with
respect to the Premises;
(iv) Tenant has either (x) fully paid for all of the Tenant
Improvements theretofore performed (or such amounts have been paid by Landlord,
or will be paid by Landlord, directly to Tenant's contractor with the requested
installment) and has furnished to Landlord a certificate from an officer of
Tenant stating that all the Tenant Improvements theretofore performed has been
paid for and setting forth the total amount that was spent on the Tenant
Improvements, or (y) included with its installment request invoices from its
contractor(s) showing the claimed amount of the work theretofore performed for
which payment is being sought;
(v) Tenant has furnished Landlord with a copy of the original,
valid, unconditional mechanic's lien releases from the general and all other
contractors and suppliers who performed Tenant Improvements or furnished
supplies for or in connection with Tenant Improvements at the Premises
(including all parties listed in the affidavits referenced in item (c)(ii)
above) covering all of the Tenant Improvements and such other evidence as
Landlord may reasonably request to evidence that no liens can arise from the
Tenant Improvements;
(vi) receipt by Landlord of an Air Balance Report if required by
the Lease or by Landlord;
(vii) receipt by Landlord from Tenant of an updated diskette of
Tenant's as-built Drawings;
(viii) Tenant shall not be in default under the Lease beyond any
applicable cure period;
(ix) the execution by Tenant and delivery to Landlord of
Tenant's estoppel certificate or statement as described in the Lease and
stating, in part (subject to a specific statement of any applicable exceptions),
that Tenant reserves no rights for claims, offsets, or back-charges;
(x) receipt by Landlord from Tenant of all certificates of
insurance required under the Lease;
(xi) the opening by Tenant of its business in the Premises; and
(xii) such other documents as may be reasonably required by
Landlord, mortgagee(s) or the title company.
All documents required pursuant hereto shall be delivered to the Landlord at
Landlord's address for notices as set forth in the Lease.
APPENDIX D
PAGE D-12
<PAGE>
5.2 Tenant shall have paid Landlord any and all costs payable by Tenant
under the Lease, or, if applicable, Landlord and Tenant shall have agreed in
writing to an offset against the Allowance for such amounts. Any improvements or
Tenant Improvements done or authorized by the Tenant or performed to Tenant's
account, the cost of which remains unpaid at the time the Allowance is otherwise
payable, and any accrued Rent which remains unpaid at the time the Allowance is
payable, will be deducted from any Allowance payment of Landlord to Tenant and
Landlord may hold the same as security against any liens arising therefrom or
Landlord may pay such unpaid costs for and on behalf of Tenant.
5.3 In addition to Tenant's estoppel certificate, Tenant shall, upon
request by Landlord or any Lender of Landlord, promptly execute and deliver to
Landlord or such Lender, or such other party as either shall specify, a
certificate certifying whichever of the following is then true: that the
Allowance has been paid in full by Landlord to Tenant; that the Allowance or a
portion thereof is due and payable by Landlord to Tenant specifying such due and
payable amount; that one or more of the conditions precedent set forth in
Section 1 hereof has not been met, specifying such unmet condition or
conditions; that the Allowance has been offset by a certain amount payable by
Tenant to Landlord pursuant to Sections 1 or 2 hereof, specifying the amount of
the offset.
APPENDIX D
PAGE D-13
<PAGE>
APPENDIX D-1
------------
TO LEASE
WatchGuard Technologies
Schematic Plans for Tenant Improvements
---------------------------------------
[Diagrams of Tenant Improvements to Be Made]
APPENDIX D-1
<PAGE>
APPENDIX E
----------
TO LEASE
WatchGuard Technologies
Mortgages Currently Affecting The Project
-----------------------------------------
Deed of Trust, Security Agreement and Fixture Filing with Assignment of Leases
and Rents between 505 Union Station Ltd., as grantor, Rainier Credit Company, as
trustee, and Bank of America, N.A., doing business in Washington as Seafirst
Bank, as beneficiary, recorded under King County Recording No. 19990929000963.
Beneficiary's Mailing Address: c/o Seafirst Bank
Seattle Private Banking (CSC-47)
701 Fifth Avenue, 47th Floor
Seattle, Washington 98104
APPENDIX E
<PAGE>
APPENDIX F
----------
TO LEASE
WatchGuard Technologies
COMMENCEMENT DATE CONFIRMATION
------------------------------
Landlord: 505 UNION STATION LTD., a Washington corporation
Tenant: WatchGuard Technologies, Inc., a Delaware corporation
This Commencement Date Confirmation is made by Landlord and Tenant pursuant to
that certain Lease dated as of _________, 2000 (the "Lease") for certain
premises known as Suite ____ in the building commonly known as 505 Union Station
(the "Premises"). This Confirmation is made pursuant to Item 9 of the Schedule
to the Lease.
1. Lease Commencement Date, Termination Date. Landlord and Tenant hereby
-----------------------------------------
agree that the Commencement Date of the Lease is _____________, 2000, and the
Termination Date of the Lease is _______________, _____.
2. Incorporation. This Confirmation is incorporated into the Lease, and
-------------
forms an integral part thereof. This Confirmation shall be construed and
interpreted in accordance with the terms of the Lease for all purposes.
TENANT: WATCHGUARD TECHNOLOGIES, INC., a
Delaware corporation
By:_________________________________
Name:_______________________________
Title:______________________________
LANDLORD: 505 UNION STATION LTD., a Washington
corporation
By:_________________________________
Name:_______________________________
Title:______________________________
APPENDIX F
<PAGE>
APPENDIX G
----------
TO LEASE
WatchGuard Technologies
Legal Description
-----------------
Unit 1, Union Station, a Condominium recorded in Volume 150 of Condominiums,
pages 37 through 45, according to the Declaration thereof, recorded under King
County Recording No. 9807280839 and any amendments thereto; situate in King
County, Washington.
APPENDIX G
<PAGE>
ADDENDUM
--------
TO LEASE
WatchGuard Technologies
Additional Lease Terms
----------------------
This Addendum is made a part of the Lease between 505 UNION STATION LTD., a
Washington corporation ("Landlord"), and WATCHGUARD TECHNOLOGIES, INC.
("Tenant") dated March 1, 2000 (the "Lease"). Undefined terms used
herein shall have the meanings set forth in the Lease. The following terms,
covenants, and agreements are made a part of the Lease (if a provision of this
Addendum conflicts with any provision contained in the Lease, then the provision
of this Addendum shall control):
1. Option to Extend. Landlord does hereby grant to Tenant the right,
----------------
privilege, and option to extend this Lease for one (1) period of five (5) years
(the "Extended Term") from the date of expiration of the initial Term hereof,
upon the same terms and conditions as herein contained, except as to "Basic
Rent" which shall be determined in accordance with the following paragraph. In
the event Tenant desires to exercise its option to extend this Lease, then at
least twelve (12) months prior to the expiration of the Term hereof, Tenant
shall give Landlord a written notice binding upon Tenant (the "Extension
Notice"), which shall set forth the name of the parties, the Lease date, and the
option period and dates of which Tenant is exercising. If Tenant exercises its
extension option in the manner set forth herein, Landlord and Tenant shall
promptly execute and deliver an amendment to the Lease. In the event that
Tenant fails to give the Extension Notice as set forth herein, then Tenant's
right to extend this Lease shall terminate and be of no further force and
effect.
The rent reserved herein, i.e., the "Basic Rent", during the Extended Term
shall be set at a figure which is equal to the then prevailing fair market
rental value for the Premises at the time of commencement of said Extended Term,
as determined by mutual agreement between Landlord and Tenant, or by arbitration
in accordance with the provisions of this Lease. Not later than thirty (30)
days after Tenant delivers the Extension Notice, Landlord shall give Tenant
Landlord's proposed determination of the fair market rental value for the
Premises for the Extended Term. If Landlord and Tenant are unable to agree upon
said fair market rental value within sixty (60) days after Landlord's receipt of
the Extension Notice, then the matter shall be determined by arbitration
pursuant to the terms of this Subsection. The parties agree to a standard of
good faith and reasonableness in their attempts to affirmatively resolve the
issue of Basic Rent. Notwithstanding anything to the contrary in this Lease,
Landlord and Tenant agree that under no circumstances shall the Basic Rent be
less during the Extended Term than during the Lease Year immediately prior to
the Extended Term.
Arbitration, if required, shall be before one disinterested arbitrator if one
can be mutually agreed upon as hereinafter provided, otherwise before three
disinterested arbitrators, one to be named by the Landlord, one by the Tenant as
hereinafter provided and one by the two thus chosen. Within fifteen (15) days
of their selection, if Landlord and Tenant are unable to agree upon the fair
market rental value of the Premises within sixty (60) days after Landlord's
receipt of the Extension Notice, then either Landlord or Tenant (the "Initiating
ADDENDUM
PAGE 1
<PAGE>
Party") may thereafter initiate arbitration by delivering to the other (the
"Receiving Party") a notice (the "Initiation Notice") requesting arbitration and
naming a proposed arbitrator. Within fifteen (15) days after the Initiation
Notice is given, the Receiving Party shall give notice to the Initiating Party
stating whether the proposed arbitrator is acceptable to the Receiving Party
and, if the proposed arbitrator is not acceptable, identifying an alternative
arbitrator who would be acceptable. Within fifteen (15) days after receipt of
the Receiving Party's response, if other than an approval of the arbitrator
proposed by the Initiating Party, the Initiating Party shall give notice to the
Receiving Party, stating whether the alternative arbitrator proposed by the
Receiving Party is acceptable to the Initiating Party. If either the Receiving
Party or the Initiating Party fails to disapprove the arbitrator proposed by the
other within the time period provided or if the Receiving Party disapproves the
arbitrator proposed by the Initiating Party but fails in its notice of
disapproval to propose an alternative arbitrator, the proposed arbitrator shall
be deemed approved. Once approved or deemed approved, an arbitrator proposed by
either the Initiating Party or the Receiving Party shall promptly determine the
fair market value of the Premises for the Extended Term, taking into account all
economic factors deemed relevant by such arbitrator. If an arbitrator is not
approved or deemed approved by the foregoing procedure, then each of the
Initiating Party and the Receiving Party shall select an arbitrator and give
notice to the other of such selection within fifteen (15) days after the
Initiating Party gives notice to the Receiving Party of the Initiating Party's
disapproval of the alternative arbitrator proposed by the Receiving Party. Each
arbitrator so selected shall have at least ten years professional experience as
a licensed real estate broker and achieved "MAI" status in the American
Institute of Real Estate Appraisers. In determining the fair market rental
value for the Premises the arbitrator or arbitrators shall determine the
controversy in accordance with the laws of the State of Washington as set forth
in RCW 7.04 et. seq., or its successor statute, insofar as they are not
inconsistent with the provisions herein. The parties agree further that the
arbitration proceeding shall be subject to Washington Mandatory Arbitration,
Rule 5.2. The expenses of arbitration shall be shared equally by Landlord and
Tenant. Each party shall be responsible for its own attorneys' fees in the
arbitration process. Except as otherwise provided herein, any dispute or
controversy concerning the fair market rental value shall be settled by
arbitration in accordance with the Real Estate Valuation Arbitration Rules of
the American Arbitration Association, and judgment upon the award rendered by
the arbitrator(s) may be entered in any court having jurisdiction thereof. The
arbitrators shall make their determination within sixty (60) days of the
selection of the third arbitrator.
If Landlord and Tenant are unable to agree upon the Basic Rent for the
Extended Term pursuant to these Option to Expand provisions, Tenant will, during
such extended term, pay Basic Rent at a rate equivalent to the lesser of (a) the
fair market rent initially proposed by Landlord and (b) a fifty percent (50%)
increase of the Basic Rent in effect immediately prior to the extended term in
question until the parties agree upon the new Basic Rent, or until the Basic
Rent is determined in arbitration pursuant to this Subsection. The amount of
the new Basic Rent for the applicable extended term will be applied
retroactively to the beginning of such extended term, and any rent adjustment
will be made in connection with the next installment of Basic Rent due,
following conclusion of arbitration.
Any option to extend the Lease term is personal to Tenant and may not be
exercised or be assigned, voluntarily or involuntarily, by or to any person or
entity other than Tenant or an
ADDENDUM
PAGE 2
<PAGE>
assignee pursuant to an assignment permitted under Section 17(d) of the Lease.
The option herein granted to Tenant is not assignable separate and apart from
this Lease.
Notwithstanding anything to the contrary set forth above, Tenant shall not
have the right to exercise any extension option if:
(a) During the time commencing from the date Landlord gives to Tenant a
written notice that Tenant is in default under any provisions of this Lease, and
continuing until the default alleged in said notice is cured; or
(b) During the period of time commencing on the day after a monetary
obligation to Landlord is due from Tenant and unpaid (without any necessity for
notice thereof to Tenant) continuing until the obligation is paid; or
(c) In the event that Tenant has, three (3) or more times during the
twelve (12) calendar month period preceding the date of Tenant's notice of
exercise, failed to pay rent and/or any other charges or expenses required under
the terms of this Lease and a late charge has become payable for any one of such
defaults under Section 26(x).
The period of time within which the option may be exercised shall not be
extended or enlarged by reason of Tenant's inability to exercise the option
because of the foregoing provisions and/or restrictions.
All rights of Tenant under the provisions of this option shall terminate and
be of no further force or effect even after Tenant's due and timely exercise of
the option, if after such exercise, but prior to the commencement date of the
new term, (1) Tenant fails to pay to Landlord a monetary obligation of Tenant
for a period of thirty (30) days after such obligation becomes due (without any
necessity of Landlord to give notice thereof to Tenant); or (2) Tenant fails to
commence to cure a default within thirty (30) days after the date Landlord,
during the term of this Lease, gives notice to Tenant of such default.
2. Tenant Signage. Tenant shall have signage on the Building directory at
--------------
Landlord's cost. As part of the Tenant Improvement Allowance, Landlord shall
provide Tenant signage at the suite entrance and at the elevator lobby of any
floor on which Tenant occupies space. All of Tenant's signage shall be subject
to the reasonable review and approval of Landlord and the rules and requirements
of applicable government authorities.
3. Right of Second Offer. Provided that Tenant is not then in default
---------------------
hereunder (beyond applicable notice and cure periods), and provided that
Landlord has not issued two (2) or more notices of default for nonpayment of
Rent during the twelve (12) calendar month period preceding the date of
Landlord's notice described below, Tenant shall have, during the initial Term,
the right of second offer to lease the space located on the second (2nd) floor
of the Building ("Option Space"). Landlord represents and covenants that,
except for the rights of Willis of Seattle, Inc. pursuant to a Lease Agreement
dated prior to the date of this Lease, Tenant's right to lease the Option Space
is not and shall not be limited, in conflict with, or otherwise affected by, any
options on the Option Space entered into prior to or after the date of mutual
execution of this Lease, unless Tenant has not exercised its right as described
in this Section. The Option Space, encompassing approximately 8,506 square feet
of rentable floor
ADDENDUM
PAGE 3
<PAGE>
area, is cross-hatched on Appendix A. If at any time during the initial Term,
----------
Landlord shall receive a bona fide offer from any third-person to lease the
Option Space, which offer Landlord shall desire to accept, or all or any part of
the Option Space becomes available for lease, then Landlord shall promptly
notify Tenant of the existence of such offer (but Landlord shall not be
obligated to disclose the economic or other terms of the third party offer) or
the availability of such portion of the Option Space. Tenant may, within ten
(10) business days thereafter, propose to Landlord the terms and conditions
under which Tenant desires to Lease the Option Space (or such portion thereof
that is identified in Landlord's notice), which offer Landlord may accept,
counter, or reject in its sole discretion. Failure of Tenant to exercise its
option within the prescribed time shall waive Tenant's right as to the space
described in Landlord's notice Landlord shall have the right to lease the Option
Space to the third-party making that offer or to any other third party or not at
all. Tenant's right of second offer during the initial Term shall continue as to
the Option Space and the procedure described in this paragraph shall be followed
if there is a failure to enter into a lease with any other third party within
one hundred twenty (120) days following the date of Landlord's notice, or if the
subject Option Space again becomes available at the termination of a lease.
This option is personal to Tenant and may not be exercised or be assigned,
voluntarily or involuntarily, by or to any person or entity other than Tenant or
an assignee under an assignment permitted under Section 17(d) of this Lease.
The option herein granted to Tenant is not assignable separate and apart from
this Lease.
Tenant's right of second offer to lease the Option Space shall expire and be
of no further force or effect upon the termination of the Initial Term.
4. Letter of Credit. As security for the performance of Tenant's obligations
----------------
under this Lease, including without limitation the payment of all Rent due
hereunder, Tenant shall deliver to Landlord upon mutual execution hereof an
irrevocable and unconditional letter of credit (the "Letter of Credit") in the
amount of $1,500,000.00 and issued by a financial institution ("Bank") that is
reasonably satisfactory to Landlord but that in any event (a) has not less than
$1 billion in total assets, (b) has a financial rating of not less than 60 as
rated by Sheshunoff Information Services, Inc. (or any equivalent rating thereto
from any successor or substitute rating service selected by Landlord), (c) has
at least an investment grade rating on its senior long term debt from each of
Standard and Poors Ratings Services, Inc., a division of the McGraw-Hill
Companies, Inc., and Moody's Investors Service, Inc., and (d) is either a local
financial institution or has local correspondent such that draws on the Letter
of Credit can be made within the state in which the Premises are situated.
Notwithstanding the foregoing, Landlord hereby approves Silicon Valley Bank for
issuance of the Letter of Credit. Upon the occurrence of the Commencement Date,
the face amount of the Letter of Credit shall be increased to $3,000,000.00 or
an additional letter of credit issued by Bank in the face amount of $1,500,000
shall be provided (in which event, both of such letters of credit shall be
referred to herein collectively as the "Letter of Credit"). If Tenant is ever
in a continuing material default hereunder beyond applicable notice and cure
periods, or if the sum of Tenant's cash and cash equivalents ever decreases
below $7,000,000.00, then Tenant,
ADDENDUM
PAGE 4
<PAGE>
within ten (10) days after request from Landlord, shall increase the face amount
of the Letter of Credit by an additional $2,100,000.00 or provide an additional
letter of credit in such amount until such time as such material default is
cured and/or the sum of Tenant's cash and cash equivalents exceeds
$7,000,000.00, at which time the additional $2,100,000.00 shall be released and
returned to Tenant.
Notwithstanding the foregoing, at the commencement of the sixth Lease Year,
and on each subsequent anniversary thereof until the end of the initial term
hereof, the face amount of the Letter of Credit may be reduced by $600,000.00
(provided that Landlord may still elect to require Tenant to provide the
additional $2,100,000.00 Letter of Credit if Tenant is ever in a continuing
material default hereunder beyond the applicable notice and cure period or if
the sum of Tenant's cash and cash equivalents ever decreases below
$7,000,000.00).
Landlord shall have the right to draw upon the Letter of Credit or any renewal
or extension thereof, in whole or in part, upon the occurrence of any one or
more of the following events, each of which shall be deemed a default under this
Lease:
(1) The occurrence of a material default under this Lease that is
continuing after expiration of the applicable notice and cure period; or
(2) Tenant's failure to deliver to Landlord, no less than 30 days prior to
the expiration date of the Letter of Credit or any renewal or extension thereof,
a renewal or extension of the Letter of Credit for a term of not less than one
year; or
(3) Receipt of notice from the Bank that it will not be extending the
terms of the Letter of Credit or otherwise intends to terminate the Letter of
Credit prior to expiration of the Term of this Lease, unless Tenant provides a
substitute Letter of Credit from another financial institution reasonably
acceptable to Landlord in its sole discretion at least ten (10) business days
prior to the termination of the existing Letter of Credit; or
(4) Any action by Tenant or the Bank which, in Landlord's discretion,
reasonably exercised, may jeopardize its rights to draw on the Letter of Credit.
Proceeds of any draw upon the Letter of Credit may be applied by Landlord to
the payment of accrued and unpaid rent, additional rent, interest, late charges,
or any other obligation then due and owing and arising out of Tenant's
obligations to Landlord under this Lease, in such manner as Landlord in its sole
discretion, deems appropriate. Unapplied proceeds shall be held as a "security
deposit" pursuant to Section 20 of the Lease. Landlord shall release its rights
in the Letter of Credit and surrender the Letter of Credit to the Bank upon
payment in full of all sums due under this Lease. Landlord shall have sole
authority and discretion to draw under the Letter of Credit in accordance with
the terms thereof and hereof. Within thirty (30) days after any such draw,
Tenant shall reinstate the amount available under the Letter of Credit to the
required amount as provided herein.
ADDENDUM
PAGE 5
<PAGE>
EXHIBIT 10.14
LOAN MODIFICATION AGREEMENT
BETWEEN: WatchGuard Technologies, Inc., a Delaware corporation ("Borrower"),
whose address is 316 Occidental Ave. S., Suite 200, Seattle, WA 98104;
AND: Silicon Valley Bank ("Silicon"),
whose address is 3003 Tasman Drive, Santa Clara, California 95054;
DATE: March 21, 2000
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 (as amended or modified 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.
2.2. Borrower acknowledges and agrees that all Obligations, including
without limitation Borrower's obligation to repay amounts advanced by Silicon to
Borrower on the terms of the Loan Agreement and Schedule as modified by this
Loan Modification Agreement, are secured by all liens and security interests
granted by Borrower to Silicon in the Loan Agreement.
3. Conditions Precedent. This Loan Modification Agreement shall not take
effect until Borrower delivers to Silicon a Certified Resolution of Borrower and
such other documents as Silicon shall reasonably require to give effect to the
terms of this Loan Modification Agreement.
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.
Page 1 - LOAN MODIFICATION AGREEMENT
<PAGE>
5. Representations and Warranties.
5.1. The Borrower represents and warrants to Silicon that the
execution, delivery and 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/ Michael McConnell
---------------------
Name: Michael McConnell
-----------------
Title: Vice President of Finance
-------------------------
Silicon:
SILICON VALLEY BANK
By: /s/ Carolyn Grant
-----------------
Name: 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: March 21, 2000
SECURED ACCOUNTS RECEIVABLE LINE OF CREDIT
Credit Limit: An amount not to exceed the lesser of: (i) $5,000,000 at any one
time outstanding; or (ii) the amount of the "Borrowing Base," as
defined below. For purposes of this Schedule, the "Borrowing
Base" shall mean (i) 80% of the Net Amount of Borrower's eligible
domestic accounts receivable, (ii) 50% of the Net Amount of
Borrower's eligible foreign accounts receivable, and (iii) 100%
of any cash pledged in an account satisfactory to Silicon. 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.
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
Page 3 - LOAN MODIFICATION AGREEMENT
<PAGE>
interest rate applicable to the Obligations shall change on each
date there is a change in the Prime Rate.
Commitment
Fee: $5,000.
Maturity
Date: February 28, 2001, at which time all unpaid principal and accrued
but unpaid interest shall be due and payable.
Letters of
Credit: Subject to the terms of this Agreement, as amended from time to
time, Silicon shall issue or cause to be issued under the Credit
Limit standby and commercial letters of credit for the account of
Borrower in an aggregate face amount not to exceed the Credit
Limit. Each such standby letter of credit shall have an expiry
date of no later than the Maturity Date. If the Secured Accounts
Receivable Line of Credit expires or is terminated prior to the
expiry date of any letter of credit issued hereunder, Borrower
shall immediately secure the full face amount of any such letter
of credit with a pledge of cash collateral. All such letters of
credit shall be, in form and substance, acceptable to Silicon in
its sole discretion and shall be subject to the terms and
conditions of Silicon's form application and letter of credit
agreement.
Merchant
Services: Subject to the terms of this Agreement, as amended from time to
time, up to $50,000 of Borrower's availability under the Secured
Accounts Receivable Line of Credit shall be allocated to
contingent liability of Borrower arising under Silicon's Merchant
Services Program. Such liability is primarily comprised of write-
offs and charge-backs arising from credit card transactions.
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 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:
Page 4 - LOAN MODIFICATION AGREEMENT
<PAGE>
Tangible Net
Worth: Borrower shall at all times maintain a Tangible Net Worth of not
less than $15,000,000.
Profitability: Borrower shall not incur a loss (as defined below) in excess of
the amount specified below for each rolling three (3) month
period. For purposes of this paragraph, "loss" means net income
after taxes of less than $0.00, as reported on Borrower's
financial statements. "Loss" shall not include expenses relating
to the BeadleNet acquisition, however, Borrower's total loss for
the quarter ending December 31, 1999, including the BeadleNet
acquisition expenses, shall not exceed $8,000,000. The Borrower
shall not incur a loss in excess of:
<TABLE>
Amount Period
---------- ---------------------------------------
<C> <S>
$4,000,000 December 31, 1999 through June 30, 2000
$3,000,000 July 31, 2000 through December 31, 2000
$2,000,000 January 31, 2001 and thereafter
</TABLE>
Quick Ratio: Borrower shall maintain a ratio of Quick Assets (defined below)
to current liabilities less deferred revenue plus outstandings
under any term loans owed to Silicon of not less than 2.00:1.00.
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 "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.
Other
Covenants: Borrower shall at all times comply with all of the following
additional covenants:
Deposit Relationship. Borrower and its subsidiaries shall at all
times maintain their primary operating account with Silicon.
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 30 days
after the end of each month, an accounts receivable aging report
and an accounts payable aging report; (c) within 30 days after
the end of each month, a Borrowing
Page 5 - LOAN MODIFICATION AGREEMENT
<PAGE>
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.
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 and the Schedule 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.
Page 6 - LOAN MODIFICATION AGREEMENT
<PAGE>
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: 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/ Michael McConnell
---------------------
Title: Vice President of Finance
-------------------------
Silicon:
SILICON VALLEY BANK
By: /s/ Carolyn Grant
-----------------
Title: Vice President
--------------
Page 7 - LOAN MODIFICATION AGREEMENT
<PAGE>
EXHIBIT A
---------
BORROWING BASE CERTIFICATE
<TABLE>
<S> <C>
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: $5,000,000
</TABLE>
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) Ineligible 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 (80% of #15) $_______
(17) Eligible Foreign Accounts/1/ $_______
(18) LOAN VALUE OF ELIGIBLE FOREIGN ACCOUNTS (50% of #17) $_______
(19) Eligible Cash Collateral $_______
(20) LOAN VALUE OF CASH COLLATERAL (100% of #19) $_______
(21) TOTAL LOAN VALUE (#16 plus #18 plus #20) $_______
BALANCES
(1) Maximum Loan Amount $_______
(2) Total Funds Available [Lesser of #22 or #21] $_______
(3) Present balance owing on Line of Credit $_______
(4) Letters of Credit outstanding/2/ $_______
- ------------
/1/ 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.
Page 8 - LOAN MODIFICATION AGREEMENT
<PAGE>
(5) Merchant Services Program/3/ $_______
(6) RESERVE POSITION (#23 minus #24, #25 and #26) $_______
- ------------
/2/ Maximum of $5,000,000.
/3/ Maximum of $50,000.
Page 9 - LOAN MODIFICATION AGREEMENT
<PAGE>
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:
-----------------------------
BANK USE ONLY
Rec'd By:_______________
Auth. Signer
Date:___________________
Verified:_______________
Auth. Signer
Date:___________________
Page 10 - LOAN MODIFICATION AGREEMENT
<PAGE>
EXHIBIT 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement
(Form S-8 No. 333-84081) pertaining to the WatchGuard Technologies, Inc. 1999
Stock Purchase Plan and the WatchGuard Technologies, Inc. 1996 Stock Incentive
Compensation Plan of our report dated February 4, 2000, with respect to the
financial statements and schedule of WatchGuard Technologies, Inc. included in
the Annual Report (Form 10-K/A) for the year ended December 31, 1999.
ERNST & YOUNG LLP
Seattle, Washington
April 28, 2000
